Report No. 22985-MOZ Mozambique Public Expenditure Management Review December 2001 Africa Region Macroenonomics 1 Document of the World Bank Currency Equivalents Currency Unit: Metical (Mt) US$1 = 22,000 Mt Measures Metric System Fiscal Year January 1 to December 31 Vice President: Callisto Madavo Director: Darius Mans Sector Manager: Philippe Le Houerou Task Manager: Jose E. Leandro TABLE OF CONTENTS Page No. EXECUTIVE SUMMARY ......................................................................j INTRODUCTION ......................................................................1 PART I. AGGREGATE FISCAL ANALYSIS ..................................................................... 2 CHAPTER 1. OVERALL EXPENDITURE TRENDS-LESSONS FROM THE PAST ............. .....................3 A Overview .......................................................................3 B. Overall Expenditure Trends ......................................................................3 CHAPTER 2. LOOKING AT THE FUTURE-TOWARD A SUSTAINABLE FISCAL POLICY .................... 6 A. The Challenge Ahead-Conditions for Fiscal Sustainability ..............................................6 B. Facing the Challenge-Toward a Sustainable Fiscal Policy and Economic Growth ....... 10 C. Limiting the Risks of Contingent Liabilities ..................................................................... 14 CHAPTER 3. INTERGOVERNMENTAL FISCAL RELATIONS-TAKING STOCK AND LOOKING AHEAD 16 A. Background .16 B. Governance .18 C. Revenues .20 D. Expenditures .24 E. Reform Agenda: Observations and Recommendations .29 PART 11. PUBLIC EXPENDITURE MANAGEMENT REVIEW .............................................................. 3 5 CHAPTER 4. BUDGET FORMULATION-IMPROVING COVERAGE AND TRANSPARENCY ... ............. 36 A. Improving Budget Coverage ..................................................................... 36 B. Increasing Budgetary Transparency-A New System of Budget Classification ............... 45 C. Enhancing Expenditure Planning and Budgeting ... ........................................................ 46 CHAPTER 5. BUDGET EXECUTION-INCREASING EFFICIENCY . ..................................................... 53 A. Accounting and Reportingfor Better Management .......................................................... 53 B. Cash Management-Saving the Government Money .... .................................................. 60 CHAPTER 6. BUDGET EVALUATION AND AUDIT-IMPROVING ACCOUNTABILITY AND COMPLIANCE ....................................................................... 69 A. Internal Auditing ..................................................................... 69 B. External Auditing ..................................................................... 71 C. Budget Evaluation ..................................................................... 72 CHAPTER 7. TOWARD A MODERN PUBLIC FINANCE MANAGEMENT SYSTEM . . 74 A. Improving the Legal Framework-The New Public Finance Management Law ............. 75 B. Integrated Financial Management Information Systems (IFMIS) .................................... 77 C. Action Plan for a More Efficient, Transparent and Accountable Budget Management System ..................................................................... 78 Annexes .............................................................. 83 Annex 1: Statistical Annex Annex 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 ....................................................................4 Table 2.1 Sustainable Primary Balance (in percent of GDP ........................................................8 Table 2.2 Sustainable Primary Balance (in percent of GDP) .......................................................8 Table 2.3 Mozambique Government Finance: 1987-2002 .......................................................... 10 Table 2.4 PARPA - Government Finances: 2002-2010 ............................................................. 12 Table 2.5 Government Finances (assuming 6 percent of GDP growth after 2005) ..................... 13 Table 2.6 Government Finances (assuming 8 percent growth after 2005) .................................. 13 Table 3.1 Functions, Revenue, and Expenditures at the Provincial, District and Municipal Levels: A Summary Comparison .................................................................. 17 Table 3.2 Central Government Transfers to Municipalities, 200 ................................................. 21 Table 3.3 Municipal Arrears .................................................................. 24 Table 3.4 Provincial and Non-Priority Capital Expenditures as a Percentage of the Total Capital Budget .................................................................. 25 Table 3.5 Per Capita Provincial Expenditures (Recurrent and Capital), 1998 and 2000 (Mts) ... 27 Table 4.1 Summary of Proposed Framework for Own Source Revenue Reform ........................ 42 Table 4.2 Budgeted and Actual Investment Spending by Functional Classification, 1999 and 2000 (Mt billions) .................................................................. 43 Table 7.1 Summary of Pressing Actions for Reform .................................................................. 79 Table 7.2 Summary of Priority Actions for Reform .................................................................. 80 Table 7.3 Summary of Actions for the Medium-Run .................................................................. 82 Boxes: Box 2.1 Theoretical Underpinnings of Debt Sustainability applied to Mozambique .................. 6 Box 2.2 Seignorage as a Source of Deficit Financing .................................................................9 Box 3.1 Popular participation is a critical ingredient to successful decentralization ................... 29 Box 4.1 The Financial Management of User Fees: An International Perspective ...................... 40 Box 4.2 Concerns About PIPs and Proposals to Address Them .................................................. 48 Box 4.3 Good Practice in MTFF Design and Implementation in Sub-Saharan Africa ................ 49 Box 5.1 Principles of Good Reporting and Types of Internal and External Reports ................... 59 Box 5.2 Alternative Models of a Treasury Single Account ......................................................... 63 Figures: Figure 1.1 Revenue and expenditure as a percentage of GDP .....................................................5 Figure 3.1 Provincial Recurrent Expenditures as a Percentage of the National Recurrent Budget .................................................................. 26 Figure 5.1 Proposed Model for Treasury Single Account in Mozambique ................................. 66 ACRONYMS BCM Banco Comercial de Mogamnbique BM Bank of Mozambique CGE Conta General do Estado CFAA Country Financial Accountability Assessment CFMIP Medium Term Fiscal Framework COFOG Classifications of the Functions of Government DflD Department for International Development DNCP National Directorate for Public Accounting DNIA National Directorate for Revenue DCI Department of International Cooperation DP Provincial Directorate DNPO National Directorate for Budget DPPFs Provincial Directorate for Plan and Finance DSA Debt Sustainability Analysis DNT National Directorate of Treasury EC European Commission EMRS Expenditure Management Reform Strategy ESRP Economic and Social Rehabilitation Program (ESRP) FCA Autarkic Compensation Fund FDF Fishing Development Fund FIIL Local Investment Fund GDP Gross Domestic Product HIPC Highly Indebted Poor Countries IGF Finance Inspectorate General IFMIS Integrated Financial Management Information System LMF International Monetary Fund MAE Ministry of State Administration MFL Municipal Finance Law MICAS Ministry of Coordination for Social Action MINED Ministry of Education MISAU Ministry of Health MOPH Ministry of Public Works and Housing MPF Ministry of Planning and Finance MTC Municipal Tax on Commerce and Industry MTFF Medium Term Fiscal Framework NGOs Non-Governmental Organizations OE State Budget PARPA Programa de Ac,co para a Redu,co da Pobreza Absoluta PEMR Public Expenditures Management Review PES Economic and Social Plan PRGF Poverty Reduction and Growth Facility PRSP Poverty Reduction Strategy Paper PSIs Integrated Sectoral Programs PTIP Three Year Investment Program SIDA Swedish International Development Agency SIPs Sector Investment Programs SISTAFE Integrated Financial Management System UTRAFE Technical Unit for the Financial Reform VAT Value Added Tax ACKNOWLEDGEMENTS The Public Expenditure Management Review (PEMR) in Mozambique is a joint effort between a core government team of experts, the World Bank and a group of donors involved in public finance in Mozambique. The government core team, led by Jose Sulemane, 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 the Financial Reform of the State (UTRAFE) led the discussions on the new Public Finance Management Law. Very useful information and insight was provided by experts in practically 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 (The Netherlands). Their extensive knowledge of public finance issues in Mozambique was extremely valuable. This report has also greatly benefited from the contributions by David Andrews (IMF-AFR), Alvaro Manoel (IMF-FAD) and Arnim Schwidrowski (IMF Resident 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 Teresa Benito-Spinetto (Macroeconomics) and Helene Grandvoinnet (Public Sector). Technical advice for the drafting of the new Public Finance Management Law was provided by Clidio Soares (World Bank consultant). Preliminary data research was undertaken by Joao Van Dunem. This report was prepared under the supervision of Philippe Le Houerou, Sector Manager Macroeconomics 1. He offered overall conceptual guidance, provided critical analytical 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 and Michael Stevens. They offered valuable advice and critical input. Helpful comments and advice were also received from Jorge Arauijo, Fahrettin Yagci and Delfin Go. Ligia Murphy assisted with managing the PEMR budget and provided editorial assistance. - i - EXECUTIVE SUMMARY Improving budget management in Mozambique requires a set of actions in the area of fiscal policy at the macroeconomic level, as well as specific measures to deal with contingent 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 and accountability in the use of public resources. AGGREGATE FISCAL ANALYSIS i. Goodfiscal management has played a central role in Mozambique's recovery over the last decade. A prudent fiscal stance, accompanied by substantial external assistance, contributed to relatively low deficits after grants, at least until 2000. Combined with a careful monetary policy, especially since 1996-97, and a program of structural reforms based mainly on privatization, tax and customs reform and trade liberalization, this resulted in low inflation, high private investment and high growth rates. At the same time, a shift in resources in favor of health, education and agriculture took place after 1998, reflecting an increasing anti-poverty focus. Education, health and agriculture increased their combined share in total budgetary allocations from 29 percent in 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 suffer from stubbornly high deficits before grants. After a considerable fiscal adjustment effort between 1992 and 1995, little change has taken place since then and the overall budget deficit 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 percent in real terms compared to the previous year. This increase was only partly linked to flood reconstruction, 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 stringently enforced and the state did not maintain a significant share of ownership in the banking sector; (ii) a significant increase in the civil service wage bill; and (iii) higher social spending made possible by HIPC debt relief. The fiscal position is projected to deteriorate even further in 2001 as a result of the combination of post-flood reconstruction expenditures and the cost of restructuring Banco Austral (BA), another bank with 40 percent government participation that collapsed in 2001. iii. The current fiscal position is unsustainable and, if not corrected, may become a threat 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 the sustainable 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 of exceptionally high levels of foreign grants. External assistance is not likely to drop - ii - significantly in the short run, at least as long as Mozambique implements sound policies and improves governance and accountability. However, relying on the current levels of external aid over the medium run would be a dangerous choice. Over time grants are likely to converge towards the average in Sub-Saharan Africa, which is around 4 percent of GDP (against 12 percent of GDP in 2000 in the case of Mozambique). Therefore, in the absence of fiscal adjustment, the maintenance of a high budget deficit will only be possible 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 adjustment that would have hampered reconstruction, it is now urgent to address these imbalances and 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 a fiscal adjustment. Recognizing this fact, the fiscal scenario underpinning the Programa de Acqdo Para a Reducdo da Pobreza Absoluta (PARPA, or PRSP) includes a significant fiscal 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 of economic growth and external assistance, a longer period before reaching sustainability may be necessary. In any case, the gradual fiscal adjustment that has now become inevitable will require the combination of a demanding revenue effort with measures to restrain expenditures. This should be accompanied by a re-focusing of public expenditures in priority areas while improving the efficiency and poverty-incidence of public intervention. v. Contingent liabilities, especially in the financial sector, including insurance, and the pension system, are a threat to fiscal stability. As Mozambique will be engaging in this renewed effort to achieve a more sustainable fiscal stance, the risks associated with further bank failures must be dealt with in a swift way. The lessons from the recent bankruptcy of BA and the difficulties that BCM faced in 2000 should lead to the urgent reinforcement of banking supervision, the active recovery of bad loans and the withdrawal of the state from the financial sector. In parallel, the state-owned insurance company, EMOSE, should launch an independent audit and be subject to supervision and strict prudential rules. There are strong signs that the civil service pension scheme is under-funded. The authorities should ensure that the actuarial study covering both this scheme and the National Institute of Social Security (INSS, which covers employees of private and parastatal enterprises) is completed soon. As part of the actions to be implemented over the short run, fiscal risks should be fully disclosed and effectively monitored. Government guarantees to financial and non-financial companies should be regulated and subject to strict limits to minimize moral hazard. vi. Decentralization and deconcentration are important issues for the improvement of fiscal management and service delivery in Mozambique. In a country as vast and diverse as Mozambique, effective fiscal management entails some degree of responsibility by sub-national levels of government to plan, implement and oversee public intervention. Finding the right balance of fiscal empowerment that maximizes the - iii - effectiveness of public action and service delivery at each level of government, while minimizing the risks of fiscal instability and guaranteeing the degree of accountability that is required by democratic regimes, is the major challenge facing policymakers in this area. The process has started and has gained impetus, particularly since the 1998 municipal elections and the creation of 33 municipalities. Decentralization in Mozambique remains, however, politically very sensitive and a gradualist approach has been followed so far. vii. Fiscal responsibilities at provincial and district levels remain smal compared to overall levels of public expenditures and revenues. Provincial own revenues represent less than 3 percent of national revenue. On the expenditure side, provincial capital expenditures in 2000 represented also around 3 percent of total national capital budget. Provincial recurrent expenditure has averaged 3 8 percent of total national recurrent spending, but the great majority of this is employee compensation. This low level of resources is strongly linked to low execution capacity at the provincial level. Fiscal responsibilities at the district level are even less important and the district budget has no legal standing. As opposed to provinces and districts that are simple deconcentrated bodies of the central government mainly covering rural constituencies, municipalities enjoy political, administrative and fiscal autonomy. viii. The roles ofprovinces and districts should be redefined, and accompanied by the strengthening of technical capacity, as well as by the creation of mechanisms for greater local participation. In a country as vast as Mozambique, suffering from poor communications and a dearth of capacity in public administration that is especially acute outside Maputo, the gradualist approach that has been followed so far regarding the extension 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 central government and the districts. The current system of dupla tutela of provincial directorates both to their sectoral ministry and the governor creates difficulties and should be reconsidered. At the district level, the rethinking of dupla tutela should be accompanied by a redefinition of the role of the districts. A clear set of functions should be defined for districts before the assignment of revenues and expenditures in order to avoid the risk of unfounded mandates. This should be accompanied by the creation of mechanisms for greater participation of local populations in the decision-making process at the district level. The strengthening of the administrative capacity of districts is a priority in this context, particularly in the area of budget management and procurement. ix. Devolution of responsibilities is seriously constrained by the low revenue base of these rural constituencies. So far, the strategy of reform of the state has been pursued both in terms of fiscal decentralization, in the urban zones, and deconcentration, in the rural zones (in pursuit of the twin goals of "democratization and integration"). From a fiscal perspective, this seems an appropriate model in the specific case of Mozambique. Indeed, the creation of the municipalities as autonomous levels of local government with the capacity to raise their own revenues deprived most districts and provinces of their main revenue base (as most "taxable" economic activities are concentrated in cities and towns). - iv - x. As far as municipalities are concerned, a set of issues will have to be faced in the nearfuture in orderfor Mozambique to consolidate its important yetfragile decentralization process . First, as more substantive functions are transferred to municipalities considerably more resources will be required, in particular when functions heavy in personnel costs, such as education and health, will be fully transferred. Currently, funding under the Autarkic Compensation Fund (FCA) is below the minimum 1.5 percent of national tax revenues required by the law, reflecting the fact that municipalities are still not fully operational. As more responsibilities and resources are transferred to municipalities, a more equitable formula of redistribution should be applied. Second, in order to ensure efficiency in tax collection and to benefit from economies of scale, the current system under which Provincial Finance Directorates (DPPF) collect municipal taxes, should be maintained, or, alternatively, a municipal tax administration agency with tax raising authority could be established. Third, there is widespread concern regarding the low capacity of municipalities to appropriately implement 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 of municipal revenues, the authorities should consider the definition of a set of minimum criteria to be met by each municipality before additional functions and responsibilities are taken up. These criteria should be transparent and purely technical. Finally, for the decentralization process to gain some depth, municipalities should be given full control over their personnel (whose wage bill represents the majority of municipal recurrent expenditures), 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 Expenditure Management Reform Strategy (EMRS) in 1997. Progress was particularly noticeable in expenditure planning and budgeting thanks to the enactment of the Budget Framework Law 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 of expenditures within years and there is no apparent problem of expenditure arrears. xii. However, the budget system continues to suffer from inadequacies that hinder efficiency, transparency and accountability. Incomplete coverage even of own resources and expenditures, inappropriate functional classification, outdated accounting procedures, weak cash management and deficient controls and audits are among the critical areas negatively affecting budget management in Mozambique. xiii. The reform process is underway but must be given new impetus and depth. The authorities share these concerns and improving the efficiency, transparency and accountability in the management of public funds are among the six priority areas in the PARPA. Recent initiatives, some of which were introduced during the course of this Public Expenditure Management Review, have contributed to improve the situation, such as the decision to introduce a more detailed budget functional classification in 2002; the approval by Parliament of a new Public Finance Management Law (Lei da Administra ao Financeira do Estado) introducing modem concepts of budget management; the publication, 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 budget management reforms. However, substantially more needs to be done and deepening the reform process will require a strong and sustained commitment at the political and technical levels. xiv. Improving budget formulation, coverage and transparency, reforming public accounting and cash management, and enhancing internal control and auditing should all be part of this new phase of reforms. Below is a summary of the recommendations included in Part II of this report. A possible action plan and time frame for 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 effectiveness of the budget as a tool of public policy. xvi. Transparency of public intervention, a fundamental issue in a democratic regime and an important factor in a market economy, is impaired by the use of a functional classification that is too aggregated and that does not offer a sufficiently detailed view of resource allocations among sectors. xvii. Budget formulation, which currently involves the preparation of four distinct documents, needs to be streamlined. Consideration should be given to bringing the overriding objective of macroeconomic stability explicitly into the budget process. 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 powers with regard to major changes in the budget. Recommendations xviii. Budget coverage. Own source revenue. As a general principle, the emphasis should 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 autonomy should be defined and the authorities should also determine which user fees currently collected should continue to be raised. * Autonomous institutions (most of them offering services with some positive externalities) should charge their own rates on the basis of partial cost-recovery and sould be allowed to retain revenue collected. All revenue and expenditures should be reported in the budget. * Central service provision and regulatory agencies (e.g. Mozambican Engineering Laboratory or the Fishing Development Service) offering private goods: rates should be set by decree annually on the basis of full cost recovery. Agencies - vi - should be allowed to retain the share of revenue necessary to cover costs. All revenue 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: rates should be set by the sectoral ministry on the basis of limited cost recovery and updated annually. All revenues should be retained by the collecting institution. Information on collection and expenditures incurred should be reported to the sectoral ministry on a quarterly basis. xix. Donor funding. The level of information on donor funded activities should be increased both in the budget and in the budget execution reports. In particular, an annex should be added to the quarterly budget execution report with information on donor-funded actual expenditures. xx. Tax expenditures. A tax expenditure is the revenue foregone because of preferential provisions of the tax structure, including exemptions, deductions, credits, deferrals and reduced tax rates. This issue is particularly important in Mozambique given the large number of fiscal incentives that are currently applied and the absence of public information on the estimated consolidated revenue loss associated with them. In particular, no information on this issue is provided in the budget. Tax expenditures should be subject to an explicit trade-off against new spending initiatives and should be as transparent as possible. A consolidated assessment of all tax expenditures should be attached to the budget document. xxi. Budget transparency. The government has decided in March 2001 to introduce a new, more detailed functional classification following the UN COFOG classifiers. The 2002 budget will formulated according to this new classification. xxii. Budget formulation process. (i) The investment plan (PTIP) should be abandoned as a stand alone document since it reflects many of the shortcomings associated with dual budgeting. (ii) The Economic and Social Plan (PES) should be reinforced and could be used as one of the instruments for the monitoring of the PARPA. (iii) The budget should be formulated and executed in current prices. In addition, (iv) the Medium-Term Fiscal Framework (MTFF) should be reinforced as an instrument of budget planning. In particular, it should be enshrined in the legislation and made available to the general public. Its management structure should provide multiple and overlapping points of responsibility and technical assistance should continue to be utilized to produce adequate sectoral expenditure frameworks. (v) The objective of macroeconomic stability should be brought into the process of budget formulation in a more explicit form. One possible way would be to use the MTFF as the vehicle that sets the overall budget deficit target for the budget year, as well as the projected targets for the subsequent years. The budget year target should be considered a ceiling not to be exceeded, while the deficit for subsequent years would be provided on an indicative basis, subject to adjustment each year. The National Assembly would not be allowed to approve changes in the budget that would lead to a higher budget deficit. (vi) The National Assembly should receive more and better information from the executive, both during budget approval and during - vii - execution. In particular, Parliament's involvement and role could be increased by splitting the process of budget approval into two stages: first, a discussion would focus on the macroeconomic and sectoral projections, policies and assumptions underpinning the budget. The MTFF and the PES would provide the main basis for this discussion. In a second stage, the discussion would focus on the detailed scrutiny of revenue and resource allocations, based on the budget proposal. Finally, (vii) the technical capacity of the National Assembly to analyze the budget and to monitor its execution needs to be reinforced, both by increasing the budgetary allocation in favor of the Parliament's Planning and Budget Committee and through capacity building with the support of the donor community. Budget execution Issues xxiii. Budget execution in Mozambique suffers from poor accounting, partial reporting and weak cash management. Mozambique's accounting system is currently one of the weakest components of the expenditure management system. It is cumbersome, offers only a partial view of financial transactions, and it is no longer capable of handling the accounting needs of an evolving public sector. With regard to the reporting function, recent progress has taken place with the publication of quarterly budget execution reports, the issuance and external auditing of the 1998 and 1999 State accounts (Conta Geral do Estado), and the implementation of an interim tracking system to monitor actual expenditures in those areas that have benefited from HIPC-related savings. However, reporting remains partial, and has not been developed 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 and cash management functions, which lead to a waste of government resources and undermine the efficient and smooth execution of budget expenditures. Recommendations xxiv. Public accounting. (i) The current system of single-entry accounting should be replaced by double-entry bookkeeping. Implementation of this new system will require a substantial training program, which should be launched urgently. (ii) The cash basis accounting system currently in use should be abandoned and replaced by modified accrual accounting (as provided for under the new Public Finance Management Law). Under this technique, revenues are recorded on a full cash basis, while expenditures are recorded on a commitment basis, irrespective of when cash is paid. Training on this technique could take place simultaneously with training on double-entry accounting. (iii) Introduction of the modified accrual accounting system should be accompanied by the elimination of the current complementary period of 3 months after the end of the year during which payment of expenditures can still take place. (iv) The so-called treasury operations ("Operac6es de Tesouraria") should be suppressed, as they can be the source of extra-budgetary - viii - operations. (v) A new chart of accounts should be implemented simultaneously with the introduction of double entry and modified accrual accounting. (vi) DNCP should be freed of all activities not directly related to public accounting and reporting. xxv. Reporting. (i) Quarterly budget execution reports, although representing a significant improvement over the past, need to be further improved. These reports should show, for each item in the budget classification, the initial allocation and the revised allocation (if any)-hence providing a consolidated view of the adjustments introduced to the budget during the execution phase-as well as actual expenditures. More and better information on donor-funded expenditures should also be included in the 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 be introduced. (ii) Currently, financial reports, other than the Conta Geral do Estado, are not published. In addition to the consolidated State accounts published since 2000, 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 on lending 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 and imposing strict rules of discipline on the way spending agencies open and operate those accounts for purposes of budget execution, are the two most urgent tasks that the treasury must face. A three-step approach is proposed in this report. (ii) A treasury single account ("Conta Unica"), following the model of an active treasury account, should be introduced. This is an account, or set of linked accounts, through which the government transacts all inflows and all outflows of funds. (iii) A new, automated treasury payments system, integrated into the new National Payments System 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 needs to be rationalized by allowing commercial banks to act as government agents in the collection of revenue, and a single document (Documento Unico) for the collection of all taxes should be introduced. Budget evaluation and auditing Issues xxvii. Budget evaluation and auditing-both internal and external-are weak in Mozambique. A dearth of trained personnel and resources undermine the auditing function of the Finance Inspectorate General (IGF)-the internal control department- and the Administrative Tribunal (TA)-a court of law entrusted with external auditing. Performance evaluation is not required by law and it is not practiced in any systematic way. In spite of these limitations, recent progress must be noted. For the first time since independence, the 1998 government accounts (Conta Geral do Estado) were audited by the Administrative Tribunal in 2000 and its report was discussed at the National Assembly, giving rise, for the first time in - ix - Mozambique, to a public debate on government accountability, or lack thereof. The 1999 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 and political backing that it deserves. In particular, specific budget lines for IGF should be introduced and allocated with sufficient resources (ii) Internal audits should be transformed into a management tool and should be primarily the responsibility of the spending units. (iii) The bulk of internal audits should be focused on assessing expenditure management systems, and conducting spot checks and special investigations. IGF, in the Ministry of Planning and Finance, should be responsible for overseeing the quality of the internal audits in the spending units, and to provide guidance and technical support when necessary. It should also be responsible for drafting the legislation needed for internal control and audit procedures and for regularly updating the Manual of Auditing Procedures for the Public Service. xxix. External auditing. (i) There is a serious mismatch between the wide powers accorded to the Administrative Tribunal (TA), on the one hand, and the means at its disposal to perform them on a meaningful way, on the other. Therefore, there is a need 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 corruption and misconduct among its officials, the Tribunal should be granted greater independence in setting salary scales for its staff. (iii) With a view to compensate its lack of capacity, partnership agreements should be made with reputable private auditing firms operating in Mozambique, which would provide guidance, know-how and support to the Administrative Tribunal. In addition, twinning arrangements could be made with a foreign-based Supreme Audit Institution. (iv) Finally, all necessary steps should be taken to ensure that the current period of 20 months for the production of audited government accounts is reduced to 12 months (in accordance with the new Public Finance Management Law). xxx. Budget evaluation. The development of a sophisticated evaluation function is not a priority in Mozambique presently. More pressing issues-improving budget coverage, increasing transparency and reforming public accounting, cash management and auditing-must be faced first. However, the introduction of this function would certainly improve budget management and should therefore remain a medium-term objective. Primary responsibility for evaluation should rest with the spending agencies, under the coordination of a central department in the Ministry of Planning and Finance. The possibility of contracting out at least part of this function to specialized firms and academics, as it is the case in several countries, should be seriously explored. xxxi. The recent approval by Parliament of a new Public Finance Management Law is a welcome development that deserves special emphasis. It is now urgent to develop 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 part of this Public Expenditures Management Review, and most of the recommendations were taken into account. Some issues, however, are not adequately addressed and will continue to be part of the on-going dialogue with the authorities. Specifically: (i) the law does not mention macroeconomic stability among the overriding objectives of fiscal policy; (ii) government borrowing guarantees are not clearly regulated and restricted to specific cases, and clear rules toward full disclosure of information are not mentioned; and (iii) the role of Parliament in the budgetary process continues to be loosely defined. It is hoped that at least some of these issues can be addressed in the 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 With the development of the Public Finance Management law, Mozambique is creating the basis for a new approach to fiscal management that integrates more closely the different functions of the fiscal process-budgeting, accounting, cash and asset management and auditing. Article 1 of the new law establishes the introduction of the Sistema de Administracdo Financeira do Estado (SISTAFE), or integrated fmancial management system. This is an important step in the right direction. The effective introduction of such systems is, however, a very demanding exercise and experience around the world calls for extreme caution in their implementation. Basically, a strong and sustained commitment at the political and technical levels, coupled with a gradualist approach that takes into account capacity constraints and avoids costly technological solutions, are key to the successful introduction of IFMIS. Above all, the basic problems affecting the current system, especially in the areas of budget coverage, accounting, cash management and auditing, must be addressed first in order to create a sound basis for the successful introduction of the SISTAFE. INTRODUCTION Improving efficiency, transparency and accountability in the use of public funds has emerged as a clear top priority in Mozambique, and improving budget management is among the six priority areas in the Programa de Acqdo para a Reduqdo da Pobreza Absoluta (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 major areas of public intervention. This PEMR took place simultaneously with a Country Financial Accountability Assessment (CFAA), whose conclusions and recommendations, particularly in the area of auditing, were taken into account. A Public Expenditure Tracking Survey in the health sector has been agreed and will be implemented with assistance from the Department for International Development (DffD). Its conclusions will be published separately. This review was launched in September 2000 as a collaborative effort between a core team of government officials from the Ministry of Planning and Finance, under the leadership of the National Director for Planning and Finance, the World Bank and a group of donors most involved in public finance in Mozambique-the European Commission, The Netherlands, Sweden and the UK. Close collaboration and coordination was maintained with the Africa and Fiscal Affairs departments in the IMF during this process. Conceived more as a results-oriented process than as a report-driven exercise, the analysis and discussions that took place during this review are already leading to changes in some areas. This is the case with the government's decision in March 2001 to introduce a new budget classification system in 2002, as well as the development of a new public finance law, approved in November 2001, which introduces modern concepts of fiscal management and for which short term technical assistance was provided by the World Bank in the context of this review. The first part of this report offers an analysis of fiscal topics at the aggregate level and discusses cross-cutting issues-recent trends of fiscal policy, medium-run sustainability, contingent liabilities and intergovernmental fiscal relations. Part II deals with the budget management system, covering budget formulation, execution, evaluation and audit. Issues related to public accounting, reporting, cash management and internal control and auditing are reviewed in this context. It describes the current system, highlights the major issues, describes government's efforts to address them and proposes concrete recommendations for further action. PART I AGGREGATE FISCAL ANALYSIS 1. This part of the report will discuss cross-cutting issues starting, in chapter 1, with an analysis of major fiscal trends since 1992, which highlights the major past features of fiscal policy and draws lessons for the near future. Chapter 2 looks at the challenges ahead and, based on a fiscal sustainability analysis, underlines the need to urgently correct fiscal imbalances in order to ensure fiscal sustainability. The issue of contingent liabilities, 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 of government-provinces and districts-as well as those of municipalities, which enjoy fiscal, administrative and political autonomy. It takes stock of the current situation and makes suggestions for improvement. - 3 - CHAPTER 1 OVERALL EXPENDITURE TRENDS-LESSONS FROM THE PAST A. Overview 2. Strong economic growth, single-digit inflation and high private investment have characterized Mozambique's performance since the mid-nineties, with the exception of 2000 when severe floods dramatically affected economic activity. Prudent fiscal policies have played a central role in this achievement (see selected economic indicators in Annex 1). 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 last decade the budget deficit before grants was notably reduced, it remains high and has practically not improved between 1995 and 1999. Underpinning these results was a significant increase in expenditures, particularly since 1996. As a result, Mozambique has been able to swiftly expand its spending program in the latter half of the 1990s while improving macroeconomic stability thanks to the high levels of donor assistance (external assistance still cover around 60 percent of total expenditures). This expansionary trend was accentuated in 2000, when expenditures increased by 16 percent in real terms compared to the previous year. 4. This chapter illustrates these trends and provides the basis for understanding why a gradual, but steady, fiscal adjustment will be necessary in order to ensure fiscal sustainability, 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 rebuild the country's economic and human infrastructure and stimulate growth while reducing domestic financial imbalances. To reconcile these objectives, the government sought to eliminate monetary financing of the budget deficit and curtailed leakages associated with the banking sector through privatization, thus reducing quasi-fiscal pressures. Simultaneously, budgetary expenditures increased to support the postwar rehabilitation of the economic and social infrastructure. 6. A considerable fiscal adjustment effort took place between 1992 and 1995. The overall deficit before grants fell from its wartime high of 21 percent of GDP in 1992 to 13 percent of GDP in 1995 (Table 1.1) and the primary deficit-which serves as a measure of the current fiscal effort since interest payments are predetermined by the size of previous deficits, and it is an indicator of fiscal sustainability-remained below 2 percent of GDP for most of the period. - 4 - 7. However, over the period 1995-99, little adjustment took place, and the budget deficit 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 16.7 lending of which: current 4.9 5.3 5.5 3.9 3.8 5.0 6.1 7.1 7.8 expenditure Total revenue 4.2 4.9 4.4 4.3 4.3 5.3 6.2 7.0 7.5 Budget balance before grants -5.3 -5.5 -6.9 -4.9 -4.1 -5.8 -5.5 -7.4 -9.2 Grants plus net external 4.8 5.1 7.3 5.2 4.5 7.0 6.9 7.8 9.1 borrowing As a % of GDP: Budget balance before grants -21 -19 -23 -13 -10 -12 -10.5 -13.2 -16.1 Grants 17 15 17 9.8 7.1 9.1 8.1 11.7 11.6 Budget balance after grants -4.4 -4.4 -6.1 -3.1 -3.1 -2.6 -2.4 -1.5 -4.5 Primary balance -0.3 -1.0 -4.2 -1.6 -1.4 -1.3 -1.4 -0.8 -4.3 Financing: Net extemnal borrowingc 2.6 3.2 7.3 3.8 4.3 5.7 4.6 1.8 2.8 Net 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, especially since 1996. Real expenditure peaked in 1994 owing to food aid and other assistance after the end of the civil war. As food aid declined after 1994, both current and total expenditure declined to what might be called the "non-war normality". But after 1996 expenditures picked up again, and real total expenditures grew at a vertiginous 20 percent annually during the period 1996-99, against a negative annual growth of -3 percent between 1992 and 1996. On the other hand, revenues rose at a slower pace-i 8 percent annually-during the period 1996-99. The increase in spending in the latter half of the nineties was supported by swift growth of concessional assistance (grants plus net external borrowing): 20 percent per year from 1996 to 1999. 9. GDP also grew strongly during the latter half of the 1990s, though not as swiftly as did expenditures. Figure 1.1 below illustrates these trends. - 5 - Figure 1-1. Revenue and expenditure as a percentage of GDP 40- -Ttlepedtr and ne ledn \ ~~~~~~~~~~~of which: current expenditure 30 - - - - - -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, when expenditures rose by 16 percent in real terms compared to the previous year. This increase is only partly related to flood reconstruction as these expenditures are taking 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 stringently enforced and the state did not maintain a significant share of ownership in the banking sector; (ii) a significant increase in the civil service wage bill resulting from the introduction in 1999 of the new career system with the associated rise of lower level salaries, accompanied with the admission of 14,356 new civil servants; and (iii) higher social spending made possible by HIPC debt relief. The fiscal position is projected to deteriorate even further in 2001 as a result of the combination of post-flood reconstruction expenditures and the cost of restructuring Banco Austral (BA), another bank with 40 percent government participation that collapsed in 2001. 11. In sum, Mozambique has been able to swiftly expand its spending program in the latter half of the 1990s while improving macroeconomic stability thanks to the high levels of donor assistance, while revenues have remained relatively flat as a percent of GDP since 1995. In 2000, a significant deterioration of the fiscal position took place resulting from an increase of expenditures partly linked to post-flood reconstruction, but which 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 to six years, and the need to develop a post-HIPC public debt strategy, militate in favor of a more forceful fiscal adjustment that will improve fiscal sustainability in the medium run (see chapter 2). - 6 - 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 external borrowing necessary to finance the budget deficit are not likely to lead to a debt crisis over time and/or rising interest rates that crowd out private investment and stifle economic growth. Box 2.1 provides the conceptual framework for a debt sustainability analysis from a fiscal perspective, describing the theoretical underpinnings of debt dynamics and its links with economic growth, the level of real interest rates and the pace of 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 the determinants of the change in public debt (defined to include both net external and domestic debt) 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 is the amount of seignorage the Government can mobilize by printing money, r is the average real interest rate on total public debt (domestic and external), g is the GDP growth rate and d is the debt to GDP ratio. Basically, this identity shows that public debt as a percentage of GDP will rise indefinitely in case the primary deficit exceeds the amount of seignorage and the real interest rate is higher than GDP growth. The level of the primary balance (deficit or surplus) 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 some adjustments to the concept of primary deficit. While in the literature the primary deficit will only include tax and non-tax receipts in total revenue, in the case of Mozambique we will also consider external grants among the regular sources of fiscal revenue, thereby recognizing the vital role external assistance will continue to play in Mozambique's fiscal policy even in the long-run. Therefore, for the purpose of the current analysis, the primary deficit taken into account 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 the debt sustainability analysis (DSA) performed in the context of the HIPC initiative. The latter adopts a balance of payments perspective, trying to determine whether a country is facing an unsustainable debt situation after the full application of the traditional debt relief mechanisms. In the HIPC framework, a debt-to-export ratio of no more than 150 percent (on NPV terms) is considered sustainable. The analysis performed here adopts a - 7 - fiscal perspective, trying to determine the level of the fiscal deficit that would allow the debt-to-GDP ratio to remain constant over time. However, despite these analytical differences, the two approaches are related, since both assess sustainability taking into account underlying macroeconomic policies. Thus, the DSA that was presented at the HIPC completion point in September 2001 points to a continuing steady decline in the ratio of the NPV of debt-to-exports over the next twenty years, assuming the implementation of sound policies. The analysis in this fiscal approach to sustainability provides an assessment on the sound policies needed for combined external as well as fiscal sustainability. 14. Perhaps the best way to analyze this issue is through the so-called accounting approach. 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 deficit exceeds the amount of money creation by the central bank. In case the government is running a non-interest deficit higher than the amount of seignorage it can obtain, and if the real interest rate on public debt exceeds the growth rate of the economy, total public debt will increase as a share of domestic income. Over time, this will lead to an unsustainable fiscal position, in which excessive budget deficits require higher debt, leading to higher debt service expenditures, which, in turn, will result in higher budget deficits. 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 debt crisis in case of foreign borrowing, or a situation in which the government will be unable to sell its debt in case of excessive domestic borrowing, and the process will have to be brought to an halt by cutting the budget deficit. 15. Applying this framework to the case of Mozambique helps to illustrate the challenges faced by the country's fiscal policy to avoid the re-emergency of excessive debt. Assuming that the debt-to-GDP ratio (D/GDP) considered acceptable is the one resulting from the HIPC initiative, the question is then to determine the level of the primary deficit (defined as the overall fiscal deficit after grants minus interest on total public debt') required to stabilize D/GDP in the medium-long-term, given realistic assumptions on economic growth, the real interest rate and the level of resources that can be mobilized through seignorage. Note that this definition of the primary deficit is different from the one traditionally used by the IMF in the PRGF program, which is defined as revenue minus non -interest current expenditures minus locally financed capital expenditure and locally financed net lending. - 8 - 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 0.2 5% -2.7 -2.5 -2.2 -1.8 -1.0 -0. 1 6% -3.0 -2.8 -2.5 -2.2 -1.3 -0.4 7% -3.3 -3.2 -2.8 -2.5 -1.6 -0.8 8% -3.7 -3.5 -3.2 -2.8 -2.0 -1.1 9% -4.0 -3.9 -3.5 -3.2 -2.3 -1.5 10% -4.4 4.2 -3.9 -3.5 -2.7 -1.8 11% -4.7 4.5 -4.2 -3.9 -3.0 -2.2 12% -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, deflated with the projected US annual inflation rate. A negative real interest rate means that the weighted average interest rate on 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 0.1 5% -1.7 -1.6 -1.4 -1.2 -0.6 -0. 1 6% -1.9 -1.8 -1.6 -1.4 -0.9 -0.3 7% -2.1 -2.0 -1.8 -1.6 -1.1 -0.5 8% -2.4 -2.3 -2.0 -1.8 -1.3 -0.7 9% -2.6 -2.5 -2.3 -2.0 -1.5 -1.0 10% -2.8 -2.7 -2.5 -2.3 -1.7 -1.2 11% -3.0 -2.9 -2.7 -2.5 -1.9 -1.4 12% -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, deflated with the projected US annual inflation rate. A negative real interest rate means that the weighted average interest rate on 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 keep constant the public debt-to-GDP ratio projected under the HIPC initiative for 2005 and 2010, given different hypothesis of real interest rates and economic growth. The simulations assume seignorage at 0.1 percent of GDP2 (see Box 2.2 below for a discussion of seignorage as an instrument to finance budget deficits). 17. The results show that the higher the GDP growth rate and the lower the real interest rate, the higher the primary deficit the government would be able to afford for any 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 the treasury. - 9 - limit the primary deficit to -2.3 percent of GDP if it were to keep the HIPC-projected D/GDP ratio constant over time at 22 percent, assuming annual economic growth of around 8 percent and an average real interest rate on public debt of -2 percent. Should the annual growth rate fall to 6 percent, a primary deficit of no more than -1.8 percent of GDP would be required. Keeping the D/GDP ratio constant while running a higher primary deficit is only possible, for any given levels of growth and interest rates, through higher 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 the demand 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 obtain from the printing of money -- in other words the amount of seignorage -- is determined by the demand for high-powered money in the economy (i.e. currency and bank deposits), the real rate of growth of the economy, and the elasticity of the demand for real balances with respect to inflation 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 the additional demand for money that is generated by economic growth (assuming, for the purpose of simplicity, that the income elasticity of demand for money is unity). Beyond that level, assuming a stable demand function for money, inflation will result. During a certain period of time, higher levels of seignorage are possible at increasing rates of inflation. However, as the public starts shifting its money holdings to foreign currency because of currency depreciation associated with rising 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 a source of deficit financing inevitably leads to hyper inflation. Source: S. Fisher and W Easterly, "The Economics of the Government Budget Constraint", The World 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 foreign exchange reserves. By running down reserves rather than printing money, a Government can hope to put off the inflationary effects of a deficit. However, such a policy results in the appreciation of the exchange rate in the short run and, over time, inevitably leads to a balance of payments and a currency crisis that will require a reduction in the budget deficit. - 10- B. Facing the Challenge-Toward a Sustainable Fiscal Policy and Economic Growth 18. Since the beginning of the reform program in 1987, fiscal policy has been driven by the need to rebuild Mozambique's economic and human infrastructure, and to stimulate growth in a non-inflationary environment. Reflecting this stance, between 1987 and 1998, aggregate government expenditures increased by an average rate of about 6 percent a year, while the average increase in fiscal revenues was just below 7. Thus, the overall deficit before grants declined from -12.3 percent of GDP in 1987 to -10.5 percent in 1998 (see table 2.3 below). Reflecting this trend, the primary deficit-defined as the overall deficit after grants minus interest on total public debt-declined from around -6 percent of GDP in 1987 to -1.4 percent in 19984, an outcome that was only made possible thanks to the high levels of foreign assistance. In 2000, however, these trends were reversed and fiscal policy became largely expansionary. As a result, the overall budget deficit before grants increased from -13.2 percent of GDP in 1999 to -16 percent in 2000, and is estimated to reach -19.3 percent in 2001. Likewise, the primary deficit exceeded -4 percent of GDP in 2000 and 2001, and is projected to increase to -7 percent in 2002. Underlying the fiscal expansion in 2000 is a 16 percent real increase in expenditures, related partly to flood reconstruction, but also to an important increase in salaries, the recapitalization of BCM, and an increase in social spending over and above HIPC-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 12.8 Expenditure 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 -18.6 Grants 5.4 8.1 11.7 11.6 14.5 10.1 Overall 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 -7.1 Sustainable 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 largely unrepresentative as it is linked to a large World Bank-financed adjustment program (EMRO) that took the form of a grant rather than a traditional loan. - 11 - 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 how unsustainable the current fiscal position is. Clearly, the sharp deterioration of the primary deficit in 2001 and 2002 is directly linked to the cost of bank restructuring, projected to reach 3 percent of GDP in 2002. After netting out these exceptional expenditures, the primary deficit would be above the sustainable level in 2002. However, it would still show a considerable deterioration when compared with 1998. 20. Until 1998-99, this policy, made possible by the high levels of foreign aid, was appropriate at a time when the demands for reconstruction were high and the potential revenue from a weak economy were relatively low. In face of the significant level of external assistance the country has enjoyed since the mid-nineties, and the sizable debt reduction that took place under the HIPC initiative since 1999, some may be led to believe that this situation can be perpetuated and that Mozambique can continue to postpone the need to adjust its fiscal policy to more sustainable levels. This would be a dangerous choice. Indeed, even though external assistance is not likely to drop significantly in the short run-at least as long as Mozambique continues to implement sound policies and makes serious efforts to improve governance and accountability- over time it is likely that assistance will converge towards the average in sub-Saharan Africa, which is around 4 percent of GDP5. Therefore, in the absence of a strong fiscal consolidation strategy, the maintenance of a high budget deficit would only be possible through higher public debt and/or increased reliance on seignorage. As discussed above, given that private domestic savings and demand for money are unlikely to increase significantly in the short-to-medium-run, such a policy would inevitably lead to higher interest rates and inflation, crowding-out private investment, crippling economic growth and undermining the fight against poverty. In addition, the need to develop a post-HIPC strategy on public debt also militates in favor of such a fiscal adjustment. Engaging in the path of a gradual-but steady- adjustment effort should therefore be considered a priority of government policy over the next decade. The current high levels of external assistance and the substantial debt relief delivered under the HIPC initiative are favorable conditions 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 fiscal adjustment that could lead to a sustainable fiscal position already by 2005 (see table 2.4 below). This scenario is based on the assumption that GDP growth will remain high over the period (above 9 percent a year), that an ambitious tax collection effort will take place in the short-run and that the current high level of external assistance will continue in dollar terms over the next decade (although declining as a share of GDP). 5 2000 World Development Indicators - 12 - Table 2.4: PARPA - Government Finances: 2002-2010 (In percent of GDP) 2002 (a) 2005 (b) 2010 (b) Total Revenue 12.8 15.4 16.7 Expenditure and net lending 31.4 27.1 25.0 Overall deficit before grants -18.6 -11.7 -8.3 Grants 10.1 8.7 6.3 Overall deficit after grants -8.4 -3.0 -2.0 Primary deficit (c) -7.1 -2.4 -1.4 Memorandum items: Sustainable primary deficit (d) -5.1 -2.9 -2.0 Real GDP growth 10.0 9.3 7.9 Source: 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 of economic growth and external assistance, a longer period before reaching a sustainable fiscal deficit may be necessary. Two alternative scenarios are discussed below (tables 2.5 and 2.6. See also Annex 2 for detailed data). They assume GDP growth rates of 6 and 8 percent a year after 20056, as well as a realistic, although demanding, tax effort and a lower level of external assistance consistent with HIPC projections7. The results show that under these circumstances sustainability would not be reached before 2010, as opposed to 2005 in the PARPA, unless a sharp contraction in expenditures takes place that could jeopardize the PARPA's objective to reduce poverty incidence to below 50 percent 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. - 13 - Table 2.5: Government Finances (assuming 6 percent GDP growth after 2005) (In percent of GDP) 2002 (a) 2005 (b) 2010 (b) Total Revenue 12.8 15.0 17.3 Expenditure and net lending 31.4 27.4 24.4 Overall deficit before grants -18.6 -12.4 -7.1 Grants 10.1 7.5 4.8 Overall deficit after grants -8.4 -5.0 -2.2 Primary deficit (c) -7.1 -4.4 -1.8 Memorandum items: Sustainable primary deficit (d) -5.1 -3.2 -1.8 Real GDP growth 10.0 6.6 6.0 Source: 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) 2002 (a) 2005 (b) 2010 (b) Total Revenue 12.8 15.0 17.2 Expenditure and net lending 31.4 27.4 24.3 Overall deficit before grants -18.6 -12.4 -7.1 Grants 10.1 7.5 4.4 Overall deficit after grants -8.4 -5.0 -2.7 Primary deficit (c) -7.1 -4.4 -2.3 Memorandum items: Sustainable primary deficit (d) -5.1 -3.2 -2.3 Real GDP growth 10.0 6.6 8.0 Source: 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 require a combination of a demanding revenue effort and measures to restrain expenditures, accompanied by reforms aimed at re-focusing public expenditures on priority areas while increasing the efficiency and the poverty incidence of public intervention. On the revenue side, gains could be achieved mainly through the continued improvement in revenue collection-which could be accomplished primarily through the broadening of the tax base rather than through a general increase in tax rates-as well as through the rationalization of tax incentives. Efforts in revenue collection should primarily concentrate on corporate and individual income tax, as well as on VAT on domestic and - 14 - imported products, as these categories are likely to yield the highest results in terms of higher total revenue. Increasing the revenue from the corporate tax must go hand in hand with the maintenance of a favorable climate for foreign direct investment. At the same time as efforts are deployed to raise budget revenue, strict policy rules should guarantee the 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 to around 24 percent of GDP by 2010, is required. Current expenditure should remain close to 14 percent of GDP over the period to 2005 and decline gradually to around 12 - 13 percent 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 debt service by the HIPC initiative. The wage bill in particular should not go beyond 6 to 7 percent of GDP, which would allow for sufficient annual increases in salaries and would be in line with the regional average. Capital expenditure should return to its pre-flood level of around 12 percent of GDP over the period 2002-2010. 25. Implementation of this strategy should be accompanied by an improvement in the fiscal management system-encompassing budgeting, accounting, cash and debt management, as well as internal and external control-together with measures to improve the transparency and accountability in the way public resources are managed (this issue is the 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 be pursued 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 more sustainable fiscal stance, the risks associated with contingent liabilities must be dealt with in a swift way. Typically, contingent government liabilities-obligations made by the government 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 the budget deficit and debt reduction does not necessarily prevent fiscal instability. Contingent liabilities can be explicit, when defined by law or contract-e.g. state insurance schemes, guarantees for borrowing, guarantees for trade, exchange rate risks and private investment risk. Contingent liabilities can also be implicit, when they constitute moral obligations, not legal ones, based on public expectations or political pressures, such as bank failures, natural disasters and defaults of public or private entities on non-guaranteed debt (World Bank, 1998). 27. In Mozambique, the main sources of contingent liabilities are associated with failures in the financial sector, the pension scheme and natural disasters. Regarding the financial sector, the lessons from the recent collapse of Banco Austral (BA) and the difficulties that Banco de Mocambique (BCM) faced in 2000 should lead to the urgent reinforcement of banking supervision, the withdrawal of the state from the financial sector 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 and strict prudential rules. 28. There are indications that the civil service pension scheme (covering both civil and military personnel) is not fully funded. The scheme, managed by the Ministry of Planning and Finance, is a defined benefit, financed through a 7 percent tax on gross salaries. 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 the military demobilized after the 1992 peace agreement. Also, the pensions of the employees 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 a legacy 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 sector scheme and the National Institute of Social Security (INSS, which covers employees of private and parastatal enterprises) is completed soon, that its conclusions are disseminated and an action plan is developed to solve the problems. 29. The implementation of an effective disaster prevention strategy must be a priority in Mozambique. Such a strategy has to take into account the regional dimension of the threats facing the country and adopt a multi-sector approach. Such a strategy has been prepared, 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 threats associated with contingent liabilities, fiscal risks should be fully disclosed and effectively monitored. The creation of budgetary reserves (beyond the ones currently in place) that would be mobilized only in very specific cases should be considered. Finally, government guarantees to financial and non-financial companies should be regulated and subject to strict limits in order to minimize moral hazard. - 16 - CHAPTER 3 INTERGOVERNMENTAL FISCAL RELATIONs-TAKING STOCK AND LOOKING AHEAD 8 A. Background 31. The purpose of this chapter is two-fold. First, it describes and analyzes Mozambique' s recent experience with fiscal reforms focusing on deconcentration and decentralization. The analysis highlights the overall fiscal impact of these reforms and identifies fiscal constraints on further reforms. Second, the chapter provides recommendations and guidelines for further fiscal deconcentration and decentralization reforms. 32. Much like the Portuguese model, Mozambique is currently governed by two parallel 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 governnent has pursued a modest policy of deconcentration, while in the urban sub-national system it has carried out a more radical policy of decentralization. In rural areas the central government has deconcentrated a limited amount of power to both provincial and district administrations.10 In urban areas the central governnent has devolved power to thirty three autonomous municipalities (autarquias) in cities and towns, which are run by elected officials (in effect, the municipalities are small islands of decentralized municipal governments surrounded by deconcentrated provincial and district administrations). In neither case, however, have the reforms been unequivocal; both deconcentrating and decentralizing reforms have been subject to impediments and reversals. Table 3.1 below summarizes 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 authority structures. 10 There are presently ten provinces, 128 districts, and 393 administrative posts. - 17 - Table 3.1: Functions, Revenues, and Expenditures at the Provincial, District, and Municipal Levels: A Summary Comparison Level Functions Revenues Expenditures Province Territorial planning and Small amount of own Small amount of oversight of all sectoral source revenues (taxes discretionary capital programs in the and mostly fees); less expenditures; about 2% province than 3% of total national of total national capital revenues budget District Territorial Small amount of own Small amounts of administration and source revenues discretionary funds for oversight of all sectoral (National non-wage recurrent programs in the district Reconstruction Tax, expenditures and fixed market and bicycle term contract labor duties, and rental fees) Municipality Economic and social -Transfers from central Authorized to make development; Govemment(FCA and recurrent and capital environment, basic FIIL) expenditures in all areas sanitation, and quality of -Own source taxes of competence life; public services; (Municipal Head Tax, health; education; Property Tax, Economic culture, leisure, and Activity Tax, Tax on sport; policing; and Commerce and Industry, urban infrastructure, and Income Tax) and construction, and fees (market fees, public housing service fees, parking fees, registration, fees, __________________________ ~~ ~~etc .)_ _ _ _ _ _ _ _ _ _ _ _ _ _ 33. Decentralization and deconcentration are typically undertaken to increase levels of local participation in governance and thereby improve service delivery to local communities. At the same time decentralization and deconcentration must be undertaken in such a way that make them fiscally sustainable. This chapter draws three main conclusions about Mozambique's deconcentrating and decentralizing reforms in light of the goal of improved service delivery and the imperative of fiscal sustainability. First, neither the deconcentrating nor the decentralizing reforms pose risks for the aggregate fiscal balance at present. Neither the deconcentrated provinces and districts nor the decentralized municipalities have unsustainably large entitlements to central government resources. Moreover, current municipal debt is modest and largely short term (and regulated by the MPF). Second, both district and municipal capital and recurrent expenditures are in line with their corresponding revenues. At present, there does not appear to be a risk of budget deficits at either the district or municipal levels (based on available data, which is unfortunately quite limited). Third, however, further improvements in the quantity and quality of service delivery at the district and municipal level will be constrained by available own source revenues as well as central governnent transfers. Districts have seen their tax and fee bases lost to municipalities, while provinces have seen their discretionary investment budgets decline as resources have been shifted back to central ministries (as part of the Integrated Sectoral Programs). Municipalities have had difficulty delivering the services for which they are currently responsible, and the transfer of new functional responsibilities to the municipalities has - 18 - 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 are contradictory tendencies at both the provincial/district and municipal levels. One thing is clear, however. If not addressed, fiscal issues have the potential to be the Achilles heel of the government's deconcentration and decentralization programs. B. Governance Provinces, Districts, andAdministrative Posts 34. The provinces, which function as deconcentrated governance structures, are formally administered by governors appointed by the President. I Governors, who are regarded as having the same rank as ministers, are jointly responsible with the sectoral ministries for provincial implementation of the government's program. At the provincial level most ministries have a provincial directorate (DP) responsible for their sectoral programs. These DPs are responsible to both their parent ministries as well as the governor. This dual authority structure is known as the dupla tutela. 35. The principal function of the provincial government is territorial planning, which is supposedly done in conjunction with the sectoral planning for which the central ministries are responsible. Some sectors, namely the "priority" ones, are characterized by centrally conceived Integrated Sectoral Programs (PSIs): education, health, agriculture, water, and roads (the judicial and prisons sectors are also considered priority in some instances). 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 the fact that he is allocated a very small professional staff; most governors have only a couple of technical advisors. In practice, the dupla tutela fosters confusion and uncertainty about powers and responsibilities, though the balance of power between governors and sectoral directors varies from province to province. In sum, though governors are formally vested with many powers and responsibilities, in practice they are not very powerful, given that budgeting, revenue collection, planning, and personnel are controlled 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, is composed of the administrator and sectoral district directors, who are accountable to their provincial sectoral directors. The dupla tutela structure is thus replicated at the district level. The district administrator, who is appointed by the Ministry of State Administration (MAE), has nominal authority over the sectoral district directors. The main function of the district administrator is that of general territorial management. The coupling 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 in practical terms. Thus, provincial govermments are not directly accountable to provincial citizens. - 19- administrative capacity means that the district administrator's role in service delivery is quite 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 (licensing bicycles), 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 between rural communities and district administrations. Postos also play a limited role in tax collections, 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, and by an elected executive officer, the Council President, together with his Municipal Council. The Municipal Council is appointed by the Council President, who must chose at least two of his city councilors (vereadores) from the ranks of the assembly. Assembly members 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 outset municipalities will not be able to exercise authority in all sectors. Therefore, the legal framework provides for the gradual transfer of functions and revenues over time as municipalities are ready to assume them. Presently, many municipalities only exercise authority in a limited number of sectors, notably policing and sanitation. 42. Tutelary authority over the autarquias is vested in the MAE for administrative matters and the MPF for financial matters (ministers can, however, delegate oversight authority to the respective provincial governor).13 Municipalities are supposed to coordinate their work with their neighboring district and provincial governments, as well as with the sectoral ministries. 43. Municipalities inherited their staffs from the central government, as civil servants were simply transferred to the municipality. Municipal civil servants are subject to the same civil service system as state employees, which means that in practice municipalities have limited autonomy to manage their personnel complements. Given that municipalities 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." - 20 - presently have little room to maneuver. These constraints, coupled with the scarcity of qualified professionals at the local level, have handicapped municipalities in terms of qualified professional staff. 44. At the same time the central government has reserved a panoply of powers that effectively fence in the municipal governments on a number of fronts. These powers are discretionary; it is up to the central government to invoke them. In the best sense these powers would only be used to thwart corruption and malfeasance. In the worst sense they would be used to continue to intervene in municipal affairs. It remains to be seen whether these powers are used for legitimate or illegitimate purposes. There is a sense within the government that the municipal decentralization reform has reached its limits for now (in terms of extension to new municipalities). There is concern that there are no obvious candidates for further municipalization (the next autarquias would have to be small villages). C. Revenues Provinces, Districts, and Administrative Posts 45. The provincial government, like the district administration, collects taxes and fees.14 The province as a unit of government has only a very small amount of own source revenues, however. In fact, total provincial own source revenues averaged 2.8 percent of total national revenues over the period 1995-2001. Over the same period tax revenues accounted for only 15 percent of total collections, while non-tax revenues made up the vast majority. While there was some detail provided on non-tax revenues in pre-1998 budgets, subsequent budgets provide no detail on the types of non-fiscal revenues collected 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 district level. The main tax collected by the districts is the National Reconstruction Tax; of the duties and fees, market duties are the main revenue generators. There are no specialized revenue generation units and district tax administration capacity appears highly limited. Non-compliance seems to be widespread as districts have limited capacity to enforce compliance. Since districts do not fully comply with the treasury regulations to deposit their IRN collections in central accounts, and since districts are responsible for their own duty and fee collections, there are no central government estimates of the amounts of funds actually collected by districts. Nor is there an established financial system for management of revenues, which seems to vary according to the district and province. Districts do, however, prepare statements of revenues and expenditures, though these statements 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 allocations are not determined by local revenue collections. - 21 - revenue bases to the municipalities. That is, the thirty three largest tax bases at the district level now fall under the jurisdiction of municipalities. In the affected districts, revenues have declined significantly. Though these thirty three municipalities only represent about 25 percent of the total number of districts, they represent a much larger percentage of the total district tax base. The shifting of the tax base from districts to municipalities is problematic because it calls into question the potential for decentralization to district administrations. Unless decentralized district administrations were to rely largely on transfers from the central government, resources would simply not be available to finance local service delivery. Current fiscal constraints suggest that deconcentration to sectoral district directorates would be more appropriate than devolution to district administrations. From a pure fiscal perspective the scope for devolution to the district level is thus quite limited. Municipalities 15 48. Municipalities have two main sources of income: transfers from the central government and own source revenues. Transfers from the central government come from the Autarkic Compensation Fund (FCA) for recurrent expenditures and the Local Investment Fund (FIIL) for capital expenditures. Both funds provide untied block grants to the municipalities. According to the law, funds are allocated according to the following allocation criteria: municipal population, municipal area, index of municipal tax performance, and weighted index of development. In practice, the only criterion used so far has been the municipal population. Funds from the FCA, which are divided between the thirty three municipalities, are to be set between a minimum of 1.5 percent and a maximum of 3 percent of annual national tax revenues, though in practice less than the minimum has so far been allocated (see Table 3.2). The FIIL, which provides funding for capital expenditures, may be used at the discretion of the municipality, given that expenditures are in line with national budget priorities. Though there are no set criteria in the law for the allocation of these funds, allocations have thus far been based on municipal population. The FIIL is financed by parliamentary appropriations on an annual basis. Table 3.2. Central Government Transfers to Municipalities, 2000 (Millions of Meticais) Budgeted tax collections 6,958,000 Actual tax collections 6,915,747 FCA Total 95,000 FIIL Total 44,000 FCA 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 also depends 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 Tutelage Law (5/97), and the Municipal Finance Law (5/97), or MFL. In addition municipal revenue collection is regulated by the Municipal Tax Code (12/00), which complements the Municipal Finance Law. - 22 - taxes (including surcharges), licenses, user fees, fines, inheritances and other gifts, and receipts from own assets, including the sale of assets. The Municipal Finance Law (MFL) 16 authorizes municipalities to collect the following taxes: (1) the Municipal Head Tax (Imposto Pessoal Autarquico), (2) the Municipal Property Tax (Imposto Predial Autarquico), levied on land and buildings, (3) the Economic Activity Tax (Taxa por Actividade Econ6mica), which applies to commercial and industrial activity and is paid by those firms that previously paid the corporate income tax (Sections A and B) and are not required to pay any of the taxes listed below, (4) the Municipal Tax on Commerce and Industry (Imposto Autdrquico de Comercio e Industria), which applies to small businesses subject to the corporate income tax, Section C, and other activities, and (5) the Income Tax, Section B, which is paid by small businesses, mostly cooperatives and farmers. Municipalities are also authorized to receive 75 percent of the national vehicle tax, which is not currently being collected.'7 Tax rates, which are set by the municipal assemblies, are limited by the MFL. 50. The MTC indicates that with the exception of the Municipal Head Tax and the Economic 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 the municipalities. Presently, municipalities are only collecting the head tax. The MPF is collecting 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 are prepared to do so. 18 51. Municipalities may issue and charge for activity licenses in fifteen areas including: (1) infrastructure, equipment, construction, subdivision of lots, and use of land and buildings; (2) delivery of public services; (3) use of reserved lots in markets and fairs; (4) street vending; (5) vehicle parking; (6) commercial advertising; (7) use of public facilities; (8) cemetery and funeral fees; (9) health inspection; and (10) registrations. Licensing fees are set by the municipal assemblies. Municipalities are also authorized to charge for direct public service provision in the following areas: (1) water and electricity, (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 data must 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 not collected in other parts of the country, which is appropriate given that autarkies are expected to provide more and better services than, say, district administrations. 19 Detailed data from Brockman and Wojtyla (2000). - 23 - in 1998 and that their accounts are not audited (the data, therefore, may be more estimates than actuals). Furthermore, data for 2000 are projections and estimates based on the first six months of the year. In addition it should be pointed out that Maputo's share is very large in comparison to the other cities. In fact, Maputo accounted for approximately 40 percent of the total revenues and 66 percent of expenditures of the five largest cities. In terms of revenue composition for the five cities as a whole, own source revenues made up approximately one third of total revenues, while two thirds came from central government transfers in 1999 and 2000. Own source revenues were largely composed of three sources: taxes, fees and licenses, and other operating revenues.21 In 1999 and 2000 taxes, fees, and licenses accounted for nearly three quarters of the total. In terms of fiscal transfers, grants from the FCA and FIIL made up 43 percent of total transfers. Another 43 percent of total transfers came from "other capital funds."22 Housing Authority Rentals (APIE counterpart funds) provided fourteen percent of total transfers, about the same level of funding as from the FIIL. The data show that the grant system provides less than half of the total amount of transfers and less than one third of total revenues. If own source revenues increase, FCA and FIIL grants will amount to an even smaller share of revenues. Overall, while taxes, 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 Annex 3). At the same time revenues from other capital funds have 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), the amounts of which may not exceed ten percent of the amount of their grants from the FCA. Longer term borrowing, while permissible, must be approved by the MPF. Borrowing by autonomous municipal departments and municipal public companies is to be regulated by the Council of Ministers. At present the cities do not appear to have any bank loans. In practice, even access to credit from local merchants is quite restricted, due to the cities' poor credit ratings, though the provision of supplier credit seems to be increasing. 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 were carried over to the current year. Given, however, the likelihood that positive year end balances were largely the result of poor reporting of actual expenses, and not actual carry-overs, this category should be analyzed with a grain of salt. - 24 - Table 3.3: Municipal Arrears Municipality Amount (Mts. '000,000) Type Beira 2,617 Borrowed from government to cover operating expenses; due in 2000. Nampula 2,464 Short-term loan Pemba 100 Short-term loan Quelimane 1,412 Supplier credits Maputo No data at municipal level. Total 6,593 Source: Wojtyla (2000). 54. Presently, tax administration seems to be just as much of a challenge for municipalities as for districts, though the problem is of greater importance for the municipalities. Most municipalities do not have specialized tax units. It is unclear when municipalities will begin to collect the taxes due themselves, given the technical complexities of revenue administration. Nor is it clear how municipalities will address the problem of compliance with taxes, licenses, and fees. Though compliance data at the municipal level are not available, anecdotal evidence suggests that non-compliance is considerable. It would seem then, under present conditions, that municipalities face a serious challenge in increasing their tax revenues. To the extent that municipal revenues do not increase considerably (assuming fiscal transfers will not increase greatly in the short term), improvements in the quantity and quality of service delivery will be compromised. The risk for the municipal decentralization program is that limited revenue raising capacity will act as the binding constraint on the transfer of responsibilities from the central government to the autarquias, thus stalling the program. 55. Another concern, which is held by some high level government officials, is that municipalization has created inequalities vis-a-vis the districts (for example, municipalities are perceived to have received favored status at the local level). Critics believe that the amounts of funding channeled to the municipalities through the FCA and FIIL are too high and that the districts have suffered in comparison. The equity problem is especially pronounced in the towns, as opposed to the large cities. In many rural areas there are not many noticeable differences between towns and districts, except that the autarkic 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 the annual national budget (OGE), including investment funds through the national Public Investment 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 in 1993. The name was changed when the PTIP became part of the MTFF. - 25 - 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, are determined by the sectoral ministries at the central level, thus provincial level government has limited input into the budget formulation process in these sectors (sectoral provincial directorates have some input into their parent ministries' budget formulation process). The non-priority sector capital budget is formulated by the provincial government, that is, the sectoral directorates in conjunction with the governor. The non-priority sector recurrent budget is largely determined by decisions about civil service staffing levels made at the center, and in practice tends to be formulated in terms of an increment over the previous year's budget. 57. In the non-priority sectors the capital budget formulation process begins when each sectoral provincial directorate submits a proposal to the DPPF.25 At the same time the MPF sets the aggregate provincial capital budget ceiling and sectoral ceilings for the PSI sectors. The residual, or difference between the provincial ceiling and the sum of the PSI sector ceilings, is allocated to the non-priority sectors. Based on the sectoral proposals and the total ceiling, the DPPF then prepares a proposal for the allocation of funds to the remaining sectors. The DPPF's recommendation is taken up by the provincial council with the governor presiding. The council then makes a final decision on non-priority sectoral allocations. Table 3.4: Provincial and Non-Priority Capital Expenditures as a Percentage of the Total Capital Budget 1995 1996 1997 1998 1999 2000 2001 Provincial capital budget 2.3% 2.7% 6.1% 2.3% n/a 2.8% 8.6% as a percentage of total capital budget Provincial capital budget as a percentage of total capital budget (excluding donor 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 budget as a percentage of total capital budget Source: 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 regional redistribution, provincial population, and the existing project portfolio. 25 To the extent that district directorates participate in the budget formulation process it is by making project proposals to their provincial directorates. 26 Discretionary spending is defined as the amount allocated by the provincial level Government during budget formulation. - 26 - 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. The data supports the argument that the PSIs in the priority sectors had the effect of reconcentrating authority at the central level by diminishing the percentage of budget funds allocated at the provincial level. In fact, the PSIs led to an average reduction in discretionary provincial spending (as a percentage of total spending) of nearly 50 percent.28 The table also shows that the non-priority sectors are not benefiting (in relative terms) from the large increase in provincial-level spending programmed for 2001. In real terms, however, the non-priority sectoral allocation grew by 53 percent from 1998 to 2000 and by an additional 27 percent from 2000 to 2001. The growth spurt in 2001 reflects the govermnent's intention to increase allocations to the provincial level as part of its "decentralization" program. In addition, the increase reflects the use of additional HIPC funds in the priority sectors at the provincial level. Thus, in real terms, the amount of the discretionary capital budget allocated to the provinces has increased. The relative amount, 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 Percentage of 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 recurrent spending over the period 1995 to 2001 (not including 1999), though it has ranged from 27 percent to 46 percent (see Figure 3.1). A steep decrease in the ratio of provincial recurrent expenditures to total national recurrent expenditures occurred in 1998, though the ratio has inched up since then. From 1995 to 1997 provincial spending on wages accounted 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% over the period 1995-2001 (excluding 1999). 28 At the same time, it seems that in some provinces and in some priority sectors there is some deconcentration of decision making to the territorial level of government. The real impact of this deconcentration, in terms of the control of resources, is unknown. 29 These figures, however, should be interpreted with caution, given the serious problem of budget coverage in Mozambique (see section on off-budget funds). - 27 - in the central government wage bill in 1998, the provincial share dropped to 47 percent on average over the period 1998 to 2001. A similar trend is evident in non-wage provincial recurrent expenditures. Recurrent spending at the provincial level is largely devoted to personnel costs, which are programmed according to civil service complements at the central level. Furthermore, once the PSI sectors are removed from total non-wage recurrent expenditures (the health, education, agriculture, and public works sectors accounted for 58 percent of total provincial recurrent spending in 2000, for example), 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 2000 Cidade Maputo 169,717 Cidade Maputo 274,954 Sofala 115,509 Maputo 266,444 Maputo 90,686 Sofala 258,793 Niassa 89,273 Niassa 248,561 Manica 84,383 Manica 230,981 Inhambane 83,152 Tete 210,484 C. Delgado 82,701 Gaza 209,127 Average 78,348 Average 188,410 Tete 78,219 C. Delgado 183,492 Gaza 74,643 Inhambane 177,018 Nampula 57,597 Nampula 138,027 Zambezia 43,661 Zambezia 118,408 Source: OGE and INE. 60. The process by which the government allocates expenditures to the provincial level is not transparent. There does not seem to be a clear set of technical criteria used to make these allocative decisions. As Table 3.5 shows, per capita provincial expenditures vary enormously. Over the two years examined, Maputo, Sofala, and Niassa were consistently the most favored, while Nampula and Zambezia consistently received the least in per capita terms. The question of inter-provincial allocation merits further attention, especially if the government intends for its deconcentration reforms to have a redistributional impact. 61. Recurrent expenditures allocated to districts are determined both centrally and locally (legally, the district budget has no legal standing). The civil service personnel component of district recurrent expenditures is determined centrally by the civil service system (districts may also use their own revenues plus any subsidy available to hire temporary contract workers, which most districts do). On the other hand districts themselves are responsible for developing the goods and services component of their recurrent budgets, such as they are, mainly because they are responsible for financing their own non-wage recurrent expenditures. 62. Districts are also allocated a very small share of the development budget. Each year as part of the annual budget process, the district administration submits capital expenditure proposals to the DPPF. As part of the deliberations about the provincial budget, district development allocations are determined. Districts are then informed of - 28 - the approved projects and their allocations. Some districts do not actually administer their allocated funds; rather, funding is transferred to the implementing agency. Due to the lack of a legislative framework, however, there is no uniform process at the district level. 63. District budget management capacity is thus quite limited. Districts neither manage 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 of goods and services, though they also have some control over the hiring of contract workers. Municipalities 64. Municipalities are required to prepare annual budgets according to the legislation governing the national state budget (OGE). Municipalities must use the same structure and classification system as used in the OGE. The intent of the MFL is to make municipal budgets compatible with the national budget and to generate uniform budget documents and processes across municipalities. The MPF provides municipalities with a budget methodology guide as well as yearly templates; both the guide and templates must be followed by the municipalities.30 The cities' treasury system, which is independent of the 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 costs absorbed about two thirds of total expenditures in 1999 and 2000 (see Annex 3 Appendices 1 and 2). Personnel costs were 36 percent of the total, while goods and services accounted for 27 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, to recent civil service salary increases. Similarly, other operating expenditures 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, according to the available data. In all likelihood, however, donor funding at the municipal level accounted for a larger share. 66. In terms of oversight, annual municipal accounts are first reviewed by the Municipal Assembly and then sent to the Administrative Court and the IGF. The IGF is supposed to issue a formal opinion to the court, which would then review the accounts. Furthermore, the government is charged with inspecting municipal financial and asset management at least twice per electoral term. As of July 2000, none of the cities had been audited since their founding in 1998. Between July 2000 and mid-2001, only seven municipalities have actually been audited, though the IGF plans to complete audits of all municipalities 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 as well as a program-based classification system. - 29 - E. Reform Agenda: Observations and Recommendations 67. The Mozambican government's reform program can indeed be described as one of gradualismo. The program has been pursued both in terms of devolution in the urban zones and deconcentration in the rural zones. Both strategies are characterized by greater local participation, though much more in municipalities than districts. At the municipal level the president and assembly are elected, while at the district level pilot projects have stressed the development of representative district consultative councils.31 Given that local participation is one of the key ingredients for successful decentralization (see Box 3. 1), the government has clearly adopted the right strategy by coupling participation with decentralizing reforms, and should continue to link the two, especially at the district level. The strategies also stress integrated planning as both municipalization and the district-level pilot projects aim to integrate sectoral planning with territorial planning. The reforms are oriented toward fostering greater urban devolution and rural deconcentration 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 responsive to citizens' needs. However, decentralization will only make the public sector more responsive if it allows citizens to hold public servants accountable and provides for broad participation in the local development process. The quality of public services increases when elected officials and administrators are held more accountable to their local constituents and clients than to their hierarchical superiors. Moving programs closer to users and allowing them to participate in program design and implementation has many potential benefits. For example, a study in South Africa found that grassroots participation improved the cost-effectiveness of transferring resources to the local poor. Another study in Nicaragua found that schools with greater local autonomy performned better on test scores than schools with little or no autonomy. International experience suggests that in order to maximize the potential benefit of decentralization, participation should not be limited to election time. In Bolivia and the Philippines grassroots associations play a formal (legally-mandated) role in policy making and administration. In Porto Alegre, Brazil a participatory budget-making process has enhanced the effectiveness of municipal resource allocation for local development. At the same time the central government has an important support role to play in the decentralization process. Central government support is necessary to ensure compliance with national policies and safeguards, especially in the area of financial management, and to coordinate activities between levels of government. Moreover, central authorities should play 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. - 30 - 68. The intentions of the reforms notwithstanding, there have been problems in both the urban and rural spheres. The municipalities have limited fiscal resources at their disposal, and it is unclear to what extent municipal revenue performance will improve over the short to medium term. The districts' revenue-raising capacity is also limited and unlikely to improve over the medium term. Moreover, fiscal constraints limit the development of district and municipal administrative capacity. The risk is that fiscal bottlenecks will constrain service delivery at the local level. Furthermore, there is another risk that poor revenue performance will lead to bailouts from the central government, which would exert increased pressure on the nation's fiscal balance and raise concerns about the fiscal sustainability of the decentralization program. The following recommendations, supported by international good practice, are intended to address these concerns. Provinces and Districts: Recommendations Recommendation: The functional roles of the provincial and district administrations need 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 provincial governor) has played a very limited role in the deconcentration program, though in some provinces and in some sectors territorial planning has played a more important role than in others. The role of the territorial provincial government, which is limited by the national constitution, seems to have been further reduced, perhaps unintentionally, as a result of the PSIs. However, the reform program will have to rethink the role of the provinces vis-a-vis the districts. One option would be for the provinces to take on the direct oversight of the districts. For example, the provinces could be charged with holding districts accountable for good administrative and financial management practices. Provinces could also provide technical support at the district level. Provinces could also take on responsibilities for coordinating district and municipal development initiatives. Given the status of both the municipal and district level reforms, the moment is opportune for a reconsideration of the role of the provinces vis-a-vis both the central and local governments. 70. The role of the provinces will depend, in part, on the role of the district administrations. Although reform of the districts is proceeding apace with discussions of district assemblies and budgets, there is a fundamental question that has been sidestepped: the functional role of the district administration. Given the structure of the dupla tutela, even if districts are given assemblies and budgets, they will still be subordinated to the sectoral ministries. Thus, districts should first be assigned functional roles. Once functions were devolved, appropriate areas of expenditure could then be established; revenue needs could then be assessed based on expenditure assignments.32 To some extent the government is putting the cart before the horse by reforming the apparatus of the district without reforming the functional division of responsibilities 32 Transferring revenues before functions raises the specter of unfunded mandates. - 31 - implied by the dupla tutela. There thus has to be a fundamental rethinking of the dupla tutela, and with it, the functional role of the district administrations. 71. Central to this point is the definition of the responsibilities of the district administrations (i.e., the district administrator) vis-a-vis the district sector directorates. The government has two basic choices: devolution or deconcentration. The fiscal analysis shows that devolution at this time is seriously constrained by the small size of the average district tax base and low administrative capacity to raise revenues at the district level. The present fiscal constraint thus limits the extent of decentralization that can be undertaken. From the fiscal perspective deconcentration would seem to be preferred 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. Some have very low yields and are costly to collect. Others, like the market fee, have a high yield, though they are undermined by low rates of compliance. In some cases the legal basis for collecting these fees is unclear. Therefore, the legal foundation of district revenue collection needs to be updated and harmonized across all districts. Moreover, district tax administration needs to be strengthened. Specialized collection personnel need to be trained and deployed, standardized forms need to be produced and disseminated, and the central govermment needs to provide the districts with the legal authority necessary to enforce compliance. It would seem that developing this complex administrative capacity across all of rural Mozambique would be a daunting challenge characterized by high administrative costs. For this reason, two considerations should be kept in mind. First, the district tax and fee structure should be simplified as much as possible: 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, given that the tax base of most districts is likely to be quite small (and the informal sector quite large), especially in light of the municipalization reform. A study on the district tax base may be necessary to determine the extent that districts should also rely on taxes on immobile factors, such as property. Moreover, to the extent that taxpayers perceive they are getting something in return for their contributions, compliance will be easier to promote. Given these considerations, the govermment should consider establishing a district tax administration agency. The role of the agency would depend on the needs of the govermnent, but it could range considerably. At a minimum the agency could provide standardized forms and manuals for tax collectors and taxpayers and impart training courses for district administrators. Or, the agency could take on actual tax collections for the districts, which would each contribute a percentage of their tax collections to its operations. Either option should reduce the total administrative costs of district 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. - 32 - Recommendation: District personnel andfinancial management capacity, especially in the areas of accounting and budget management, should be strengthened. 73. Districts need to readjust the ratio of technical to support staff, not only by increasing expenditures for technical personnel but also by reducing expenditures for administrative personnel (especially those who act as the personal staff of the administrator). The districts also need technical assistance in developing sound financial management practices. In many, if not most, districts financial management is rudimentary. District financial management, including revenue collection and expenditure, needs to be standardized. A guidebook along the lines of the budgeting guide developed for the municipalities should be developed and promulgated by the MPF. Strengthening public expenditure management at the district level would be aided by granting the district budget legal status and integrating it fully into the national and provincial budget process. Municipalities: Recommendations Recommendation: Municipal tax andfee administration need to be overhauled, especially if municipalities are going to assume additionalfunctional responsibilities and improve municipal service delivery. 74. Currently, municipal revenue collections are quite low and there is no evidence that municipalities, especially the smaller ones, are ready to assume additional tax responsibilities. In order to mitigate these problems, it is imperative that the government help improve revenue raising capacity at the municipal level. Though the government has provided the municipalities with ample regulations, it has not provide the materials and tools necessary to develop administrative capacity in this area. Presently, the DPPFs are assuming municipal tax collection responsibilities, which makes sense in the current context. DPPFs should continue to collect municipal taxes until the municipalities are ready to assume them. However, there are legitimate concerns about whether the smaller municipalities will develop the necessary expertise in the short to medium term. Given that municipalities will have to collect a wide range of personal, corporate, and property taxes, administration will be costly and complicated. Creating thirty three municipal tax administrations, many of which would have to be established in very small towns, does not seem the best way forward. It might make more sense, in terms of capacity and administrative costs, for the DPPFs to collect municipal revenues indefinitely.4 Alternatively, a municipal tax administration agency could be established to handle selected aspects municipal tax administration. The responsibilities of the municipal tax agency could range from producing common publications (forms and guides) to providing data processing and property valuation services to outright tax collection (the agency could be funded by a percentage of its collections). Several countries follow variations of this model. In China there is a tax agency responsible for all local collections. 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 to undergo a major reform in the near future. - 33 - municipal tax agency. The government thus has a number of specific options to consider for improving municipal tax collections. Recommendation: The government should comply with the funding and legal requirements of the fiscal transfer system and should consider increasing transfers as the municipalities assume new functions. 75. Presently, fiscal transfers from the central government account for the major share of municipal income (for the five major cities), which is consistent with the ratio of transfers to own source revenues experienced by sub-national governments in most developing countries. In addition, the sum of transfers plus own source revenues is greater than the amount of recurrent expenditures, which is again consistent with international experience. The appearance of the current financial situation is, however, clouded by the fact that municipalities have yet to become responsible for many functions. Once social service functions are transferred to the autarkies, the financial picture will look more worrisome. As more substantive functions are transferred to the autarkies, considerably more resources will be required. Transferring additional functions heavy in personnel costs, such as education and health, might also lead to an imbalance in the amount of recurrent expenditures as compared to revenues. Even given substantial improvement in revenue collections, additional transfers might be required in order to match revenues to expenditures. Currently, funding for the FCA is below the minimum 1.5 percent of national tax revenues required by law and funds are transferred only according to population, in spite of provisions in the law for transfers based on additional factors (such as socio-economic status). As the government transfers more responsibilities, especially for major social functions, to the municipalities it should also move 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 widespread concern that many, if not all, municipalities are not following the law in this area. There is a clear need for a program of training and auditing. The MPF recently launched a three day program in this area at the municipal level. This is a welcome start, but much more is needed. The MPF should develop a follow-up program immediately after the completion of the training program. In addition, the World Bank-funded municipal project should play a role in identifying and addressing specific financial management deficiencies. Initial needs identified include: accounting practices, budget classification (for both revenues and expenditures), and sectoral planning. The MPF, together with the Tribunal Administrativo, should also launch a high-profile program of municipal auditing. Audits would initially need to be corrective, but could shift to a sanctioning mode after an initial trial period. 35 For further details, see World Bank Country Financial Accountability Assessment, 2000. - 34 - Recommendation: The transfer of revenue and expenditure powers to the municipalities should be rationalized and regulated. 77. The assumption of revenue and expenditure responsibilities by the autarkies has been left completely to the autarkies themselves, according to the law. The government should ensure, however, that as the decentralization program goes forward, autarkies match revenues with their expenditure responsibilities. The government might establish some idea of a timetable for progress. The government should clarify the requirements for the transfer of functions and responsibilities. There should be clear, transparent, technical criteria by which the appropriateness of responsibility transfers to the municipal level could be judged. Without some sense of a timetable with technical criteria, the reform could flounder unnecessarily. Recommendation: Municipalities should be empowered to manage their own personnel according to a set of municipal civil service regulations developed by the central government. 78. Another important constraint on municipal decentralization concerns central government control over municipal civil servants. Autarkies inherited civil servant complements without any regard for the match with their functions, expenditures, and revenues. Given that the central government effectively controls staff complements, and that municipal employees are subject to the same civil service system as central civil servants, municipalities do not have control over their own staffs. This means that, for example, if civil service wages increase, municipal wages increase as well, even though the considerations that support central civil service wage increases may not coincide with the situation at the level of the municipalities. Since the municipal wage bill accounts for the majority share of recurrent expenditures, municipalities have no control over their single largest expenditure item. Effectively this means that the central government has an undue influence in municipal expenditure management. For the decentralization reform to 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 civil services for subnational governments, while in other countries subnational public employees are part of the national civil service system. The particularities of the Mozambican case merit serious consideration of a subnational civil service system. - 35 - PART II PUBLIC EXPENDITURE MANAGEMENT REVIEW 79. In 1997, the government embarked on a comprehensive Expenditure Management Reform Strategy (EMRS) covering the areas of budgeting, expenditure programming and aid management, budgetary execution, accounting, debt management, and auditing. Based on a multi-year, phased fiscal management review supported by the World Bank and other donors, the central objectives of the EMRS were to increase the coverage and transparency of the process of public expenditure management, to ensure the efficiency and effectiveness of public expenditure programs in supporting policy objectives, and to guarantee the long-term fiscal sustainability of fiscal programs3 . 80. Significant progress was achieved in expenditure planning and budgeting, mainly as a result of the approval of the Budget Framework Law in 1997 and the launching of the Medium Term Fiscal Framework (MTFF) in 1998. Overall, the existing system provides for good aggregate control of expenditures within years and there is no apparent problem of expenditure arrears. 81. However, the budget system continues to suffer from inadequacies that hinder efficiency, transparency and accountability. Incomplete coverage even of own resources and expenditures, inappropriate functional classification, outdated accounting procedures, weak cash management and deficient controls and audits are all issues that the government intends to address as part of a new round of reforms, some of which were launched recently during the period of this Public Expenditure Management Review. 82. Following the budget cycle (formulation, execution, control and auditing), this part of the report will review major issues confronted by the Mozambique expenditure management system. Chapter 4 focuses on the improvement of budget coverage and transparency-two major issues in Mozambique-recommends ways to streamline budget formulation and to bring the objective of macroeconomic stability more explicitly into the process of budget formulation. In this context, this chapter also discusses possible ways to clarify the role of Parliament in the budgetary process. The following chapter examines budget execution and recommends concrete actions to improve public accounting, reporting and cash management, three of the weakest links in the budgetary chain. Chapter 6 assesses budget evaluation and audit mechanisms and recommends specific actions to improve accountability and compliance. Finally, chapter 7 discusses the introduction of the Public Finance Management Law (Lei de Administradao Financeira do Estado) and the development of an integrated financial management information system (IFMIS). Based on the recommendations in this report, this chapter offers 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 the Government" and "to ensure a high degree of efficiency in the use of public resources as well as the financial sustainability of Government-funded activities". - 36 - CHAPTER 4 BUDGET FORMULATION-IMIPROVING COVERAGE AND TRANSPARENCY 83. Budget formulation and expenditure planning are the areas where progress is most visible 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 was greatly improved, the fiscal year was unified for current and investment expenditures and a set of four consistent budget classifications was introduced. All budgets since 1998 have been discussed and approved by the National Assembly before the beginning of each fiscal year (except in 2000 due to the floods). 84. However, the budget offers only a partial view of public revenue and expenditures, violating the principles of universality and integrality, and undermining the effectiveness of the budget as a tool of public policy. 85. Transparency of public intervention, a fundamental issue in a democratic regime and an important factor in a market economy, is impaired by the use of a functional classification that is too aggregated and that does not offer a sufficiently detailed view of resource allocations among sectors. 86. Budget formulation, which currently involves the preparation of four distinct documents, needs to be streamlined in order to optimize the use of limited technical capacity, while at the same time improving the presentation of the budget document and reinforcing the role of the medium-term fiscal framework. Consideration should be given to bringing the overriding objective of macroeconomic stability explicitly into the budget process. 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 powers with regard to major changes in the budget. A. Improving Budget Coverage 87. The fact that the budget does not fully reflect all government revenue and expenditures is certainly among the most serious issues confronting the Mozambique budget system. This practice breaks two fundamental principles of budgetary management-integrality and universality- both of which are already stated in the Budget Framework Law since 1997, but obviously not implemented in practice. 88. The principle of integrality requires that revenues and expenditures be presented in a single document (the budget), which according to the principle of universality must also include all revenues and expenditures. Adherence to these principles ensures full democratic 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 same rules of fiscal discipline, equity and efficiency. 89. As in many other developing countries with evolving budget management systems and heavily dependent on external assistance, there are two major sources of - 37 - extra-budgetary operations in Mozambique: own source revenues (and corresponding outlays) and donor-financed expenditures. Tax expenditures represent another important area that has been kept outside the scope of the budget. Own source revenues 90. Substantial flows of own source revenues are currently unaccounted for in Mozambique's budget system. These own source revenues, or user fees, derive from the sale of goods, services, and real estate, as well as the interest earned on these funds. This chapter 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 earmarked tax revenues. Own source revenues are collected by a wide range of ministries and autonomous institutions, at the provincial, district and central levels, including ministerial departments, commissions, institutes, special funds, and local service providers, including schools, clinics, hospitals, and public utilities. User fees are collected for social and infrastructure service provision (e.g. health care, education fees, sewerage services), direct service provision (e.g. technical training, civil engineering services, laboratory testing), 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-budget problem 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 amento do Estado "; Austral), which covered the Ministry of Coordination for Social Action (MICAS)37, the Ministry of Public Works and Housing (MOPH), and the Ministry of Health (MISAU). At the provincial level it covered Sofala and Zambdzia. The ministries of 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 the sectors examined in the 1999 study some revenues are used as salary supplements, while others are used to purchase materials. There is a dearth of knowledge about the use of these funds precisely because there are no uniform accounting practices, which, in turn, would make auditing problematic. Furthermore, in some cases own source revenues are deposited in accounts meant for budgetary funds, which complicates the task of budget execution reporting, thereby reducing accountability. 93. The Austral study estimated that the MOPH's own off-budget user fees represented 107 percent of its recurrent budget in 1998 (excluding autonomous institutions and public enterprises), equivalent to about US$ 791,500. MISAU is estimated to collect about US$ 3,805,000 in intra-ministerial off-budget own source revenues, which represented about 34 percent of its 1998 budget. Compared with its African neighbors, Mozambique has one of the highest ratios of user charge collections to recurrent 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 own revenues collected at the district and provincial levels (in nurseries, childcare centers, etc.). - 38 - fourth highest ratio (Shaw and Griffin, 1995). In the education sector, the ministry did not 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 7 percent of the sector's 1998 recurrent budget. The amount of user fees collected by schools is unknown. Similarly, the Ministry of Agriculture and Fishing did not provide much information on own source revenues. 94. At the provincial level, user fees are similarly large with respect to the recurrent provincial budgets.38 In Sofala off-budget user fees are equal to 136 percent of on-budget user 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. In Zambezia off-budget user fees were equivalent to 80 percent of on-budget fees and 33 percent 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 the sewerage services it provides in Maputo City. Similarly, neither the National Directorate of Construction nor the Civil Works Registration Commission have a legal basis for charging professional licensing fees. Likewise, the "Special Clinic" of the Maputo Central Hospital, which collected approximately US$ 2 million in user fees in 1998, has no legal authority to charge for its services (Austral; Table 3). The Regional Center of Sanitary Development, which collected an estimated US$ 220,000 in 1998 in user fees for 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 most important own source revenues from the point of view of the average citizen, have no legal foundation. 96. Some own source revenues do have a legal foundation, though most of these are collected by autonomous institutions. Of the eleven legal user fees collected in the public works sector, only one (the percentage of the fuel tax earmarked for the road maintenance fund) 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 budgetary status of autonomous institutions. 97. There is another set of user fees with legal standing that are collected by ministerial 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 legal foundations, 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 to off-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), and the Instructions on the Execution of the State Budget (October 2000) issued by the accounting department at the MPF. - 39 - though, few are. Even when own source revenues are deposited in central government accounts and later requisitioned, practices vary inter- and intra-sectorally, and from province to province. Some departments provide data neither to the MPF nor their parent ministry about collections and expenditures of user fees (e.g. the National Directorate of Construction). Some other fees are deposited directly by the users in private banks. Thus there are a multiplicity of payment, deposit, transfer, requisitioning, and reporting practices. 99. The government has taken measures to address this problem. In addition to the informational study done in 1999, the Ministry of Planning and Finance issued a set of instructions in October 2000 ordering ministries to comply with the law on own source revenues, namely that all revenues should be first deposited in central government accounts and subsequently requisitioned40. 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, the deposit/requisition process does not distinguish between agencies with financial autonomy and those without autonomy (except that financially autonomous agencies do not have to report on previous expenditures before receiving new transfers). The procedures seem overly burdensome, especially for agencies with financial autonomy and for the management of earmarked revenues. 101. Discussions with three line ministries (public works and housing, education, and health) revealed that the instructions are not being followed. There are two rationales given by the sectors for their flouting of the law. The first is that the existing treasury system is riven with administrative problems and shortcomings. There is a very real sense that, once deposited, funds would be very difficult to reclaim, and even if funds were returned to the collecting departments, the requisition process would not be completed in a timely manner. The second rationale is that user fees are considered as essential 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 be difficult to secure the voluntary cooperation of the sectors. 102. Guidelines for reform. The challenge is to include own source revenues in the budget in a way that minimizes the potential disruption to service provision and elicits the cooperation of line ministries. If, due to inadequacies in the public accounting and treasury systems, user fees were not returned quickly, without undue bureaucratic burden, and in the correct amounts to the appropriate line ministries, important social services might be disrupted. If service delivery, especially in the health and education sectors, were disrupted significantly, the greater budget coverage attained would be offset by potentially high social costs. The government, however, does not have to trade off social service provision for greater budget coverage; these two objectives do not need to be mutually exclusive. 40 Instrucoes sobre a Execuqdo do Orcamento do Estado (Outubro de 2000), Sections 10 and 11. - 40 - 103. The intersections of these financial management, institutional capacity, and service delivery questions are such that the MPF may have to rethink its approach to the problem. In general terms, the MPF should consider changing the instructions and/or law so that some own source revenues do not have to be deposited in central accounts, but can be retained by the ministries for direct service provision. In lieu of having to deposit revenues in central accounts, however, the ministries would be required to report all transactions involving the collection and expenditure of own source revenues, thus bringing them on-budget. 104. Any recommendations in this area, however, must be tempered by practical considerations: there cannot be a "one size fits all" solution to the problem of own source revenues. This differentiated treatment would be consistent with common practice in Sub-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 local retention will stimulate increased collections, thereby leading to better service provision that will disproportionately benefit the poor. Several studies have examined each link in this chain of logic. In terms of increasing collections, the argument is simple: officials have better incentives to collect fees when they retain them (Shaw and Griffin, 1995: 45). Laurent (1982), cited in Ainsworth (1984: 35), argues that "the level at which fees are retained may have some effect on the incentive to collect user fees." Laurent shows that average receipts per bed in Rwandan hospitals that retain user fees amounted to 1.9 to 2.7 times more than receipts in hospitals that remit fees to the ministry of health (similar results were obtained in Togo). A recent study of the Zimbabwean health sector reports that, since hospitals' budget allocations are unaffected by their revenue 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 cost recovery rates in many countries may be due, in part, to requirements that user fees be remitted to central ministries (Ainsworth, 1984: 35). In addition, this literature argues that local retention will benefit users by improving service quality and fostering greater equity. Shaw and Griffin (1995: 26) argue that local facilities suffer disproportionately from disruptions and malfunctions in the budget process. Given that local facilities 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), who studied 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 revenues generally performed substantially better than facilities that sent all their revenues to the treasury." Lastly, local retention arrangements allow for greater decentralization in revenue collections and expenditure management. In highly centralized systems, collection and management of own source revenues is a sensible first step toward greater decentralization. Local agencies would acquire useful experience in financial management, which could serve as a base for subsequent fiscal and administrative decentralization. It is not surprising, then, that Ainsworth (1984: 40), Hecht et al. (1992: 27), and Shaw and Griffin (1995:52) all recommend retention of some or all user fees by local health facilities. Of course care would have to be taken to ensure local compliance with revenue collection procedures. Audits carried out by central bodies would be an instrumental component of the reform. - 41 - Recommendation: Autonomous institutions 105. These institutions would charge their own rates based on the principle of partial cost recovery, given that some autonomous institutions provide services that have substantial positive externalities (housing, roads, etc.). They would retain all collections for their own use and make their own decisions on internal allocation of expenditures, as under current law. They would report on all collections and expenditures directly to the MPF 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 provided directly by the institutions. The goal is for these institutions to have authentic financial and managerial autonomy yet to include information on their financial activities in the budget. The treatment of autonomous institutions would be easiest in the context of the current legal framework. Recommendation: Central service provision and regulatory agencies 106. This category of organizations includes agencies that operate at the central and provincial levels and provide either regulatory services or services to discrete categories of private users. This category includes, for example, the Mozambican Engineering Laboratory, the Civil Works Registration Commission, the National Health Institute, the Regional Center of Sanitary Development, and the Fishing Development Service. What distinguishes these agencies is that they provide discrete goods and services, including regulatory services, to a self-defined set of users largely in the private sector. The principle guiding rate setting here should be full cost recovery, since benefits accrue mostly to private users. Rates would be set by the corresponding ministry through decrees 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 of these agencies' receipts should be deemed earmarked revenue ("receitas consignadas"). The rate of retention should be set to ensure full cost recovery only. Additional revenues accruing beyond cost recovery should revert to the treasury. This is an important qualification, given that many regulatory activities (e.g., granting fishing licenses) will generate 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 daycare centers. Services are provided to the general public (e.g., health) and in some cases are mandatory (viz., education). Many of these services have substantial positive externalities and some are public goods. Many of these services have a direct impact on poverty, so rate setting for this category is based strictly on limited cost recovery (a high level of subsidy would continue to come from the state budget). Rates would be set by the corresponding ministry through decrees updated annually. One hundred percent of these user fees would be retained directly by the collecting institutions (schools, clinics, etc.). Fees would be deposited in bank accounts exclusively for that purpose and information on account movement would be provided by the bank to the MPF. Expenditures would be allocated by sectoral ministries in order to ensure commensurate levels and quality of - 42 - services across regions. Information on their collections and budget execution would be reported 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 Reform Rate 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 MPF Central Service Set centrally based on Retained; data on Annual budget Provision/ full cost recovery and collections remitted to allocations by sectoral Regulatory Agencies regulatory sectoral ministry ministry considerations Local Social Service Set centrally based on Retained; data on Annual budget Delivery 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 this PEMR, the Minister of Finance has sent letters to all other ministers requiring information on all revenue being raised by their departments and all subordinated institutions, their legal basis and the amounts raised in 1999 and 2000. This is a welcome development and a first step in the establishment of a full inventory, which is necessary a requirement. However, the following steps should also be undertaken in addition to the recommendations above: * Specific criteria for institutions that will enjoy administrative and financial autonomy should be defined. * The legal-administrative status of each public sector entity (for example, commissions, institutes, laboratories, funds, administrations, etc.) should be clarified according to the criteria above, as well as the treatment of each category in the state budget. All public entities, including autonomous institutions, should report on revenues and expenditures using the economic and functional classifications. * There is an urgent need to determine which of the user fees currently collected should continue to be collected (given that many fees collected have no legal basis). Those with no legal foundation deemed unworthy of collection should be abolished. * New instructions should be issued allowing for retention of fees by autonomous institutions and local social service delivery organizations, following the recommendations 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 66 percent in 2000) as the government increases its own contribution, but remains high, highlighting the level of aid dependence. The investment budget offers a relatively comprehensive view of total investment expenditures projected for the year. Indeed, 80 - 43 - percent of the estimated total investment (both internally and externally financed), was included 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, and contrary to a commonly expressed view, Mozambique's budget seems to provide a good coverage 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 at the aggregate level (i.e. according to the economic classification), it is almost always the case that donor funding in specific functional areas (e.g. higher education, housing or basic 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 the normal budgetary procedures, following donor-specific disbursing channels, classifications, procurement and reporting requirements, and therefore are not captured by the public accounting system. 112. These problems are best illustrated by comparing planned and actual investment spending by major function (see Table 4.2). Table 4.2: Budgeted and Actual Investment Spending by Functional Classification, 1999 and 2000 (Mt billions) 1999 2000 Investment account Budgeted Actual Budgeted Actual Agriculture 479 75 1,042 33 Health 711 110 1,015 55 Prim./Sec.Education 612 180 793 114 Higher Education 153 Ilnfrastructure 2,488 401 2,269 353 All Other Ministries 1,094 1,025 1,004 807 Total 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 for primary and secondary education. 113. In all sectors, and for the total, the reported execution of the investment budget was far less than budgeted. This is because the reported executed amounts reflect basically the domestic contribution to investment, omitting most of externally financed expenditures. Hence the investment account numbers are not of great value. The policy conclusion to be drawn from this analysis is that serious efforts must be made both by government and donors to better report on execution of donor-funded investment projects. 114. Increasing the share of external assistance that is disbursed and used through the normal budgetary procedures and avoiding the proliferation of parallel donor-driven arrangements, has been one of the major objectives of the govermuent for a number of - 44 - years. The advantages of such a move have been thoroughly discussed, in Mozambique and elsewhere41, and are now generally accepted. However, while recognizing these advantages, donors remain cautious and stress the need to ensure that the fiduciary risks associated with increased budget support are dealt with. This is one of the reasons why government has decided to step up reforms of the budget management system, particularly those directly affecting transparency and accountability, to which the recommendations in this report will contribute. 115. Recommendation. For those donor-financed outlays that are not captured by the accounting system (because they are executed outside the normal budgetary procedures), an annex should be added to the quarterly budget execution reports with information on donor-funded actual expenditures, based on information to be provided by donors and sector ministries. Tax expenditures 116. Tax expenditures are an instrument of fiscal policy. Like government lending and contingent liabilities (see chapter 2), they should be included in the budget. A tax expenditure is the revenue foregone because of preferential provisions of the tax structure, and covers the following: (i) exemptions, which exclude the revenues of a special group of taxpayers from the tax base; (ii) deductions, which reduce the tax base by some expenses or a lump sum; (iii) credits, which are deducted from the tax due (as opposed to deductions which reduce tax income); (iv) deferrals, or postponements of the deadline to pay taxes, without interest or penalties; and (v) reduced tax rates for certain categories of taxpayers or activities (Schiavo-Campo and Tommasi). 117. This issue is particularly important in the case of Mozambique given the large number of fiscal incentives that are applied under the form of total or partial tax exemptions to a wide range of activities. Most tax expenditures are associated with investment incentives, but other activities benefit also, such as the imports of cars by the members of Parliament. 118. A recent study undertaken by the IMF at the request of the MPF42 provides an estimation of the revenue foregone and offers recommendations for the rationalization of the current system of tax incentives. According to this report, around 20 percent of total potential 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 by members of Parliament. Regarding the corporate income tax (contribuicdo industrial), it is estimated that tax exemptions amounted to around 53 percent of the total potential revenue from this tax in 1998. 41 Particularly at the Strategic Partnership for Africa (SPA), a donor coordination forum in which this issue has received particular attention. 42 Gorman, Sab and Ramos, Racionalizacdo dos Incentivos Fiscais, IMF Fiscal Department, August 2000. - 45 - 119. These fiscal incentives are regulated by around 30 laws, decrees and specific government decisions, and no official estimate of their consolidated revenue cost is made public. In particular, no information on this issue is provided in the budget document, hindering transparency and accountability, and reducing the scope for meaningful scrutiny of these activities by the Parliament and the public in general. 120. Recommendation. Tax expenditures should be subject to an explicit trade-off against new spending initiatives and should be as transparent as possible. Ideally, as in the case of government lending, the direct impact of tax expenditures should be budgeted in gross terms both on the revenue side and on the expenditure side. However, as the explicit budgeting of tax expenditures may be difficult in some cases, a consolidated assessment of all tax expenditures should be attached to the budget document. Some countries (France, Spain and the United States) require the executive to present to the legislature such a consolidated statement, even though it is not subject to a vote by Parliament. B. Increasing Budgetary Transparency-A New System of Budget Classification 121. There are four types of budget classifications used in Mozambique: economic, functional, institutional and territorial. The economic classification follows the standard international nomenclature generally used to classify public revenue and expenditure. The institutional classification reflects government structures, while the territorial classification 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 a recurring issue in the dialogue with the MPF and ranked high among the issues treated over the course of this Public Expenditure Management Review. These are the following: first, it does not provide the detail necessary to analyze public intervention in the areas considered to be priority by the government, such as primary education, rural roads or primary health care. This results in a loss of political visibility for the government, and makes it difficult for the legislature to compare government political objectives and programs with the allocation of public funds. Second, and related to the previous point, it reduces fiscal transparency, and when associated with limited or incomplete reporting on actual expenditures, it contributes to a loss of accountability. Third, the lack of detailed information on the allocation and use of budgetary resources reduces donor confidence in the budget, undermining the government's strategy to gradually increase the share of external assistance executed through direct budget support. Finally, the broad classification used hinders the efforts to effectively measure the efficiency and poverty incidence of public expenditures, therefore neutralizing the necessary monitoring of the impact of public intervention and the use of techniques of performance-based budgeting. 123. In addition, while the law provides for the use of four different types of budget classifications, ministries are required only to submit their expenditure proposals - 46 - according to the economic classification. Therefore, even though the budget document presents expenditures according to the four classifications, the functional classification is merely derived from the institutional one. Likewise, during execution, expenditure returns by line ministries as well as the accounting process in the MPF (executed by the Direcado Nacional da Contabilidade Publica, DNCP) are exclusively performed on the basis of the economic classification. Budget execution data by government functions is therefore not captured by the accounting system, and is simply calculated by aggregating those monthly expenditure returns submitted by line ministries along sectoral lines (education, health, etc). 124. Recognizing these shortcomings, the government decided in March 2001 to introduce a new and more detailed functional classification, which will be used in all stages of the fiscal management process-budgeting, accounting, reporting and control - starting with the 2002 budget (government decree No. 10/2001 of March 20, 2001). This will represent a major step forward in terms of greater fiscal transparency. It is also a decisive move to improve donor's confidence in the budget, thus helping the authorities in their strategy to increase the share of external assistance directly executed through the normal budgetary mechanisms. 125. The new functional classification will be introduced following the standardized nomenclature recommended by the United Nations (Classifications of the Functions of Government, COFOG, which is identical to the IMF's Government Financial Statistics), adjusted marginally to reflect the specificities of Mozambique. The COFOG will be introduced in its full detail allowing for a breakdown along functional-programmatic categories. The COFOG classification contains three levels of detail - major groups (1 to 14, which are the ones currently used in Mozambique43), groups (61) and sub-groups (127). 126. As international standards on budget classifications tend to evolve44, it is important to ensure that the nomenclatures used in Mozambique are regularly revised and updated. C. Enhancing Expenditure Planning and Budgeting The budget preparation process 127. Budget formulation is the annual most important process in the translation of government policies and programs into resource allocations. It must reflect a clear overall policy strategy, as defined in government's political program and mandate; it must 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 and security; Education; Health; Social security and social action; Housing and community services; Sporting, recreational, cultural and religious services; Fuel and energy; Agriculture, forestry, fishing and 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. - 47 - well as the structural reforms to be implemented; and it must be embedded into a medium-term fiscal strategy that takes into account the projected overall resource envelope and that promotes fiscal sustainability. It is therefore a demanding process, which beyond the technical work necessary to collect information, process it and draft the necessary documents, often entails complicated negotiations and compromises, requiring the full consideration of decision-makers, both at the political and the technical levels. 128. Budget formulation in Mozambique involves the preparation of four documents each year: the medium-term fiscal framework (MTFF or Cendrio Fiscal de Medio Prazo), the investment plan (Plano Trienal de Investimento Puiblico, PTIP), the economic and 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 documents demands the mobilization of considerable human resources and expertise in a public service where technical and administrative capacity are scarce, and diverts the attention of decision-makers from the policy debates that should be at the core of the budgeting process. 129. The investment plan in particular seems superfluous. The PTIP, as in many other developing countries highly dependent on external aid, does not provide an accurate estimate of capital expenditures because it also includes recurrent outlays, and reflects many of the shortcomings associated with dual budgeting, even though the budgeting processes for recurrent and investment expenditures are now combined in theory. The disadvantages associated with this type of plans are now widely accepted (see Box 4.2). - 48 - Box 4.2: Concerns About PIPs and Proposals to Address Them Public Investment Programs (PIPs) have long been a staple of developing countries. They attempt to provide a mechanism to manage investment projects more effectively, both strategically 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 the dysfunctional budgeting, resource allocation, and financial management practices around the world. In particular, PIPs are associated with dual budgeting - the separation dejure or defacto from the regular current budget, often under the pressure from donors for whom this separation brought both visibility and facilitated aid coordination. Of even greater concern is that PIPs usually 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 of government funds and instability in all three levels of budgeting - aggregate fiscal discipline, resource allocation and use based on strategic priorities, and efficiency and effectiveness of programs 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 of criteria, both economic and non-economic and, in particular, the chosen role of government within a sector. Getting the latter clarified will improve the selection of projects; * There is greater emphasis now on the recurrent budget as the starting point. Related to this, there is a recognition that the PIP and the recurrent budget should be integrated into a medium-term fiscal framework in which the resource envelope is defined by central government, not donors. * More emphasis tends to be placed now on clarifying what should and should not be in the PIP (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 of what constitutes public investment to a more managerial interpretation of the PIP as a tool 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 the absence of a link between medium term sectoral expenditures and overall resources, given the projected macroeconomic framework, as well as to improve the link between multi-annual sectoral expenditure objectives and the annual budget. However, the MTFF to date has been disjointed from the budget process. It has been quite difficult for the government to link the MTFF effectively with the annual budget-at present the MTFF is seen 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 the budget process because it is not seen as "credible." One of the reasons for this is the fact - 49 - that, like the budget, a significant share of revenues and expenditures is not captured (see Section A above). Moreover, the opinion exists within parts of the government that not developing the MTFF does not carry "grave consequences." That is, the value added of the MTFF approach, given its cost in time and resources, is not readily apparent within the government. 131. These problems are not unique to Mozambique, and while the introduction of a MTFF has been advised in several countries, its effective implementation remains difficult and requires managerial changes, political support and technical training (see Box 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 actors should also play an important role in bringing the process together. In South Africa MTFF review 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 State Expenditures before being passed on to the Minister's Committee on the Budget. The entire process is overseen by a Medium Term Expenditure Committee. These overlapping, yet distinct committees reinforce responsibility for the MTFF at each stage. In Tanzania the permanent PER Working Group manages the overall process. Sector working groups, composed of government officials, donors, IFIs, academia, and the private sector, develop the sector expenditure frameworks. 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 management tool, and to attain this status it needs high level political backing. At the very least the MTFF should be subject to high level political approval as a signal of its importance. For instance, in Kenya the MTFF, which is released a few months before the budget, is approved by both the cabinet and the parliament. In South Africa the Medium Term Budget Policy Statement, which is published three months before the budget, is presented by the minister of finance to the parliament. Technical training: Given the challenges of launching a government-wide MTFF, training is critical. Moreover, training cannot be a one-shot event; it must be continuous, adapting to needs as they arise. In Ghana workshops were held for all central and sectoral ministries on strategic planning. In addition, an MTFF technical guide and user manuals were developed. In Tanzania the Ministry of Finance provides the sectors with the format for their sectoral expenditure frameworks. 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, mainly investment). The modified limits are communicated to spending agencies but are not published. This fact makes it difficult to compare budget allocations (published in constant prices) and actual expenditures (recorded in current prices) and therefore reduces transparency. This is aggravated by the fact that adjustments are not uniform and may vary widely between budgetary categories. For example, in 1998 the allocation for - 50 - the Office of the Prime Minister was adjusted upwards by 85 percent, while that for the Ministry of Foreign Affairs was increased by only 0.4 percent (although the total adjustment remained close to projected annual inflation). 133. Recommendations. The following concrete actions should be implemented to improve the process of budget formulation. Recommendation: The PTIP should be abandoned while the PES should be reinforced and used as a document for the monitoring of the PARPA (Plano de Ac do para a Reducdo 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 should better spell out the policy and program objectives underpinning the proposed allocation of resources. In particular, the OE should be more specific regarding the annual program targets and monitoring indicators, at least for the PARPA priority sectors. The links in the budget document between fiscal policy objectives and monetary, exchange rate and structural policies, should also be reinforced. Recommendation: The MTFF needs to be reinforced A number of steps can be taken for this purpose: first, the MTFF needs to be incorporated formally into the budget process. The authorities could take advantage of the new public finance law (see Chapter 7) to enshrine the place of the MTFF in the budget process and give it a legal and institutional basis. It should also become a public document. Second, the MTFF needs to be seen as having high level political support, including support from line ministries. For this purpose, authorities should consider the possibility for the MTFF to be discussed and formally approved by cabinet. Third, the management structure of the MTFF needs to be reformulated so that it provides multiple and overlapping points of responsibility. Fourth, technical assistance should continue to be utilized to produce adequate sectoral expenditure frameworks. The objective of macroeconomic stability and the role of Parliament 134. Bringing the fundamental objective of macroeconomic stability squarely into the budget formulation process is an issue that has started to receive particular attention in many countries around the world. Several countries now use some sort of specific targets for the overall budget deficit (expressed as a share of GDP, in absolute value or as an annual rate of change). Once properly determined, the overall budget deficit and its mode of financing are considered immutable ceilings, not to be reopened at each stage of the budget process. These variables must be based on solid macroeconomic projections and 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 on the 1998 and 199 State accounts. - 51 - 135. In Mozambique, such constraints have not been built into the budgetary process and this issue has not received particular attention. There are at least two reasons for this fact: first, the overall budget deficit has mirrored the targeted level agreed beforehand with 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, basically approving 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 Budget Framework Law of 1997. Article 18 only specifies that the National Assembly must decide on the budget before December 31 of each year, and adds that after approving the budget the Assembly cannot take initiatives that would increase expenditures or reduce revenue. 137. Recommendations. As the conditions that have prevailed until now will tend to evolve, it would be important to address this issue. One possible way would be to use the MTFF as the vehicle that sets the overall budget deficit target for the budget year, as well as the projected targets for the subsequent years. The budget year target should be considered a ceiling not to be exceeded, while the deficit for subsequent years would be provided on an indicative basis, subject to adjustment each year. As a corollary, the MTFF's role in the budget formulation process must be reinforced along the recommendations proposed above. 138. The National Assembly would not be allowed to approve changes in the budget that would brake the deficit ceiling. Increased expenditures in one area would only be possible if matched by offsetting savings in another or an increase in revenue. If exceptional 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 target could be revised, but a new budget law would have to be submitted by the executive to the Assembly. 139. In order to compensate for this limitation on its own discretionary powers, the National Assembly should receive more and better information from the executive, both during budget approval and during budget execution. The detailed functional classification that will be introduced in 2002 will help addressing the first issue, while the publication of quarterly execution reports showing actual expenditures according to this detailed classifier should help addressing the second. 140. In addition, the procedures for discussion and approval of the budget by the Assembly could also be revised in order to improve its involvement and reinforce its role as a counterweight to the executive. The process could be split into two stages: first, a discussion would focus on the macroeconomic and sectoral projections, policies and assumptions underpinning the budget. The MTFF and the PES would provide the main basis for this discussion. This first stage could take place earlier in the budgetary process, depending on whether it is decided to submit these documents ahead of the budget document itself. In a second stage, the discussion would focus on the detailed scrutiny of revenue and resource allocations, based on the budget proposal. - 52- 141. Finally, the technical capacity of the National Assembly to analyze the budget and to monitor its execution must be reinforced. This could be done both by increasing the budgetary allocation in favor of the Parliament's Planning and Budget Committee and through capacity building with the support of the donor community. - 53 - CHAPTER 5 BUDGET EXECUTION-INCREASING EFFICIENCY 142. Budget execution is the phase where resources are used to implement policies incorporated in the budget. It is possible to implement a well formulated budget badly; it is not possible to implement a badly formulated budget well. Hence the importance of a well conceived budget, based on strong macroeconomic assumptions and including realistic revenue and expenditure objectives. However, this is not to say that budget execution comes down simply to mechanisms for ensuring compliance with initial programming. It is a demanding exercise, which requires (i) that the budget be implemented in conformity with the authorizations granted in the law, in both the financial and policy aspects; (ii) that adjustments to unexpected new developments arising 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 savings and to ensure relevant and timely reporting (Schiavo-Campo and Tommasi). 143. Overall, the existing system in Mozambique provides for good aggregate control of expenditures within years-there have not been significant over-runs of expenditures-and there is no apparent problem of expenditure arrears. The system suffers, however, from major weaknesses that hinder efficiency and transparency in the use of public funds. 144. Strengthening budget execution in Mozambique will require a set of actions to address two main challenges. First, reforming public accounting and transforming it into an effective management tool capable of generating, managing, and analyzing high quality accounting information on a timely basis. Second, establishing a cash management system that ensures the cost-effective use of resources and saves the government 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 accounting regulation. 146. The system relies on single-entry registration of payments or receipts, managed through a system of three books that must be kept manually: Livro de Control Orcamental or budget control book, where expenditures are recorded through all their phases (verification, commitment and payment); Livro Numerador de Requisicoes, the book where only requisitions, or commitments, are registered; and finally Livro de Control Bancario, which registers all checks issued for payment and the reconciliation with bank statements. Expenditures are recorded following the economic classification. Therefore, the accounting system reflects simply the registration of the successive stages in a purchasing process: the pro-forna invoices, the issuing of checks and bank - 54 - reconciliations. Before the 1 Oh of each month, spending agencies must send to the National Directorate of Accounting (DNCP), or the Provincial Finance Directorate (DPPF) for those expenditures executed at the provincial level, a summary of all their expenses (balancete), following a pre-determined format set by DNCP46 as well as bank statements. This information is then entered into a database operated by DNCP at the central 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 a complementary period up to three months after the end of the fiscal year for the liquidation and payment of expenditures committed before 315 December47. No new expenditures can in principle be incurred during this time. Often, however, spending agencies use this period to continue incurring new expenditures by simply backdating supporting documents. 148. In addition to accounting for budgetary fumds, the accounting system at the central level also allows for "treasury operations", or Operaq5es de Tesouraria. Treasury operations should, in principle, constitute temporary movements of funds, payments or receipts, that within a certain period of time should be settled with a balancing transaction in the opposite direction. At the end of the fiscal year, these operations are then re-posted to the respective budgetary code and cannot, in principle, be higher than the budgetary allocation48. However, treasury operations have also been used to finance various non- budgeted expenditures on the assumption that they will eventually be approved and that budgetary funds will be made available to settle these advances. Treasury operations can amount to a significant share of total budgetary outlays - in 2000, they represented 11 and 50 percent of actual current and domestically financed investment expenditures, respectively. 149. In addition to performing its normal accounting functions, including production of the State accounts (Conta Geral do Estado) for the National Assembly and the Administrative Tribunal, the accounting department, DNCP, is also responsible for monitoring execution, processing monthly transfers to spending agencies, and producing the quarterly budget execution reports. Moreover, DNCP also manages the whole public sector pension system, covering civil servants and all the military personnel. To perform these functions, DNCP employs 144 people and is the biggest department in the Ministry of Planning and Finance. 46 According to DNCP, spending agencies are not required to send the balancete on paper; they can send it on a disk, as long as it follows the specified format. However, this information is contested by some line ministries, who claim that a hard copy, in large A3 paper sheets, is always required by DNCP officials, which makes the process extremely paper-intensive and cumbersome. 47 The complementary period runs until end-February for expenditures administered at the provincial level 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 the beginning of the year and which are settled at the end of the fiscal year. Another example are the advances to civil servants for medical treatment abroad, which are only settled once the final statement of expenditures is entered by the beneficiaries. - 55 - 150. Major issues. Mozambique's accounting system is currently one of the weakest components of the expenditure management system. Its main characteristics are that it is cumbersome, offers only a partial view of financial transactions, and it is no longer capable of handling the accounting needs of an evolving public sector. The inability to properly account and monitor the use of government funds is undermining the usefulness of the budget as a tool for fiscal management. Furthermore, weak government accounting contributes to donors avoiding the use of budgetary support and encourages the setting-up of parallel extra budgetary systems, undermining the reform effort in general. 151. Significant effort and resources have been used to improve the system, and DNCP has been implementing a program of training and computerization with donor assistance for a number of years, but without changing the fundamentally flawed nature of the current system. The government shares these concerns and a consensus exists among decision makers on the main direction and the nature of the reforms that must be introduced. Recently, reform efforts have been intensified and a plan for the reform of public accounting has been prepared. 152. Five broad problems characterize the government's accounting system. First, the accounting system is out of date, with a proliferation of rules and regulations introduced over the years having compounded the problems of an archaic accounting framework introduced in 1881. Incomplete information flows and obsolete procedures, together with the omnipresent problem of weaknesses in technical capacity, contribute to make it difficult 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 check for mistakes. The problem is exacerbated in a country such as Mozambique where execution is relatively decentralized, with many payments being made at the provincial level, for example, rather than all through the central Treasury. Unnecessary accounting routines and reporting procedures also contribute to slow reporting on budgetary execution. 154. Third, although since 1998 budget accounts also include financial assets and liabilities linked to flows of funds into and from the central treasury account, the system is not set up to capture assets and liabilities that are not the result of financial flows, such as fixed assets and receivables. Hence it cannot show, for example, a change in the stock of government debt due to exchange rate movements, or a change in the value of government buildings due to price fluctuations. 155. Fourth, the coverage of government accounts-like the budget-has not been comprehensive, either with respect to types of institutions or types of transactions. (i) The accounting system has excluded certain public institutions. Autonomous sectoral funds, established by government with the objective that they would raise their own revenue and finance sectoral expenditures, continue to be financed largely by the central budget, but accounting information on these expenditures frequently escape the government's accounting system. (ii) Similarly, certain types of transactions, in - 56 - particular on-lent funds to public-enterprises, and revenue from state assets or the sale of privatized state companies, are not covered by the accounting system. Expenditures generated by certain revenues, such as specialfundos consignados (earmarked funds) and some special levies (such as for land concessions) are not captured by government accounting, as they are administered through special accounts. 156. Fifth, and a constraining factor in the efforts to fill the lacunae above, is again the lack of trained, qualified personnel in the area of accounting. Few of the 144 staff in DNCP have a post-secondary school level degree or a background as trained accountants. There are no Mozambican chartered accountants. The lack of capacity and appropriate systems is the same, or more serious, in each of the upstream spending agencies that feed accounts to DNCP. 157. Recommendations for fundamental change. Accounting is the primary source of financial information linked to the operations of the government. The quality and timeliness of accounting information is critical for an efficient fiscal management system. It constitutes the basis for decisions regarding budgeting (e.g. resource reallocations among budget categories based on information on actual expenditures) and cash and asset management, and may have a tremendous impact on public sector resources-wrong or untimely decisions based on poor accounting information may lead to important financial losses, or have a negative impact on the efficiency of public expenditures. The following reforms are recommended to improve the situation. Recommendation: Introduce double-entry bookkeeping. 158. The current system of single-entry accounting should be replaced by double-entry bookkeeping. Implementation of this new system will require a substantial training program, both at the central and provincial level, which should be launched urgently. It is suggested that the on-going technical assistance program to DNCP, which includes a considerable 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 and replaced by modified accrual accounting49 (training on this technique could take place simultaneously with training on double-entry accounting). Under this technique, revenues are recorded on a full cash basis, while expenditures are recorded on a commitment basis, irrespective of when cash is paid. By doing so, income is brought in line with actual cash available to pay the bills, while assuring that the recording of expenditures cannot be manipulated by simply delaying until the bill is paid. In addition to the advantage of recognizing expenditures from the verification stage, the modified 49 This is also provided for in the new Public Finance Management Law. - 57 - accrual accounting systems also offer an adequate framework for assessing assets and liabilities (including possible expenditure arrears) 50. Recommendation: Eliminate the complementary periodfor payment of expenditures. 160. Introduction of the modified accrual accounting system should be accompanied by the elimination of the complementary period. With the introduction of this new recording system, the complementary period necessary to close accounts becomes superfluous because revenues are recorded on a full cash basis, while expenditures are recorded starting from the valuation stage. In other words, there is no need to wait until the 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 after this 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 the introduction 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 defines the 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 of accounts that are related to budgetary operations. Hence the need to synchronize the implementation of a new chart of accounts with the introduction of the new functional budget classification. Under a cash accounting system, as the one currently used in Mozambique (but which it is proposed here to abandon in favor of modified accrual accounting), the chart of accounts is often limited to budgetary accounts for payments. In the particular case of Mozambique, budgetary accounts capture expenditures only after the 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 possible expenditure arrears. Recommendation: DNCP shouldfocus exclusively on accounting and reporting. 163. DNCP should concentrate exclusively on managing, generating and analyzing high quality accounting information on a timely basis, as well as on monitoring and reporting on government financial operations, particularly those related to the budget execution. All other functions currently performed by DNCP should be transferred elsewhere. This means, for example, that management of the public sector pensions 50 Although requisitions, or commitments, are registered by spending agencies, no consolidated information seems to be kept of the total amount of commitments and how they relate to actual payments. In particular, the quarterly budget execution reports do not present such information. - 58 - 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 an important function and no reports on budget and financial government transactions were made available by the executive, even though the need to report quarterly to the National Assembly on budget execution is clearly established in the Budget Framework Law since 1997 51. Since 2000, however, this has started to change and some welcome developments have taken place. The consolidated State accounts (Conta Geral do Estado), covering the 1998 fiscal year, were established for the first time since independence and submitted to the National Assembly and the Administrative Tribunal for information and external auditing. The 1999 accounts have also been produced and the opinion of the Administrative Tribunal issued. Since 2000, budget execution reports, comparing budget allocations and actual expenditures, have been issued by DNCP on a quarterly basis, which is a major step forward in terms of transparency. For 2001, an interim tracking system was established to monitor execution of expenditures in the areas that have benefited from HIPC-related savings. This system shows actual expenditures in more detail than the existing functional classification and it is expected that it will be generalized 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 developed into an effective tool of policy planning, formulation and monitoring. This should come as no surprise given the weakness of the existing accounting system, which is at the source of the budget and financial information to be used in the reports. Reforms need to be implemented in order to improve the situation (Box 5.1 offers an overview of the main reporting requirements in a well-functioning budget system). 51 Lei No.15/97, Art. 31 - 59 - 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 a performing accounting function. The relevance of external reporting in particular is increasingly recognized as a key factor affecting decisions by foreign investors, which has led countries, such as Argentina, to post quarterly financial reports on the internet. Access to such information can have an impact on the risks investors associate with a country and the interest rates at which they are prepared to lend funds. Reports prepared by the government for internal and external use must be governed by the following basic principles: (i) completeness (they should cover all aspects of the reporting entity's mission); (ii) legitimacy (they should be appropriate for the intended users and consistent in form and content with accepted standards); (iii) user-friendliness (reports should be understandable, presented in a way as to permit information to be captured quickly and communicated 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 in response to a specific need); (vi) consistency (consistency is required internally and over time; in case of changes in the methods or coverage of the report, this should be explicitly mentioned); (vii) timeliness. Acceptably good reporting must involve the production of budget execution reports and financial reports. Budget reports must show, for each item in the budget classification, the initial appropriation, the revised appropriation (if any), the amount apportioned, as well as commitments, expenditures at the verification stage, payments or (at least) arrears and payment. 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 and on-lending; statement of forward commitments; statement of cash flows; statement of tax expenditures; statement on other liabilities and contingencies and statement on physical assets. 166. Recommendations. The quarterly budget execution reports, although representing a significant improvement over the past, need to be further improved. These reports present actual expenditures, both recurrent and investment, compared to the budget allocation (as modified during the year) according to the economic and territorial classifications. Actual expenditures are also reported following the functional and institutional classifications, but no comparison is provided with the corresponding budgetary allocation under these two classifications. Hence it is not easy to assess budgetary performance for, say, health, education or infrastructure, since the simple comparison with the budget figures published in the budget document may be misleading due to the adjustments introduced during the fiscal year. The minor effort required to address this problem would be more than compensated by the increase in transparency that it would generate. In addition, the reports should also include information on funds and institutions that benefit from financial autonomy. In addition, execution reports did not provide information on the complementary period, an issue the authorities have already agreed to address. - 60 - 167. Since budget coverage remains partial (see Chapter 4, section A), the execution reports 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 to ensure that, starting in 2002, reporting on budget execution follows the detailed function classification that will be introduced. Finally, quarterly budget execution reports should show, for each item in the budget classification, the initial appropriation and the revised appropriation (if any), hence providing a consolidated view of the adjustments introduced to the budget during the execution phase. 168. Currently, financial reports, other than the Conta Geral do Estado, are not published. This situation should be corrected as soon as possible. In addition to the consolidated State accounts published since 2000, the following reports should be made available: (i) report on short and medium-term external and domestic debt (an issue increasingly pertinent given the recent increase in domestic debt); (ii) report on lending and on-lending (showing loans contracted and extended, and stock and flow of arrears by beneficiary); (iii) statement on forward commitments (in fulfillment of accountability to the Parliament, showing forward commitments and the projected payment schedule by line ministry/agency); (iv) statement of cash flows (this monthly statement should show flows of cash revenues and cash payments, and opening and closing balances; it should cover all cash and bank accounts); (v) statement of tax expenditures (by sector/function and type of tax concession); (vi) statement of other liabilities and other contingent liabilities (in addition to debt reports, it should show other liabilities and contingencies, such as pensions and insurances); (vii) statement on physical assets (showing the most significant assets, infrastructure and others). Reports (i), (ii) (iv) and (v) should be given special priority. B. Cash Management-Saving the Government Money 169. Poor cash management is one of the major issues faced by the Mozambique expenditure management system. Multiple treasury accounts, deficient cash flow projections and ineffective integration between accounting and cash management functions lead to a waste of government resources and undermine the efficient and smooth execution of budget expenditures. 170. The authorities are aware of these problems and since 1999 the treasury department in the Ministry of Finance (DNT) has embarked on a process of reform with technical assistance support from the European Commission. A wide-ranging program of activities has been devised to address the most pressing issues, covering the rationalization of bank accounts, the streamlining of payment mechanisms and the introduction of more effective cash flow projections. This is the first time a comprehensive reform process has been put in motion seeking to modernize the treasury function. However, given the seriousness of the deficiencies that must be addressed and the tremendous lack of technical capacity available-all linked to the fact that the treasury had for a long time been seen as simply the disbursing office for the government rather than the center for efficient cash management-the reform plan has suffered from a rather slow start, but seems now to be gaining pace. - 61 - The current system 171. Bank accounts. Every fiscal year, each ministry or spending agency with a budgetary 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 the instructions issued by the MPF52, each financial department in line ministries is required to 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 keep accounts opened from one fiscal year to the next, with no effective central control over their balances. This results in a snowball effect, by which accounts opened one fiscal year are kept operating during the next fiscal year and are added to new accounts. At the provincial level, accounts are also opened by the Direc,ces Provinciais, most of the cases in 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 situation prevailing at the provincial level, it is unlikely to differ much from the one existing at the central level. 172. This means in practice that there is no effective cash management. According to information received in the Banco de MoVambique, there are currently more than 2,000 bank accounts in BM only53 over which the treasury has no control and no information on their holdings. As a result, the treasury controls only the central treasury account (Caixa do Estado), which it manages directly, but has no effective control over all available resources. 173. Beyond the fact that it reflects a lack of financial discipline on the part of line ministries and the lack of a pro-active stance on the treasury side to actively address the problem, this situation raises questions regarding the necessary compatibility between budget balances on one hand and financial results on the other. Indeed, in the absence of a timely closure of bank accounts, it is difficult to understand how budget and financial execution data are reconciled. 174. Finally, there seems to be a lack of clarity regarding the legal basis for the control by DNT over bank accounts opened by spending agencies, which in turn is used as an explanation by the treasury for the current unsatisfactory situation. Indeed, no bank account can in principle be opened by line ministries without prior formal authorization by DNT. This rule is routinely disregarded, however, and bank accounts are opened in the name of spending agencies without prior treasury agreement. 175. DNT is aware of these problems and is making efforts to address them (for example, an inventory of bank accounts is already under way), but these efforts have not been 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 includes accounts managed by public enterprises and possibly other institutions. - 62 - level and through the explicit intervention of the Minister of Finance. All legal means already 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 new public finance management law (Lei da Administraqdo Financeira do Estado,) recently approved by Parliament (see chapter 7). To minimize borrowing costs or maximize interest-bearing deposits, operating cash balances must be kept to a minimum. In countries where funds are released through an imprest system, as in Mozambique, spending agencies often accumulate idle balances in their bank accounts at various moments during the fiscal year. These idle balances increase the borrowing needs of the government, which must borrow or, alternatively, reduce central government deposits, to finance the payments of some agencies even though other agencies may have excess cash balances. The introduction of a treasury single account that allows for a consolidated view of all government holdings at any point in time, is the solution that is being adopted by a growing number of countries. 177. Several models exist for the implementation of the notion of a treasury single account (see Box 5.2), but a unifying feature is always the consolidated management of cash balances that cover all government agencies and transactions. The feasibility of their implementation depends mainly on the level of technological development of the banking sector, as well as on the degree of decentralization of budget execution procedures. Poor banking and technological infrastructure in some developing countries is often an obstacle to combining centralization of cash balances with decentralized budget execution mechanisms, in which case a realistic compromise must be accepted. - 63 - Box 5.2: Alternative Models of a Treasury Single Account A variety of methods have been used to centralize transactions and cash management. These can be grouped very broadly into two categories: 1. Passive treasury single account The treasury single account consists of several bank accounts linked between them. Periodic cash limits are set for each spending agency, in accordance with the budget implementation plan, 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 their balances are transferred to the treasury central account. This variant has the advantage of making the spending agency responsible for internal management, while keeping control of cash. It requires, however, a well developed computer network in order to ensure the daily clearing. 2. Active treasury single account The main difference compared to the previous model is that spending agencies do not operate bank accounts and do not make payments directly. Payment orders are issued by spending agencies within the limits of their cash ceilings, but payments are effected by the treasury. In order to avoid the risk of fraudulent transactions, such a system requires a separation between the accounting and the payment functions. Accounting would be performed by the spending agencies, 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, while combining the advantages of centralized cash management with decentralized budget execution procedures. 178. The system to be implemented in Mozambique must consider all these issues, particularly the degree of technological development and integration in the banking sector. DNT is currently developing the overall concept for the implementation of the treasury 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 match budget allocations and global fiscal targets on one side, and expected revenue inflows and planned expenditure outflows, on the other. These plans are elaborated by DNT based on the budget and the fiscal program agreed under the PRGF. They are prepared for spending agencies at central level and for each province and are used to inform government borrowing decisions, especially since 1999 when government short-term treasury bills for budget financing were first introduced. The accounting and treasury departments are supposed to meet on a weekly basis to compare actual budget execution with cash flow projections and to introduce the necessary adjustments. 180. Financial planning and cash flow forecasts suffer from major shortcomings that hinder the effective execution of the budget and the efficient use of government resources. First, budget implementation plans, which must be consistent with the budget and offer the projected rhythm of budget execution both for revenues and expenditures, - 64 - are poorly prepared or not at all. The use of the system of duod&cimos, by which each spending agency is entitled to spend one-twelfth of its budget allocation each month, is used as the defacto budget implementation plan together with the quarterly fiscal targets set under the PRGF (but which are not appropriate for this purpose since they are prepared at a fairly aggregated level). However, fluctuations in revenue inflows and expenditure outflows do not coincide during the fiscal year: peak revenue intake periods are in the last two quarters of the year, due in large part to the payment of taxes on company profits in October, whereas expenditure payments usually peak in the first quarter 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 servicing obligations given highest priority in any given month, it is expenditures on goods and services, particularly for implementing the investment program, that are curtailed if cash is short. When combined with the lack of a consolidated treasury account, poor financial planning often leads to delays in the transfer of programmed monthly resources to spending units54. Although sequestering55 and cash rationing do not seem to be a major issue in Mozambique, delays in the release of funds sometimes lead to stalled implementation of activities. 181. Revenue collection. Revenue is collected by 27 tax offices, of which 5 are located in Maputo, administered by the Direccao Nacional de Impostos e Auditoria (DNIA), or national directorate for taxes and auditing. All cash collected is deposited on treasury accounts (there are 27 revenue accounts, in Maputo and the provinces) on a daily basis. When tax payments are made by check, however, these are deposited first in transitory accounts, managed by DNIA, until the checks are cleared, and only then are these funds transferred to a treasury account. 182. Every month, DNIA sends information to DNT on all revenue collected and transferred to treasury accounts for reconciliation purposes. This information is also sent directly to the office of the Minister of Finance. DNIA is also responsible for the accounting of all revenue, including customs, following the economic classification, and transmits 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 the transitory accounts, and should therefore be able to determine, on a daily basis, the exact amount of revenue collected. In practice, however, transmission of this information between DNIA and DNT is deficient and the latter has difficulties assessing the aggregate revenue position on a timely basis. These difficulties are compounded by the fact that all provinces except two-Sofala and Nampula-are allowed to retain fully the revenue collected in the province to help paying provincial expenditures, which is therefore not transferred to the central treasury account56. According to DNT, inforrmation on 54 Delays in reporting on expenditures by spending units also contribute to delays in replenishment of accounts. 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 over provincial expenditures, mainly because of the taxes collected at the ports of Beira and Nacala. - 65 - provincial revenue may take a minimum of 5 days to reach the treasury. Recognizing these difficulties, both directorates intend to issue shortly ajoint circular regulating the exact time span for the transmission of data as well as the circuit to be followed for the deposit of receipts and their transmission to the treasury. 184. The payment system. For those spending agencies benefiting from a budgetary allocation, transfers of funds are made by DNT on a monthly basis, after issuance by DNCP of titulo de liquidacao, or imprest document. These documents are issued for the exact amount to be reimbursed to spending agencies on the basis of their justification of expenditures incurred the previous month. These transfers are made to the sector bank accounts, both at the central and the provincial levels. For those institutions with financial autonomy, which are entitled to earmarked revenues (e.g. the road maintenance fund), transfers are also made on a monthly basis. The payment instrument consists on an imprest document, M3V/P, that is deposited in the bank account of the beneficiary agency. 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 also incompatible with good financial programming and cash flow management. In addition, the imprest documents used are prone to falsifications and can be the source of fraudulent financial 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 the core of a well functioning fiscal management system. The treasury, responsible for cash management, must be seen as the government agency responsible for managing the flow of government resources in such a way as to minimize net borrowing costs, maximize interest income and at the same time assure that the functions of government have the cash resources required on a timely basis. To accomplish this, cash management must be closely integrated with the other components of the fiscal management system, particularly budgeting and accounting. Recommendation: Rationalize the number and operating procedures of existing bank accounts. 187. Reducing the number of existing bank accounts and imposing strict rules of discipline on the way spending agencies open and operate those accounts for purposes of budget execution, are the two most urgent tasks that DNT must face. The following actions could be taken as a matter of priority (these actions could be taken first at the central level, and later extended to the provinces) and represent a necessary step before the introduction of a treasury single account: * Finalize the inventory of al bank accounts operated by public institutions both in the Banco de Moqambique and in commercial banks. - 66 - * Take all the necessary steps to ensure that all accounts relating to past fiscal gyears are closed and their balances are properly transferred to the central treasury account . * Urgently issue new instructions stating that, starting with the 2002 fiscal year, all bank accounts opened by government departments (i) will require the explicit prior authorization from DNT, who must be one of the co-holders and (ii) will be automatically closed by DNT on March 31 st of the following year in accordance with current legislation. Recommendation: Introduce a treasury single account ("Conta Unica"). 188. Cash balances must be centralized through a treasury single account. This is an account, or set of linked accounts, through which the government transacts all inflows and all outflows of funds. 189. The figure below illustrates a possible model for the treasury single account in Mozambique, based on the model of an active treasury single account (see Box 5.2 above). Figure 5.1: Proposed Model for a Treasury Single Account in Mozambique Central Treasury Budget Execution | Eiternal Asisisqce L 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 three sub-accounts: one for revenue, one for the execution of the budget and a third for external assistance. All accounts would be held at the BM or in a cormmercial bank in those provinces 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 by stating that "the bank accounts of all institutions relating to the current fiscal year will be closed by the National Directorate of Treasury (DNT) or by the Provincial Directorates for Planning and Finance (DPPF), depending on the specific case, on March 31st of the following fiscal year at the latest". 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 open from one fiscal year to the next without control. - 67 - 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 be set for each spending agency. The latter would commit expenditures according to their budget allocations, but would no longer pay suppliers directly. Instead, they would issue payment orders up to their monthly spending limits. Actual payments to the suppliers would 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 to budgetary operations, which will require the introduction of a new, automated, payments system. Recommendation: Develop a new treasury payments system. 191. An automated payments system should be developed and managed by the treasury. It must be integrated into the new National Payments System being developed by the Banco de Moqambique, which will allow for electronic payments and financial compensation in real time. Close coordination between the MPF and BM technical teams will 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 would consist 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 and financing requirements, are currently prepared by DNT at the beginning of the fiscal year on the basis of fiscal targets agreed with the IMF. However, they must be updated on a monthly basis and revised every quarter. This requires close coordination between the treasury, revenue and budget departments as well as with the central bank. 194. A budget implementation plan, derived from the budget, should be prepared at the begnning of the fiscal year in close collaboration with spending agencies. An effective plan should take into account the timing of cash inflows and outflows and be rolled over quarterly to allow for changes in the macroeconomic environment and progress in budget execution. 195. Monthly cash plans should be derived from the budget implementation plan. They should show forecasts of financial flows before new borrowing, including reimbursement of loans or bills due, repayment of arrears and drawings on loans already contracted. These monthly plans should be prepared on a pure cash basis and take into account, inter alia, movements of interest rates and exchange rates, changes in the payment schedule of investment projects of significant size and outstanding obligations. These monthly cash plans would be the principle guide for determining monthly cash limits by spending agency. - 68 - Recommendation: Rationalize revenue collection and improve consolidation. 196. Commercial banks with wide national networks should be used to collect revenue against a negotiated fee, and should gradually replace the existing tax offices. Revenue collected by these banks should be transferred to the treasury accounts, both at the central and 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 taxes should be introduced, along the lines of the Documento UInico used by the customs administration. - 69 - CHAPTER 6 BUDGET 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 of disbursements. Second, external audits (ex-post) by an independent institution (or one that responds exclusively to the legislative branch of government) verify the legality and correct use of funds by spending agencies in the executive branch. Third, evaluations of budget programs by various institutions emphasize outcomes and performance to improve the effectiveness of government expenditure. These three modes of compliance reviews are complementary and mutually reinforcing (World Bank, 1996). 198. Recent developments in budget management have led to a change of emphasis about compliance. While the traditional meaning of conforming to budget appropriations and government financial rules is still important, compliance has evolved to include also conformance with explicitly stated performance-based criteria, among others. 199. Budget evaluation and audit-both internal and external-are weak in Mozambique. A dearth of trained personnel and resources undermines the auditing function of the Finance Inspectorate General-the internal audit department- and the Administrative Tribunal-a court of law entrusted with external auditing. Performnance evaluation 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 progress has taken place recently. For instance, for the first time since independence, the 1998 government accounts (Conta Geral do Estado) were audited by the Administrative Tribunal in 2000 and its report was discussed at the National Assembly, giving rise, for the first time in Mozambique, to a public debate on government accountability. The 1999 accounts have also been audited in 2001. 201. This chapter, largely based on a recent Country Financial Accountability Assessment (CFAA), presents an overview of the current systems of internal and external audit and proposes actions for improvement58. It also offers a brief discussion on the main concepts associated with budget performance evaluation and suggests possible ways of introducing them in Mozambique over the medium run. A. Internal Control 202. The Finance Inspectorate General (IGF), attached to the MPF, is responsible for auditing of all public institutions. Its mandate, organizational structure and key operational policies are defined in the Decree No.40/99 of June 28, 1999. IGF is still being 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 Financial Accountability Assessmenf', 2001. - 70 - 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 years ago, Mozambique's representative at the International Organization of Supreme Audit Institutions (INTOSAI). Its 1999 statute places it squarely within the MPF as an internal organ of that Ministry. 203. IGF applies INTOSAI auditing standards, and has a detailed Manual of Auditing Procedures for the Public Service, which describes in detail such matters as: concepts and types of audits; objectives of financial auditing; auditing standards; INTOSAI auditing standards; planning and execution of an audit; review of internal control; risks and materiality, evidence; audit reporting; as well as a detailed audit program. It also has a manual for the audit of state enterprises. IGF does not systematically feed results of its audits into the external audit, but only provides the Administrative Tribunal with such information 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 60 professional staff. None of the staff holds an internationally recognized qualification, such as Chartered Accountant (ACA), or Certified Public Accountant (CPA). IGF is currently 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 being implemented. 205. Recommendations. First of all, IGF's role needs to be given the institutional and political backing that it deserves. In particular, specific budget lines for IGF should be introduced 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 should be primarily the responsibility of the spending units and they should be designed to help management. * The bulk of internal audits should be focused on assessing expenditure management systems, and conducting spot checks and special investigations. IGF, in the Ministry of Planning and Finance, should be responsible for overseeing the quality of the internal audits in the spending units, and to provide guidance and technical support when necessary. It should also be responsible for drafting the legislation needed for internal control and audit procedures and for regularly updating the Manual of Auditing Procedures for the Public Service. - 71 - B. External Auditing 207. The independent audit of government accounts and financial statements is the responsibility of the Administrative Tribunal (TA). The TA derives its auditing mandate from 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 arising from administrative acts and procedures; (ii) adjudicate appeals against decisions of organs of State, their office holders, agents, and employees; (iii) examine the accounts and 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 the only court in its category. Its head, who represents Mozambique at the International Organization of Supreme Audit Institutions (INTOSAI), is appointed by the President for a term of five years. The National Assembly ratifies the appointment. The TA's President can only be dismissed or suspended from his office because of proven physical or psychological incapacity, or for serious reasons of a moral nature. According to Law No. 16/97 of July 10, 1997, the TA is "the supreme, independent body responsible for external control over the legality of public revenue and expenditure, the judgment of accounts submitted to it by law and the enforcement of financial liability for financial infractions". Therefore, unlike Anglo-Saxon type Superior Audit Institutions, which can only report their findings and hope the government will take prosecuting and/or punitive action against offenders, the TA actually has the power, not only to investigate and report financial misconduct, but also to apply sanctions and impose punishment. Its jurisdiction extends throughout the Mozambican territory, including services and representation offices abroad. Institutions covered include: the state and all its services; autonomous State services and organizations; local representative state bodies; municipalities; public enterprises in which the state has total or majority ownership; collectors, treasurers, receivers, payers, and other persons responsible for the safe keeping or administration of public funds; persons handling or managing funds, loans, guarantees, subsidies, grants or donations 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 the auditing of government accounts-audited accounts are available only 20 months after the end of the corresponding fiscal year59-largely reduces their relevance and is one of the factors that seriously limits accountability. 210. There is a serious mismatch between the wide powers and prerogatives accorded by the law to the Administrative Tribunal on the one hand, and the means at its disposal for carrying them out, on the other. As of March 31, 2001, the TA had only 13 staff assigned to the post-audit function, of whom only eight had a formal accountancy or auditing 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 of the following fiscal year. The TA is required to submit its report and opinion on the statements to the National 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. - 72 - under-paid, with salaries said to be below those paid to the staff of the government's internal audit department, IGF, in the Ministry of Finance. 211. Recommendations. The responsibilities and powers accorded to the Administrative Tribunal are adequate and well specified in the legislation. What is needed now is to provide the institution with the financial, human and operational means to operate and to fulfill its mandate in an acceptable way. 212. In order to attract and retain qualified personnel, and reduce the risk of corruption and misconduct among its officials, the Tribunal should be granted greater independence in setting salary scales for its staff. 213. With a view to compensate its lack of capacity, partnership agreements should be made with reputable private auditing firms operating in Mozambique, which would provide guidance, know-how and support to the Administrative Tribunal. A twinning agreement with a foreign-based Supreme Audit Institution would also be useful in this respect. 214. Finally, the current period of 20 months before the production of audited government accounts should be reduced to 12 months (to be reflected in the new Public Finance Management Law. See Chapter 7). C. Budget Evaluation 215. Budget evaluation has become an integral part of budget management in many countries, complementing the more traditional functions of internal and external auditing. It takes a more global perspective on compliance by examining the effectiveness of public expenditure programs. Evaluation relies on the use of scientific and systematic techniques to quantify the direct and indirect effects of a budget program in relation to set explicit and implicit objectives and the means provided for their accomplishment. In other words, evaluation compares the stated objectives of specific expenditure programs with the outputs, as well as the relation between the resources allocated and the objectives. The wealth of information produced by the evaluation function can be a valuable tool for the improvement of decision making and resource allocation, as long as it is properly integrated into the budget cycle60. 216. Several countries have chosen to assign responsibility for evaluation to their Supreme Auditing Institution, which in the case of Mozambique would be the Administrative Tribunal. In other countries this responsibility was assigned to the budget department, 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 in Mozambique at this point. More pressing issues-improving budget coverage, increasing 60 For details on different budget evaluation techniques and the experience of several countries around the world, see for example T. Carlyle and A. Premchand, "Public Expenditure Management", Chapter 9, IMF, 1993, or S. Schiavo-Campo and D. Tommasi, "Managing Government Expenditure", Chapter 9, Asian Development Bank, 1999. - 73 - transparency and reforming public accounting, cash management and auditing-must be faced first. However, the introduction of this function would certainly improve budget management, as long as it is properly performed and its findings are integrated into the budget formulation process and used as a management tool for decision making. Its introduction 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, as this function is developed and gradually introduced, along with the resources necessary for its effective implementation, a set of evaluation techniques to be used (mid-term evaluations, ex-post evaluations, etc), as well as a clear set of criteria guiding the use of these techniques according to the specific nature of the programs to be evaluated, should be developed. This function could be contracted out to specialized firms, as it is the case in several countries. - 74 - CHAPTER 7 TOWARD A MODERN PUBLIC FINANCE MANAGEMENT SYSTEM 219. The government embarked on an Expenditure Management Reform Strategy in 1997. As explained earlier, most of the progress took place in the area of budget formulation and expenditure planning, with the introduction of the Budget Framework Law in 1997 and the Medium Term Fiscal Framework in 1998. By contrast, relatively little progress was achieved in public accounting, cash management and auditing, which are all areas where reform is typically more difficult. One of the major reasons has been the absence until recently of a central unit in charge of fostering, steering and coordinating budget management reform. 220. Transparency, efficiency and accountability in the use of public funds has emerged as a clear priority in government, and improving fiscal management is among the six priority areas in the PARPA. A renewed effort is currently under way to address the main challenges faced by the budget system in all its dimensions-budget formulation, execution and auditing. This Public Expenditure Management Review is intended to support this process. 221. As part ofthis new emphasis, the government has decided to improve the legal framework underpinning the whole budget system. A new public finance management law (Lei da AdministraVdo Financeira do Estado), was developed in 2001 and approved by the National Assembly. At the request of the authorities, the World Bank, in close coordination with the IMF and other donors, has provided technical advice for the drafting of this new law during 2001. A new technical unit for the financial reform of the State (Unidade Tecnicapara a Reforma da Administrapao Financiera do Estado, UTRAFE), was created in March 2001. It is directly attached to the office of the Minister of 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 proposes recommendations for the drafting of the new law, most of which have been taken into account in the government proposal to Parliament. Since the stated objective in the new law is the development of an integrated financial management information system (IFMIS), this chapter also discusses briefly the main requirements for the successful implementation of such systems and provides a note of caution regarding its implementation 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 reforms according to their degree of priority, identifying first those actions that are considered urgent and which should be implemented within the next few months. - 75 - A. Improving the Legal Framework-The New Public Finance Management Law 223. Until 1997, the budgetary framework in Mozambique was based on a budget law dating from 1901, overlaid with a proliferation of fiscal directives and regulations issued since then. Layered with legacies from the colonial administration and a command economy, the budget system was based on separate recurrent and investment budgets, each following different fiscal years, the budget classification system was not internally consistent, and the budget instrument failed to capture much of the actual flow of public funds, even those financed domestically. 224. Among the changes introduced by the Budget Framework Law, two important improvements stand out: (i) it unified the budget years for the investment and recurrent budget and shifted the fiscal year to correspond to the calendar year and (ii) it introduced a 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 underpin budgetary policy: annuity, unity and universality (i.e. the budget must include all gross revenues and expenditures of State institutions, except those with administrative and/or financial autonomy, municipalities and public enterprises61), non-earmarking of revenue (as a general rule, revenues cannot in principle be earmarked for specific expenditures without legal exceptions 62), and specificity of both revenues and expenditures (the budget specifies the minimum projected revenues and the maximum limits on expenditures according to the classifiers). 225. In spite of these positive developments, the present legislative framework is incomplete and suffers from some critical weaknesses. The Budget Framework Law regulates only partially public finances. It does not offer a comprehensive normative basis for the effective integration of all the subsystems that are part of the fiscal management process-budgeting, accounting, cash and asset management, internal control and auditing. In particular, the law does not specify what are the exact stages in the expenditure process 226. Recognizing this fact, the government has decided to prepare a new law, Lei da Administraqdo Financiera do Estado, or Public Finance Management Law, aiming at regulating the whole financial administration of the State and providing the basis to move toward an integrated financial management system (Sistema Integrado de Administraado 61 However, according to the law, the budget document must include in annex all the information necessary for the assessment of the financial situation of autonomous institutions, municipalities and public enterprises. 62 Notable exceptions currently are the maintenance of roads and bridges (financed in part by the Road Fund which is funded by a share of petroleum taxes) and hospitals (financed in part by consulting fees). 63 From Decree No.7/98, one can assume that these stages are: verification, commitment and payment, but they are not clearly specified. - 76 - Financeira do Estado, SISTAFE). UTRAFE was charged with the drafting the new law and the implementation regulations. 227. Recommendations. All the recommendations in this section have been part of the dialogue with the government and most of them have been included in the law submitted to Parliament; others, however, have not been taken into account and will continue to be part of the on-going dialogue with the authorities. Recommendation (included in the law): The new law should replace the 1997 Budget Framework Law. The new law is intended to become the major legal instrument in the area of public sector financial management. As such, and in order to avoid possible confusion and conflicts of interpretation with the existing Budget Framnework Law (Lei de Enquadramento Or,amental, No. 15/97), the new law should replace it. Recommendation (partly included in the law): The law should clearly state the fundamental objectives offiscal policy. Macroeconomic stability, resource allocation and use based on strategic priorities, and the efficiency and effectiveness of public sector programs and service delivery, should all be stated as the fundamental objectives of fiscal policy. (Macroeconomic stability has not been mentioned among the fundamental objectives stated in the law). Recommendation (included in the law): The fundamental principle of a single, unified treasury account should be unarnbiguously stated in the law (see Chapter 5 Section B for a 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 the production of audited financial accounts should be reduced to 12 months (included in the law); * The provision in the Budget Framework Law allowing for price adjustments during the fiscal year should be suppressed. The budget should be prepared and executed in current 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), commitment and payment, and it should specify that no expenditure can be incurred without prior cabimento (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 to specific cases, and clear rules toward full disclosure of information on this issue should be specified (not included in the law); - 77 - * The introduction of modem accounting techniques (double-entry accounting and modified accrual accounting) should be specified (see Chapter 5 Section A for an analysis of public accounting) (included in the law); * The role of Parliament in the budgetary process should be specified, in particular any restrictions to its discretionary power to increase the overall budget deficit beyond the government's proposal, as well as the specific nature and periodicity of information on actual expenditures it is entitled to receive from the executive (see Section C above) (not included in the law); * Modifications by the executive to the budget during the execution phase should be subject to prior approval by the Assembly, except if they do not entail a change in the overall 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, Mozambique is creating the basis for a new approach to fiscal management that integrates more closely the different functions of the fiscal process-budgeting, accounting, cash and asset management, and auditing. This is a desirable objective since one of the problems with the existing system is precisely the lack of effective communication between these functions. Article 1 of the law clearly establishes the creation of an integrated financial management system, which it calls Sistema de Admininistra,do Financeira (SISTAFE). 229. The introduction of such systems is a very demanding exercise and experience around the world calls for extreme caution in their implementation. Annex 6 offers an overview of integrated financial management systems and provides advice on the steps to be taken for their introduction. Basically, a strong and sustained commitment at the political and technical levels, coupled with a gradualist approach that takes into account capacity constraints and avoids costly technological solutions, are key to the successful introduction of IFMIS. 230. Above all, the basic problems affecting the current system, especially in the areas of budget coverage, accounting, cash management and auditing, must be addressed first in order to create a sound basis for the successful introduction of the SISTAFE. - 78 - C. Action Plan for a More Efficient, Transparent and Accountable Budget Management System 231. This section summarizes the recommendations made in Part II of this report. It provides a road map to reach the final objective stated in the PARPA-the creation of a more efficient, transparent and accountable budget management system. 232. While the action plan proposed here should be considered as a comprehensive package of reforms that reinforce and complement each other-and as such should be implemented fully-its implementation must be phased. Thus, the actions recommended here are phased according to their degree of priority: pressing measures, which are urgent and should be implemented before end-2001; priority measures, which should be implemented within a 12 months period; and medium-term measures, whose implementation will require a longer time frame. Implementation of this set of actions, designed to create the basis for the future introduction of an integrated financial management system (Sistema Integrado de Administraqao Financeira do Estado, SISTAFE), should not take longer than two to three years. - 79 - 233. Pressing measures. The table below summarizes the actions considered urgent. They lay the foundations for the introduction of more fundamental reforms later in the process. Implementation of these actions within the time frame proposed would constitute a clear sign of commitment and progress on the way to a better budget management system. Table 7.1: Summary of Pressing Actions for Reform Area Recommendations Time Comments Frame Budget * Submit the 2002 budget using the new, more Before Fulfilled formulation detailed budget functional classification. end-2001 * Formulate the budget in current prices, Fulfilled starting with the 2002 budget. Legalframework * Draft the implementation regulations of the 2001- On-going new public finance management law (Lei da March Administra9do Financeira do Estado). 2002 Cash and asset * Issue new instructions on bank accounts Before management managed by public institutions stating that, end-2001 starting in fiscal year 2002, all accounts opened by spending agencies (a) will require the explicit prior authorization from the treasury (DNT) who must be one of the co- holders and (b) will be automatically closed by DNT on March 31 st of the following year according to current legislation. Public accounting * Implement all necessary actions to ensure 2001 that the 2002 budget execution is consistent with the new budget functional classification. - 80 - 234. Priority actions. The following actions (Table 7.2) should be considered as priority by govermnent and should be implemented within a 12 month period. Basically, priority actions consist of those reforms that are considered important to improve transparency and accountability. Their timely implementation should raise the confidence level in the quality of budget management, thus helping to create the conditions for increased budget support as an alternative to project aid, an important government objective. Table 7.2: Summary of Priority Actions for Reform Area Recommendation Time Comments Frame Budget coverage * Take all the necessary steps to ensure that a 2002 First significant share of own source and instructions earmarked revenues currently outside the issued in budget are included in the 2003 budget. A August 2001. plan of action for that purpose has already been formulated by the MPF. * Include in the budget documents submitted annually to the National Assembly information on tax expenditures starting with the 2003 budget. Reporting * Quarterly budget execution reports should 2002 present (i) the initial budget allocation, (ii) the revised appropriation (if any) and (iii) all actual expenditures according to the new budget functional classification. * Include an annex to the budget execution reports with information on donor-funded actual expenditures according to the action plan prepared by the MPF. Legalframework * Implement the new public finance 2002 management law through the approval and implementation of the regulations and according to a time-bound action plan. - 81 - Public Issue instructions to all spending units Before accounting informing that the complementary period October for the 2002 fiscal year will be reduced by 1 2002 month and announcing its suppression simultaneously with the introduction of modified 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 Before management operated by public institutions both in the March Banco de Mocambique (BM) and in 2002 commercial banks. * Close all bank accounts not related to the Before 2002 fiscal year. June 2002 * Create globalizing bank accounts for 2002 revenue and expenditures in BM. * Create task force composed of MPF and January BM staff to monitor the introduction of the 2002 treasury single account and the new payments system. Internal control * Introduce specific budget lines for the 2002 In and auditing internal audit department (IGF) in the 2003 accordance budget and allocate an appropriate level of with resources. Continue to implement reforms ministerial to raise IGF's capacity. decision. * Increase budgetary allocation in favor of the The actions Administrative Tribunal (TA) and grant the related to the TA the ability to set its own salary scale. TA go beyond * The Administrative Tribunal should government's establish partnership agreements with responsibility reputable private audit firms operating in and must be Mozambique and a twinning arrangement treated at the with a foreign Supreme Audit Institution appropriate should be sought. institutional level. - 82 - 235. Actions for the medium-term. Table 7.3 below presents the reforms that are considered necessary to complete the transformation of the current budget management system into a modem structure capable of responding to the needs of an evolving public sector in an emerging market economy. Table 7.3: Summary of Actions for the Medium-Term Area Recommendation Time Comments Frame Budget I Reinforce the MTFF by (i) creating its 2003 The decrees formulation legal basis and (ii) making it a public regulating the document. implementation of the Lei da * (i) Eliminate the Three-Year Investment Administracdo Plan (PTIP) as a stand alone document Financeira do and treat investment expenditures within Estado provide the normal budget formulation process. the MTFF with (ii) Develop the Economic and Social a legal basis. Plan (PES) into one of the instruments to inform on the implementation of the PARPA. Public * Launch the gradual introduction of 2003- accounting double-entry accounting and modified 2004 accrual accounting. * Free the accounting department (DNCP) To be of all activities not related to accounting implemented in and reporting. parallel with the organizational reform in the MPF. - 83 - Reporting * Develop and make available on a regular 2003- The specific basis, financial reports in addition to the 2004 format and Conta Geral do Estado, starting with (i) a content are still report on short and medium-term external to be defined. and domestic debt, (ii) a report on lending and on-lending, (iii) reports on cash flows and (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-going introduction of annual cash plans, budget implementation plans and monthly cash plans. * (i) Extend the current mechanism of VAT collection through the banking system to other taxes after assessing its feasibility by banks operating in Mozambique. (ii) Introduce, whenever possible, a single document (Documento Unico) for the collection 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. - 84 - 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 - 85 - Page 1 of 3 Annex 1 Table 1: Selected Economic and Financial Indicators (1998-2002) Actuals Estimated Projected Indicators 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 10.0 Real GDP per capita 1.7 4.4 8.4 10.4 5.4 -0.3 12.9 8.1 Real consumption per capita -13.4 4.7 4.8 4.8 7.1 4.5 7.9 8.9 Inflation (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 2,131 Exports (fo.b.) at current prices 174 226 230 245 284 364 744 778 Termns 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 12.4 of 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 19.0 M2 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 11.6 Nontax 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 31.4 Unallocated expenditures 0.0 0.0 0.4 -0.2 -0.4 -0.4 0.0 0.0 Overall 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 5.5 Private 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 60.0 Public sector 12.0 103 12.1 9.8 11.6 13.3 14.5 13.2 Private 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/ ... ... 710.8 549.1 212.0 194.4 113.8 101.6 External debt service (nonfinancial public sector) Scheduled, before HIPC Initiative assistance (Naples terms) 20.0 26.1 25.2 21.9 17.9 Scheduled, after original HIPC Initiative assistance ... ... ... ... 15.3 5.5 4.4 8.6 Scheduled, after enhanced HIPC Initiative assistance . .. ... 2.5 2.8 6.2 Scheduled, after additional bilateral assistance ... . ... ... 2.7 5.2 (In millions of U.S. dollars, unless otherwise specified) Gross official reserves In millions of US$ 225 383 532 625 670 745 729 740 In 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$) 8890 11294 11546 11850 12689 15689 20606 23852 Current GDP (in US$ 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 applying traditional debt relief mechanisms (Naples terms). The data for 1999-2000 includes the impact of total debt relief under the original HIPC Initiative. Data for 2001-02 include the impact of total debt relief under the enhanced HIPC, additional bilateral assistance, and new borrowing. FINAL December 6,01 Annex 1 Page 2 of 3 Table 2: Revenue and Actual Expenditure, 1992-2000 1992 1993 1994 1995 1996 1997 1998 1999 2000 Nominal (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 16,735 of 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 16,735 of 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 28.4 of 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 1 Page 3 of 3 Table 3: Expenditure by economic classification, 1992-2000 1992 1993 1994 1995 1996 1997 1998 1999 2000 Nominal (Mt 10^9) Total expenditure and net lending 1,483 2,305 4,097 5,157 6,773 9,521 10,141 12,815 16,735 Current 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 3,844 Goods and servicesb 253 360 839 780 989 1,334 1,834 1,928 1,976 tnterestonpublicdebtc 113 199 151 344 473 530 463 324 118 Transfer 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 7,826 Net 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 16,735 Current 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 3,844 Goods and services 1,626 1,623 2,322 1,397 1,225 1,553 2,123 2,165 1,976 Interest on public debt 728 896 416 616 586 617 536 364 118 Transfer 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 7,826 Net 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 51 compensation (%) 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 one hand 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 the breakdown. 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 net float (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 2 Page 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 2010 Actual 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 40,631 Tax 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 13,780 Taxes 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 19,064 Taxes 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 5,284 Othertaxes 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 57,410 Current 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 16,217 Goods 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 8,878 Interestonpublicdebt 463 324 118 515 1,133 724 736 679 775 830 891 960 1,036 Domestic 21 6 14 270 737 306 306 306 348 394 447 507 575 Extemal 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 29,120 Of 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 00 Of 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 10,384 Project 1,894 2,787 3,810 5,591 6,112 6,596 6,288 6,508 6,635 6,763 6,895 7,029 7,165 Nonproject 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 4 Table 2: Mozambique: Government Finance-Scenario for Fiscal Sustainability,1998-2010 (Billon Mt) 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Actual Actual Actual 1/ Estimate Projection 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 37,302 Taxrevenue 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 12,585 Taxes 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 17,363 Taxes 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 4,852 Othertaxes 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 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 25,767 Compensation 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 14,770 Goods 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 8,086 Intereston public debt 463 324 118 515 1,133 724 736 679 769 815 867 923 985 Domestic 21 6 14 270 737 306 306 306 341 380 423 470 523 External 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 26,737 Of 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 0 Of 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 10,384 Project 1,894 2,787 3,810 5,591 6,112 6,596 6,288 6,508 6,635 6,763 6,895 7,029 7,165 Nonproject 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) 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Actual Actual Actual 1/ Estimate Projection 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 17.3 Taxrevenue 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 5.8 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 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 0.0 VAT 5.8 8.3 8.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Consumption 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 2.3 Other 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 24.4 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 0.5 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 0.2 External 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 12.4 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 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 (+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 4.8 Project 4.0 5.4 6.5 7.7 7.0 6.7 5.6 5.2 4.7 4.3 4.0 3.6 3.3 Nonproject 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 -1.8 Nominal 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 AND LoOKING AHEAD I. Introduction 1. The purpose of this Annex is two-fold. First, it describes and analyzes Mozambique's recent experience with fiscal reforms focusing on deconcentration and decentralization. The analysis highlights the overall fiscal impact of these reforms and identifies fiscal constraints on further reforms. Second, the chapter provides recommendations and guidelines for further fiscal deconcentration and decentralization reforms. 2. Much like the Portuguese model, Mozambique is currently governed by two parallel 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 Govermment has pursued a modest policy of deconcentration, while in the urban sub-national system it has carried out a more radical policy of decentralization. In rural areas the central Government has deconcentrated a limited amount of power to both provincial and district 2 administrations. In urban areas the central Government has devolved power to thirty three autonomous municipalities (autarquias) in cities and towns, which are run by elected officials (in effect, the municipalities are small islands of decentralized municipal governments surrounded by deconcentrated provincial and district administrations). In neither case, however, have the reforms been unequivocal; both deconcentrating and decentralizing reforms have been subject to impediments and reversals. Table 1 summarizes 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 authority structures. 2 There are presently ten provinces, 128 districts, and 393 administrative posts. - 93 - Annex 3 Page 2 of 35 Table 1: Functions, Revenues, and Expenditures at the Provincial, District, and Municipal Levels: A Summary Comparison Level Functions Revenues Expenditures Province Territorial planning and Small amount of own Small amount of oversight of all sectoral source revenues (taxes discretionary capital programs in the and mostly fees); less expenditures; about 2% province than 3% of total national of total national capital revenues budget District Territorial Small amount of own Small amounts of administration and source revenues discretionary funds for oversight of all sectoral (National non-wage recurrent programs in the district Reconstruction Tax, expenditures and fixed market and bicycle term contract labor duties, and rental fees) Municipality Economic and social -Transfers from central Authorized to make development; Governient; about 2% recurrent and capital environment, basic of national revenues expenditures in all areas sanitation, and quality of (FCA and FIIL) of competence life; public services; -Own source taxes health; education; (Municipal Head Tax, culture, leisure, and Property Tax, Economic sport; policing; and Activity Tax, Tax on urban infrastructure, Commerce and Industry, construction, and and Income Tax) and housing fees (market, public service, parking, and registration fees) 3. Decentralization and deconcentration are typically undertaken to increase levels of local participation in governance and thereby improve service delivery to local communities. At the same time decentralization and deconcentration must be undertaken in such a way that make them fiscally sustainable. This chapter draws three main conclusions about Mozambique's deconcentrating and decentralizing reforms in light of the goal of improved service delivery and the imperative of fiscal sustainability. First, neither the deconcentrating nor the decentralizing reforms pose risks for the aggregate fiscal balance at present. Neither the deconcentrated provinces and districts nor the decentralized municipalities have unsustainably large entitlements to central government resources. Moreover, current municipal debt is modest and largely short term (and regulated by the MPF). Second, both district and municipal capital and recurrent expenditures are in line with their corresponding revenues. At present, there does not appear to be a risk of budget deficits at either the district or municipal levels (based on available data, which is unfortunately quite limited). Third, however, further improvements in the quantity and quality of service delivery at the district and municipal level will be constrained by available own source revenues as well as central government transfers. Districts have seen their tax and fee bases lost to municipalities, while provinces have seen their discretionary investment budgets decline as resources have been shifted back to central ministries (as part of the Integrated Sectoral Programs). Municipalities have had difficulty delivering the services for which they are currently responsible, and the transfer of new functional responsibilities to the municipalities has 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 are - 94 - Annex 3 Page 3 of 35 contradictory tendencies at both the provincial/district and municipal levels. One thing is clear for both, however. If not addressed, fiscal issues have the potential to be the Achilles heel of the Government's deconcentration and decentralization programs. II. Governance 4. The two ministries most involved in sub-national governance are the Ministry of Planning and Finance (MPF) and the Ministry for State Administration (MAE). The MPF's Provincial Directorates of Planning and Finance (DPPFs) manage revenues and public expenditures, including procurement, at the provincial and district levels.3 The MAE has two National Directorates, Local Administration (DNAL) and Municipal Development (DNDA), which are responsible, respectively, for overall local and municipal management issues. The MAE also has Provincial Directorates of Support and Control (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 and administrative oversight, respectively, of deconcentrated and decentralized entities. Both DPPFs, the DNDA, and the DNPO also have some interaction with the autonomous municipalities, and, though the engagement is limited, these units are the only central government offices that interact with the municipalities. A. Provinces, Districts, and Administrative Posts 5. The provinces, which function as deconcentrated governance structures, are 4 formally administered by governors appointed by the president. Governors, who are regarded as having the same rank as ministers, are jointly responsible with the sectoral ministries for provincial implementation of the government's program. At the provincial level most ministries have a provincial directorate (DP) responsible for their sectoral programs. These DPs are responsible to both their parent ministries as well as the governor. A provincial executive council, composed of representatives from each central government ministry that maintains a provincial directorate, advises the governor. The governor and his executive council are considered the "provincial government." This dual authority structure is known as the dupla tutela. 6. The principal function of the provincial government is territorial planning, which is supposedly done in conjunction with the sectoral planning for which the central ministries are responsible. Territorial planning is supposed to take as its starting point the problems and resources that characterize a particular region, and is supposed to be based on sectoral development strategies and inputs from local constituents, including the development 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 of the 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 practical terms. Thus, provincial govermnents are not directly accountable to provincial citizens. - 95 - Annex 3 Page 4 of 35 conceived Integrated Sectoral Programs (PSIs): education, health, agriculture, water, and roads (the judicial and prisons sectors are also considered priority in some instances). As MPF points out, "The majority of resources for financing state interventions at the provincial level are channeled through the sectoral programs. Therefore, the mobilization of financing for actions considered priority by the provincial government will depend on its capacity to negotiate with the responsible ministries through their respective provincial directorates. The basis of this negotiation should be a clear strategy for the development of the province, consistent with sectoral strategy."5 These orientaq5es clearly recognized the subordinate role that territorial planning plays to sectoral planning. Interestingly, they indicate that the provincial government should negotiate with the provincial directorates, which is another way of saying that the governor must negotiate with the sectors in order to obtain funding for territorial priorities (given that the provincial government is composed of the sectoral representative plus the governor). The PSIs 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 the fact that he is allocated a very small professional staff. Most governors have only a couple of technical advisors. Governors do have a large administrative and service staff, which is responsible for maintaining the governor's official home. Most governors thus have no specialized expertise on which to draw in their dealings with the sectors. Governors, then, must rely on the sectoral directorates for technical and administrative support. 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 and responsibilities. The balance of power between governors and sectoral directors varies from province to province. Informally, some governors are able to influence the provincial 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, and several governors have resolved the ambiguous nature of their power in practice by exerting leadership through the promotion of regional development strategies and regional investment. However, recent constitutional reform proposals did not advocate decentralization to the provincial level. 9. Provincial governors have nominally gained some competencies over personnel management. The National Civil Service Council deconcentrated (Decree #49/94) control over less than mid-level staff, representing about 95 percent of provincially-based staff, 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 have the staff to handle the provincial civil service, the DPACs have for the most part taken over 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. - 96 - Annex 3 Page 5 of 35 10. In surn, though governors are formally vested with many powers and responsibilities, in practice they are not very powerful, given that budgeting, revenue collection, planning, and personnel are controlled by other entities. With the possible exception of a minor coordinating role, at present the real value added of the governors is not 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 at the provincial level, is composed of the administrator and sectoral district directors, who are accountable to their provincial sectoral directors. The dupla tutela structure is thus replicated 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 the district administrator is that of general territorial management. In addition, the administrator is responsible for a myriad of functions in the following sectors: civil authority, infrastructure (including water supply, electricity, and public works), economic development, housing, agriculture (including livestock and fisheries), commerce and tourism, industry, health, education, culture and sports, environmental protection, natural disaster management, transportation and communications, social action, and civil registry. The coupling of numerous responsibilities with few resources and little administrative capacity means that the district administrator's role in service delivery is quite limited. 12. In practice, then, the administrator serves two purposes. First, he engages in general territorial management, which includes resolving disputes, negotiating with traditional leaders, undertaking ad hoc initiatives (for example, mobilizing the population for agricultural or vaccination campaigns, or hiring contract workers to clean up a section of the district), and overseeing the implementation of sectoral programs through the district's Socio-Economic Plan. The administrators are also responsible for coordination with the administrative post chiefs (chefes de posto), who represent the administrator at the sub-district level. Second, the administrator also plays a role in the sectors that are not represented by ministerial district directorates (direcc5es distritais). Most ministries operate 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 that the district administrators have some responsibilities for revenue collection, licensing, and other regulatory activities, as well as provision of select services. Specific licensing and regulatory responsibilities include, for example: land use (approving new construction, new crop plantings), commerce (licensing informal sector activities, logging), transportation (licensing bicycles), education (granting exemptions from school fees), public health and sanitation (issuing fines for littering), and public order (gun licensing). 14. The government recognized that the role and functions of the district administrator were ambiguous, not only because the legislation on district administration 6 Public Works and Housing operates a very small number of district directorates. - 97 - Annex 3 Page 6 of 35 was vague in some cases, but also because some administrators were not familiar with the applicable legislation and did not have records of it in the district offices (due, in part, to destruction caused by the civil war). For this reason the MAE published a guide for district administrators in 1997.7 The guide contains much of the relevant legislation as well as templates of the administrative documents most used. The purpose of the guide was to standardize district administration across the country. Given the lack of training and resources, though, it is doubtful whether standardization has taken place. 15. District administrators may fashion more or less of a role for themselves depending on their own initiative and support staff. One administrator reported instructing 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 also serves as an authority figure at the local level. Some administrators consider themselves the representative of the president in the districts. Administrators seem to command some respect from the local population (for example, it is not uncommon for citizens to greet 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 seem to be important local authority figures. 16. In addition to the district palace, district administrations also have offices in the district seat. Generally, these offices are not well-equipped. Many do not have any computers. Telephones, typewriters, photocopiers, air conditioners, and furniture are sparse. Districts do maintain radios to communicate with the posts at the sub-district level. Some districts have an official vehicle, but as many are in disrepair, district administrators often use their own private vehicles or seek transportation by other means. Given the large distances between posts, and between posts and the district administration, intra-district transportation and communications are serious problems. 17. Administrators do have staff under their control, though their administrative employees greatly outnumber their technical ones, and no sectorally specialized organizational units or personnel operate at the district level. Many administrators have a few chefes de secretaria, who are responsible for specialized administrative functions like accounting, land demarcation, tax collection, and a large number of support staff, including chauffeurs, radio operators, mechanics, gardeners, cooks, and domestic employees.8 The district administrator, along with his staff, are technically civil servants mapped to the MAE. The staff complements are determined centrally by the civil service system. Administrators may also hire contract workers (funded out of own source district revenues), whose numbers can be quite high. In one district the contract workforce was equal to more than 50 percent of the civil service staff complement, while in another it exceeded 100 percent. District staffs are not necessarily small, though they seem to be heavily skewed toward administrative support functions, which means that the district layer of government is fairly thin in terms of technical capacity. Moreover, training and education seem to be very serious problems at the district level. Given small, ill-trained technical 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. - 98 - Annex 3 Page 7 of 35 responsibilities at the central and provincial levels, the district has little authority, and thus little capacity, to govern. 18. The district government is also responsible for developing the district development plan (PDD). The district is considered the base level in the planning system, given that the district is the level of government "closest to the population." The role of the district council in planning is four-fold: to define territorial development strategies; to promote the participation of civil society in the development and implementation 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 of infrastructure and use of natural resources.9 Once the PDD is approved by the district council, it is then sent to the provincial government for approval. Districts are responsible for initiating their own plan and for its financing. The orientagdes instruct the districts to rely on the following sources of financing for the plan: own source revenues, transfers from the provincial budget, sectoral provincial budgets, NGO and donor financing, and in-kind contributions from civil society. The orientaq5es also recommend 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 district administrator plays a minor role in developing the plan, given his lack of administrative capacity. 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 of coordination in implementation. Many sectoral district directorates operate without much technical input from the district administration. Provincial directorates and central ministries have more control over sectoral district directorates than district administrators have. 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 between rural communities and district administrations. Postos also play a limited role in tax collections, and business regulation and licensing of very small scale activities. Many administrative posts do not yet have offices, so post chiefs work out of their homes or make other arrangements. 21. The existence of the dupla tutela at the district level means that MAE's DPACs share normative and supervisory responsibilities regarding district administrations with the provincial governors. DPACs, as their name suggests, play two roles with respect to the districts: support and control. They provide administrative support to the districts, including, for example, help with the census and electoral matters as well as general orientation when necessary. DPACs also communicate district-level concerns to the governor and represent district issues at the provincial level. In addition, DPACs audit district administrations for compliance with financial and administrative regulations, 9 Plano Distrital de Desenvolvimento: Orientaq6es Para Elaboragdo e Implementagao, MAE/MPF, September 1998, p. 7. - 99 - Annex 3 Page 8 of 35 including procedures, use of funds, personnel issues, and revenue collection. Periodic visits to district administrations serve to reinforce DPACs' audit presence. The role of the 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: the assembly. Both provincial and district assemblies are elected bodies that are supposed to be responsible for overseeing the provincial and district governments. These assemblies are responsible for approving provincial and district development plans, as well as approving 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-national governance.10 Moreover, given that elections for the provincial assemblies were last held more 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 revised 1996 national constitution, which defined the concept of "Local Authority (Poder Local, articles 188-198)." The constitution defines two types of local autarkies: the municipality, which includes cities and towns, and the village, which includes administrative posts. Through the promulgation of a series of laws in 1997 (laws # 2/97 and 4/97-11/97), thirty three initial autarquias were created and elections were held in 1998. The initial set of autarquias included Maputo city plus all ten other provincial capitals'2 as well as the twelve remaining cities and ten of the nation's towns.13 Villages have yet to be included in the group of autarquias. 24. Municipalities are governed by an elected legislative organ, the Municipal Assembly, and by an elected executive officer, the Council President, together with his Municipal Council.'4 The Municipal Council is appointed by the Council President, who must chose at least two of his city councilors (vereadores) from the ranks of the assembly. The size of the assembly and council are based, respectively, on the number of electors and citizens residing in the autarquia.15 Assembly members and the president both serve five year terms. Assemblies elect presidents and vice-presidents to preside over themselves. 10 In spite of this, a line item allocation for the provincial assemblies exists in both the capital and recurrent 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 was considered a province. 15 The minimum sizes of the assemblies and councils are 13 and 5 (including the president), respectively. - 100- Annex 3 Page 9 of 35 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 mandate includes: (1) economic and social development; (2) environment, basic sanitation, and quality 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 all sectors. Therefore, the legal framework provides for the gradual transfer of functions and revenues over time as municipalities are ready to assume them. Presently, many municipalities only exercise authority in a limited number of sectors, notably policing and sanitation. 26. Tutelary authority over the autarquias is vested in the MAE for administrative matters and the MPF for financial matters (ministers can, however, delegate oversight authority to the respective provincial governor).16 Municipalities are supposed to coordinate their work with their neighboring district and provincial governments, as well as with the sectoral ministries. 27. Municipalities inherited their staffs from the central government, as civil servants were simply transferred to the municipality. Municipal civil servants are subject to the same civil service system as state employees, which means that in practice municipalities have limited autonomy to manage their personnel complements. In addition, the central government is authorized to ratify municipal personnel charts. Given that municipalities were born with full staff complements regulated by the civil service, they presently have little room to maneuver. There seems to have been little staff turnover caused by the advent of municipal independence. Municipalities do have the authority to hire contract workers as their resources permit. These constraints, coupled with the scarcity of qualified professionals at the local level, have handicapped municipalities in terms of qualified professional staff (for example, in engineering, finance, planning, etc.). 28. Municipal office holders are entitled to a remuneration package that includes salaries or honoraria, travel expenses, and medical care. In addition, the council president is entitled to housing, protocolar travel expenses, and representation expenses. The autarkic legislation sets limits on the relative and absolute remuneration that municipal office holders can eam. The municipal assembly, in determining monetary remuneration packages, must ensure that remuneration does not exceed 30 percent of own source revenues collected by the municipality. At the same time the absolute salary levels, which are established in the autarkic legislation, must not exceed the limits set in accordance with the government salary scale. In addition, the salaries of the municipal staff are set according to the civil service salary scale.17 29. The planning function is carried out by the autarquia through the municipal development 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 the municipal wage bill. - 101 - Annex 3 Page 10 of 35 be submitted by the president to the assembly and subsequently ratified by the central government. In addition, the president must submit reports to the assembly at each of its sessions 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 that effectively fence in the municipal governments on a number of fronts. These powers are discretionary; it is up to the central Government to invoke them. In the best sense these powers would only be used to thwart corruption and malfeasance. In the worst sense they would be used to continue to intervene in municipal affairs. It remains to be seen whether these powers are used for legitimate or illegitimate purposes. There is a sense within the Government that the municipal decentralization reform has reached its limits for now (in terms of extension to new municipalities). There is concern that there are no obvious candidates for further municipalization (the next autarquias would have to be small villages). III. Revenues A. Provinces, Districts, and Administrative Posts 31. The provincial government, like the district administration, collects taxes and fees.'18 The province as a unit of government has only a very small amount of own source revenues, however. In fact, total provincial own source revenues averaged 2.8 percent of total national revenues over the period 1995-2001 (see Table 2 below). Over the same period tax revenues accounted for only 15 percent of total collections, while non-tax revenues made up the vast majority. While there was some detail provided on non-tax revenues 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 are considered revenues of the central government; they are not earmarked for the provincial level. Note that own-source provincial revenue collections are not related in any way to the province's budgetary allocations.'9 Sectoral directorates also collect own source revenues, but these are for the most part considered central government revenues (see section on off-budget own source revenues). Though provinces also receive large amounts of capital expenditures from donors, there is very little information on this funding at the provincial level (see section on off-budgets for more detail). 18 However, neither provinces nor districts are autonomous budget entities and capital budget allocations are not determined by local revenue collections. 19 At the level of treasury management, most provinces (except two), through their DPPFs, actually retain collected revenues as a credit of sorts toward their budget allocations. -102 - Annex 3 Page 11 of 35 Table 2: Provincial Revenues Nominal Terms Millions of Mts. 1995 1996 1997 1998 1999 2000 2001 Tax Revenues 15,000 17,000 23,000 34,450 39,520 9,703 9,000 Non-Tax Revenues 1,000 1,000 2,300 120,350 128,000 178,569 159,000 Own Source 62,000 96,000 114,700 n.a. n.a. n.a. n.a. Revenues Provincial 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 8,481,000 Provincial/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 there is no legislative framework governing public finance at the district level. The main tax collected by the districts is the National Reconstruction Tax (Imposto de Reconstruado Nacional). The IRN is an annual head tax (with several exemptions) of Mts. 5,000 which yielded Mts. 3.3 billion in 1999 and is projected to yield 3.5 billion in 2000. Exact figures 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 (about US$ 0.01) at the district level in 2000.20 The IRN is collected by the district administration as well as the administrative posts, which are able to retain a small percentage (between five percent and 25 percent seems to be the norm in some areas); the remainder is transferred to the district. What the district does with its collections is a matter of controversy. Officially, districts are required to deposit all tax collections in central government accounts (in the DPPF or Finance Divisions). These revenues (that is, 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 the collectors). One DPPF also reported district non-compliance with the transfer of revenues. Other districts reported retaining a percentage of revenues, and transferring the difference to the DPPF. Some districts reported that only a fraction of the centrally deposited revenues are returned to the district, which might explain, to some extent, the problems of non-compliance. 33. Districts also collect a variety of duties and fees. The most important revenue generator among these are the market duties, which are levied according to whether the operator has a permanent or an informal establishment. Informal operators are charged Mts. 2,000 per day, while formal operators are charged between Mts. 50,000-65,000 per month.21 According to some district administrators, formal establishments are supposed to pay more than informal operators, but are unwilling to do so. Non-compliance seems to 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 the source. Estimate made based on the population residing in the districts as compared with an estimate of the collections of the IRN in the districts. 21 Data based on interviews in the Gaza province. It is likely that taxas vary from district to district and province to province. It is not known whether legislation setting these duties exists. - 103 - Annex 3 Page 12 of 35 market duties are highly seasonal, which means that districts suffer cash constraints during non-harvest time. 34. Districts also receive an operating subsidy from the provincial budget. The subsidy 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 legal basis for this activity is not clear, rental income seems to be an important source of financing for current expenditures (see Box 1). 35. There is no specialized district collections unit. Market duties are collected on a daily and monthly basis by the administrator's asistentes, while IRN collections are farmed out to administrative post chiefs at the sub-district level and are handled either by the 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 a citizen comes in to the district offices to transact some other business, as other transactions are made contingent on payment of taxes, duties, and fees owed to the district. Given this self-declaration system, it would be difficult to estimate compliance levels. One district has, however, estimated non-compliance with the IRN. The district of Mecubuiri estimates that 74 percent of (non-exempt) citizens are non-compliant with the IRN.22 36. Since districts do not comply with the treasury regulations to deposit their IRN collections in central accounts, and since districts are responsible for their own duties and fee collections, there are no central government estimates of the amounts of funds actually collected by districts. Districts do, however, prepare statements of revenues and expenditures, though these statements are rudimentary. One district, for example, reports its own source revenues by four categories: IRN, duties and fees, rental income, and other. Another district reports revenues using a more detailed classification scheme (ten general categories with 17 subcategories). Thus, at this point it would be impossible to enter into detail on the composition of revenues. 22 Assumptions: about 83% of the total population is exempt from paying the tax; the district retains 25% of tax revenues. - 104- Annex 3 Page 13 of 35 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 collecting Mts. 781,934,392 in 2000 (annualized from 11 months of data), which yielded a per capita collection ratio of 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 were available on specific duties and fees, the market duties were believed to account for the largest share of that category of revenues. In Mandlakazi, rental income accounted for the largest share of total revenues (48 percent), while fees, duties, and others accounted for 35 percent. The IRN accounted for 17 percent. Both districts received slightly more in subsidies from the province than they collected in revenues (Bilene and Mandlakazi 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 capita yield of Mts. 790 (in 2000 prices). Over 38 percent of district revenues came from rental of a tractor, 43 percent 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 assessed administratively, while fees are collected under a de facto self-declaration system. There are no specialized revenue generation units. Nor is there an established financial system for 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 their revenue bases to the municipalities. The introduction of the decentralized municipalities has had an adverse effect on district revenues. In most cases the creation of municipalities hived off the most urban parts of the districts, thus transferring important segments of the revenue base from the districts to the municipalities. Given the importance of market fees in district revenue composition, district own source revenues have been reduced significantly. In the affected districts, revenues have declined significantly. Though these thirty three districts only represent about 25 percent of the total number of districts, they represent a much larger percentage of the total district tax base. The shifting of the tax base from districts to municipalities is problematic because it calls into question the potential for decentralization to district administrations. Unless decentralized district administrations were to rely largely on transfers from the central government, resources would simply not be available to finance local service delivery. Current fiscal constraints suggest that deconcentration to sectoral district directorates would be more appropriate than devolution to district administrations. From a pure fiscal perspective the scope for devolution to the district level is thus quite limited. - 105 - Annex 3 Page 14 of 35 B. Municipalities23 39. Municipalities have two main sources of income: transfers from the central government and own source revenues.24 Transfers from the central government come from the Autarkic Compensation Fund (FCA, Fundo de Compensaqdo Auttirquico) for recurrent expenditures and the Local Investment Fund (FIIL, Fundo do Investimento de Iniciativa Local) for capital expenditures. Both funds provide untied block grants to the municipalities. According to the law, funds are allocated according to the following allocation criteria: municipal population, municipal area, index of municipal tax performance, and weighted index of development. In practice, the only criterion used so far has been the municipal population. Funds from the FCA, which are divided between the 33 municipalities, are to be set between a minimum of 1.5 percent and a maximum of 3 percent of annual national tax revenues, though in practice less than the minimum has so far been allocated (see Table 3). The total amount and allocation is presented and approved each year in the national budget. Table 3. Central Government Transfers to Municipalities, 2000 (Millions of Meticais) Budgeted tax collections 6,958,000 Actual tax collections 6,915,747 FCA Total 95,000 FIIL Total 44,000 FCA 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 the discretion of the municipality, given that expenditures are in line with national budget priorities. 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 FCA and the FIIL are allocated according to population, there is a fixed ratio of recurrent to capital expenditure transfers at the municipal level. The available data (for 1999 and 2000) show that the ratio has averaged about 2.3. The FIIL, which began disbursements in 1999, is financed by parliamentary appropriations on an annual basis. Law 11/97 also allows for project specific and other investment grants for municipalities, though no grants have yet been made under these mechanisms. The project specific grant provision is for projects approved by the national government, while the other investment grant provision is to reimburse municipalities for expenses related to national projects. These grants would be made annually as part of the national budget. Furthermore, extraordinary grants for emergency purposes (e.g., floods) can be released by the Council of 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 Municipal Tutelage Law (5/97), and the Municipal Finance Law (5/97), or MFL. In addition municipal revenue collection is regulated by the Municipal Tax Code (12/00), which complements the Municipal Finance Law. 24 This section draws from Levy (2001) on municipal finance law and Wojtyla (2000) and Brockman and Wojtyla (2000) on municipal financial management. - 106 - Annex 3 Page 15 of 35 transferred to the municipalities as necessary. Lastly, municipalities are authorized to receive funds from the housing authority (APIE) for rents collected on municipal properties. All municipalities receive fifteen percent of APIE housing receipts, except Maputo, which receives 30 percent.25 41. Some municipalities report delays in receiving grant funds, especially during the early part of the year. In some municipalities both the FCA and FIIL are disbursed three times per year (March, June, and September) by the corresponding DPPF (municipalities do not utilize the duoddcimo system). In others, however, the FCA is disbursed monthly. 42. In addition to transfers from the central government, municipal finance also depends on the following own source revenues: municipal taxes, a share of national taxes (including surcharges), licenses, user fees, fines, inheritances and other gifts, receipts from own assets, including the sale of assets, and other receipts established by law. The Municipal Finance Law (MFL)26 authorizes municipalities to collect the following taxes: (1) the Municipal Head Tax (Imposto Pessoal Autarquico), applicable to residents between the ages of 18 and 60 who are able to work, but exempting the handicapped, members of the military, students, retirees, and domestic women, (2) the Municipal 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 that previously paid the corporate income tax (Sections A and B) and are not required to pay any of the taxes listed below, (4) the Municipal Tax on Commerce and Industry (Imposto Autdrquico de Comercio e Industria), which applies to small businesses subject to the corporate income tax, Section C, and other activities, including street vending and artisanal activities, and (5) the Income Tax, Section B27, which is paid by small businesses, mostly cooperatives and farmers. Municipalities are also authorized to receive 75 percent of the national vehicle tax, which is not currently being collected.28 In addition, municipalities were supposed to receive 30 percent of the Tourism Tax, though it has since been repealed. Tax rates, which are set by the municipal assemblies, are limited by the MFL: the Municipal Head Tax may not exceed two-tenths of the minimum monthly industrial wage (about US$ 7.25), the Municipal Property Tax must be set between 0.2 percent and 1 percent of the asset value, the Economic Activity Tax must be below twenty times the monthly minimum national industrial wage per business location (a maximum of about US$ 720), and the Municipal Tax on Commerce and Industry is also set with reference to the minimum industrial wage.29 In general, the Municipal Tax Code provides highly detailed regulations on how the municipalities are to administer their taxes, leaving little room for discretion. 43. The MTC indicates that with the exception of the Municipal Head Tax and the Economic 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. - 107 - Annex 3 Page 16 of 35 which will then transfer the net revenues (after deducting administrative costs) to the municipalities. Presently, municipalities are only collecting the head tax. The MPF is collecting 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 has not retained a percentage for administrative costs). Municipalities are authorized to take responsibility for tax collection when they are ready, and may do so by notifying the MPF of their intention by December in anticipation of the new fiscal year. Note that the Municipal Tax on Commerce and Industry and the Municipal Property Tax are not collected in other parts of the country, which is appropriate given that autarkies are expected 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 land and buildings; (2) delivery of public services; (3) use of reserved lots in markets and fairs; (4) street vending; (5) vehicle parking; (6) commercial advertising; (7) use of public facilities; (8) cemetery and funeral fees; (9) health inspection; and (10) registrations. Licensing fees are set by the municipal assemblies. While there are no specific restrictions imposed by the MFL, all licensing fees must meet the standards of proportionality and ability to pay. 45. The MFL also authorizes municipalities to charge for direct public service provision in the following areas: (1) water and electricity, (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 unrestricted by the MFL, which only encourages that rates be set on a cost recovery basis. Municipalities may also create autonomous municipal departments (servi os aut6nomos) and municipal public companies to deliver services. The advantage of an autonomous department is that it could be managed on commercial terms; it would thus have more administrative and financial autonomy. 46. Presently, compliance with taxes, licenses, and fees seems to be just as much of a problem for municipalities as for districts. Though compliance data at the municipal level 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 estimated tax collections because the city was unable to collect as much of the Municipal Head Tax as had been budgeted. At the same time the city is having trouble collecting market fees from certain types of businesses. Many established businesses, which are supposed to pay higher market fees than 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 fees slowly, so as to avoid "violence." 47. Municipalities may also finance themselves by borrowing short term funds (due the same fiscal year), the amounts of which may not exceed ten percent of the amount of - 108 - Annex 3 Page 17 of35 their grants from the FCA. Longer term borrowing, while permissible, must be approved by the MPF. Borrowing by autonomous municipal departments and municipal public companies is to be regulated by the Council of Ministers. At present the cities do not appear to have any bank loans. In practice, even access to credit from local merchants is quite restricted, due to the cities' poor credit ratings, though the provision of supplier credit seems to be increasing. Table 4 shows the five largest municipalities' financial obligations. Table 4: Municipal Arrears Municipality Amount (Mts. '000,000) Type Beira 2,617 Borrowed from government to cover operating expenses; due in 2000. Nampula 2,464 Short-term loan Pemba 100 Short-term loan Quelimane 1,412 Supplier credits Maputo No data at municipal level. Total 6,593 Source: Wojtyla (2000). 48. Appendices 1 and 2 show detailed total revenue and expenditures for the period 1998-2000 for the five largest cities: Beira, Maputo, Nampula, Pemba, and Quelimane.30 The data must be interpreted cautiously, given that municipalities began to function independently in 1998 and that their accounts are not audited (the data, therefore, may be more estimates than actuals). Furthermore, data for 2000 are projections and estimates based on the first six months of the year. In addition it should be pointed out that Maputo's share is very large in comparison to the other cities. In fact, Maputo accounted for approximately 40 percent of the total revenues and 66 percent of expenditures of the five largest cities. In terrns of revenue composition for the five cities as a whole, own source revenues made up approximately one third of total revenues, while two thirds came from central government transfers in 1999 and 2000. Own source revenues were largely composed of three sources: taxes, fees and licenses, and other operating revenues.32 In 1999 and 2000 taxes, fees, and licenses accounted for nearly three quarters of the total. In terms of fiscal transfers, grants from the FCA and FIIL made up 43 percent of total transfers. Housing Authority Rentals (APIE counterpart funds) provided fourteen percent of total transfers, about the same level of funding as from the FIIL. The major share of transfers (43 percent) came from other capital funds.33 The data show that the grant system provides less than half of the total amount of transfers and less than one third of total revenues. If own source revenues increase, as they are expected to, FCA and 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 year were carried over to the current year. Given, however, the likelihood that positive year end balances were largely the result of poor reporting of actual expenses, and not actual carry-overs, this category should be analyzed with a grain of salt. - 109 - Annex 3 Page 18 of35 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 other capital funds have increased 57 percent from 1999 to 2000, while FCA grants increased modestly. 49. Excluding Maputo from the analysis allows for a sharper focus on the smaller cities (Appendices 3 and 4). On the revenue side the data show that 40 percent of revenues were generated by the municipalities while the remainder was transferred by the central government. Fees and licenses comprised 30 percent of total revenues while taxes only accounted for two percent, though taxes quadrupled between 1999 and 2000, while fees and licenses increased by only nine percent. Though other operating revenues declined slightly, the net overall effect was an increase in total own source funds. In terms of transfers the FCA and FIIL grants accounted for nearly 50 percent of total revenues, with the FCA grants accounting for 34 percent. APIE and other capital funds accounted for less than ten percent. 50. Focusing exclusively on Maputo provides for some contrast (Appendices 5 and 6). Maputo generates fewer revenues than the other cities as a percentage of total revenues. Own source revenues represented 32 percent of total revenues, leaving transfers to account for slightly more than two thirds of the total. One difference between Maputo and the others is that taxes were higher (fifteen percent) relative to fees and licenses (seven percent) as a percentage of total revenues. Both taxes and fees and licenses have been increasing, though other operating revenues has fallen precipitously, the net result of which has been a decrease in total own source revenues. Another difference is that the FCA and FIIL grants component of total revenues was relatively smaller, at nineteen percent (the FCA accounts for thirteen percent). Other capital funds provided 39 percent of total revenues in Maputo. 51. For the four cities (excluding Maputo) revenues from fees and licenses were greater than tax revenues. Fees and license revenue was mostly from market fees and related activities, garbage collection fees, street vendor licenses, and charges for the use of public land. In Pemba's case the largest component of fees and licenses was the "use and improvement of public land," which was mostly market fees; "building licenses" also provided a significant share of income. In Beira "publicity and neon signs" provided a large share of own source revenue, while in Quelimane "fines and penalties" was important. Tax revenues in Nampula were limited to the head tax. Maputo's "other operating revenues" included "receipts from municipal fixed assets," which the smaller cities presumably do not have (Brockman and Wojtyla, 2000). In Maputo' s case, the tourism tax accounted for about half of tax revenues; the elimination of the tourism tax in 2001 will have a disproportionate effect on Maputo's finances. 52. Presently, then, tax administration seems to be just as much of a problem for municipalities 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 previous status as a province. National, provincial, and municipal financial management seem to overlap. -110- Annex 3 Page 19of35 unclear when municipalities will begin to collect the taxes due them, given the technical complexities of revenue administration. Nor is it clear how municipalities will address the problem of compliance with taxes, licenses, and fees. Though compliance data at the municipal level are not available, anecdotal evidence suggests that non-compliance is considerable. It would seem then, under present conditions, that municipalities face a serious challenge in increasing their tax revenues. To the extent that municipal revenues do not increase considerably (assuming fiscal transfers will not increase greatly in the short term), improvements in the quantity and quality of service delivery will be compromised. The risk for the municipal decentralization program is that limited revenue raising capacity will act as the binding constraint on the transfer of responsibilities from the central government to the autarquias, thus stalling the program. 53. Another concern, which is held by some high level Government officials, is that municipalization has created inequalities vis-a-vis the districts (for example, municipalities are perceived to have received favored status at the local level). Critics believe that the amounts of funding channeled to the municipalities through the FCA and FIIL are too high and that the districts have suffered in comparison. The equity problem is especially pronounced in the towns, as opposed to the large cities. In many rural areas there are not many noticeable differences between towns and districts, except that the autarkic towns receive more funding, and have more control over it, than the districts. - 111 - Annex 3 Page 20 of 35 IV. Expenditures A. Provinces, Districts, and Administrative Posts 54. Provinces, much the same as sectoral ministries, are assigned a portion of the annual national budget (OGE), including investment funds through the national Public Investment Program (PIP)35, which permits provinces to develop provincial PIPs.36 The 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, are determined by the sectoral ministries at the central level, thus provincial level Government has limited input into the budget formulation process in these sectors (sectoral provincial directorates have some input into their parent ministries' budget formulation process). The non-priority sector capital budget is formulated by the provincial government, that is, the sectoral directorates in conjunction with the governor. The non-priority sector recurrent budget is largely determined by decisions about civil service staffing levels made at the center, and in practice tends to be formulated in terms of an increment over the previous year's budget. 55. In the non-priority sectors the capital budget formulation process begins when each sectoral provincial directorate submits a proposal to the DPPF.37 At the same time the MPF sets the aggregate provincial capital budget ceiling and sectoral ceilings for the PSI sectors. The residual, or difference between the provincial ceiling and the sum of the PSI sector ceilings, is allocated to the non-priority sectors. Based on the sectoral proposals and the total ceiling, the DPPF then prepares a proposal for the allocation of funds to the remaining sectors. The DPPF's recommendation is taken up by the provincial council with the governor presiding. The council then makes a final decision on non-priority sectoral allocations. 35 The first PIP, formerly known as the Triennial Public Investment Program (PTIP), was developed in 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 regional redistribution, provincial population, and the existing project portfolio. 37 To the extent that district directorates participate in the budget formulation process it is by making project proposals to their provincial directorates. -112- Annex 3 Page 21 of 35 Table 5: Provincial and Non-Priority Capital Expenditures as a Percentage of the Total Capital Budget 1995 1996 1997 1998 1999 2000 2001 Provincial capital budget as a percentage of total capital budget 2.3% 2.7% 6.1% 2.3% n/a 2.8% 8.6% Provincial capital budget as a percentage of total capital budget (excluding donor funding) 7.0% 8.1% 18.3% 6.9% n/a 8.4% 25.9% Non-PSI (discretionary) provincial capital budget as a percentage of total capital budget 1.5% n/a 2.0% 2.0% Source: OGE for 1995-1998 and 2001, execution report for 2000, and World Bank staff estimates. 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 that 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).39 That is, discretionary provincial spending, which was quite low, shrunk even further. The data supports the argument that the PSIs in the priority sectors had the effect of reconcentrating authority at the central level by diminishing the percentage of budget funds allocated at the provincial level. In fact, the PSIs led to an average reduction in discretionary provincial spending (as a percentage of total spending) of nearly 50 percent.40 The table also shows that the non-priority sectors are not benefiting (in relative terms) from the large increase in provincial-level spending programmed for 2001. In real terms, however, the non-priority sectoral allocation grew by 53 percent from 1998 to 2000 and by an additional 27 percent from 2000 to 2001. The growth spurt in 2001 reflects the government's intention to increase allocations to the provincial level as part of its "decentralization" program. In addition, the increase reflects the use of additional HIPC funds in the priority sectors at the provincial level. Thus, in real terms, the amount of the discretionary capital budget allocated to the provinces has increased. The relative amount, 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 govermment during 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 some deconcentration of decision making to the territorial level of government. The real impact of this deconcentration, in terms of the control of resources, is unknown. - 113 - Annex 3 Page 22 of 35 57. These figures, however, should be interpreted with caution. Given the serious problem of budget coverage in Mozambique (see section on off-budget funds), an analysis of data from the budget will be incomplete. For example, as the off-budget section notes, while the aggregate investment amount indicated in the capital budget might be between three-quarters and four-fifths of actual total investments, the data at the provincial level are less accurate than the aggregate amounts, due to the fact that donors often do not specify the geographical allocation of their funding with any precision or detail. While it is true that the government has been able to capture more and more donor funding in the budget at the aggregate level over the past few years, the same cannot be said for the provincial level. Thus the result that discretionary provincial capital expenditure is decreasing could be spurious (given improvements in accuracy at the aggregate level but not at the provincial level). At the same time, there is a great deal of donor 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 budget figures must be taken as indicative only. Figure 1. Provincial Recurrent Expenditures as a Percentage of 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 recurrent spending (see Figure 1) over the period 1995 to 2001 (not including 1999), though it has ranged from 27 percent to 46 percent. A steep decrease in the ratio of provincial recurrent expenditures to total national recurrent expenditures occurred in 1998, though the ratio has inched up since then. Figure 1 shows that from 1995 to 1997 provincial spending on wages accounted for a hefty two-thirds of the total national wage bill. Due to a massive increase in the central government wage bill in 199841, the provincial share dropped to 47 percent on average over the period 1998 to 2001 (see Appendix 7). A similar trend is evident in non-wage provincial recurrent expenditures. One main difference 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). - 114- Annex 3 Page 23 of 35 expenditures at the central and provincial levels. Spending on wages averages 62 percent of total provincial recurrent spending, whereas it only accounts for 33 percent of total central recurrent spending over the period 1995-2001. Recurrent spending at the provincial level is largely devoted to personnel costs, which are programmed according to civil service complements at the central level. Furthermore, once the PSI sectors are removed from total non-wage recurrent expenditures (the health, education, agriculture, and public works sectors accounted for 58 percent of total provincial recurrent spending in 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 sector financial management. Provincial sectoral directorates are responsible for managing some projects funded by sectoral ministries, especially in the education sector, in which provincially managed projects account for about 25 percent of the total number of sectoral projects, as well as for managing projects in the provincial PIP. 60. Within the sectors, budget management is also somewhat deconcentrated. In the health sector, for example, the Provincial Directorates of Health (DPS) play a significant role in the allocation of resources at the district level. In fact, the DPSs determine the intra-provincial allocation for each of the districts and major health facilities (rural and provincial 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), the responsibilities of the DPPFs, the DPSs, and the district health directorates are not clearly defined; uniform regulations are lacking. Based on calculations by the DPPF, which are informed by the provincial budget and district tabelas de despesa, the relevant treasury office advances funds to the province. In some provinces, funds are transferred directly to the provincial directorate, while in other more deconcentrated provinces funds are transferred to the district directorate. Subsequent monthly transfers are contingent on the executing agency's submission of an accounts report (presta,co de contas) by the tenth of the following month to the DPPF. In cases in which the district directorate is the direct recipient of funds, it must render accounts to the provincial directorate, which then passes the consolidated accounts on to the DPPF. Accounts must be supported by control, balance, and bank reconciliation documentation (as regulated by the DNPO). The DPPF examines accounts for compliance with the provincial budget. However, given that district budgets have no legal standing, the DPPF only verifies accounts at the level of the province. The responsibility for verification at the district level seems to rest with the sectoral provincial directorate. The DPPF then authorizes the next advance (reposi,cao), once the previous accounts are approved. At present no new funds are released until previous 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 not available, the replenishment might be reduced. 61. In practice, however, the system of inter-governmental transfers does not operate quite so smoothly. There are three main problems. First, the operation of the system depends on available resources. Due to a chronological mismatch between revenue collection and expenditure needs, liquidity problems are common, especially at the - iFs - Annex 3 Page 24 of 35 beginning of the fiscal year. Second, the process of submitting accounts, in which the DPPF must approve of submitted accounts before releasing more resources, often causes delays. It is not clear whether this bottleneck is due more to the DPPFs or the provincial and district directorates (it is in this context that own source revenues are used to some extent by the collecting agencies to bridge unanticipated shortfalls). This problem is compounded by the duodecimo system, which does not permit agencies to make up for past shortfalls. Table 6. Per Capita Provincial Expenditures (Recurrent and Capital), 1998 and 2000 (Meticais; cur ent prices) 1998 2000 Cidade Maputo 169,717 Cidade Maputo 274,954 Sofala 11 5,509 Maputo 266,444 Maputo 90,686 Sofala 258,793 Niassa 89,273 Niassa 248,561 Manica 84,383 Manica 230,981 Inhambane 83,152 Tete 210,484 C. Delgado 82,701 Gaza 209,127 Average 78,348 Average 188,410 Tete 78,219 C. Delgado 183,492 Gaza 74,643 Inhambane 177,018 Nampula 57,597 Nampula 138,027 Zambezia 43,661 Zambezia 118,408 Source: OGE and INE. 62. The process by which the Government allocates expenditures to the provincial level is not transparent. There does not seem to be a clear set of technical criteria used to make these allocational decisions. As Table 6 shows, per capita expenditures vary enormously. Over the two years examined, Maputo, Sofala, and Niassa were consistently the most favored, while Nampula and Zambezia consistently received the least in per capita terms. The question of inter-provincial allocation merits further attention, especially if the Government intends for its deconcentration reforms to have a redistributional impact. 63. Recurrent expenditures allocated to districts are determined both centrally and locally (legally, the district budget has no legal standing). The civil service personnel component of district recurrent expenditures is determined centrally by the civil service system (districts may also use their own revenues plus any subsidy available to hire temporary contract workers, which most districts do). On the other hand districts themselves are responsible for developing the goods and services component of their recurrent budgets, such as they are, mainly because they are responsible for financing their own non-wage recurrent expenditures. In the 2001 budget for Mandlakazi, for example, the subsidy from the provincial budget was equal to expenditures on salaries, including temporary contract workers (note that the subsidy does not cover training or travel costs). The provincial subsidy may exceed the annual salary cost of civil service personnel. Districts thus have some discretion over how to spend the subsidy (if it exceeds permanent staff costs) and their own source revenues. Still, some districts report shortages of basic items, including supplies and electricity, due to budgetary - 116 - Annex 3 Page 25 of 35 inadequacies. In addition, some districts report problems with transfers from the provincial budget. Liquidity problems, stemming from inadequacies in the duodecimos system, seem somewhat frequent. Erratic disbursements from the provincial budget coupled with seasonality in own-source revenue collections make the district recurrent budget quite uncertain on a monthly basis. One district, for example, had a very high variance in its monthly expenditures for these reasons. The implications for planning are serious. Box 3: Salaries at the District Level in Mandlakazi The district administration in Mandlakazi consists of 30 permanent civil servants and 15 temporary contract workers. The district administrator and his adjunct earn, respectively, Mts. 39,960,000 and 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 average annual 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 and expenditures, though these statements are rudimentary and non-standardized. One district, for example, reports its expenditures only by month; there is no further classification. Another reports expenditures according to an economic classification. 65. The other important financial management component is the district development budget. Each year as part of the annual budget process, the district administration submits capital expenditure proposals to the DPPF. As part of the deliberations about the provincial budget, district development allocations are determined. Districts are then informed of the approved projects and their allocations (one district complained of submitting its proposal in June and not being informed of a decision until the following January). Some districts do not actually administer their allocated funds; rather, funding is 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 an administrative post building in Chalala (Mts. 450,000,000), construction of a residence for the chefe de posto of Chalala (Mts. 400,000,000), and acquisition of furniture and equipment (Mts. 100,000,000), for a total value of about US$ 53,000. In Mandlakazi the proposed budget for 2001 included three projects: the expansion of the district office, construction of a new office in Tlavene, and furnishing of the district administrator's palacio, for a total of Mts. 750,000,000 or roughly US$ 42,000. The capital budgets from these two districts suggest two hypotheses that merit further attention: (1) that districts prefer to spend their scarce capital resources on building construction projects; and (2) that districts spend large percentages of their 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 neither manage the capital budget nor the civil service component of the recurrent budget. - 117- Annex 3 Page 26 of 35 Districts, for the most part, manage their own source revenues for the acquisition of goods and services, though they also have some control over the hiring of contract workers. 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 District Planning and Financing Project provides funding for the planning and implementation of small-scale infrastructure projects at the district level. The District Development Fund (DDF) is used as a mechanism for channeling donor funding through the provincial treasury of Nampula to the participating districts. Unlike many other donor-funded projects, the pilot makes use of the existing budget and treasury systems in an attempt to strengthen them at both the provincial and district levels. 68. The pilot is being conducted under the auspices of the government's National Decentralized Planning Program, which is responsible for a number of decentralizing and deconcentrating reforms over the past several years, including the creation of the decentralized municipalities. In addition, a new district decentralization anteproyecto is currently under consideration.42 While the details of the reform have not been made available, it is believed that the Nampula pilot is used as the model for reform at the district level. The reform may also go farther than the pilot by giving the district a real role in sectoral decision making. Though the details are not clear, the reform proposal would strengthen the technical and decision making capacity of the district administration vis-a-vis the sectors. Moreover, the reform intends to establish district development councils to increase civil society participation in the planning process. 69. The project is predicated on districts' producing their own medium-term development plans (DDPs). The districts would then use their DDPs, as well as the provincial socio-economic plans (PESs) to develop their annual capital budgets, which would then be approved by the provinces and incorporated into the provincial PIP. District capital budgets would have to be consistent with the provincial PESs, which means 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 to providing sorely needed infrastructure, the project also aims to develop administrative capacity at the provincial and district levels and to foment the participation of civil society, through consultative councils, in the district planning process. 70. The project, which intends to disburse US$ 2.8 million over three years, has helped thirteen of Nampula's twenty one districts, through their executive councils, produce district development plans according to the national guidelines promulgated by the MPF and MAE.43 In terms of financing, the provincial government has committed initially to providing the district development fund with five percent of the provincial PIP in 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 much more sophisticated plans than districts not participating. - 118- Annex 3 Page 27 of 35 the Bank is preparing a Local Management and Development Program to establish district-level participatory planning systems, including DDFs, initially in the districts of two provinces. The DDFs would finance public infrastructure and public services. The Bank 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 package was 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 in Excel (Beira, which uses a DOS-based accounting system, developed with Swedish support, is the exception). The cash accounting system does not record accounts payable or 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 asset valuation inventory (Brockman and Wojtyla, 2000). 72. Municipal accounting is to be further regulated by the Council of Ministers. In terms of oversight, annual municipal accounts are first reviewed by the Municipal Assembly (by the end of March of the following fiscal year) and then sent to the Administrative Court and the IGF (by June). The IGF is supposed to issue a formal opinion to the court, which would then review the accounts. Furthermore, the government is charged with inspecting municipal financial and asset management at least twice per electoral term. As of July 2000, none of the cities had been audited since their founding in 1998. Between July 2000 and mid-2001, only seven municipalities have actually been audited, though the IGF plans to complete audits of all municipalities by the end of 2001. 73. Municipalities are required to prepare annual budgets according to the legislation governing the national state budget (OGE). Municipalities must use the same structure and classification system as used in the OGE. The intent of the MFL is to make municipal budgets compatible with the national budget and to generate uniform budget documents and processes across municipalities. The MPF provides municipalities with a budget methodology guide as well as yearly templates; both the guide and templates must be followed by the municipalities.44 Some, however, go beyond the minimal requirements. Nampula, for instance, prepares monthly departmental budgets as part of the budget process and Pemba, among others, issues monthly reports to its Council President. 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 operated according 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 well as a program-based classification system. - 119- Annex 3 Page 28 of 35 74. Municipalities must present a draft budget to the MPF by July 31st of the previous fiscal year. The municipal council has until fifteen days before the last session of the year to submit the budget, along with a plan of activities, to the municipal assembly. The assembly may only approve or reject, but not alter, the budget (though it may reject with specific suggestions). Budgets approved by the assembly must then be forwarded to the MPF for ratification.45 In addition, three copies of the budget must be made available to the public. Currently, the MPF limits its review to three criteria that autarkic budgets must follow: (1) the classification system must be used to the third digit; (2) the year-end balances are used only for capital expenditures; (3) salaries must not exceed thirty percent of own-source revenues. In addition, the MPF verifies that the budget was approved by the municipal assembly. The MPF may also approve budgets conditionally (in 2001 approximately forty percent were ratified conditionally). The MPF has taken a liberal approach to ratification thus far, on the belief that a legalistic approach would result in failure rates of over fifty percent. 46 It is of the view that budget preparation will improve gradually (in 1998 most autarquias did not present budgets). In fact, most autarquias do not present the corresponding financial and administrative informnation that they are required to submit. This is partly because the government has yet to issue all the regulations that are required by the autarkic legislation, including regulations on territory, municipal debt, and socio-economic criteria for grant allocation. The MPF is presently imparting, 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 items may be added. All budget modifications must be approved by the MPF, with a maximum of 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 for salaries.47 In addition, any remaining funds at the end of the year may only be used for capital expenditures. If a municipality does not approve a budget by March 31 " of the fiscal year to which it applies, the Council of Ministers may remove municipal officials or dissolve the municipal council and assembly.48 76. In terms of the expenditures of the five largest autarquias, recurrent costs absorbed about two thirds of total expenditures in 1999 and 2000 (see Appendices 1 and 2). Personnel costs were 36 percent of the total, while goods and services accounted for 27 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, to recent civil service salary increases. Similarly, other operating expenditures have increased 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 loan obligations. 46 This may be due, in part, to the fact that the MPF has limited to capacity to manage autarkic budgets, which are handled by the same unit that oversees the provincial budget process. Creation of a new autarkic budget unit is under consideration. 47 Neither government transfers nor municipal own-source revenues are earmnarked by the central government, which is appropriate given the mandate of the municipalities to program expenditures based on 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 of illegal activity or negligence, including excessive borrowing and unauthorized personnel expenses. - 120 - Annex 3 Page 29 of 35 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 one percent of total expenditures, according to the available data. In all likelihood, however, donor funding at the municipal level accounted for a larger share. 77. Given Maputo's special status, it is also useful to examine the subset of the other four cities separately (Appendices 3 and 4). In terms of expenditures recurrent costs account for 76 percent of the total, with personnel costs alone accounting for 41 percent of that. Personnel costs grew by about 39 percent between 1999 and 2000 while spending on goods and services declined by a small amount. Capital expenditures grew by fifteen percent. These cities also have positive year-end balances, which are on the order 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 costs increased by 46 percent, slightly higher than in the other cities, while spending on goods and 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 percent of total expenditures for the two years. 79. In terms of capital investment programs, municipalities and the government are required to coordinate, though the division of responsibility is unclear. What is clear is that the government has reserved final authority to itself, even with respect to individual investment projects within one municipality. Public works contracts are regulated by the Council of Ministers, down to the level of pricing. Concessions, in which the municipality may transfer assets temporarily to a third party, are also regulated by the government. Whether the government exercises its authority on a continuous basis, or reserves it for special cases, remains to be seen. 80. The Bank is presently preparing a project to support a number of the decentralized municipalities, starting with the five largest. The project aims to assist the government in developing the legal, institutional, and fiscal framework for municipal governance, to train municipal officials and staff, and to pilot a Municipal Grants Fund for capital expenditures. V. Reform Agenda: Conclusions and Recommendations 81. The Mozambican government's reform program can indeed be described as one of gradualismo. The program has been pursued both in terms of devolution in the urban zones and deconcentration in the rural zones. Both strategies are characterized by greater local participation. At the municipal level the president and assembly are elected, while at the district level pilot projects have stressed the development of representative district - 121 - Annex 3 Page 30 of 35 consultative councils.49 Given that local participation is one of the key ingredients for successful decentralization (see Box 5), the Government has clearly adopted the right strategy by coupling participation with decentralizing reforms, and should continue to link the two, especially at the district level. The strategies also stress integrated planning as both municipalization and the district-level pilot projects aim to integrate sectoral planning with territorial planning. The reforms are oriented toward fostering greater urban 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 responsive to citizens' needs. However, decentralization will only make the public sector more responsive if it allows citizens to hold public servants accountable and provides for broad participation in the local development process. The quality of public services increases when elected officials and administrators are held more accountable to their local constituents and clients than to their hierarchical superiors. Moving programs closer to users and allowing them to participate in program design and implementation has many potential benefits. For example, a study in South Africa found that grassroots participation improved the cost-effectiveness of transferring resources to the local poor. Another study in Nicaragua found that schools with greater local autonomy performed better on test scores than schools with little or no autonomy. International experience suggests that in order to maximize the potential benefit of decentralization, participation should not be limited to election time. In Bolivia and the Philippines grassroots associations play a formal (legally-mandated) role in policy making and administration. In Porto Alegre, Brazil a participatory budget-making process has enhanced the effectiveness of municipal resource allocation for local development. At the same time the central government has an important support role to play in the decentralization process. Central government support is necessary to ensure compliance with national policies and safeguards, especially in the area of financial management, and to coordinate activities between levels of government. Moreover, central authorities should play 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 over the short to medium term. ''he districts' revenue-raising capacity is also limited ad unlikely to improve over the medium term. Moreover, fiscal constraints limit the development of district and municipal administrative capacity. The risk is that fiscal bottlenecks will constrain service delivery at the local level. Furthermore, there is another risk that poor revenue performance will lead to bailouts from the central government, which would exert increased pressure on the nation's fiscal balance and raise concerns about the fiscal sustainability of the decentralization program. The following recommendations, supported by international good practice, are intended to address these concerns. Provinces and Districts: Recommendations 49 Local councils (conselhos de localidade), which would promote democracy at the sub-district level, are also presently under consideration. - 122 - Annex 3 Page 31 of 35 Recommendation: The functional roles of the provincial and district administrations need 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 provincial governor) has played a very limited role in the deconcentration program, though in some provinces and in some sectors territorial planning has played a more important role than in others. The role of the territorial provincial government, which is limited by the national constitution, seems to have been further reduced, perhaps unintentionally, as a result of the PSIs. However, the reform program will have to rethink the role of the provinces vis-a-vis the districts. One option would be for the provinces to take on the direct oversight of the districts. For example, the provinces could be charged with holding districts accountable for good administrative and financial management practices. Provinces could also provide technical support at the district level. Provinces could also take on responsibilities for coordinating district and municipal development initiatives. Given the status of both the municipal and district level reforms, the moment is opportune for a reconsideration of the role of the provinces vis-A-vis both the central and local governments. 84. The role of the provinces will depend, in part, on the role of the district administrations. Although reform of the districts is proceeding apace with discussions of district assemblies and budgets, there is a fundamental question that has been sidestepped: the functional role of the district administration. Given the structure of the dupla tutela, even if districts are given assemblies and budgets, they will still be subordinated to the sectoral ministries. Thus, districts should first be assigned functional roles. Once functions were devolved, appropriate areas of expenditure could then be established; 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 the apparatus of the district without reforming the functional division of responsibilities implied by the dupla tutela. There thus has to be a fundamental rethinking of the dupla tutela, and with it, the functional role of the district administrations. 85. Central to this point is the definition of the responsibilities of the district administrations (i.e., the district administrator) vis-,a-vis the district sector directorates. The Government has two basic choices: devolution or deconcentration. The fiscal analysis shows that devolution at this time is seriously constrained by the small size of the average district tax base and low administrative capacity to raise revenues at the district level. The present fiscal constraint thus limits the extent of decentralization that can be undertaken. From the fiscal perspective deconcentration would seem to be preferred 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. Some have 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. - 123 - Annex 3 Page 32 of 35 yield, though they are undermined by low rates of compliance. In some cases the legal basis for collecting these fees is unclear. Therefore, the legal foundation of district revenue collection needs to be updated and harmonized across all districts. Moreover, district tax administration needs to be strengthened. Specialized collection personnel need to be trained and deployed, standardized forms need to be produced and disseminated, and the central Government needs to provide the districts with the legal authority necessary to enforce compliance. It would seem that developing this complex administrative capacity across all of rural Mozambique would be a daunting challenge characterized by high administrative costs. For this reason, two considerations should be kept in mind. First, the district tax and fee structure should be simplified as much as possible: 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, given that the tax base of most districts is likely to be quite small (and the informal sector quite large), especially in light of the municipalization reform. A study on the district tax base may be necessary to determine the extent that districts should also rely on taxes on immobile factors, such as property. Moreover, to the extent that taxpayers perceive they are getting something in return for their contributions, compliance will be easier to promote. Given these considerations, the Government should consider establishing a district tax administration agency. The role of the agency would depend on the needs of the Government, but it could range considerably. At a minimum the agency could provide standardized forms and manuals for tax collectors and taxpayers and impart training courses for district administrators. Or, the agency could take on actual tax collections for the districts, which would each contribute a percentage of their tax collections to its operations. Either option should reduce the total administrative costs of district taxation. Whatever the decision, urgent action needs to be taken.51 Recommendation: District personnel andfinancial management capacity, especially in the areas of accounting and budget management, should be strengthened. 87. Districts need to readjust the ratio of technical to support staff, not only by increasing expenditures for technical personnel but also by reducing expenditures for administrative personnel (especially those who act as the personal staff of the administrator). The districts also need technical assistance in developing sound financial management practices. In many, if not most, districts financial management is rudimentary. District financial management, including revenue collection and expenditure, needs to be standardized. A guidebook along the lines of the budgeting guide developed for the municipalities should be developed and promulgated by the MPF. Strengthening public expenditure management at the district level would be aided by granting the district budget legal status and integrating it fully into the national and provincial 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. - 124 - Annex 3 Page 33 of 35 Municipalities: Recommendations Recommendation: Municipal revenue administration needs to be overhauled, especially if municipalities are going to assume additionalfunctional responsibilities and improve municipal service delivery. 88. Currently, municipal revenue collections are quite low and there is no evidence that municipalities, especially the smaller ones, are ready to assume additional tax responsibilities. In order to mitigate these problems, it is imperative that the Government help improve revenue raising capacity at the municipal level. Though the Government has provided the municipalities with ample regulations, it has not provide the materials and tools necessary to develop administrative capacity in this area. Presently, the DPPFs are assuming municipal tax collection responsibilities, which makes sense in the current context. DPPFs should continue to collect municipal taxes until the municipalities are ready to assume them. However, there are legitimate concerns about whether the smaller municipalities will develop the necessary expertise in the short to medium term. Given that municipalities will have to collect a wide range of personal, corporate, and property taxes, administration will be costly and complicated. Creating thirty three municipal tax administrations, many of which would have to be established in very small towns, does not seem the best way forward. It might make more sense, in terms of capacity and administrative costs, for the DPPFs to collect municipal revenues indefinitely. 2 Alternatively, a municipal tax administration agency could be established to handle selected aspects municipal tax administration. The responsibilities of the municipal tax agency could range from producing common publications (forms and guides) to providing data processing and property valuation services to outright tax collection (the agency could be funded by a percentage of its collections). Several countries follow variations of this model. In China there is a tax agency responsible for all local collections. In Peru other municipalities contract out collections for a fee to the Lima municipal tax agency. The Government thus has a number of specific options to consider for improving municipal tax collections. Recommendation: The Government should comply with the funding and legal requirements of the fiscal transfer system and should consider increasing transfers as the municipalities assume newfunctions. 89. Presently, fiscal transfers from the central Government account for the major share of municipal income (for the five major cities), which is consistent with the ratio of transfers to own source revenues experienced by sub-national governments in most developing countries. In addition, the sum of transfers plus own source revenues is greater than the amount of recurrent expenditures, which is again consistent with international experience. The appearance of the current financial situation is, however, clouded by the fact that municipalities have yet to become responsible for many functions. Once social service functions are transferred to the autarkies, the financial picture 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 to undergo a major reform in the near future. - 125 - Annex 3 Page 34 of 35 autarkies, considerably more resources will be required. Transferring additional functions heavy in personnel costs, such as education and health, might also lead to an imbalance in the amount of recurrent expenditures as compared to revenues. Even given substantial improvement in revenue collections, additional transfers might be required in order to match revenues to expenditures. Currently, funding for the FCA is below the minimum 1.5 percent of national tax revenues required by law and funds are transferred only according to population, in spite of provisions in the law for transfers based on additional factors (such as socio-economic status). As the Government transfers more responsibilities to the municipalities, especially for major social functions, it should also move 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 widespread concem that many, if not all, municipalities are not following the law in this area. There is a clear need for a program of training and auditing. The MPF recently launched a three day program in this area at the municipal level. This is a welcome start, but much more is needed. The MPF should develop a follow-up program immediately after the completion of the training program. In addition, the World Bank-funded municipal project should play a role in identifying and addressing specific financial management deficiencies. Initial needs identified include: accounting practices, budget classification (for both revenues and expenditures), and sectoral planning. The MPF, together with the Tribunal Administrativo, should also launch a high-profile program of municipal auditing. Audits would initially need to be corrective, but could shift to a sanctioning mode after an initial trial period. Recommendation: The transfer of revenue and expenditure powers to the municipalities should be rationalized and regulated. 91. The assumption of revenue and expenditure responsibilities by the autarkies has been left completely to the autarkies themselves, according to the law. The Government should ensure, however, that as the decentralization program goes forward, autarkies match revenues with their expenditure responsibilities. The Government might establish some idea of a timetable for progress. The Government should clarify the requirements for the transfer of functions and responsibilities. There should be clear, transparent, technical criteria by which the appropriateness of responsibility transfers to the municipal level could be judged. Without some sense of a timetable with technical criteria, the reform could flounder unnecessarily. 53 For further details see World Bank Country Financial Accountability Assessment, 2001. - 126 - Annex 3 Page 35 of 35 Recommendation: Municipalities should be empowered to manage their own personnel according to a set of municipal civil service regulations developed bv the central government. 92. Another important constraint on municipal decentralization concerns central Govermment control over municipal civil servants. Autarkies inherited civil servant complements without any regard for the match with their functions, expenditures, and revenues. Given that the central Government effectively controls staff complements, and that municipal employees are subject to the same civil service system as central civil servants, municipalities do not have control over their own staffs. This means that, for example, if civil service wages increase, municipal wages increase as well, even though the considerations that support central civil service wage increases may not coincide with the situation at the level of the municipalities. Since the municipal wage bill accounts for the majority share of recurrent expenditures, municipalities have no control over their single largest expenditure item. Effectively this means that the central Government has an undue influence in municipal expenditure management. For the decentralization reforn to 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 civil services for subnational governments, while in other countries subnational public employees are part of the national civil service system. The particularities of the Mozambican case merit serious consideration of a subnational civil service system. - 127- Annex 3 Appendix 1 Page 1 of 1 Appendix 1: Revenue and Expenditures: Beira, Maputo, Nampula, Pemba, and Quelimane (Millions of Meticais) Actual Projection 1998 1999 2000 Revenue: Own Source Taxes 12,996 24,888 32,699 Fees and Licenses 14,502 33,583 38,253 Other Operating Revenues 71,766 34,321 13,201 Sub-total (Own Source) 99,265 92,792 84,153 Fiscal Transfers Municipal Compensation Fund (FCA) 5,993 46,548 53,992 Counterpart APIE 4,125 23,298 22,568 Local Investment Fund (FIIL) - 21,559 22,637 Other Capital Funds 661 57,441 90,322 Donor Funds for Capital Projects 256 - 1,891 Sub-total (Central Transfers) 11,035 148,847 191,411 Total Revenues 110,300 241,639 275,564 Expenditure: Operating Expenses Personnel 27,738 52,095 74,438 Goods and Services 43,460 46,985 44,758 Other Operating Expenditures 423 2,636 11,749 Sub-total (Operating Expenses) 71,621 101,716 130,944 Capital Expenditures - - - Municipal Projects 1,418 46,622 66,085 Central Government Projects 434 - - Donor Funded Projects 256 - 1,891 Sub-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. - 128 - Annex 3 Appendix 2 Page 1 of 1 Appendix 2: Revenue and Expenditures (Percentage Terms): Beira, Maputo, Nampula, Pemba, and Quelimane Actual Projections 1998 1999 2000 Revenue: Own Source Taxes 12% 10% 12% Fees and Licenses 13% 14% 14% Other Operating Revenues 65% 14% 5% Sub-total 90% 38% 31% Fiscal Transfers Municipal 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 Expenses Personnel 38% 35% 37% Goods and Services 59% 32% 23% Other Operating Expenditures 1% 2% 6% Sub-total 97% 69% 66% Capital Expenditures Municipal 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% - 129 - Appendix 3: Revenue and Expenditures: Beira, Nampula, Pemba, and Quelimane (Millions of Meticais) Actual Projection 1998 1999 2000 Revenue: Own Source Taxes 147 544 2,443 Fees and Licenses 13,539 22,072 24,105 Other Operating Revenues 3,438 6,068 5,662 Sub-total (Own Source) 17,125 28,684 32,209 Fiscal Transfers Municipal Compensation Fund (FCA) 5,993 24,080 27,977 Counterpart APIE 4,125 4,438 4,634 Local Investment Fund (FIIL) - 11,153 11,711 Other Capital Funds 661 1,963 3,371 Donor Funds for Capital Projects 256 - 1,891 Sub-total (Central Transfers) 11,035 41,635 49,582 Total Revenues 28,160 70,318 81,792 Expenditure: Operating Expenses Personnel 12,048 24,294 33,713 Goods and Services 11,713 21,597 20,437 Other Operating Expenditures 423 2,636 4,641 Sub-total (Operating Expenses) 24,184 48,527 58,791 Capital Expenditures Municipal Projects 1,418 15,440 15,903 Central Government Projects 434 - - MGF Projects - 0 DonorFunded Projects 256 - 1,891 Sub-total (Capital Expenditures) 2,108 15,440 17,794 Total Expenditure 26,292 63,967 76,585 Year-end Balance 1,868 6,351 5,207 Source: Brockman and Wojtyla, 2000. - 130 - Appendix 4: Revenue and Expenditures (Percentage Terms): Beira, Nampula, Pemba, and Quelimane (Millions of Meticais) Estimates Projections Averages 1998 1999 2000 1999-2000 Revenue: Own Source Taxes 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 Expenses Personnel 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 Expenditures Municipal 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% - 131 - Appendix 5: Revenue and Expenditures: Maputo (Millions of Meticais) Actual Projection / Budget 1998 1999 2000 Revenue: Own Source Taxes 12,849 24,344 30,256 Fees and Licenses 963 11,511 14,148 Other Operating Revenues 68,328 28,253 7,540 Sub-total (Own Source) 82,140 64,108 51,944 Fiscal Transfers Municipal Compensation Fund (FCA) - 22,468 26,016 Counterpart APIE - 18,860 17,935 Local Investment Fund (FIIL) - 10,406 10,927 Other Capital Funds - 55,478 86,951 Donor Funds for Capital Projects - - - Sub-total (Central Transfers) - 107,212 141,828 Total Revenues 82,140 171,321 193,772 Expenditure: Operating Expenses Personnel 15,690 27,801 40,724 Goods and Services 31,747 25,388 24,321 Other Operating Expenditures - - 7,108 Sub-total (Operating Expenses) 47,437 53,189 72,153 Capital Expenditures Municipal Projects - 31,181 50,182 Central Government Projects MGF Projects Donor Funded Projects Sub-total (Capital Expenditures) - 31,181 50,182 Total Expenditure 47,437 84,370 122,335 Year-end Balance 34,703 86,951 71,437 Source: Brockman and Wojtyla, 2000. - 132- Appendix 6: Revenue and Expenditures (Percentages): Maputo (Millions of Meticais) Actual Projection I Budget Average 1998 1999 2000 1999-2000 Revenue: Own Source Taxes 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 Transfers Municipal 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 Expenses Personnel 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 Expenditures Municipal 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 3 Appendix 7 Page 1 of 1 Appendix 7: Recurrent Expenditure by Province: Wage and Non-wage Recurrent Expenditures Millions of Meticais OE OE OE OE OE Execution OE 1995 1996 1997 1998 1999 2000 2001 Niassa 17,100 31,629 49,926 70,318 106,078 202,423 228,950 C. Delgado 26,413 48,336 66,179 111,678 148,025 257,815 266,995 Nampula 48,708 93,341 130,710 173,013 219,095 429,564 469,598 Zambezia 49,053 80,714 109,198 128,317 206,834 372,473 406,036 Tete 28,204 47,601 65,105 94,195 120,992 259,673 248,876 Manica 21,463 35,853 48,437 88,635 125,171 253,574 253,189 Sofala 41,054 77,753 111,756 156,152 204,526 354,851 362,085 Inhambane 24,678 42,629 58,360 95,364 124,679 215,310 244,132 Gaza 24,875 38,533 53,518 79,411 133,361 234,039 262,452 Maputo 25,063 41,189 56,172 76,485 117,939 231,647 239,836 Cidade 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 3,260,888 Wage expenditures 236,584 402,259 583,104 770,584 1,042,340 1,738,274 1,920,278 Non-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 9,213,467 Provincial 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 5,952,579 Central wage expenditures 139,416 188,931 242,595 930,543 1,246,802 1,677,837 2,169,335 Central 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 prices 1996 at constant 1995 prices 1997 at constant 1996 prices 1998-2001 in nominal terns Annex 3 Appendix 8 Page 1 of 1 Appendix 8: Capital Expenditure by Province In Millions of Meticais Execution 1995 1996 1997 1998 1999 2000 2001 Niassa 6,363 7,398 Data 13,960 84,577 C. Delgado 7,070 9,523 not 11,100 69,025 Nampula 14,717 15,090 available 21,211 71,348 Zambezia 142,948 16,493 20,250 131,107 Tete 6,716 9,046 18,146 113,020 Manica 92,163 7,346 9,155 51,908 Sofala 65,130 11,790 21,416 38,876 Inhambane 6,335 9,087 7,049 113,165 Gaza 12,723 10,406 17,602 31,592 Maputo 6,080 8,211 17,199 29,424 Cidade Maputo 8,130 10,801 29,362 30,497 Provincial 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 8,843,662 Prov. 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). - 135 - Annex 4 Page 1 of 2 ANNEX 4 THE PROCESS OF BUDGET FORMULATION 1. Until the application of the Lei de Enquadramento Or,amental (or Budget Framework Law) in 1998, the budget preparation process in Mozambique was different for the recurrent and investment budgets, driven in part by the different fiscal years applicable to the two budgets. Under the current law, a unified budget proposal, including current and capital expenditures, needs to be discussed and approved by the National Assembly by December 31 st. Following approval, the budget execution commences in January on the basis of a fiscal year that runs from January through December, and a detailed budget document is supposed to be prepared and published in the first quarter of the calendar year. 2. The budget cycle starts with the preparation of the first draft of a Medium Term Fiscal Framework (Cenario Fiscal de Medio Prazo, or CFMP) that sets the aggregate expenditure limits , broken down by priority sectors, based on projections of the overall resource envelope. Expenditure limits are subsequently communicated by circular to all ministries and State institutions participating in the budgetary process by May 31 5t 1 In June and July sector ministries and provinces generally organize sectoral meetings where discussions are held with all key officials, including provincial level representatives. These lead to the submission of the budget proposal by the ministry -- including both recurrent and investment expenditure estimates -- to the budget department in the Ministry 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 sole responsibility 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 for resource allocation rests with the Minister of Planning and Finance who submits the budget for approval to the Council of Ministers. 4. The OE is complemented with the preparation of two important companion instruments: the Plano Trienal do Investimento Pzublico (PTIP) and the Plano Econ6mico e Social (PES). The Three Year Investment Plan (PTIP), produced since 1990, has been the primary tool for investment programming and management. The PTIP is presented to the National Assembly, but has in itself no legal basis. Programmed I Mozambique's budgetary institutional framework is organized into central and provincial administrations. These include ministries -- most of which are represented in the 11 provinces by provincial sector directorates -- services and autonomous institutions, totaling 67 units, of which 30 are at the central level. Each one of these institutions constitutes a budget and accounting entity. - 136- Annex 4 Page 2 of 2 expenditures under the first year of the PTIP are the samne as the investment component in the national budget. The PTIP offers a relatively comprehensive view of total investment expenditures projected for the year, the majority of which - an estimated 66 percent in 2000 and 69 percent in 2001 -- are externally financed. 5. To complement and support the budget document, the government also prepares its Economic and Social Plan (PES), which is presented to the National Assembly prior to approval of the budget. The PES makes a presentation of the state of the economy over the 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 social sector 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 of the economy, although in practice they are hardly put to any use. 6. Annual budgets are approved and published in real terms, based on 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, mainly investment). The modified limits are communicated to spending agencies but are not published. This fact makes it difficult to compare budget allocations (published in constant prices) and actual expenditures (recorded in current prices) and therefore reduces transparency. This is aggravated by the fact that adjustments are not uniform and may vary widely between budgetary categories. For example, in 1998 the allocation for the Office of the Prime Minister was adjusted upwards by 85 percent, while that for the Ministry of Foreign Affairs was increased by only 0.4 percent (although in aggregate terms the total adjustment 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 the budget document, lacks the resources and the capacity to effectively perform its role. - 137- Annex 5 Page 1 of 3 ANNEX 5 THE PROCESS OF BUDGET EXECUTION 1. Budget execution and accounting for central government is the responsibility of the Directorate of Public Accounting (Direcqdo Nacional da Comptabilidade Publica, DNCP), while the Provincial Directorates of Finance (Direcqdo ProvinVal do Plano e Finan as, DPPF) undertake provincial level budget execution and accounting. The execution process follows a strict cash basis budgetary system that ensures a rigorous control of resources, but which may be too stringent and cumbersome, especially given that most of the operations are performed manually. 2. In the case of non-salary recurrent expenditures, as well as all expenditures in the investment budget, the financial execution system entails, first, an advance of funds to the spending agencies (line ministries and autonomous institutions); second, a reporting by these agencies on incurred expenditures; and, third, a reimbursement of spent funds by the Ministry of Planning and Finance to the spending agencies. At the beginning of the year, the Ministry of Planning and Finance holds back a reserve for each the recurrent and the investment budgets'. Net of these reserves, funds are then transferred to spending agencies on the basis of one -twelfth (duodecimo) of their respective budgetary allocation each month, except in the beginning of the year when a transfer of two-twelfths takes place2. These funds are deposited in special bank accounts - two per spending agency, one for recurrent and another for investment expenditures - that agencies are required to open each fiscal year. 3. Regarding the provinces, funds are advanced to the DPPFs to finance those expenditures executed at the provincial level. These advances are meant to cover the projected 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 each line item of goods and services as an "execution" reserve, including the covering of eventual overspending by a sector for any given month. A separate recurrent budget emergency reserve is held by MPF to cover unforeseen expenditures (such as expenses for epidemics, floods, etc.). In the case of the investment budget as well, a reserve, which was close to 20 percent of the total investment budget in 1998, is administered by DNPO and used for contingencies, for new projects approved during the course of the year, and for supplementing (reforco) the budgets of projects as required during the year. 2 Certain legal exemptions exist to this duodecimos system in cases, such as road rehabilitation, where large, discrete expenditures are programmed for specific (dry season) months during the year. -138- Annex 5 Page 2 of 3 collected by the province - which the provinces are allowed to retain - and the provincial government expenditure provided in the budget3. 4. Before the 1 O"h of each month, spending agencies (the Department for Administration and Finance [DAF] in the case of the central ministries; DPPFs in the case of provincial governments) must justify expenses incurred during the previous month by submitting to DNCP a summary (balancete) listing each type of expenditure -- current and investment -- according to the economic classification, and accompanied by statements for each bank account. After reviewing this information and ensuring that each expenditure is properly justified, the following tranche, matching the exact amount of expenditures justified and up to one-twelfth of the budgetary allocation, is liberated by DNCP, after verification of the availability of funds by the treasury. As this whole process is expected to take close to a month, the "second" twelfth of the budget paid out in January acts as a rolling buffer throughout the year and is settled at the closing of the year. 5. Salary expenditures aren't subject to the rule of duod&cimos4. Instead, the monthly salary bill is paid to each spending institution according to programmed salary expenditures based on sectoralfolhas de salarios. In the case of central ministries, these salary bills are usually paid into each Ministry's bank account (usually at the Bank of Mozambique). In the case of provincial level salaries, the payments are made through the DPPFs at the provincial level to the sectoral ministries' DAF in the province. At the provincial level, given the absence of Bank of Mozambique branches in most provincial capitals, DPPFs and sector Ministry DAFs usually have their accounts with Banco Comercial de Mocambique (BCM), a private bank with minority government shareholding. The actual timely payment of salaries in the provinces continues to undergo 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 a given project is centrally or provincially administered. Projects managed centrally by the sector ministries in Maputo have their investment budget payments executed through the central ministry. In the case of provincially administered projects, the payments are made through the provincial DPPF. 7. Spending agencies are supposed to follow several steps in the execution of expenditures, but these are unclear and not specified in the legislation. The first step is the verification that a sufficient budget allocation is available (cabimento); the second is liquidacdo, or the estimation of the exact amount to be paid; and the last is the actual payment. However there seems to be an additional stage, commitment, before 3 As provinces tend to systematically underestimate the collection of taxes and no downward adjustment is done of the advances during the execution of the budget, provincial Governments have in 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 current expenditures, customs duties and operations during the complementary period. -139 - Annex 5 Page 3 of 3 liquidaqdo, but which is not explicitly mentioned in the Budget Framework Law nor in the implementation regulations. 8. It is at this point that decisions are also made about nominal salary adjustments to be taken during the year. For mid-year reallocation of budgetary resources from one budget line to another within sector ministries, the ministry would require permission from MPF. As mentioned above, the government also uses the fractions held as reserve (budgeted under a line entitled "provisionary allocation") to supplement ministerial allocations. The government is however obliged not to exceed the limits set in the budget document under the economic classification, and would need to obtain the authorization of 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 covers the period January-February for expenditures administered at the provincial level and January-March for those administered at the central level. No new expenditures can in principle be incurred during this period, which can only be used for the payment of expenditures already committed before the end of the fiscal year. In practice however, agencies use this period to continue incurring new expenditures they were unable to commit before the end of the year simply by backdating supporting documents, hence undermining fiscal discipline. - 140 - Annex 6 Page 1 of 3 ANNEX 6 TOWARDS AN INTEGRATED FINANCIAL MANAGEMENT SYSTEM IN MOZAMBIQUE-KEYS TO TIE SUCCESSFUL IMPLEMENTATION OF THE SISTAFE Overview 1. The new Law on the Financial Administration of the State (Lei da Administracdo Financeira do Estado) creates the basis for the introduction of an integrated financial management system (IFMIS), or Sistema de Administracdo Financeira do Estado (SISTAFE, as it is known in Mozambique) that integrates more closely the different functions of the fiscal process-budgeting, accounting, cash and asset management, reporting, and auditing. This is an important step in the right direction. The effective introduction of such systems is, however, a very demanding exercise and experience in Sub-Saharan Africa calls for extreme caution in their implementation. Basically, a strong and sustained commitment at the political and technical levels, coupled with a gradualist approach that takes into account capacity constraints and avoids costly technological solutions, are key to the successful introduction of IFMIS. Above all, the basic problems affecting the current system, especially in the areas of budget coverage, accounting cash management and auditing, must be addressed first in order to create a sound basis for the effective 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 and leadership at the political level, supported by a small but efficient technical unit that ensures coordination of all services involved, monitors implementation of an action plan and provides technical guidance. This is a complex and demanding task. If UTRAFE is to play this role, it must be able to mobilize the required expertise. It will need to ensure the services of a small team of qualified experts with experience on IFMIS in Africa. > The IT component must not be an end in itself While the IT component is at the core of the development of an IFMIS, it should not be an end in itself, nor the driving force behind the reform process. It must support whatever organizational changes are necessary to make the system work, and its success will be measured not by the successful 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. - 141 - Annex 6 Page 2 of 3 > The solutions adopted must be aligned with broader reforms in public service. The design of the IFMIS, and the technical choices adopted, must be in line with and support a broader public sector reform process that addresses institutional, organizational and behavioral weaknesses. In the specific case of Mozambique, this will require a very close coordination between UTRAFE and UTRESP to ensure coherence between the civil service reform process and the gradual introduction of the SISTAFE. Sequencing 3. The development of a specific and time-bound action plan for implementation of the SISTAFE should be consistent with the following broad steps. > "Getting the basics right". The improvement of the current budget management system is a necessary condition for the effective implementation of the SISTAFE. The following areas are among those that require urgent attention: (i) reducing the number and rationalizing the operational procedures of bank accounts operated by spending units; (ii) including in the budget all revenues, earmarked or not, and related expenditures; (iii) revising the chart of accounts in line with the new budget functional classification and (iv) improving the information in the budget execution reports, in particular by including data on donor-financed sectoral expenditures. > Concentrate first on improving the inputs of the system. Implementation of the SISTAFE should focus first on the areas of accounting and cash management (treasury) and only later be extended to the other sub-systems or modules (budget formulation, auditing, physical assets, etc). Accounting is important because it is the primary source of financial information linked to the operations of the government. As such, the quality and timeliness of accounting information is critical for the efficient finctioning of all the other components of the system. As far as the treasury is 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 to ensuring the smooth implementation of the budget. A roll-out strategy, directing the gradual 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 to success. Whatever the decision taken on the scope of the project, the SISTAFE should be conceived around self-contained modules and should concentrate first on a small core of functions considered key. Experience in several other countries, e.g. in Ghana, shows that overly-complex projects inevitably run into considerable difficulties and are likely to fail. > Build capacity and retain qualifled staff Experience indicates that the capacity building demands are substantial as modern FMS require skills which are not readily available in the public sector. This refers in particular to professional accounting skills as well as the IT skills to effectively use and operate the new system. In Mozambique, one of the most urgent needs is to train staff on double-entry - 142 - Annex 6 Page 3 of 3 accounting and modified accrual accounting. Although the future introduction of a computerized accounting system will tend to simplify the tasks required from staff, and hence reduce the need for a deep knowledge of accounting techniques, this will take 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 of the SISTAFE: > Develop an action plan. The first step must be the preparation of a realistic action plan describing both the final objective (the scope and main components of the SISTAFE) and the specific steps to get there. It must be accompanied by a timetable and clearly identify those responsible for each of the tasks. > Project implementation needs to be organized around clearly identiflable results and achievements. To maintain the enthusiasm and the momentum for reform during the implementation phase, is a critical success factor. To ensure continuous support for the reform process clear benchmarks and demonstrable results must be identified that would enable to measure implementation progress. These performance criteria should be part of the project implementation plan. Too often, performance indicators focus on technical achievements rather than demonstrable results. Improvements in budget coverage, in the quality of accounting reporting and in treasury control of bank accounts-all mentioned in the latest report of the Administrative Tribunal and in 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 that might endanger the implementation of project components and sub-components, (ii) an assessment of the likelihood for these problems to occur, and (iii) the development of options to overcome the problems including the implications for the project. Based on the experience in other countries, the main risks are associated with difficulties in the effective introduction of the IT component and with resistance from users to the new system. > An active information campaign is criticaL The introduction of the SISTAFE, to be successful, needs to be supported and understood by end-users and stakeholders at all levels. 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 of the exercise. 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