Report No. 13752-MOZ

MozambiqueImpediments to Industrial Sector Recovery

August 22, 1995

Macro, Industry, and Finance DivisionSouthern Africa Department

Document of the World Bank

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

GLOSSARY OF ABBREVIATIONS

ADENA State-owned Customs brokerASYCUDA Computer system for CustomsBCM Commercial Bank of MozambiqueBRE Export Registration BulletinBRI Import Registration BulletinCFM Mozambican RailwaysCNAA National Commission for Valuation and PrivatizationCPI Center for Promotion of InvestmentCRF Clean Report of FindingsDD Duty DrawbackDE Duty ExemptionDFIA Duty Free Import AdministrationDPR Enterprise Restructuring DossierEGA Customs Handling FeeESRP Economic and Social Economic Recovery ProgramFD Fixed DrawbackFRIGO Maputo Road TerminalGATT General Agreement on Tariffs and TradeGREI Office for Restructuring Industrial Enterprises within the Ministry

of Industry & EnergyHS Harmonized SystemID Individual DrawbackIDA International Development AgencyIFZ Industrial Free ZoneIPEX Institute for Export PromotionL/C Letter of CreditLAM Mozambican AirlineNIEs Newly Industrialized EconomiesPSI Pre-Shipment InspectionSGS Societe Generale de SurveillanceSMWs Special-bonded Manufacturing WarehousesTIRO Beira Road TerminalUREA Unit for Restructuring Agricultural Enterprises within the Ministry

of AgricultureUTRE Technical Unit for Enterprise Restructuring within the Ministry of

FinanceVAT Value Added Tax

PREFACE

This World Bank report is based on the findings of a mission which visitedMozambique during June - July 1994. The mission was comprised of Rocio Castro(AFlMI), Task Manager, Arnold Sowa (AFIMI), Peter Glenshaw (IEMIN), YungRhee (PSD), Araceli de Leon (IFC), Patrick Low (IECIT), Jehan Arulpragasam(AFIMI), Bert Cunningham, Katherine Katterbach, Hilmar Hilmarsson and BretMasterson (Consultants). This report was discussed with the Government ofMozambique in October 1994. It was presented to the Consultative Group meeting forMozambique in Paris in March of 1995 and at the First Private Sector Seminar inMaputo in July of 1995.

TABLE OF CONTENTS

Executive SummaryOverview iIndustrial Sector Performance and Constraints iiiPolicy and Implementation Issues xviii

Chapter 1 - Industrial Sector Performance and ConstraintsBackground IImpediments to Industrial Recovery: A Firm-level Analysis 3Policy and Implementation Issues 18

Chapter 2 - Customs Administration and Pre-Shipment InspectionIntroduction 21Weaknesses in Current Customs Procedures 22Customs Modernization Program 28

Chapter 3 - Development of Mozambique's Manufactured ExportsIntroduction 33Access to Imported Inputs at World Market Prices 34Access to Trade Finance for Exports 45Access to Foreign Collaboration 48

Chapter 4 - The Business and Investment ClimateIntroduction 55Regulatory and Institutional Constraints 56Summary of Recommendations 66

Chapter 5 - Privatization Policy and ImplementationIntroduction 68Preparatory Procedures 69Redundant Labor 72Transparency in the Bidding and Sales Process 74Summary of Recommendations 75

Chapter 6 - The Cashew Sub-SectorIntroduction 77Output Performance 78Pricing and Marketing System 79The Current Processing Situation 82Growth Prospects for Cashew 84Summary and Recommendations 89

AnnexesAnnex I - Companies Interviewed by Mission with Summary AssessmentsAnnex 2 - Proposals Regarding Pre-Shipment Inspection Contract Renewal

EXECUTIVE SUMMARY

OVERVIEW

1. While most sectors in the Mozambican economy have responded favorably to theEconomic and Social Rehabilitation Program (ESRP) initiated in 1987, the level of grossindustrial output is no higher today than in 1986. Industrial output has actually declinedsteadily since 1990 with negative implications on export revenue. The value ofcommodity exports fell from a post-reform peak of US$162 million in 1991 to US$131million in 1993. Exogenous factors can partly explain this situation. The war hasdisrupted production and marketing systems in rural areas and the supply of raw materialsfor agro-processing, Mozambique's largest manufacturing sub-sector. In addition, theloss of markets in the former Soviet Union and the Eastern Bloc has severely hit textileexports. However, it is also evident that the policy environment currently in place has notfacilitated a reversal of the on-going decline in output.

2. In addition to restoring macroeconomic stability, reducing domestic inflationthrough tight fiscal and monetary policies, economic reform under the ESRP has focusedon four key areas. First, trade has been substantially liberalized and the exchange raterealigned with the objectives of removing foreign exchange constraints and improving thecompetitiveness of tradable goods. Most exchange controls and quantitative restrictionson imports have been removed, and since 1992 the exchange rate has been determined bya unified market for foreign exchange. Second, the tax and tariff regime has beenrationalized to reduce dispersion and to eliminate anomalies. In 1991, ad-valorem taxesreplaced specific duties, and the number of duty categories were reduced. More recently,import duties on raw materials were lowered, industrial inputs exempted from theturnover tax, and the export tax suspended for five years. Third, enterprise and financialsector reform has aimed at increasing the efficiency of real and financial resources. Byend 1994, 370 small and medium state-owned enterprises and twenty large ones had beenprivatized. Banking reform introduced new legislation and separated the commercial andcentral banking functions of the Bank of Mozambique in order to improve bankingservices and to stop the transfer of financial resources to loss-making parastatals. State-owned commercial banks are also being restructured and stricter lending rules are beingenforced. Fourth, in order to boost private investment, a revised investment code enactedin 1993 simplified authorization procedures, revised the incentive package, andestablished an investment promotion center.

3. Despite these reforms, industrial performance in Mozambique has remaineddisappointing. The industrial sector is no larger today than it was in 1986; manufacturingoutput has declined since 1990. The purpose of this study is to identify impediments toindustrial recovery that can be addressed in the short term, to assess growth potential, andto propose a strategy for achieving this potential. Taking the general macroeconomic andpolicy framework as given, a firm-level analysis has been carried out to determine howmuch of the industrial decline could be attributed to ownership, management andtechnological factors (microeconomic constraints) and how much to shortcomings in

ii

policy design and/or implementation. Other constraints less amenable to short-termpolicy remedies such as poor infrastructure and lack of skilled labor, are not directlyaddressed in this study. The methodology relies largely on firm-level interviews and, tothe extent possible, on available official data.

4. The conclusion of the study is that a multiplicity of factors account for poorindustrial performance. First, a sharp distinction needs to be drawn between state andprivately-owned firms. For the most part, private firms are potentially well placed tocompete in the world markets given installed technologies, capital stock, and productioncosts.' However, firm-level analysis of the business environment points to severalimpediments to enterprise and industrial development. These include: (i) unevencollection of statutory duties and taxes, where local producers (generally) pay duties andtaxes on their inputs and outputs while most importers escape them, resulting in'negative' effective protection for import-substituting firms; (ii) inadequate provisions toensure quick access to inputs at world prices undermining the capacity of manufacturingexporters to compete in international markets (for example, lack of a functioning dutydrawback or temporary admission regime, retention schemes, or pre-financing facilities);and (iii) the imposing and often non-transparent regulatory framework, as evidenced bycurrent labor and investment regulations, has further exacerbated the unfavorableconditions under which firms are forced to operate, and discouraged private investment,both domestic and foreign.

5. The picture with respect to state-owned firms is quite different. Apart from theconstraints described, the operating difficulties of most state firms stem primarily fromproblems of poor management, low productivity, and high levels of indebtedness. Theslow privatization of "large" firms has delayed enterprise restructuring, leavingapproximately half of industrial output, notably agro-industrial exporting firms, underpoor management and in a state of near paralysis. While the government has beensuccessful in privatizing small and medium enterprises only eight large industrial firmshad been privatized as of the end of 1994. Such slow progress reflects implementationproblems resulting, in particular, from lengthy preparatory procedures and uncertaintyabout the accrual of labor liabilities (such as excess labor and wage arrears).

6. Finally, the cashew industry, historically one of Mozambique's main exportearners, faces several distinct problems that go beyond those that affect public and privateindustrial firms which are a function of sub-sector specific policies. Most factories areeither being privatized or rehabilitated. However, privatization/rehabilitation alone willnot suffice to ensure the viability of the industry. High levels of protection have beengiven to the local industry, through low producer prices and exports restrictions on raw

I This conclusion is supported by the findings of "Mozambique: Industrial Sector Study - TheDevelopment of Industrial Policy and Reform of the Business Environment", May 22, 1990, WorldBank.

iii

nuts, at the expense of the farmer, and of overall export revenues for the country as awhole.

7. The study has been organized in six chapters. Chapter 1 presents an overview ofindustrial sector performance and competitiveness on the basis of firm-level informationand the existing policy environment by sub-sectors (import substitution industries,manufactured exports, and agro-industrial exports). The subsequent chapters areconcerned with policy and implementation constraints. Chapter 2 deals with theadministration of Customs and pre-shipment inspection. Chapter 3 presents priority tasksto develop manufactured exports. Chapter 4 examines the business and investmentclimate. Chapter 5 discusses privatization policy and implementation. Chapter 6presents a detailed discussion of the problems facing the cashew sub-sector.

A. INDUSTRIAL SECTOR PERFORMANCE AND CONSTRAINTS

8. In order to identify constraints to output recovery and determine the potential ofMozambique's industry, an assessment has been made of the efficiency andcompetitiveness of the sector given: (i) management and technical capabilities; and (ii)the impact of the incentive structure resulting from the existing trade and price regime(e.g., tax structure, exchange rate). Because of the lack of official disaggregated sub-sectoral data (on production, imports, prices, taxes and duties paid, etc.), relevantinformation was obtained through interviews conducted with sixty medium to largeindustrial firms (employing on average 580 workers). Taken together the firms representover half of gross industrial output. Of the sample of firms interviewed, thirty-eight wereprivately-owned, six majority state-owned but privately managed, and sixteen state-owned. About a half of the firms interviewed are exporting or have the potential toexport.

9. Based on these interviews, a distinction needs to be drawn between state andprivately-owned firms when analyzing the efficiency and growth potential of theindustrial sector. For the most part, existing capital stock, installed technologies,management capabilities and production costs within privately-owned firms indicate thatmost firms would be well placed to compete in the world market given a more conducivebusiness environment. High protection levels are not a precondition for private firms tosurvive and prosper. However, several factors are preventing this competitive potentialfrom being realized: (i) a discriminatory tax collection pattern whereby a large flow ofimports enter the country tax-free while local producers generally have to pay taxes,severely undermining the capacity of domestic industry to compete against imports; (ii)lack of access to duty refunds or a temporary admission regime, impairing the ability ofexporters to compete in international markets; and (iii) cumbersome and often non-transparent regulations and procedures significantly increasing the cost of doing businessfor the private sector.

iv

10. The picture with respect to the majority of state-owned firms is different. Theslow privatization has left large industrial firms, which account for about half ofindustrial output, in need of restructuring and in a state of near paralysis. Because ofinappropriate incentives and lack of managerial skills, these firms face problems of poormanagement, low technical performance (such as poor maintenance of machinery andequipment), and high levels of non-performing debts. Already starved of workingcapital, many enterprises have incurred wage arrears and are not in a position to makebadly needed investments to replace obsolete plant and machinery. Moreover, once theannouncement has been made that a company is to be privatized, it becomes difficult forthe company to operate. Banks are reluctant to extend credit because of uncertainty aboutthe future of the loans and customers are wary of engaging in any contractualarrangements.

11. These unfavorable conditions have led to low levels of output and capacityutilization, excess labor, and severe financial distress. Though more pervasive amongstate firms, a situation of excess labor is evident throughout industrial firms, as costlymandatory severance payments have prevented necessary reductions in the work-force,fuirther limiting competitiveness. While significant rehabilitation would be required formost state firms to work at full capacity, most private firms could increase productionwith little or no additional investment. Since over half of the firms interviewed are eitherexporting or possess the potential to compete in world markets, creating conditions forfirms to better utilize installed capacity should have a significant impact onMozambique's foreign exchange earnings.2

Import-substitution industries

12. With the liberalization of the trade regime through the removal of quantitativerestrictions and the basic realignment of the exchange rate, the competitiveness ofdomestic industry is determined by the tax structure. The tax and tariff structure inMozambique has been greatly rationalized and simplified with a reduction in the leveland number of import duties, elimination of 'specific' duties, and homogenization ofdomestic and import taxation.3 Measures to lessen the cascading effect and tax burdenfor local manufacturers have been adopted over the past year. These have involved areduction of import duties on raw materials and industrial inputs to 5 percent, loweringthe customs handling fee, the Emolumentos Gerais Aduaneiros (EGA), from 7.5 to 2.5

2 Financial difficulties constitute a symptom rather than a cause of the problems currently being facedby industrial firms.

3 A tariff reform was implemented in 1991. There are five import duties (5, 10, 15, 25 and 35percent) applied according to degree of processing plus a customs handling fee (EGA) whichoperates as a minimum duty. Both imported and domestically-produced goods are subject to aturnover tax (5 percent) and a consumption (excise) tax ranging from 20 to 150 percent for aselected number of products.

v

percent, and exempting industrial inputs (both imported and locally produced) from the 5percent turnover tax.

13. Firm level data on prices and production costs indicate that if the statutory tax andtariff structure were applied in practice, enterprises would enjoy positive levels ofeffective protection in the domestic market,5 ranging from minus 40 percent to 114percent for the sample of goods examined in this study. Such protection levels are notexcessive for developing countries, but the variance suggests some need for furtherrationalization of the tax structure, once the current problem of poor tax collection issolved.

14. Despite the apparent rationality of the tax structure from the point of view ofdomestic industry, in practice many producers face 'negative' protection in the localmarket. This derives from the fact that domestic manufacturers are more easily targetedby tax authorities to pay consumption and turnover tax on their final output, whileCustoms is often unable to enforce payments of duties and taxes on competing imports.The resulting negative effective rates of protection for domestic industry could be veryhigh. In the extreme case, where local producers pay all taxes and importers evade them,negative rates of protection are estimated at minus 35 to minus 440 percent for the sampleof products shown in Table 1. Although some importers of competing goods probablypay some taxes and some domestic producers have found ways to evade theirs, the lack ofcomprehensive data on tax and duty collection makes it impossible to assess actual levelsof protection by product or sub-sector category.

15. Nevertheless, the evidence obtained in this study demonstrates a tax collectionpattern that severely discriminates against the domestic industrial sector. First, a roughcomparison between the revenue collected by Customs in 1993 and what should havebeen collected if statutory duties had been charged on recorded imports, reveals ashortfall of at least 55 percent. Part of this shortfall is explained by exemptions grantedunder various regulations (donor financed projects, the investment code), which accountfor some 18 percentage points; the remaining gap of 36 percent reflects tax evasion. Itshould be noted that this gap is under-estimated as it excludes the effect of under-declaration of goods by importers, thought to be a major vehicle of tax evasion, and

4 These measures were taken in December 1993 and August 1994.

5 Effective protection is the protection (duties and taxes) relating to the value-added whereas nominalprotection relates to the final product. The level of effective protection depends on the level ofduties and taxes on output and on the imported inputs. It measures the proportionate differencebetween value-added at domestic prices (including duties and taxes) and the value-added at worldprices. Nominal protection affects the consumer. Effective protection is the relevant concept for aproducer.

6 The effective rate of duty collection (including EGA), which is, total duties collected over totalimports recorded by customs, was 12.4 percent in 1993. If exemptions were included, the ratewould increase to 17.2 percent. This compares with a theoretical rate of 26.9 percent estimated usingthe import structure of 1992.

vi

because it is based on the value of imports recorded by Customs (US$598.9 million)which is well below the value estimated for the balance of payments (US$955 million).Second, the effective domestic tax burden on industry is proportionally much higher thanthat on imports.7 Third, actual price comparisons between imported and domesticallyproduced goods sold in local markets indicate that many imported products, mostlyconsumer goods, enter the country effectively duty-free.

Table 1: Mozambique - Effective Protection of a Sample of Products

Theoretical effective Estimated effective rateProduct rate of protection of protectionCapulana (Texlom) 51 3o -69%Capulana (TA) 58% -100%Gray Fabric (TL) 88% -84%Gray Fabric (TA) 92% -87%Shirts 107% -113%Trousers 1 14% -126%Sacks 31% -60%Cigarettes 32% -331%

Fluorescent lamp 32% -113%

Rail tanker -40% -134Plastic razor 32% -127%Ball point pen 31% -239%Plastic pencil sharpener 41% -127%Metal truck trailer 10% -63%Tire 16% -44%PVC paint (I liter) 49% -35%Margarine 16% -82%Condensed milk 92% -439%

Source: Survev data, WForld Bank analysis

Manufacturing exports

16. Although the potential exists for manufacturing exports to expand, the inability toaccess imported raw materials and intermediate inputs at world market prices is viewedby exporting firms as the main reason for their lack of competitiveness in internationalmarkets. The impact of duties and customs charges (including the 5 percent EGA and theone percent ADENA charge) on manufacturing costs is considerable, raising these costsby 10 to 22 percent of total manufacturing costs for the sample of exports shown in Table2. This reflects the high import content of Mozambican manufacturing exports,averaging 65 percent for the sampled exports.

17. Although duty drawback/exemption schemes for exporters are defined under thelaw, in practice, such schemes have proved virtually inoperable mainly because of lack of

7 For example. the turnover tax collected from industry amounted to US$17 million in 1993 and theturnover tax collected from imports amounted to US$20 million even though the value of industrialsales is at least half the level of imports.

vii

implementation procedures and the inability of Customs to evaluate technicalcoefficients. Seven out of the exporting firms interviewed claimed to have applied in thepast for duty drawbacks but with no success; only five exporters were found to holdlicenses to operate bonded manufactured warehouses.

18. A second major difficulty confronting manufacturing exporters is the lack ofquick access to short-term trade finance in hard currency. This difficulty stems primarilyfrom the underdeveloped local banking system and uncertainty about the availability offoreign exchange (including allowed export retention schemes) which depends largely onexternal donor funds.

Table 2: Impact on Manufacturing Costs of Duties Paid on Inputs *Excess costs of lack ofaccess to imports at

Excess costs of imported world price as % ofinputs over world market Import total manufacturing

Export Item prices (%) content costsBall point pen 33% 60% 20%Plastic pencil sharpener 26% 66% 17%Disposable razor 32% 69% 22%Fluorescent light fitting 32% 65% 21%Steel roofing materials 22% 78% 17%Rolling stock 16% 60% 10%Car tire 23% 48% 11%Steel pipe (general use) 29% 770/o 22%Drainage pipe 28% 77% 21%Bicycles 23% 60% 14%Asbestos/cement constructionmaterials 16% 60% 10%

* Assumes EGA of 5% effective until August 1994.Source: Survey data, World Bank analysis

Agro-industrial exports

19. Agro-industrial exports (cashew, tea and sugar), historically Mozambique's mainforeign exchange earners, have been severely hit by the war which disrupted productionand marketing systems.8 In addition, most agro-industrial firms are still controlled by thestate and face serious problems of excess labor and wage arrears, obsolete/destroyedcapital equipment, and high levels of overdue debts.9 Operations have nearly stopped inmany factories because of lack of working capital and because significant investments,including the restoration of farm-level production systems, would be required to expandoutput.

8 The state "intervened" these firms after independence and grouped them into large conglomerates.For example, Caju de Mocambique (for cashew) and Emocha (for tea). The sugar estates have beenkept separate.

9 These firms are among the largest delinquent debtors of the banking system.

viii

20. The economic viability of investments in tea and sugar will depend uponinternational technological and market changes and the establishment of efficient farmlevel production and marketing systems. Clearly, the risk of such investments should beborne by the private sector through privatization. The government should therefore re-assess its decision to embark on expensive rehabilitation projects prior to privatizationwhich could generate marginal or negative returns. °

Box 1: Cashew Industry: A Case of "Negative" Value-Added

In the early 1980s, the country had fifteen mechanized processing factories (six privately-owned and therest managed by the state-owned Caju de Mocambique) with a capacity of 70,000 tons. At present, actualcapacity is estimated at 40,000 tons. In 1993, only one private cashew factory with a capacity of 6,000 tonswas operating. Production at Caju de Mocambique, the state holding company accounting for 80 percent ofcapacity, has virtually stopped since 1992 pending its privatization.

The technical performance of cashew factories in Mozambique is extremely poor. The kernel yield for allCaju de Mocambique's factories is on average 18.7%, compared with 21% for the privately-owned factory,and 25% in India, the leading world producer. Moreover, the export price for the low quality kernel producedby Mozambican factories is below what could be obtained for raw nuts and hence, the country is actuallylosing foreign exchange by processing and exporting kernels.

............................................................................................... ............................ "I""..................................................................................Raw cashew Caju de Moc. Value added Monapo Value added

price kernel price* (US$/ton) kernel price* (US$/ton)l 991/92 (US$/ton) (US$/ton) (US$/ton)l 1991/92 600 589 (I1) 621 211992/93 680 593 (87) 645 (35)1993/94 750 692 (58) 729 (21)

I .................................................................................................................................... ...............................................................

* Kernel raw nut equivalent (conversion factor for Caju de Mogambique is 5.40 and for Monapo 5.13)Note: The weight of raw cashew in the total processing costs is about 50%.Source: Secretary of Statefor Caslhew

21. In the cashew sub-sector, neither privatization nor rehabilitation alone will sufficeto ensure the viability of the industry, unless prevailing marketing distortions areremoved. Over the past years Mozambique's processing industry has generated negativeor marginal value-added and hence has required high level of protection to operate (seeBox I). Minimum producer prices and export restrictions have been used to ensure cheapsupplies of raw nuts to local factories. For example, in 1993 the minimum farm-gateprice for raw nuts was 15.5 percent of the border price. This is extremely low byinternational standards (in Tanzania the producer price is about 50 percent of the borderprice.)'" As a result, output of raw nuts has been depressed at around 35,000 tons/year,

10 Funds for these rehabilitation projects are being provided by multilateral agencies: US$40 millionfor tea and US$130 million for sugar.

II Minimum prices effectively work as fixed prices given the lack of competition particularly at thewholesale level. Depending on the degree of competition, farmers sell their nuts above or belowthe minimum price. In 1993 prices fliuctuated from Mt 500 to Mt 1,000/Kg, compared with aminimum price set at Mt 700/Kg.

ix

compared with a short-term potential of about 80,000 tons. In 1993, only one privatefactory with a capacity of 6,000 tons was operating therefore the government allowed theexport of surplus raw nuts (about 22,000 tons). Export licenses were issued to sixwholesale traders who dominate the cashew market in Mozambique. As a result, thesesix traders and one factory made profits equivalent to four times the combined income ofhundreds of thousands farmers producing cashew. These policies are reducing incentivesand incomes for cashew farmers, encouraging the rehabilitation of inefficient processingfactories, and jeopardizing growth prospects for the sub-sector.

B. POLICY AND IMPLEMENTATION ISSUES

22. A number of policy and implementation constraints have hindered industrialdevelopment. It is important that key areas be identified in order to guide governmentintervention in the short and medium-term. The priority tasks for the short- term include:(i) improving the effectiveness of Customs administration; (ii) promoting manufacturingexports; (iii) enhancing the business climate affecting the private sector; (iv) acceleratingthe privatization process; and (v) removing distortions within the cashew-sub-sector. Inthe medium-term, further rationalization of taxes and tariffs and extensive Customsreform would be required to strengthen industrial policy (see Matrix of Policy Prioritiesin Table 3).

Customs Reform and Pre-shipment Inspection

23. Severe shortcomings in the administration of Customs have resulted in seriousinjury to domestic industry and significant revenue losses for the government. The mainareas requiring attention include transparent operating procedures, strengthened controlsand enforcement activity, rationalized processing of import declarations, improvedmanagement and reporting systems, and strengthened human resource and infrastructure.

24. Although Mozambique has employed the services of a pre-shipment inspection(PSI) company since 1990, the country has derived very little benefit from the service.Customs authorities have regularly allowed imports to be cleared without the presentationof a clean report of findings.12 Customs and ADENA, the state-owned clearing house,also tend to ignore or modify PSI determinations as to value and classification of imports.Moreover, no procedure exists for checking the tax liability on import consignments

assessed by the PSI company against the taxes actually paid by importers.

25. A high level of commitment on the part of the government will be required toimprove the effectiveness of the administration of Customs. As a first step, a new PSIcontract should be negotiated as soon as the existing one expires, with the necessary

12 In 1993, only half the value of goods subject to PSI (US$729 million) were actually inspected(US$357.8 million) and approximately 50 percent of CRFs issued were not picked up by importersto clear the goods through Customs.

x

features to make the service more effective, particularly with regard to ex-postreconciliation of taxes assessed and actually paid. In parallel, a high-level anti-smugglingtask force headed by the Ministry of Finance should be created with an explicit mandateto detect, apprehend, and prosecute those parties involved in contraband activities. Inparticular, efforts should focus on post-clearance investigation and prosecution. Obvioustargets would be visible contraband items such as alcohol, beer, and cigarettes.

26. A comprehensive Customs reform program should be initiated with immediateeffect. The implementation of the ASYCUDA computerized customs system should bethe center piece of this effort and be coordinated with the broader reform programproposed in this report. The main tasks to be undertaken include the elaboration ofstandard operating procedures, development of information and management systems,and preparation of a comprehensive human resource and infrastructure plan. Theprogram should be overseen by a ministerial-level committee, with day-to-dayresponsibility assigned to the National Director of Customs, who would be supported bya team of Customs advisers. The possibility of establishing an independent RevenueAuthority should also be studied in order to provide the government with options in themedium to long-termn.'3

27. While strengthening Customs and improving tariff collections will help thedomestic industry in the short-run, it will be very difficult to maintain a high tax-tariffregime in Mozambique over the longer-run. Many countries trade through Mozambique,and a high tax-tariff regime will promote large-scale smuggling which will be impossibleto control. The medium run solution is to rapidly move to a value-added tax (VAT), withzero or low protective tariffs, thereby eliminating the cascading effects inherent in thecurrent tax system. A VAT system would also greatly simplify the administration ofexport policies outlined here. However, a careful assessment needs to be made of thefiscal implication of introducing such a system since indirect taxes contribute about 80percent of total fiscal revenues.

Export Policy

28. In view of the limited size of the domestic market and the urgent need to reducedependency on external aid in the medium to long-term, export policy should be giventhe highest priority. Main factors preventing the development of manufacturing exportsinclude: (i) failure to assure access to imported inputs at world market prices; (ii) lack ofquick access to short-term trade finance at world interest rates; and (iii) limited access toexport markets and technical know-how through foreign collaboration. Theseshortcomings in the export regime should be rectified as matter of urgency.

13 The establishment of such an authority in some countries, for example Zambia, has had immediatebeneficial effects on tax collection.

xi

Duty-free import schemes

29. While the basic legal framework for export-related duty-free schemes exists, thereare no established implementation procedures. This situation invites administrativediscretion: access to duty exemptions is decided on a case-by-case basis or simplyrefused. As a first step, transparent rules and regulations for duty drawback andexemptions schemes should be prepared, disseminated and adopted. Duty exemptionsshould include import duties and EGA charges on all imported inputs and capital goodsfor all exporters, irrespective of whether the imports are produced domestically. Initially,licenses to operate bonded manufactured warehouses should be made available toestablished exporters with a minimum export record. Physical supervision ordocumentary monitoring (stock accounting) would be required to operate bondedmanufacturing warehouses, and input-output coefficients would be applied to producerswho export less than 100 percent of their product.

30. A fixed drawback scheme, not requiring prior licensing, should be adopted forpartial/irregular exporters. To this end, fixed refund rates for specific product categories,based on average input-output coefficients, should be estimated and published. Underthis scheme, only evidence of export declaration would be needed to obtain the refund.This scheme would be much easier to administer than other drawback schemes, andwould be suitable for a situation with limited implementation capacity.

31. To ensure the effective implementation of duty-free arrangements for exporters, itis proposed that a separate duty-free import administration office be created at theMinistry of Finance, where the Ministry of Commerce and the pre-shipment inspectioncompany would be represented. The office would be responsible for: (i) formulation ofrules and regulations for various duty free import; (ii) estimation, publication, andperiodic revision of fixed drawback schedules with the assistance of external technicalexperts; (iii) administration of the duty draw back fund; and (iv) ensuring effectivemonitoring and implementation of the different schemes by contracting the services of thepre-shipment inspection company.

Short-term tradefinance

32. To facilitate quick access to short-term finance for exporters, transparent rules andregulations should be prepared and disseminated by the Bank of Mozambique for exportretention schemes and for the introduction of specialized financing mechanisms.Dissemination is critical to ensure effective implementation. For example, according tothe Bank of Mozambique all exporters are automatically eligible for retention accountswhereby they can retain 25 to 35 percent of their export earnings, but, in practice, manyof them seem unaware of this. Considering the need to provide additional incentives tonon-traditional manufacturing exports, retention rates for these exports may be initiallyset at 100 percent. No restrictions should be imposed on the use of retention funds whichshould continue to be denominated in hard currency.

xii

33. While export retention schemes would be helpful in allowing quick access toforeign exchange and would obviate the foreign exchange risk, these would not besufficient to support rapidly expanding exports. Therefore, concerted efforts should bemade by the government and commercial banks to institute financing of import letters ofcredit (L/Cs) based on irrevocable export L/Cs through the creation of a revolving exportfund at the Central Bank.

Foreign collaboration

34. To induce diversified forms of foreign enterprise collaboration for exportdevelopment, an aggressive strategy must be developed and adopted. In view of itsspecific impact on exports, attention should be given to the legislation for foreigninvestment, in particular for industrial free zones (IFZs). The legislation concerningforeign investment is reviewed later in the report (see the Business and InvestmentClimate in Chapter 4).

35. The implementation of rules and regulations for IFZs must aim at puttingMozambique on an equal footing with successful programme in other countries. Firstly,the requirements to obtain IFZ certificates/licenses should be greatly simplified. Theminimum investment requirement of US$50,000 should be eliminated and existingmanufacturing facilities should be eligible as long as the enterprises are committed to atleast 85 percent exports. Secondly, tax and labor regulations as well as the customs andtrade regimes for IFZs should be reviewed. Notably, royalty payments, set at 2 percent ofgross revenue during the first five years and 5 percent thereafter, could amount to aneffective tax rate on profits of 50 percent for highly competitive labor-intensive activitiessuch as garment manufacturing. In addition, labor regulations applicable to IFZs shouldbe modified to address existing policies on annual leave (extremely liberal) and hiring ofexpatriates (restrictive) which effectively would increase the cost of both local andexpatriate labor.14

36. The Institute of Export Promotion and the Center for the Promotion of Investmentshould jointly develop a strategy to more aggressively induce non-equity foreigncollaboration such as sub-contracting arrangements and technical marketing agreements,through match-making and information services.

The Business and Investment Climate

37. The regulatory system should be simplified and rationalized. While thegovernment is already considering the simplification of existing licensing procedures andthe reduction of company registration fees, currently high by international standards,

14 See "Review of Foreign Investment Legislation and Recommendations for Development of theMozambican Investment Promotion Center (CPI)", July 1994, Foreign Investment AdvisoryService, a joint facility of the International Finance Corporation, MIGA, and the World Bank.

xiii

these measures alone would not to create a truly enabling business environment.Additional measures include rationalization and removal of most licensing requirements,elimination of various stamp taxes, and reduction of notarization requirements. Licensesissued by supervisory ministries, which are often used to limit competition, should for themost part be eliminated and restricted to activities involving the exploitation of naturalresources (for example, fishing, mining, forestry). Although such measures wouldsignificantly lessen the regulatory burden faced by the private sector, the most criticalareas of attention include the investment and labor laws.

Investment code

38. The investment code, enacted in June 1993, defines investors' eligibility for fiscalbenefits and charges the Center for Promotion of Investment (CPI) with approval andpromotion functions. A positive feature of the code is that it offers equal treatment tolocal and foreign investors. An authorization issued by the CPI is required for investorsto gain access to fiscal incentives and to the right to remit foreign exchange (in the caseof direct foreign investment).

39. The application process of investments is complicated and costly. In addition tothe documents required to submit an investment proposal under the code, which includebank guarantees, criminal records and the curricula vitae of applicants, the proposedarticles of association, and an environmental impact assessment, the CPI has addedseveral other requirements. These include a five-year financial forecast, a marketfeasibility study, and proof that the minimum share capital has been paid. In someinstances where the allocation of land has been involved, a bank guarantee equivalent to30 percent of the value of investment has been required to ensure that the investmentwould actually be implemented. Finally, a fee equivalent to one half of one percent of theinvestment, up to a maximum of US$50,000, must be paid to CPI once the investmenthas been approved. Clearly, such requirements are excessive, for the most partunnecessary, and more appropriate for a credit institution than a promotion agency.

40. The investment incentive package defined under the code (income tax breaks,import tax exemptions, profit remittances) contains a number of shortcomings. The limitfor eligibility, set at US$15,000 for local investment and US$50,000 for foreigninvestment, discriminates against small investors. Import tax exemptions (which apply toraw materials/inputs used for exportation and all imports for project implementation) aregranted only if the goods are not produced domestically. This is clearly a disincentive forexporters. Access to income-tax concessions, determined according to the type (whetherrehabilitation or new investment) and geographical location of the project, is notautomatic. Finally, the rules for foreign exchange remittances are restrictive and lead to agreat deal of uncertainty. Only foreign investment authorized by the CPI is entitled totransfer funds abroad. According to the code, profit remittances are conditional onconfirmation that legal reserves have been met and that adequate provisions have beenmade to cover debt service obligations on loans contracted for the realization of the

xiv

investment. Implementation procedures, however, are yet to be issued by the Bank ofMozambique.

41. The investment climate is being rendered less attractive by cumbersomeapplication procedures and the uncertainty that inevitably follows from discretionarydecision-making. The investment code needs to be significantly revised if privateinvestment is to expand from the current low levels.'5 The requirement to obtainauthorization by the CPI should be removed and access to any investment incentivesmade automatic and written into the appropriate tax code. Issues pertaining to landallocation should be addressed by legislating the use of commercial land. Import taxexemptions for exporters should not be restricted to inputs that are unavailable locally.Implementation procedures for capital and profit remittances should be prepared anddisseminated by the Bank of Mozambique as sooII as possible. In particular, conditionsto meet legal reserves and debt service obligations should be removed. Finally, the roleof the CPI needs to be significantly redefined. The approval functions of the CPI shouldbe removed and more emphasis slhould be placed on investment facilitation andmonitoring activities.

Labor regulations

42. Labor regulations in Mozambique are extremely cumbersome and, for companieswith a large work force, involve a heavy administrative and financial burden. Thissituation stems from the fact that the labor law (written in 1985) is outdated andinappropriate for a non-command economy. Companies are required to submit a numberof reports to the Ministry of Labor on a regular basis (reports on all overtime labor withinfifteen days of its occurrence, labor contracts every six months indicating changes inwages and bonuses, and full payroll statements on a monthly basis). In addition,mandatory severance payments, set at one and half months salary for every year ofemployment, are expensive compared with other developing countries, and tend to fosterinefficiency.'6 Employers have an incentive to avoid severance payments either bykeeping a high turnover of workers, discouraging on-the-job training, or avoidingdismissal altogether, in which case labor becomes a fixed cost.

43. The labor law should be revised. Specific areas requiring attention include theneed for flexible contracts, streamlined procedures for disciplinary dismissal, and arevision of the formula used to determine severance payments. In this respect,consideration should be given either to reducing the payments or to establishing an upperlimit, for example, equivalent to a maximum of six to twelve months.

15 Although authorized investments from 1985 to September 1994 amounted to approximately US$870million, just over US$160 million are under implementation. Of this total, about US$60 million isdirect foreign investment. Most of the US$300 million authorized during 1985-90 never reached theimplementation stage.

16 For example, in Turkey severance payments amount to fifteen days per year of employment.

xv

Privatization Policy and Implementation

44. The slow privatization of large enterprises has delayed enterprise restructuringwith adverse repercussions on output performance and overall macro-economic stability.As of late 1993 almost two-thirds of gross industrial output remained in the hands of thestate; the privatization program had primarily focused on small and medium-scale firmswhich have little significance in total production. To date, about 370 small and medium-scale firms have been privatized or leased out, including eighty-eight industrial firms.UTRE, the privatization unit within the Ministry of Finance created in 1991 to overseethe privatization of large enterprises, has sold twenty large companies (eight industrialfirms), mostly over the past year. 17

45. Several reasons have accounted for the slow pace of privatization of large firms,including delays incurred in the preparation of an appropriate legal and institutionalframework. Most importantly, given the lack of domestic savings in Mozambique, aninability to attract foreign investment partly due to the war has retarded the privatizationprogram. Clearly, priority should be given to improving the investment climate.However, specific problems pertaining to the privatization process itself have beenidentified which should be immediately addressed. These include: (i) lengthy preparatoryprocedures; (ii) excess labor issues; and (iii) lack of transparency in the sales process.

46. The procedures established by UTRE for the privatization of large firms havebeen excessively lengthy and complicated. The preparation of the Diagnostico doPotencial de Restructuraqdo (DPR) requires large amounts of information and can beexpensive (US$100,000 to US$300,000), often taking up to one year to complete. Inaddition, the company's 'reference' price, set on the basis of the net present value of thecash flow generated by a proposed investment, is hypothetical and has the potential ofdiscouraging prospective investors unless appropriate clarifications are given18 . Whilesome sort of reference price might be useful to potential bidders, it should be estimatedthrough less elaborate methods, for example, based on the current cash flow net of debtservice payments or the scrap value of assets, leaving the bidding process itself todetermine the value of the company. With a view to speeding up current procedures,UTRE is revising the DPR formats so that they can be completed in two to three months.

47. The employment policies of the last two decades have resulted in redundant laborin state enterprises. While some companies have reduced their workforces, most havenot. Financial difficulties to meet mandatory severance payments and political sensitivityhave constrained necessary workforce reductions. Moreover, faced with cash flowproblems and other operating constraints, many state companies have accumulated

17 Six of these large enterprises were sold early in the process and followed less formal proceduresthan the ones now established by UTRE. One of these companies has reverted back to the state.

18 For example, in Jamaica, overvaluation delayed privatization, leading in the end to lower prices(20% of the asking price in some cases) because of the physical and financial deterioration of assetsduring the long run-up to sale.

xvi

substantial wage arrears.19 In several instances, the non-payment of salaries has led tolabor unrest and strikes.

48. The existence of excess labor, wage arrears, and the consequent labor unrest nowpose a serious problem to the privatization of many state companies. Althoughgovernment practices have not always been consistent, the policy has generally been tomaintain firm-level employment during privatization and pass labor liabilities (excesslabor, wage, and pension arrears) to the private buyer. The financial cost of suchliabilities is not trivial, especially for companies that have been paralyzed for a long time.This issue should be dealt with by the government prior to the sale of the enterprise. Forthis purpose, a special fund should be created to cover retrenchment costs and other laborliabilities. This fund should be sourced from revenues generated from the sale of stateenterprises. If necessary, the possibility of partial financing of this fund should be soughtfrom donors to initiate the process.

49. Finally, there has been the perception among investors that the bidding and salesprocess is not transparent. For example, it is common for negotiations to be held withselected bidders even after the bidding process has been officially closed. While thispractice is stated to work out the details of the bidder's development plans for thecompany, it is sometimes used to play bidders off against each other. A pre-qualifyinground of bidding should be used to determine a potential buyer's technical and financialability to run the company being sold. During the final round of bidding, bids should becarried out on a standardized contract, containing the development objectives for thecompany being sold, with the selection of a winning bid being based solely on the priceoffered. Currently. up to 80 percent of a bid is weighted on each bidders proposeddevelopment plans and other non-price factors. The awarding of points for these variedand unenforceable proposals can be subjective and arbitrary. To ensure transparency,UTRE should adopt a bidding process that is based on a standard contract to be bid upon,with only price being the determinant of the winning bid. It should also institute thepractice of inviting interested bidders to the opening of the bids for all companies sold aswell as publicizing the details of the winning bid. These steps should alleviate anyconcerns among potential investors on fairness. These practices should also be followedby the privatization units dealing with the small and medium enterprises.

Cashew Policy20

50. There is consensus that Mozambican cashew factories are not efficient. The kernelyields, both in quantity and quality, are well below those achieved in Brazil and India,

19 In the industrial sector, many companies have not paid salaries in over six months. In theagricultural sector, this non-payment of salaries has lasted over two years.

20 The review of the cashew sub-sector presented in this report is largely based on the preliminaryfindings of a more comprehensive study being carried out by the Agriculture and EnvironmentDivision of the Southern Africa Department of the World Bank entitled "Mozambique AgriculturalMarketing and Pricing Study."

xvii

where more labor intensive-technologies are used. This inefficient industry has beensupported over the years through export restrictions and low producer prices for raw nutswhich in turn have depressed raw nut production levels. The growth and equityimplications of such policies are evident: low output levels (35,000 tons of raw nuts peryear versus a medium-term potential of 80,000 tons); foreign exchange losses (US$29-60per ton equivalent of raw nut); and reduced incomes for hundred of thousands of familyfarmers. Unless producer prices are substantially improved (to at least 50-70 percent ofthe border price) future output growth, including that of industry, will be seriouslyjeopardized.

51. In view of this, it is recommended that export of raw nuts be fully liberalized.The elimination of licenses will introduce more transparency in the trading system andpromote competition among traders. This will boost producer prices, and thereby outputgrowth.

52. Since most cashew factories are either being privatized or rehabilitated,Mozambique has a unique opportunity to make a transition towards a more efficient, lessmechanized industry without incurring high costs. A number of private firms are alreadymoving in this direction. Should the government wish to provide a temporary(reasonable) protection for local firms to adjust to new techniques, consideration may begiven to the introduction of a low export tax, for example starting at 15 percent anddeclining over a period of three years. In any event, the overriding concern to guide anytax intervention should be to protect price incentives for farmers.

xviii

Table 3: Matrix of Policy Priorities

General Problems | Strategy I Specific Recommendations

Customs and Tariff Reform

* negative protection to import * improve administration of short-termsubstituting industry customs * negotiate new PSI contract to include ex-post verification of taxes

* low fiscal revenues * improve enforcement of tax assessed and paid* high transaction costs to import and duty collection * enforce use of CRFs for clearance* weak governance l* imit and monitor exemptions

* strengthen enforcement mechanisms (e.g. through ex-postinvestigations, increased penalties)

medium-term* develop standard operating procedure manuals for customs service* implement computerized ASYCUDA customs system* re-write and enact new customs law* develop human resource plan for customs* study possibility of establishing independent Revenue Authority* introduce V'AT

Export Promotion (Manufacturers)

* inability of exporters to access * provide free trade status for short-terminputs at world priccs manufacturing exporters * set up duty free import administration (DFIA)

* develop transparent implementation rules and regulation for fixedduty drawback and bonded warehouse schemes

* allow exemptions on duties of all imported inputs and capital goods* contract PSI company to monitor implementation of duty exemption

regime for exporters

medium-term* establish duty exemption and individual drawback schemes

* inability of exporters to access * provide quick access to short-termtrade finance Ior exports import finance * disseminate transparent rules and regulations for export retention

scheme* permit retention rates of 100% for nontraditional manufactured

exports* in general no restrictions on the use of retention funds* examine creation of foreign currency revolving fund to facilitate

back-to-back import-export L/C financing....... ..... .......... ........................................................................................ .......................................................................................................................................* inability of exporters to access * aggressively promote cquity medium-term

foreign collaboration and non-equity foreign * simplify requirements to obtain IFZ certificatesenterprise collaboration * review tax, labor, customs and trade regulations pertaining to IFZ

* develop match-making services, information services. etc.

Export Promotion (Agro-Processing)

* poor pertormance and paralysis * enterprise restructuring * accelerate privatization of large enterprisesof firms due to inefficient * retrain from rehabilitation of enterprises by statemanagement by state

. . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ................................................................... .............................................................. * obsolete and dilapidated firms * rehabilitation of firms and * accelerate privatization of large enterprises

and equipment: redundant labor retrenchment of labor byprivale sector. alter

_ pris atization

xix

General Problems Strategy Specific Recommendations

Export Promotion (Agro-Processing - Cashew)

* implicit taxation of farmers * remove pricing and marketing * abolish exporl licensing requirement for tradersresulting in low production/ distortions to ensure * disseminate price information among farmersexports and incomes from raw competitive prices for farmersnuts

* non-viable capital intensive * remove incentives to invest in * expedite privatization of cashew processing sub-sectorprocessing industry with capital-intensive productionnegative value added

mproving the Business and Investment Climate

* slow private sector investment * streamline procedures for short-termand growth starting a businiess * requirc registration at Nlinistr\ of Finance and Bank of Mozambique

'olll.

* eliminate need for authorization by CPI* eliminate need Jor licenses by supervisory ministries (except in the

case of natural resource exploitation).............. ...................... ........................ .................................................................................................. ........................................

* enhance investment climate short-term* reform CPI so that it is only a promoter and facilitator of investment* permit automatic remittance of funds for all registered foreign

investors and simplify and make transparent regulations andimplementation procedures for such remittances

medium-term' revise investment code

* make access to fiscal incentives automatic for all investment andwrite these incentives into the tax code

.............................................................. ............ I............................................................................................................................

f tacilitate and lower costs of medium-termoperating a business * revise labor law to: permit more flexible contracts, streamline

procedures for disciplinary dismissal: revise severance pav formula* rationalize tax regime by: removing starnp tax: replacing numerous

high taxes with a VAT

Privatization

* slow sale of state firms leading * speed up preparatory * allow UTRE to select and prioritize sale of all state companiesto paralysis of companies, procedures leading to sales * redesign and simplify pro forma requireme nts for DPR includingfinancial losses, and wage valuation of reference pricearrears

* do not require private sector * establish re-deplovment fund (from revenue from sales of statefirms to shoulder costs of enterprise and from additional donor funds) to cover cost ofhiring or firing redundant retrenchmentlabor

* increase confidence in the * all bidders should bid on standardized contract that includebidding and sales process development plans and winning bids should be based only on pricethrough transpareney * invite bidders to opening of all bids: publicize details of all winning

bids* accept cash payments for sale of firms over installment payments

1. INDUSTRIAL SECTOR PERFORMANCE ANDCONSTRAINTS

BACKGROUND

1.1 The industrial base that Mozambique inherited from the colonial period wasdiverse and large by African standards. In 1973 total manufacturing value-added per-capita was estimated to be the sixth largest in Sub-Saharan Africa. Initially built aroundagro-processing activities for exports such as cashew, tea, sugar, cotton, and sisal, themanufacturing sector expanded rapidly before independence, reflecting an upsurge offoreign investment from South Africa. During that time, the sector diversified intomanufacturing consumer and intermediate goods such as construction materials, foodproducts, garments, furniture, glass, metal products, soap and cigarettes. By 1972 themanufacturing sector had expanded to contribute 12 percent of value-added andemployed 100,000 workers among 1,400 firms.

1.2 The post-independence period saw a massive exodus of the settler population andthe loss of entrepreneurial and management capacity. The state assumed ownership ofmost industrial firms and intervened to manage those abandoned by private owners,known as intervencionadas. As many as 254 manufacturing firms out of 575 registeredfirms were either state-owned or state-operated by 1984. Despite large investmentsundertaken in the early 1980s (such as state farms, iron, steel, aluminum, chemicals, andtextiles), industrial output suffered a severe setback during this period reflecting theimpact of the growing internal war, inadequate incentives provided under the centrallyplanned system, and lack of foreign exchange to import spare parts and raw materials.'By 1986, manufacturing output was less than half its 1980 level and one third its pre-independence level.

The Economic and Social Recovery Program: 1987-94

1.3 The Economic and Social Rehabilitation Program (ESRP) that began in 1987focused on sharply revising the macroeconomic setting and incentive structure to createthe right conditions for private sector-led growth in a market-driven economy. Whileprogress has been made in reducing macroeconomic instability through increased fiscaland monetary discipline, the rate of inflation has remained relatively high, averaging 44percent in 1993. Trade and exchange rate liberalization have been implemented toremove foreign exchange constraints and to improve the competitiveness of tradableproducts. A market for foreign exchange was instituted in 1992 with the removal of mostexchange controls and the unification of several exchange windows; the market-basedexchange rate has remained within the 10-20 percent range since March 1992.2

I For more details see "Mozambique Industrial Sector Study - The Development of Industrial Policyand Reform of the Business Environment", May 22, 1990. World Bank Report No. 7795-MOZ.

2 The exchange rate was significantly adjusted at onset of the reform program. As a result, the gapbetween the parallel and the official rate declined from 2,100 to 200 per cent in 1987, and narrowed

2

Quantitative restrictions on imports and exports have been essentially removed.3Domestic markets have been liberalized and price controls progressively eliminated formost goods and services. The system of "conditioned" prices, which involved ex-postreview of industrial prices, was phased out in 1992 and price controls are currentlyrestricted to a few foodstuffs and services.

1.4 A major tariff reform implemented in 1991 greatly rationalized the tax and tariffstructure. The reform has substituted "specific" duties for ad-valorem taxes, reduced thenumber of duty categories (from over thirty to five) and the level of duty rates (5, 10, 15,25 and 35 percent). Duty rates are applied on the CIF value of imports according to thedegree of processing so as to provide moderate protection to industry. Import anddomestic taxes were homogenized such that both locally produced and imported goodsare subject to a general turnover tax of 5 percent and a consumption/excise tax, rangingfrom 20 to 150 percent, levied on a select group of final products.4 A Customs handlingfee, or Emolumentos Gerais Aduaneiros (EGA), which effectively works as a minimumduty, was initially set at 7.5 percent but subsequently lowered to 5 percent and recently to2.5 percent of CIF value.

1.5 In addition to lowering the EGA, the government has further revised the taxsystem. Modifications include (i) reduction of import duties on all raw materials to 5percent; (ii) exemption from turnover tax on all "industrial" inputs, both imported anddomestically produced; and (iii) five-year suspension of the 0.5 percent export tax. Thesemeasures have lessened the "cascading" effect implicit in the turnover tax, lowered thetax burden on manufacturers producing for the domestic market, and reduced the taxesthat should be refunded or remitted with respect to exports.5

1.6 Policy reforms have fostered private sector development both by privatizing state-owned enterprises and by changing legislation and administrative procedures that affectthe flow of financial and real resources. A privatization program was initiated in 1989,and government agencies were established to coordinate and facilitate the sale ofparastatals. As of December 1994, 370 small and medium state-owned enterprises andtwenty large ones had been privatized. In parallel, a financial sector reform was initiatedwith the aim of improving the provision of basic banking services and stopping thetransfer of financial resources to loss-making parastatals. Following the introduction ofnew banking legislation and the separation of the commercial and central bankingfunctions of the Bank of Mozambique in 1991-92, the state-owned commercial bankswhich account for over 50 percent of total lending are now being restructured, stricterlending rules are being gradually enforced, and competition is being encouraged through

gradually in subsequent years, reaching an average of 50 percent in 1991 and about 15 percent whenthe foreign exchange system was liberalized.

Restrictions continue on certain export crops such as cashew.

Domestic taxes were initially levied on the import plus duty value, but since December 1993 areapplied on the CIF import value only.

The referred measures were adopted in December 1993 and August 1994.

3

the entrance of new financial institutions. In addition, efforts have been made to facilitateand promote private investment. A new investment code enacted in mid-1993 simplifiedauthorization procedures, revised the incentive package, and established an investmentpromotion center.

1.7 The extensive reforms undertaken under the ESRP have resulted in the recoveryof most economic sectors in Mozambique, including agriculture, commerce, andconstruction. The industrial sector, however, is no larger today than it was in 1986. Infact, after a short-lived recovery during 1987-89 attributable to a large inflow of externaldonor funds that eased the foreign exchange constraint hindering the import of rawmaterials, manufacturing output has actually declined in every year since 1990 withserious implications for exports. The value of commodity exports has fallen from a post-reform peak of US$162 million in 1991 to US$131 million in 1993. Currently, theindustrial sector (including fisheries) accounts for about 11 percent of total value-added,down from 30 percent in 1980.

1.8 The lack of industrial production response is partly attributable to exogenousfactors. Most notably, the war and the loss of export markets in the former Soviet Unionand the Eastern Bloc in the early 1990s clearly had a detrimental impact on industrialoutput, particularly for the textile sub-sector. Difficulties with the transition from a state-managed to a market economy, have also had much to do with disappointing aggregatesectoral growth. For example, delays in the privatization of state-owned firms coupledwith the progressive curtailment of subsidies has led to the collapse of many firms.Policy-related factors, namely the policies themselves, policy implementation, andinstitutional factors could be acting as constraints to industrial sector growth. Theidentification of the most important of these policy constraints and of strategies toalleviate them is the main focus of this report. Other constraints less amenable to short-term policy remedies such as poor infrastructure, lack of skilled labor, and low domesticdemand are not directly addressed.

A. IMPEDIMENTS TO INDUSTRIAL RECOVERY: A FIRM-LEVEL ANALYSIS

1.9 The development of the private sector requires an enabling business environment.In turn, the business environment is defined by the macroeconomic and incentiveframework as well as by the regulatory and institutional systems within which businessoperates. Such development encompasses the interface of policies and regulations, ofpolicy implementation, and institutional factors, including behavioral patterns andattitudes, as these actually affect enterprise economics and firm-level decision-making.

1.10 The firm-level is consequently an appropriate focus for an assessment of thebusiness environment and the constraints it may present to private sector development.This study employs firm-level interviews to identify the most important factors (policy-related, institutional or otherwise) which are limiting production, sales, and exportperformance within the manufacturing sector. This methodology is also used partlybecause of the lack of consistent official sectoral data on production, prices, taxes. The

4

study then presents recommendations with which to alleviate the constraints identified atthe firm-level. This report is not intended to be a comprehensive sector-wide reviewdocument. Clearly, the attainment of macroeconomic stability by reducing domesticinflation, the preservation of a competitive exchange rate policy, and the acceleration ofenterprise and financial sector reform, constitute essential components of any industrialstrategy. However, the general economic policy framework, has been discussed in othermacroeconomic and sector work, and is taken as a given in this report. Instead, emphasisis placed here on understanding sector specific constraints.

Characteristics of Industrial Sector Firms

1.11 The Mozambican industrial sector is diverse. Output structure has remainedessentially unchanged compared with the pre-independence period. Food processingindustries account for about a third of total gross output; light industry such as beverages,textiles, and wood processing, are important too. Unlike many other Sub-Saharancountries, however, output from heavier industries also figures prominently in industrialproduction. Metallic products and machines, chemicals, and rubber and plastic products,for example, combine to contribute over a quarter of total gross output. About 40 percentof industrial output (for example, agro-processing products and some non-traditionalmanufactures) is currently being exported.

Figure 1.1: Structure of Industrial Sector Output in Mozambique(Percent of total output value -based on ownership status as of mid-1994)

No. o fcompanicsrepresenting 80%of

oroduction

Food procer.ing 2821

Metallic products &mach-ns

17Textiles, shoe les, r _ethr 1

* 12Chemtcals ~

6Non-metallic miners is Private

Bverages _ *State

Wood &furnmture _ v 31* 4

Rubber&plastic products _,

Tobacco 2

Other [

0% 5% 10% 15% 20% 25% 30% 35%

Source: CNP; Ministry of Finance; Ministry of Industry & Energy; World Bank analysis

5

1.12 Approximately two-thirds of industrial production was still controlled by the stateas of mid-1994. This reflected the fact that the privatization program intensively focusedon small and medium firms with little impact on industrial output. Out of ninetyprivatized industrial firms only eight 'large' state industrial enterprises had been sold tothe private sector as of October 1994. 6 The legacy of large state-run holdings continues tobe evident in the concentration of sub-sector output by a few firms: 90 firms (out of atotal of about 500) account for 80 percent of output and employment.

Sample and Survey Description

1.13 For the purpose of identifying the main firm-level constraints to industrial sectorgrowth, sixty medium to large-scale industrial firms were interviewed for the study. Mostof the firms employed over 100 workers, with an average of 580. The firms are located inand around Maputo, as well as in the Zambezia, Manica, and Cabo Delgado provinces(see Annex I for a complete listing of firms visited).

1.14 The sample was chosen to cover a close to comprehensive range of sub-sectors.Taken together, the firms interviewed represent over half of total gross industrial output.With the exception of wood and furniture the sample represents at least 40 percent ofproduction in each of the major manufacturing sub-sectors. Of the sample of firmsinterviewed, thirty-eight were privately-owned, six majority state-owned with privatemanagement, and sixteen state-owned. The sample selection was also made to includefirms that produce import-substituting goods for the domestic market as well as firms thatproduce for the export market. About half of the firms interviewed are currentlyexporting or have exported.

Table 1.1: Interview Sample by Sub-Sector- ~ :_

Ttl Subsector, , ~~~~~Total , otut as %outputa

No * o S Iir Sample as % employees of totalSub-sectrNo. of firmsi of sub-sector in sub- industrial

Su-sector .interviewed : uptvle sector oul utoutpt valu seto. ____ ____ olipu

Food processing 11 58% 21,200 30

Textiles, shoes, & leather 21 71% . 19,200 15...................................................................... ........................... ...................................................................................

Machines/metallic products 9 45% 6,500 17

Chemicals 2 41% 3,600 9.. .. .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...... . . . . . . . . . . .... .... .... ......... -.-...'!.--''-'''''.'''-.'..'.'''Beverages 3 53% 2,400 8

Non-metallic minerals & glass 5 62%/ 3,100 7

Rubber & plastic products 5 75% 2,000 4

Wood & furniture 2 15% 2,600 5

Tobacco . 2 91/% 400 2

Totals 60 Avg: 56% 61,000 97%Source: CNP; survey results; World Bank analysis

6 These include Fabrica de Refrigerantes da Machava (now called Sosun), Fabrica de Refrigerantes daBeira, Forjadora, Cimentos de Mocambique, Projecta, Fasol, Saborel, and Complexo Textil deMocuba. This last firm has since reverted back to the government.

6

1.15 In the interviews a systematic effort was made to gather information with whichto assess the technical, managerial, and financial conditions of each company. Thetechnical, management, and financial status of each firm visited were rated using factualand subjective information. The technical rating relies primarily on inspections of theplant and equipment and simple calculations of production efficiency. The managementrating is based on the perceived degree of the management's knowledge of the firm'seconomic and financial situation, markets. The financial status takes into accountavailable financial performance indicators such as debt burden, current profitability, andcash flow situation. The ratings have been averaged by sub-groups of firms accordinf toownership: state-owned, state-owned with private management, and privately-owned. Inaddition, data was collected on per unit costs, and cost structures for various industrialproducts, wherever possible, in order to determine firm-level ability to compete at worldprices.

Ownership and Performance

1.16 The performance assessment of surveyed firms based on technical, financial, andmanagement criteria shows that privately-owned firms do much better on all threeaccounts than do state-owned firms. Privately-managed state-owned firms also do betterthan state-owned companies (see Figure 1.2).

Figure 1.2: Average Technical, Financial, and Management Ratings by Ownership StatusOe ttep rA 5

--- -Private

l - - * State

4 -_-- state(w/pvtrnint) , .- t

2

0Technical Financial Managenmnt

Worse

Source. Company interviews; World Bank analysis

Most "state-owned with private management" firms started out as private firms but the state assumedmajority ownership through conversion of debt into equity, held by the state-owned banks.

7

1.17 In particular, firm visits revealed that, with some exceptions, most state firmshave not carried out maintenance or replacement of plant and equipment on a regularbasis. Where rehabilitation was carried out, it was not always implemented effectively.8

Management is also weak. In most state-owned firms, management did not demonstrateknowledge of unit production costs, market share, profit margins, or other basicmanagement information. Furthermore, examination of the financial situation of statefirms shows them to be in severe financial difficulty. Most state-owned firms have non-performing loans with the banking system. An analysis of the top fifty creditors to thebanking system as of the end of 1993 reveals a direct correlation between ownership andperformance on outstanding loans. Almost all performing loans are private sectorborrowers, while the majority of non-performing borrowers are state-owned companies(see Figure 1.3).9

Figure 1.3: Loan Performance of Top 50 Bank Borrowers by Ownership Status of Borrower(% of total outstanding credit to the top 50 borrowers - as of end-1993)

No. of

| 1 ~~~~~~~~~~50% 28

Performing % 2

I 6% 2

o Private

* State

H 6% 2Non-

performing~~~~~~39% 18

0% 10% 20% 30% 40% 50%

Source: BCHM, World Bank analysis

8 The cases of Vidreira de Mocambique E.E., rehabilitated with Italian aid, and Cimentos deMo,ambique E.E., which was being rehabilitated with World Bank, EIB, NORAD, and OPEC fundswhile still state owned, are two examples.

Refers to non-performing loans from the Commercial Bank of Mozambique (BCM), the country'slargest bank. Excludes bad debt from state-owned companies prior to 1987, which was assumed bythe Government.

8

Factor productivity

1.18 Factor productivity was also found to be particularly low in state enterprises.Labor productivity is low in state enterprises due to the retention of excess labor,primarily for political reasons. While some state firms have managed to reduce theirwork force in response to declining output levels, most have not. Often firms continue tokeep workers on the pay-roll (or incur wage arrears) even when production has stopped,typically firms that are in the process of being privatized. Among the main factorsexplaining this situation are: (i) costly mandatory severance payments; (ii) politicalsensitivity to laying off workers; and (iii) uncertainty about the employment impact ofprivatization. For operating state firms (those which are not paralyzed), the averageamount of excess labor has been estimated by their own management to be at over 40percent.

1.19 Although the private sector has been generally more successful in adjusting theirwork force, even some private firms have reported excess labor due to the financial andtransaction cost of laying-off workers. Severance payments stipulated under the law, ofone and a half months salary for every year of employment, are high compared to otherdeveloping countries. Consequently, firms with large work-forces and workers with longtenure, are especially reluctant to lay-off workers and staff. Instead, firms prefer to keeppaying salaries and wait for natural attrition, or use other forms of dismissal (such as ondisciplinary grounds) in order to avoid severance payments. Labor therefore effectivelybecomes a fixed cost that cannot be adjusted with production levels. This has a negativeeffect on factor productivity. Perceived excess labor among interviewed private firms,excluding paralyzed firms, averaged 25 percent.10

1.20 The majority of industrial firms visited are also operating at extremely low levelsof actual capacity. Interviewed firms were operating on average at 25 percent of capacity.Many have stopped operations altogether. Under these conditions, overhead costs have tobe spread over lower output levels, further reducing factor productivity. In the case ofstate-owned firms, significant investments for rehabilitation would be required to expandcapacity utilization because of poor historical maintenance and physical damage causedby the war; a case in point are agro-industrial exporting firms. In comparison, little or noinvestments appear to be required to expand production in most private firms.

1.21 Several reasons explain why state-owned firms perform much more poorly thantheir private sector counterparts. First, state firms lack appropriate incentives to run theiroperations in an efficient and viable manner. Overall, state firms have been accustomedto covering operating losses with bank credit and other forms of government subsidies(for example, non-payment of taxes and/or counterpart funds). It is only recently thataccess to bank credit by state-owned firms (such as those with non-performing loans) hasbecome more difficult in the context of stricter lending practices. Second, political

There are also a number of paralyzed firms within the private sector, particularly in the textiles sub-sector, where workers continue to be paid or accrue wage arrears.

9

interference in management decision-making has impeded the implementation ofnecessary cost-saving measures (for example, laying-off workers). Third, managers lackthe skills and experience to deal with rapidly changing business situations. Finally, insome cases, three years in the privatization process has made many firms' futureexistence uncertain resulting in low worker and management morale, stripping of assetsby management and workers, lost export orders because customers do not wish to engagein contractual arrangements, and lack of access to credit from the banking system. Thesefactors have combined to virtually shut down the operations of many companies targetedfor privatization.

Competitiveness and Growth Constraints

1.22 The competitiveness of any given industry can be assessed by the cost ofproduction relative to the prices of competing products on the relevant market. In turn,such costs are determined by input and factor costs. Because of its rich agricultural baseand cheap labor, Mozambique has a comparative advantage in developing agro-processing and labor-intensive activities. In the case of manufacturing goods producedfor the domestic market, or import substituting industries, the relevant cost comparison isbetween value-added at domestic prices (including the impact of duties and taxes onoutputs and inputs) and value-added at international prices. For goods exported, whetherthey be manufacturing exports or agro-industrial exports, the domestic price must becompetitive with the world price of the good. Provided that exporters have access toinputs at world prices, their ability to compete would depend on factor costs (such as,labor).

Import-substituting industries

1.23 Effective Protection. Under the present liberalized regime, and given thesubstantial realignment of the exchange rate, industrial protection should essentially bedetermined by the effective structure of import tariffs and taxes. In order to assess thedegree of protection provided by current import duties and taxes, effective rates ofprotection have been calculated for a sample of manufacturing products for whichconsistent data could be collected. The effective rate of protection measures theproportionate difference between value-added at domestic prices (including duties andtaxes) and value- added at world prices. Because it relates to the value-added (that isoutput minus inputs costs), the measure of effective protection is a function of both thelevel of duties and taxes on the final output and on the imported inputs. 'I

1.24 Production and price data collected at the firm level indicate that if statutoryduties and taxes were applied, enterprises would generally enjoy positive levels ofeffective protection in the domestic market. For the sample of goods examined in this

'Effective' protection is the relevant concept for the producer as it calculates the protective rate foreach activity they undertake. 'Nominal' protection, which refers to the protection resulting from theduties on the final output, is the relevant measure for the consumer as it affects the final price of thegood.

10

study, the average estimated level of effective protection is 47 percent (with a range ofminus 40 to 114 percent - see Table 1.3). Such levels of effective protection are notexcessive for developing countries, although the variance in the rates would suggest someneed for further rationalization of the tax structure.'2

1.25 Despite the seeming rationality of the tax structure from the point of view of mostdomestic industries, in practice many face 'negative' effective protection in the domesticmarket. This 'negative' protection results from an uneven collection of taxes wherebymost local producers pay taxes on their inputs and outputs while most importers escapethem. A large proportion of imports enter the country tax-free partly because of officialexemptions, but mostly because of the inability of Customs to enforce the payment ofduties and taxes. On the other hand, tax authorities are apparently more successful incollecting duties on inputs imported from manufacturers, who must also pay theconsumption tax and turnover tax on their final output (see Box 1.1). In effect, formallyregistered manufacturing firms are easier targets for tax authorities, particularly withregard to the consumption and turnover taxes which are collected on a regular basis.

Table 1.3: Levels of Protection for Sample of Products Produced in Mozambique.Theoretical effective Maximum negative rate

Product rate of protection of protectionCapulana (Firm A) 51% -69%Capulana (Firm B) 57°'0 - I 000aGray Fabric (Firm A) 88% -84%Gray Fabric (Firm B) 92% -87%Shirts 107% -113%Trousers 114% -126%Sacks 31% -60%Cigarettes 32% -331%Fluorescent lamp 32% -113%Rail tanker -40% -134Plastic razor 32% -127%Ball point pen 31% -239%Plastic pencil sharpener 41% -127%Metal truck trailer 10% -63%Tire 16% -44%PVC paint (I liter) 49% -35%Margarine 16% -82%Condensed milk 92% -439%

Simple average 47% -131.

Source: Survey dala; World Bank analysis

1.26 No doubt, some importers of competing goods pay some duties and taxes, anddomestic producers must have found ways of evading part of theirs. However, empirical

12 Theoretical effective protection is defined here as: 100% x {[(world price + duties) - (imported inputs+ duties) - (domestic inputs)] / [world price - domestic inputs - imported inputs]} - 1. The actualeffective protection is calculated as: 100% x {[world price - (imported input + duties) - (domesticinputs) - (output taxes)] / [world price - domestic inputs - imported inputs]} - 1.

I1

evidence supports the conclusion that most import-substituting firms face 'negative'protection in the domestic market. Considering the extreme case, where local producerspay all taxes and imports evade them, and using price data obtained from firms and visitsto the local markets, such 'negative' effective rates of protection could range from minus35 to 440 percent, for the sample of products analyzed in this study (see Table 1.3 -column 3). Unfortunately, the lack of disaggregated data on duties and taxes paid makesit impossible to assess actual protection rates by product or sub-sector category.

Figure 1.4: Estimated Forgone Revenue from Lost Duty Collection(for 1993 in millions of US$)

60

~~~~~~............ ............~~161

74

Actual dutes reported Exemptions Dutes based on Knownby Customs br '93 reported imports by revenue

Customs shortfl

Source: Customs, Ministry of Finance, IMF, World Bank analysis

1.27 Evidence of a tax collection pattern which discriminates against local industry hasalso been found at other levels. First, a rough comparison between the revenue collectedby Customs in 1993 against what should have been collected if statutory duties had beencharged on recorded imports reveals a shortfall of 55 percent (see Figure 1.4). 3Approximately one-third of this shortfall (or US$27 million) is accounted for by officialexemptions granted under various exemptions programs (such as donor-financed projects,diplomatic cargo, those allowed under the investment code) while the remaining gapprobably reflects tax evasion. This gap is an under-estimation because it excludes the

3 Import duties (including EGA) of US$74.2 million were paid on a total import value of US$598.8million, resulting in an effective rate of collection of 12.4 percent. This compares with a theoreticalrate of 26.9 percent estimated on the basis of the import structure for 1992.

12

effect of import under-declaration, thought to be a major source of tax evasion, andbecause it is based on the value of imports reported by Customs (US$598.8 million),which is well below the value of imports estimated for the balance of payments (US$878million excluding emergency aid). Second, the effective domestic tax burden on industryis proportionally much higher than that on imports: the value of the turnover tax collectedfrom industry is comparable to that collected on imports (US$17 and US$20 million,respectively, in 1993) despite the fact that industrial output is less than half the level ofimports. Third, price comparisons between imported and locally produced goods sold inthe local market confirms that many imported goods, mostly consumer goods, areactually entering the country duty-free.

1.28 While this situation persists, in which domestic industries pay taxes on theirinputs and output, and importers of competing goods enjoy de facto tax-free status,domestic industry will continue to suffer from a severe price disadvantage in themarketplace. This inability to compete on price has led to falling demand for theirproducts and subsequently declining output. The textile sub-sector is certainly on thistrack and if this trend is allowed to continue there will eventually be no production onwhich to collect taxes (see Figure 1.5).

Figure 1.5: Consumption and Circulation Taxes from Domestic Textile Firms

8

7

,6

i 5 . \ Taxes inMeticais

] 3 \ Projected

i 2 Taxes in US$ /

0.~~~~~~~~~~~~~~~~~

1989 1990 1991 1992 1993 1994

Source: Ministry of Finance; IMF; World Bank analysis

13

Box 1.1: Negative Protection, the Example of Locally Produced Capulanas

Textile firms producing capulanas (sarongs) for the local market must pay a 35% import tax onimported inputs (30% duty and a 5% EGA on the CIF value) plus a 35% domestic tax on the final product(30% consumption tax and a 5% turnover tax on the output value) at the factory gate. These taxes make up33% of the domestic ex-factory gate price and are difficult to avoid as these firms, which are formallyregistered, are easy targets for the authorities. Imported capulanas are subject to import taxes of 35% (30%duty and a 5% EGA), consumption tax of 30%, and a turnover tax of 5% on the CIF value. However, inpractice, the bulk of imported textile products seem to avoid statutory taxes, through smuggling or under-valuation, as evidenced by the prices charged at the local markets. The figure illustrates the cost structurefor the local production of a capulana, and clearly shows that the domestic producer could indeed becompetitive if imported products paid the statutory taxes.

Box Figure 1.1: Price Structure of Local vs Imported Capulanas (prices in US$/meter)(Taxes and duties are indicated by the darkened areas of the chart).

$1.88

i i Hypothetical priceadvantage from postive Conswnption &

$1.53 effective protection turnover taxes

I Consurption and Price disadvantage fromturnover taxes negativeeffective Duties&EGA

turnover taxes protection

Value added 0.43

Local cotton 0.31 1.10 1.10 World price

Duties & EGA

Imported raw

naterial 0.29

Domestic Imported Importedproducer wth no wth taxes

taxes & &dutiesduties

Source. Company interviews; World Bank analysis

Note: The effective rate of protection based on the above stated nominal statutory duties is: I 00% x {[(1.1 o + (1.10 x 35%/o)) - (0.29+0.10+ 0.31) [1.10 - 0.31 - 0.29]} - I = 57%. Actual effective rate of protection: 100% x ([1.10 - (0.29 + 0.10 + 0.31 + 0.40)] /[1.10 - 0.31 - 0.291) - I = -100%. This calculation simplifies the concept of "value added" by using the Corden method whichincludes all non-traded inputs (See W.M. Corden, Journal of Political Economy 74(1966): 221-237 for details of the methodology).

14

Manufacturing exports

1.29 Mozambique has the potential to expand manufacturing exports given itsrelatively diverse industrial base, cheap labor costs, and high degree of under-utilizedcapacity. Most interviewed manufacturing firms are partial and irregular exporters, withorders ranging from US$10,000 to US$100,000, with the exception of garmentmanufacturers and agro-processing firms which are 100 percent exporters. Exportmarkets include primarily the PTA, South Africa, OECD countries and the USA (forfurther details see Box 1.2).

Table 1.4: Impact on Manufacturing Costs of Duties Paid on Inputs*Excess costs of Excess costs of failure to

imported inputs have access to importsat world price as % of

over world Import total manufacturingExport Item market prices (%) content costsBall point pen 33% 60% 20%Plastic pencil sharpener 26% 66% 17%Disposable razor 32% 69% 22%Fluorescent light fitting 32% 65% 21%Roofing materials madefrom galvanized steel 22% 78% 17%Rolling stock 16% 60% 10%Car tire 23% 48% 11%Steel pipe (general use) 29% 77% 22%Drainage pipe 28% 77% 21%Bicycles 23% 60% 14%Asbestos/cementconstruction materials 16% 60% 10%

* Assumes EGA of 5% effective until August 1994.Source: Survey data; World Bank analysis

1.30 The inability to access imported raw materials and intermediate inputs at worldmarket prices is regarded by interviewed exporting firms as the most important reason fortheir lack of competitiveness in international markets. The impact of duties and Customscharges (including the EGA and the one percent ADENA charge for freight forwarding)on manufacturing costs could be considerable as Mozambican manufactured exports havea very high import content, averaging 65 percent for the sample of export products. Thepayment of duties and import charges increases the cost of imported inputs by anestimated 16 to 33 percent above world market prices for the exports sampled. As aresult, the manufacturing costs for these products is estimated at 10 to 22 percent overworld prices (see Table 1.4). Note that even if the payment of duties and taxes were to beavoided (partly or wholly) by smuggling the industrial inputs, the cost of smuggling is anadditional cost for the exporter which would work just as an export tax.

1.31 Although the basic legal framework for export-related duty drawback/exemptionschemes actually exists, there are no established rules for implementation. In fact, accessto such schemes has been subject to administrative discretion (decided on a case-by-casebasis) or simply refused. Moreover, due to the lack of implementation experience,

15

Customs officials have been unable to handle these schemes which require, for example,the understanding and application of input-output coefficients.

1.32 Seven out of sixteen companies interviewed claimed to have applied for dutydrawbacks over the past few years with no success. In addition to the highermanufacturing costs resulting from the payments of duty and EGA, the impact on tied-upworking capital can be considerable. One company has duty drawback refundsoutstanding for a cumulative value of roughly US$1.03 million for the last three years.Another has US$400,000 outstanding from 1992 and $40,000 for 1993. Few exportershave access to duty-free bonded warehouses but in most instances still have to pay theEGA.14 In our sample of users of this facility, only two had obtained an exemption fromthe EGA, and then only after considerable paperwork was completed.

Box 1.2: Summary Characteristics of Manufacturing Exporters Interviewed

Sample: Sixteen actual and potential exporters were interviewed. The sample includedmanufacturers of garmnents, fabric, construction materials, rolling stock, bicycles, tires, agro-processed products, brushes and brooms, clocks, foundry products, and pens/school accessories.

Size: The size of sample firms (as defined by number of employees) was nine of medium size(currently employing between 80 and 250 workers) and seven large (the largest employs 1,425workers).

Markets: Eight companies export to OECD countries: four export cloth or garments ininternational subcontracting agreements, three export agro-processed goods, and one assembleswall clocks for export. The six firms exporting to the region --neighboring PTA countries andRSA-- include exporters of construction materials, bicycles, rolling stock, brooms, brushes, andtires. One firm exports pens, school accessories and lighting fixtures to both the region andPortugal. Two firms are also diversifying into new export activities; one furm has signed a jointventure agreement with a US manufacturer to assemble electricity and water meters for export tothe region.

General: Most firms are partial and irregular exporters (one to two times a year) and usually onlyhave small export orders (from US$10,000 to US$100,000); only the three garment exportersand the agro-processing firms are 100% exporters. Two firms are potential exporters. One iscurrently working on trial orders with OECD buyers (for garments) after the market in theformer Eastern Bloc countries disappeared; the other is actively soliciting export orders forfoundry products after having last exported in 1975.

1.33 A second major difficulty confronting manufacturing exporters is the lack ofquick access to short-term trade finance in foreign currency. This is a particularly seriousconstraint for most manufacturing firms in Mozambique as the current decline in outputand sales has led to severe shortages of working capital. Partly because of the under-developed status of the local banking system, commercial banks are reluctant to provide

l At the time of the mission only five exporters had licenses to operate bonded manufacturingwarehouses.

16

import finance based only on confirmned export L/Cs. In addition, quick access to foreignexchange is not always assured given Mozambique's dependency on external donor fundsto finance imports, which are generally subject to lengthy administrative procedures.

Agro-industrial exports

1.34 Agro-industrial exports (such as, cashew, tea, sugar, cotton) were a major sourceof foreign exchange earnings in Mozambique during the colonial period. Afterindependence, most agro-industrial processing firms were taken over or 'intervened' bythe state and grouped into large holdings.'5 By 1980-81, cashew, tea, and sugar stillaccounted for a large proportion of commodity exports (40 percent). However, theadverse impact of the war compounded with the poor performance of the state-managedfactories led to a steady decline in production thereafter. The war severely disrupted ruralmarketing/production systems and destroyed installed capacity in strategic export areas.Problems of obsolete capital equipment, low productivity, and high levels of indebtednessattributable to the state-management of these firns, further exacerbated the situation.

Box 1.3: Rehabilitation of Sugar and Tea Estates*

Sugar: Large investments are required to restore irrigation systems and processing capacity.Production of sugar has fallen below 20,000 tons/year (326,000 tons in 1972) andMozambique has resorted to importing sugar to cover domestic consumption needs (of about50,000 tons/year) and to meet its export quota to the US (15-20,000 tons/year) which issubject to preferential prices. At present, the rehabilitation cost of the three state-ownedfactories is estimated at US$170 million, which if implemented could expand output to120,000 tons/year, more than enough to cover domestic needs and the export quota. However,in order to compete with imports in the domestic market, sugar factories will need to reduceproduction costs, which in the past few years have exceeded even the preferential quota prices.

Isa: Significant replanting of the orchard base is needed as well as large-scale rehabilitations.The tea industry was adversely affected by the war and production has fallen to under 3,000tons, compared with a peak of 23,000 tons in 1981. Only two of the twenty factories run byEMOCHA, the state holding company, are operational. Another three are to be rehabilitatedwith multilateral funds estimated at US$40 million. EMOCHA is in the early stage ofprivatization and it is unlikely that the company could be sold and operated as a single unit.The possibility of sub-dividing the 14,000 hectare estate is therefore being considered.

* See Papers on Agro-industry, November 1993, Southern Africa Department, the World Bank.

1.35 With the exception of cotton, which is operating and expanding under a jointventure arrangement since the early 1990s, most agro-industrial exporting firms havebeen partially or fully paralyzed for several years. Already starved of working capital andlacking funds to make badly needed investments to replace obsolete plant and machinery,most firms are unable to operate. Moreover, stricter lending rules and uncertainty aboutthe future of outstanding loans/wage arrears pending privatization have made access to

15 For example, cashew factories fell under management of Caju de Moqambique E.E., the tea estatesunder Emocha E.E. The sugar estates were kept separate.

17

bank credit very difficult. Significant restructuring, through privatization/rehabilitationwould be required for most firms to resume or expand production.

1.36 In view of international technological and market changes, and given the need toensure efficient farm-level production and marketing systems, rehabilitation of some ofthese firms to be economically viable is questionable. Clearly, therestructuring/rehabilitation of agro-industrial enterprises would be best met throughprivatization. From this perspective, the government should reconsider its decision toinvest in costly rehabilitations prior to privatization, (around US$40 million for tea andUS$170 million for sugar) which may have low or negative returns.

Cashew industry

1.37 In the case of cashew, privatization/rehabilitation alone would not suffice toensure the economic viability of investments unless existing distortionary trade policieswere corrected. Prior to independence Mozambique was the largest world producer ofcashew with a production of over 200,000 tons and a capacity to process 150,000 tons ofraw nuts a year. Current production is only about 35,000 tons/year versus outputpotential of around 80,000 tons and processing capacity of 40,000 tons. Depressedoutput levels reflect the impact of the war, aging orchards, and unfavorable prices for rawnuts enforced to support an inefficient industry.

1.38 The cashew processing industry is inefficient because of the use of outdatedcapital-intensive techniques (which are not competitive with major world producers likeIndia and Brazil), poorly run state-owned factories, and bad geographical location. Infact, cashew factories in Mozambique have been generating marginal or negative value-added. This implies that the country could actually earn more foreign exchange byexporting raw nuts instead of kernels (see Box 1.4). To protect this inefficient industry,the farm-gate price of raw nuts has been kept down both through low minimum pricesand export restrictions on raw nuts. Lack of competition within the cashew market hasmeant that minimum prices effectively operate as fixed prices. The minimum farm-gateprice has averaged less than 20 percent of the border price over the past years, which isextremely low by international standards (in Tanzania the share is 50 percent of FOB andeven this is considered to be highly inadequate).

1.39 In 1993 only one private factory with a capacity of 6,000 tons was operating, as aresult the government allowed the export of surplus raw cashew output (about 22,000tons). Export licenses were issued to six wholesale traders, who dominate the cashewmarket in Mozambique. These six traders and one factory made profits equivalent to fourtimes the combined income of several hundred thousand farmers producing raw cashew.Clearly, current policies are reducing incentives and incomes for cashew farmers,encouraging the rehabilitation of inefficient capital-intensive processing factories, andcompromising export growth for the country as a whole. A shift toward semi-manual ormanual techniques would probably be required if Mozambique's cashew processing isever to maximize foreign exchange earnings and farmers' incomes.

18

Box 1.4: Cashew Industry - A Case of "Negative" Value-Added

In the early 1980s, the country had fifteen mechanized processing factories (six privately-owned and therest managed by the state-owned Caju de Moqambique) with a processing capacity of 70,000 tons of raw nuts.Effective capacity was estimated at 40,000 tons in 1993/94. In 1993, only one private cashew factory with acapacity of 6,000 tons was operating. Production at Caju de Mocambique, the state holding companyaccounting for 80 percent of capacity, had virtually stopped since 1992 pending its privatization.

The technical performance of cashew factories in Mozambique is extremely poor. The kernel yield for allof Caju de Mocambique's factories is on average 18.7%, compared with 21 % for the privately-owned factory,and 25% in India, the leading world producer. Moreover, the export price for the low quality kernel producedby Mozambique's mechanized methods is below what could be obtained for raw nuts: the country is actuallylosing foreign exchange by exporting cashew kernels.

....................... .................I........................................................ . ........................................................................................................... .........................................

Raw nut price Caju de Value added Monapo Value added(USS/ton) (US$/ton) kerel price* (US$/ton)kernel price*I (US$/ton) ~~~~~~~~(US$/ton)

1991/92 600 589 (I1) 621 211992/93 680 593 (87) 645 (35)1993/94 750 692 (58) 729 (21)

* Kemel raw nut equivalent conversion factor for Caju de Moqambique is 5.40 and for Monapo 5.13Note: The weight of raw cashew in the total processing costs is about 50%.Source: Secretarv of Stalefor Cashew

B. POLICY AND IMPLEMENTATION ISSUES

1.40 Based on the interviews conducted with firms, a sharp distinction needs to bedrawn between private and state-owned firms when analyzing the efficiency and growthpotential of the industrial sector. For the most part, existing capital stock, installedtechnologies, and production costs within privately-owned firms indicate that most firmswould be well placed to compete in the world market, given a level playing field and aless hostile business environment. These conclusions support those reached in the"Mozambique Industrial Sector Study",16 carried out by the World Bank in May of 1990,that found many enterprises in Mozambique to be competitive.

1.41 High protection levels are not a precondition for private firms to survive andprosper. However, some fundamental factors are preventing Mozambique's competitivepotential from being realized. First, further rationalization and enforcement of tariffs andtaxes and the concurrent strengthening of the Customs administration is of the utmostpriority for both import-substituting and export-manufacturing firms. Despite therationalization of the tariff structure, a weak Customs administration and ad-hocenforcement of duties and taxes has undermined the capacity of local firms to compete.On the one hand, domestic industry, which in effect has to compete with duty-freeimports while paying domestic taxes, is faced with negative protection in the domestic

16 "Mozambique Industrial Sector Study - The Development of Industrial Policy and Reform of theBusiness Environment". May 22, 1990, World Bank Report No. 7795-MOZ.

19

market. On the other hand, the export-manufacturing industry, which might reasonablyexpect guaranteed access to inputs at world prices, is unable to secure duty refunds orbenefit from a temporary admissions regime.

1.42 Improving the administration and enforcement of Customs is critical if tradepolicy is to be effective. For Mozambique's industries not to be handicapped as soon asthey are exposed to the rigors of international markets, duties should be properlyadministered so that industries are not subject to negative protection. Moreover,enhanced duty collections would contribute to fiscal revenues and offer a sustainablesource of income to finance the budget. A detailed examination of the technical andprocedural problems associated with the administration of Customs and pre-shipmentinspection, along with recommended solutions are the subjects of Chapter 2.

1.43 In the medium-term, however, further tax reform would be required to reduceincentives to smuggling resulting from a high tax-tariff regime and the fact thatMozambique is a transit point for regional trade. In this regard, the government isstudying the possibility of introducing a Value Added Tax (VAT), which would combinethe turnover and consumption tax within a two to three-year period.'7 From the point ofview of industry, moving to a VAT system and establishing a zero or low protectivetariff, would eliminate the cascading effects inherent in the current taxation system.While lowering the tax-tariff burden is expected to expand the tax base by reducing theincentives for tax evasion, the fiscal implications of introducing such a system should beexamined carefully since indirect taxes account for 80 percent of total fiscal revenues.

1.44 In addition to Customs and tariffs, a second area for government prioritizationshould be export promotion. Despite undertaking important reforms in the exchange rateregime and declaring a pro-export policy, the government has done little to activelypromote export growth. Since over half the firms interviewed are either exporting, orclearly possess the potential to compete in world markets, creating conditions for firms tobetter utilize installed capacity could have an immediate and significant impact onMozambique's foreign exchange earnings. The inability of exporters to gain access toimported inputs at world prices along with limited access to credit and working capitalwere found to be two major impediments to export-manufacturing growth. Chapter 3examines in detail the main constraints faced by manufacturing exporters and proposespriority tasks for implementation.

1.45 The removal of regulatory and administrative constraints for private sectordevelopment, as well as more rapid privatization of state companies is essential to ensurea sustainable recovery of all private industry in Mozambique, including import-substituting, export-manufacturing, and agro-processing. As discussed earlier, privatesector firms perform better than state firms in general. Yet private investment (bothforeign and domestic) has been slow to respond the newly liberalized environment inMozambique. In large part the impediments to growth are the result of problems with theimport and export regime. In addition, the business environment is weighted with

This work is being carried out with the assistance of the International Monetary Fund.

20

additional bureaucratic procedures that increase the transaction costs of starting andoperating a business, for example labor regulations. Chapter 4 reviews the business andinvestment climate in greater detail, focusing on regulatory and institutional constraints todoing business and presents proposed solutions.

1.46 Private sector growth is also constrained by difficulties in the implementation ofthe privatization program itself. The historically slow privatization of large state firmshas left approximately half of industrial output under poor management and in need ofmajor restructuring. The long lags between declaration of intent to sell and actual salehave resulted in the paralysis of many state firms, which are no longer able to secure bankfinancing or to attract investment. The actual sale of state companies is proceeding withdelays caused by lengthy preparatory procedures and difficulties associated withdismissing redundant labor. This latter problem is particularly serious in the case of agro-industrial exporting firms. Chapter 5, examines current constraints to rapid privatizationand highlights policy recommendations and some steps already being taken to expeditethe process.

1.47 Finally, Mozambique's agro-processing industries hold especially great promiseas a future source of export revenue. The cashew sub-sector in particular has thepotential for rapidly increasing export revenues, industrial production, and farmers'incomes. rhe regeneration of the sub-sector as a primary source of foreign exchange,however, will require the removal of distortionary policies restricting domestic andinternational trade. These policies result in low production of raw and processed output,reduced foreign exchanges earnings, and reduced incomes to farmers. Chapter 6evaluates the costs of these distortionary policies. It also assesses the gains to begarnered in exports and rural incomes within a liberalized trade regime.

2. CUSTOMS ADMINISTRATION AND PRE-SHIPMENTINSPECTION

INTRODUCTION 18

2.1 The current Customs administration in Mozambique is extremely inefficient andineffective. Inadequacies in current practices are resulting in injury to domestic industryand serious revenue loss. Main problems include weak physical and documentary controlmechanisms, from arrival through the clearance of goods, and ineffective implementationof duty exemptions regimes for exporters. The root of these problems lay in the lack ofappropriate standard operating procedures, weak enforcement mechanisms, lack ofcomputerized information and management systems, and poor human and infrastructureresources.

2.2 Although Mozambique has employed the services of a pre-shipment inspection(PSI) company since 1990, very little benefit has been derived from this service. In fact,Customs authorities have regularly allowed imports to be cleared without a clean reportof findings. Moreover, Customs and ADENA, the state-owned clearing house, often tendto ignore or modify PSI determinations as to valuations and classifications of imports.Moreover, no procedure exists for checking the tax liability of import consignmentsassessed by the PSI company against taxes actually paid by importers.

2.3 A high level of commitment would be required to address the seriousinadequacies encountered in Customs administration. In the short-term, the negotiationof a new PSI contract would provide an excellent opportunity to enhance the value of theservice for the country by including critical features such as ex-post reconciliation ofimport documentation. At the same time, priority must be given to enhancingenforcement mechanisms through the creation of a high profile anti-smuggling task forcewith an explicit mandate to detect, apprehend and prosecute those parties involved incontraband activities.

2.4 In the medium-term, the implementation of the ASYCUDA computer systemshould be the cornerstone of an overall Customs Modernization Program proposed in thisreport. This will provide the basis for the elaboration of standard operating procedures,the development of necessary information and management systems, and the preparationof a comprehensive human resource and infrastructure plan. The possibility ofestablishing an independent Revenue Authority should also be studied to provide thegovernment with options in the medium to long-term.

This Chapter summarizes the main findings of a comprehensive report prepared by the mission onCustoms Modernization in Mozambique. The report has been left with the Mozambican authorities.

22

A. WEAKNESSES IN CURRENT CUSTOMS PROCEDURES

Controls Over Imports Up to Clearance

2.5 Inadequate Customs control mechanisms over cargo/conveyances from the timeof arrival until clearance, are no doubt the main avenues for the large flow of smuggledgoods into the country.

Cargo control upon arrival

2.6 Physical and documentary control of import cargo arriving in the country isinadequate by international standards. Main shortcomings include: (i) reliance on cargoagencies (the port authority (CFM), the airline (LAM) and road terminals) to identify andreport cargo overages/shortages; (ii) all bills of lading and airway bills are not receiveddirectly from the carrier/shipping agent but from the importer/agent (ADENA) as asupporting document to the goods declaration; (iii) there is little Customs surveillance todetect and deter smuggling over ships or airplanes during their call at the ports or airport.In addition, Customs is not exercising effective control over significant quantities of'unclaimed' cargo. Cargo remaining in the port for long periods without Customs controlis susceptible to smuggling, pilferage, insurance fraud, and malfeasance between traders,Customs aad port authority officials.

Box 2.1: 'Unclaimed' Containers

The Maputo port authority reports that 300 to 400 import containers currently remain at theport for more than 180 days. Beira port authority reports that just over 200 containers havebeen there for more than 90 days. Many of these containers have been at the port for periods inexcess of 800 days.

Unclaimed cargo at Maputo port has also an impact on transport costs for traders. A CFMcomputer listing of 670 full import containers currently in Maputo port reveals that the averagecontainer dwell time (from date of arrival until departure) was 114 days. This unacceptabledwell time has led shipping lines to impose surcharges of up to $225 on containers destined forMaputo. Port demurrage charges (US$15/day) begin to accrue only three days after off-loading, even before the bill of lading is available from the shipping agent. Importers faceadditional charges by shipping lines if the container remains in the port for more than 90 days.

2.7 Specific measures to strengthen documentary control over individualconsignments should be adopted. These would include providing Customs with copies olconsignment level manifests by carriers; undertaking selective physical verifications; andincreasing controls over unclaimed goods.

Control of goods in transit

2.8 Customs documentary and physical controls are inadequate for cargo in transitfrom frontier border offices to inland clearance warehouses (from Namahacha andRessano Garcia to FRIGO/Maputo and from Maachipanda to TIRO/Beira). The impact

23

of weak Customs control is likely to be more serious at the Swaziland and South Africanborders (Namahacha and Ressano Garcia) where the bulk of import trade is concentrated.Transit controls are weak for cargo transiting Mozambique enroute between Zimbabwe,Malawi and Zambia. There is only one Customs office on the Zambian border andvarious Customs posts on the Malawi and Zimbabwe borders are either unmanned or notoperating for other reasons. 9

2.9 The current system relies on transit documents being carried/presented by thetruck driver to Customs upon arrival at the office of transit termination/inland clearancewarehouse. Only a limited number of Customs Police are available to escort trucks fromthe frontier to the inland warehouse. No documentary reconciliation procedure existsbetween the Customs office at the border and the terminal. This opens the door tofraud/malfeasance and does not allow Customs to effectively verify that transitprocedures have been properly completed.

Import Declaration Process

2.10 Submission by ADENA. Until very recently, a single state-owned agency(ADENA) held a virtual monopoly over the Customs brokerage industry. Only a limitednumber of brokers were licensed to operate outside ADENA, and then only to practice onbehalf of their employer/importer. ADENA's monopoly has effectively preventedimporters from preparing/presenting their own goods declarations and resulted in highbrokerage fees (one percent of the CIF import value).

2.11 The importer provides ADENA with required documentation - invoices, bills oflading, import licenses (BRIs), and clean report of findings (CRFs)- to prepare thedeclaration. According to ADENA, importers can obviate the presentation of a CRF byobtaining a letter of dispensation from Customs for a small administrative fine(approximately US$10). ADENA holds that it is not obliged to utilize the tariffclassification (Harmonized System codes) that appear on the CRF and that it amendsapproximately 50 percent of the CRFs tariff codes before submission to Customs.Furthermore, ADENA claims that it is required to utilize the reference prices recentlyissued by Customs for a list of goods rather than the values stated by the CRF for dutypayments.20 The declaration preparation operation is not computerized. All declarationsare handwritten and do not contain any coded data elements other than the HS tariff code.Since ADENA is paid its fee in full, and also holds the importer's duties/taxes, there is nofinancial incentive to expedite the completion of the declaration.

19 In Zimbabwe, operating posts include Machipanda, Espungabera, Penhalonga and Cuchamano. InZambia only the main post (Cassicatiza) is open. In Malawi, in addition to Zobue, other posts havebeen recently opened (Biri-Viri, Vila-Nova de Fronteira, Milange, Entrelagos, Mandimba and Chale).

20 According to Customs, this list of minimum prices is meant to avoid under-valuation (identified insome cases) and to be used as a reference by the Customs officers responsible for the verification ofimport declarations.

24

2.12 Processing by Customs. The current document flow and procedures for verifyingimport declarations are extremely cumbersome and inefficient. A series of redundantverifications are performed by different Customs offices before the goods can be cleared.For example, in Maputo agents are required to physically take the declaration to theregional Customs office (where Customs performs an initial verification and duties/taxesliabilities), then to the port office (where the dispatch is re-verified and the goodsphysically inspected), then to Customs headquarters (for a third and final reverificationby the Deputy National Director).

2.13 The current processing of declarations blurs the normal distinction between port,regional and headquarters functions. It adds significant time and cost to the clearanceprocess without any visible benefit of increased control (see Pre-shipment Inspection).Indeed, having the declaration pass over so many Customs officers desks before clearanceincreases the likelihood of malfeasance.

2.14 A sample of declarations should be selectively re-verified by personnelspecializing in classification and valuation on a post-clearance basis at the regional level.This re-verification will ensure that consignments are being correctly and consistentlyassessed, and revenue is being collected.

Controls iver Exemptions

2.15 The issuance and administration of exemptions is weak and open to significantadministrative discretion. Duty and/or tax exemptions are issued by various agencieswithin the Ministry of Finance, either the tax department or the National Director ofCustoms. Duty exemptions are granted to foreign aid, diplomatic exemptions, industrialinputs, authorized investments under the investment code, and personal effects ofreturning miners. Criteria to be used in determining whether to grant an exemption arenot sufficiently transparent.

2.16 In general, exemption letters are issued from Customs headquarters to theCustoms regional office where the shipment is to be cleared. Exemption letters do notnormally specify HS codes, value and/or quantitative limitations, or a detailed goodsdescription but refer to attachments such as BRIs or pro-forma invoices. At present,Customs produces only aggregate information on exemptions but there are nodisaggregated reports indicating the value of goods exempt and the amount ofduties/taxes exempted by each exemption program.

2.17 A thorough review of all exemption programs should be undertaken to evaluateeconomic benefits against the cost of exempted revenues. Criteria for granting ofexemptions should be reviewed and where appropriate strengthened to minimizeadministrative discretion. In particular, controls over the returning miners' personaleffects exemptions should be strengthened by setting quantitative limits and submissionof a declaration with a complete inventory of all goods being imported.

25

2.18 Exemptions issued should include a full and complete description of the goods(ideally an HS code); any quantity and value limitations; and reference to the legalauthority/program through which the exemption is granted. In the short-term, theinspection company should receive a copy of all exemptions granted; indicate theexemption on the CRF (duty/tax assessment net of exemptions); and producemanagement information reports on exemptions.

Pre-shipment Inspection

2.19 Mozambique has employed preshipment inspection (PSI) services since July1989. The contract for these services, awarded to Societe Generale de Surveillance(SGS), focuses on both over-invoicing (foreign exchange) and under-invoicing (revenue).On the Customs side, the authorities have made limited use of PSI, thereby foregoingsignificant opportunities to enhance revenue collections and facilitate trade. Among themajor problems have been the failure of Customs to use the information provided in PSIdocumentation and the failure to insist that importers present a CRF as a precondition forclearing goods through Customs. The information contained in CRFs is not checkedagainst import declarations (dispatches) nor against revenue receipts to ensure that taxeshave been properly assessed and collected (ex post reconciliation).

BRIs and the Ministry of Commerce

2.20 Importers are required to obtain import licenses (BRI - Boletim de Registro deImportaqdo) from the Ministry of Commerce for consignments valued at US$500 orabove. The Ministry of Commerce is responsible for determining whether PSI is

22required.

2.21 With the exception of items on this list, the Ministry of Commerce should alwayscode and stamp BRIs as subject to inspection. Consignments subject to inspection willeither require "complete" (including price verification) or "basic" (physical examinationonly) PSI, depending on whether procurement has been involved in the acquisition of thegoods in question. In 1993, the Ministry of Commerce issued BRIs worth US$869.7million, of which US$140.4 million (or 16.1 percent) were exempt from pre-shipmentinspection. In terms of the number of consignments, almost half (49.6 percent) were PSI-exempt. Two potential weaknesses at this stage of the import process are: (i) that not all

21 The current instruction, Circular aos Importadores No. 001/DNCE/91 de 29.08.91, issued jointly bythe Ministry of Commerce and Ministry of Finance, lays out the procedural requirements forpreshipment inspection.

22 This determination should be based on the following list of pre-specified exemptions: goods valued atless than US$5,000; emergency food aid; certain donor-financed imports; certain imports/equipmentfinanced by project aid; precious and semi-precious stones; explosives and arms for use by themilitary; antiques; personal items for own use; used cars and scrap metal; live animals; fruit,vegetables, fish and meat, fresh, chilled or frozen, eggs; newspapers and magazines; postal shipments;commercial samples; and imports by government, NGOs, and multilateral institutions for their ownuse.

26

the BRIs which should be subject to inspection are so treated because of lapses in theprocedures of the Ministry of Commerce; and (ii) that importers seek to avoid PSI bysplitting consignments or under-stating the true value of the goods.

The use of clean reports offindings

2.22 Upon receipt of BRIs from the Ministry of Commerce, the PSI company transmitsinspection orders to its affiliate offices in exporting countries (in respect of those BRIsindicating a PSI requirement). Unless the transaction in respect of which a BRI has beenissued falls through, the inspection order should trigger an inspection, and eventually, aCRF. The system has not functioned satisfactorily in this regard. In 1993, the value ofBRIs subject to inspection amounted to US$ 729.3 million, but the amount that SGSreported as having been inspected was only US$ 357.8 million (or approximately 49percent). Only half of the value of goods that should have been subject to PSI wereactually inspected.

2.23 A second weakness under the present arrangements is that even when PSI hasbeen carried out, and a CRF has been issued, Customs does not necessarily insist on theuse of a CRF to clear goods. It is impossible to obtain reliable data on the frequency withwhich Customs has allowed clearance without CRFs, but an indication of the magnitudeof the problem is given by the fact that approximately 50 percent of CRFs issued in 1993were not picked up by importers from the SGS offices. This means either that Customsallowed clearance without a CRF, or that the goods in question were smuggled into thecountry. Either way, a substantial revenue shortfall is likely to have been the result.

2.24 A third problem relates to the practice of Customs and ADENA (the clearingagents) to change tariff classifications or valuations established in clean reports offindings (as indicated earlier). These practices seriously undermine the PSI program.The reference prices issued by Customs are in all probability being used by Customsofficers as minimum import prices, regardless of SGS opinions as to value for Customsduty purposes. Such reference prices are superfluous in the face of PSI. For goods notsubject to PSI, on the other hand, the Customs authorities could use unit price data fromprevious CRFs to establish price ranges that would assist in Customs valuation.However, such unit price data should never be used to establish minimum import prices.

Improving the impact of PSI

2.25 Ex-post reconciliation. For PSI to work properly, and yield full benefits to thegovernment, a system of ex post reconciliation is indispensable. Reconciliationestablishes whether all duties and taxes due, have in effect, been paid. The PSI companyshould be mandated to undertake this task and to make a monthly report on alldiscrepancies between tax liabilities and amounts paid.

2.26 Timeliness. In order for PSI to work effectively, procedures must be timely. IfPSI becomes an undue burden on account of extended delivery times or Customsclearance, exporters and importers will have a further incentive to circumvent the system.

27

The PSI company should make every effort to accommodate suppliers' needs in fixingthe time and place of inspections.

2.27 For a country like Mozambique, where a high proportion of trade takes place withneighboring countries and involves short transit times, goods sometimes arrive before thecorresponding clean report of findings. This means that the PSI requirement can delayCustoms clearance, unless arrangements are in place to avoid such an occurrence.

2.28 Trade facilitation. Although PSI inevitably adds to import procedures, it can alsofacilitate trade. Preshipment inspection should relieve Customs of the need to inspect andverify consignments as intensively as might otherwise be the case, thus acceleratingclearance times. In addition, a potentially useful facilitation measure would be to requirethe PSI company to seal full container loads (FCLs). Containers sealed in this mannerwould only be subject to physical examination upon arrival in special circumstances.

2.29 Appeals and complaints procedure. An appeals and complaints body should beestablished to adjudicate differences of opinion between importers and the PSI companyin regard to the classification or valuation of merchandise. In addition, this body shouldhear any complaints from traders about the functioning of preshipment inspection. Suchcomplaints should be presented in writing, and the PSI company would be given theopportunity to respond. These procedures would bring complaints and criticisms aboutPSI services out into the open, and allow their validity to be independently assessed.

Customs Enforcement

2.30 It can be argued that the little risk of being detected/penalized by Customs clearlyincreases the incentive to smuggle in Mozambique. While there is no doubt that asignificant amount of contraband enters the country in small quantities along the remotefrontier, the sizable volumes of contraband on the market would indicate that smugglingis very organized and institutionalized, enabling whole container or truck loads ofbeer/spirits, tobacco, textiles, and consumer goods to systematically evade Customscontrols. It would appear that attempts to curb organized smuggling through Maputoport, Namahacha, and to a lesser extent Ressano Garcia and Machipanda, have had verylimited success.

2.31 Approximately 450 of Custom's personnel (over 50 percent of total staff) areCustoms Police. This force reports through a Director at Customs headquarters to theNational Director. Despite requests, no data were obtained from Customs managementon their enforcement effectiveness.

2.32 Customs enforcement efforts are ineffective for a number of reasons (i) poorinfrastructure (vehicles, radios, inspection facilities) and lack of enforcement aids; (ii)lack of coordination and cooperation with other enforcement agencies (immigration andlocal police); and (iii) lack of post-clearance investigation and prosecution. In particular,there appears to be little attempt to investigate firms suspected of having in theirpossession contraband goods and require that they produce evidence that the goods in

28

question have properly entered the country. For example, the significant amount ofcontraband alcohol, beer and cigarettes found in Mozambique would be an obvious targetfor post-clearance investigations.

B. CUSTOMS MODERNIZATION PROGRAM

2.33 A radical reform must be implemented in order to address the serious weaknessesencountered in Mozambique's Customs administration. In the short-run, emphasisshould be given to enhancing the value of pre-shipment inspection services, selectivelyimproving Customs practices, and strengthening enforcement mechanisms. In themedium term, an overall Customs modernization program should be implemented underthe umbrella of the ASYCUDA system.

2.34 The renewal of the PSI contract, which expired in October, 1994, provides avaluable opportunity to rectify shortcomings in existing PSI procedures and to ensure thatthe Government of Mozambique derives maximum benefits from preshipment inspection,in terms both of enhanced revenue collection and greater efficiency in Customs. Detailedproposals regarding provisions to be included in a new PSI contract are contained inAnnex 2. Provisions to ensure ex-post reconciliation of import documentation will beespecially critical to reduce illegal imports and enhance revenue collection.

2.35 In parallel, the government should establish an anti-smuggling task force toundertake an all-out campaign to control the entry of contraband into the country. Thistask force should be comprised of a high-profile hand-picked cadre of personnel fromvarious enforcement agencies (Customs Police, Immigration, national and local Police,Attorney General's Office). Ex-post investigation should be developed (on alcohol,cigarettes) and penalties/fines resulting from failure to comply with Customs regulationshould be substantially increased. In particular, fines for not presenting CRFs should beraised to at least 20 percent of the value of the import consignment, after assessment bythe PSI company.

Management and Information Systems

2.36 Accurate and timely management information is vital to the effective and efficientadministration of Customs. There is currently an acute lack of accurate and timely tradeand revenue information which should be derived from import and export declarations.There is also a serious lack of operational information to assist managers at both Customsoffices and national headquarters in measuring workload and performance. Without suchreports it is difficult for Customs management to ensure that its limited resources aredeployed both efficiently and effectively.

2.37 In the short-term the inspection company should be required to produce thefollowing types of management information from data compiled from declarationsreceived from Customs in order to perform the reconciliation against CRFs:

29

* total value of imports (split between PSI/Non-PSI)* total duties, taxes and other fees assessed;* total value and revenues exempted (by exemption type);* total duties, taxes, and other fees collected; and* reports on specific commodities imported (by the Harmonized System code).

2.38 In the medium-term, the ASYCUDA system's statistical database should beutilized for the bulk of Customs management information reporting. Using the statisticaldatabase package EUROTRACE, (developed by the Statistical Office of the EuropeanCommunity in Luxembourg) import and export declaration data will be efficientlyextracted from the ASYCUDA system to meet the information needs of Customs andother governmental departments. Customized retrievals/reports can be output based onselection criteria (to allow specific queries on importers, exporters,, commodities,countries, individual declarations, and any combination of this criteria).

2.39 The ASYCUDA database will be of importance not only to the Ministry ofFinance for budgetary and fiscal decisions, but also to the Bureau of Statistics (it couldeliminate their current requirement to input/compile trade data). It will allow governmenteconomic decisions to be based on more recent and accurate trade data; avoid duplicationand errors due to data transcription, and allow human resources to be deployed to moreeffective tasks.

Standard Operating Procedures

2.40 There is no comprehensive set of internal standard operating procedures manualsto instruct Customs officials/traders on the steps to follow when administering/complyingwith each Customs procedure. While various ministerial decrees and Customsheadquarters circulars exist, these generally do not contain the level of detail necessary toensure effective and efficient administration. Standard operating procedures are criticalto ensure consistency in the administration of Customs; to allow internal operationalaudits/inspections; to permit transparency; and to promote voluntary compliance fromtraders.

2.41 A complete set of standard operating procedure manuals should to be developedfor use by Customs staff and an edited version made available to the trade community(sold on a cost-recovery basis). These manuals should reflect the new proceduresdictated by the implementation of the ASYCUDA system. They must be comprehensivein providing detailed instructions for administering all Customs procedures (cargoreporting and control; transit control; import/export declaration processing; exemptioncontrol; revenue accounting; tariff classification; valuation; appeal mechanisms;warehousing; drawback/duty exemption schemes for exporters, export processing zones;passenger processing; postal operations; management and operational reportingrequirements).

30

Customs Law

2.42 The current Customs law pre-dates independence and is ill-adapted to supportCustoms present and future needs. It is understood that a draft law has been prepared, butneeds significant review and amendment before it can be tabled for enactment.

2.43 The Customs law needs to be revised to support Customs' current and futurerequirements. It should support the systems and procedures dictated by the introductionof the ASYCUDA system and be in-line with the Kyoto Convention on theSimplification and Harmonization of Customs Procedures. In revising the Customs law,it is recommended that three instruments be clearly and separately established: the tarifflaw; the basic Customs code; and the executive regulations.

Administration of the Customs Tariff

2.44 Mozambique uses the Harmonized System Nomenclature (HS) at the six digitlevel. At present, neither ADENA nor Customs inform SGS when they unilaterallydecide to amend the CRFs tariff classification. While an appeals tribunal exists by law tohandle importer appeals on tariff classification, this tribunal has not been functional forsome tirr.e. Consequently, there is a lack of transparency as to how importers canformally appeal questions of classification. Customs headquarters has no structuredsystem for the issuance of classification opinions/rulings. Consequently, there is nocertainty that goods are classified uniformly from one port to the next.

2.45 A well-structured tariff book was published in 1991 and a supplement issued totake effect in January 1. 1994. This separate supplement was required because the tariffbook was not bound in a manner to allow amended pages to be replaced/updated. SGSMaputo reported that they were not given a copy of the new tariff supplement on a timelybasis and only learned of the new rates many weeks after the supplement came into effectwhen it appeared in the public gazette.

2.46 Importers/agents should be required to use the tariff classification as stated on theCRF (if the consignment was subject to preshipment inspection). If Customs and/or theimporter wishes to challenge the tariff classification stated on a CRF, this should be doneon the basis of clear administrative procedures. The matter should be first raised to theinspection company for discussion and, if no satisfactory conclusion can be reached, toan independent appeals tribunal. If agreement could not be reached in this appeals body,the matter would be referred to a higher authority for a final decision.

2.47 Customs headquarters should establish a structured system of tariff classificationrulings/opinions to ensure greater uniformity in the interpretation/application of the tariff.Copies of all rulings/opinions issued should be forwarded to the inspection company forcomment and to ensure uniformity for treatment when similar or identical goods areimported through the PSI or non-PSI systems.

31

2.48 Additional technical training on the Harmonized System should be given toCustoms officials, Customs agents. and interested traders. This training should focus onthe proper use of the HS explanatory notes, which need to be made more widely availableto Customs staff and the trade community.

2.49 All amendments to the tariff code should be forwarded directly and on a timelybasis to the inspection company to ensure that it will apply new rates when these becomeeffective. The next tariff book should be printed and bound such that it can be moreeasily amended/updated.

Customs Valuation

2.50 The current procedures by which Customs determines value of imports for dutypayments are ambiguous and not in conformity with internationally accepted methods ofvaluation. There is no effectively operating appeal mechanism for traders wishing todispute the inspection company's or Customs valuation. It is highly probable that themajority of consignments entering Mozambique are being undervalued, resulting insignificant revenue loss.

2.51 In the short-term, Customs should not accept a declaration to clear goods thathave been deemed to be subject to PSI without a CRF. The value for duty found on theCRF should be that utilized on the goods declaration. If Customs and/or the importerdisagrees with the value of goods on the CRF, this should first be discussed with theInspection company and if agreement cannot be reached, appealed to an independentappeals tribunal outside Customs. The inspection company's reconciliation of CRF'sagainst goods declarations must include reconciliation of values. Where thisreconciliation identifies a discrepancy, a follow-up investigation must be made by theMinistry of Finance.

2.52 The use of minimum reference price lists by Customs should not be allowed forPSI consignments and discouraged for PSI-exempt consignments. If Customs feels thatreference prices are required to assist them in valuing PSI-exempt declarations, the priceson the list should be compiled from such sources as recently issued CRFs. In this way,there is a greater likelihood of uniformity of treatment between PSI and PSI-exemptgoods and less incentive for traders to attempt to circumvent PSI by splittingconsignments. Such reference prices should be treated as an internal document and notbe made available to traders.

2.53 In the medium-term, Customs valuations should be brought further in conformitywith the GATT valuation principles, and appropriate technical training and assistancebrought to bear to attain this objective. Exemptions should be administered through theASYCUDA system (all exemptions input into the system to be validated against thedeclaration data). The ASYCUDA Extraction Module of the system should be able toproduce regular management information reports for each exemption program.

32

Human Resource Plan

2.54 It is recommended that a thorough human resource plan be developed to assessthe adequacy of current personnel against existing and future requirements. The plan willneed to address such issues as recruitment, re-deployment, training and remuneration.

2.55 The current structure at the headquarters, regional and port levels is ineffectiveand needs to be modernized such that Customs can adopt and manage changes dictated bythe Customs Modernization program. In the short-term, it is recommended that a steeringCommittee be formed, chaired by the Vice-Minister of Finance; the National Director ofCustoms be held responsible for the Customs modernization Program; a senior full-timeCustoms project manager be assigned to implement ASYCUDA, a number of expatriateadvisors be recruited to assist Customs in implementing the Customs ModernizationProgram and short-term measures be taken to redress the weaknesses in internal controls.

2.56 To further increase revenue collection over the medium to long-term, it may alsoprove beneficial to the government to establish an independent Revenue Authority. Inother countries, such as Zambia, where similar authorities have been established, taxcollection has improved. The need for and feasibility of establishing an independentRevenue Authority in Mozambique should be studied.

3. DEVELOPMENT OF MOZAMBIQUE'SMANUFACTURED EXPORTS

INTRODUCTION

3.1 Although a reliance on export growth constitutes part of the government'sdeclared strategy, export policy should be further prioritized. While exchange raterealignment and trade liberalization might have created necessary conditions for apositive supply response, policy and implementation constraints are underminingMozambique's capacity to generate sustainable export expansion. Apart from theproblems faced by the industrial sector in general, exporters face additional constraints.

3.2 Through interviews conducted with manufacturing exporters, officials, andbankers, three major constraints to Mozambique's manufactured export developmenthave been identified. First, the failure to assure quick and unrestricted access to importedinputs at world market prices is the most serious obstacle hindering the competitivenessof Mozambique's manufactured exports, which have a very high import content (morethan 60 percent on average). A second difficulty confronting exporters is the lack ofquick access to working capital to finance production and export sales. By and large, theunderdeveloped banking system and uncertainty associated with foreign exchangeavailability and exchange rates constitute overriding factors. Finally, the unfavorablebusiness environment characterized by the constraints discussed earlier and imperfectinformation have hindered the inducement of export-oriented foreign enterprisecollaboration (foreign investment, sub-contracting and technical/marketing agreements).In the infant stage of Mozambique's manufactured export development, foreign enterprisecollaboration is critical to assure rapid access to export markets and technical know-how.

3.3 In view of the limited domestic market and large inflow of illegal imports,manufactured exports are critically important to attaining sustainable growth andfinancial viability. A number of priority tasks should be carried out as a matter ofurgency in order to reduce or eliminate constraints. The major issues and the prioritytasks in these three areas are now presented.

34

A. ACCESS TO IMPORTED INPUTS AT WORLD MARKET PRICES

Ineffective Duty-Free Import Schemes for Exports

3.4 The lack of access to duty-free imports of raw materials and intermediate inputshas seriously undermined the ability of Mozambique's manufacturers to compete ininternational markets. The impact of unrecovered duties and Customs charges onmanufacturing costs is estimated to be substantial, 10 to 22 percent for the sample ofexports reviewed here, reflecting the high import content of Mozambican manufacturedexports (on average over 65 percent). In addition to rendering manufacturing costshigher, the impact on working capital tied up by duty and EGA payments is alsoconsiderable. The characteristics of exporters interviewed are shown in Box 3.1.

Table 3.1: Impact on Manufacturing Costs of Duties paid on Inputs*Excess costs of Excess costs of failure toimported inputs have access to imports

importerwd inputs at world price as % Ofover world Import total manufacturing

Export Item market prices (%) content costsBall point pen 33% 60% 20%

Plastic pencil sharpener 26% 660 17%Disposable razor 32% 69% 22%Fluorescent light fitting 32% 65% 21%Roofing materials madefrom galvanized steel 22% 78% 17%Rolling stock 16% 60% 10%Car tire 23% 48% 11%Steel pipe (general use) 29% 77% 22%

Drainage pipe 28% 77% 21%

Bicycles 23% 60% 14%Asbestos/cementconstruction materials 16% 60% 10%

*Assumes EGA of 5% effective until August 1994.Source: Survey data; World Bank analysis

3.5 While Mozambican legislation makes provisions for duty-free imports forexporters, in practice, existing schemes have proved either ineffective or virtuallyinoperative. The duty exemption regimes reviewed in this report include: (i) the dutydrawback scheme; (ii) Customs warehouses; and (iii) special bonded manufacturingwarehouses.

The duty drawback scheme

3.6 The duty drawback (DD) scheme is okay in the Customs Act of 1960 and is basedon Ministry of Finance Decree No. 18/89. The drawback is defined as restitution of partof or all import duties paid on raw materials, finished and semi-finished goods that areincorporated into exported goods. It does not include the EGA.

35

Box 3.1: Characteristics of the Manufacturing Exporters Interviewed

Sample: Sixteen actual and potential exporters were interviewed. The sample includedmanufacturers of garments, fabric, construction materials, rolling stock, bicycles, tires, agro-processed products, brushes and brooms, clocks, foundry products, and pens/school accessories.Size: The size of sample firms (as defined by number of employees) was nine of medium size(currently employing between 80 and 250 workers) and seven large (the largest employs 1,425workers).Markets: Eight companies export to OECD countries: four export cloth or garments inintemational subcontracting agreements, three export agro-processed goods, and one assembleswall clocks for export. The six firms exporting to the region --neighboring PTA countries andRSA-- include exporters of construction materials, bicycles, rolling stock, brooms, brushes, andtires. One firm exports pens, school accessories and lighting fixtures to both the region andPortugal. Two firmns are also diversifying into new export activities; one firm has signed a jointventure agreement with a US manufacturer to assemble electricity and water meters for export tothe region.General: Most ftrms are partial and irregular exporters (one to two times a year) and usually onlyhave small export orders (from US$10,000 to US$100,000); only the three gannent exporters andthe agro-processing firms are 100% exporters. Two firms are potential exporters. One is currentlyworking on trial orders with OECD buyers (for garments) after the market in the former EastemrBloc countries disappeared; the other is actively soliciting export orders for foundry products afterhaving last exported in 1975. J

3.7 Although provided for under the law, the DD scheme is virtually inoperative in

Mozambique. Seven of the sixteen sample firms have regularly attempted to obtain duty

drawback refunds in the past. Except for one exporter, who received one refund after six

months, none of the firms interviewed have received any duty refund during the course of

their export activities. Despite this poor refund prospect, several firms continue to submit

refund applications. Most never receive a response, either positive or negative, from the

regional Customs offices responsible for handling duty drawback applications; inquiries

and investigations on the part of the firms have remained without result.

3.8 A combination of factors have contributed to make the DD scheme virtually

inoperative in Mozambique. Most notably these include: (i) the lack of transparent rules

and regulations; (ii) the inability of Customs to evaluate input-output coefficients; and

(iii) the lack of budgetary funds earmarked for this purpose.

3.9 Lack of transparent rules and regulations. According to exporters, there is a

complete lack of transparency in the implementation of the DD scheme. In the absence

of standard procedures, exporters are left to speculate about the necessary documentation

to file a complete refund application. On the other hand, Customs officials place their

own interpretation on the procedures to be followed, which, however, are not published

anywhere. For example, many exporters seem unaware that obtaining a DD license is a

pre-requisite to be eligible for duty refunds. According to Customs, a license must be

issued by their head office prior to the actual importation of inputs or else a claim cannot

be processed. The license application involves the presentation of a formal letter,

submission of past and future production plans, itemized import requirements, evidence

that the goods to be imported are not produced locally.

36

3.10 Inability to evaluate input-output coefficients. Another important reason for thenon-functioning DD scheme appears to be Custom's inability to evaluate exporters' self-declared physical input-output coefficients23 (technical norms) in the absence of standard,pre-tabulated input-output coefficients. One exporter has in the past submitted a requestfor certification of technical norms to the Ministry of Industry and Energy, which wasdeclined by the latter on the grounds that the Ministry did not have the necessaryexpertise to evaluate the norms. However, it appears that Customs will not processrefund applications without certified norms.

3.11 Lack of Budgetary Funds. Clearly, given Mozambique's tight budgetarysituation, particularly in terms of local currency funds, the scope for making refunds ofpayments already made by the exporter is rather limited.

Customs warehouses

3.12 Customs warehouses are defined in the Customs Act, Decree No. 43, 199 ofSeptember 29, 1960. This type of warehouse operates as a deferred duty paymentscheme. Importers are allowed to move imported inputs from the point of entry to thewarehouse with a warehouse declaration which does not involve payment of dutiableamounts. The import declaration and duties on the imported inputs are paid when thegoods are moved from the warehouse into the factory for production. No bonding isrequired. Customs control of the imports brought into the warehouse is done throughdocumentary and physical checking.24

3.13 No export incentive. Once an export is completed, a DD claim has to be made inorder to recover the duties paid on the inputs incorporated in the firms' exports. Whileoperating a Customs warehouse allows the exporter to defer duty payments and thereforedelays the tying-up of scarce working capital, this scheme makes no difference betweenimported inputs used in production for exports or for the local market and therefore is notconsidered an export incentive.

3.14 No transparent eligibility criteria. In the absence of a functioning DD scheme,exporters could probably benefit from using this deferred duty payment scheme. Theeligibility criteria for obtaining a Customs warehouse license are unclear, however, andfew permits to operate such a warehouse have been issued.

23 The input-output coefficient indicates how many units of inputs are required to produce one unit ofoutput.

24 Two registered accounting books are kept to record imports in transit, one by the warehouse operatorand the other by the regional Customs office. In addition, each has a different key which togetheropen the warehouse. A Customs official thus needs to be on-site with one set of keys and bookswhenever goods are taken into and out of the warehouse. In practice, because of under-staffing, therequirement of Custom's presence is not always enforced.

37

Special bonded manufacturing warehouses

3.15 Special bonded manufacturing warehouses (SMWs) for exporters are also definedin the 1960 Customs Act. Under this scheme, exporters can operate a bonded warehouseat their factory site. Imported inputs to be used for exports are exempt from dutypayments provided they are included in the list of regularly imported items specified inthe license. A 100 percent export orientation is not a requirement for a firm to operate aSMW, but duty-exempt inputs and manufactured export items are supposed to be keptseparately from those destined for the local market. In order to cover Customs expensesfor the operation of a SMW, licensees must pay a fee depending on the size of thewarehouse.

3.16 Six firms in the sample are using or have used this facility (currently, only sixexporters in Maputo have a license). Three of the firms operating SMWs (one has in factlost his license because of temporary failure to export and is re-applying) are garmentmanufacturers working under international subcontracting arrangements. Two firms areassembly-type operations where the manufacturer imports kits of components (bicycles,wall clocks) and assembles them for export. The remaining firm has applied for a SMWlicense to import inputs for the production of brushes and umbrellas for export.

3.17 Overall, the rules and regulations concerning the licensing and operation of theSMWs are not transparent. There are no standard procedures to determine bondrequirements, eligibility for exemption on the EGA charge or the requirement of Customssupervision of transit imports.

3.18 SMW licensing and duty-free status. Exporters reported that licenses for SMWsare effectively negotiated on a case-by-case basis and that personal access to high-levelgovernment officials is an important factor. In order to obtain a license, an applicationmust be sent to the headquarters of Customs; the application should include copies of theimporter/exporter registrations issued by the Ministry of Commerce, legal proof of thecompany's existence, as well as an outline of the proposed manufacturing warehousespace to be inspected by the regional Customs office. Evidence of export activities (pastexport record, confirmed orders) appears to be another requirement to obtaining andrenewing SMW licenses.

3.19 In general, exporters face a great deal of uncertainty about obtaining and renewinglicenses to operate SMWs. One garment exporter lost his license because of temporaryfailure to export because of problems in former Eastern Bloc countries, previously theexclusive export destination. As the firm has recently managed to obtain trial orders fromUS buyers and expects to obtain export orders soon, it is re-applying for the license but isnot certain to get it. One small, irregular exporter was denied a license withoutexplanation. Another exporter reported to be actually operating a SMW, having obtainedapproval from the Ministry of Finance, while the regional Customs office denied thiscould be possible because a license for this particular warehouse had not been yet issued.Exporters are also concerned about Custom's random suspension of their duty-freeimport status. One exporter was recently denied access to the duty-free import of fabrics

38

for about a month because Customs was in the process of updating bond values. As thefabric could not be cleared in time, the exporter in question lost the order and lostcredibility with the buyers.

3.20 EGA charge exemption. Lack of transparency in the implementation of the SMWis also evident in the uneven application of the exemption from the EGA. Two of thefirms interviewed stated that they were 'exempt' from paying the EGA, while theremaining firms and a Customs official at the regional Customs office stated that EGAhad to be paid on imported inputs brought into the SMW. Those firms that do not payEGA appear to have negotiated this exemption on an individual basis.

3.21 Bornding requirements. There is a bonding requirement associated with the SMW,but confusion appears to exist among exporters as to the formula by which the value ofthe bond is calculated. While Customs stated that the bond value is calculated as thevalue of goods typically imported at full warehouse capacity, some exporters using thisscheme stated that they were required to provide a bond equivalent to the full value ofeach import consignment (not only the duty liability of the imports). Most exportersmeet bonding requirements through standing bank guarantees. As commercial bankscharge normally 10 percent on the value of the guarantee, this bonding requirement is aconsiderable expense for exporters.

3.22 Customs control mechanisms. In principle, effective Customs control of a specialwarehouse would either require: (i) a 24-hour Custom's surveillance to monitor the transitof goods into and out of the warehouse; or (ii) documentary checking mechanismswhereby incorporation of imported inputs in exports is verified through technical normsand book accounting of goods brought into and out the warehouse. In practice, Custom'ssurveillance is not always assured given under-staffing problems, and the documentarychecking cannot really be implemented due to the fact that no pre-tabulated, certifiedinput/output coefficients exist in Mozambique.

Main Issues

3.23 While the basic legal framework for export-related duty exemptions exist inMozambique, there are no established procedures for implementation. The use of specialbonded warehouses and duty drawback schemes for exporters are defined in the CustomsAct of 1960. Exporter eligibility for duty exemptions is also defined in the investmentcode, Article 8. These provisions do not include exceptions to the EGA which could begranted by the Ministry of Finance, Article 55, Decree 11/1994, if exports are consideredof national importance. Finally, the Industrial Free Zone Act (IFZ), effective from1/1994, allows duty-free imports of inputs for exporters with IFZ certificates.

3.24 The Jack of transparent implementation rules and regulations implies that accessby exporters to duty-free import status is not automatic and is subject to discretionarydecisions. Moreover, because of implementation experience, officials are unable todevelop the capability to handle input-output coefficients which is especially critical forthe implementation of duty drawback schemes.

39

3.25 In addition to the extremely poor administration of duty-free imports forexporters, the failure to institute preferential treatment for exporters in the application ofimport procedures (including BRI, preshipment inspection, cargo handling, Customsprocessing, and banking procedures) has resulted in long delays in accessing imports forexport production. In view of this, permanent mechanisms that treat the importprocedures for export production separately from those for non-export on a priority basisshould be instituted.

Priority Tasks

New bonded warehouse scheme

3.26 Transparent implementation rules and regulations for the SMW scheme should beprepared, disseminated and adopted. Duty exemptions should include import duties andEGA charges on all imported inputs and capital goods for established exporters with aminimum export record. While less than 100 percent export-oriented firms must beallowed to operate the SMW scheme, separate bonded warehouses must be initially usedto store export-related imported inputs and manufactured export products. In addition,Customs must oversee the inflow of inputs and the outflow of outputs through physicalmonitoring; and only when physical input-output coefficients are published, Custom'sphysical monitoring can be modified by instituting spot checks and stock accountingrecords.

3.27 Implementation rules and regulations. The SMW scheme should be based on thefollowing criteria: (i) all firms meeting minimum export levels in the preceding year andminimum warehouse requirements, must be allowed a SMW license; (ii) all products andcapital goods not included in a negative list must be eligible for a SMW license; (iii)bonding requirements should not exceed the duty liability associated with the maximuminventory of duty-free import materials; and (iv) duty-free capital good imports should beallowed provided that more than 50 percent of the products produced by the importedcapital goods are exported during the initial five consecutive years; the annual bondingrequirement for the capital goods should not exceed one-fifth of the total duty liability.

Fixed drawback scheme

3.28 Transparent rules and regulations for a fixed drawback (FD) scheme that providesimport duty and EGA charge refunds to those exporters who cannot have access to theSMW should be prepared, disseminated and adopted. A FD scheme would be mucheasier to administer than other duty drawback schemes, and would be more suitable foran economy with limited implementation capacity like Mozambique. The schemeinvolves the estimation and publication of fixed refund rates for specific productcategories based on average or representative input-output coefficients. Under thescheme, only evidence of export completion (endorsed by the export inspection agency)

40

would be needed to obtain duty (and EGA charge) refunds calculated on fixed drawbackschedules. 2 5

3.29 The implementation of alternative schemes, such as the individual or dutyexemption regimes, require a highly efficient administration. The actual duty paymentsincorporated or to be incorporated in the export item have to be verified by detailedphysical input-output coefficients on an individual basis. In addition, both import andexport documentation (including a bank guarantee on the duty liability) have to besubmitted to support the verification procedure. By contrast, the FD scheme is simplerbecause the refund schedules are already available and detailed import documentation(including bank guarantees) are not needed.

3.30 Estimation of Fixed Drawback Schedule. Tables 3.2 and 3.3 illustrate onemethodology for estimating FD schedules. The FD rate is defined here as a percentage ofthe ex-factory price per unit of output. There are two different approaches to estimatingFD schedules. One approach relies on a "representative product" concept, whereby theFD rate is estimated for a representative product and then generalized for the moreaggregate product category. In Table 3.2, chapa (roofing material) is taken as therepresentative product. The FD rate is equal to the total value of duties and EGA taxesper unit of product (per ton) divided by the ex-factory unit price. The total local currencyvalue of duties and EGA taxes paid per unit of product is estimated by adding the dutyand EGA tax liability for each imported input which in turn is calculated as: (input-outputcoefficient) x (import price of input) x (duty rate + EGA rate). On this basis, the FD ratefor roofing material is estimated at 17 percent. Table 3.3 shows similar calculations forsteel pipe. A second approach is based on the estimation of average input-outputcoefficients for aggregately defined product categories.

3.31 While the first approach obviates the need to estimate detailed physical input-output coefficients for every product within a category, the second one makes itunnecessary to measure detailed physical input-output coefficients for any individualproduct. Table 3.1 shows FD rates estimated on this basis lor eleven product categories,relying on average input-output coefficients. Although these rates may have to be refinedfurther, they are a good starting point. The benefits of having more detailed estimatesmay need to be sacrificed for the sake of administrative convenience and speedyimplementation. In any case, it is desirable that FD schedules be updated at least everysix months to reflect input and output price changes arising from changes in world marketprices, exchange rates, as well as in duty and other indirect tax rates.

2 A FD scheme not based on import documentation could be interpreted to be against the GATT ruleson export subsidies. In Mozambique such inference would be wrong because the scope forsubstitution between local and imported input materials is very limited in the short run. By-passingimport documentation checks should not be viewed as a means of allowing local substitutes to benefitfrom drawbacks but simply as a means of achieving administrative convenience.

Table 3.2: Estimate of Fixed Duty Drawback - Roofing Material

Export Product Raw Materials Value of Draw back a/

Value (Import Duty Value ofHS Code Name Unit Ex-Factory IIS Code Name Unit Price/Tnn in Rate E.G.A. Duties and

Price b/ Norm Mieticais) (%) (%/) E.(G.A.(a) (b) (c) (d) (a)'(b)(c+d)

Chapa(Roofing tonMaterial)

72 08/72.09 Aco Laminado a Frio ton J I 1,840,000 15 5 368,000

|_79_01_11i Zinco ton | 09 [ 5.260.059 10 J 71,011

7801.99 C'hunibo ton .00043 2,214,839 10 5 143

r -z j t i 8001 10 Fstanho! ton .00012 27.586,207 1 |0 5 ! 496

l l l | Sl ~~~~~~~~~9110 Antimonio| ton .00009| 9,302,326| 35 | 3 35|

2 1 2811.19 |AcidoCromico ton | 00003 133333331 5 5 so

|| 28 0610 | Acido Cloridrico |ton | 0072 3211,805 1 5 | 4,625= a - - - = 1 | | 2807 Acido Sulfurico J ton .0072 3,204,315 I 5 5 4.614

I I ~ - -t____ a|1.1| 28 02 Enxofre ton -0004 [ 3.645,833 j 15 5 292

Fluxo ton | 0028 19,071,763 | 25 5 3,345I f ~~~~28 27.10 Clorelo deAmonio ton .0065 2,572,815 1 5 1 16.020; m - m -- i--- - -;

TOTAI. 2 758,569 | _ j I I 1 468.961 17%

a/ The fixed draAback rate indicated was calculated based on data for one firm. In order to obtain a fair fixed drawback rate for this product, comparable data should be collected from other manufacturers.b/ The ex-factory price was estimated using aggregate data for the firm.

Table 3.3: Estimate of Fixed Duty Drawback - Steel Pipes

Export product Raw Matcrials Value of Drawback a/

. . _ Value Duty | E.G.A. Value ofHS Code Name Unit Ex-Factory HS Code Name (Import Rate (%) Duties and

Price b/ tlnit Norm Price/Ton in (%) (d) E.C.A.(a) %leticai') (c) (2)-(b)-(c+d)

(b)

Tubo BS(Steel Pipe) ton

T 72 08/72 09 Aco Lamiiinando a Frio tun I ,840,000 15 5 368,000

79.01 11 Zinco [ton J 08 5,260,059 10 5 631,207

78.01.99 'hunibo ton __ 004 2,214,839 i_0 5 _ 1329

76.0910 Aluminio ton ! 00043 6,010,929 10 !5 !388 2807 tAcidooSullurico toll 015 3,204,315 5 !9612

| 28 11.29 Coiitracido [ Ion J 00005 | 5,000,000 | 15 5 | 50 |

= I __ _ [ 28.42.90 01tosifictll) de Sodio [ _ I 002 | 6,6bhh.67 | 1 |5 267 _

I _______ [ ____________ 1 28 27.10 C irclo de Amonio toil 0025 2,572,815 !i J 5 i 1,286

___________ I _______ [ ______________ If 38.10.90 JFluxo [ton 003 19,071,763 25 5 ! 17165 _

TOTAL I ________ 1 _______________ 12841.30 [ Dicromato de Sodio [ ton .0007 12,213,740 1IS 5 5 1,709 ITOTAL l l | 468,641 | _ _ _ _ _ _ 1 103,101 || 22%

a/ The lixed drawback rate indicated was calculated based on data for one firm In order to obtain a fair fixed drawback rate for this product, comparable data should be collected from other manufacturers.b/ The ex-factory price was estimated using aggregate data for the firni.

43

3.32 Implementation rules for FD. The operation of a FD scheme should be based onthe following criteria: (i) all firms not eligible to use the SMW scheme must be allowedto use the FD scheme solely on the fixed drawback schedule and presentation of exportdeclaration documents, endorsed by the export inspection agency; (ii) all products that arenot included in a negative list should be eligible for FD; (iii) no prior licensing orimport/export approval procedures should be required; (iv) drawback payments should bemade to the exporters' bank account within fifteen days after export completion; and (v)the Ministry of Finance should earmark a duty drawback fund directly based on customrevenues in the annual budget so as to fulfill the drawback payment obligations withoutdelay.

Duty exemption and individual drawback schemes

3.33 Only after experience has been accumulated with the estimation of technicalnorms (physical input-output coefficients) and detailed physical input-output coefficientshave been estimated for most export items, should a duty exemption (DE) scheme and anindividual drawback (ID) scheme should be offered for exporters.

3.34 Implementation rules for DE. The implementation rules and regulations for theDE scheme should be based on the following criteria: (i) all firms not using the SMWscheme, FD scheme, or ID scheme and all inputs and capital goods not included in anegative list should be eligible for DE; (ii) DE should be granted solely on an export L/Cor export order, pre-tabulated physical input-output coefficients, import L/C and invoice(cross-checked with the preshipment inspection agency's records) and bank guaranteecovering the duty and Customs charge liabilities; (iii) no prior approval procedure ofimport and export; (iv) duty-free imported capital goods will be granted if the firmexports more than 50 percent of the products produced by the capital goods during theinitial five consecutive years; and (v) if the export obligation is not fulfilled within oneyear, the appropriate government agency will collect back duties and custom chargesbased on the bank guarantee, while bank guarantees would be released as soon as exportsare completed within one year.

3.35 Implementation rules for ID. The implementation rules and regulations for the IDscheme should incorporate the following criteria: (i) all firms not using the SMWscheme, FD scheme, or DE scheme and all inputs not included in a negative list should beeligible for ID; (ii) ID should be granted solely based on presentation of import andexport declarations (endorsed by the export inspection agencies); pre-tabulated physicalinput-output coefficients; (iii) no prior import or export procedure; and (iv) ID paymentsshould be made into the bank accounts of exporters within fifteen days of exportcompletion.

44

Administration of duty-free import schemes

3.36 In order to ensure the effective implementation of the duty-free import schemes, itis proposed that a separate office for duty-free import administration (DFIA) be created atthe Ministry of Finance, where the Ministry of Commerce, the Ministry of Industry andEnergy, and the pre-shipment inspection company would be represented. Theresponsibilities of the DFIA would be (i) to formulate of duty-free import policies forexporters; (ii) to prepare, publish, and disseminate transparent implementation rules andregulations for the various duty-free imports schemes, namely the SMW, FD, DE, ID andIFZ; (iii) to estimate, publicly announce, and periodically revise FD, DE and ID schemes;(iv) to administer the duty drawback fund; and (v) to oversee the implementation andmonitoring of the duty-free import schemes.

3.37 In carrying out the above tasks, the DFIA will be assisted by technical specialistsfrom the Ministry of Industry and external technical experts with proved experience inestimating physical input-output coefficients in successful duty-free importadministrations of developing countries. It is also proposed that an automated system beestablished for monitoring duty-free regimes for exporters.

Proposalfor Monitoring Duty Drawbacks and Export-Related Duty Exemptions

3.38 Properly functioning duty drawback and duty exemption schemes should permitmanufacturers to enjoy defacto free trade status in respect of their export operations. Theobjectives of these schemes can easily be frustrated if they are poorly managed.Moreover, inadequate management of drawback and exemption schemes can also resultin an unacceptable level of revenue risk.

3.39 In view of the difficulties currently confronting duty drawback and exemptionschemes in Mozambique, it is proposed that the government establish an automatedsystem for monitoring and managing these schemes. It is proposed that a PSI companybe contracted to administer the system and report to the DFIA. The government couldhire a PSI company to perform this service, but it would almost certainly be more cost-effective to procure the service as an add-on element to the government's main PSIcontract. An immediate advantage of this approach is that the PSI company would havealready undertaken pre-shipment inspection on inputs imported by exporters (or at leastregistered such imports), and would be able to feed the relevant informnation directly intothe computer.

3.40 Information on imported inputs would be matcheJ with information obtainedfrom the export entry documentation relating to realized eligible exports. Separatecomputer records would be kept for each firm entitled to drawbacks or duty exemptionfacilities, in respect of each of the firm's export product lines (defined at the same level ofaggregation as the input-output conversion ratios). By matching import and export data,and applying the relevant conversion ratios, it would be straightforward to calculate: (i)the amount of duty refund to which an exporting firmn was entitled, and (ii) in the case of

45

firms entitled to temporary admission or other duty and tax remission arrangements, theimputed value of a firm's stocks of duty-free inputs at any moment in time.

3.41 In the case of duty drawback, the PSI company would issue certificates on aregular basis, indicating the amount of firms' duty drawback entitlements. Suchcertificates should be available within one week of the presentation by the exporter to thePSI company of the documentary evidence of importation and exportation, which wouldbe verified against the PSI company's own computerized records. Exporting firms wouldthen be able to present these certificates to the relevant government authorities for aprompt refund of duties.

3.42 In the case of duty remission arrangements, the PSI company would monitorinformation on imputed stockholdings of duty-free inputs. If imputed stocks appeared tobe rising above commercially reasonable levels, this would suggest leakage of duty-freeitems onto the domestic market. Suspicion that this was occurring would justify an on-site audit of the firm concerned. Infornation on imputed stocks of duty-free inputs wouldbe used over time to build up a risk profile of firms that should be audited. The need forsuch audits should diminish over time. In addition, arrangements for continuing randomaudits should be made. Five or ten firmns per month could be randomly audited. Theseaudits would be undertaken jointly by Customs and the PSI company. Prior to thecommencement of the part of this scheme dealing with remissions, beneficiary firmswould be required to declare their existing holdings of duty-free stocks. Customs and thePSI company may wish to audit a few of these declarations to ensure their accuracy.

3.43 As noted above, information on the imported inputs of eligible exporting firnswould be obtained from PSI data. The export information, however, would need to beverified periodically through physical export inspections. In order to avoid interferingunduly with export activity, these physical inspections should be kept to a minimum. It isproposed that in the first instance, physical inspections be carried out on 10 percent ofeligible exports, based on a combination of targeted and random selection. If manyanomalies are discovered through these inspections, it may be necessary to increase theircoverage, although a proper application of penalties for false declarations should curbsuch behavior.

B. ACCESS TO TRADE FINANCE FOR EXPORTS

3.44 In view of the underdeveloped banking system and uncertainty associated withforeign exchange availability and exchange rates, it is not surprising that many exportersexperience difficulties in obtaining trade finance for export production and sales.Furthermore, the existence of bank credit ceilings to control inflation, has contributed torestrict overall credit expansion, including trade finance for exports.

46

Underdeveloped banking system

3.45 Commercial banks do not appear willing to assume the risk of exporters' non-performance, even if exporters have confirmed export L/Cs from countries with lowpolitical risk. Imperfect information and resulting risk perceived by banks is especiallyhigh in the current stage of export development in Mozambique, which is characterizedby small and irregular or new exporters with no track record and collateral. Therefore,short-term lending for exporters is credit-line based rather than export-L/C based. Thelack of working capital to finance the import of fabric has forced all three interviewedgarment manufacturers to rely on subcontracting arrangements; while the other fiveexporters interviewed are being financed through their mother companies.

3.46 Given the acute cash flow and working capital shortages faced by manymanufacturing firms, the cost of borrowing in local currency at an interest of 48 percent,is perceived as too expensive. Consequently, access to foreign currency-denominatedshort-term loans to finance imported inputs seems an attractive alternative, especially tothose exporters less sensitive to exchange rate fluctuations. Such loans would allowimport financing at world market interest rates, providing exporters a level playing fieldwith global competitors. It would also save Mozambican exporters the additional cost(estimated at two percent) of converting local currency to hard currency to make importpayments and exchanging export earnings in foreign currency to meticals in order toliquidate their short-term loans. Some commercial banks have started to extend foreigncurrency denominated loans but seem uncertain as to whether these loans would beincluded within the credit ceilings established by the Bank of Mozambique, the centralbank.

3.47 Many firms referred to the ineffective handling of L/Cs by the Commercial Bankof Mozambique (BCM) as another serious problem. The BCM, the bank with the largestcredit ceiling, accounts for 65 percent of total commercial bank credit; consequently itsperformance affects the majority of exporters. Opening import L/Cs takes an average offour weeks, partly because the BCM is very slow in communicating with correspondentbanks. Managers reported that their personal involvement is often necessary to expeditethe process. Finally, L/Cs are frequently not accepted by import suppliers because oferrors (such as typing mistakes), necessitating amendments to the L/Cs and implyingunnecessary delays for exporters who depend on timely import consignments.Confirming import L/Cs regularly takes several months; often the original terms willhave expired and need to be renegotiated, adding further to the delays and raisingadministrative problems for the concerned firms.

3.48 Another factor affecting access to credit is the uncertainty associated with theprivatization process. Commercial banks are reluctant to lend to firms which are going tobe privatized because most of these firms are already highly indebted, and there isuncertainty about how past and future debt would be eventually be settled (for furtherdetails see Chapter 5).

47

Foreign exchange finds

3.49 Export Retention Funds. Given Mozambique's high dependency on donor aidfunds to finance imports, free foreign exchange is not always readily available to meetexporters' import needs. From this perspective, export retention schemes could play acritical role as a complementary source of financing. In principle, export retentionfacilities are available to exporters, at variable rates, but implementation rules andregulations are unclear both for exporters and bankers.

3.50 Some exporters reported to have foreign currency retention accounts while oneexporter indicated to have been denied access to such facility. According to Bank ofMozambique officials, all exporters are automatically eligible for retention accounts of 25to 35 percent, but, in practice many seem unaware of this. Exporting companiesregistered under the new investment code, whether foreign or local, are supposed to beautomatically granted a minimum of 30 percent of the firm's total foreign exchangeearnings (for retention levels beyond this floor, the allowable percentage of retention is tobe determined by the commercial banks on a case-by-case basis, with the percentage ofretention to be determined by the firm's demonstrated need). A commercial bankrepresentative indicated that all foreign exchange earnings currently have to besurrendered to the central bank and that no clear implementation guidelines for theretention scheme exist. Another bank reported to be using the guidelines contained in a

26circular issued by the central bank which, however, was not official.

3.51 In any event, it appears that in addition to the confusion regarding the eligibilityfor export retention schemes, actual access to these funds is subject to delays because ofthe complex procedures required by the Bank of Mozambique (exporters need to presentjustification on the use of funds every time they need to import inputs).

3.52 Donor import funds. Most exporters complained about the lengthy andbureaucratic procedures in place to access donor funds for imports. Apparently,procedures differ somewhat depending on the donor funds, adding to the confusion anddelays. Partly due to such procedural delays, import L/Cs will have expired by the timethe foreign exchange comes through. Confirming L/Cs can take several months partlyowing to procedural requirements, and partly due to uncertainty on foreign exchangeavailability.

Main Issues

3.53 In sum, exporters face difficulties in obtaining short-term trade finance at worldmarket interest rates. Such difficulties stem from a combination of factors. Theseinclude: (i) commercial banks' lack of experience in handling limited risk-taking trade

26 For reference see the circular issued by the Bank of Mozambique - Circular No 5/GGBM - whichhowever is not official. According to this circular, retention rates for exporters are set according tothe value of exports: 10 percent for exports up to US$10,000; 15 percent for exports from US$50-500,000; and 20 percent for exports above US$1 million.

48

finance using confirmed export L/Cs from countries with no political risks; (ii) limitedcredit ceilings imposed for macro stabilization; (iii) uncertainty about the availability(including the allowed export retention accounts) of foreign exchange; (iv) time-consuming procedures needed to access donor funds; and (v) commercial banks'inefficiency in opening and confirming import L/Cs.

Priority Tasks

3.54 The Bank of Mozambique should prepare and disseminate transparent rules andregulations for the export retention scheme. All exporters should be automaticallyeligible for retention accounts, regardless of whether the exports are the result ofinvestments registered under the investment code. Considering the need to provideadditional incentives to non-traditional manufactured exports, retention rates for this typeof export should be initially set at 100 percent. In general, no restrictions should beimposed on the use of retention funds which should continue to be denominated inforeign currency.

3.55 Clearly, even a 100 percent retention fund would not be sufficient to cover theimport needs of rapidly expanding exports, and specialized financing mechanisms mustbe made available to exporters. In this regard, concerted efforts need to be made by thegovernment and commercial banks to institute financing of import L/Cs for exportersusing confirmed export L/Cs. This would involve: (i) giving a high priority to openingand confirming import L/Cs based on irrevocable export L/Cs; and (ii) considering thecreation of a foreign currency revolving fund at the Bank of Mozambique, earmarked tofacilitate import L/C back-to-back export L/Cs financing.

3.56 Finally, it is proposed that a short-term post-shipment export finance mechanismbe offered by instituting an intemational market discount rate-based completed short-termexport bill (bankers' acceptance) rediscount scheme.

C. ACCESS TO FOREIGN COLLABORATION

The Role of Foreign Enterprise Collaboration

3.57 Empirical evidence shows that foreign-domestic collaboration at the firm level iscrucial at an early stage of an outward-oriented development strategy. This has beendemonstrated by the East Asian newly industrialized economies (NIEs) and most recentlyby China and Vietnam, where collaboration with export-oriented firms from NIEs israpidly transforming planned economies into outward-oriented economies.

3.58 Recent research on export capacity building in sixteen sub-Saharan Africancountries also indicates that foreign collaboration is critical for the development of infantmanufacturing exporters. Foreign collaboration brings such critical elements as access toworld markets, modem management practices, and the latest production processes. It canalso provide the financial resources for investment and working capital.

49

3.59 Not surprisingly, the survey strongly suggests that diversified forms of foreigncollaboration are a necessary condition to develop manufactured exports in Mozambique.As shown in Box 3.1, virtually all the sample export firms have used different forms offoreign collaboration as a means of supporting their exporting activities. The sixteensample firms combined show forty instances of different forms of foreign collaboration,some of them simultaneous.

Exporters Needs for Foreign Enterprise Collaboration

3.60 Manufacturing exporters in Mozambique realize the importance of foreignenterprise collaboration for the acquisition of production and marketing know-how aswell as access to the international market network. For the most part, firms stated stronginterest in additional or continued foreign collaboration. Some firms stated that theycould export more using their existing installed capacity or diversify into new exportactivities if they could obtain additional forms of foreign collaboration. Those firmswhich currently do not have access to foreign collaboration are not exporting, but haveexport potential. These firms expressed a strong interest in foreign collaboration but didnot know which agencies to approach for this purpose and what form of foreigncollaboration would be most appropriate.

3.61 For example, in export marketing, the local manager of a garment factory wasconfident that with the knowledge acquired through foreign collaboration the firm couldexport directly provided that the working capital constraint was resolved. Direct exportand sourcing of own inputs would result in a significant increase in the profit margin ofthose exports. Another example, Riopele, an integrated spinning/weaving/garmentmanufacturer, currently exporting, is struggling to find export markets for products madein the firn's new cotton shirting facility. While strong interest was expressed onsubcontracting or joint venture arrangement with a foreign partner, the firtn had noinformation on effective mechanisms for contacting foreign partners.

50

Box 3.2 - Foreign-Domestic Collaboration in Sample Firms

Risk-taking collaboration

100 % foreign direct investment There are only two firms with 100 percent foreignownership in the sample, both in agro-processing (sisal rope). The mother companies are based inPortugal.

Joint ventures Five firms are joint ventures with foreign partners: Portugal (3), UK (I) andUSA (1). In two cases, former Portuguese owners, who had abandoned the firms at independence,bought back shares when the firms were privatized. A US firm has recently invested in the wallclock manufacturing firm, and now owns 99 percent of the shares. The newly-constituted jointventure will diversify production into electricity and water meters, mainly for the South Africanmarket. The US partner is providing investment and working capital and more importantly,production and marketing know-how. Two potential foreign/joint venture partners are currentlybidding for an equity share in the rolling stock firm. The Portuguese subcontracting partner isplanning to invest in the gray cloth firm as soon as its debt problem is resolved. A Hong Kong firm|divested from one local garment firm because of political and economic uncertainty. The East Asianfirm, a majority shareholder since 1987, provided capital equipment and 35 skilled workers to trainlocal ones. After the divestment, the Hong Kong firm is now providing technical assistance andquality control, and has a subcontracting agreement with the local firm.

Subcontracting Agreements Three firms in the sample are exporting under subcontractingagreements. Two local garment firms are collaborating with East Asian companies who provide rawmaterials and orders. The gray fabric manufacturer is relying on a Portuguese finishing operationfor raw material purchases. The fabric is exported to Portugal for finishing.

Without significant risk taking

Fixed-fee management contract Virtually all sample firms have expatriate management atdifferent levels including general directors, plant managers, administrative staff and foremen. Onaverage, there were six expatriates in the sample firms, mainly Portuguese and South Africannationals.

Fixed-fee technical assistance Three firms - the bicycle manufacturer, the tire factory andone of the garment manufacturers - have technical assistance contracts with foreign firms who arehelping them rehabilitate their plant and install new machinery as well as train workers in newproduction techniques. These are mainly fixed-fee contracts for two to five years.

Brand name licensing One firm has a licensing agreement with BIC to manufacture ballpoint pens and disposable razors. The foreign partner provides partial know-how as well asmarketing elements.

Turm-key plant The bicycle plant was originally a turn-key plant project with a Frenchcontractor.

Main Issues

3.62 In the infant stage of Mozambique's manufactured export development (compareUS$131 million total commodity exports of Mozambique with US$1.5 billion garmentexports of Bangladesh in 1993), a more aggressive export marketing assistance isrequired to facilitate access by local firms to the international market network and exportproduction know-how. From this perspective, assistance provided by the Institute of

51

Export Promotion (IPEX), which is limited to organizing international fairs and datagathering, is grossly insufficient. The quickest way to resolve such difficulties is to relyon the diversified forms of foreign enterprise collaboration such as international sub-contracts, technical marketing agreements, and turn-key plants as well as joint venturesand foreign direct investment.

3.63 The necessary conditions must be created to encourage the various forms offoreign collaboration both of non-equity involvement and direct foreign investment. Inthe short-run there is an urgent need to utilize existing idle capacity, rather than generatenew investment, possibly through non-equity foreign collaboration. However, a moresignificant involvement of foreign direct investment will be required to support furtherexpansion and to meet enterprise restructuring/rehabilitation needs of firms mostly in thehands of the state. Given foreign investors reluctance to take investment risks at thisjuncture due to uncertainties, existing conditions to attract foreign direct investment,including those contained in the IFZ Act, need to be significantly reviewed.

Industrial Free Zone Act

3.64 The legal framework for the operation of Industrial Free Zones (IFZs) inMozambique is incorporated into the new investment code - Law 3/93 of 8 June 1993 andmore specifically under the IFZ Act issued by Decree 18/93 of September 14th, 1993.The IFZ Act, in force since January 1994, provides for free trade under both a fencedindustrial estates scheme as well as a special bonded manufacturing warehouse scheme,(an individual factory that operates under IFZ status). However, the implementation rulesand regulations have not been prepared yet.

3.65 The IFZ Act also specifies eligibility for IFZ development. IFZs can bedeveloped and administered by private developers in a joint venture with a Mozambicanpartner, which most likely would be the government, as it has exclusive right to landownership. Private provision of infrastructure services such as electricity and watersupply is permitted.

3.66 Minimum investment requirements. The IFZ Act requires a minimum investmentof US$ 50,000 for operating an IFZ unit. This prohibits utilization of the existing idlecapacity for 100 percent export-oriented activities. The optimum level of investmentmust be determined by IFZ enterprises themselves without a minimum level arbitrarilyset by the government.

3.67 Licensing procedures. Eligibility for IFZ licenses is based on project viability,which potential IFZ investors are expected to prove to the Center for Promotion ofInvestment (CPI), the designated implementing agency. Eligibility is also based on thenature of the investment, degree of export orientation, number of jobs created, extent oflocal resource utilization, local value- added, and projected net foreign currency earnings.Investment applications for IFZ licenses are to be analyzed by CPI within 30 days and besubmitted to an Investment Evaluation Board, which in turn should make arecommendation to a final decision-making authority, the Minister of Planning or the

52

Council of Ministers, depending on the amount of the proposed investment. Decisions onfinal authorizations are to be made within 45 days. There is a 90-day time limit foraccepted IFZ applicants to register and form their company. Given that IFZ firms will beprimarily export-oriented (except for a 15 percent local sales allotment) and operatingunder a separate fiscal and Customs regime, there is no reason to undertake suchelaborate evaluation of the domestic impact of a proposed project. Investors in the typesof export activities Mozambique is most likely to attract are very sensitive to the cost andtime of setting up a business, and will be deterred by existing requirements, such aspreparing a feasibility study and providing detailed technical infornation. The reviewprocess should focus on the most basic information such as the investor's background.

3.68 Import-export procedures. IFZ firms would be required to register as importerswith the Ministry of Commerce before starting any import activity, providing detailedinformation on products to be regularly imported. Similarly, in a separate step, firms alsoneed to obtain an exporter registration from the same Ministry, implying additionalpaperwork. The importer registration needs to be renewed annually. The registrationmust be renewed if a firm needs to import items not included in the list of scheduledimports. The importer and exporter registrations duplicate information given by the firmearlier in the registration process, of regularly imported raw materials, intermediateinputs, capital equipment and spare parts. These separate steps should be combined into asingle procedure to reduce the administrative burden on new IFZ companies.

3.69 IFZ firms would be required to obtain import and export registrations bulletins(BRI and BRE, respectively), as any other importer or exporter, implying additionaldelays. According to several firms interviewed, it takes at least five working days to beissued a BRI and two days for the BRE. Such delays would be unacceptable for IFZfirms, whose ability to be competitive in the world market depends critically on speedyimport and export procedures (garment manufacturers especially have very short leadtimes, and a five day delay in clearing import consignments would be prohibitive). Therequirement for BRIs and BREs should be eliminated to ensure a streamlinedimplementation of the IFZ regime.

3.70 Customs procedures. For IFZ firms to import raw materials and intermediategoods free of duties, the firms would need to submit yet another list of approved,regularly imported goods for confirmation by Customs. This adds an additional layer ofbureaucracy and paperwork for a new IFZ firm and should be eliminated. For IFZenterprises that chose not to stay inside an industrial estate with fences, the Act has tospecify whether Customs will rely on (i) physical checking mechanisms (having oneCustoms official stationed around the clock at the factory site to monitor all inflows andoutflows of goods); or (ii) documentary checking mechanisms (where Customs control isensured through frequent spot checks of stocks and documents). While (i) would requireCustoms staff resources, (ii) would need an adequate administration of input-outputcoefficients. It is also unclear to what extent the financial burden resulting from IFZCustoms administration will be shifted to IFZ firms. Under current provisions, the IFZdeveloper/administrator is responsible for payment of IFZ Customs charges. to be made

53

in advance. Also the provision that Customs may demand a bond for the goods importedfree of duties may impose an additional burden for exporters; IFZ firms in other countriesare usually exempt from such requirements.

3.71 Fiscal regime. The tax rate provisions as they currently exist in the IFZ decree areconfusing or highly unfavorable compared to those offered by Mozambique'scompetitors. Most other countries with IFZs offer at least a five or ten-year tax holiday,and a low tax on profits thereafter, while charging market rentals for land use. Under theMozambique IFZ regime, both IFZ developers and firms are required to pay a 2 percentroyalty payment on gross revenue during the first five years, and 5 percent thereafter. Onemay interpret this as a mixture of a fixed rent for land use and government taxes for IFZactivities. It would be better to separate the land rent component from the government taxcomponent. While charging market rentals for land use for IFZ estate development wouldbe desirable, a tax based on gross revenue is highly unusual and would be veryunattractive to labor-intensive export manufacturers who face strong competition in theworld market and operate on relatively low profit margins. For such firms, a 5 percentgross revenue tax in fact would correspond to a 50 percent tax on profits, before takinginto account the dividends tax.27

3.72 Profit repatriation and foreign currency accounts. Firms holding IFZ licenses orcertificates are permitted to hold foreign currency accounts. Foreign investors arepernitted retention of 100 percent of their foreign currency earnings (Mozambicaninvestors may only retain 20 percent). Foreign exchange outflows for profit and re-exportable capital repatriation and payment of foreign loans are in principle permitted.However, the transfer of funds abroad is subject to the rules established by the Bank ofMozambique. Its procedural requirements are however restrictive in their current form, asindicated in Chapter 4. For example, the firm has to submit proof of payment of taxliabilities, legal reserves, and sufficient foreign exchange generation from the firm'soperations and have all these confirmed by the Ministry of Finance. These administrativerequirements will have an impact on transparency and automaticity of the transfer processand will deter potential investors.

3.73 Labor laws. The extremely liberal leave policy specified in the IFZ regulations ishighly unfavorable for employers because it has the potential to undermine workerdiscipline and disrupt production schedules. The total number of guaranteed paid leavedays adds up to 56 days per year (this includes annual leave 20 days, sick leave 18 days,additional sick leave for prolonged illnesses 18 days, and mourning leave 6 days. Femaleemployees in addition can claim another two months of paid maternity leave. Themaximum number of paid leave days for female workers (and female employeesrepresent a majority in the IFZ labor force of many countries) thus corresponds to almosttwo paid days of leave per week.

3.74 Another discouraging factor to potential investors will be the provisions regardingexpatriate work permits. The maximum number of expatriate employees for IFZ firms is

27 There is an exemption from taxes on dividends during the first 10 years for IFZ zones.

54

limited to 10 percent of the total work-force. Employers are required to guarantee thetraining of local workers to replace expatriates when their contracts expire. To enforcethis, the fees to renew expatriate work permits (necessary every two years) are very high:the charge for the first renewal of an expatriate work permit is eight times the normalamount, fifteen times that amount for a second renewal, and twenty times thereafter.Given that expatriates are in any case very expensive employees for a firm, it should beleft up to the economic decision-making of the firm to train and replace expatriates withlocal employees. Private investors strongly resent this kind of interference in theirinternal decision-making. Such regulations may well dissuade potential investors fromlocating in Mozambique.

Priority Tasks

3.75 In order to induce diversified forms of foreign enterprise collaboration for exportdevelopment, an aggressive strategy must be developed. In addition to recommendationsmade earlier in this report regarding the business climate for foreign investment andremoving constraints for exporters, particular attention should be given to the legislationfor IFZs and promotion of non-equity foreign collaboration.

3.76 The implementation rules and regulations for IFZs must aim at puttingMozambique's policy regime on an equal footing with successful experiences in otherdeveloping countries. First, the requirements to obtain IFZ certificates should be greatlysimplified. Existing manufacturing facilities should be eligible as long as the enterprisesare committed to be engaged in exports alone. Second, tax and labor regulations as wellas the Customs and trade regime for IFZs should be reviewed. In particular, it isrecommended that royalty payments and import/export registration requirements beeliminated and labor regulations be modified to allow more flexibility in the hiring offoreign workers.

3.77 The IPEX and the CPI must jointly develop a strategy to induce moreaggressively the diversified forms of foreign enterprise collaboration needed for exportdevelopment through match-making services, information services, and other innovativemechanisms. The critical bottleneck for inducing foreign collaboration is the lack of arational basic export policy regime as described above. IPEX should strengthen its role inexport policy design, improve coordination among relevant government agencies anddisseminate implementation rules and regulations concerning exports through itspublications and seminars.

4. THE BUSINESS AND INVESTMENT CLIMATE

INTRODUCTION

4.1 The business environrment in Mozambique poses serious constraints to privatesector development. Among the reasons for this are the imposing regulatory burdenfacing enterprises, inefficiency in Customs and port operations, and a poorly functioningfinancial system. Overall, the adverse business climate in Mozambique is rooted in thedominance of an interventionist approach on the part of the state, which seeks to controlrather than facilitate private sector activities. In part, this is a reflection of the coloniallegacy and the centralist regime established after independence. But, the state lackscapacity to implement its own complex and excessively demanding regulations, renderingthe system ineffective and inefficient.

4.2 Regulations in Mozambique are numerous and excessively demanding on privateentrepreneurs. Even minor transactions, require notarized signatures, special paper, andstamp taxes. Many, often repetitive steps, are required before firms can establishthemselves and undertake business operations. A number of registrations, permits andlicenses must be obtained from a variety of government agencies. These requirementsfrequently complicate entry and exit, and inhibit competition.

4.3 In many instances regulations lack transparency and procedures are notstandardized or automatic. Consequently, few entities, private or public, are aware of allthe steps needed to complete a specific transaction. Too often, regulations are enforced ona discretionary basis and open the door for unwarranted additional costs.

4.4 The government's limited capacity to administer complex and cumbersomeprocedures further adds to the costs of doing business in Mozambique. Delayedresponses by government agencies to applications and authorizations are cited by manyfirms as a major obstacle to their operations. On the other hand, the enforcement ofdemanding regulations carries a high opportunity cost for the state which could be usingscarce resources in more productive ways.

4.5 The following sections describe key impediments to private sector developmentarising from existing regulations and institutional weaknesses. Ilarticular attention isgiven to regulatory constraints; registration, licensing, labor regulations, tax structure,and investment incentives contained in the investment code.

56

A. REGULATORY AND INSTITUTIONAL CONSTRAINTS

The Establishment of a Business

4.6 To establish a business in Mozambique a company must meet registration, permitand licensing requirements, which can constitute a bureaucratic and financial burden andact as a disincentive for private investment, particularly foreign investment.

4.7 Procedures for the registration of a company, defined under the commercial code,are standard but expensive in comparison with other countries, and disproportionately sofor smaller companies. A company must first register at the Commercial Registry andthen at a local tax office of the Ministry of Finance (see Box 4.1 and Table 4.1). Therequirement to publish the articles of company association in the official gazette (theBoletim da Republica) may take several months because of limited space. Mostimportantly, the cost of registration is high - typically 1.8 percent of the share capitalwhen the registration fee and stamp duties are included. The government is currentlyreviewing the possibility of lowering registration costs. In this regard, Mozambiquecould follow the example of other countries, like Malaysia, where company registrationare based on standard formats and subject to a flat registration fee, equivalent to less than0.1 percent of share capital.

Box 4.1: Company Registration Steps

Under the Commercial Code:

# Notary Public, Certificate of the Formation of Company* Registration in the Commercial Registry* Publication of Articles of Association in the Boletim da Reptublica* Registration at the Tax Office of the Ministry of Finance

Under the Investment Code (for investments authorized under the code):

* Authorization of Investment issued by the Center for Promotion of Investment* Registration of Direct Investment at the Bank of MozambiqueI Registration of Indirect Investment at the Bank of Mozambique

57

Table 4.1: Costs of Registering a Company at the Commercial Registry

Share Capital Fees to Other Notary TOTAL(Mts) Registry Fees

<1 million 3% 0.2% 3.6% 6.8%

1-5 million $12 +3% on the excess over 0.2% 2.4% 5.6%Im Mts

5-10 million $50 + 2% on the excess of 0.2% 2.4% 4.6%5m Mts

10-20 million $85 + 1.5% on the excess 0.2% 1.2% 2.9%over l Om Mts

20+-million $130 + 1.0% on the excess 0.2% 0.6% 1.8%of 20m Mts

4.8 In addition, companies to be established under the investment code28 must obtainan authorization from the Center for the Promotion of Investment (CPI) and register theirinvestment at the Ministry of Finance and the Bank of Mozambique in order to accessfiscal incentives and the right to remit profits. While each of these steps involves a greatdeal of time and paper work, the procedures to obtain an investment authorization by CPIare a bureaucratic hurdle for investors.

Investment authorization by CPI

4.9 The application procedures to obtain an investment authorization, as dictated bythe investment law, are complicated and costly. The CPI has added several requirementsfor the submission of investment applications, in addition to the those stipulated underArticle 10 of the code (see Box 4.2). These include (i) a five-year financial forecastindicating revenue, profits and cash flows; (ii) a market feasibility study containingdetailed technical plans; and (iii) proof that the minimum share capital has been paid tothe commercial registry. In addition, a bank guarantee equivalent to 30 percent of thevalue of investment has been required in some instances where the allocation of land hasbeen involved, making the process even more difficult and costly. Finally a feeequivalent to 0.5 percent of the investment, up to US$50,000, must be paid to CPI oncethe investment is approved.

4.10 The documentation required to process the application is excessive, for the mostpart unnecessary, and more appropriate for a credit institution than a promotion agency.The investment application is too long by the time financial forecasts and feasibilitystudies are incorporated. The requirement to submit criminal records, CVs and so onreflects a perception that the private sector cannot be trusted, which is hardly

28 The new investment code approved in June 1993 defines investors' eligibility for fiscal benefits andcharges the CPI with approval and promotional functions.

58

29encouraging. The CPI has no capacity to use the information received in anymeaningful way (e.g., to undertake analyses of financial statements, project evaluationnor to carry out policing activities of potential investors). The inclusion of a bankguarantee against a proposed investment as an additional requirement poses a seriousconstraint, both because it involves a steep financial cost for the investor and becausebanks are unlikely to take equity risks on top of credit risks. It is preferable that land-related issues be addressed through appropriate changes in the land legislation.

Box 4.2: Investment Code - Decree No. 14/93, Article 10(Documentation Required to Accoinpany Application7s)

l Bank references for each prospective investorl Documents proving the legal existence of each prospective corporate investorl Accounts of previous financial year, as well as existing catalogues, brochures* Curriculum vitae and certificate of criminal record for each proponentl Proposed articles of association of the companyl Any proposed alteration to the articles of association if the company already

exists* Agreement or contract of association between parties of company, if applicable* Evaluation study of environmental impact of project

4.11 An internal report with recommendations for the Evaluation Committee isprepared by the CPI in a period of 30 days after submission of the application. Thecommittee consists of high-level representatives (Vice-Ministers and National Directors)from the central and line ministries as well as from the Bank of Mozambique. Despitethe fact that investment approvals are granted by this high-level committee, there havebeen instances where the fiscal package approved by the CPI has reportedly beeninvalidated by the Ministry of Finance at a later stage, defeating the whole purpose ofgoing through the process.

4.12 The investment authorization by CPI is yet another bureaucratic step whichneither eliminates nor facilitates the completion of additional requirements imposed uponinvestors in order to establish a business. Companies are still required to complete arange of additional steps including registration at the commercial registry, publication ofregistration in the government gazette, registering with the local tax authorities, obtaininglicenses. The CPI is currently set-up to screen investment proposals and does little topromote investment. Too much emphasis is placed on project evaluation, to no obviousadvantage: little or no contact is being developed with prospective investors.

29 According to the CPI, although stipulated by the law, criminal records in practice are not required.

59

Licensing

4.13 Registration processes can be costly and lengthy but the main complaints ofbusinesses are related to the licensing system. After complying with the registrationprocedures described, a company must obtain a number of licenses from variousministries in order to operate legally in Mozambique. Typically, these include a licensefrom the relevant supervisory ministry (which can include more than one, depending onthe activity)30 and separate importer/exporter or trading licenses from the Ministry ofCommerce. Most licenses have to be renewed every year and involve often repetitive andunnecessary documentary requirements (criminal records, educational degrees).

Box 4.3: Requirements for License from the Ministry of Industry & Energy

* Articles of company association* Notarized photocopies of personal ID documents* Criminal record issued by the Ministry of Justice of the investor's country+ Certification of residence and good standing by the relevant municipality* Fiscal stamp of Mt 10,000* Technical plans of proposed installations* Approval by the local administrative authority (generally the provincial

governor)* Notarized photocopies of educational degrees

If new partners enter the company a new license must be obtained whichrequires:

* Notarized photocopies of title to property or evidence of rental payments* Photocopies of latest receipts of water, electricity bills of the company* Notarized certification of tax payments from the Ministry of Finance* Notarized criminal records* Notarized copies of two ID cards

Requirements for Importer License from the Ministry of Commerce

* Copy of company registration* Letter from the Ministry of Finance stating that no tax payments are

outstanding* A bank reference letter* A letter from Customs certifying no duty payments are outstanding# Specification of type (class) of items to be imported* Nominal fee determined according to the type of imports

4.14 Licenses are often used to restrict the number of firms operating in a particularsector and therefore constitute a barrier to entry of potential competitors. A highpremium is paid to buy operating or incumbent firms already holding approved licenses.

30 A company wishing to build fishing boats, for example, must obtain a license from the Ministry ofIndustry, the Ministry of Transport, and from the Secretary of State of Fisheries.

60

License fees can be expensive as in the case of mining, where payment for mineral rightsare about 100 times higher than those in the Ivory Coast.

4.15 Draft legislation is being prepared to harmonize and simplify the licensing regimefrom the various ministries. While the standardization of requirements may beconsidered a positive step, the existence of a licensing system in itself does not renderobvious benefits but rather adds to the cost of doing business in Mozambique. Moreover,the draft foresees that license applications be published in the Boletim da Republica priorto approval in order to allow objections from affected third parties. Clearly, this would bea way of formalizing the role of licenses as an instrument to inhibit competition (in orderto favor specific firms) which could only have a detrimental impact both on employmentand output.

4.16 In sum, the climate for private investment is being rendered less attractive than itwould otherwise be by cumbersome application procedures, and by the uncertainty thatinevitably follows from discretionary decision-making. Streamlining and the eliminationof unnecessary procedures and requirements are urgently needed if Mozambique is to bemore successful in attracting private investment. Although investments authorized by theCPI amounted to US$870 million, from 1985 to September 1994, only just over US$160million are under implementation (including US$60 million in foreign investment).About US$300 million approved during 1985-90 never reached the implementation stage.

4.17 It is recommended that a flat fee be levied for company registration comparablewith international practices. The requirement to obtain investment authorizationcertificates by the CPI should be eliminated and eligibility for any tax breaks/concessionsshould be made automatic based on the investment registration (see below).31 Finally,operating licenses issued by the various supervisory ministries should be restricted toactivities involving the exploitation of natural (exhaustible) resources, such as fishing andmining.

Operating Constraints

4.18 While the removal of restrictions to company entry are extremely important,appropriate regulations governing business operations are just as relevant to attractprivate investment. Key regulations include the labor and tax laws and existinginvestment incentives such as the ability to remit profits.

For further discussion on the investment code in Mozambique see "Review of Foreign InvestmentLegislation and Recommendations for Development of the Mozambican Investment PromotionCenter (CPI)", July 1994, Foreign Advisory Service (FIAS), a joint facility of the IFC, MIGA, andthe World Bank.

61

Labor regulations

4.19 Labor-related regulations are extremely cumbersome, and for companies withlarge numbers of employees, involve a heavy administrative burden. For example, allovertime must be reported to the Ministry of Labor within fifteen days of its occurrence.Labor contracts must be presented to the Ministry of Labor for approval every six monthsindicating changes in wages and payment of any bonuses. This is a costly task forcompanies every time that they adjust wages, and discourages productivity-linkedpayments. In addition, a full payroll statement signed by the employer must be sentmonthly to the Ministry. Finally, monthly inspections are also carried out, during whichit is ensured that the company's working hours are advertised on the walls affixed withthe appropriate stamps.

4.20 In cases of unilateral termination of contracts, a severance payment to the workeris required, except when dismissal is justified on disciplinary grounds. The labor lawstipulates three months of current salary for workers employed from six months to threeyears, and three months of current salary for every two years when the worker has beenemployed for over three years. In addition, the employer is required to give three monthsadvance notice to the worker and the Ministry of Labor before laying-off a worker, orelse pay the three months salary as severance. These terms are quite unfavorable in termsof ensuing costs, compared with other developing countries,32 and tend to promoteinefficiency. Because severance payments depend on tenure, employers have anincentive either to ensure a high turnover of young workers or not to dismiss workers toavoid severance payments altogether. Under the latter, labor is effectively treated as afixed cost and becomes unresponsive to market conditions. Moreover, on-the-jobtraining and productivity-linked wage increases tend to be discouraged, negativelyaffecting labor efficiency.

4.21 There is general consensus that the labor law should be revised. The current lawwritten in 1985 is outdated and irrelevant in a non-command economy. In view of this,the Ministry of Labor should draft a new law as a matter of priority. Specific areasrequiring attention include the need for flexible contracts, streamlined procedures fordisciplinary dismissal and for a revision of the formula used for severance payments. Inthis regard, consideration should be given to the introduction of an upper limit to the totalseverance payable, (for example, up to six to twelve months salary, following theexample of countries with more flexible labor regulations).

Tax regulations

4.22 Registered companies in Mozambique are obliged to pay a number of direct(corporate tax, payroll tax) and indirect taxes (consumption, turnover tax, import duties)plus assorted stamp duties associated with specific transactions. While progress has beenmade in rationalizing the tax regime, through reductions in the level and number of taxrates, the tax burden in Mozambique remains heavy and constitutes a strong incentive for

32 For example, in Turkey, severance payments amount to fifteen days per year of employment.

62

informal sector activities, particularly for import smuggling, as discussed in earlierchapters.

4.23 The latest tax package adopted in December 1993 reduced the corporate tax inMozambique from 50 percent to 35-45 percent, depending on the type of economicactivity. Provisions have also been made to reduce import duties on raw materials and toexempt industrial inputs from the turnover tax. However, the level of statutory indirecttaxes, particularly on imported consumer goods, remains too high and provides a strongincentive for tax evasion. While the level of import duty alone is not excessive, 35percent, the total import tax on consumer goods amounts to a minimum of 62.5 percentwhen other taxes are included.33 In addition, any move through the distribution chainadds a further 10 percent to the sale price.

Table 4.2 Mozambique - Tax Regime34

Type of Tax

Costs Income Turnover Consumpt. Stamp Payroll Customs ImportTax* Tax Tax Taxes Taxes Fee Duties

Administra Yearly Detailed Paid once Seal and a) ISS Paid Paidtive costs External accounting at factory various b) Tax on once at once at

Audits. for each gate or at stamp salary border borderPaid twice product or border taxes income.a year service. Company

Numerous mustexemptions retain and

keepaccounting

Financial 35-45 % of ad-valorem ad-valorem small ISS 4% 2.5% of (5-35%)Costs net profits (5%-10%) (20-150%) lump sums C.l.f. C.i.f.

I ~~~~~~~~~~~~~~value value

* This rate is applicable to companies in group A. This group includes large companies with sales in excessof Mt 25 million , foreign investors, state-owned companies and limited partnerships.

4.24 According to the companies interviewed, the payment of taxes involves a greatdeal of paper work and can be very time consuming (special forms for the turnover taxmust be submitted monthly in five copies for each sale/product unit). Stamp and sealtaxes (carimbo), required to legitimize a number of transactions, are considered a majornuisance. While the monetary cost of the stamp tax is modest (Mt1OO each), compliancecosts are high as they involve time and resources for both private and government agents:the "carimbo tax" is an example (see Box 4.4). A more serious problem arises from themethods used to calculate stamp duty liabilities for specific transactions. For example,stamp duties payable for notarization of collateral in credit transactions can be as high as

Including a minimum consumption tax (20%), turnover tax (5%) and Customs handling fee (2.5%).

There are other taxes not mentioned such as fuel, tourism, and vehicle taxes.

63

7 percent of the value of the asset. The value of the stamp tax is determined according tothe size of the project, the sector, the number of pages per document and other factors.

Box 4.4: The Carimbo Tax

The carimho, or seal stamp is an example of excessive bureaucracy which can costcompanies more in time and resources than the revenues actually collected. The seal tax isrequired on all sales invoices which must be pre-stamped at the Ministrv of Finance. Somecompanies have reportedly hired a full time clerk for the sole purpose of carrying out thisstamping procedure at the Ministry. In addition, companies must send a photocopy to theMinistrv of every single invoice issued. One company interviewed stated that it was requiredto send over 500 photocopies a day to the Ministry of Finance.

Seal stamps are also required on commercial calendars, movie tickets, playing cards,tickets for games, raffles, and rental agreements for housing. For example, promotionalcalendars must be stamped at the regional office of the Ministry of Finance. The calendars arecounted and measured by a tax officer since the tax value is a function of the surface area ofthe item to be stamped. Each item is then physically stamped. For a company distributingthousands of promotional calendars this could entail tying up a truck, driver, and a clerk forover a day, a cost much greater than the $50 paid in taxes. If the calendars are distributedwithout the appropriate seal, a fine equivalent to five times the amount of the tax is payable bvthe company.

4.25 The high level of indirect taxation creates incentives for negotiation of ad-hocexemptions with the Ministry of Finance. This is also the case of many taxexemptions/reductions provided under the tax law (e.g., turnover tax on "industrial"inputs, import duty reductions) which are not written in the tax code. Even in the case oftax breaks provided under the investment code, companies must undertake additionalpaperwork to make the benefits effective, despite the fact that the investment registrationat the Ministry of Finance already indicates eligibility.

Fiscal incentives

4.26 The new investment code, enacted in July 1993, defines a number of fiscalbenefits for investments authorized by the CPI as well as the eligibility criteria to accesssuch incentives. A positive feature of the code is that it provides equal treatment to localand foreign investors. However, small investments are discriminated against as the limitfor eligibility is US$15,000 for local investment and US$50,000 for foreign investment.

4.27 Under the code, raw materials/inputs used for expcrtation and all materials,including capital equipment, used for project implementation are eligible for import taxexemptions (both duties and other taxes). However, duty exemptions are only granted ifthe goods in question are not produced domestically. While provision is made for qualityand price differentials, this is clearly a disincentive for exporters.

64

4.28 In principle, income tax concessions are determined according to the type andgeographical location of the investment. New investments and rehabilitation of facilitiesparalyzed/destroyed by the war are entitled to a 50 percent reduction (80 percent inspecific zones) of corporate and supplementary taxes, for a maximum of ten years, whileother investments are entitled to a 100 percent deduction from taxable income, for fiveyears. The elimination of outright tax holidays is a positive feature as it discourages theflow of transitory investments. However, access to these and any other investmentincentives should be made automatic and not subject to an authorization by the CPI.

4.29 The fiscal package contained in the investment code should be revised and accessbe made automatic and more transparent. To the extent possible, all tax exemptions andreductions must be written in the appropriate tax schedule (corporate tax, tariff schedule).More importantly, emphasis should be given to further rationalizing the tax regimethrough the introduction of a Value Added Tax or a combination of the consumption andturnover tax. The experience worldwide suggests that stable political andmacroeconomic conditions, clear and enforceable property rights, simple bureaucraticprocedures, and relatively free access to capital markets are much more relevant factorsfor potential investors than ad-hoc fiscal incentives.

Remittances offunds

4.30 While the investment code makes provision for the remittance of funds (profits,royalties, debt service and invested capital) in the case of foreign investment, the termsfor accessibility stated under the code are restrictive and constitute a source of greatuncertainty. First, only foreign investment authorized by the CPI is entitled to transferfunds abroad, which means that this right is not automatic. Second, in addition to thecertificate issued by the CPI, an investor must undergo registration procedures at theMinistry of Finance and the Bank of Mozambique to be able to remit funds. Third, profitremittances are conditional on confirmation that outstanding tax payments have been met,that the legal reserve fund has been constituted/replenished, and that adequate provisionsto cover debt service have been made on the loans contracted to finance the investment.While the first condition makes sense, the others although sound business practicesshould not be up to the government to enforce. There is also uncertainty as to whetherprofits could actually be remitted in any given year. According to the code, profitremittances shall be "promptly processed" as long as the positive foreign exchangebalance generated by the investment allows for the necessary coverage. If no surpluswere generated, the remittances will be processed the next financial year.35 Finally,implementation procedures are yet to be published by the Bank of Mozambique.

4.31 The impact on foreign investment of such restrictions is clearly negative and it isnot surprising that many investors end up using alternative methods to remit profitsillegally (through transfer pricing, technical assistance arrangements with headquarters,

For example, import-substituting firms can remit profits under terms to be agreed with the investor,provided that it can be demonstrated that net foreign exchange savings have been generated.

65

and so on). It is strongly recommended that the right to remit funds abroad be madeautomatic for all registered foreign investment and not conditional to prior authorizationby the CPI. Regulations regarding profit remittances should be greatly simplified andmade more transparent. The requirements such as legal reserve funds and debt servicecoverage should be eliminated. Transparent implementation procedures on capital andprofit remittances should be prepared and properly disseminated by the Bank ofMozambique as soon as possible.

Other Implementation Constraints

4.32 Other key impediments reported by the private sector include the inefficiencies ofCustoms and ports as well as the poorly functioning banking system. A detaileddiscussion on the weaknesses of the Customs administration has been presented inChapter 2. The main complaints among the business community are the lack of storagefacilities and high security risk for trade cargo channeled through the various Customsterminals (FRIGO, Maputo port), and the inefficiency and corruption of personnelinvolved in the clearance of goods including ADENA, the Customs broker agent. Inresponse, many companies are forced to set up parallel facilities (warehouses, specializedvehicles) and deploy a considerable number of personnel to deal with Customs.36 Thelack of transparent and standard procedures to access duty exemption regimes forexporters is another major constraint for private sector development and exportsdiscussed in detail in Chapter 3.

4.33 In addition to import tax payments, an importer typically incurs additional costspayable to shipping lines, port authorities and ADENA. Demurrage charges begin toaccrue three days after cargo arrival (at US$15 to 20 per day per container).37 Becausethe dwelling time for a container in the Mozambican ports is exceptionally high, around114 days in Maputo, shipping lines are charging a surcharge of US$225 for containersshipped to Maputo. Several reasons explain this situation including lack of funds to payimport taxes and other import charges by both government and private importers,inadequate information systems to communicate arrival of cargo, and shortage of storagefacilities. A more efficient system would include longer grace periods (fifteen days) andsteeper demurrage charges thereafter. While the new legislation makes provision for theoperation of private Customs brokers, in practice ADENA still functions as the soleCustoms agency. Charges are high, equivalent to 1-2 percent of import value, and hiddenpayments are reportedly necessary to speed up the completion of required paper work.

4.34 Another major constraint to the private sector are the costs resulting from theinefficiency of the banking system. By and large, poor performance results from the lackof competition and relative predominance of state-owned banks which suffer frommanagement and capacity weaknesses. Common problems include long delays in

For example, to ensure the safety of merchandise, one importer uses his own labor to carry outcontainer unloading/stripping at the port, and to witness cargo inspection by Customs.

About 600 containers were reported to have remained at Maputo and Beira ports for over 180 days.

66

undertaking any standard bank transaction and the associated costs of the tied up capital:opening a letter of credit takes at least three weeks at the Commercial Bank ofMozambique (BCM). In addition, access to credit to the private sector has been restrictedas most of the credit was being absorbed by loss-making parastatals. It is expected thatthis situation can be improved in the medium-term with the on-going reform of thefinancial sector (supported under the current IDA funded structural adjustment operation),which includes bank restructuring and the entry of new private banks.

B. SUMMARY OF RECOMMENDATIONS

4.35 The role of the state in relation to the private sector needs to be redefined ifMozambique is to succeed in expanding investment and output on a sustainable basis.The state should see its role as that of a facilitator rather than a controller of private sectoractivities. This would involve creating a simple and enabling business environmentthrough the removal of bureaucratic red tape and restrictions now embodied in theregulatory system. In the immediate future, efficiency gains in the use of scarce humanresources should be attained by the removal of all non-essential regulations, institutionsand policies.

Regulations

4.36 The regulatory system should be greatly simplified and rationalized. Prioritiesinclude streamlining procedures and reducing the cost for company registration,eliminating the various stamp taxes, and reducing notarization requirements.

4.37 The requirements to establish a company should be restricted to the registration atthe Commercial Registry, at the Ministry of Finance (as tax payer) and the Bank ofMozambique in the case of foreign investment. Authorization by the Center for thePromotion of Investment should be eliminated. Licenses issued by supervisory ministriesshould be limited to activities involving the exploitation of natural resources such asfishing, mining, or forestry which require environmental assessments.

4.38 The investment law should be revised to redefine the role of the Center forPromotion of Investment and to eliminate its role as a reviewer of the fiscal incentivepackage and conditions for the capital and profit remittances. Overall, access toinvestment incentives should be made automatic and transparent for all investmentundertaken in Mozambique and not be conditional on any, prior approval.

4.39 All duty reductions/exemptions on capital goods imports should be written intothe tariff code. Duty exemptions for exporters should not be restricted only to inputs thatare unavailable locally, and should include the EGA. Access to duty exemption regimes,including bonded warehouses, should be made available to all exporters even when noinvestment is involved.

67

4.40 In the case of foreign investment, the right to remit capital and profits should beautomatic. Clear and simple procedures should be prepared and disseminated by theBank of Mozambique as soon as possible.

4.41 The labor law needs to be revised. Specific areas of attention include the need formore flexible contracts, for streamlined procedures for disciplinary dismissal, and forrevision of the formula used to calculate severance payments.

Institutions

4.42 The approval function of the Center for Promotion of Investment (CPI) should beeliminated. The CPI should become a center for investment promotion and facilitationwhose only role should be to help investors navigate through the bureaucratic proceduresrequired by government agencies. This could include the publication of an investor'smanual indicating necessary procedures to make an investment in the country. Theinternational marketing and promotional activities of CPI should be contracted out toexperienced private firms.

4.43 The activities of sector ministries should focus on data monitoring, and selectiveex-post inspections where appropriate (health, quality control, environmental impact,worker safety). In particular, enforcement of environmental regulations should be animportant aspect of a ministry's activity.

4.44 Procedures to regulate capital repatriation and profit remittances by foreigninvestors should fall fully under the domain of the Bank of Mozambique with exclusionof the Ministry of Finance.

4.45 Detailed recommendations to reform the Customs administration andimplementation of duty exemptions regimes for exporters are given in Chapter 2 andChapter 3.

5. PRIVATIZATION POLICY AND IMPLEMENTATION

INTRODUCTION

5.1 The slow pace of privatization of large industrial firms has delayed enterpriserestructuring within the industrial sector with adverse repercussions on outputperformance and overall macro-economic stability, especially since privatization has beenmade the main instrument to address the restructuring needs of state-owned firms. Whilesignificant progress has been made in the last half of 1994 in the divestiture of state-owned companies, as of the middle of that year just under two thirds of gross industrialoutput remained under the control of state-owned firms.38 Loss-making operations ofmany state firms have been covered partly through direct budgetary subsidies, amountingto one percent of GDP in 1993, but mostly through indirect transfers (through the bankingsystem non-payment of counterpart funds, subsidized inputs, and inter-enterprise debts).Not surprisingly, large state industrial firms account for a high percentage of the non-performing loan portfolio of the banking system.39 In addition, the transfer of resourcesto loss-making state enterprises has crowded out access by the private sector, furtherconstraining output recovery.

5.2 As indicated earlier, apart from the adverse business environment confronting theindustrial sector overall, most state firms are additionally burdened by problems of poormanagement, low productivity, and a heavy debt burden. In addition to management andfinancial restructuring, these firms are also in dire need of substantial physicalrehabilitation to expand capacity utilization. In some instances the government hasinitiated expensive rehabilitation projects, prior to privatization, with the support ofexternal donor financing. As demonstrated by the track record of state firms inMozambique and elsewhere, the government is really in no position to assume high risksinvolved in such investments. Instead, concerted efforts should be made to accelerate theprivatization program, so as to ensure that the risk and cost of investment decisions bebome by the private sector, which is better placed to judge market signals.

5.3 Several reasons account for the slow pace of privatization of large firms,including the delays incurred in the preparation of an appropriate institutional and legalframework and the uncertainty generated by the war. Because of the lack of domesticsavings, the privatization program in the post-war period depends critically on thecountry's ability to attract foreign investment either through direct sales or joint ventures.

State-owned firms in this report refers to all companies with majority state ownership, either throughdirect majority ownership by the state, or indirectly through other majority state-owned entities (i.e., thestate-owned banks).

As of the end of 1993, over 50 percent of the loan portfolio of the Commercial Bank ofMozambique (BCM), the state owned largest bank, was non-performing. State-owned firms such asCaju ue MoNambique, Emocha, Cimentos de Monambique, L.A.M., and Vidreira were among thelargest bad debtors.

69

Therefore, improving the investment climate, by simplifying the legal and regulatoryprocedures to start up and operate a business, is a key priority as discussed in earlierchapters. In addition, a number of other problems specifically associated with theprivatization process itself have been identified, which would need to be addressed in orderto speed up and ensure a successful program. These include: (i) lengthy preparatoryprocedures; (ii) excess labor issues; and (iii) the need for additional transparency in thebidding and sales process.

A. SLOW PREPARATORY PROCEDURES

5.4 The situation facing some state enterprises has been worsened by the uncertaintycaused by the slow pace of privatization. In an effort to demonstrate commitment to theprivatization program, the government announces early on in the process whichcompanies are to be privatized. Once the announcement is made, it becomes difficult forthe enterprises in question to do business. Credit dries up, as banks face uncertainty as tothe status of loans following privatization. For the same reason, foreign customers arereluctant to enter into contractual arrangements with such firms. Since most of thesecompanies are incurring operating losses, reduced access to bank credit affects theirability to meet costs such as workers' salaries, and operations are rendered virtuallyimpossible. In some instances, this period of uncertainty has lasted up to almost threeyears (see Table 5. 1).40

Table 5.1: Sample of Larger Firms to be Privatized and their Status as of the end of1994Date first

Company name Sector announced Status end-1994Agro-alfa Agricultural equip. Apr. 1993 In bidding stageCaju de Moc,ambique Cashew processing Nov 1991 2 of 7 units sold in Dec. '94

............................................................. .. . . . . . . . . . .. . .. .. .. . . . . .. . . . .. . . . . . ... . . . . . . . . . . . . .. . . . . . . . .. . . . . .. . .. . . . .Carbomoc Coal production Feb. 1994 DPR still being completed............... j............................................................................................... ........... .........................................................................................

Cometal Metal working Nov 1991 Reopening bidding processComp. Ind. da Matola Grain milling Apr. 1993 I of 2 units sold......................... ....... ............................................................. i...........I..................... ..................................................................

Campanhia do Boror . Copra production Apr. 1993 DPR being reviewedEncatex Clothes distributor Apr 1993 in bidding stageEplama Plastic molding Nov. 1991 3 of 5 units sold

........................ .. ....................................................................................................................................................................

Fabrica de Cerveja -2M Beverages Apr 1993 Bidding completedFasol .. Soap & oil prod. Apr 1993 Sold in Nov. '94Forjadora Metal working Nov. 1991 Sold in April 1994b .. . . . . . . .. . .. . .. . .. . .. . .. . . . . ..................... ............................ ................................ ................................................................. ;

.eomoc . Construction . Feb. 1994 DPR yet to startMobeira Grain milling Feb. 1994 DPR yet to start

...................................................... . .. . . . . . . . . . . . .. . .. .. ........ .. . . . . . .. . . . .. . . . . . . .. . . . .. . . . . . . . . . . . . . . . .. . . . . . .Soveste Garment mfg. Apr. 1993 DPR being reviewedSteia . Equip wholesaler Apr 1993 In bidding stage

Source: Boletim da Republica; UTRE, Mfinistry of Finance

For example, garment manufacturers working under sub-contracting arrangements have been particularly hardhit by this problem (for example, Soveste). Foreign customers, who ship cloth for assembly into the factories,have sought alternative manufacturing sources in order to avoid the risk of becoming caught in a legal limboduring the privatization process.

70

5.5 UTRE, the privatization unit within the Ministry of Finance, which was created in1991 to oversee the privatization of 'large' firms, has sold twenty large companies,fourteen of them during 1994. This recent progress is to be commended, but delays up tothis point can explain the lack of restructuring that has occurred within the industrial andother sectors. For example, only enterprises sold during 1994 are expected to begin tohave a significant impact on output as indicated in Figure 5.1 below. Another delaystems from the actual selection of which companies are to be privatized. Line ministriesmust first select companies to be privatized by UTRE. Numerous companies have neverbeen identified for privatization due to either vested personal interests within theministries4 ' in retaining certain enterprises or simply a lack of interest within theindividual line ministry.

Figure 5.1: Impact of the Privatization Program on the Value of Gross Industrial Output(Breakdown based on ownership - calculated using enterprise output datafor 1993 and 1994)

19%

Stateowned 56% .........

5%,

.......... .....

Privatelyowned

Breakdown ofgross Gross value ofoutput Gross value ofoutput Gross value ofoutput Breakdown ofgrossvalue of industrial output ofenterprises sold ofenterprises sold mi ofenterprses to be value ofindustrial output

prr topriValZatin prior to 1994 1994and Ist half 1995 soldi 2ndhalf'95& expectedinmid-1996I st half '96

Source: UTRE, Ministry of Finance; CNP; World Bank analysis

41 The situation of the glass factory, Vidreira de Mo,ambique E.E., is one such case.

71

5.6 The procedures for the privatization of large state-owned firms can be lengthy andcomplicated. In some cases, the preparation of the Diagnostico do Potencial deReestruturaqdao (DPR) requires excessive information, is time consuming and isexpensive. While the DPR process is important to clarify ownership issues and to put thefinances of the company to be sold in order, the DPR actually collects much informationwhich is not essential to the sale of the company. UTRE is currently reviewing the DPRformats with the aim of shortening the time required for completion to two-three months.

Box 5.2: Pro Forma Requirements and Costs of the DPR

* The average DPR includes seventy-five separate tables describing various aspects of theenterprise being sold: from a ten year projection of cash flows based on a hypotheticalinvestment to historical balance sheets of the firm, which in many cases needs to be puttogether for the first time.

# Nine separate annexes.* Seven charts including a Gant Chart showing the future rehabilitation program for the

enterprise and a graph depicting historical sales of the company.* The DPR for Caju de Mo9ambique took nine months to complete, cost US$120,000 and

is just under 500 pages long.* The DPRs and Sales Memos for Boror and Emocha, the state-owned copra and tea

companies, will cost US$290,000 and US$300,000 respectively and are expected totake over eight months to complete. Sales for Boror in 1993 were only $432,000.

5.7 Furthermore, the valuation method used to determine the 'reference price' of thecompany, also part of the DPR, could be simplified. The current estimation methodinvolves the calculation of the net present value of the firm's projected cash flowassuming hypothetical, projected investment levels. Such valuations are very subjective,based on weak assumptions, and are not suitable for setting a realistic value for the firm.

5.8 Bearing in mind that the selling price of any company should be ultimatelydetermined by the market, it is acknowledged that some sort of valuation can be used tohelp set a reference value. However, such reference values could be estimated using lesscomplicated methods, and be based on the current cash flow net of debt service or thescrap value of the assets. In fact. the technical methods employed in preparing a DPRvaluation seldom determine the market price for an enterprise. Moreover, overvaluationand unrealistic price expectations published in the Sales Memorandum prepared from theDPR can delay the privatization process by scaring off potential investors. Interviewswith both local and foreign potential investors indicate that inclusion of these referencevalues in past Sales Memoranda may have led these investors to believe that thegovernment expected prices in this range. This has kept some of these investors frompursuing the matter further, an undesirable result from the perspective of the government.Therefore, DPR prices should not be published in the Sales Memorandum sent toprospective buyers, or if they are to be included, the assumptions used to reach this priceshould be clearly stated. It should also be noted in the Sales Memorandum that the DPRvalue is a reference price only and that government will consider any reasonable bid.

72

5.9 While it is important that a reasonable price be ensured for the sale of a company,the main objective of privatization is, above all, to attain sustainable enterpriserestructuring through the transfer of assets into more productive hands in the case ofviable enterprises and in the case of non-viable enterprises, liquidation. These enterprisesare of more value to the government when they begin to generate a profit and pay taxes,and to the economy as a whole through job creation and foreign exchange generation.4 2

As long as the privatization process is delayed these enterprises will continue to be adrain on the budget and the economy, rather than a net contributor.

B. REDUNDANT LABOR

5.10 The employment policies of the last two decades have resulted in redundant laborin state enterprises. While some state companies have undertaken a reduction in theirwork-force by using severance pay, most have not. There are two main constraints to thereduction of the labor-force: (i) most state-owned enterprises are in financial difficultyand do not have the cash to pay the legally-mandated severance pay;43 and (ii) thegovernment is especially sensitive to laying-off workers. Labor unions have a strong andimportant role both at the firm and national level. After years of socialist policies,workers and unions have come to feel some sense of "ownership" in state enterprises, andworkers feel they have a right to their job.

5.11 Faced with difficulties in reducing their work-force, combined with otheroperating constraints, state-owned enterprises with cash-flow problems have difficultiesin paying their wage bills. Consequently, many companies are asking all or part of theirwork-force to stay at home. While base salaries must be paid, the cost of providingtransport, food, and health benefits are thereby reduced. Even with much of their workforce at home, for "paralyzed" or "inactive" firms, the wage bill continues to constitute alarge fixed cost. Many companies are often not able to pay salaries at all. Instead, theyare accumulating debt in the form of salaries-in-arrears. These firms are also often nothonoring their pension obligations (and thereby also posing a threat to the viability of thenational pension scheme). In the industrial sector, many companies have not paid salariesin over six months. In the agricultural sector, this non-payment of salaries has lasted overtwo or three years and some state farms have given workers pieces of the farm tocultivate for themselves in lieu of salary. In several instances, the non-payment ofsalaries has led to labor unrest and strikes.

42 The approach of officials from the Treuhand, the German privatization agency, was "we are notselling companies; we are buying management and technology."

For example, a worker that has been employed with the firm for sixteen years, would be entitled totwenty-four months of salary as severance pay, presenting a prohibitive cash-flow problem to most state-owned enterprises. This is true despite the fact that average salaries in the industrial sector are on theorder of only USS38 per month and the non-agricultural minimum wage is on the order of US$ 18 permonth. This system also encourages companies to lay off their newest workers, rather than trying todevelop an early retirement package for older workers.

73

5.12 The existence of redundant labor, the accumulation of salaries-in-arrears, and theconsequent labor unrest among state enterprises are now posing a problem to theprivatization of these companies. Current policies and practices relating to the salesprocess of state-owned enterprises effectively transfer these labor liabilities from thegovernment to the private buyer. Such practices are also an attempt to distance thegovernment from the political and economic cost of the eventual retrenchment of theseworkers. Although government practices have not always been consistent, the oneunifying theme has been a policy by the government to maintain firm-level employmentduring privatization and to pass labor liabilities to the private buyer.

5.13 The current labor law, written in 1985 prior to reform, is outdated and irrelevantin a non-command economy. It provides no guidance, for example, regarding laborissues arising from privatization. Specific areas requiring change that were identifiedinclude the need for flexible contracts, stream-lined procedures for disciplinary dismissal,and a revision of the formula for severance pay. In the absence of applicable law, aTripartite Commission of government, union leaders, and management representativesmeets regularly. They resolve outstanding labor issues and have initiated preliminarydiscussions regarding the revision of the labor law, although nothing definitive has beenenacted yet.

Box 5.3: Labor Liabilities are Hindering Privatization

At the level of the National Commission for Valuation and Privatization (CNAA), prospective buyersof small and medium enterprises are being required to ensure that the firm they privatize willcontinue to engage in the same productive activity and will be purchased with the same work-force(in its entirety and with existing labor contracts). According to people who sit on this Commission,the labor retention requirement is obligatory. A higher bid that proposes a lower work force will berejected. In other words, the price is not being allowed to incorporate the cost of redundant labor (orthe cost of removing redundant labor).

With full ownership of title, newly privatized companies may down-size their labor force by payingthe legally-mandated severance pay. However, many private firms have transitional titles ofownership for three to five years until they have paid for the company in full. During this time thegovernment has the leverage to ensure that the work force is retained as per the sales agreement.There have been several cases in which prospective private buyers of state-owned enterprises werealso asked to incur the pension liabilities of the enterprise to be sold.

In the case of large and strategic firms being sold through the privatization unit within the Ministry ofFinance (UTRE), there have been fewer sales and little precedent with respect to the labor retentionrequirement. In two cases of state-owned enterprises with redundant labor there was somediscounting of the sales price in exchange for the retention of the whole labor force. However, UTREbelieves that the labor retention requirement may be the cause for a lack of interest amongprospective buyers in bidding for Hidromoc, for example, with its estimated 200 redundant workers.

74

5.14 The financial costs of retrenchment will not be trivial. These costs will include:(i) the severance pay for all workers of liquidated companies; (ii) the cost of voluntaryretrenchment of non-liquidated state companies; (iii) the severance pay of still redundantworkers in state enterprises in the process of privatization; and (iv) the cost of pensionplans of state enterprises. For example, retrenchment of 30.000 workers assuming anaverage wage of twenty five US dollars and average worker tenure of ten years wouldcost US$ 11.3 million.

5.15 A re-deployment fund should be established to cover these costs of retrenchment.These costs should be primarily borne by the government from revenue from the sale ofstate enterprises. Additional funding may also be required from donors. However, thisfund does not yet exist in practice. According to the Ministry of Finance, up to veryrecently, revenues from the sales of small and medium scale enterprises, net of liabilities,have been too small to establish a functional fund. Consequently, these revenues godirectly to the Treasury. With the recent sale of larger companies, such as Cimentos deMocambique and some of the plants of Caju de Mocambique, the establishment of thisfund should be a priority.

C. TRANSPARENCY IN THE BIDDING AND SALES PROCESS

5.16 Bank experience worldwide with privatization has shown that to be successful,these transactions should be transparent. It is also important that the perceptions ofinvestors, whether justified or not, are that the program is administered fairly. Failingthis, investors will be difficult to attract or the wrong type of investors may be attracted tothe program. Transparency can be ensured through clearly defined competitive biddingprocedures, clear and simple selection criteria for evaluating bids, disclosure of purchaseprice and buyer, well-defined institutional responsibilities, and adequate monitoring andsupervision of the program.

5.17 A number of potential investors interviewed during this study seem to be underthe impression that it is actually possible to influence the selection of a winner in thebidding process. Whether true or not, the perception that these irregularities exist in itselfis damaging to the program. Some reasons for this include the subjective and non-transparent nature of awarding points in the final bidding for factors other than price (upto 80% of the final weight in many cases is based upon factors such as widely divergentdevelopment plans for the company put forth by the bidders) and the fact that lengthynegotiations can take place with one or two selected bidders after the final bidding periodhas been closed. The use of non-price criterion in the evaluation of bids should beavoided as it opens the room for discretionary decisions and, at best, for wrongimpressions among potential investors. The Commissao Executora da Privatizad7ao(CEP) should make a careful evaluation of potential bidders during the pre-qualifyinground of bidding based on their experience and qualifications to operate the companybeing sold. The selection of the winner in the final round of bidding should then be based

75

exclusively on the bid price, with simple enforceable development objectives (if they areso desired) for the company being worked into the contract of sale that is being bid upon.

5.18 To ensure transparency in the sales process, participating bidders should beinvited to the opening of the bids and then information on the details of the winning bidshould be publicized. In this way, all bidders can see how their bid faired compared tothe others. UTRE has stated that it only intends to follow these procedures "in somecases." CEP's have also stated that they intend to "invite interested bidder to the openingof bids in the sale of some companies." These procedures should be followed for AUlcompanies being sold, not just select cases. Similar procedures should be followed forthe divestiture of the small and medium sized companies being sold by the privatizationunits within the various ministries (GREI, UREA).

5.19 Recently, UTRE has sold a number of companies on a delayed payment plan. Asone of the main objectives of privatization is to transfer the possession of assetsirreversibly from the government to the private sector, payment should be made on a cashbasis. This is the only way that the umbilical cord between the government and a newfirm will be cut. It will also ensure that the firm will not revert back to the government,nor use its unpaid balance to pressure the government into further concessions.

D. SUMMARY OF RECOMMENDATIONS

5.20 UTRE, the privatization unit within the Ministry of Finance, should as a matter ofpriority be given expanded terms of reference that include the development of a planwhich will set out to begin the divestiture of the most important state-owned enterpriseswithin a year. This would include those companies currently not on the list to beprivatized including, but not limited to the state-owned sugar estates, L.A.M.,Telecomunica,oes de Mo,ambique, C.F.M., and Eletricidade de Mo,ambique.Remaining companies should be sold within an additional year, or liquidated with theassets sold off in an auction. Selection of which companies to be privatized should not beleft to individual ministries.

5.21 The pro-forma requirements for the DPR should be redesigned and greatlysimplified. When consultants are hired to prepare the DPR a two month preparation timeshould be stipulated as part of the terms of reference of their work.

5.22 A retrenchment fund for excess labor should be operationalized as a matter ofurgency. Funds originally targeted for developing programs for redundant labor underthe Industrial Enterprise Restructuring Project (IDA Credit 2081) could be used as theseed of such a fund. Payment of wage arrears and reduction of excess labor at each state-owned enterprise should begin as quickly as possible.

5.23 Winning bids should be evaluated exclusively on price and not on the subjectiveaspects of the bid, such as proposed development plans for the company by the bidder.The technical ability of the bidder should be evaluated during the pre-qualifying stage of

76

the bidding and simple, enforceable development plans for the company should beincluded in the contract that is part of the package being tendered.

5.24 Procedures for conducting the opening of bids in the presence of all bidders forthe sale of companies and the publication of the details of the winning bid should beadopted for Dll companies being privatized by UTRE, not just a select few. Thisprocedure should be also enacted as quickly as possible by the privatization units forsmall and medium enterprises (GREI, UREA).

5.25 Payment for large companies should be on a cash basis only. Payment plans forthe purchase of companies should not be used as this does not sever the ties between thegovernment and the company, which is one of the main objectives of privatization.

6. THE CASHEW SUB-SECTOR

INTRODUCTION4 4

6.1 The cashew sub-sector has historically played a leading role in Mozambique'seconomy. Developed in the late 1960s around industrial processing for the exportmarket, cashew production is still an important source of income for hundreds ofthousands of family farmers, who remain the sole producers, and is potentially a majorsource of foreign exchange earnings for the country. After peaking at 216,000 tons in1972, production of raw nuts declined steadily since independence, bottoming out in1983 when it reached 18,000 tons. Although Mozambique's output potential is currentlyestimated at 80-90,000 tons of raw nuts per year, less than half the pre-independencepeak, output and exports levels have remained depressed over the past decade (on average35,000 tons of raw nuts per year) largely as a result of the adverse impact of the war andgenerally unfavorable producer prices.

6.2 The cashew industry needs to undergo a major restructuring if a sustainablerecovery of the sector is to be ensured. Most processing factories are paralyzed pendingtheir privatization or because significant rehabilitation would be needed for many of themto resume operations. However, privatization/rehabilitation alone will not suffice toensure the viability of the industry unless pricing and marketing distortions are removed.Installed capital-intensive technologies used to process the raw nut are not competitivevis-a-vis major producers like India and Brazil, where manual or semi-manual techniquesare employed. As a result, Mozambique's cashew factories are producing marginal ornegative value added, and thereby losing foreign exchange by exporting the cashewkernels. Moreover, low minimum farm-gate prices combined with export restrictions,aimed at ensuring cheap supplies to an inefficient local industry, have led to depressedoutput levels of raw nuts, compromising growth prospects for the sector as a whole.

6.3 The main purpose of this chapter is to discuss the scope for developing asustainable cashew processing industry in the context of alternative pricing and marketingpolicies. To this end an attempt is made to quantify the impact on output, foreignexchange earnings and incomes of: (i) continued protection to local industry through lowminimum prices and export restrictions on raw nuts; and (ii) full liberalization of exportsof raw nuts. The review includes projections of the potential impact of cashewprocessing if less mechanized, more labor-intensive, processing technologies wereintroduced by the private sector. The chapter does not review agronomic aspects ofcashew growing (e.g., extension, research, inputs) nor does it estimate farm levelproduction costs. Therefore, no evaluation has been made of the comparative advantage

The review of the cashew sub-sector presented in this report is largely based on the preliminaryfindings of a more comprehensive study being carried out by the Agriculture and EnvironmentDivision of the Southern Africa Department of the World Bank entitled "Mozambique AgriculturalMarketing and Pricing Study".

78

of cashew growing in Mozambique versus alternative crops, nor are policyrecommendations given on future production of cashew.

A. OUTPUT PERFORMANCE

6.4 In the early 1970s, Mozambique produced more than 40 percent of the worldoutput of raw nuts, reaching a peak of 216,000 tons in 1972. However, production begana steep decline after independence reflecting the exodus of Portuguese managers andtraders. The war, which forced farmers to flee key production areas, combined withdeclining real producer prices and high transport costs contributed to the collapse of theindustry in the early 1980s. By 1983 output reached only 18,000 tons (91,500 tons in1980). Since then production has remained below 50,000 tons for all years except 1992.Reflecting the decline in output, the value of cashew exports have plummeted fromUS$65 million in 1980 to just about US$23 million in 1993 (including both raw nuts andkernels).

Table 6.1: Marketed Output, Processing, and Export of Raw Nuts in Mozambique,1980-94 (thousands of tons)

Marketed Export of raw AccumulatedYear raw nuts Processing nuts Residual * residual

1980/81 91.5 83.2 0.0 8.3 8.3.. ............... .... ........... ............................. ........... .................... ................. ........................ .................... ............ ......................................

1981/82 57.3 65.1 0.0 (7.8) 0.5

i98283 17.6 24.2 0.0 (6.6) (6.1)

i983/84 25.3 21.9 0.0 3.4 (2.7)....... .... ........... . ..................... .............................. ..................................... ............................... .....................................1984/85 29.2 15.7 0.0 13.5 10.8

.............. ......... . ............. ........... . ............ ................ .. ...... ............... .............. .................... ............ ............................. ....... 1985/86 40.1 24.8 0.0 15.3 26.1

.............. .......... . ..................... ........... ......................... ............... .............................. ............ .......................... ............... ..............................1986/87 34.9 38.2 0.0 (3.3) 22.8

.... .......... ......... ....... ........................... .. ..... .............................. ........... ................................... ............ ............................. ....... 1987/88 44 4 39.3 0.0 5.1 27.9

1988/89 50.2 39.0 0.0 11.2 39.1

1989/90 22 I 208 0.0 >3 40.4

1990/91 311 24.0 0.0 7.1 47.5............. ........... ...................... ............ .............................. ........ .............................. ............. ................................ ..............I,1991/92 54.0 29.7 6.0 18.3 65.8

.............. 40 .... ........... ............ ..... ........... .............................. ............... .............................. ............ ...................I ............ ............... ........................1992/93 23.9 13.1 9.5 1.3 67.1

~~~~~~~~~~.................. .......... ........................ ........... ............................. .......................................... ............ ............................. ....... 1993/94 35.4 6.0 21.6 7.8 74.9

* Residual = (marketed production - processing - export of raw nut)Source: Secretary of Statefor Cashew

6.5 Mozambique has currently a national orchard of about 30 million trees, most ofwhich are beyond their productive age and provide low yields. This translates into amaximum potential capacity of 80,000 to 90,000 tons of raw nuts per year, less than halfthe pre-independence peak. Production of raw nuts is concentrated in the northernprovince of Nampula, which generates about 70 percent of marketed output. Other majorproduction areas include the provinces of Gaza (12 percent), Inhambane (10 percent) andZambezia (8 percent).

79

6.6 Overall world production of raw nuts has declined since 1974 when it reached apeak of 470,000 tons, and is presently around 400,000 tons. Combined with the fact thatcashew faces a high income elasticity of demand, the world price of cashew kernel hasremained strong. While the two leading African suppliers, Mozambique and Tanzania,have steadily lost world market share since the early 1970s, India, and especially Brazil,have increased their production almost every year. Collectively, these two countriespresently supply about 80 percent of world cashew production (see Figure 6.1 below).

Figure 6.1: Historic Marketed Output of Raw Nuts

500* Brazil

I0 1 O,dmaA

4 * Kenya

j ITanzania

03 Mozambique

255

O0

05

I 5(1

B. PRICING AND MARKETING SYSTEM

6.7 Pricing and marketing policies for cashew have aimed at ensuring cheap suppliesto local processing factories. Until 1991/93 the cashew industry was totally protected:exports of raw nuts were banned and the prices for wholesalers, retailers, and farmerswere determined as a residual depending on processing costs. Although price controlshave, in principle, been removed since then, lack of competition within the domesticcashew market have kept producer prices down. The minimum farm-gate price, whichshould just be a floor price, operates effectively as a fixed price because of lack ofinformation about prices among farmers and the highly concentrated nature of the tradingsystem at the wholesale level. The producer price (as measured by the minimum price)for raw nuts relative to the world price has deteriorated significantly over the recentperiod: from 54 percent in 1990 to 15.5 percent in 1993.45 This share is extremely lowby international standards, for example in Tanzania the ratio is around 50 percent. Thefactory-gate price has also remained low, at about 40 percent of the border price, astraders must first sell the raw nuts to local factories at a "negotiated" price, with thegovernment acting as a referee. Once the demand of factories has been met, wholesalerswith access to export licenses can export surplus amounts to India, the main market forMozambican raw nuts.

Measured at the official exchange rate.

80

6.8 The trading system of cashew in Mozambique is characterized by a large number ofretail traders (spread throughout a vast geographical area) but is highly concentrated at thewholesale level. For the most part, retailers depend upon wholesalers for credit to buy theraw nuts and are therefore in a weak bargaining position with the wholesalers. In addition,transportation costs faced by retailers are very high. For example, in the province ofNampula, the feeder road that retailers use to move the raw nuts from the farm-gate (or theretailer shop) to the city of Nampula are in very poor condition. Under these circumstances,retailers have very little ability to pay farmers above the minimum price.

6.9 In contrast with the retailers, the cashew wholesalers are few in number, wellorganized and financially very strong. Compared to the poor state of feeder roads fromthe farm-gate to the main road to the city of Nampula (where the retailers sell their crop),the road from the warehouse-gate (in the city of Nampula) to the main export port inNacala (about 150 km away), is in very good shape. Transport costs for wholesalers arethus low as compared with those for the retailers. The port of Nacala, through which thebulk of cashew is exported in Mozambique, has recently been rehabilitated and itsfacilities are in excellent condition.

Table 6.2: Farm and Factory Gate Prices for Cashew Raw NutsFarm-gate price Factory-gate price Trader margin

Year (Mt/kg) (Mt/kg) (%)1988/89 165 * 251 * 52.1~~~~~~~~~~~~~~~~~~~................................. ~ 5 ............ .... 1989/90 200* 295* 47.51990/91 380* 606* 59.51991/92 480* 639** 33.1l i992/93 55 * 80.** ' 46.0I993/94 . 700 .,792 ** 156.0

* Administratively set by the govemment; **Liberalized; *** Proposed by tradersSource: Secretary of State for Cashew, World Bank 1994

6.10 The margin between the factory-gate price and the farm-gate price has typicallybeen around 50 percent, the retailer receiving 15 to 20 percer.t and the wholesaler 30 to 35percent (these margins cover transportation costs, financial costs, packaging, tax, etc.). In1993/94, however, this margin shot up to 156 percent (see Table 6.2) as wholesalers wereallowed to export raw nuts directly to India where they could more than double the priceobtained from Mozambican factories. With Caju de Mocambique, the largest processingholding company, being paralyzed pending its privatization and only one private factoryoperating (with a capacity of 6,000 tons), exports of raw nuts amounted to 21,600 tons.Although some cashew farners reportedly received Mtl,000/Kg compared with a minimumprice of Mt700/kg, the main beneficiaries were six wholesalers with access to exportlicenses who were able to make extraordinary "rents" by selling the raw nut at the border

46price (at Mt4,200/Kg).

According to the Secretary of State for Cashew and field visits carried out in the province ofNampula, farmers received a farm-gate price ranging from Mt 500 to Mt 1,000/kg. Monapo, the onlyfactory operating that year paid about Mt2,000/Kg. Wholesalers exported raw nuts at US$680-750/ton.

81

Table 6.3: Price Structure and Trade Margins for 1993/94Price structure Share of world Trade margin as a

1993/94 price share of farm gate(Mt/kg) (%) price (%)

Farmn-gate 700 15.5.......... .....I.. . .. . .. . .. . .. . . ................. .......................... . .. . . . . ....... . . . .. -° ...... . .. . .. . .. 1..5. . .. . . . . . . .. . . . . .. .

Retailer to warehouse gate 1124 24.9 60.6................................................................... -................ ........................................ ........... ............................... ... ...... ................................................

Wholesaler to factory gate 1792 39.8 95.4................................................................... ................................................. ......... ............................... ................................................

Wholesaler to border 4200 100.0 482.3

Source: Secretary ofStatefor Cashew, World Bank 1994

6.11 Current procedures to issue export licenses are not transparent. According torules announced by the Ministry of Commerce for the 1993/94 season, exporters wereobliged to supply at least one third of the exported raw nuts to local factories in order toobtain a license. They were also required to pay an export tax of 30 percent on thedifferential between the factory gate and the border price. In practice, these rules werenot always followed. Several wholesalers obtained export licenses without having to sellfirst to the factories, presumably because of the limited absorptive capacity of localindustry during that season. Although it is known that six traders obtained an exportlicense it is not clear what selection criteria were used to extend these licenses. Inprinciple, processors who have procured the raw nuts from wholesalers (at a subsidizedprice) are not allowed to export the raw nuts, making the licensing system even lesstransparent.

6.12 In addition, not everyone paid the mandatory export tax as suggested byinterviews with wholesalers (in Nampula and Maputo) and available official figures ontax collection. Some wholesalers claim to have paid the 30 percent export tax on theborder price (FOB Nacala) and others to have paid it on the difference between the borderand the factory-gate price. It is also argued that in some "exceptional" cases taxes werenot paid at all. According to Customs data, total export tax collections between Januaryand October 1994 amounted to Mt4.7 billion while the value of exports totaled Mt82.4billion, implying a shortfall in collections of about 70 percent. Finally, it would appearthat significant amounts of raw nuts are being exported illegally as suggested by theresidual between total marketed production, total processing, and total exports. In1993/94 alone, this residual amounted to 8,000 tons equivalent to about US$6 million(see Table 6.1).

82

C. THE CURRENT PROCESSING SITUATION

Processing Capacity

6.13 At present, Mozambique has fourteen highly-mechanized, capital intensivecashew processing factories originally designed to process about 150,000 tons/year ofraw nuts. Of these, only nine factories can be operated and their collective actualcapacity has been estimated at around 40,000 tons/year.

6.14 Of those nine factories, two are private and located in the Nampula province -Monapo and Inducaju - with a collective processing capacity of about 9,000 tons/year.During the 1993/94 season, only Monapo, with a processing capacity of 6,000 tons peryear, was actually operational. This factory, owned by Entreposto, employs about 1,500workers. The remaining seven factories are in the hands of Caju de Mo,ambique, thestate-owned company, and account for about 80 percent of the country's total processingcapacity. Partly because of the war, Caju de Mocambique focused its past operations onthe four factories (with a processing capacity of 30,000 tons) located in the south(Inhambane, Maputo, and Gaza). Low marketed production in this area (averaging10,000 tons in 1990-93 and peaking at 15,000 tons in 1980), have meant hightransportation costs to procure supplies from the north (where more than 80 percent ofcashew production takes place). Operations at Caju de Mo,ambique have been virtuallyparalyzed since 1992/93 as all seven factories are in the process of being privatized. Asof November 1994, the government had completed the sale of two factories whereproduction is expected to resume during the 1994/95 season.47 The privatization processof the remaining five is well advanced but production would probably not resume beforethe following season.

Technical Performance

6.15 The current technical performance of Mozambican cashew factories is extremelylow in terms of: (i) the kernel yield (as a percentage of raw nut weight); and (ii) theproportion of whole kernels obtained. Over the 1988-92 period, the kernel yield for all ofCaju de Mo,ambique's factories averaged only 18.7 percent which is comparable withTanzania's poorly performing public sector factories, but well below the 23-25 percentresults obtained in India.48 During 1992 and 1993, Monapo achieved a kernel yield of 21percent compared with an average for CM factories of 17.8 percent. The relatively lowkernel yield result from a range of factors: poor grading/selection of nuts, poor operating

These include the Angoche and Beira factories.

48 Significant variations in technical perfornance are observed among Caju de Mocambique factories.For example. the Chamanculo factory had an average kernel yield of 19.4% over the 1988-92 periodand exceeded 21% in a few years. In contrast Angoche 2 had an average kernel yield of only 17.6%over this period.

83

equipment, and general management problems, which in principle could well beaddressed through rehabilitation and changes in management and ownership.4 9

6.16 However, Mozambique has a fundamental structural competitive disadvantagebecause of the technologies employed. Both Mozambique and Tanzania rely upon highlymechanized technologies which, as a result of the method used to crack the shell, yield arelatively low proportion of whole kernel. As there are substantial price differencesbetween whole kernels and broken kernels (reaching as high as 50 percent per unit),Mozambique receives far lower export earnings per ton of raw nuts processed. With lessthan half of Mozambique's processed product being whole kernels, the country earns 11percent less than Tanzania, 17 percent less than Brazil and 27 percent less than India perton of kernel.

Table 6. 4 Technical and Earnings Comparison of Cashew Kernel ExportersAverage unit Percentage of Portion of exported

value Indian unit kernels which areCountry US$/ton) value whole Processing method

Manual processing;India 5088 100 83% high quality

* -,-...... .. ....... ,.... ............. ....... .. -.... ....... .. ......... .. ......... . . . .. . .. .. . . . ..... ... ... ... ... ..... ... ... ... ... .. .... . . . . . . . . . .. . . . . . . . . . . .. . . . . . . . . . .Semi-mechanical processing;

Brazil 4426 87 70% mdu ult, . . , ~~~~~~~~~~medium quality.................................. ............................................................................................................................................................................................Mechanical processing;

Tanzania 4136 81 55%loqait, , . . I~~~~~~~~~~~ow quality................................................................................... ...................................................................................................................................

Mechanical processing;Mozambique 3691 73 l 43%qualic

. I I i ~~~~~~~~~~~low quality

Source: World Bank, 1993

6.17 As a consequence of the low technical perfornance described earlier, value addedhas, in recent years, been either marginal or negative for both the Monapo factory and theCaju de Mo,ambique factories. This not only means that the total processing costs (otherthan the raw nuts) have been wasted, but also that foreign exchange earnings derivedfrom exporting cashew kernels have been less than those that could be derived byexporting raw nuts (see Table 6.5).

Table 6.5: Value Added by Local IndustryRaw nuts Caju de Mo. Value added Monapo Value added(USS/ton) kernels* (US$/ton) (USS/ton) kernels (USS/ton) (USS/ ton)

1991/92 600 589 (I1) 621 21... . . ............... ........... ............................... ................ . . . . . . .. . .. .......................................... .. .... ... .... ... .

1!9.92/.93 ... . , ..680 593 (87) 645 (35)1993/94 750 692 (58) 729 (21)

* Kernel raw nut equivalent (conversion factor for Caju de Mo,ambique is 5.40 and for Monapo 5.13).NOTE: The weight of raw cashew in the total processing costs is about 50 percent.Source: Secretary of Statefor Cashew

6.18 It is not surprising that this inefficient industry has required high levels ofprotection in order to survive. For the 1994/95 season the Secretary of State for Cashew

See Papers on Agro-Industry, November 24, 1993, Agricultural Division, Southern African

Department, the World Bank.

84

(SSC) set the minimum price at Mtl,500/kg, taking as reference the historical trademargin of 46 percent and the price that the local industry (Monapo and Caju deMo,ambique) could pay in order to make a five percent profit margin on total revenue.The factory-gate price agreed between industrialists and traders was set above that. levelat Mt2,800/kg. Thus, the farm-gate price would be raised to about 30 percent of theborder price and the factory gate price would increase to around 60 percent of the borderprice estimated at Mt4,550/kg.

6.19 But, according to SSC's calculations, Mozambique's industry cannot pay a farm-gate price for raw nuts above 30 percent of the border price and still be financially viable.Even if current factories (which use Oltramare technology) were rehabilitated, they wouldstill require a substantial subsidy to remain in business. This is recognized by localprocessors in Mozambique.

D. GROWTH PROSPECTS FOR CASHEW

6.20 Mozambique faces the decision of whether to: (i) continue directing marketedproduction to local factories for processing; or (ii) to liberalize the export of raw nuts inorder to increase producer prices and thereby output recovery. Arguments in favor oflocal processing include, for example, employment generation by the processingfactories, an opportunity to add value to the raw product, and avoidance of dependencyon the Indian market, which has a monopsony position vis-a-vis Mozambique. However,current processing technologies in use are highly inefficient and lose rather than generatevalue added. In terms of employment, Mozambican cashew factories could employ (iffully operating) around 8,000 workers compared with millions of farmers that areinvolved in cashew production.

6.21 Clearly, export restrictions have served to keep producer prices down andconsequently led to depressed levels of output. Although Mozambique's short termoutput potential, based on the national orchard stock, is estimated at around 80-90,000tons of raw nuts per year, marketed output has averaged only 35,000 tons over the pastdecade. In fact, output fell from 54,000 tons in 1991/92 to 35,400 tons in 1993/94,following a decline in producer prices (from 54 percent of the FOB price to 15.5 percentbetween 1990 and 1993). If protection continues, through export restrictions and lowproducer prices, production of raw nuts is likely to remain depressed and consequentlyindustrial output (cashew kernels) will stagnate. Already, production of raw nuts (35,000tons) is below existing processing capacity (40,000 tons) after some rehabilitation.

6.22 This section reviews the possible impact of full liberalization on future output,foreign exchange earnings, incomes and employment within the cashew sub-sector. Indoing so a distinction is made of the results when exporting raw nuts or cashew kernel ifmore efficient (labor-intensive) technologies were to be adopted by the private sector.

85

Exporting the Raw Product

6.23 Clearly, there is ample scope to expand output of raw nuts by raising producerprices. Assuming that liberalization would yield a producer price increase closer to parity(50 to 70 percent of border price), significant gains could be captured in increased foreignexchange revenues and farmers' income. What follows are a few hypothetical supplyresponse scenarios using fairly conservative price elasticities50 (see Table 6.6 ).

6.24 No empirical estimation has been made of supply elasticities for cashew becauseMozambique is a former war economy and a time series estimation would probably yieldbiased and insignificant price elasticities. Interviews with farmers in the mainproduction area, the province of Nampula, support the hypothesis that higher producerprices would in fact yield a supply response, both in the short and the long run. The short-run supply response would basically come as a consequence of better daily care of thecashew trees (e.g., by cleaning of the area around the trees), and the long-run supplyresponse would come from re-planting. Instead of carrying out an empirical estimation ofsupply elasticities, these have been borrowed from several empirical studies analyzingtree crops in several developing countries.51

6.25 Potential Supply Response: If producer prices increased to 50-70 percent of theborder price and the initial production of raw nuts was 35,000 tons, the immediate supplyresponse could be 45-55,000 tons (i.e., additional 10-20,000 tons) in the first two years.After five years, production from existing trees could reach a maximum 65,000 tons. Thisresponse will only be achieved provided that farmers utilize trees that have beenabandoned and take better care of currently underutilized trees while constraints totransport and marketing of nuts are removed. Necessary inputs and extension servicesmust also be available and the terms of trade of inputs versus output must become, andremain, favorable. Assuming replanting of one million trees a year, starting around 1996,farmers could produce an additional 40 to 70,000 tons in twelve to fifteen years.52Production above 130,000 tons would probably require a more ambitious replantingscheme.

50 Those supply elasticity coefficients were selected in consultation with tree crop specialists andempirical economists in the World Bank's International Economics Department.

51 See, for example, Akiyama and Trivedi (1987), Akiyama and Varangis (1990), and Akiyama andColeman (1993).

52 The yield averages used are: 1.5 kg after 4 years, 4.0 kg after 5 years, 7.0 kg after 6 years, 9.0 kgafter 7 years, 12.0 kg after 8 years, and 15.0 kg after 12 to 25 years. This yield average assume goodquality grafted trees.

86

Table 6.6. Hypothetical Supply Response For Raw Nuts - Base Scenario

Thousand tons Export value Farmers' incomel t (million US$) (million US$)................................................ ................................................... .............. ................................. ....................................................

Producer price US$ 0.375/kg - Producer share 50%.... .... .................. .. ................ .. .... .............................................................. ........................ ....

Short-term 46.6 34.9 17.4Medium-term 54.3 40.7 24.5

... .................................................... ........... ....................................................... ..... ............ ........ ....Long-term 96.7 72.5 36.2Producer price US$ 0 45/kg Producer share 60%

ort-term 49.9 37.4 22.4Medium-term 59.9 44.9 29.9

............................................................ ........... ................................ ...................... ...................................................Long-term 114.7 86.0 51.6Pru.cer. price US$ 0 525/kg Producer share 70%

ort-term 53.3 39.9 27.9

Medium-term i 65.5 49.1 i 34.4............................................................ ....................................................... .........................................I............. ........ ......................Long-term . 132.6 99.4 i 69.6

The table assumes an initial production of 35,000 tons of raw nuts. Short-term is immediate supplyresponse (one to two years), medium-term is within 5 years, and long-term is within 10 to 15 years.Elasticitiesforscenario(1)are: 0.15(short-term), 0.25 (medium-term), 0.80(long-term).Source: World Bank 1994

6.26 Foreign Exchange Earnings. Under the fairly conservative supply elasticitiesconsidered here and assuming that the border price for raw nuts remains unchanged indollar terms, Mozambique could substantially increase foreign exchange earnings byexporting raw nuts. A 50 percent producer price share on the border price could lead tomore than double foreign exchange revenues from US$23 million to about US$40-50million within five years, and to about US$100 million in ten to fifteen years (see Table6.4).

6.27 Farmers' Income. Farmers' income could significantly improve from the abovesupply response. Under the current pricing system, farmers receive about US$4.1 millionfor marketing 35 thousand tons of raw nuts. If the producer share became 50 percent,their income could reach US$24 million in five years, six times the level obtained atpresent. Such an increase in income would significantly contribute towards the alleviationof poverty among smallholder farmers in Mozambique, who remain the sole producers ofcashew. Furthermore, the growth of production along with increased income andmultiplier effects could promote stronger employment generation.

6.28 The employment generation and income provided by the cashew processingindustrv is dwarfed by the above. The Monapo factory, for example, which employsabout 1,500 people and processes about 5,000 tons/year of raw cashew, pays only aboutUS$0.5 million in total salaries each year. According to the conservative scenariopresented here, the income increase to farmers in five years of US$20 million (US$24 -US$4.1 million) would be sufficient to pay the equivalent of about 60,000 factory workersalaries (compared with about 8,000 factory workers currently in the payroll).

87

Exporting the Processed Product

6.29 While Mozambican factories currently employing mechanized methods would notbe able to survive under a liberalized trade regime, there is no reason to assume that amore efficient industry could not be established in the short to medium term. In fact,since most factories are either in the process of being privatized or rehabilitated,Mozambique has a unique opportunity to make such a transition without incurring highcosts. Among the options to be explored by private sector cashew processing entrants inMozambique, would be the feasibility of moving from the current high-cost, low-yield,capital intensive processing techniques to small-scale, semi-mechanized processingtechnologies similar to those employed in Brazil, or manual methods, such as hand-shelling, currently used in India. While it is important to minimize the cost of processingraw nuts in Mozambique, this approach must be subject to maximizing kernel yield andthe share of whole kernels obtained.

6.30 This view is shared by many firms. For example, Entreposto is exploringpossibilities of using less mechanized processing methods fully, or in part, to improve theefficiency of its factories. In addition to Monapo, Entreposto owns two other factories inNampula (in Nacala and Angoche) that have not been operational and are currently underrehabilitation. These factories, both of which are highly mechanized, could each have aprocessing capacity of 5,000 to 10,000 tons/year of raw nuts. The management of Cajude Mo,ambique was also reportedly exploring the feasibility of introducing less capitalintensive processing technologies like, for example, the 'steam heated cutting process'which is a combination of Indian and Brazilian processing methods. This processingmethod would require a substantial investment in the training of labor, but only aminimal investment in machinery. Joao Ferreira dos Santos has decided to startprocessing in the 1994/95 season using manual processing methods. The JFS factory willbe located in Angoche; its processing capacity is expected to be 5,000 tons/year.5 3

6.31 As indicated earlier, a substantial supply response could be realized in theshort/medium-term by liberalizing the export of raw nuts. If more labor intensivetechnologies like those used in India or Brazil were adopted by the private sector, itwould also be possible to substantially increase the value of the finished product (seeTable 6.8). Full liberalization of raw nuts exports could result in a lower border price dueto India's current monopsony situation. Technical transfer would, however, reduce thisrisk since the entry cost of manual processing is low. Also, alternative buyers of rawcashew are emerging (for example, in South East Asia).

Anglo American Farms Limited, a South African concern, is also considering the rehabilitation of afactory in Xai-Xai in Gaza (which belonged to Caju de Mocambique) but using Oltremaretechnology. The Xai-Xai factory would have a processing capacity of 8,000 tons/year.

88

Table 6.7. Value of Cashew Kernel Using Different - Processing Methods(Product base is 35, 000 tons of raw cashew)

Tons of kernel (= base Average unit Total valueamount/raw nut value - raw nut (million US$)

conversion factor) equivalentMozambique 8,900 = (35,000/5.6) 656 23.0

... ............................................................................................................................................Tanzania 9,450 = (35,000/5.3) 782 . 27.4

................................ ......................................................... ................... .........................................................................Brazil 11,111 = (35,000/4 5) 984 34.4

India 12,000 = (35,000/4.17) 1222 42.8

Source: World Bank 1994

6.32 As shown in Table 6.7, should the performance of Mozambique's factories reachthe level in Tanzania, export earnings could increase to US$27.4 million (assuming35,000 tons of raw product). If the Brazilian methods were adopted, total export valuewould become US$34.4 million. If the Indian methods were adopted, the value of exportearnings would go to about US$43 million. The higher raw nut equivalent obtained byusing different processing technologies would create additional scope to increase farmers'income substantially. This would promote smallholder income and alleviate poverty,increase foreign exchange earnings, and contribute to the overall growth ofMozambique's economy.

Table 6.8. Hypothetical Supply Response For Raw Nuts - Base ScenarioExport value of raw nuts versus export value of kernel using Indian technology

Export value - Kernel-Export value - raw Indian technology

Thousand tons nuts (million US$) (million US$)Producer Price US$ 0.375/kg - Producer share 50%

............................................................................................................................................................................................................................Short-term 46.6 34.9 56.8Medium-term. 54.3 40.7 66.2

......................................................... ....................................................... ....................................................... .......................................................Long-ter n 96.7 72.5 118.0.......................................................................................................................................................................... ........................ ................

Producer Price US$ 0.45/kg - Producer share 60%............................................................................................................................................................................................................................

Short-tern 49.9 37.4 60.8.................................................................. .........................................................................Medium-term 59.9 44.9 73.1Long-term 114.7 86.0 139.9

....................................................... ....................................................... ....................................................... .......................................................Producer Price US$ 0.525/kg - Producer share 70% .Short-term 53.3 39.9 64.9Medium-term 65.5 49.1 79.9Long-term . 132.6 99.4 161.7The Table assumes initial production of 35 thousand tons of raw cashew. Short-term is immediate supplyresponse (one to two years), medium-term is within 5 years, and long-term is within 10 to 15 years.Elasticities for scenario (I) are: 0.15 (short-term), 0.25 .(medium-term), 0.80 (long-term).Source: World Bank 1994

6.33 If Mozambique could simultaneously achieve the supply response shown inTable 6.6 and employ a technology similar to the Indian technology, the total exportvalue (assuming 50-70 a percent producer price share and the conservative supplyelasticities of the base scenario), could increase to US$66-73 million in five years and

89

US$118-162 million (more than Mozambique's total foreign exchange revenues today)within ten to fifteen years (see Table 6.8).

SUMMARY AND RECOMMENDATIONS

6.34 Exports of raw nuts from Mozambique have been restricted for many years toensure cheap supplies to domestic processing factories. Such restrictions have supporteda non-viable processing industry. Smallholder farmers have been taxed through lowproducer prices and reduced income and the whole nation has been taxed through lowereconomic growth, reduced foreign exchange revenues, and slower employmentgeneration.

6.35 Overall liberalization of the cashew sub-sector should take place and thepossibility to export raw nuts should be opened and remain unrestricted. The traderlicensing system should be abolished. Competition in trade should be promoted, byproviding credit to retailers who should be allowed to export raw cashew directly.Competition among traders, especially wholesalers, would result in lower trader marginsand higher producer prices.

6.36 Value added has, in recent years, been either marginal or negative for the cashewindustry in Mozambique because of the use of high cost, low-yield technologies. Thisnot only means that the total processing costs (other than the purchase of raw cashew) isbeing wasted, it also means that the value of the processed kernels is less than the valueof the raw nuts exports. Thus, cashew processing is at present a foreign exchange loserindustry in Mozambique.

6.37 Increased value by adopting semi-mechanized or manual processing methodscould increase total foreign exchange revenues significantly and also increase farmersincome further due to higher value raw nut equivalent. If Mozambique could, forexample, simultaneously achieve the supply response shown in the base scenario andemploy a technology similar to the Indian technology, the total export value (assuming a50-70 percent producer price share), could increase from US$23 million to US$66-73million in five years and US$118-162 million within ten to fifteen years.

6.38 The adoption of more labor intensive technologies could gradually create manymore jobs than are present in the current highly mechanized factories. Introduction ofless capital-intensive processing technologies should be demand rather than supply drivenand should be acquired through private sector entry only. In the short term however itmay be beneficial to promote the introduction and establishment of infant cashewprocessing industries in Mozambique that utilize new technology. The feasibility andbenefit of administering a temporary, low export tax on raw cashew nut for such apurpose should be examined. While the guiding concern should be to protect priceincentives for the farmer, initially the imposition of a low export tax on raw nuts will notresult in lowering current producer incentives given the large concurrent producer priceincreases that would be associated with the liberalization of cashew export. Any suchtemporary export tax should be phased out quickly over a period of three years or so.

ANNEXES

ANNEX I

MPEDIMENTS TO INDUSTRIAL SECTOR RECOVERY,ompanies interviewed by mission with summary assessments

Majority Percentcapacity

Company Sector Main products ownership utilization Brief summary of company situation

1 Belita Textiles / Shirts, trousers State 0% In privatization limbo. Firm is paralyzedgarments because of this by lack of access to credit and

foreign orders. Complete lack of workingcapital. Unable to produce for domestic marketdue to cheap imports entering country withoutpaying duties and taxes.

2 Caju de Moc., Food processing Cashew nuts and State 5% Very capital intensive technology, inefficientMachava oil management. To be privatized in late '94.

3 Celmoq Machinery / Electric cables Private 20% Technically good. Modern machinery, goodmetallic products staff and management. Low production due to

low domestic demand and competing importsnot paying duties and taxes. Is consideringexportina to RSA.

4 Ceres Food processing Cookies and State (private 50% Need some rehabilitation and financing for rawpasta management) materials. To be privatized in late '94.

5 Cicomo Textiles / Sisal rope Private 30% Needs cheaper working capital (i.e. loaned on $(Quimigal) garments terms) to increase production. Exports to

Europe. Negatively affected by hurricaneNadia.

6 CIM Food processing Milled grain State 10% Poor management, plant in need of majorproducts rehabilitation. In privatization limbo.

7 CIMA Textiles I Fishing nets State 25% Low demand in local market is primary reasongarments for low production.

8 Cimentos de Non-metallic Cement State n/a Poor management and technical ability haveMocambique minerals & glass limited production and raised costs of

production such that they are not competitive.To be privatized in July 1994.

9 Cometal Machinery I Railway cars, State 25% Good facilities. Management inexperienced.metallic products road trailers, Duties and lack of functioning draw back

metal tanks scheme on inputs make them less competitive.In privatization process.

10 Comp. Caju Food processing Cashews Private n/a Only cashew nut processing plant operating inMonapo, SARL country.

11 Comp. J.F. dos Variety of Cotton, cashews Private n/a lnteiview centered around import and exportSantos industries only.

12 Comp. Machinery I Private nla Interview centered around import and exportSiderurgica Moc. metallic products only

13 Crown Cork Machinery I Bottle caps Private n/a Recently privatized. Delays in process aremetallic products preventing more rapid rehabilitation.

14 CT Pungue Rubber and Polypropylene Private 10% Low domestic demand due to low production of(Quimigal) plastic bags agricultural products. Must compete against

bags that come with food aid. Working capitalproblems + low utilization rates put companyat cost disadvantage.

Page A - I

ANNEX I

IMPEDIMENTS TO INDUSTRIAL SECTOR RECOVERYCompanies interviewed by mission with summary assessments

Majority Percentcapacity

Company Sector Main products ownership utilization Brief summary of company situation

15 EMMA Textiles / Knit fabrics and State 10% In privatization limbo. Firm is paralyzedgarments garments because of this by lack of access to credit and

foreign orders. Complete lack of workingcapital. Cannot sell products in the domesticmarket as unable to compete against cheapimports that don't pay taxes.

16 Entreposto Textiles / Pressed cotton Private n/a Operating profitably. Indicate need for the(cotton) garments Government to better promote cotton growing

(extension services, etc.).17 Emplama Rubber and Molded plastic State 30% Good technical staff, but poor management.

plastic products Low yields of products. Little competition fromimports. In privatization limbo. Should be soldas 5 separate plants. In need of smallinvestment for spare Darts.

18 Fab. de Cober. Textiles / Blankets Private 30% Low domestic demand. Main competition isR.K. garments from donated blankets purchased outside

Mozambique by donors and given out free tothe population.

19 Fabrica de Beverages Beer State 40% Poor management, need for minorCerveja, Mac rehabilitation. In privatization limbo. DifficultMahon to get raw materials as banks won't lend

money. Have had problems accessing forex.

20 Fabrica de Machinery / Bicycles Private 9% Face problems caused by delays in gettingBicicletas metallic products forex. Lack of workable duty drawback

scheme does not allow them to export toneighboring country. Completed imports notpaying duties also hurts them.

21 Fabrica de Textiles / Garment Private 30% Access to cheap working capital (i.e. on US$Confeccoes garments assembly terms) and simplified import/export proceduresNinita would go a long way to help this company.

Cannot produce for domestic market as cannotcompete against completed product imports notpaying duties and taxes.

22 Fabrica de Textiles / Socks State 0% In privatization limbo. Firm is paralyzed withPeugas garments complete lack of working capital. Financial

situation resulted from canceled order forformer USSR. Firm could otherwise operateprof itably.

23 Fasol/Saborel Food processing Edible oils, soaps State 0% In need of major rehabilitation. Some goodwarehouse space available. Poor management.Lack of access to credit as in privatizationlimbo.

24 Fibraglass Rubber and Polyurethane Private 30% New operation. Mgmt eager to prosper.Sundlet Moc. plastic foam, mattresses, Competition from illegal imports and reduced

cushions domestic demand from government is reasonfor low production. Competing imports don'tpay duties and taxes. Could be competitive.

Page A - 2

ANNEX I

\/PEDIMENTS TO INDUSTRIAL SECTOR RECOVERY:ompanies interviewed by mission with summary assessments

Majority PercentMajority ~~capacityCompany Sector Main products ownership utilization Brief summary of company situation

25 Forjadora Machinery / Metal trailers, Private n/a Just privatized and in process of rehabilitating.metallic products large truck trailers Concern over finished imports from RSA not

paying duties and taxes and receiving exportsubsidy.

26 GEMP Textiles / Shirts Private n/a Have shortage of working capital to financegarments exports. Need functioning duty free

importation of raw materials for export. Cannotcompete in domestic market against cheapimports that don't pay duties and taxes.

27 IMA Machinery / Metal roofing Private 9% Good facilities. Committed and innovativemetallic products sheets, metal mgmt. Competition from imports not paying

piping duties and taxes combined with lower domesticdemand have negatively affected IMA.

28 INAL Wood & Private n/a Interview centered around import and exportfurniture only

29 Lomaco - Textiles / Processed cotton Private 40% Operating profitably. Low production due toMontepuez garments low amount of raw cotton available.(cotton)

30 Lusalite Non-metallic Asbestos cement Private 17% Good equipment, staff, & mgmt. Low domesticminerals & glass roofing materials demand and donors buying products from

and water tanks Zimbabwe (no duties paid but their productmust pay duties and taxes making them non-competitive for these buyers).

31 Mabor Rubber and Tires, inner tubes State (private 65% Good mgmt. Well run with good training ofplastic management) locals. Lack of effective duty draw back

scheme makes export difficult. Imports comeinto country without paying duties and taxes.Could be competitive otherwise.

32 Madal Food processing Copra, margarine, Private n/a Currently rehabilitating operations withbeef, fish, other IDA/IERP funds. Margarine production facesagro-industry imports that don't pay duties.

33 Madeiras de Wood & Wood - ebony Private n/a Privatized 1 yr ago. Since privatization quotaCabo Delgado furniture and rosewood of wood reduced by gov't so unable to(Socimo) rehabilitate company. Lacking tractors and

trucks to transport wood from forest. Sawmillokay. _ _ _ _ _ _ _ _ _ _

34 Magim Textiles / Shirts, trousers, Private 40% Import/export paperwork complicates ability toConfeicoes garments uniforms bring in goods without paying duty that are to

be exported. Unable to compete in domesticmarket against cheap imports that do not payduties and taxes.

35 Maler Textiles / Leather shoes Private 0% Plant closed down as could not compete withgarments imports coming into country that did not pay

duties and taxes. Still has 77 workers.36 Marmont Non-metallic Marble mining State (private n/a Low world demand and high transport costs

minerals & glass and processing management) keep production down. Processing plant isoverdesigned. Built with Italian aid for $18million. To be privatized.

Page A - 3

ANNEX I

IMPEDIMENTS TO INDUSTRIAL SECTOR RECOVERYCompanies interviewed by mission with summary assessments

Majority P:iercent

Company Sector Main products ownership utilization Brief summary of company situation

37 Mobeira Food processing Milled grain State 63% Irregular raw material supplies from donors.products Need some funds for rehabilitation. In

privatization limbo.38 Moc. Produtora Rubber & Bic pens, erasers, Private 17% Imports entering country without paying duties

(Modil) Plastics other plastic and taxes are undercutting their prices.school products Production is down due to these imports.

39 Mogas Chemical Industrial gases Private 25% Old but good equip. Good mgmt. Lowproduction due to slow economy for gasproducts. Imports not paying duties and taxeson welding rods dampens demand. Road taxon diesel used to produce C02 makes it lesscompetitive.

40 Moc. Industrial - Food processing Edible oils, soaps Private 70% Excellent facilities and mgmt. Soap importsBeira that don't pay duty and taxes are undercutting

their price. Could compete if no negativeprotection.

41 OTEX Textiles / Trousers, shirts, Private 15% High levels of indirect taxation make competinggarments uniforms on domestic market impossible. Difficult

import/export procedures & customs clearance.Since exporting would like to see loans tied toUS$.

42 Prosul Non-metallic Umbrellas and State n/a Imports that don't pay duties and taxes areminerals & glass brooms undercutting production. Lack of working duty

drawback scheme limits ability to export.

43 Protal Food processing Sweetened Private n/a Competing with illegal imports. Due to recentlycondensed milk, enacted lower duties on finished products fromcheese RSA, at cost disadvantage and find hard to

compete.44 Riopele Textiles / Cloth Private 4% Old debts and high inventory of finished

garments products due to canceled order with formerUSSR have contributed to high productioncosts. Produce quality material. Imports w/oduties and taxes make it difficult to compete.

45 S.A.T. Tobacco Cigarettes Private 15% Very well established. Good mgmt. Importsavoiding the 150% excise tax does not allowthem to compete effectively. Some of theseimports also get 20% export subsidy from RSA.

46 S.U.T. Tobacco Cigarettes Private 10% Very well established. Good mgmt. Importsavoiding the 150% excise tax does not allowthem to compete effectively. Some of theseimports also get 20% export subsidy from RSA.

47 SIPEL (Modil) Machinery / Lighting fixtures Private 20% Completed imports entering country withoutmetallic products paying duties and taxes are undercutting their

prices. Production is down due to negativeprotecton. __ -

Page A - 4

ANNEX I

IMPEDIMENTS TO INDUSTRIAL SECTOR RECOVERYCompanies interviewed by mission with summary assessments

Majority Percentcapacity

Company Sector Main products ownership utilization Brief summary of company situation

48 Soberana Textiles / Shirts, trousers Private 25% In privatization limbo. Firm is paralyzedgarments because of this by lack of access to credit and

foreign orders. Were unable to compete indomestic market against cheap imports whichdonp-ay duties and taxes.

49 Sociedade Food Processing Sugar State (private 33% Questionable economic viability. Need $50Agricola do management) million for rehabilitation of transportation andlncomati irrigation equipment. Turned over 51% of

company to state to become eligible for Kuwaitfund. Not received vet.

50 Sogere Beverages Soft drinks, beer State n/a State holding company for all state owned soft-drink and beer factories. Poor management,high debts, and lack of access to credit haveparalyzed this company. Major assets are beingprivatized.

51 Sosun Beverages Soft drinks Private 65% Was state owned, but privatized. Just started.Despite duties are able to produce at lower costthan imports not paying duties and taxes due totransportation costs. Trouble getting goodquality bottles and crates from state owned

___S1_`_rt_s _ suppliers.52 Soveste Textiles / Shirts, trousers State 0% In privatization limbo. Firm is paralyzed

garments because of this by lack of access to credit andforeign orders. Currently not operating. Wasunable to compete against cheap imports thatdo not ay duties and taxes.

53 Texlom Textiles / Fabrics, State (private 30% Negative protection from imports not payinggarments capulanas management) duties is limiting demand for their production.

Lack of working capital also a major problem.

54 Texmanta Textiles / Blankets State (private 10% Low domestic demand. Main competition isgarments management) from donated blankets purchased outside

Mozambique by donors and given out free tothe population.

55 Texmoque Textiles / Fabric Private 0% Cheaper imported goods that don't pay dutiesgarments and taxes undercut their sales. Local cotton

price have been described as too high. Ownersindicated ability to make multi-million $investments if didn't face problem of negativeprotectionr.

56 Textafrica Textiles / Cotton cloth, Private 0% Old, but good facilities. Good staff and mgmt.garments blankets Owners indicated ability to make multi-million $

investments if didn't face problem of negativeprotection resulting from cheap imports not

-_ ________________________________________ p aying taxes and duties.57 Tintas Berger Chemicals Premium and low Private 22% Excellent & innovative mgmt. Good facilities.

end paints Competition from imported paints not payingduties and taxes is hurting premium paint sales.Low end paint is made from all local materialsand is doing well. Expected to grow rapidlyand possibly export.

Page A - 5

ANNEX I

IMPEDIMENTS TO INDUSTRIAL SECTOR RECOVERYCompanies interviewed by mission with summary assessments

Majority c:nl

Company Sector Main products ownership utilization Brief summary of company situation

58 Tudor Machinery / Dry cell batteries, Private 20% Good facilities and mgmt. Dry cell productionmetallic products car batteries facing negative protection from Chinese

batteries not paying duties or taxes. Carbatteries facing competition from South Africanbatteries getting 20% exoort subsidy.

59 Vestafrica Textiles / Shirts, trousers Private 10% Non-functioning duty drawback schemes makegarments export operation difficult. Could compete

otherwise. Cannot supply to domestic marketas difficult to compete against cheap importsthat don't pay duties or taxes.

60 Vidreira Non-metallic Glass bottles and State 29% Good technical staff. Poor mgmt. In need ofminerals & glass glass domestic major rehabilitation - $10 million. Past rehab

items (plates, oil financed with Italian aid Poor quality productionlamps) and in danger of losing biggest account (Coke)

due to this. Could export more to RSA ifproduction higher.

Page A - 6

ANNEX 2Attachment to Chapter 2

PROPOSALS REGARDING PRESHIPMENT INSPECTION CONTRACT RENEWAL

BACKGROUND

Mozambique's preshipment inspection (PSI) contract with SGS expires in October,1994. The following proposals regarding elements of a new contract focus on particular aspectsof PSI arrangements which are essential to the proper functioning of the service in Mozambique.They are designed to rectify shortcomings in the current system, which have allowed significantrevenue shortfalls and inefficiencies in Customs to co-exist with preshipment inspection. Thechanges proposed affect both the operating procedures of the PSI company, and of Customs.

These proposals focus primarily on those aspects of the contract relating directly torequirements and procedures that will ensure the efficient delivery of PSI services and theappropriate use by Customs of information generated by the PSI company. Other legal andinstitutional provisions of the contract are not addressed here, unless they also appear to bemissing or deficient under the present contract. The proposals made here are not drafted informal legal language, and explanations are sometimes included alongside the proposedprovisions. In certain cases, additional explanatory notes have also been provided. It isrecommended that the contract features specified below be integrated into the main contract,which could be based on the 1989 contract between SGS and the Government of Mozambique,as amended by the 1991 supplemental agreement (i.e. the present contract).

It is further recommended that the duration of the new contract be three years, and thatno provision be included for the automatic extension of the three-year period. I Thisarrangement will remove the presumption, implicit in the current automatic extension clause,that the same PSI company will continue indefinitely to supply the service. Instead, it should beassumed that the contract will be put out to competitive tender after the three year period.Indeed, the Government of Mozambique needs to decide whether to issue a tender for the 1994contract renewal, or whether to negotiate only with SGS on this occasion, and then put futurerenewals out to tender. There is enough time between now and October 1994 to issue a tenderand evaluate bids, if the government so wishes. Periodic open tendering for PSI services is themechanism most likely to induce competitive behavior and efficient service delivery by theincumbent PSI company.

It is strongly recommended that the idea of splitting the contract between two companiesbe discarded, for the following reasons:

I Under present arrangements, the contract is automatically extended unless either party gives notice to thecontrary six months prior the expiration of the current contract period.

A2 -2

i) Geographical splits are unlikely to engender greater competition, since they do littlemore than replicate the operating conditions within each geographical area that wouldprevail under a single contract.

ii) The national Customs authorities will find it easier to establish an efficient workingrelationship, with lower transactions costs, if they only need to deal with one company.

iii) The ex post reconciliation function and other reporting and data generationresponsibilities of the PSI company will be more straightforward, and easier forgovernment authorities to respond to, if only a single company is reporting.

iv) Split contracts lower business volumes for individual firms and increase the cost ofthe service.

SPECIFIC CONTRACTUAL PROPOSALS

1. Treatment of BRIs

a. The PSI company will receive copies of all BRIs from the Ministry of Commerce assoon as they have been issued.

b. The PSI company will use the information contained in the BRls to trigger inspectionorders in their affiliate offices where PSI (complete or basic) is required.

c. The PSI company will verify that all BRIs in respect of which a PSI exemption hasbeen granted qualify for such exemption in accordance with the criteria for exemptionsestablished under the PSI contract (according to annexed list). Similarly, the PSIcompany will verify that designation for either complete or partial inspection conformsto established criteria. Any apparent anomaly with respect to eligibility for exemption ortype of PSI (complete or basic) will be referred back to the Ministry of Commerce forclarification prior to the issuing of an inspection order, and the Ministry of Commercewill promptly clarify the matter and adjust the BRI as required.

d. Importers entitled to duty exemptions will indicate the relevant entitlements on theirBRIs. The PSI company will be furnished separately with information on dutyexemption entitlements, and will check this information against that provided in theBRIs. Any apparent anomalies will be checked with the government agency responsiblefor granting the exemption, and any necessary adjustments to the BRI will be made.

e. In order to avoid unjustified exemptions from PSI, and to facilitate the process oftracking BRIs, all BRIs should be color-coded or otherwise pre-marked according to PSIrequirements, and sequentially numbered. Non-sequential numbering and the use of an

A2 - 3

ink stamp to indicate status with respect to PSI requirements has led to complications intracking and verifying the accuracy of BRIs.

[Explanation: Proper management of BRIs is essential to ensure that no imports subject to PSIescape the requirement at the start of the import process. There should be no discretionaryelement in regard to PSI, and all exemptions must be specified in the PSI contract. In additionto supporting these objectives, the PSI company will be required to monitor importer behaviorin relation to the exemption threshold (US.$ 5,000). so as to guard against consignmentsplitting and gross undervaluation. However, it will be more efficient for the PSI company tofulfill these functions in the context of the ex post reconciliation exercise described below. Theinclusion of information about duty exemptions on the BRIs will assist in the effectivemonitoring of exemptions and make it easier for the PSI company to calculate duty exemptionscorrectly on the CRFs (see below).]

2. PSI. and the content and delivery of PSI documentation

a. The PSI company must carry out the inspection within at most one week of beingrequested to do so. If a physical inspection proves satisfactory and the price verificationdoes not reveal any discrepancy, the CRF must be issued within forty-eight hours of theinspection. In the event that a physical inspection proves unsatisfactory, or the priceverification reveals a discrepancy, the CRF must be issued within forty-eight hours afterthe matter has been resolved, or in the case of under-invoicing, forty-eight hours after thesupplier has been given an opportunity to challenge a price uplift for Customs dutypurposes. If a supplier fails to convince the PSI company that the intended price uplift isunwarranted, the PSI company will nevertheless issue a CRF with its price uplift. Ifagreement cannot be reached in respect of an alleged physical discrepancy or over-invoicing, the PSI company will issue a non-negotiable report of findings and the goodsin question shall not be imported into Mozambique.

b. In order to shorten PSI processing times to the maximum extent possible, the PSIcompany will use electronic data interchange (EDI) and/or fax in communications withits affiliates.

c. The PSI company must always be able to guarantee delivery of a CRF or some otherprovisional clearance document when goods are ready for clearance at destination. Sincethis requirement may sometimes cause problems in respect of imports originating inneighboring countries and consignments arriving by air, special arrangements should bemade in respect of these goods. In addition to making every effort to ensure the speedycompletion of PSI procedures, both the PSI company and importers should impress uponsuppliers the importance of delivering a copy of the final invoice to the PSI company assoon as possible following satisfactory preshipment inspection. As an additional meansof accelerating the process, the PSI company may forego the proof of shipmentrequirement for issuing a CRF. The revenue risk of this approach will be minimal, since

A2 - 4

any consignment in respect of which a CRF has been issued, but which is subsequentlynot cleared through Customs with that CRF, will be identified through the ex postreconciliation exercise.

d. In addition to the above measures, the PSI company should, in consultation with thegovernment, choose one of the following procedures for ensuring that the clearance ofneighbor-country and air freighted imports is not delayed by the late arrival of the CRF:

i) The PSI company should issue a provisional CRF to any importer or his agentin respect of goods ready for clearance, but for which the CRF is not yetavailable. The provisional CRF should specify the importer's tax liability on thebasis of the best information available. The PSI company should issue thisprovisional document within six working hours of a request. Any importerrequesting a provisional CRF must subsequently collect the final CRF, present itto Customs for stamping, and settle any outstanding tax liability. If taxes wereoverpaid on the provisional CRF, Customs would issue the importer with a creditfor the amount of overpayment. The importer must furnish the PSI companywith a copy of the final dispatch stamped by Customs, indicating that clearanceagainst the final CRF has been completed. The PSI company will not issue anyfurther inspection orders on BRIs for importers who have used provisionalclearance documents on previous shipments and failed subsequently to submitfinal documents.

ii) The PSI company could modify inspection procedures such that the finalinvoice could double as the CRF and travel with the consignment. Under thisarrangement, the inspector would take the result of the preliminary priceverification to the inspection site. If no quantity or quality discrepancies weredetected, the inspector would transform the pro forma invoice into the finalinvoice, affix a fraud-resistant label to the document, and allow the importer topresent this to Mozambican Customs as both the final invoice and the cleanreport of findings. The security of this arrangement will be assured if aneffective ex post reconciliation system is in place.

e. The PSI company must be able to supply importers or their agents with CRFs at themain points of entry into Mozambique. For this purpose, the PSI company mustestablish offices in Maputo, Beira, Nacala and Quelimane.

f. The assessment of taxes due on CRFs will be net of exemptions. The PSI companymust be supplied the necessary information on entitlement to exemptions, which willhave already been checked against duty exemption entitlements indicated on importlicenses (BRIs).

A2 - 5

[Explanation: PSI documentation needs to be available to traders at the earliest opportunity,and no later than when goods are ready for clearance at the port of destination. The time limitson carrying out inspections and issuing CRFs should be seen as maximum times, and the PSIcompany should endeavor to better them. All data relating to PSI processing times will bereported to the principal on a regular basis (see below). The use of EDI andfax should speedup document delivery. The special procedures for ensuring the timely arrival of CRFs for goodsfrom neighboring countries and goods arriving by air are essential if Customs are to use CRFsproperly and PSI is not to be a barrier to trade. The requirement that the PSI company musttake account of all official exemptions in estimating the tax liability recorded in the CRF is anessential part of overall fiscal control, and will also provide the necessary data for monitoringand analyzing the exemptions regime. It requires, however, that the PSI company be suppliedwith the necessary information on exemptions, and that the exemption regime is clearly specifiedand devoid of discretionary elements.]

3. Use of CRFs by Customs

a. Imports subject to PSI should not, in any circumstances, be cleared by Customswithout a CRF, of (if appropriate) a provisional clean report of findings.

b. The Customs authorities shall not modify the value or Customs classification recordedby the PSI company on the clean report of findings.

c. Importers are to be actively discouraged from shipping non-exempted goods toMozambique that have not undergone preshipment inspection. Any goods that do arrivewithout PSI will be subject to a destination inspection, and in addition to all duties andtaxes due, will be required to pay for the inspection, and will be subject to a fine of 30percent of the value of the goods involved.

[Explanation: If Customs continue to clear goods without CRFs, the PSI system will not work.Until the situation improves in Customs, PSI valuation and classification decisions should notbe challenged by Customs. If, after Customs training and reform have progressed satisfactorily,it is decided that Customs should be empowered to make such challenges, it will be essential toestablish clear procedures for altering PSI company decisions. If discretionary elements areallowed to enter the picture here, it will make ex post reconciliation more complicated and lesseffective. Importers will have the right to challenge PSI valuation and classification decisionsthrough the appeals procedures set out below. Destination inspections should be regarded asexceptional, and if a 30 percent fine does not prove a sufficient disincentive for importers, thepenalty for failing to submit to PSI in the country of export should be increased]

A2 - 6

4. Ex post reconciliation

a. The Customs authorities must promptly supply the PSI company with copies of allimport dispatches, including those relating to goods not subject to preshipmentinspection.

b. The PSI company will undertake the following reconciliation steps:

i) Match all import dispatches and CRFs, with reference to CRF numbers (whichmust appear on dispatches), tariff classification, valuation, and duties and taxesdue (as recorded on the CRF and indicated as having been paid on the importdispatch). For the last of these, the PSI company will require information on theexchange rate used by Customs in order to specify the tax liability in localcurrency. This exercise will identify all anomalies between CRFs and importdispatches.

ii) Identify chronologically all CRFs issued which cannot be matched withimport dispatches. After a certain interval (two or three months), theseunrequited CRFs should be investigated to establish whether importation actuallyoccurred.

iii) Identify chronologically all BRIs in respect of which inspection orders weretriggered, but for which no inspection occurred. This information will be used toestablish whether importation occurred without preshipment inspection.

iv) Identify all import dispatches unmatched with CRFs where PSI shouldseemingly have taken place. This information will help detect certain kinds ofconsignment splitting and any other instances in which PSI has beencircumvented.

v) Identify the aggregate amount of revenue that should have been paid over tothe Ministry of Finance on all imports recorded in the reporting period, includingthose not subject to preshipment inspection.

vi) Monitor imports for signs of consignment splitting (which aims to circumventpreshipment inspection by declaring goods to have a value of less than US$5,000). An examination of import dispatches issued without CRFs (see point iv)above) and/or of unrequited CRFs (see point ii) above) should revealconsignment splitting involving partial shipments of larger items identified onimport licenses (BRIs). A second kind of consignment splitting that requiresmonitoring is that involving the establishment of multiple BRIs for the sameproduct, each with a value of less than US 5,000 dollars. In general, prima facieevidence of consignment splitting would be successive imports of the same

A2 - 7

goods by the same importer from the same supplier at values below the thresholdlevel.

vii) Monitor imports valued at less than the PSI threshold level for any evidenceof undervaluation.

c. The PSI company will submit reconciliation reports on a monthly basis, containing allthe above information to the Minister of Commerce, the Minister of Finance, and theNational Director of Customs.

d. The PSI company will train the relevant officials, selected by the Governnent ofMozambique, in how to interpret and use the information contained in the monthlyreconciliation reports. This will facilitate the necessary follow-up by governmnent ofanomalies and tax payment shortfalls revealed by the reconciliation report.

[Explanation. The ex post reconciliation exercise is at the heart of an effective PSI service. It isessential that Customs cooperates fully by promptly supplying the PSI company with copies ofall import dispatches, that the PSI company is diligent in the performance of the monthlyreconciliation, and that the government demonstrates the necessary political will to follow up onall tax delinquents and to apply the full force of the law. Once the government publiclydemonstrates a willingness to do this, importers and tax collection officials are likely to modifytheir behavior. The purpose of the contractual requirement of the PSI company to submit itsreconciliation reports to different branches of government is to ensure transparency, and tomaximize the likelihood that follow-up action will be taken.]

5. Trade facilitation

a. The PSI company will be required to seal all full container loads (FCLs) shipped toMozambique, having witnessed their stuffing at the point of embarkation.

b. The Customs authorities will permit sealed containers to pass unhindered andunopened through Customs, unless:

i) The PSI company seal is broken or missing;

ii) The seal does not match the seal number recorded on the CRF;

iii) Customs has received intelligence suggesting irregularities from a sourcesuch as the PSI company or another Customs administration;

iv) There is evidence that the seal or the container has been tampered with.

A2 - 8

c. If the Customs authorities do open a sealed FCL, this must be done in the presence ofrepresentatives of the PSI company, in order to ensure that the PSI company can acceptliability if appropriate, and also to ensure that the PSI company can use availableevidence to undertake any internal investigation that might be necessary.

6. Appeals and complaints procedures

a. The authorities will establish an inter-agency Appeals and Complaints Committee tohear appeals from importers on any valuation or classification decisions of the PSIcompany, and to hear any complaints from importers regarding any aspect of theperformance of the PSI contract by the PSI company.

b. Before lodging a formal appeal or complaint in writing, importers must attempt tosettle the matter directly with the PSI company. It would be hoped that many grievancescould be settled informally.

c. The secretariat of the Committee (located in the Ministry of Finance or the Ministry ofCommerce) would register all appeals and complaints filed, distribute relevant materialto Committee members, set meeting times, and service meetings.

d. While an appeal on valuation or classification is being processed, the importer will beallowed to clear the relevant goods against provisional payment of the duties and taxesassessed by the PSI company.

e. The Committee would be comprised of a representative from the Ministry of Finance,the Ministry of Commerce, Customs, and the private sector. The PSI company would siton the Committee, but would not participate in its decisions. The Committee's decisionswould be binding, and would be made public.

[Explanation: An appeals and complaints procedure for PSI would promote fairness,transparency and uniformity of treatment. It would also ensure that the PSI company is heldaccountable for its decisions and actions on a continuing basis.]

7. Reporting

a. The reporting responsibilities of the PSI company should include the following:

i) Monthly reports

- Inspection activity and results;- Reconciliation report, as described in point 4. above;- Inconsistencies and irregularities detected on BRIs;- Tracking data, reporting on PSI processing times;

A2 - 9

- Record of provisional CRFs issued and outstanding.

ii) Quarterly reports

- Summary and analysis of duty exemptions granted;- Import statistics, including PSI-exempt imports;- Repatriatable commissions.

b. The PSI company will also stand ready to undertake additional statistical analysis andreporting at the request of the principal.

c. The above reports will be summarized and consolidated in an annual report.

8. Training

a. The PSI company will undertake training activities, providing one-week courses eachyear of the contract for 15-20 individuals on the following subjects:

- PSI techniques;- Classification;- Risk management and profiling;- Intelligence and investigation techniques;- Enforcement;- Surveillance escorting techniques;- Customs middle management training.

9. Dissemination of information

a. The PSI company will publish detailed instructions for exporters and importers on PSIprocedures and requirements. The company will also organize periodic meetingsthrough private sector organizations at which information on the PSI process will bedisseminated.

10. Consistency with international obligations

a. The PSI company will commit itself to act in a manner fully consistent with theobligations assumed by Mozambique under the Agreement on Preshipment Inspectionnegotiated in the Uruguay Round.

IBRD 272926 ZAIRE A.\

o t I( TANZANIA P

ANGOAT Poa m

SBIE; . ZIMsEUI:9; '( MADSUR )' - '> > ' - Mueda0

_ CGSZID CABO

DELGADO

________________ _ - . ( PEMBA

MALAWI ! LICHINGANIASSA Moniepuez ±

ZAMBIA Lilongw\

~~~ \ \ \ \ - ~~~~~~~~~~~~~~~~~~Nacala.r \ X . ~~~~~~NAMPVA°

TL - PULA Mocombique

fOSongo Molocue

( t ZAMBEZIA,

g , \> g ~~~~MocuboTo Horore

Harore )MANC' Coia,g ' ~~~~~~~)v.AI4 0 QUELIMANE

MOZAMBIQUE+ r - ~~Gorongos

ZIMBABWE Goronoso 1IMPEDIMENTS TO INDUSTRIALSECTOR RECOVERY

PAVED ROADSBEIRA

- / K |RAILROADS

/ *~ INTERNATIONAL AIRPORTS

) ± OTHER AIRPORTS

To R.deogo PORTS OF REGIONAL IMPORTANCE

A / LOCAL PORTS

O SELECTED TOWNS

' HAMBANE®) PROVINCE CAPITALS

)I"JHAPvBANE NATIONAL CAPITALS

PROVINCE BOUNDARIES

- t . INTERNATIONAL BOUNDARIESINHAMBANE

K Masstigr........ )SOUTH ±AFRICA

! A - oo100 200 300

)(XAI-XAI KILOMETERS

Th. b-udre.- -AIA-, dnnrloscdAyAh,A

IvBMrPUTO ,ludgm-enhto n iVtheo AS ohoAyS- t,or -dArA--eS

SVVAZILAND A' ocAeptoAAeofSuch ondones

.' babane APUTO

08/28/1995 w m c 2I 3 cx abo l__i TR g

j! k ,