PROJECT INFORMATION DOCUMENT (PID)

APPRAISAL STAGE

Report No.: AB4226

Project Name

/ MZ-Competitiveness & PS Development
Region / AFRICA
Sector / General industry and trade sector (70%);Micro- and SME finance (30%)
Project ID / P106355
Borrower(s) / Republic of Mozambique
Implementing Agency
Ministry of Industry and Commerce
Praca 25 de Junho, No. 300, 7# Andar
Maputo
Mozambique
Tel: (258-21) 427-204
Environment Category / [ ] A [X] B [ ] C [ ] FI [ ] TBD (to be determined)
Date PID Prepared / October 27, 2008
Date of Appraisal Authorization / October 28, 2008
Date of Board Approval / February 5, 2009

1. Country and Sector Background

Mozambique has staged a remarkable recovery from a devastating civil war that ended in the early 90s and has successfully completed an ambitious program of “first generation” reforms. Since 1992, infrastructure has been improved and is now approaching its pre-war levels, and incomes have risen considerably. The poverty headcount fell from 69 percent in 1997 to 54 percent in 2003. On average the economy grew by 8 percent annually since 1996. This accomplishment can be attributed to the Government’s phased but determined approach to stabilization and structural reforms, as well as to concessional assistance (half of Government expenditures), healthy agricultural growth, and fast expansion in tourism, construction, and certain manufacturing sub-sectors. Another significant factor was the authorities’ success in attracting “mega-projects” in aluminum smelting, natural gas, and titanium mining.

Nevertheless, the country remains poor (US $ 310 per capita income in 2006); infrastructure is still inadequate; there are serious unmet education and health needs; and poverty rates remain high. Of the estimated 18 million Mozambicans in 2003, nearly 10 million were below the poverty line. The urban working population is expected to grow at 4 percent until 2010, underscoring the need for a growth path with job creation. The 2008 Gender, Poverty, and Social Assessment concluded that rural poverty rates, while still high, declined faster than urban poverty rates. The situation would have been exacerbated by the recent increase in food and fuel prices and the return of migrant workers from South Africa which has increased tensions in major urban centers.

It is unclear now, having completed the first generation reforms, whether the growth rates will continue to be sustained or be as poverty-reducing as before. If Mozambique is to sustain its growth rate, continue to improve its low GDP per capita, and harness the opportunities provided by regional trade integration, it is essential to broaden the base of economic growth and enhance domestic private sector competitiveness. The Government of Mozambique’s (GoM) second Poverty Reduction Support Strategy (PARPA II) covering 2006-2009, placed the private sector as the main engine for investment, growth, and employment. Realizing the vision set out in the PARPA II requires improving the business environment, stimulating exports, promoting growth in sectors where Mozambique has a comparative advantage, and targeting small and medium enterprises (SMEs), which generate the greatest number of jobs.

The Private Sector: A Snapshot

The Mozambican private sector can be characterized by two distinct types of enterprises. On the on the one hand are the few foreign-owned export oriented, capital intensive “mega-projects” that have contributed nearly 1.6 percent to the GDP growth rate since 1998. On the other hand are the vast majority of firms, primarily small and medium enterprises, which sell mostly to the local market, face severe resource constraints, and contribute modestly to economic growth and exports. According to the National Statistics Institute, there were 31,735 private enterprises employing 310,000 people in 2002, the last year for which such data is available. The data breakdown reveals that almost 90 percent of these firms were small, employing less than 10 employees, and 9 percent were medium firms employing 10-99 workers. Additionally, with the exception of the mega-projects, the export performance of Mozambican firms has been weak with only 7 percent of manufacturing output in 2003 exported. Expanding manufacturing output, improving quality of produce, and tapping into international markets are all essential if Mozambique is to diversify its exports and lessen its dependency on mega-projects. Additionally, developing linkages between SMEs and large investments would also help in expanding the benefits of these investments; while there has been increasing linkages between the mega-projects and smaller firms there remains great potential for deepening and expanding these linkages.

Agriculture continues to play a significant role in this predominantly rural country, making it the second largest contribution to GDP growth over the past decade, after the mega-projects, and employing nearly 80 percent of the workforce, much of them engaged in informal subsistence activities. With the majority of the poor being subsistence farmers in rural areas, sustaining agricultural growth, improving agricultural productivity, and tapping into international markets for agricultural produce are vital to poverty reduction. Tourism is another sector that should be part and parcel of a strategy for broadening the private sector. The plethora of Mozambique’s cultural, historic and natural attractions makes tourism a tradable sector in which Mozambique has an inherent comparative advantage. Its linkages to other sectors, such as transport, agriculture, food & beverage, retail, financial services, construction, arts and crafts, and the potential to develop and increase revenues from a relatively unexploited resource base—such as 2500km of coral fringed coastline—offer compelling job creation and economic growth opportunities.

Private Sector Development: Challenges and Opportunities

Despite some modest efforts at reform, Mozambique’s business environment remains restrictive with a global ranking of 141 out of 181 and a regional ranking within SADC of 10th out of 14th on the 2008 Doing Business Indicators. This continues to hinder business registration, expansion, and sustainability. In the past two years, there have been legislative changes that have made it easier for businesses to start-up, protect investors, and add flexibility to labor regulations. There have also been administrative improvements that should streamline business licensing, facilitate tax administration, and accelerate contract enforcement. Efforts are under way to improve business closure and reform customs procedures. However, these reforms have not yet resulted in a fundamental shift in the regulatory business environment as evidenced by recent ranking in the Doing Business report. Reforms remain incremental in crucial areas such as labour, land, trade facilitation and business licensing and inspection. Furthermore, legislative reforms and administrative decrees are only a first step in the reform efforts. Equally important is awareness of the private sector of these reforms and strengthening public sector capacity to implement the reforms – aspects that are not fully captured through Doing Business reports.

The 2008 ICA data reveals that the most prominent obstacle that firms mentioned has been the practices of informal competition. Specifically, the ICA found that 78 percent of firms compete against unregistered or informal firms. Informal firms, by their very nature, do not expand, are more vulnerable to external shocks, provide irregular earning for their employees, and undermine the competitiveness of other formal firms. On the other hand, informal firms have made a major contribution to job creation and poverty reduction in the past ten years[1]. A strategy that seeks to further understand the dynamics of informality, distinguishes between rural and urban informality, and points the way to bringing in the informal sector to the formal sector is crucial to broaden the base of the private sector. Simultaneously, it should be recognized that informality is not likely to go away completely. Therefore, pragmatic approaches that can help informal firms through linkages with larger firms would be equally important.

The second major constraint identified by the ICA survey was access to finance (it was the first constraint in the 2003 survey). The ICA revealed that for small enterprises, only 1 percent of working capital and 1 percent of investment in fixed assets were bank financed whereas for medium enterprises it was at only 4 percent and 5 percent respectively. The obstacles to access to finance include continued high interest rates, limited risk appetite by banks, weak credit information systems, a weak collateral registration and enforcement system, and limited business and financial management skills in SMEs. While there are some indications of increased bank competition and interest in lending to smaller firms, lack of financing remains a major bottleneck for SME development.

The forthcoming 2008 CEM highlights continued constraints inhibiting private sector competitiveness, including shortage of skills, inadequate access to land, burdensome customs and tax administration procedures, and lack of standards and certification for exports[2]. The CEM confirms the need to further reform the business environment while emphasizing the importance of complementing general reform efforts with sector-specific reforms. Finally, the CEM calls for a strategy that focuses on economic diversification, export promotion, and SME development to broaden and sustain Mozambique’s growth. Adding to the urgency of dealing with these issues is the regional trade integration within the Southern Africa Development Community (SADC)[3], which envisions a customs union by 2010 and a common market by 2015.

In response to stronger advocacy by the private sector and international partners’ advice, the Government of Mozambique (GoM) has embarked on a five year strategy to improve the business environment. The Ministry of Industry and Commerce remains the focal point for business reforms; however, there has been recognition that reforms require concerted effort across the government. Therefore, the strategy envisions a more active role for the Prime Minister and a closer oversight by the Council of Ministers. The Business Environment Strategy contains the following four pillars: (a) Legal Reform: aims to improve the business environment through reforms covering business registration, licensing, inspection, and closure; labour law; competition law; import-export facilitation; property registration; simplification of tax administration; (b)Fiscal and Financial Sector Reform: aims to improve the fiscal environment and promote access to finance for SMEs; (c) Infrastructure: aims to reduce costs and increase access for private sector to basic infrastructure services, such as electricity and telecom; (d) Governance and Implementation Mechanisms: covers the capacity building needed to implement the reforms and establishes a mechanism for overseeing and monitoring the strategy implementation

To further complement the strategy, the Council of Ministers in June 2008 adopted an action plan which provides a road map of timelines, reform actions, indicators of achievement, and the responsible agencies under each of the main pillars of the business environment reform strategy. MIC has also recently developed a strategy for SME development that was adopted by the Council of Ministers in 2007. The SME strategy is supposed to complement that overall business environment strategy and focuses on specific areas of support needed for SMEs, through promoting access to finance, improving SME management and technical capacity, and ensuring that reforms are supportive of SME development. The Government has also been working on sector-specific strategies in agriculture, tourism, as well as an overall approach to dealing with trade integration.

While these strategies can signal an understanding of the challenges and a seriousness to undertake changes, it is not clear what the level of consultation has been both within Government and with the private sector at large in the strategy development process and whether the capacity will exist to implement the far-reaching reforms envisaged in some of these documents. It is also important that policy development be coupled with results on the ground for them to be validated by the public, gain credibility in the eyes of investors (whether large or small), and establish a virtuous cycle of reforms yielding results that spur on more reforms. It is in supporting the Government in the process of informing needed reforms, building capacity for implementation, and assisting in realization of results for business owners and workers that the World Bank, working in concert with other international partners, can play a catalytic role.

2. Objectives

The project’s overall objective will be to improve the business environment andenhance the competitiveness of targeted enterprises. This will be achieved by: (i) reducing the cost of doing business through support to GoM reforms and capacity building of key public sector agencies (ii) developing and strengthening the capacity of local intermediaries to deliver business services in targeted sectors; (iii) and piloting region specific interventions in tourism and horticulture sectors. Indicators include results at the enterprise level such as increased sales; results at the intermediary level such as number of new business services to SMEs; and at the policy level such as through improved Doing Business ranking.

3. Rationale for Bank Involvement

The Government of Mozambique, through the Ministry of Industry and Commerce (MIC), requested Bank support for a new PSD operation which will assist in the business environment reform efforts, in implementing the strategy to deal with greater international and regional trade integration, and in strengthening the small business sector. The Bank is regarded as the key interlocutor on PSD and business environment issues by the GoM and the donor community and has provided advice and technical input into the development of the strategy on business environment and the SME support strategy.

The Bank’s engagement in private sector development has been long-standing, with the most significant intervention in recent years being the PoDE Enterprise Development Project, a 6-year multi-donor project which concluded in June 2006. PoDE aimed to broaden private sector participation by strengthening the access of Mozambican firms to training and advisory services, promoting linkages with mega-projects, enhancing access to finance, and capacity building of key public agencies and business associations. A first broad-based program following the structural adjustments of the post-war period, PoDE succeeded in laying the foundation for a local marketplace for consultancy, training, and linkages and played a catalytic role in advancing key business environment reforms. However, the market for these services remains under-developed and the private sector continues to face a restrictive business environment. The proposed Mozambique Competitiveness and Private Sector Development (MCPSD) Project seeks to advance PoDE’s achievements in improving private sector competitiveness by catalyzing the delivery of second generation business services focused on sectors with growth and export potential such as tourism and agribusiness and advancing policy reform and implementation. With regards to access to finance, the PODE ICR concluded that stand-alone credit lines has not been an effective instrument for promoting sustainable access to finance by SMEs. The ICR recommended that future interventions in this area consider both the financing and technical assistance aspects of access to finance, including working closely with selected financial institutions, building the capacity of firms to borrow, and keeping the design of any financing mechanism simple.