Document of

The World Bank

FOR OFFICIAL USE ONLY

C to ?z m 024 Report No. 7987-MOZ

STAFF APPRAISAL REPORT

MOZAMBIQUE

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

NOVEMBER 21, 1989

Industry and Energy OperationsSouthern Africa Department

lbis document has a resicted dIstbutio and may be u_d by recipiens only In the peaformaace oftheir officrl duties. its contents may not otherwise be diosed wit Wodld Bsnk authizaon.

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

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

C UVA,SY EQVALES

(OCTOBER 1989)

USS 1 - 813 Meticais (MT) - October 1989US$1 . 682 Meticais (NT) - at time of appraisal (March 1989).

MT 1000 - US$1.47

ABBREVIATIONS AND ACRONYMS

AEPRIMO Association of Mozambican Private EntrepreneursLM, Banco de MocambiqueBPD Banco Popular de Desenvolvimento3STM Banco Standard Totta de Mocambique,CADR Caixa de Credito Agrario e Desenvolvimento RuralEFC Enterprise Financing ComponentERP Economic Rehabilitation ProgramFB Final BeneficiariesQAPI Gabinete de Consultoria Dos Projectos da Pequena

IndustriaIDIL Instituto Nacional da Desenvolvimento de

Industria LocalMCA Ministry of Construction and WaterMIE Ministry of Industry and EnergyPFI Participating Financial InstitutionPPF Project Preparation FacilitySEILA Secretariat of State for Light Industry (now

part of HIE)SME Small and Medium EnterpriseUCPI Coordination Unit for Industry Import ProgramsUGP Apex Unit (Unidade de Gestao de Projecto)

FISCAL YEAR

Government and Public Enterprises: Calendar Year

FOR OMCIL USE ONLY

MOZAMBIQUE

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

STAFF APPRAISAL REPORT

TABLE OF CONTENTS

CREDIT AND PROJECT SUMMARY ..................... . i-v

I. INTRODUCTION .... . . . . . . . . . . . . . . . . . . . . . . 1

II. THE INDUSTRIAL SECTOR .... . . . . .. 2The Economic Background .... . . . ... . . . . . . . . 2Industrial Development .... . . . . . 3The Structure of Industry . . . . . . . . . . . . . . . . . 5Post Independence Industrial Stra.tegy and Planning . . . . . 6The Role of Small and Medium Faterprises . . 7The Current Business Climate . . . . . . . . . . . . . . . . 8Current Industrial Output and Employment . . . . . . . . . . 9The Market for Industrial Products . . . . . . . . . . . . . 10The Reform of Industrial Policy . . . . . . . . . . . . . . 11The Economic Efficiency of Industry . . . . . . . . . . . . 13Industrial Strategy and Implications for Small and MediumEnterprisu Development .. 14Institutional Structure for Small Enterprise Promotion . . . 15Instituto Nacional da Desenvolvimento de Industria Local.(IDIL) . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

III. THE DEVELOPMENT OF THE FINANCIAL SECTOR ANDTHE DEMAND FOR INDUSTRIAL CREDIT .17

Financial System, Institutions and Background . . . . . . . 17The Strategy For Financial Sector Reform. . . . . . . . . . 18Banking System Arrears .... . . . . . . . . . . . . . . . 21Organization and Operation of the Banks . . . . . . . . . . 22

Bank of Mozambique .22Banco Popular de Desenvolvimento (BPD) .25Banco Standard Totta de Mocambique (BSTM) . . . . . . . 27

The Financial Sector: Summary and Conclusions . . . . . . . 28The Role o.i the Small and Medium Enterprise DevelopmentProject in the Financial Sector Reform Strategy . . . . . . . 29The Demand for Industrial Credit . . . . . . . . . . . . . . 29

IV. THE PROJECT .. 31Project Objectives .. 31The Role of IDA and the Rationale for Assistance. . . . . . 31Project Concept ... . . . . . . . . . . . . . . . . . . . . 32Project Description . . . . . . . . . . . . . . . . . . . . 33The Enterprise Financing Component . . . . . . . . . . . . . 33Technical Assistance and Training . . . . . . . . . . . . . 34Project Costs and Financing Plan .. 35

V. ANALYSIS OF THE ENTERPRISE FINANCING COMPONENT . . . . . . . . . . 37The Enterprise Financing Component and its Rationale . . . . 37The Apex Unit and Institutional Arrangements . .38Participating Financial Intermediaries . . . . . . . . . . . 39

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

Operating Mechanism and Credit Management Process . . . . . 40Subproject Eligibility and Selection Criteria . . . . . . . 42Accounting, Auditing and Reporting . . .. . . . . . . . 44

VI. THE TECHNICAL ASSISTANCE AND TRAINGNG PROGRAM . . . . . . . . . . 44Technical assistance . . . ....... . 44Training Program . . . . . . . . . . . . . . . . . . . . . . 46

VII. DISBURSEMENT, PROCUREMENT AND IMPLEMENTATION . . . . . . . . . . . 47Disbursement . . . . . . . . . . . . . . . . . . . . . . . . 47Procurement . . . . . . . . . . . . . . . . . . . . . * * 48

VIII.SPECIAL ISSUES . . . . . . . . . . . . . . . . . . . . . . . . 48The Role of Women in Industry .. . . . . . . . ... 48Environmental Considerations ... . ...... 49

IX. PROJECT BENEFITS AND RISKS ........ ...... ...... 49

X. RECOMMENDATIONS. AGREEMENTS AND UNDERSTANDINGSTO BE REACHED . . . .50

Conditions of Credit Effectiveness . . . . . . . . . . . . 50Conditions of Disbursement......... coAssurances received from the Government . . . . . . . . . 51

kAnexes:

Annex 2.01 Structure of Manufacturing IndustryAnnex 2.02 Scale Distribution of IndustryAnnex 2.03 Enterprises So14 bv the StateAnnex 2.04 1988 Production Data (HIE Heavy Industry)Annex 2.05 Department of Planning, Production TableAnnex 2.06 Financing of Enterprises under the Small Medium

Enterprise FundAnnex 2.07 Import Tariff Rates - 1989Annex 2.08 Short Run Domestic Resource Cost AnalysisAnnex 2.09 Small Enterprise Credit SchemeAnnex 2.10 Decree No. 6188 Instituto Nacional de Desenvolvimento da

Industria Local (IDIL)Annex 2.11 IDIL - Organization ChartAnnex 2.12 IDIL - Provisional 1989 Budget SummaryAnnex 2.13 External Donor Financing of IDIL Inv.stmentsAnnex 2.14 Legal Status of EnterprisesAnnex 2.15 UNIDO Study - Main problems affecting the firmsAnnex 2.16 Export Retention Rates, 1986-88Annex 2.17 Fixed Consumer Prices, 1980-April 1988

Annex 3.01 Structure of Interest Rates, September 1989Annex 3.02 Distribution of Bank Credit to the Economy!.nex 3.03 Estimated Subsidies to State EnterprisesAnnex 3.04 Bank Branch Networks - June 1986Annex 3.05 Distribution of Deposits by bank and terms 1980-1988Annex 3.06 Evolution of Lean Asset Structure and Rationalisation of

Arrears - BMAnnex 3.07 Subsectoral Breakdown of Bank CreditAnnex 3.08 Banco Popular de Desenvolvimento - Organization ChartAnnex 3.09 Structure of Loan Authorization Responsibility (BPD)Annex 3.10 Summary Accounts of BanksAnnex 3.11 BPD Provisional Balance SneetAnnex 3.12 Proposal for the Financial Rehabilitation of BPD's Loan

PortfolioAnnex 3.13 Lending Arrears: BST, BPDAnnex 3.14 Industrial Credit Survey: Summary of Credit ResponsesAnnex 3.15 Mo-etary and Credit Developments - 1984-88Annex 3.16 Baak of Mozambique - Organization Chart

Annex 4.01 Project Cost Estimates and Financing Plan

Annex 5.01 Participation Agreement - DraftAnnex 5.02 Operating Policies and Procedures for the Financing ComponentAnnex 5.03 Instructions for Preparation of Subproject Appraisal ReportAnnex 5.04 Instructions for Rediscount Request and Appraisal FrameworkAnnex 5.05 Terms of Reference for Interdepartmental Commission (CI)Annex 5.06 Preliminary Operating Budget - UGPAnnex 5.07 Information Requirements for Project Completion Reports and

Supervisions

Annex 6.01 Terms of Reference - Adviser to UGPAnnex 6.02 Terms of Reference -

Technical Assistance for upgrading of accounts of thecommercial banksTechnical Assistance for the Study of the Restructuringof the Banking System

Annex 6.03 Terms of Reference - IDIL *^mall Business Advisory ServiceAnnex 6.04 Proposed Small Business Lovisory Service (IDIL) - Terms of

Reference and Provisional Budget

Annex 7.01 Approximate Projected IDA DisbursementsAnnex 7.02 Disbursement ArrangementsAnnex 7.03 Procurement Arrangements

Annex 8 Selected Documents Available in the Project File

HOZANBIQUE

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

CREDIT AND PROJECT SMI4ARY

Borrower: People's Republic of Mozambique.

Beneficiaries: Ba'! of Mozambique, Ministry of Industry and EnergyInstitutc Nacional da Desenvolvimento de IndustriaLocal (IDIL), participating banks, and eligtblesmall to medium scale business enterprises.

Amounts SDRs 25.1 million (US$32 million equivalent)

Terms: Standard IDA terms, with 40 years maturity

Onlendina terms From the IDA funds of US$32.0 million equivalent,the Bank of Mozambique (BM), acting as executingagent, would make available approximately US$28.5million to the participating financial institutionsMPFIs), for onlending on the basis of actual loanapprovals and agreed eligibility criteria. Theremaining total of about US$3.5 million would beretained by BM (Central) for technical a. sistanceto the banks and the industrial promotionorganization (IDIL), and for training. The PFIswould onlend the credit proceeds in local currencyto beneficiary enterprises at adjustable interestrates based on the structure of rates prevailing inMozambique.

The onlending credit risk would be borne by the PFIswho would receive a spread as determined within thebanking system. The foreign exchange risk would beborne by the BM (Central) on behalf of theGovernment, and would be covered by the interestyield on funds onlent, net of the service charge onthe IDA credit, the administration costs, and thespreads of the PFIs on onlending. Subloans underthe Credit would have a maturity of 3 to 12 yearswith 1 to 4 years grace period. The onlending termsand conditions are to be reviewed annually.

Prolect Obiectivesand Description: The aims of this project are: (a) to promote the

rehabilitation and development of manufacturing,processing, and a range of service industries byproviding foreign exchange financing to small an!medium enterprises capable of efficient operationwithin the reformed business environment; (b) torestore the capacity of the banking system for thedelivery and management of credit to enterprises;and (c) to assist the Government in the formulationof industrial policy.

- li -

There are two components, nanely (a) financing, and(b) technical assistance and training. The financingcomponent is to be based on an apex line of creditwhich will be made available to BM (Central) througha Subsidiary Administration Agreament and onlentto the commercial arm of BM, the Banco Popular deDesenvolvimento (BPD), and the private sector BancoStandard Totta (BST). The project as a whole,including the line of credit, will be supervised byan apex unit in BM and there will be a projectsteering committee. Subject to meeting efficiency(including environmental) criteria, subloans willbe available for fixed investment, permanent workingcapital, and sub*-oject preparation service.

Technical assistance will finance consultancy inputsto set up the apex unit and the initial operationsof the Credit, to advise on upgrading the accountingcapabilities of the commercial banks, and to carryout policy advisory studies in the industrial andfinancial sector. There would also ba support tothe IDIL to set up a small business advisoryservice, part of whose role would be to supportsubloan applications. A training program for bankemployees, initiated with UNDP financing, will becompleted under the Project. A Business EnvironmentStudy has been completed which provides the policybasis for the project.

Proiect Benefitsand risks Subprojects using the line of credit would be

expected to earn a rate of return above theopportunity cost of capital. For subloans of overUS$250,000, the economic rate of return would beexpected to exceed 122. For all subprojects therequired financial rate of return would also exceed12Z. Thus the total financing component would beexpected to earn a return of over 12X. Significanteconomic benefits would arise from the startup andrehabilitation of SMEs which are efficient earnersor savers of foreign exchange, and capable ofyielding substantive employment and income. Inaddition, benefits would flow from improvements infinancial infrastructure.

- tit -

There are three main areas of risks (a) problemsin the banking reorganization, the lack of creditexperience of the banks themselves, and the need toresolve entorprise financing problems, could resultin delays in implementation; these potentialproblems would be addressed through technicalassistance and training; (b) social or politicalpressures might cause a slow-down in the pricereform under the ERP; however the commitment shownby Government suggests that these risks are amall;finally, (c) there is the risk of deterioration ofthe security situation; however because of t.heirsmall capacity and because the large majority areurban-based (and these are likely to comprise thebulk of subloan applications), SMEs are likely tobe less vulnerable to disruption of ruralinfrastructure, supplies and markets.

- iv -

PROJECT COST ESTIMATES(US$ Million or equivalent)

Item Local Foreign Total ZCost Cost Cost of Total

(1) Enterprise Financing Component

Civil works, machinery,equipment, spares, materials 10.00 34.07 44.07Consultants services 0.50 1.50 2.00

Sub Total 10.50 35.57 46.07 01.8

(2) Institutional StrengthenilngComponent

IDILAdvisers - 0.36 0.36Equipment. facilities 0.05 0.07 0.12

Apex Unit/UGPAdviser - 0.36 0.36

Equipment, facilities 0.05 0.20 0.25Materials, operating costs 0.05 0.10 0.15

Consultants ServicesStudies (finar.ciallindus) - 0.24 0.24Training 0.05 0.48 0.53PFI accounts upgrading - 2.00 2.00

Policy Study (Businessenvironment) 0-12 0.12

SUB TOTAL 0.20 3.93 4.13 8.2

(3) TOTAL 10.70 39.50 50.20 100.0

- V -

PROPOSED FINANCING PLAN(US$ Million or equivalent)

Local Foreign Total zCost Cost Cost of Total

(1) Enterprise Financina CauuDonentIDA - 28.57 28.57European Investment Bank - 7.00 7.00Enterprises 5.50 - 5.50Participating Banks 3.00 - 3.00Government 2.00 - 2.00Sub Total 10.50 35.57 46.07 91.80

(2) Ihstitutional Strengthen1npComponentIDA - 3.43 3.43UNDP - 0.50 0.50Government 0.20 - 0.20Sub Total 0.20 3.93 4.13 8.20

(3) Totals 10.70 39.505 0.20 100.00

of which:Total IDA - 32.00 32.00 63.70Total Cofinancing (EIB, UNDP) - 7.50 7.50 15.00Total Banks and Enterpriset 1.50 - 8.50 16.90Total Government 2.20 - 2.20 4.40Total Cost 10.70 39.50 50.20 100.00

APPROXIMATE PROJECTED IDA DISBURSEMENTS(US$ million or equivalent)

Fiscal Year 1990 1991 1992 1993 1994 1995 1996 Total

Enterprise financing - 2.00 4.00 6.00 6.00 7.00 3.57 28.57Equipment - 2.58 0.50 - - - - 3.08Training - 0.10 - - - - - 0.10Refund of PPF 0.25 - - - - - - 1.00Totals 0.25 4.68 4.50 6.00 6.00 7.00 3.57 32.00

Cumulativedisbursements Z 0.80 15.40 29.50 48.20 67.00 88.80 100.00

MOZAMBIQUF

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

STAFF APPRAISAL REPORT

1. INTRODUCTION

1.01 The Government of the People's Republic of Mozambique has requestedan IDA Credit of US$32 million for a Small and Medium Enterprise DevelopmentProject (the Project). The Project comprises two principal components - anenterpr.se financing component (EFC), and an institutional strengtheningcomponent. The EFC consists of a line of credit to be onlent through thebanking svstem. The institutional strengthening component consists oftechnical assistance and training, designed to upgrade the lending capabilityof the banks and the industrial promotional infrastructure, and to supportindustrial policy formulation.

1.02 This Project supports and complements the Government's ongoingEconomic Rehabilitation Program (ERP) launched in 1987, by assisting with therehabilitation of the industrial and financial sectors. The ERP has had asignificant impact on industry through changes in exchange rate policy andforeign exchange allocation, interest rate reform and credit control, reformof public expenditure and its financing, and by decontrol of enterprisepricing, output and distribution, previously under the control of the centralplanning authorities. The private sector, both in industry and banking, hasbeen accorded a revitalized role, and the Government is actively seeking waysto introduce private sector participation into the state and 'intervened'companies. Aid flows which have supported the ERP have also been used toprovide short-term import support for industrial enterprises, permittingproduction to continue during the adjustment phase.

1.03 The Project builds on the short-term import support assistancewhich has up to now been the main focus of external aid efforts to industryin Mozambique, and starts to address the longer term issue of industrialinvestment and rehabilitation, focussing upon the smaller enterprise sector,which has shown potential as an important source of future growth. At thesame time the Project is concerned to stimulate the recovery of the bankingsector and the revival of prudent investment lending to enterprises, whichhas in recent years all but ceased as a result of inter alia shortage offoreign exchange, and the need to support short term enterprise operatingdeficits.

1.04 The Government of Mozambique, over the period 1987 to 1989, hasdemonstrated clearly its commitment to reform of the financial sector, inorder to restore the position of the banks as mobilizers of savings forefficient investment. Of most significanci have been reform of interest ratesand credit controls, carried out in conjunction with the IMF, cessation oflending to finance enterprise operating deficits, enterprise assetrevaluation and debt clearance, and the reemergence of private banking alongwith a major reduction in the lending share of the Central Bank and progresstowards separation of its commercial from its central banking functions. Thelatter measures, also supported by the IMF, are aimed at the revival of theCentral Bank's regulatory and policy making role.

-2-

1.05 Total cost of the Project would be about US$50.2 million includingapproximately US$39.5 million in foreign exchange. The proposed IDA creditwould amount to US$32.0 million, 64S of the total Project costs. Cofinancingof US$0.5 million has been provided by UNDP for project preparation; US$7.0million has been provisionally proposed by the European Investment Bank.

11. THE INDUSTRIAL SECTOR

The Economic Backsround

2.01 At independence the economy of Mozambique was built up around fourmain activities - subsistence agriculture, processing of agriculturalcommodities for export, migrant labor, and transititourism services. Theexternal account depended on merchandise exports (principally cashew nuts,prawns, cotton and tea), transit trade (from South Africa, Zimbabwe andMalawi), tourism, and mine workers remittances, (largely from the SouthAfrican coal mines). The revenue from remittances and services was usuallysufficient to offset deficits on the merchandise trade account, which rangedbetween 20? and 352 of import value over 1960 to 1973. The industrial sectorexpanded rapidly from a low base in the five years preceding independence,following the opening up of the economy to private foreign investment.

2.02 Following independence a series of major setbacks occurred. Theseincluded the departure of 90? of the settler population, and virtually allskilled manpower over 1974-77, which forced the Government to take overcontrol of numerous industrial enterprises. The emigration also hadparticularly savere effects on plantation agriculture, rural distribution andthe railways and ports. In 1974, foreign exchange reserves were almost fullydepleted. The overall situation was aggravated by the diversion of transittrade to South Africa, reductions in mine labor remittances, and fall off intourism earnings.

2.03 In 1980 serious problems arose with the intensified attacks byarmed bandits. Inter alia this led to a 602 reduction in exports over 1980to 1984. In addition, the central c-ntrol of prices and production resultedin major exchange rate and price distortions in the production and bankingsectors, with diversion of goods on to parallel markets. The shrinking of thetax base as a result of the departure of the settlers, and the subsidies toenterprises assisted the growth of the fiscal deficit which grew to 30? ofGDP. In addition by 1987 external debt exceeded US$3.0 billion and the debtservice requirements exceeded 200? of exports of goods and services. Thebalance of payments gap was met by donor assistance amounting to 80 - 85? ofMozambique's foreign exchange inflows. As a result of the fundamentalproblems facing the economy GDP per capita is estimated to have declined by50? in real terms between 1973 and 1983.

2.04 In January 1987 the Economic Rehabilitation Program (ERP) wasinitiated. The ERP introduced major macroeconomic changes with respect to theexchange rate, credit controls, public expenditure, pricing, trade anddistribution of goods, taxes and tariffs, and a series of other measuresrelated to these. The state Central Plan, in force since 1978, has beenreduced in scope to more of a review function. As a result of the ERP

- 3-

measures, and major international financial support, including foreign debtservice renegotiation, real GDP is estimated to have risen by about 42 in1987 and 1988.

2.05 The major source of growth has been the family and privatecommercial farm sector, which responded to improved price incentives andprobably also to the increased availability of consumer (incentive) goods.In addition industrial production rose by about 7? (see below) in 1987, aftersix years of decline, and the rise seems to have continued in 1988. Arecovery in merchandise exports occurred from a low point of US$79.0 millionin 1986 to an estimated US$105 million in 1988. Inflation and fiscal deficittargets have been met, and the exchange rate is now around 40 to 502 of theparallel rate, implying a considerable realignment of internal and externalprices. The impact of the ERP has to be seen in context, however; productionstill remains well below 1980 levels and the serious problems of securityremain, along with those of inadequate skilled manpower and rundown capitalstock.

Industrial Development 1,

2.06 Pre-independence. Apart from a few agroprocessing plants such assugar and sisal, industrial development began in Mozambique in the 1930's,when Portugal turned its attention to its colony as a source of rawmaterials. From about 1930, smaller scale manufacturing started partly tosupply the settler community. At the same time certain industries werecurtailed in the colony, in order to ensure that markets were open toPortuguese exports, (as in the case of the Portuguese textile industry,Which was based on Mozambican cotton exports). After 1946, the emergingindustrial sector diversified away from primary processing into consumer andintermediate manufacturing. The first textile factory was permitted to startproduction in 1952, and cement productiox expanded rapidly. The domesticmarket was boosted by a sharp rise in the settler population to about 240,000by 1970. The most rapidly growing industry was metals and enginecring, whichrecorded an increase of 302 per annum from 1964 to 1970). Importsubstitution manufacture increased its share of total industrial outputsteadily, from approximately 372 in 1955 to 612 in 1972, while the share ofexport processing activities declined proportionately. Nevertheless the mostimportant subsector (in terms of employment and investment) remained primaryprocessing, i.e. cashews, tea, sugar, sisal fibre, cotton ginning, and edibleoil. There was extensive South African investment in cashew processing, whichby 1973 comprised about 252 of organized industrial employment, and was amajor world supplier.

2.07 Over the period 1957 to 1970 the rate of growth of industrialoutput averaged between 6 and 72 per annum, with an acceleration to over 102during the period 1965 to 1969, as Portugal opened up the economy to foreigninvestment, particularly from South Africa. The 'open door' policy forforeign investment included a series of incentives such as tax holidays, andprofit repatriation entitlement; previous regulataons requiring financial

11 The discussion of this chapter is elaborated in the BusinessEnvironment Study, IDA May 1989, Chapters 2 and 3.

- 4 -

participation by Portuguese firms were dropped. In one sense the legacy ofthis period has been helpful to industrial viability, because the need toface foreign competition probably resulted in the establishment ofeconomically efficient operations. However, the new enterprises also tendedto be highly dependent on imports, and were often equipped with second handmachinery; their reliance on foreign managemhent and technicians was also apotential weakness. Summary data on enterprises and employment inmanufacturing and processing over the period prior to independence in 1974are as follows.

Table 2.1

Bnterprises and employment 1962 - 73

1962 1967 1969 1970 1972 1973

Number of enterprises 1283 1602 1802 1904 1488 1418Employment 59090 68653 73044 85050 95810 99503

Sources Estatisticas Industriais; various years; Instituto Nacional deEstatistica 1973.

2.08 The post independence decline. Following independence in 1974 theexodus of 200,000 Portugiese settlers caused a serious disruption inproduction since the settler community had all but monopolized managerialand skilled jobs. This situation necessitated the 'intervention' by theGovernment in numerous enterprises, many of which were by then in a state ofneglect, and in some cases with heavy debt arrears. The coal mines were takenover after two serious accidents. Formal nationalization however onlyoccurred in the case of petroleum refining and a shipping company. A seriesof closures and amalgamations of foreign owned banks took place to create thestate controlled central bank (the Bank of Mozambique) and the Banco PopularDe Desenvolvimento. The Banco Standard Totta remained private. The state alsotook over commercial operations necessitated by closure of Portuguese firms.In 1975 criteria were established for intervention, including a 60 day delayfollowing the publication of a statutory notice during which owners ofabandoned units or their representatives could oppose. A total of about 300enterprises were intervened initially: including many small distributionoutlets which were after 1980 returned to the private sector. In 1987, atotal of 140 manufacturing and processing enterprises were listed asintervened. It appears that the Government has returned the majority ofenterprises to private ownership, largely in the small-scale distributionsector, but increasingly in manufacturing.

2.09 Table 2.2 shows a partial index of industrial production for therecent periods

- 5 -

Table 2.2 21

Index of Industrial rroduction (1980 - 100) al

1973 1975 1980 1982 1983 1984 1985 1986 1987 1988Total manufac-turing output 139 87 100 90 70 56 43 42 45 50 est.

a/ The index applies to nationally registered enterprises (approximately 50workers and above), and excludes certain industries.

2.10 The rapid decline in output immediately after independence waspartly reversed by 1981. In 1981 however sabotage of infrastructure by armedbandits bugan. 1986 output fell to less than half its 1980 level inmanufacturing and agroindustry, and 302 of the pre-independence peakproduction. Sabotage was responsible for the decline of electric powergeneration from 11.3 GWH in 1980 to 0.4 GWH in 1986. Petroleum refining washalted in 1985. The centralized control of production, distribution andpricing probably also reduced the ability of enterprises to adapt to adverseconditions. Capacity utilization of industrial plant fell to 302 or less in1986 in many industries. The most seriously affected industries were sugar(6Z utilization), cashew, oils and soaps (10Z), because of their reliance ondomestic materials and transport subject to sabotage. In manufacturing themost seriously affected were containers and paints (both estimated at 82),while only batteries and radio assembly recorded higher than 50X. In 1987,however, there was an increase in industrial output, the first for six years,as a result mainly of increased material provision through donor importsupport; it is expected that this increase would have been maintained in1988.

The Structure of Industry

2.11 The composition of industrial output. Annex 2.01 shows thestructure of employment and output, for 1973 and 1987 over all manufacturingand processing enterprises. Despite its externally dependent situation, in1973 industry was relatively diversified, with a relatively high level ofinternal linkages. In particular metals and engineering had a significantshare of output. The traditional colonial industries, represented mainly bythe food, beverages and tobacco sector, comprised 44Z. The largest singleindustry in terms of value added contribution was sugar, and the largest interms of employment was cashew processing. The split between consumer, andproducer (intermediate and capital) goods production was approximately 67 t

33 in terms of value added. The direct export sector comprised about 202.In 1987 the structure of industrial production shifted towards textile andgarments subsector, as a result of investments in the 1970's; there has beena major decline in the case of nonmetallic mineral products partly due to thesecurity constraints on particularly the cement industry, which is producing

21 Source: UNIDO Informacao Estatistica, Commi8sao Nacional de Plano (CNP)1987, and provisional MIE estimates. Based on gross output.

-6-

at less than 30X of its 1981 level. The preindependence engineering base isstill largely intact, but in great need of refurbishment.

2.12 Industrial location. In 1973, Maputo (Lourenco Marques) provinceaccounted for 44Z of employment, and 51S of industrial value added. Beira andMaputo together accounted for 60Z of employment, and 71. of value added. Themost widely distributed industries were cereals milling, cotton ginning,sisal, and timber which were located largely outside Lourenco Marques/Maputoprovince. In general the food and fibre processing industries, as expected,were widely distributed, while manufactured goods such as rubber, plastics,chemicals, paints, and metals and engineering were heavily concentrated inthe two major towns. By 1987 the recorded pattern was altered with aconsiderable increase in the share of Maputo province. Maputo and Beiracontinue to dominate the sector in terms of employment and output. There areadvantages in this in terms of economies of concentration and secAtrityconsiderations for those enterprises not dependent on materials sromupcountry. However, against this in the longer term is the issue of incomedistribution and regional balance.

2.13 Ownership structure. As stated, following independence theownership of industry changed radically as a result of the decision by thestate in 1975 to 'intervene' abandoned or commercially sabotaged enterprises.After an initial intervention in about 300 enterprises the 1977 law 31permitted various changes, including full state ownership or reversion toprivate ownership, depending on the circumstances. In 1984 the structure ofownership of 575 nationally registered enterprises was as follows: state 114;intervened 140; private 294; mixed and cooperative 27 (see Annex 2.14). Theextent of public ownership is a constraint on industrial rehabilitation andmechanisms for expanding private sector involvement are being discussed 4/.

Post Independence Industrial Strategy and PlannIng

2.14 The rapidly developing economic difficulties of the country in theearly 1980's obliged the Government to set aside long term plans that hadbeen drawn up previously which had laid emphasis on large scale basicindustries such as iron and steel, aluminum, and chemicals. In 1983 the 4thparty congress adopted a new policy emphasizing the increase in utilizationof existing capacity, rehabilitation, and a new focus on small scale industryand the private sector. The role of the central plan, which had set targetsfor pricing, production and distribution since 1979 for about 575 nationallyregistered enterprises, started to be reduced. By 1983 it was accepted byGoverrment that a greater degree of flexibility had to be introducee into thesystem. The current situation is that the plan is now based on 'tottom up'submissions of production price and shipment figures rather than the 'topdown' instructions of the Planning Commission. Nevertheless, businessbehavior in the industrial sector is still constrained by the effects of pastcontrols - e.g. there is little procurement or marketing experience, nor

3/ Decree Law No. 18177

4/ Some options are also examined in the Business Environment Study; opcit.

- 7 -

experience of actively seeking opportunities for profit making. This appliesto both the public and the private sector enterprises.

The Role of Small and Medium EnterDrises

2.15 As stated the role of small and medium enterprises in the economyhas only become a focus of Government concern relatively recently. Availablestatistics for the scale distribution of industry in 1973 and 1987 are atAnnex 2.02. Bearing in mind omissions and under-reporting, the scalestructure has shifted towards microenterprises (under 10 workers), whichcomprised 11Z of 1987 employment compared with 2? of 1973 employment inindustry. The 1987 employment in microenterprises is shown to have doubledover 1973. The total micro and small scale sector, defined as enterpriseswith 1 to 100 workers, comprised 25Z of total employment in 1973 and 31? in1987. The small tO medium scale category in 1987 (all enterprises of 1 to200 workers) would include over 90Z of enterprises with 46Z of totalemployment. At the other end of the scale, for large enterprises of over 500employees, the 1973 share of 402 of employment has fallen to 29Z, largelybecause of the semi-closure of industries such as cement, cashew processingand sugar. By subsector the cmallest average scale is in the wood productsand textile (garment) industries (average 15 workers). The food sector alsohas a relatively large number of micro and small enterprises but alsocontains the largest (e.g. sugar).

2.16 The overall 1973 estimate of 252 of employment in all recordedenterprises of under 100 workers appears comparatively low; this could beaccounted for by the known history of rural Mozambique before independencewhere a combination of migrant labor and plantation agriculture may havedistorted downwards the contribution of rural industry. The 31? estimate for1987 however also reflects the low capacity utilization of larger enterprisesas well as a switch towards the smallest scale of production.

2.17 In the case of Maputo province alone the employment figures showan increase in employment between 1973 and 1987, from 43,000 to 46,400 (seeAnnex 2.02). The Maputo results confirm that the only sector to exhibitsignificant growth, contrary to the overall trend, has been microenterpriseswith under 10 employees. There is also an increase in employment in thelargest scale categories, which is principally explained by the establishmentof textiles in Maputo province during the early 1970's. The structure ofmicroenterprises in Maputo in 1987 was dominated by the garment industry,(consisting of 210 separate enterprises with 42? of total microenterpriseemployment). The next most important activities were engineering and metalproducts (small repair shops), and wood products.

2.18 Enterprises in the range of 10 to 200 workers have not fared betterthan the rest of industry; however, those employing less than 10 workers,largely metalwork and small mechanical workshops, wood products, and garmentproducers, seem to have countered the decline over the sector as a whole. Theevidence of relative dynamism in the smallest firms is not easy to interpret;given the highly protected post independence environment and severe lack offoreign exchange and skills, it is possible for the small enterprise sectorwith lower dependence on imports and technical skills to earn profits evenwith high pricellow quality products. Nevertheless, the apparent fact of

-8-

solid growth in this sector is consistent with international experience andit is likely that small scale enterprises are potentially economic as aresult of their ability to utilize capacity more fully, and their moreappropriate pattern of factor utilization, including use of indigenous skillsand managerial know-how.

2.19 In terms of the reestablishment of longer term investment lendingin Mozambique, there is therefore an a priori justification for identifyinga target group of more managerially and technically progressive enterpriseswithin these subsectors which are looking to expand capacity from workshopscale.

The Current Business Climate

2.20 Security. An inescapable issue is that of the security situationwhich has effectively isolated the rural economy and population. Thisconstraint affects industry both in terms of procurement of raw materials andthe sale of finished products. There is however some optimism in the businesscommunity that the situation will be alleviated as the economic reformsassist in the reintegration of the rural economy through price incentives tocommercialized agricultural production.

2.21 The role of the Government, while still predominant, has shiftedtowards policy setting and away from detailed decision making. Its mainfunction is now perceived by business to be its role in taxation andallocation of foreign exchange, and therefore must be conceived in terms ofits ability to provide the right type of incentive framework. Stateenterprises are in principle expected to rationalize their production andcosts based on their ability to sell at competitive prices in the market.Government policy is now openly discussed with the business community. Thischange is reflected in the creation of the Association of Mozambican PrivateEntrepreneurs (AEPRITO) and the Industrial Association AEPRIHO in 1988. Twoindustrial conferences were held in 1987 and 1988, and Government statementsshowed strong support for increasing the role of the private sector.

2.22 New investment and company formation. Industrial investment sinceindependence has been limited, and concentrated in cereals processing, shiprepair, bus assembly, timber processing, farm implements, vegetable oil, andtextiles. Industrial investment financed by the state reached a peak innominal and real terms of 251 of total public investment expenditure over theperiod 1981-83, averaging about Mt 4.0 bn per annum. However, there was adecline to a 1986 nominal level of Mt 1.30 bn. Indications of an upturn ir.activity may be seen in renewed investor interest. Foreign investmentproposals increased significantly in 1988, with over 20 being approved,compared to 15 over the period 1985 to 1987. As of January 1989 approximately20 further proposals were under investigation, mainly tourism and traderelated; processing industry proposals included fish, cashew nuts, andtobacco.

2.23 A number of company sales to private entrepreneurs at the nationallevel have occurred over the past few years. A total of 45 company sales arereported over the period 1983 - 88 (Annex 2.03). These included principallywood products manufacturers and electrical equipment agencies, as well as

-9-

food, beverages, oil and soap, garments, leather, plastic products, andmetalvorks. Sell offs have increased over the period, with a bunching in 1987and 1988. At the local level (defined by the Government as the group ofenterprises with less than about 50 workers), 40 company privatizations wererecorded over 1985-88. Of these 26 were in Haputo, 4 in Nampula, and 12 inBeira, largely in small wood-working and metal-working units. There havebeen very few new company registrations at the national level in recentyears. At the 'local' level new company registrations in Haputo amounted toabout 150 over 1985 - 88 of which 50 were bunched over the period Tanuary toOctober 1988. The products included largely food processing (includingmilling), wood and metal work, and to a lesser extent garments and pottery.

2.24 Pricing and distribution. Prior to 1987 all costs and prices offinished products of nationally registered enterprises were strictlycontrolled. Companies generating losses due to price control were givenautomatic access to credit from the banking system. Three categories ofprices now exist: (a) controlled, which apply to about 7 industrial products,including milled grain, oil, and soap (see Annex 2.17); (b) conditional,which permit enterprises to set prices on a cost plus markup basis, and tosubmit for ex post approval which is generally given; and (c) free prices.The conditional category is transitional between controlled and free prices.Initially the new process for approving price increases was slow andcumbersome, both within the fixed price and conditional price category, butby the end of 1988 it had been reportedly speeded up. In those few caseswhere industrial products are still price controlled, official prices arealso being regularly adjusted to reflect real costs. The number of productssubject to price control will be reduced progressively. 51

2.25 Prior to 1987, all industrial goods from nationally registeredenterprises were supposed to be sold to government designated buyers. Forproducers with low quality products the system of designated buyers was amajor benefit as all production was guaranteed to be sold. This meant thatproducers were not accountable for poor quality, which in turn led to abreakdown in the quality control functions, and labor efficiency. The reformsof January 1987 began to eliminate designated buyers, and firms have becomemore conscious of normal marketing considerations such as price and quality.Additionally, the concept of cost accounting has become more important,particularly in the area of raw material costs.

Current Industrial Output and Emplo7ment

2.26 In 1987 industrial production expanded for the first time since1981. The index of production (Table 2.2) was about 6-7Z above that of 1986;this was mainly due to the effects of donor import support programmes,including two IDA Rehabilitation Credits which allocated about US$60 millionto industry. The recovery was however spread unevenly between branches. In1987 the major increases were in textiles (21Z), wood products (46Z),chemicals and plastics (161), and basic metals (136X). However tobacco, andleather registered declines. Provisional data for HIE enterprises (over 50workers) in 1988 show an overall increase of about 20? in real terms (Annexes

5/ See Hozambique; Policy Framework Paper, 1988-90

- 10 -

2.04 and 2.05). covering both increases and declines. The availablestatistics show a continued recovery from the low point of 1986. althoughproduction has not yet approached the level of 1980. It would be expectedthat the poor state of plant and equipment in many enterprises would act asa constraint on further significant increases, prior to more majorrenovations of plant and equipment. There is also the problem of a possiblemarket constraint, discussed below.

2.27 Several estimates of current employment are available. A 1987 laborsurvey shows employment of 66,500 in manufacturing, (with 17,700 inconstruction, and 3,700 in public utilities), covering all enterprises. TheNational Planning Commission estimates 87,800 in manufacturing for nationallyregistered enterprises alone (22,100 in construction and 4,600 in publicutilities), which would give an adjusted estimate of total industrialemployment in manufacturing and processing enterprise of about 110,000. UNIDO 6/estimated a total of 150,000 employees in the organized sector, plus 30,000in locally registered units and a further 20,000 in microenterprises. Giventhe difficulties that have faced industry since 1973, when industrialemployment was estimated at 99,500, combined with the relaxation of lawsrelated to security of employment in 1985, the current organized sector totalis likely to be in the range 80,000 to 100,000.

The Market for Industrial Products

2.28 There is no certainty that either the short or long-term level ofdemand within the economy is sufficient to justify the retention of allexisting industrial capacity. Aggregate demand for industrial goods may beconsidered to have been influenced by longer term demographic changes, andthe more immediate impact of devaluation on the pattern of urban/ruraldemand. There have also been transitional problems resulting fromuncoordinated imports (e.g. garments), and donor aid goods such as blankets,soap, cooking oil, and agricultural tools which have constrained the marketavailable to local producers.

2.29 Demand in the long run. The level and pattern of demard have beeninfluenced principally by the settler exodus in the 1970's, partly offset bythe arrival of the foreign aid community, and internal and external migrationcaused by sabotage and dislocation. Consumption shows a 11Z reduction overfive years since 1982, and an estimated reduction of around 212 since 1973.The Business Environment Study estimated that, without the effects of thedislocation and refugee problem, aggregate consumption would have increasedby 15 to 202 since 1973 given zero growth in consumption per capita. However,the market for higher value manufactures would not have risen as much, sincethe departure of the settlers would have affected this sectordisproportionately. Thus it is possible' that the market for manufactureswould have expanded little if at all over 1973 to 1987, even without thedislkcation. Demand for some industrial products (particularly consumerdurables) could take several years to regain its 1973 level, even withreestablishment of peace.

6/ UNIDO Industrial Situation in Mozambique' May 1987.

- 11 -

2.30 lmpact of devaluation on purchasing power. The impact ofdevaluation on the market has more immediate implications for the industrialsector. Relative costs have fallen, but urban real wages and purchasing power

! would be expected to have fallen as well; at the same time the rural market,which would have been expected to have gained from changes in domesticrelative prices, is partly inaccessible because of disruption of distributioninfrastructure. The indications of the trend in urban real wages areambiguous; however, if there has been a significant reduction in urban realincome tnen discretionary purchases would be severely cut back, whileessentials such as food would be cut but to a lesser extent. The first typesof expenditure to be cut back would be for consumer durables such aselectrical goods (e.g. radios) and bicycles, as well as clothing, beveragesand cigarettes, and certain nonessential processed/packaged foods. Certainindustries have in fact noted a decline in production from 1986 levels dueprimarily to a retraction in demand. These include oils and soaps, footwear,mattresses, cardboard containers, car tires, bicycles. and PVC pipes.

2.31 Problems related to the security situation. In terms of marketingand distribution the security problem had made the delivery of goods to (andfrom) rural areas difficult and in some cases impossible with a severereduction in the accessible market. In addition farms unable to getcommercial crops to market because of disrupted transport would havc suffereda significant reduction in ircome, and reduced purchasing power. Increasedproducer prices would in this situation be unable to increase effectivepurchasing power. It is notable that smaller scale production of manufacturedgoods generally would be less vulnerable to security problems to the extentthat it draws supplies and delivers to markets within neighboring areas.

The Reform of Industrial Policy

2.32 The most important reforms related to industry that have takenplace or are in process under the Economic Rehabilitation Program are thefollowing.

2.33 Exchange rate and foreign exchange allocation. Currency devaluationhas tended to lower the real value of domestic factor payments, particularlyreal wages, and has improved the medium/long term competitive position oflabor intensive and domestic resource based industry. A phased opening up ofthe foreign exchange market is in process through the new system fornonadministrative allocation of foreign exchange, under the IDA ThirdRehabilitation Credit, and through mechanisms such as special funds - the'market fund' for trading companies, and the 'small medium e_terprise fund'for producers. In 1988 a total of US$6.0 million was disbursed under bothfunds (SME fund financing is at Annex 2.06). The fund allocatiun for 1989 isexpected to total US$25 million. In addition an export exchange retentionscheme was introduced in 1984 (see Annex 2.16).

2.34 Pricing and distribution. Since January 1987 price policy hasaimed at reducing the number of products with fixed prices and allowingprices to be more related to costs of production and market demand.Distribution policy is expected to continue to change alongside pricing, witha reduction in the number of final products subject to administrative

- 12 -

allocation to 15 in 1989. All enterprises are now permitt-ed to trade directlyrather than through a trading company; state trading companies are expectedto compete with the private sector. However, control on foreign procurementis still partly exercised through foreign exchange allocation and importlicencing, with control of some internal trade through rationing.Recommendations on reform in foreign exchange allocation and import licencinghave been made to the Government in the Businesa Environment Study, andspecial arrangements have been made regarding import licenses for equipmentfinanced by the present project (see para. 5.19).

2.35 Investment incentives. Positive efforts to attract foreign anddomestic private investors are being made through the establishment of tradeessociations, and through privatization and joint ventures. The 1984 and1987 foreign and local investment laws relating to tax exemptions and!'centives and foreign exchange retention included tax holidays, depreciationand capital allowances, and exemptions from labor income tax, turnover tax,and import and export duties. In 1988 a debt-equity swap law was passedsetting out conditions under which foreign investors could acquire localassets. The export retention scheme, despite limitations, is a particularlyimportant inducement to foreign and local investors. However, the actualimpact of the system is difficult to judge in current conditions whereinvestment is constrained by numerous other factors (summarised in Annex2.15). Proposals for refinement of the incentive framework in a number ofareas have been made in the Business Environment Study.

2.36 Tariff and tax reform. From 1987 to 1989, partly as a result ofdiscussion with business, reforms have been instituted to rationalize andsimplify the system of company taxes, and trade tariffs, and to introduce theconcept of limited tariff protection as opposed to quantitative controls.Among the main changes has been the abolition of dividend taxation. Under theBusiness Environment Study simplification and increased transparency of thesystem is recommended, in order to improve the incentive framework. The IMFhas also proposed certain modifications to the system 71. The currentstructure of tariff rates is shown in Annex 2.07.

2.37 Enterprise financial restructuring and financial services capacity.Restructuring is required because of the effects of devaluation andaccumulated debt on enterprise balance sheets. These effects distort taxliabilities and discourage bank lending. By December 1988 the Government hadtaken steps to transfer about Mts 8.0 billion of the debt of 10 state andintervened companies to the Central Budget, where revised terms andconditions of repayment will be worked out. Transfers up to now have beenconfined to public sector companies. Some individual debt reschedulings havealso been arranged through the Bank of Mozambique, on easier terms. A decreehas been issued requiring revaluation of assets of enterprises within 1988balance sheets. The regularization of bank lending and the establishment ofan accountable private sector also require auditing capacity to be set up,and some progress is being made in this regard. A system of standard accountswas instituted in 1984; however, there is an acute shortage of accountantsand the Government is considering allowing foreign accountancy firms to open

7/ 'Memorandum on the tax system of Mozambique' IMP January 1988.

- 13 -

offices. Currently, capacity for external auditing of enterprise accounts isnot sufficient; internal auditing is carried out and auditing for taxpurposes is undertaken by the Ministry of Finance.

2.38 Campamy sales and ownirship. The overall question of companyformation and ownership has been addressed by the Government throughlegislation relating to the intervened companies. Most recently (1989) therehas been a move to transfer some intervened companies to the state sector asa possible precondition for eventual company sale. The Government has soldoff assets abandoned by previous owners under the original legislation, andhas come to specific agreements with new owners. Sales are dealt with on acase by case basis, and no general clarification of the legal position ofintervened companies has been made. Proposals for mechanisms for sell off ofstate assets are made in the Business Environment Study, and ownership andother corporate legal issues are being examined by a Government working groupunder the Minister of Industry.

2.39 Labor. In January 1987 decree law 5187 set 20 grade ranges inindustry, specifying new pay levels and allowing supplementary payments sucbas performance linked and seniority bonuses. After the decree, a series ofinterim increases were permitted to offset part of the effects of devaluationinduced price increases. The aim is to increase flexibility in employment,in terms of rewards for efficiency and ability of enterprises to lay offworkers. It is intended that these measures will allow wage costs to moreaccurately reflect operating conditions. Industrial costs have fallen in realterms due to devaluation; however, where overmanning still exists the longerrun competitive position of the industries may be adversely affected.

The Economic Efficiency of Industry

2.40 The economic efficiency of the industrial sector has been improvedby the series of devaluations that have taken place. The devaluation hasgenerally lowered wage costs as a proportion of total costs so thatenterprises are more competitive vis a via international prices. Accordingto the results of an industrial efficiency analysis carried out under theBusiness Environment Study (Annex 2.08), in the short run, ignoring plantreplacement costs, most industries are able to operate efficiently ineconomic terms. This means that they are earning or saving foreign exchangeefficiently enough to justify the commitment of domestic resources.

2.41 The results imply that, treating plant and equipment as a sunkcost, it is economically justifiable to supply working capital and carry outorganizational improvements, repairs and minor replacements over a range ofconsumer, intermediate and capital goods industries. There is some doubthowever about industries such as textiles, certain footwear products, glass,and edible oil given the present state of their operations, and the sugarindustry which at the moment is unable to cover variable costs at worldprices. However, the efficiency study could only give approximate guidelinesand is no substitute for case-by-case feasibility studies which would becarried out under the Project.

2.42 The long run viability of many enterprises (after taking accountof costs of equipment replacement) can only be determined after detailed

- 14 -

analysis at the enterprise level because the current situation is distortedby excess capacity, low efficiency and possible market constraints. For manyindustries complete refurbishment is required which would involve not onlyplant -eplacement but reorganizationlreduction of the labor force and radicalimprovements in productivity through for example reducing material wastageif economic efficiency is to be restored.

2.43 The efficiency study included a group of small enterprises;however, the results did not suggest that this category showed asystematically different level of efficiency than the total sample; again,case-by-case analysis would be essential for determination of the specificprospects for the smaller enterprises.

Industrial Strategy and Implications for Small and Medium EnterpriseDevelopment

2.44 The stagnation of industrial investment and production over thepast few years, and the price distortions in the industrial sector resultingfrom centralized control, do not permit a clear view of the impact of thereforms on SHE. Unlike other countries there is no experience of systematicdisadvantages facing SME, vis-a-vis larger enterprises, in areas such asforeign exchange allocation, fiscal incentives, access to credit, or publicinvestment planning since the reforms of 1983, when a number of smallenterprise development units were set up. In addition, foreign exchangefunds were created for small enterprises and a microenterprise creditprogram. (see below and chapter 3). However, it would be expected thatadministrative allocation would tend to favor large enterprises.

2.45 In general, the reform process should favor domestic resourceusing, labor intensive production; these are characteristics of smallerenterprise production; in addition the SMEs would benefit from greaterflexibility of production and ability to utilize capacity more fully in thecontext of continuing uncertainty of input supply and markets. It is in thissector that an earlier supply response may be expected while largerenterprises attempt to rehabilitate their rundown plant and. equipment, anddisused marketing and distribution systems.

2.46 The strategy for rehabilitation of industry involves the creationof an environment in which industrial ent.epreneurship can be fostered; thisrequires a difficult transition frum a supply-oriented planned industrialsector to a market-oriented environment in which production and investmentrespond to market and price signals. It is likely that smaller enterprisesare in a better position to make the transition. The process of price (andwage) adjustment must continue in order to allow costs and prices to varyaccording to domestic market conditions, and secondly in order to permitdomestic prices to converge over time with international prices, so that anefficient distribution of production between domestic and internationalmarkets is attained. This requires continued action in main policy areas ofthe ERP.

- 15 -

Institutional Structure for Small Interprise Promotion

2.47 The Govern.-nt decision to switch policy in favor of small-scaleenterprise resulted in the rapid creation of small industries units underseveral Government Institutions - Ministries of Industry and Energy (MIE),Agriculture, Fisheries, Construction, and Labor. The Banco Popular deDesenvolvimento (BPD) set up a department specializing in small enterprisecredit. n January 1988, Instituto Nacional da Desenvolvimento de IndustriaLocal (IDIL) was formed from the Department of Local Industry as anindependent agency under the Secretariat of State for Light Industries(SEILA). In 1988 MIE and SEILA were merged, and IDIL became an agency of MIE.

2.48 In addition, in 1984 the Gabinete de Consultoria dos Projectos daPequena Industria (GAPI) was founded as a technical assistance unit for smallenterprise mainly in rural areas (supported by the F. Ebert Fcundation of theGerman Federal Ripublic). GAPI has approved a total of about US$1.2 millionto about 90 projects over four years and also arranges technical assis_ance.The disbursed loans (to about 50 projects) have averaged about US$18,000.The modal range of loans has been US$6,000 to US$25,000, and they are largelydirected to small rural units, such as grain mills, vegetable oil, soap,woodworking and pottery. The actual geographical dispersal has beenrestricted largely to Cabo Delgado, Niassa, and Maputo provinces. Recentlya number of loans have been approved in Tete province (see Annex 2.09).

2.49 The coordination of SHE promotion is complicated by the fact thatthe Provincial Directorates of Industry and Energy have responsibility forregistration, licencing and promotion of industry in their region, and havea dual reporting function, to both the MIE and the Provincial Governor.However, the situation is being clarified as the agency which has beenoificial.y designated the role of promoting small scale enterprise is IDIL,and IDIL delegations are to be attached to existing provincial directorates.

Instituto Nacional da Desenvolvimento de Industria Local (IDIL)

2.50 IDIL is a technical advisory agency, legally established in 1988under decree No 6188 (Arnex 2.10). The president of IDIL now reports directlyto the Minister of Industry and Energy. The decree states that IDIL wouldhave the following main areas of activity: (a) appropriate technologydevelopment and transfer; (b) technical support and consultancy assistance;(c) arranging of local and external financing, and mobilization of externalcooperation; (d) training; (e) provision of advice on industrial protection;(f) registration and data collection; and (g) promotion of industrialactivity based on local resources and needs.

2.51 IDIL (and its predecessor DIL) collaborated with GAPI in theprocessing of mos. of the projects financed by the Ebert foundation and a fewadditional projects sponsored by other bilateral donors. Of 100 projectsproposed about 50 have been approved, of which 36 were under the GAPI program(see para 2.48). The level of investment averaged about US$10,000. The maintypes of activity financed were, as in the case of the GAPI program, woodproducts, vegetable oil pressing and soap, and cereal milling, plus a smallnumber of other activities, including repair units, pottery, tanning,

- 16 -

vegetable and fish preservation. The actual role of IDIL in these projectshas been mainly one of checking proposals which may have been forwarded byBPD, and in working with GAPI to arrange technical support and loans. Onoccasions IDIL has also despatched its own technician or arranged one fromelsewhere (e.g. through the Sector Ministries) to assist in appraisal orrepair/installation of equipment. IDIL's in house technical staff currentlyconsists of technicians (chemicals and leather', supported on occasions byteci.nicians from its technology development a iliate, PRODIL. The lattercompany has produced and installed a number of village oil presses, and someprototypes of other equipment, along with its main commercial production ofmetal furniture.

2.52 The provisional staffing target of IDIL is 28 in 1989, and in themedium term 44. Of these latter about 19 may be categorized as professionalor semi professional staff, and 25 as administrative and support. Theseexclude provincial delegation staff. Five departments would be set up, -administration (including economics and accounts), technical, training,management, and external relations (see Annex 2.11). IDIL delegations arebeing set up in the provinces of Sofala, Cabo Delgado, Niassa, Inhambane,Zambezia, Tete and Nampula.

2.53 The most recent 1989 IDIL budget requires expenditure of Hts 62.9million against estimated receipts of Hts 21 3 million. (Annex 2.12),excluding the proposed IDA Project. All expatr-iate assistance costs areassumed to be financed outside the budget. Sources of local finance foroperating expenditure are deficient by about Mts 41.6 million, or 601 ofadministrative and personnel costs, but this deficit is expected to be metout of the Government budget. The proposed 1989 equipment investment budgetof Mt 242.8 million is financed largely (861) by four foreign aid projects,totalling approximately US$306,000 (Annex 2.13). The potential for makingIDIL self supporting will be improved by the proposed Small Business AdvisoryService (para 2.57).

2.54 From the point of view of the SME Project, there are limitationsto the extent that technical assistance is likely to be effective for IDILin the short run. This is (i) because IDIL's experience up to now has beenwith mainly micro-enterprises in rural areas; and (ii) because of itscurrently very small size and reliance on Government budgetary resources(which the mission were informed have now been committed). In addition, thenumber of external donors interested in assisting IDIL inevitably createspressure on its internal administrative capacity. Nevertheless, theGovernment has made it clear that IDIL will be the principal vehicle forpromotion of the smaller enterprise sector in general. Proposals for otherexternal assistance received by IDIL, which are either ongoing or are underserious consideration, have come from UNIDO, ILO, Swedish and US Governmentsand non-government organizations from Holland, Italy and the Eduardo Mondlanefoundation. Assistance includes technical personnel, vehicles and officeequipment.

2.55 An alternative approach to assisting IDIL under the Project wasexamined; this involved a skills exchange, to be set up with a local currencybudget to subcontract technicians from existing larger industrial enterprisesfor provision of assistance to smaller enterprises, avoiding build up of IDIL

- 17 -

in-house technical staff, but at the same time allowing expansion oftechnical capacity. However, the Government felt that any approach taken atthis stage should be more cautious, and should consist of advisory assistancetargeted at areas not covered by other resources, primarily in support of theeffective use of the proposed line of credit.

2.56 IDIL's future program also includes a proposal for setting up asmall industry development fund (Fundo de Fomento a Pequena Industria). Itis proposed that this would be a fund managed by the BPD, and would be adevelopment of the existing GAPI system.

2.57 The proposed IDA assistauce program under the Project would belimited in scope because it is not considered that the IDIL organization issufficiently strong as yet to absorb larger external inputs. It would,therefore, be confined to provision of a pilot small business advisoryservice designed to provide financial, management and marketing advice tobusiness in Maputo and Beira areas. The limited size of the assistanceprogram is justified because it is not considered that the IDIL organisationis not sufficiently strong as yet to effectively use a larger input. Thisproject component is elaborated in Chapter 6.

Ill. THE DEVELOPMENT OF THE FINANCIAL SECTOR ANDTHE -DEMAND FOR INDUSlRlAL CREDIT.

Financial System, Institutions and Background

3.01 Mozambique's financial sector currently consists principally ofthree banks, and one insurance company. In addition, there is anAgricultural Credit Fund and two development funds - for agricultural andirrigation projects - which are administered by, but not strictly part of,the banking sector. The following analysis is restricted to the bankingsystem, which attained its current configuration after a restructuring in1978, involving closures and the amalgamation of a number of foreign banksunder the control of the state sector. Of the three banks currentlyoperating, one, the Bank of Mozambique (BM), acts both as Central Bank andas the leading commercial bank. A second fully state owned bank is the BancoPopular de Desenvolvimento (BPD). The third bank, Banco Standard Totta deMocambique (BSTM), is a foreign-owned private bank.

3.02 Over the period 1980 to 1986, the banking system acted as a conduitfor financing the production plans of the economy. A rapid expansion ofdomestic credit occurred so that while GDP fell in real terms by 8Z per annumover this period, domestic credit expanded rapidly, and serious arrears werebuilt up amounting to over 50Z of lending by 1986. Interest rates on lendingand borrowing were not used for rationing of credit and were controlled atnegative real rates. Bank deposits were very largely non-interest-bearingdemand deposits. The situation was not conducive to mobilization of realsavings and would normally have led to excess demand for investment funds,even in the highly adverse investment environment. However, thenonavailability of foreign exchange for import of investment goodsconstrained investment, so that liquid reserves were accumulated. Lendingtended to be concentrated in BM, partly financed by deposits from the other

- 18 -

banks. Deposits in the commercial banking sector were predominantly shortterm in character (including refinancea overdrafts). The dual role of the BMwas not conducive to the development of its regulatory and policy makingresponsibility. Commercial banks were able to maintain financial stabilitybecause of the high levels of liquidity, and lack of alternative outlets forsavings within the underdeveloped financial mLrket; book earnings wereapparently positive because of high yield margins over the average cost ofdeposited funds (and also possibly because of the accrual of unpaidinterest). However, even with nonperforming loans accounted for at fullvalue, combined capitalization was not adequate.

3.03 As stated in chapter 2, public investment fell by about two thirdsin nominal terms between 1980 and 1986; data on private investment are notavailable but it fell to a negative net level where enterprises were notmaintaining their capital. Thus the foreign exchange shortage, repression ofinterest rates, and the other problems facing the banking system resulted ina situation whereby over the period 1980-86 the banks virtually ceasedfinancing longer-term borrowing for investment, especially in industry.(Finance of enterprise operating deficits was entered in bank balance sheetsas long term debt, but this was not related to investment). To address thissituation, the Government since 1987 has adopted a series of relativelyradical measures for the banking sector under its Economic RehabilitationProgram (ERP), with the objective of restoring capability for efficientmobilization of savings and allocation of investment. The pace of chsageimplies a high level of commitment. The measures taken have been includedin agreements between the Government, IDA and the IMF.

The Strateay For Financial Sector Reform

3.04 Process of financial reform. The task which the Government hasembarked on since 1987 is complex and lengthy, requiring that the financialsector undergo a transition from a system whose main purpose was theadministrative allocation of public funds according to the requirements ofthe central plan, to one in which private savings can be effectivelymobilised and channelled to economic investment outlets via a marketdetermined price (interest rate) system, and which can be monitored andregulated through monetary instruments by the central bank. Under theprevious system the main instrument of monetary control was the annual creditplan, which complemented the annual production plans; the interest rate waseffectively redundant and monetary and regulatory control of the banks wasimpracticable. In order to rehabilitate the financial sector, the reformprocess has had to address the following basic areas: (a) interest rates; (b)institutional development; (c) financial restructuring of the banks, ld)establishment of performance guidelines. The combined effect of reforms iaall these areas would be to raise domestic savings and ration credit via theprice system to more profitable outlets, allow necessary specialisation ofthe functions of the central bank, and permit a fresh start to be made in thecommercial banking system.

3.05 The ERP, reflected in the Government's Policy Framework Paper, hasinitially addressed (a) and (b) above. Under the program agreed with the IMF,nominal interest rates have teen increased in successive steps towardpositive real levels as the rate of price inflation declines, with a target

- 19 -

of achieving positive real rates in 1990. The interaction between the fiscaland monetary policy has been addressed by setting targets (ceilings) for thefiscal deficit in combination with bank credit ceilings, whereby Governmentfinancing by the banking system has been significantly reduced in real terms;in addition, banking system financing of operating losses of enterprises hasbeen curtailed and a portion of doubtful loans transferred from the bankingsystem to the Ministry of Finance. These measures have in turn permittedprogress under (c) above, in terms of the restructuring of the balance sheetsof the commercial banks by the removal of a portion of nonperforming assets.In the institutional area, the complex task of separating the Bank ofMozambique (BM) into its central and commercial functions has been initiated.This separation is a necessary step towards the restoration of the centralbank's regulatory and monetary control functions, and its role as financierof central government. In addition, some initial progress has been made ondiversification of instrumeits of Government Finance and prudentialregulatory controls.

3.06 The no-xt stages of the rehabilitation of the financial systemwill require continued progress on interest rate reform and on institutionbuilding and reorganization. The financial restructuring area is relativelyless advanced, and the reintroduction of an effective regulatory system forthe commercial banks will to some extent require inter alia the priorachievement of progress in restructuring and the final clearance of lendingarrears, which, up to now, has been confined to those of BM (see paras. 3.15and 3.16). The regulatory powers of the BM have not been utilised because,for example, reserve requirements have not been effective due to excessderosits in the commercial banks and, in consequence, the central bankre iscount facility has been redundant 8/. In addition, regulationsconcerning financial performance and prudent lending have not been effectivebecause of the financing of enterprise deficits during the period of centralplanning. The pace at which improvements can be made in these areas dependsto a large extent on the progress of institutional reform, in terms both oforganization (of the BM), and in terms of capacity (skilled manpower) of allthe banks. In particular, manpower constraints in the commercial banks in thearea of accounting, financial management and credit analysis will take timeto resolve, as well as skill shortages in central banking functions. Theproposed project will provide technical assistance and conditionality relatedto the next stages of the financial sector rehabilitation (para. 3.42).

3.07 Structure of interest rates. The structure of lending rates ofinterest in Mozambique is shown in Annex 3.01. Rates in effect from 1981 to1986 were very low in nominal terms, ranging from 0 to 62 for deposits, and3 to 102 for lending. and negative in real terms. The structure of interestrates was revised with effect from January 1987 according to Mozambique'sagreements with the IMP for a Structural Adi1!<ment Facility (SAP), withrates ranging from 31 on demand deposits and 121 to 201 on time deposits, and54 different lending rates ranging from 12X to 35X. Provision was also madefor a rediscount rate of 101, applicable on amounts up to 61 of demanddeposits, and rising to 121 on amounts up to an additional 61 of demanddeposits. The most recent revision of rates came into effect in September

8/ These powers are codified under the Organic Law, decree 2/75.

- 20 -

1989, with the number of lending rates now reduced to 16, ranging from 152to 35?. The number of term lending rates (over one year) has declined from27 to 7, and the range contracted from 18-35Z to 22-35Z. Time deposit ratesare in the range 14? to 222 and the Central Bank rediscount rate is nowunified at 122. These interest rates remain negative in real terms.Nevertheless, the higher interest rate structure will have a positive impact,with credit demand shifting to firms that have better prospects in thecurrent business environment. Under the terms of Mozambique's agreement withthe IMF, they should continue under review and be revised progressively witha view to achieving positive real interest rates by 1990. This is likely tobe achieved on the basis of current projected inflation rates. Under itsPolicy Framework Paper Government has committed itself to reduce over timethe differential between subsidised and commercial rates of interest. Annualreviews of progress on achieving positive (weighted average) real interestrates would also take place under the proposed project (see para. 5.13).

3.08 Credit control and lending shares. Mozambique had no active formalcredit allocation policy until 1987, when a ceiling on domestic creditexpansion was introduced of Mt 40 billion. Of this amount, Mt 25 billionwere allocated to lending to the state, with the remaining Mt 15 billionbeing allocated amongst the three banks for lending to the economy, accordingto their share in lending. Additional credit expansion was allowed underagreement with the IMF to the extent of the countervalue in meticais ofcertain foreign exchange resources, such as World Bank loans. For 1988, theceiling was raised to Mt 74 billion, of which Mt 20 billion for lending tothe State, and Mt 54 billion for lending to the economy (including stateenterprises). There was thus a very significant decline in 1988 in realterms in the level of banking system financing to be made available to theState. This shift partly reflects changes in the channelling of financialresources to state enterprises, in the context of rationalization of theiroperations, as well as increasingly tight controls on the Government's budgetand the desire to prevent 'crowding out' of the private sector.

3.09 Data for 1988 show a below-ceiling Mt 64.9 billion expansion indomestic credit, and a distinct shift in the allocation of funds had becomeapparent 9/. In 1986, BM accounted for 792 of total bank lending, BPD forabout 182, and BSTM for about 32; by end 1988 these figures were 69.5X, 23.62and 4.3? respectively, with the remaining 2.62 lent by the newly establishedCaixa de Credito Agrario de Desenvolvimento (CCADR). More significant arethe shares in incremental lending in 1988 (i.e. out of the additional Mt64.9 billion): BM lent less than 482 of this amount, with BPD accounting foralmost 37?, BSTM for close to 7Z, and CCADR for almost 9?. Along with theopening up of foreign exchange transactions (para. 3.11), competition betweenthe three banks is beginning to strengthen, although progress is constrainedby shortages of skilled staff. Once the banks have addressed their urgenttraining needs, promotion of fuller competition will be critical to thedevelopment of an efficient financial sector. Under the Project assuranceswere received that the Government would formulate a program, by June 30,

9/ The relending of reimbursements from the Government to BM howevereffectively increased new lending outside the ceiling by about 10? (seepara 3.15).

- 21 -

1992, for the continued extension of competition within the banking sector,to be implemented promptly thereafter.

3.10 At present, there are no established guidelines for the sectoraldistribution of credit, although they are under consideration. In recentye&rs, agriculture has accounted for around half of total bank lending; ofthe remainder, industry accounts for about 172 (39-422 if primarytransformation of agricultural products is tncluded). while constructionaccounts for about 5-72, transport and communications around 12-14Z, domestictrade some 7-9? and foreign trade 6Z. These shares have not changedsignificantly over the period 1986-88, except for an increase in domestictrade credit. Data for BM suggest that manufacturing industry receives some11? of total lending. As of end 1988, BH accounted for 702 of total lendingto industry, down from 85Z in 1986, while BPD and BLZM accounted for 13.5Zand 12.92 respectively, and the newly established CCADR accounted for 3.5Z(see Annex 3.07).

3.11 Foreign exchange operations. When the banking system wasrestructured in 1978, it was also decided that BM would have a monopoly onforeign exchange operations (handled through the commercial department ofBM). The Government is now moving towards a loosening of this monopoly; inparticular, the private sector bank, BSTM, has recently been granted alimited foreign exchange license.

3.12 Deposit regulations. A further constraint on competition in thebanking system has been the restriction of firms to holding an account atonly one bank. An exception has been made for firms that have their accountwith either BPD or BSTM and subsequently require a foreign exchange account,for example for export activities, which must be held at BM. The lifting of.his restriction is under consideration by the Government, in order toencourage greater competition between the banks. BM is also consideringintroducing compulsory deposits with the Central Bank, which couldpotentially facilitate monetary regulation. Provision might be made forremunerating any deposits over and above the compulsory level.

3.13 Government fimnance. Treasury bonds were introduced in a verylimited way in 1988 (Mt 10 billion, on which interest is paid in US dollarsat an annual rate of $1.30 per Mt 10,000 bill), and a secondary bond markethas been initiated, under the responsibility of the recently establishedSociedade de Investimentos e Estudos Financeiros (SOCIEF). The morewidespread use of Treasury bonds is expected to provide an alternativeinvestment for both institutions and individuals, thus reducing the liquidityof the banking system and pulling interest rates on bank deposits up to alevel reflecting the opportunity cost of Government resources. Extending theuse of Treasury bonds could have significant positive affects on theallocation of funds in the economy.

Banking System Arrears

3.14 Despite the indications of positive progress, the banking systemstill faces a serious arrears problem, which has arisen from several sources(see Annexes 3.06 and 3.13). A significant portion of the arrears dates backto independence, when many Portuguese firm owners left the country; a number

- 22 -

of these firms were subsequently intervened by the Government. The bulk ofthe arrears of the private bank, BSTM, date from this period. The largestshare of arrears, however, has stemmed from lending, largely to stateenterprises and intervened firms, by the banks (mainly BM and BPD) at theGovernment's request. Much of this lending was to cover operating deficits(up to 1986 inclusive) considered to be due to price controls and thedifficult economic environment facing the firms. Total figures for this typeof lending, and for arrears arising from it, are not currently available.Since 1987, the Government has covered such deficits through direct fiscalsubsidy and has reduced their level substantially; in 1987, such subsidiestotalled Mt 9.1 billion, most of which went to the agricultural sector, withthe total declining to Mt 6.8 billion in 1988 (Annex 3.03).

3.15 The Government has decided to address this aspect of the arrearsproblem by assuming much of this type of debt itself. Since 1988, BM tLasbeen holding negotiations on these measures with the Government; it also helda great part of these arrears, exceeding Mt 40 billion (see Annex 3.06). Theother two banks are now undertaking similar negotiations with the Government;this will be especially significant for BPD which faces major arrears fromthe state farm sector (see Annex 3.13). As yet, the total amount of debtthe state will assume is not clear, although a mechanism has been found toprovide the necessary resources: i.e. the metical countervalue of funds madeavailable under the first two IDA Rehabilitation Credits has been (at leastpartially) earmarked for this purpose.

3.16 If the banks had to recognize the full extent of their currentarrears as a loss, they would all have highly negative net worth. Whetheror not write-offs are necessary, however, the current capital base of thebanking system is no longer adequate in view of the greatly increased assetbase. The capital to assets ratio was about 4? for BM in December 1987 afteran 82? capital increase 10/, 2.32 for BPD, and 1.12 for BSTM. Under thetechnical assistance component of the proposed Project these aspects wouldbe reviewed and the need for capital reconstruction evaluated. In order toreestablish a viable banking sector it is important that current negotiationsbetween the Government and BM for the clearing of lending arrears be alsoextended to BPD and BSTM. Assurances were received that the Governmentthrough BM would, on the basis of agreements with all commercial banks,formulate an action program to settle lending arrears of the commercialbanking institutions (including BM (Commercial), by December 31, 1991, andan action program for the rehabilitation of the banking system, by June 30,1992, for prompt implementation, to include performance benchmarks in termsof capitalization ratios and arrears ratios.

Organization and Operation of the Banks

Bank of Mozambique

3.17 BM is by far the largest of the three banks, and the one with thebroadest mandate. It was created in 1975 to take over the central banking

10/ Based on the ratio equity to gross assets applicable to BM'scommercial banking activities.

_ 23 -

role previously played by Portugal's Banco Nacional Ultramarino, and in 1978absorbed the Mozambican operations of four Portuguese-owned banks.

3.18 Branch structure and lending responsibilities. As Annex 3.04indicates, DM has 10 filiais (provincial head offices), 17 agencias (districtbranches) and 13 delegacoes (deposit offices). The limits attributed to eachbranch for credit approval are currently under review. Loans above theapproval limit of the manager of a filial are referred to headquarters forapproval. The loan request will be reviewed by the relevant lendingdirectorate (industry, agro-industry, or trade, transport and others) forsubmission to the Director, the department General Manager or, if necessary,the Governor for approval. Each directorate has three or four credit analyststaff, including on average one university graduate, with the rest eitherhigh school or vocational training graduates.

3.19 BM is concerned to improve the quality of analysis in its branches,in order to be able to delegate more approval authority to that level. Thiswould free the headquarters' analysts to put together new types of creditoperations and focus more on overall coordination. Among the constraints arethe number of qualified personnel; the problem is a national one, and BM asa whole has only some 20 university graduates. The lack of data processingand transport equipment is a further constraint. These problems are beingaddressed under this project through the training program and technicalassistance (Chapter 6), and are also the subject of bilateral donor aid.

3.20 Lending share. Annex 3.07 shows the distribution of credit bysector and bank. BM lending between 1987 and 1988 rose strongly in trade andLransport sectors, while lending to agriculture, industry and constructionfell in relative terms. This resulted in an overall lending decline in therelative share of agriculture from about 42? to 39Z of total lending, whileindustry's share declined slightly from 172 to 162. The overall share ofdomestic trade increased from 8? to almost 14?, construction and foreigntrade each accounting for about 7-82, and transport and communications forthe remaining 17-18Z.

3.21 The separation of central and commercial banking functions. The twofunctions of PM, as Central Bank and commercial bank, have been clearlydistinguished in the bank's Organic Law of 1975. However, in practice, AMhas not distinguished these functions for accounting or operations. A neworganizational structure was introduced in BM in 1987 in order to help definethe lines along which the central and commercial banking roles should beseparated (see Annex 3.16) 11/. Of the eight departments, two have purelycentral banking functions (Planning and Economic Studies, and BankingInspection), two have purely commercial banking functions and the remainingfour serve both parts of the bank. The separation of activities within threeof the remaining four departments poses no major conceptual problem, since

11/ The Bank of Mozambique's Board of Directors is entirely internallyconstituted, comprising the Governor and the eight departmentAdministradores (General Managers).

- 24 -

they are support departments 12/. The Department of International Relatioasand its directorates are responsible for negotiating all foreignloans/assistance to BM and to the Government. This involves issues ofinstitutional responsibility for foreign exchange risk. It is expected thatit may take some two to three years fully to resolve this and other controlissues and to reflect the results in BM's accounts. To this end a newaccoanting framework has been under implementation with IMf assistance in allthe banks since July 1989.

3.22 The separation of accounts of BM will permit all aspects ofoperations to be clearly identified as pertaining to either the centralbanking or the commercial banking function of BM. A full separation ofaccounts along these lines is not expected to be available before 1992,however, for reasons explained above. The establishment of a new commercialbank, and the transfer of BM's commercial activities to it, is also apossible option for the Government. Under the project assurances werereceived from the Government that a phased program for the separation of BM'scentral and commercial banking functions would be provided to IDA by June 30,1991, leading to its prompt implementation thereafter.

3.23 The Government's desire to introduce greater competition withinthe financial sector is constrained in practice by the lack of developmentof BH's central banking role (particularly its regulatory functions). Whilethe other banks also face constraints with respect to their operationalcapabilities, these can be most effectively resolved by allowing, and indeedencouraging, them to compete effectively. The etrengthening of BM's centralbanking role will thus continue to be of considerable importance. The recentshifts in new credit allocation show positive progress in decentralizationof the system, and under the Project an action program for extension ofcompetition would be formulated (see para 3.09).

3M's Financial Situation

3.24 Foreign exchange liabilities. The financial situation of thecommercial banking area of BM is sensitive to the decision about whether itshould retain foreign exchange liabilities on its balance sheet. Foreignmedium-to long-term debt booked at Mt 37 billion at year-end 1986 rose byend-1987 to Mt 413 billion, and Mt 612 billion by end-1988, due todevaluation. The difference constitutes as yet unrealized foreign exchangelosses. If foreign borrowing were accounted for as a commercial liability,then the separate commercial BM would clearly be insolvent (see Annex 3.10).

3.25 Because of the lack of an accounting division between central andcommercial functions, the allocation of overall responsibility for individualborrowings, and for associated profits and losses, will have to be clarifiedon a case-by-case basis. It will then be possible to reflect this status inaccounting terms using the new accounting framework. Given that in manycases foreign loans were contracted on the instructions of the authoritiesin order to finance the deficits of primarily state-owned and intervened

12/ These are the Departments of Legal Affairs and FinancialParticipations, Staff and Administration.

- 25 -

enterprises, it may be considered appropriate for most foreign exchangeliabilities to be placed on the Central Bank's balance sheet. These issuesare currently being addressed with the assistance of an IMF-financed advisor.

3.26 Deposits. Annex 3.05 shows the evolution of banking systemdeposits since 1980. BM's demand deposits were Mt 36.3 billion for a lendingportfolio of Mt 108.3 billion in December 1986: some of BM's lending wasfinanced by the other banks through their deposits with the Central Bank (Mt16 billion in 1986), as well as through foreign borrowing. In order to makeBM's commercial banking activities more self-financing, BM started to acceptterm deposits in 1987 and to stimulate sight deposits. BM's share in totaldeposits rose from 46S in 1986 to 592 by December 1988, capturing 69Z ofincremental deposits over that period. As a result, deposits rose to 752 oflending portfolio (excluding Government), as opposed to only 48Z in 1986(Annex 3.10).

3.27 Lending arrears. As stated in paragraph 3.15, the Government hasagreed to take over responsibility for about Mt 40 billion in BM loans tostate and intervened enterprises, which are in arrears and unlikely to becollectible. This amount represents only the principal in arrears, since BMdoes not accrue interest on doubtful loans. Annex 3.06 shows the evolutionof the different components of BM's loan portfolio. Of the Mt 40 billionthat the Government has agreed to assume, Mt 8.8 billion has been paid (outof countervalue paymeuts from firms receiving foreign exchange under thefirst two IDA rehabilitation operations), while another Mt 10 billion hasbeen rescheduled. As a result, the proportion of these arrears to BM'soverall portfolio is declining quite rapidly, dropping to 152 by December1988 from 342 in December 1987 and 411 in December 1986.

3.28 Other arrears considered capable of rescheduling have declined from422 of portfolio to 21Z over the same two years, while rescheduled amountsnow constitute 252 of portfolio, and doubtful debts remain fairly steady atabout 62. In the meantime, the satisfactory component of the portfolio hasincreased from 132 to 332, or to 582 if rescheduled amounts are included, orto 732 if the amounts the State has now agreed to assume are also included.BM's equity and reserves also increased substantially in the last quarter of1987, to Mt 25.9 billion; the adequacy of this is currently difficult tojudge, because of uncertainty as to the extent of the as yet unrealizedforeign exchange losses that may be allocated to the commer--ial banking areaof BM. However, BM is addressing the problem both from the point of view ofasset quality and capitalization, and its asset position has beenstrengthened.

Banco Popular de Desenvolvimento (BPD)

3.29 Banco Popular de Desenvolvimento (BPD) was formed in 1977,integrating the Instituto de Credito de Mocambique and Montepio deMocambique. It has traditionally been responsible for the financing ofagriculture (and, by extension, the rural sector), housing and construction,and for domestic savings mobilization. However, it is also empowered underits charter to invest in equity, new ventures, and take up commercial paper.This latter role has not been fulfilled, but recently a share capital

- 26 -

participation department was set up for the purpose. It also holds equity ina few enterprises, notably textiles, inherited from nationalized banks.

3.30 Bran4.h structure and capacity. BPD is 10O2 state-owned, with 10regional and 22 district branches, 46 deposit offices and 70 savingscollection posts. It thus has by far the largest branch network in thecountry, with 148 offices as opposed to BM's 40 (see Annex 3.04). BancoPopular de Desenvolvimento's current organizational structure is given inAnnex 3.08.

3.31 The credit approval limits for BPD branches are given in Annex3.09; loans for amounts above the General Manager's limits are submitted toBPD's President for approval. At headquarters, the lending operationsdirectorate is made up of four sections, three of which are responsible forlending by area (northern, central, and southern zones of the country). Thenumbers of staff and educational levels of credit analysts both inheadquarters and in the regions are very similar to those of BM. In 1987,BPD held a training course for credit analysts and is also receivingtechnical assistance from the Friedrich Ebert Foundation, and an AfDB loanis under preparation that would finance training and technical assistance.

BPD's Financial Situation

3.32 Liquidity. BPD's balance sheet (Annexes 3.10 and 3.11) showsconsiderable excess liquidity, largely because its savings mobilization rolehas combined with the lack of lending opportunities, due to, inter alia,shortage of foreign exchange. In December 1987, over 90Z of BPD's lendingportfolio consisted of nominally short term working capital loans, althoughit is understood that the proportion was reduced during 1988. According toBM figures, which exclude interbank deposits, in 1986 BPD had Mt 35 billionin deposits, but only Mt 22 billion in its loan portfolio (excluding loansto the State). By June 1988, deposits had increased to Mt 53.7 billion andloan portfolio to Mt 35.3 billion. According to BPD's own figures, depositswere Mt 61.8 billion in 1986, and Mt 102.3 billion by November 1988, ofwhich Mt 39.5 billion were deposits by the State. Lending totalled Mt 29.8billion in 1986, Mt 34.7 billion in June 1988 and Mt 53.4 billion in November1988. Thus in November 1988 liquid assets were about 402 of total assets.

3.33 Arrears. BPD has severe arrears problems. Including lending to thestate and state farms, Mt 33.9 billion of BPD's Mt 35.3 billion portfoliowere in arrears by June 1988. BPD considers that, with some rescheduling,itcould collect about Mt 6.0 billion of its arrears, but that it may not bepossible to reschedule a further Mt 27.9 billion (see Annexes 3.11 to 3.13).A large proporti^n of the arrears are old, with Mt 10 billion correspondingto loans granted before independence, and recent arrears increases have beenlargely due to interest accruals on old loans. Almost 93Z of BPD's lendingto the economy was to the state-owned sector, with about 1.6Z going tocooperatives, and 5.7Z to the private sector. Loans to the state sectoraccounted for 97?Z of BPD's arrears in late 1987 (91.5Z of state portfolio inarrears), while cooperatives accornt for 0.62 (35.72 in arrears), and theprivate sector for 2.6? (39.62 in arrears). A start has been made inresolving state sector arrears and it is understood that in 1988 arrears werereduced to about 502 of total portfolio, while the proportion of lending to

_ 27 -

the state sector was reduced to 67Z. BPD is negotiating with the Governmenton a more comprehensive resolution of its arrears problem, based on detailedanalysis of individual loans (see para 3.16).

3.34 Earnings and capital base. As noted above, the overhang on BPD'sdeposits relative to lending has increased since 1986, as lending droppedfrom 702 of deposits in 1986 to 572 in 1987. However, the increased interestrates introduced in 1987 more than compensated for potential earnings loasesbecause of the increased average spread over borrowing rates. This effecthas been reduced however from 1988, when CCADR started borrowing from BPD ata lower rate than BPD would lend directly to the agricultural sector. (Seepara 3.36). Despite the higher expected net income, BPD's capital base, atabout 2.32 of total liabilities, needs to be strengthened.

3.35 Future role. At present, BPD is trying to define its possiblefuture role in Mozambique's evolving financial sector. BPD would like tooffer a full range of development banking services, as allowed in itscharter, lending more to indistry and the service sectors, with a significantrole in financing long term investment, as well as possible equity financing.BPD has also established a small but apparently successful microenterprisecredit program with the Ebert Foundation which has disbursed about US$1.2million to 60 units, largely agro-processing in rural areas (see para 2.48).Under the IDA Urban Rehabilitation Project BPD is also responsible formanaging credit to small and micro-enterprises in the building materialsindustry.

3.36 Caixa de Credito Agrario e Desenvolvimento Rural (CCADR).The agricultural credit fund, CCADR, was established in 1988 as a mechanismto channel credit to the rural sector. It is managed on behalf of theGovernment by BPD. It started operations in the second quarter of 1988,lending Mt 5.6 billion in 1988, mainly to agriculture and industrialprocessing activities. The CCADR provides subsidised credit (at a currentinterest rate of 62). Significant growth of the fund would not be consistentwith rationalization of the financial sector. Its principal rationale is tochannel donor finance to contractually agreed uses, and it is a fund ratherthan a bank insofar as it does not intermediate private or commercialdeposits. Provided that CCADR retains a small share of the market, andinvolves a transparent form of subsidy financed by resources outside thebanking system, it should not in principle adversely affect the financialreform program.

Banco Standard Totta de Mocambique (BSTM)

3.37 Branch structure. BSTM is the only private bank remaining in thecountry. The number of branches has declined, however, from 44 beforeindependence to 7 today. The bank's ownership is made up as follows:Standard Chartered UK, 302; Standard RSA, 52; Totta e Acores Portugal,302; Fonsecas e Burney Portugal, 102; Anglo American RSA, 52, and others201. BSTM lost its foreign exchange license after the restructuring of thebanking sector at independence, which contributed significantly to thedecline in the bank's operations. However, in 1988 BM granted BSTM a lUn'tedforeign exchange license, for personal transactions, and BSTH is planning toopen two new branches in 1989. This is a positive development, which

- 28 -

complements the increased share of lending by BSTM. Assurances have beenreceived from the Government that an action program for the extension ofcompetition would be undertaken (see para 3.09). In addition capitalizationand arrears targets will be required (see par& 3.16). BSTM can be expectedto continue to rehabilitate traditional commercial banking activities in thefuture, and has recently started discounting bills.

BSTH Financial Situation

3.38 Liquidity. Although it has operated on a much smaller scale thanthe other two banks, BSTM has had the same type of deposit overhang as BPD,with 1986 deposits totalling Mt 7.6 billion while its loan portfolio amountedto Mt 3.8 billion (Annexes 3.10 and 3.13). By August 1988, portfoliototalled Mt 6.7 billion vhile deposits reached Mt 18 billion ( Mt 11.7billion according to BM figures for Sept 1988). Almost all lending has beenshort-term, to urban commercial enterprises. For a number of reasons,including portfolio arrears, deposit overhang, and the fact that BSTMdeposits at the Central Bank are not remunerated, BSTM is not currentlypaying interest on current accounts nor accepting time deposits.

3.39 Arrears. BSTM also suffers from a serious arrears situation, withclose to Mt 1.8 billion (about 40X) of portfolio classified as doubtful in1988, most of which stems from the period just after independence. Again,however, this amount is dwindling quite rapidly as a proportion of totalportfolio. BSTM has constituted provisions against some of its bad loans,and adds to them each year. However, BSTM's capital base of 1.1 ofliabilities is inadequate and declining in relation to the increase innominal value of assets. Once BSTM has defined capital adequacy requirements,BSTM's shareholders would be expected to inject new equity into the bank.

TV- Financial Sector: Summary and Conclusions

3.40 Mozambique's financial sector is underdeveloped and not on a soundfinancial footing at present, with serious arreaL-s and toe small a capitalbase. However, a good start has been made in the complex transition from acentrally planned environment to a market economy. The separation of BEWs twobanking functions is inevitably quite a lengthy process, and could probablynot be speeded up significantly since the principal binding constraint ismanagement time. Timely provision of the institutional support alreadyplanned under other IDA projects in Mozambique will also be important.Interest rate reform has maintained progress and positive real interest ratesshould be achieved in 1990 given the current decline in inflatic.n andincrease in nominal rates. The arrears situation is being addressedprogressively by the Government. The banks' capital base is an area thatwill perhaps take longer to address, in BM's case because a final evaluationof the needs can only be made when the two functions are fully separate inaccounting terms; in addition, the shortage of Government resources may delayequity increases for BM (Com.ercial) and BPD -- assuming that they are bothto remain fully state-owned.

- 29 -

3.41 In the meantime, the policy measures that DM has taken haveinvolved cautious but sustained steps towards revival of commercial banking.In addition, the financial sector is reflecting the changes in the realeconomy, with the recent shifts in the sectoral distribution of credit, aswell as an increasing share of lending being channelled through the otherfinancial institutions. These are all strong indicators both of BM's intentto continue liberalizing the system and of the syst3m's basic capacity toadapt to the changing environment.

The Role of the Small and Medium Enterprise Develoment Prolect in theFinancial Reform Stratea

3.42 The Project is designed to support the Government's strategy forfinancial sector reform. The proposed apex line of credit would be amultibank instrument which would assist in the extension of competition, andreintroduction of longer term investment lending and appraisal skills. Underthe Project a series of formal action programs would be prepared andimplemented, for the separation of the commercial and central bankingfunctions of EM, the clearance of lending arrears and financial restructuringof the commercial banks, the introduction of performance guidelines, thecontinued extension of competition within the banking s ctor, and theupgrading of the accounting capabilities of the commercial banks. The Projecttherefore focuses particularly on the micro aspects of banking system reform,while also addressing issues such as institutional change. Under an annualproject implementation review interest rates will also be monitored. Finally,the Project addresses the real economy issues of improving the efficiency ofindustry through lending to viable enterprises, and fills a supply gap inmedium-to long-term credit during the continuing financial reform process.

The Demand for Industrial Credit

3.43 The market for longer term indurtrial credit is difficult to assessbecause of the disruption on both the supply and demand side over the pastfew years. Supply of longer term credit has, as discussed above, beenconstrained by a series of interlinked problems, including interest raterepression, contraction in banking capacity, shortage of foreign exchange,and emphasis on short-term lending and financing of enterprise deficits onGovernment instruction. More recently, domestic credit ceilings have alsobeen imposed, partly in order to reduce or eliminate bank financing ofenterprise deficits. Supply conditions have started to improve with interestrate reform, institutional reorganization and reactivation of the privatesector. On the demand side, credit requirement projections cannot bemeaningfully based on past trends because of the disruption of lending. Inorder to gain an initial estimate of likely financing requirements, a creditsurvey was carried out as part of the preparation of the project,

3.44 The industrial credit survey was designed to obtain some indicativeinformation about the appropriate size of the proposed lending program. Atotal of 200 questionnaires were di.stributed by the Government toenterprises, and 120 responses were received. A summary analysis of theresults is given in Annex 3.14. The survey has a number of limitations,notably the fact that estimated financing requirements of a number of firms

- 30 -

were highly tentative, and also because it could not be ascertained a prioriwhether the enterprises responding would qualify for loans on profitabilityor economic efficiency grounds, especially given the uncertainty of demand.Finally, it should 'Js noted that demand for foreign exchange does notnecessarily imply a need for credit as such. However, given the depreciatedvalue of metical savings balances, a requirement for long-term credit islikely to account for the bulk of stated foreign exchange needs for equipmentand inventories. The results of the survey may be regarded as a startingpoint.

3.45 The total estimated requirement for 119 enterprises was US$61million, excluding a single proposal of US$10 million for one enterprise. 75enterprises were at national level (roughly above 50 workers), and 44 atlocal level (below 50 workers) of which all were in the Maputo area. Totalrequirement at larger scale (excluding the largest proposal), was US$55million, and at small scale was US$6.0 million. Average loan size for thelarger scale group was US$822,000, of which US$420,000 was for fixed andUS$402,000 for working capital. For the smaller scale group average loan sizewas US$127,000, of which US$78,000 was for fixed and US$49,000 for workingcapital.

3.46 Direct extrapolation of the sample of 75 national level enterprisesfor the sector as a whole (580 enterprises) is inadvisable due to the degreeof uncertainty of the sample estimate. If it is assumed that 25Z of thesample estimate of $55 million were economically viable enterprises, thenextrapolation would lead to a total requirement of about US$110 million forfixed and working capital. Given the time period needed to implement majorreplacements,or new investments, the phasing of such a requirement wouldprobably be realistically over a three year period. Extrapolating from the44 local enterprises to the national estimate of about 600 enterprises in thesize range 10 to 50 workers is even more hazardous since the sample isconsiderably less representative. A lower bound estimate of US$20 million isprobably a conservative starting point for smaller enterprises. The targetgroup for the present project (enterprises of up to about 200 workers)consists of approximately 502 of the total requirement in the larger scalegroup of enterprises surveyed and the whole requirement of the smaller scalegroup, amounting to approximately US$75 million over about a three yearperiod, at an average investment of about US$ 250,000. At an average subloansize of $250,000, the total number of subloans under the proposed IDA Creditwould be about 110.

3.47 The scale of the proposed IDA enterprise Financing Component(US$28.5 million equivalent) may be regarded as conservative in relation tothe requirements estimated through the survey. There is clearly a pent updemand for credit in the industrial sector, although it cannot beascertained, a priori, whether this is from viable and bankable applicants.Under the SHE Project viability would be established prior to the grantingof any loans to enterprises.

_ 31 -

IV. THE PROJECT.

Project Objectives

4.01 The aims of this project are as followstl

X (a) to promote the development of the industrial sector byproviding medium to long-term foreign exchange financing

focussing on notentially efficient small to medium-scaleenterprises in the industrial, mining, agricultural-related,transport, construction, and other commercial subsectors,capable of efficient operation within the reformed businessenvironment.

(b) to promote institution rebuilding by restoring the capabilityof the public and private sector financial institutions of thecountry, and to facilitate the development or rehabilitationof an effective medium to long-term finaucing capability forenterprises.

(c) to assist in the formulation of Government policy forindustrial and financial development with emphasis on smalland medium enterprises.

The Role of IDA and The Rationale for Assistance

4.02 General IDA involvement In Mozambique. Eleven credits have beenmade to Mozambique up to November 1989, including both general balance ofpayments assistance and project related investment credits. The principalmacroeconomic support has been through three rehabilitation credits whichhave been designed to support economic policy changes in particular relatingto pricing and exchange rates, and to decontrol of production anddistribution. The objective of sector investment credits has been to supportsupply responses in directly productive activities, to take advantage ofimprovements in the macroeconomic environment, and to support rehabilitationof social and economic infrastructure. The present project would complementthe existing IDA assistance strategy, and the Government's EconomicRehabilitation Program (ERP), by strengthening the industry and financesectors tiarough the finance of potentially efficient industrial enterprisesand by strengthening the financial institutions.

4.03 IDA's role in the Industry and finance sector. Since the start ofthe ERP in January 1987 external assistance to the industrial sector hasconcentrated on balance of payments support to finance recurrent imports ofmaterials and spares for a range of consumer and intermediate goods, notablyfood products, textiles and tires, and also for technical assistance. Underthe First Rehabilitation Credit (1610-MOZ) US$37 million went mainly to lightindustries, and approximately US$25 million has so far been allocated toindustry under the Second Rehabilitation Credit (1841-MOZ). The result ofthese inputs has been to assist industrial production to increase by 6-72 in1987, the first increase after six years of rapid decline in output. However,this type of assistance does not address the longer term issues of theviability and structure of the industrial sector as a whole, nor the creation

- 32 -

of an environment in which efficient industries are encouraged to expand. Itis this need which is addressed through the present project. In addition IDAis considering a credit under the proposed Industrial EnterpriseRestructuring Project, which will focus on selected larger scale enterprises.

4.04 Restructuring the financial system is of particular importance forindustry. The banking sector has contracted significantly and is currentlyunable to perform adequately the functions of mobilizing savings andintermediating credit. The banks need strengthening in order to effectivelyprovide medium to long ter-m loans for industrial investment. Given the seriesof measures for financial reform already taken by the Government, andoutlined in Chapter 3, and the clear resolve of the Government to revitalizethe sector as central planning is phased out, this is an opportune time toassist in maintaining the momentum of revival, and at the same timestrengthen portfolios, ensuring that the banks develop the capability forprudent investment lending. The project would fill a supply gap in medium-to long-term financing within the ongoing reform process.

Proiect Concept

4.05 Efficient allocation of medium to long-term credit requires lendingbased on assessments of profitability, both in financial and in economicterms, as well as the reestablishment of conventional banking criteria.Economic analysis is important given the changing but still protectedindustrial environment, and continuing need to adjust relative prices.

4.06 The Project focuses on the small and medium enterprise sector; thisis defined approximately as including enterprises with less than 200 workers.The importance of the sector is reflected in the fact that small and medium-scale industrial enterprises, as defined, currently account for a significantproportion (46Z) of industrial employment. The Credit is directed to a widerange of subsectors, with a focus on manufacturing, but with the expectationthat subprojects will also materialize in subsectors such as mining,agribusiness, construction (including building materials), transportation,distribution and commercial services. A directed credit of this type isjustified by its relatively broad focus, and by the likelihood that sourcesof indigenous entrepreneurship, skill formation and growth would originateacross the broad spectrum of efficient smaller enterprises. Moreover, giventhe large number of enterprises within the sector, there is a need to createan effective decentralized institutional framework to appraise and financeproject proposals. The microenterprise sector (under 10 workers) hasexhibited particular resilience to the economic difficulties of the countryand it is intended that the Credit would be available for enterprises at thisscale as well as those in the formal economy.

4.07 The proposed lending operation is a means of rehabilitating thefinancial system by reintroducing the techniques and criteria for termlending, so that investment funds reach enterprises which are likely to haverelatively favorable long-term prospects, and bank lending portfolios canbegin to be strengthened. In order to achieve its objectives the Projectfocusses on the environment for efficient industrial investment and banklending.

- 33 -

Proiect Description

4.08 The Project is divided into two main components: (i) an enterprisefinancing component (EFC), and (ii) an institutional strengthening component.The EFC consists of a line of credit to be onlent through the banking system.The institutional strengthening component consists ofs (a) technicalassistance; and (b) training, the latter two components being designed toupgrade the lending capability and financial management of the banks and theindustrial promotional infrastructure. The proposed IDA Credit would be madeavailable by the Government to BM through a Subsidiary AdministrationAgreement. Formalization of the Subsidiary Administration Agreement, underterms and conditions approved by IDA, would be a condition of Crediteffectiveness.

The Enterprise Financing Component

4.09 The EFC would involve a line of credit to finance fixed assetinvestment, associated incremental permanent working capital and projectpreparation services. The EFC would be managed by an apex unit (Unidade deGestao de Projecto -- UGP) within the central banking area of BM, establishedwith its own operating policies and procedures. Funds would be onlentthrough the participating financial intermediaries (PFIs), which are expectedto comprise all three commercial banks. 13/

4.10 Approximately US$28.5 million of the IDA funds would be madeavailable through the Subsidiary Administration Agreement to finance the EFC.In addition, cofinancing of US$7.5 million has been proposed by other donors.The PFIs and Government are expected to contribute about USS million incomplementary financing in local currency, with a further minimumUS$5 million equivalent expected as equity participation from enterprises.It is expected that the line of credit would be committed within a four tofive year period after Credit effectiveness. There would be no pre-established allocation of credit funds between the PFIs, although it islikely that the commercial area of BM would account for the largest share dueto its predominance in the finan-ial system. The foreign exchange risk wouldbe borne by the Bank of Mozambique on behalf of the Government, while thecommercial risk would be borne by the PFIs. The finance of eligibleenterprises would be on the basis of prior apprais&.L.

4.11 The UGP would be responsible for the management and supervision ofthe EFC, and would review the aporaisals and would have to approve subloanapplications above the free limit granted to the PFIs. It would also morLitorsubproject eligibility, terms and conditions of onlending, approval limits,select'ic. criteria and procurement, and be responsible for disbursements,munitoring and reporting, and other issues.

13/ The role of the Central Bank in the channelling of funds is addressedin paragraph 5.01.

- 34 -

Technical Assistance and Training

4.12 The technical assistance will consist of: (a) the provision ofexpertise to assist in the implementation and operation of the line ofcredit, (b) assistance in the strengthening of banking capacity andindustrial policy formulation; (c) strengthening of the Instituto Nacionalda Desenvolvimento de Industria Local (IDIL) and (d) subproject preparation.Technical assistance for policy analysis has also been provided through theBusiness Environment Study, funded by UNDP.

4.13 The proposed assistance to DM would take the form of the provisionof an adviser to the apex unit and a provision for consultancy assistance toaddress problems connected with the upgrading of the accounts of theparticipating banks, and the development of the financial sector. Assistanceto IDIL would be in the form of the provision of two advisers to establisha small business advisory service in Maputo and Beira. A further provisionis for subproject preparation and appraisal services, and for requiredstudies of banking and industrial development issues.

4.14 The training program for credit and project analysts began inFebruary 1989 and is due to be completed prior to the effectiveness of theCredit; it is financed by UNDP. It consists of a series of seminars andworkshops, designed to provide required analytical skills in projectappraisal for about 50 members of staff of the BM and PFIs, and someadditional participants from IDIL and the Ministry of Industry. The programis designed to upgrade the skills required to operate the credit line as wellas more general bank lending skills. Additional IDA funding is proposed forfollow up training after the completion of the program.

The Demand for Credit

4.15 Projections of past bank lending as indicators of credit demand arenot meaningful because of the virtual halt in investment lending over thepast few years, and the abandonment of normal bank lending criteria. A creditsurvey of 120 responding enterprises is reported on in paragraph 3.44 andfollowing. A preliminary indication of the scale of financing that might berequired for the sector as a whole, including both fixed and working capital,on the basis of survey and other estimates, is at least US$130 million frompotentially economically viable enterprises. The proposed Credit would meetpart of this need.

4.16 The proposed total IDA Credit is expected to be onlent at anaverage rate of about US$5 million per annum, which would amount toapproximately 1OZ of total 1988 domestic disbursements by the banking systemto the economy 14/.

14/ At the exchange rate of Mt 813 - US$1.00.

_ 35 -

Project Costs and Fimaucina Plan

4.17 Project costs and financing are presented in Table 4.1 and inAnnex 4.01. Total project cost is estimated at about US$50.2 millionequivalent of which US$39.5 million would be in foreign exchange. The IDAj component of U$ 32 million would therefore finance about 641 of the total.

4.18 The Project cost breakdown has a number of implications. First ofall, the contribution of the participating banks is expected to be relativelysmall; this reflects a relatively low share of the financial costs ofinvestments in local currency in the case of rehabilitation projects whereinfrastructure and civil works are already in place. Secondly, a minimumassumption is made that 10 of the subproject's financing requirements willbe met through local equity investment. The main contribution of theGovernment is in terms of a share of operating costs of the apex unit,support to the training program, administrative support to the IDIL advisers,and some equity type participation, based on existing assets.

TABLE 4.1(a)PROJECT COST ESTIMATES

Local Foreign Total Z ofCost Cost Cost Total

(USSmillion)(1) Enterprise Financing Comnonent

Civil works, machinery,equipment, spares, materials 10.00 34.07 44.07Consultants services 0.50 1.50 2.00

Sub Total 10.50 35.57 46.07 91.8

(2) InstitutioDal StrengtheningCompoaent

IDILAdvisers - 0.36 0.36Equipment, facilities 0.05 0.07 0.12

Apex UnitIBMAdviser - 0.36 0.36Equipment, facilities 0.05 0.20 0.25Materials, operating costs 0.05 0.10 0.15

Consultants ServicesStudies (financial/indus) - 0.24 0.24Training 0.05 0.48 0.53PFI accounts upgrading - 2.00 2.00

Policy Study (Businessenvironment) - 0.12 k.12

Sub Total 0.20 3.93 4.13 8.2

(3) TOTAL 10.70 39.50 50.20 100.0

- 36 -

TABLE 4.1(b)PROPOSED TINKCING PLAN

Local Foreign Total 2 ofCost Cost Cost Total

(USMmillion)(1) Eaterprise Financina Component

IDA - 28.57 28.57European Investment Bank - 7.00 7.00Enterprises 5.50 - 5.50Participating Banks 3.00 - 3.00Government 2.00 - 2.00

Sub Total 10.50 35.57 46.07 91.8

(2) Institutional StrengthennComponent

IDA - 3.43 3.43UNDP - 0.50 0.50Government 0.20 - 0.20

Sub Total 0.20 3.93 4.13 8.2

(3) Totals 10.70 39.50 50.20 100.0

of which:

Total IDA - 32.0 32.0 63.7Total Cofinancing (EIB, UNDP) - 7.5 7.5 15.0Total Banks and Enterprises 8.5 - 8.5 16.9Total Government 2.2 - 2.2 4.4Total 10.7 39.5 50.2 100.0

4.19 Parallel cofinancing of ECU 6.0 million (about US$7.0 million) hasbeen provisionally proposed by the European Investment Bank. UNDP cofinancingof US$0.5 million for project preparation and training has been committed.Given the apparent substantial unrealized demand for credit by industry.discussions are taking place with other possible sources of cofinancing,which may be included during project implementation. The terms of theonlending of external funds would be as detailed for the IDA Credit inChapter 5, according to prevailing interest rates for term lending, andcommercial bank spreads of a proportion of the onlending interest rate. Thereview and development of cofinancing activity would be addressed in theannual project implementation review (see para 10.03(e).

- 37 -

V. ANALYSIS OF THE ENTERPRISE FINANCING COMPONENT.

The EnterDrise Financing Component and its Rationale

5.01 The enterprise financing component (EFC) would be administered bythe Central Bank, under a Subsidiary Administration Agreement between theGovernment and the Central Bank, through an apex unit (Unidade de Gestao deProjecto - UGP). The apex unit has been formally established within the BM(Zentral) in order to permit it to operate independently of the otherfunctions of BM (Central), with a specific statement of operating policiesand procedures and a participation agreement with the commercial banks (seeAnnexes 5.01 to 5.04). It is expected that this would help to preventpossible conflicts of interest in the approval of loans and the managementof the credit in general. In this respect it should be noted that the UGPwould be independent of the regulatory and control functions of the centralbank, and that all credit risk would be borne by the commercial banks.Therefore the UGP would not interfere with the process of separation of thecentral vis a vis commercial banking. The credit would be channelled throughparticipating fV'ancial intermediaries (PFIs) to the final beneficiary (FB)enterprises. It is intended that all three commercial banks (viz: thecommercial banking area of BM, the BPD, and BSTM) would operate as PFIs. Theline of credit would finance medium to long-term lending for fixed assetinvestment and associated incremurntal permanent working capital needs throughsubloans made by the commercial banks and refinanced up to 90Z by the CentralBank.

5.02 The need for the financing component derives from the aim ofrehabilitating the financial system. As stated in chapter 3, almost all non-agricultural lending is short-term and principally for working capitalpurposes, and a series of factors have constrained supply, related to theinstitutional structure and interest rates. What long-term lending existsis generally linked to assistance from foreign donors (recipient firms arenow expected to pay over a period of time the local currency cost of donorinputs, including both technical assistance and equipment). Provision ismade under the prevailing interest rate structure for longer term lending bycommercial banks but longer term lending has largely ceased, inter-aliabecause the premium of long-term over short-term rates does not adequatelyoffset the perceived additional risk to the banks. The commercial banks arealso financed primarily, and increasingly, by sight deposits, furtherdiscouraging longer term lending. The Project would fill a gap in the supplyof medium-to long-term financing during the period of financial reform.

5.03 The proposed apex line of credit for long-term investment lendingwould be a new type of financial instrument for Mozambique. It wouldintroduce a structure (apex unit and channelling mechanivm) that can be usedas a general financing instrument for future IDA or other external lines ofcredit through the central bank, in addition to its immediate role in therevival of long term investment lending. The principal advantage of an apexoperation lies in its ability to involve the banking sector as a whole in theproposed project, including the private bank which has been marginalised overthe past few years, with resulting broad-based improvement in appraisalcapability and portfolio quality.

_ 38 -

The Apez Unit CUGP) and Institutional arranmente

5.04 The enterprise financing component would be channelled through the(UGP) in BM (Central) , vith funds being onlent through the PPIs. The UGP hasbeen set up as a unit within the International Relations Department under thecentral banking function of BM.

5.05 In addition to its manager who has been appointed, the staff ofthe UGP would consist of two senior level project analysts, at least one ofwhom would have an accounting background, two administrative officers, andsupport staff. The Central Bank and UGP are receiving assistance from anexpatriate technical advisor in setting up the line of credit mechanism andin the operations of the UGP for a total of 36 months, initially financedunder a PPF. The project analysts to staff the UGP may be selected in parton the basis of achievement under the training programs (para. 6.09). TheUGP would be fully staffed, with an adviser, two project analysts, twoadministrative officers and support staff, and operational, as a conditionof Credit effectiveness.

5.06 i project steering committee (Comissao Interdepartamental -CI) hasbeen set -.p to oversee the implementation of the project. The CI would bechaired B 3M (Central), and membership would comprise Ministries of Finance,IndustrJ and Energy, Commerce and Trade, and the National PlanningCommission, plus, at BM's discretion representatives of other relevantsubsector Ministries, PFIs, and the private sector (e.g. the Chamber ofCommerce). Once the proposed project becomes effective, CI members would bekept informed on a regular basis as to progress of operations under the lineof credit and the project as a whole, and would organize formal meetings asrequired (see Annex 5.05).

5.07 The UGP would receive a spread of 0.5Z per annum on the outstandingvalue of subloans to cover its administrative expenses. While expensesduring the start-up period may exceed initial receipts, revenues when theproposed project is underway should compensate for this (see Annex 5.06).The principal functions of the UGP would be to:

(i) ensure adherence of PFIs to established procedures inselecting eligible subprojects and ensure application ofappropriate standards for subloan appraisals;

(ii) review the eligibility and authorize financing under theline of credit for subprojects submitted by PFIs, subjectto IDA approval where appropriate. For subloans of up toUS$100,000 equivalent, the UGP would only ensure that therequests meet the eligibility criteria (paras 5.23 and 5.24)and would give its clearance, confirming the rediscountrequest, within ten working days of submission. For subloansbetween US$100,000 and US$250,000 equivalent, the UGP would,within ten working days, review the requests in more detail,make any comments on the quality of the appraisal to thePFI, and ensure that the eligibility criteria were met. Forsubloans above US$250,000 equivalent, the UGP would

- 39 -

undertake the above steps prior to submitting the subprojectto IDA for approval;

(iii) through the CI, facilitate issuance of import licenses forenterprises receiving subloans (see para 5.19).

(iv) administer the Special Account (para. 7.02), ensuring properdisbursement of funds, and supervise and centralize thecollection and forwarding of supporting documentation;

(v) monitor the PFIs' compliance with their various obligationsunder the Project (para. 5.08);

(vi) supervise, on a sample basis, SME subprojects;

(vii) ensure liaison between IDA and the PFIs on matters relatingto SME subprojects, and maintain records required forsupervision and project completion reports by IDA (seeAnnex 5.07).

(viii) act as Secretary to the CI (project steering committee).

A model form of agreement is at Annex 5.01.

Participating Financial Intermediaries

5.08 All three commercial banks operating in Mozambique will be eligibleto participate as financial intermediaries under the proposed project,providing the commercial bank has entered into a participation agreement withthe Central Bank, under terms and conditions satisfactory to IDA. Thisagreement would, inter alia, specify that the PFIs shouldt

(i) designate qualified staff to manage the loans financed bythe proposed project;

(ii) perform satisfactory subproject appraisals and submitrequired appraisal reports to the UGP;

(iii) ensure that resources are used by the final borrowers forthe purposes intended and that procurement proceduresacceptable to IDA are followed;

(iv) supervise subprojects according to required schedules andprovide the UGP with periodic reports on the status ofsubprojects;

(v) adhere to terms of lending and repayment of loans; and

(vi) provide the UGP and IDA with such information as they mayreasonably request.

- 40 -

5.09 Receipt by IDA of satisfactory signed and authorized participationagreements between the Central Bank and at least two commercial banks wouldbe a condition of Credit effectiveness. Receipt by IDA of a satisfactorymodel subloan agreement between each participating bank and beneficiaryenterprises would be a condition of first disbursement by each particpatingbank.

5.10 BM will be acting in both its capacities, namely as the CentralBank and as the leading commercial bank, with no legal separation of the twofunctions. While work is underway to achieve a clear separation betweenthese functions, BM does not expect that a full separation of accounts wouldbe available before 1992. However, the new accounting framework, which hasbeen introduced, will enable BM to distinguish between central and commercialbanking roles for any given operation (see para 3.22).

5.11 It is expected that all three commercial banks would participateunder the EFC of the proposed project, although it is likely that thecommercial bank'rig area of BR will account for the largest share ofoperations, reflecting its general predominance.

Operating Mechanism and Credit Hanagement Process

5.12 The IDA Credit would be made to BM (Central), acting as theGovernment's agent, which would onlend funds under the line of credit to thePFIs in local currency, which in turn would onlend it to beneficiary SMEs.The foreign exchange risk would be borne by EM (Central) on behalf ofGovernment. A residual spread, estimated to average around 'II at currentinterest rates, would be retained by the Government through Bh .o cover thecosts of administering the line of credit through the apex unit and to offsetthe foreign exchange risk.

5.13 The interest rate to beneficiary SMEs would be in line with thecurrently prevailing interest rate structure in Mozambique, and would bevariable with changes in thi' structure (paras 3.07 and Annex 3.01 detail theexisting rate structure). 'he present interest rate structure has beenestablished by the Government according to a Despacho of September 1989.This structure is in accordance with a program agreed between the Governmentand the IMF in which the level of interest rates will evolve so that theybecome positive in real terms by 1990. The revised interest rate structureintroduced in January 1989 raised lending rates for terms over one year tobetween 22Z and 342 (and 22-352 in September 1989), and was also considerablysimplified. To the extent that these areas may cease to be coveredc byagreements with the DMF, assurances were received that an annual proiectimplementation review by the Government and IDA would take place, in orderto review onlending terms and cenditions, and progress on the achievement ofpositive weighted average real onlending interest rates.

5.14 The PFIs would pay interest on funds onlent by the Central Banksuch that they would receive a spread of a percentage of the onlendinginterest rate which would be higher for longer maturity subloans withmaturities over 7 years. The onlending interest rate would be based on therate determined jointly by the Ministry of Finance and BM. The spreadformula has been determined as a result of consultations within the banking

- 41 -

system, and is based on current bank'ng conditions. It reflects therelatively high administrative costs of such projects, and the need to ensurethat the spreads are realistic by comparison to those on other funds inMozambique at the present time. The perceived risk on lending, andespecially on medium to long-term lending for investment purposes, iscurrently high. Provisionally, BM (Central) has proposed that it wouldretain a 73Z 3f the final onlending rate for subloans of up to a seven yearterm, and 651 for subloans of more than a seven year term; this isapproximately equivalent at current rates to a spread range of 7 to 9? (seeAnnex 5.01).

5.15 Funds under the line of credit would be onlent to the PFIs in localcurrency, with tte same maturities as the individual subloans to finalbeneficiaries. Subloan terms to beneficiaries wouid range from a minimum ofthree to a maximum of twelve years, inclusive of grace periods of one to fouryears. The Central Bank may subsequently relend repaid amounts to PFIs forsimilar purposes in line with the objectives of the project, through itsrediscounting mechanism, for a period of up to 20 years from the date ofCredit effectiveness.

5.16 Subloans granted under the line of credit could finance up to 90Zof the total project cost for rehabilitation/extension subprojects and up to80Z for subprojects carried out by tLew enterprises to limit the debt toequity ratio of new projects. Thus, entrepreneurs would be required tofinance a minimum of 102 and 202 of subproject costs for existing and newfirms respectively. However, in exceptional cases, and only if the relevantPFI agrees, the 20? minimum participation for new projects could betemporarily reduced to 10 at the beginning of a project if all generatedprofits are applied to reach 20X as quickly as possible.

5.17 Subloan processing under the line of credit would be coordinatedby the UGP, which would serve as the principal link between IDA, the PFIs andthe beneficiaries of the proposed project's enterprise financing component.The UGP would send subprojects for approval to IDA, according to the laiddown approval criteria (see para 5.24).

5.18 Initial preparation of subprojects will be undertaken by potentialbeneficia.y firms, which may seek assistance from IDIL or private consultantsif necessary, and presented to the PFI of the firms' choice. The PFIs wouldreview the subprojects in accordance with their own loan analysis proceduresand with operating requirements defined under the EFC (Annexes 5.01 to 5.03).PFIs would then prepare for submission to the UGP an appraisal reportaccording to a standard format, which would vary in depth and detaildepending on the size and nature of subprojects. The report would coverrelevant information about the enterprise and the proposed investment,including its technical soundness, financial viability, economic efficiencyand managerial capacity. The report would also set down loan securityrequirements. Financial rate of return (FRR) calculatioDs would be requiredfor all subloans, on the basis of cash flow analysis, with balance sheetanalysis also required for subloans above US$100,000 equivalent. An economicrate of return (ERR) calculation would also be required for subloans aboveUS$250,000 equivalent.

- 42 -

5.19 The UGP would review the appraisal reports to verify that alleligibility conditions are adequately met. This review would be carried outthrough a checklist of these conditions, which would be supplemented forsubprojects above the PFIs' free limit by a more thorough process to reviewthe viability of the firm and the subproject (Annex 5.03). If the subprojectis eligible for financing and viable, the UGP would authorize (subject toprior IDA approval for the largest subprojects) the corresponding rediscount.With a view to accelerating subproject implementation, it was agreed that,through the CI, the issuance of import licences to enterprises receivingsubloans for imported goods would be facilitated y the Ministry of Commerceand Trade, and a supplemental letter to that effect would be included.

5.20 Mozambique's foreign exchange position is expected to move towardsequilibrium and to permit phased liberalization, inter alia, throughextension of the system introduced under the IDA Third RehabilitationCredit 15/. However, there is a likelihood of foreign exchange bottleneckswhich could cause problems for enterprises which require replenishment ofimported supplies beyond the period allowed for working capital under thecredit (maximum one year). These bottlenecks may occur as a result of thetransitional excess demand for foreign exchange and the segmented nature ofthe foreign exchange market. Consequently, it was agreed that a supplementalletter would be included confirming that, for subprojects financed under theline of credit, the Government would facilitate allocation of foreignexchange for imported inventory replenishment.

5.21 Because this is the first project of its kind in Mozambique, thefirst three subprojects from each PFI, as well as the first three subprojectsrequiring UGP approval, would be subject to prior IDA review and approval.Thereafter, with the exception of subprojects over US$250,000 equivalent,which would require prior IDA approval, IDA would review a sample ofsubprojects on an ex-post basis during supervision missions.

5.22 PFIs would be responsible for making supervision visits to SMEsreceiving Project funds, for maintaining adequate records to monitor theevolution of subprojects, and for reporting to the UGP on the progress ofeach subproject and the status of the corresponding subloan. For thispurpose, trar -portation equipment is provided for under the technicalassistance subcomponent of the Credit. Supervision reports, ir. a standardformat prescribed by the UGP, would be required from the PFIs at least twicea year until the loans are repaid. These supervision responsibilities of thePFIs are specified in the Participating Agreement which the PFIs would signwith the Central Bank (see Annex 5.01 for the draft agreement). In addition,the UGP would conduct its own selective supervision of SME subprojects inorder to monitor the performance of intermediaries' supervision activities.

15/ This is the 'system for non-administered allocation of foreignexchange' which currently covers about 5Z of imports but is expected to beexpanded.

- 43 -

Subproiect Eligibility and Selection Criteria

5.23 Beneficiary SMEs would be enterprises with up to 200 employees thatare legally constituted in Mozambique according to local regulations andprocedures. However, subprojects with a high expected rate of return andmeeting the objectives of the proposed Project, in the case of enterprisesof over 200 employees, may be considered on a case-by-case basis. No morethan 25Z of overall funds available under the EFC are available to such 'highmerit' larger enterprises. Subsectors eligible for financing would includeagribusiness, mining and quarrying, all manufacturing and processing.construction, transport and commercial services. Given the increasinglyimportant role of microenterprises (detailed in Chapter 2) there would be norequired lower limit to the scale of enterprises eligible for financing underthe Credit. The line of credit would finance fixed assets and associatedincremental permanent working capital and consultants' costs. forrehabilitations, extensioaw and new operations.

5.24 In order to receive financing under the line of credit, thefollowing aspects of each subproject would ),ave to prove satisfactory:

(i) subloans for any subproject for a nesi or existing enterpriseshould not exceed US$1.0 million equivalent;

(ii) for all subprojects, technical viability, including marketanalysis, would be required as well as an opinion on themanagerial capacity of the firm, and an assessment of anysignificant adverse environmental impact or hazard;

(iii) for all subloans, cash flow analysis on an incremental basiswould be required, leading to a financial internal rate ofreturn (FRR) calculation with a 12 percent real rate ofreturn hurdle; in addition, summary cash flow analysis wouldbe required for the firm as a whole, to ensure its overallviability and ability to service its debt;

(iv) for subloans above US$100,000 equivalent, current andprojected balance sheets and income statements would alsobe required, along with financial ratio analyses, includingliquidity, debt service coverage, leverage, and earningsratios.

(v) for subloans above US$250,000 equivalent, economic analysiswould also be required including an economic internal rateof return (ERR) analysis with a 12 percent hurdle.

(vi) for all enterprises financed, an overall equity/asset ratioof 25Z for the total company would normally be desirable.But equity asset ratios of a minimum IOZ will be acceptable.Where, in an otherwise viable enterprise applying for a subloan, financial ratios are unsatisfactory due to the effectsof debt accumulated as a result of price and distributioncontrols prior to 1987, the UGP would require the PFI to

- 44 -

submit a satisfactory financial restructuring plan beforeapproving a subloan.

Accounting. Auditing and Reportu

5.25 The UGP would maintain separate accounts for each part of theproposed project. These accounts, including the Special Account, would beaudited annually by independent auditors acceptable to IDA, and the auditreports would be submitted to IDA no later than six months after the end ofeach fiscal year, including an opinion regarding the adequacy of supportingdocumentation for disbursement of IDA Credit funds based on statements ofexpenditure. Subproject supervision reports would be prepared by the PFIson a quarterly basis during implementation, and twice yearly thereafter untilthe subloan has been fully paid off. These would be submitted to the UGP.

5.26 The UGP would submit to IDA quarterly reports on the status of theportfolio, transactions relating to the Special Account, collections of PFIsubloans, and pipeline of PFI subloan applications. It would submit semi-annual reports on its overall financial situation and operations. The UGPis also responsible for coordinating the data required for supervisionreports and project completion report by IDA (see Annex 5.07). Monthlysubmissions for replenishment of the Special Account are discussed inparagraph 7.02.

5.27 BM, through the UGP, would be responsible for coordinatingprovision of audited financial statements of the PF1's, submitted not laterthan nine months after the end of the relevant fiscal year, to be consideredat the proposed annual project implementation reviews (see para. 5.13).

VI. THE TECHNICAL ASSISTANCE AND TRWNING PROGRAM.

Technical Assistance

6.01 The objective of the technical assistance input iss (a) to improvethe effectiveness of the credit operation; (b) to upgrade bank accountingcapability; and (c) to establish generalizable skills in investment lendingand industrial consultancy assietance. In order to achieve this, technicalassistance is proposed to BM and participating financial institutions, andto the Instituto Nacional da Desenvolvimento de Industria Local (IDIL).

6.02 Technical assistance to the banking system would consist oft (a)the provision of an adviser and operating support for the apex unit; (b) theprovision of consultancy/advisory assistance for the participating banks inorder to upgrade financial statements to international auditing standards,and to carry out studies of the banking system required by the Government;and; (c) continued training of loan officers and credit analysts. Associatedoffice and transportation equipment would also be provided. The UGP advisorypost is proposed to be of up to 36 months duration, and its initial financinghas been covered through a Project Preparation Facility. The adviser-designate also participated in the appraisal mission for the Project, and theGovernment has been closely involved in preparations.

- 45 -

6.03 The terms of reference for the proposed UGP adviser are at Annex6.01. The main function of the adviser is to assist in the establishment andinitial operations of the apex unit. This vili involve advice on staffing,setting up a work program, finaliting operating procedures, and preparingdocumentation, including the implementation of memoranda of agreement betveenBM and the participating banks. The initial work program of the unit willinclude inter alia establishing the operational procedures for monitoring ofthe credit operation, supervising appraisal standards, maintaining approvallimits and advising on approvals, referring to the IDA proposals above thethreshold for local approvals, and liaising with the interdepartmentalsteering committee on lending policy.

6.04 The terms of reference for consultancy assistance for the upgradingof the accounts of the PPIs are at Annex 6.02. The objective will be toupgrade the financial statements of the PFIs so that they meet internationalauditing standards, suitable for submission to IDA. Under the Project, asupplemental letter would be included confirming that the BM (Central) wouldcarry out a review of the PFIs' accounting capabilities and would prepare anaction program, by March 31, 1991, for their strengthening, to be implementedpromptly thereafter. In addition, draft terms of reference for possibleconsultancy assistance for the restructuring and recapitalization of thebanking system are at Annex 6.02.

6.05 The terms of reference for advisory assistance to the IDIL are atAnnex 6.03. The objective of this input is to set up a capability within IDILfor providing business advice to enterprises, especially in financialmanagement and project preparation for bank financing. A small businessadvisory unit of two advisors would initially focus on assisting enterprisesto make proposals for financing under the line of credit, in order toincrease the effectiveness of the lending operation. Later the work programwould be broadened to include a wider range of business consultancy. Theadvisory unit would need to emphasize training and skill transfer to localprofessional staff of IDIL. Office and transportation equipment would alsobe provided.

6.06 The small business advisory service woild be set up in Maputo andBeira, at IDIL delegation offices. The location for this pilot scheme isjustified by the fact that these two towns account for well over 502 ofindustrial employment and output (see Chapter 2). However, future expansionof the scheme could incorporate other centers. Each adviser would have twolocal counterparts, and the duration of the advisory post would be for 18months. Charges would be made for advisory services which could be financedthrough the eventual subloan, if granted. A revenue projection has been madeby IDIL based on fee income from preparation of loan applications and generaladvice. From a market survey of the existing private consultancies in MaputoIDIL considered that a fee of 1.52 of the value of successful loanapplications would be appropriate. For other work a range of other fees isto be charged. An updated terms of reference and income/expenditure statementfor the proposed unit is set out at Annex 6.04, based on IDIL's ownestimates.

6.07 After the first year the service is expected to be able to coverits local costs, including training, but not the costs of foreign advisers.

- 46 -

This assumes the ability to handle over 200 separate items of assistance, ofvarying degrees of complexity, in year three, with eight consultants. (Afterthe departure of the advisers it is intended that a further four localconsultants would be recruited, making a total of eight in Maputo and Beira).If revenue is only 502 of the assumed amount, it would cover about two thirdsof costs. If training is covered from other sources then the service wouldcover its costs at 50? of projected revenue. There is thus some safetymargin for the revenue projections.

6.08 The Business Environment Study, with funding by UNDP of US$0.12million, which is a component of the overall technical assistance, has beencompleted and sent to the Government. Its purpose is to provide initialindustrial policy recommendations on a broad range of areas, including theforeign exchange regime, trade tariffs, the fiscal system, industrialefficiency and methods of industrial finance and enterprise restructuring.A follow up study is also under way which will make recommendations for thedevelopment of the legal regulatory system for the enterprise sector. Thisstudy will provids policy support to the IDA lending program for industry,and an additional I-)A provision of US$0.24 million is included for followup-studies relating to the industry and f4nance sectors. The progress ofindustrial policy reform will be a4.ressed in the annual proijectimplementation review, based on the recommendation of the BusinessEnvironment Study.

The TraininR Program

6.09 The training program started in February lS39. It consists of aseries of two principal six week courses and a further three workshopslasting for two weeks. These are phased to be comp'eted prior to the date ofeffectiveness of the credit. The objective of the program is to developcapability within the banks to carry out project appraisals and to processsubprojects under the credit. This is an essential component of an effectivelending operation in view of the lack of experience in medium to long-termlending to enterprises.

6.10 A total of about 50 staff of the participating banks, and somerepresentatives from the Ministry of Industry, and IDIL attended the firstcourses and evaluation comments were positive. The program is funded by UNDPto the extent of US$0.38 million, which includes training, office equipment(including computers) and a vehicle. The first part of the program waspitched at: (a) an elementary; and (b) a more advanced level, and coveredfinancial, technical, market, and economic analysis, and bank lendingpractice; computer based models for project appraisal at differing levels ofsophistication, conforming with the proposed approval mechanism of the lineof credit are being developed. The second phase of training started on June19, 1989.

6.11 An additional IDA provision of US$0.1 million is included under theProject for followup training assistance after the conclusion of the currentprogram. In addition, cofinancing of further training through the UNDP andother sources will be discussed

- 47 -

VII. DISBURSEMEN. PRCREMENT AD IMPLEMENTATION

Disbursement

7.01 A Project Preparation Facility advance of US$250,000 was approvedby IDA on January 26, 1989. This provided financing for (a) hiring of anadviser to the UGP (apex unit); (b) provision of consultancy services to thebanking system; and (c) equipment.

7.02 The disbursement schedule for the IDA Credit is given inAnnex 7.01, and disbursement arrangements are shown in Annex 7.02. TheCentral Bank would serve as disbursement and collection agent for therefinancing granted to the PFIs. To expedite disbursements under theproposed line of credit, a Special Account would be established in acommercial bank satisfactory to IDA and managed by the UGP. IDA would makean initial deposit of US$2.5 million, representing about four months ofdisbursement requirements. Applications for replenishment of the SpecialAccount, accompanied by appropriate supporting documents including reconciledbank statements, would be submitted on a regular monthly basis.

7.03 Withdrawal applications would be submitted with full supportingdocumentation, except for payments against contracts with a total value ofless than US$100,000 for which reimbursement could be claimed on the basisof statements of expenditure (SOEs). Documents in support of SOEs would beretained by the UGP, and would be available to IDA for inspection duringsupervision missions.

7.04 Funds under the line of credit would finance 10O? of foreignexpenditures of directly imported goods and 70? of the local expenditures.It would finance up to 100? of civil and engineering works undertaken as partof an investment project, and 1002 of expenditures for consultants' servicesand training costs. Other costs, including any taxes and tariffs imposed onimports, would be financed either by the entrepreneur or the PFIs under theirdomestic credit ceiling.

7.05 The final date for submission of subloan proposals for IDA'sapproval would be December 31, 1995. The expected project completion datewould be June 30, 1996, and the closing date for disbursements would beDecember 31, 1996, in accordance with the expected disbursement profile.However, faster disbursement of the line of credit component seems quitepossible. Subject to annual review, IDA would disburse for expendituresincurred up to 90 days prior to the approval of the subproject by IDA, orreceipt by IDA of the information required in the case of a free-limitsubproject.

- 48 -

Procurement

7.06 Under a line of credit project intermediated through the bankingsystem regular commercial procurement by private enterprises is usuallyregarded as efficient and economic. However, since this is the first suchproject in Mozambique procedures for procurement of goods and servicespurchased with credit funds under the Project would be specified in eachsubproject proposal appraised by PFIs, according to IDA's procurementguidelines. Aggregate amounts under each type of procurement are not knowna priori for subprojects. For items over US$100,000 and below US$500,000, atleast three quotations would be obtained, using the method of Internationaland Local Shopping (ILS) or Local Competitive Bidding (LCB). Any projectsinvolving a civil works component would require LCB with public bid openingfor contracts of between $100,000 and $500,000. International CompetitiveBidding (ICB) would be required on contracts of above $500,000. For items ofbelow $100,000, PFIs would assure themselves that sub-borrowers had canvassedthe main sources of supply and had chosen appropriately. PFI appraisalswould, inter alia, cover the procurement procedures used, and PFIs wouldmaintain records of the procurement process during subproject implementation.The UGP would be responsible for ensuring that the PFIs comply with theseguidelines. The procurement arrangements are shown in Annex 7.03.

VHIL SPECIAL ISSUES

The Role of Women in Industry

8.01 During the appraisal of the Project efforts were made to identifyspecial issues affecting women in Mozambique, in relation to such matters asopportunity for industrial jobs and training, access to credit, andproperty/enterprise ownership, Under the constitution of the People'sRepublic of Mozambique, the rights of women are explicitly safeguarded in anumber of areas. Article 7 states "Work is the right and duty of everycitizen of either sex, and it is the criterion for the distribution ofnational wealth.' Article 17 states 'The emancipation of women is one of thestate's essential tasks. In the People's Republic of Mozambique women and menhave equal rights and duties, this equality extending to the political,economic, social and cultural spheres.' Article 26 states; many acts aimedat jeopardizing social harmony, or creating divisions based on color, sex,ethnic origin, place of birth, level of education, social position oroccupation are punishable by law.' Further safeguards of a similar natureare in Articles 29 and 30. The Organization of Mozambican Women (OMW) isrelatively strong and well supported.

8.02 In a recent employment survey (1989) of Maputo Province it wasfound that literacy (ability to read), although very low overall, was higherfor women than for men. Nevertheless, only 22Z of the active femalepopulation was employed compared to 73Z of men, with a high concentration incommerce, including distributive trades and in self-employment, while theopen unemployment rate (defined as those actively seeking work) was 21Z forwomen compared to 7.6Z among men.

- 49 -

8.03 Credit under this project would be available for workshoplmicroscale enterprises (as well as larger enterprises), such as cereal and oilmilling and other food processing, garment manufacture, pottery and ceramics,in which women are likely to be active. Under the onlending appraisalcriteria the focus will be on financial and economic viability and managerialcompetence, without any prior stipulation concerning gender or nitionality(provided that an applicant firm is registered according to Mozambique law).No legal barriers exist to the set up of enterprises by women. Femalerepresentation in governing assemblies is modest but not insignificant.

Environmental Considerations

8.04 This Project is designed to finance smaller enterprises across arange of industries. Within the industrial sector environmentalconsiderations are important; this applies to for example industries which(a) extract natural resources (e.g. timber); (b) cause particular pollutionproblems (e.g. paper, chemical products, cement); (c) create special hazardsfor workers (e.g. coal mining, chemical products, hot processing of metal);or (d) create risks for consumers (e.g. processed foods). Mozambique isfortunate in having natural resources which would continue to support withoutdifficulty significant increases in population, particularly in the North.However, the South is more vulnerable due to higher population density andmore fragile drought prone soils. Similarly in the South deforestation hasreduced over 40Z of woodland to scrub. This is largely the result of demandfor fuelwood, which increased significantly as a result of the Government'srelaxation of controls in 1981 in an attempt to switch away from importedkerosene and LPG. (The IDA Urban Household Energy Project is designed tointroduce fuel efficient household stoves using coal, accelerateelectrification of urban households and introduce other fuels).

8.05 Data are not available, but in terms of international experiencethe large majority of economy-wide timber usage would be for fuel, and asmall minority for furniture and other timber products. It is likely that thetimber demand from small scale furniture and wood products manufacturingenterprises would not involve a significant impact on resources, given theunderdeveloped state of industry in general. For this reason type b) problemsmay also not be very important. In the case of type c) and d) some protectionis given under current Mozambican law on safety at work and through publichealth regulations regarding food processing. However, in order to addresspossible environmental hazards, appraisals of subprojects, in industriesspecified under the IDA Environmental Directive, would be checked forenvironmental effects, in particular pollution and nonrenewable resourceconsumption, and that supervision of subprojects financed under the Creditwould provide for the monitoring of these issues.

DL PROJECT BENEFfTS AD RISIS

9.01 Economic benefits under the proposed project would arise from thestartup and expansion of productive enterprises which are efficient earnersor savers of foreign exchange, capable of economic provision of substantiveemployment and income benefits. In addition benefits would flow fromimprovements in financial infrastructure. This would include in particular

- 50 -

the strengthening of bank portfolios, the upgrading of bank staff capabilityin project appraisal and monitoring, and the reorganization of the banksystem as a whole. It is expected that 100 to 120 enterprises would befinanced under the IDA Enterprise Financing Component. Rehabilitation ofthese enterprises would be expected to provide or secure productiveemployment for about 6,000 workers, and increase the supply of goods andservices.

9.02 All subprojects would go through an appraisal process (includingenvironmental assessment), and those requiring subloans of more thanUS$250,000 would receive an economic appraisal. The hurdle rate proposedwould be 122 economic rate of return, while all enterprises would be expectedto earn a financial rate of return in real terms of 122. Thus the financingcomponent of the Credit would earn a rate of return of over 122.

9.03 The main areas of risk include: (a) implementation delays due todelays in reorganization of the banks, the lack of long term lendingexperience of the banks, (to be addressed through technical assistance andtraining), and unresolved financial problems of enterprises; and (b) slowdownof ELP reforms due to social or political pressures; however, the commitmentshown by Government suggests that the latter risks are manageable; thirdly,(c) deterioration of the security situation, which could adversely effectindustry; this problem is however under control in the most likely urbanlocations for subprojects, and small-scale producers tend to be lessvulnerable to disruption of sales and supplies.

K. RECOMMENDATIONS AGREEMENTS AND UNDERSTADINGSTO BE. REACHE.

Conditions of Credit Effectiveness

10.01 Before the Credit is declared effective the Government woulds

(a) enter into a Subsidiary Administration Agreement with BM(Central) under terms and conditions approved by IDA (para.4.08);

(b) finalize the staffing of the UGP and make it fullyoperational (para. 5.05); and

(c) provide to IDA the signed and authorised participationagreements between at least two PFIs and BM (Central) (para.5.09).

Conditions for Disbursement

10.02 (a) Before first disbursement by each PFI, provide to IDA asatisfactory model sub-loan agreement between the PFI andbeneficiary enterprises (para. 5.09); and

- 51 -

(b) Before disbursement under each sub-loan ensure that -he sub-loan has been made in accordance with the procedures, termsand conditions agreed with the Association.

Assurances Received from the Government

10.03 During the implementation of the Project the Government would:

(a) through BM (Central), carry out no later than March 31,1991, an action program to strengthen the accountingcapabilities of the PFIs. to be implemented during projectexecution; (para. 6.04 and supplemental letter);

(b) make available to IDA for its approval a phased program, byJune 30, 1991, for the separation of the central andcommercial banking functions of BM, leading to its promptimplementation thereafter (para 3.22);

(c) based on agreements between BM (Central) and the commercialbanks, including BM (Commercial), (i) formulate an actionprogram, by December 31, 1991, to settle lending arrears ofthe commercial banks; and (ii) by June 30, 1992, formulatean action program for the rehabilitation of the bankingsystem, including a plan for its recapitalization and thesetting of performance benchmarks (para. 3.16) and a programfor the continued extension of competition in the bankingsector (para 3.09), for prompt implementation;

(d) through the CI, facilitate the issuance of import licensesto enterprises receiving subloans, and, through BM (Central)facilitate the allocation of foreign exchange forreplenishment of imported inventories by subprojects; (paras5.19 and 5.20, and supplemental letter);

(e) through BM, carry out an annual project implementationreview with IDA starting not later than March 31, 1991 to:(i) monitor progress made in achieving project objectives;(ii) review progress on the implementation of the actionprograms for settling lending arrears, restructuring, andextension of competition within the banking sector (para3.16); (iii) review progress on achieving positive (weightedaverage) real onlending interest rates, their terms andconditions (para 5.13); (iv) at the first annual review,consider proposals for industrial policy reform, based onthe Business Environment Study (para 6.08); (v) reviewaudited financial statements of the PFIs, which would besubmitted not more than nine months after the end of therelevant fiscal year (para 5.27), and; (vi) review anddevelop the ongoing cofinancing of the Project (para. 4.19).

10.04 Subject to the above assurances and conditions the Project issuitable for an IDA Credit of US$32.0 million to the Government ofMozambique.

STATISTICAL ANNEXES

1973 1987 */Number of 1978 Velu Added Employmnt output

Food Product. Estabilishents Percentage Employmnt Percentage (Eec Million) Percentage U I

Food Product. 772.0 64.8 41648.0 42.1 1616.4 29.6 26.0of which:

Vegetabl- Oil 9.0 1687.0 180.6Flour Mille J81.0 1909.0 61.6Supgr 6.0 6298.0 650.2Cshew Processing 16.0 20860.0 264.4TOO 19.0 8078.0 67.6Bakery, Contectionary 265.0 4804.0 88.6

Bev rmg e, Tobscco 24.0 1.7 4111.0 4.2 782.0 14.8 80.0 b/ 11.0TetilIm, armentsLeather Fibre 111.0 7.9 16679.0 16.9 606.5 16.6 24.0 26.0of which:

Cotten clning 21.0 2964.0 106.6Splining, WUsle 8.0 4461.0 266.9ramnts 26.0 4211.0 164.2

Wood, Paper, Priatiog 227.0 16.1 16707.0 16.0 626.5 10.8 14.0 10.0 cof which:#1

L4ging, samillitng 76.0 7665.0 148.0Carpentry, furittre 91.0 850.0 102.6Printing 45.0 8268.0 199.9

Petroleum Cmicals oRubber, Plcatic 06.0 4.6 4066.0 4.1 449.9 8.6 8.0 11.0 uof which: w

Rubber Products 2.0 774.0 66.6Pluttc Products 12.0 742.0 54.2Paint, Varnish 4.0 898.0 129.7

Nonmetal, Mineral Products 62.0 4.4 4804.0 4.7 U80.8 7.0 8.0 2.0 c of which: X

Glas Products 1.0 047.0 8.1 Cement 8.0 898.0 164.0

Metals and engineering 189.0 9.9 11464.0 11.6 6092.9 18.6 19.0 14.0ot *hich: t

Struct. MLotl Prods. 40.0 2107.0 101.4 CIA

Baglc Iron A Steel 8.0 1181.0 67.0Met l Furniture 16.0 1618.0 69.0Shipbldg, Ropirs 6.0 1486.0 110.6 _

Other Industries 9.0 0.6 860.0 0.4 28.2 0.5 2.0

TOTAL 1409.0 100.0 96068.0 100.0 5114.8 100.0 100.0 100.0----------------------------------------------------------------- __----------__-------------------------------------------------------------

Source: Based an Estatisticais Industrials 1973 and 1987.Note: a/ Based on gross output at 1906 prices, VA figures are not available for 1987; however 1978 and 1987 output shares appear comparable. X

b/ Includs food products and beverages, tobacco, textiles ond garment..

o

- 53 -

ANNEX 2.02

MOIDUIQUE

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Scale Distribution of Industry - 1973 and 1987

Size category. Number of workers per enterprise.Total 1- 9 10-49 50-99 100-199 200-499 500-999 1000-

1973 Number of enterprises

1418 583 480 133 134 56 20 18

Total employment by size category (000)

99.5 2.1 12.4 9.5 18.4 18.0 13.0 26.5100? 1.8? 13.0Z 10.OZ 18.0Z 18.0Z 13.0Z 26.5?

Total 1- 9 10-49 50-99 100-199 200-499 500 -

1987 Number of enterprises

2020 1145 551 134 98 64 28

Total employment by size category (000).

57.5 6.3 5.2 6.0 9.1 14.1 16.8100X 11.02 9.0? 10.62 15.8? 24.6C 29.2Z

Scale Distribution of Industry: Maputo province - 1973 and 1987.

Enterprise size by employment category.

No employed Total 1-9 10-49 50-100 100-199 200-499 500+

1973No of enterprises 498 97 226 68 61 36 10Approx employment 43350 450 6100 4700 8100 10800 13200Z of employment 100 1.2 14.1 10.8 18.7 24.9 30.4

1987No of enterprises 823 445 229 58 48 30 13Approx employment 46400 2400 5430 4690 7560 11230 15080Z of employment 100 5.2 11.7 10.1 16.3 24.2 32.5

Sourcest based on Estatisticas Industrials 1973 and Ministry of Labor 1987(unpublished, and excludes Zambezia province).

5 54 -

ANNEX 2.03Page 1 of 2

SMALL AND NEDIUDINTRPRISE DEVLOPMENT RJECT

Enterprises Sold by the State(Empresas Tresgassados)

Sectors/Subsectors Company Date ofSale

A. Light Industry

1. Agro-industries Limari 1988Palmar 1988Jacaranda 1988

2. Food industry Fasebel 1983Imeal 1987

3. Salt Empresas EstatzadosSalina de ZambeziaSalina Mieze

4. Textiles Fabrica investroHotex 1987

5. Leather Calcado Zambezia Incala 19886. Wood, furniture Falcao e Ferreira 1986

A. Ferreira 1986Gobomar 1986Pandora Industrial 1987Moveis Ribeiro 1987DecoramaMobiliario ManicaMobiliario SofalaMobiliario Nampula 1988Mobiliario Cabo Delgado 1988Mobiliario Niassa

7. Oils, soaps Corol 1985Soboes/de Maio 1987

8. Light engineering Femol (Jointownership)

Enterprises Partially Sold

Nets, mesh Malhas de HocOther FarbeiraOther Irmaos UnidoOther Famma

ANNEX 2.03- 55 - Page 2 of 2

B. Heavy Industrg

1. Paper products Sacoes de Papel2. Non-metallic

minerals Fabrica de Calcoes Ted3. Engineering Cofusel

Fabrica de Radiadores4. Electrical goods a/ Marca

(distibutors) OlivettiAdlerIBMNCROlympiaPhillips+ 3 others

5. Other PTL (Industrial)Telarame

al Previously part of 'Empresa Nacional de Equipamentos Materiais deEscritorio (Eneme)

Source: Based on handwritten notes provided by Ministry of Industry &Energy, Maputo, March 1989

- 56 -

ANNEX 2.04

MOZAMBIQUE

SMALL AND MEDTIM ENTERPRISE DEVELOPMENT PROJECT

Production Data

Ministry of Industry and Energy(heavy industry)

(constant 1988 prices)million metic&ls

1987 1988 1989(plai

Tyres 4102 2978 5528Mechanical engineering 3490 5132 7896of which:

agriculture tools 355 549 1171bicycles 777 1074 1110

Electrical Engineering 1288 1401 2039Refrigeration 1798 2533 3311Heavy Engineering 1256 2007 2149Metal processing/products 3809 3419 5515Paper products 327 313 396Petroleum products 1434 1893 1578Chemical products and allied 4956 5916 7928of which:

paints 2119 1804 2156cardboard cartons 1528 1471 3249

Glass products 1402 2197 1200

Electricity Generation 7180 6999 6358

Total heavy industry & energy 31042 34789 43891

Source: Ministry of Industry and Energy, Department of PlanningMaputo, November 1988

Note: Data as in original document.

MOZAMBlUE

SMALL ND MEDS U ENTERPRISE DEVELOPMENT PROJECT

S.crenUia de Estado de Industnit Limir. e Alimanter

Deprtment of Plonning

Prodbctioe Table

UnidaWd de Direccao Controlo do Plan Jan-o.c 1967 Controlo do Pleno Jan-Dec, 198 C.C.Volue of Main Vafue of Otner TOTAL Vlue of- Min V Tlue of Oth-r TOTAL

Preduction ProductTon Production Productton U

Textile 1,289,219 6S9,8S9 1,849,078 1,720,992 1,203,726 2,924,71n 1S8

¢arments 1,487,084 - 1,487,084 1,479,438 - 1,479,483 99

Leather 229,029 184,191 404,220 178,883 138,442 317,106 78

Food Industries 1,851,187 1,132,408 2,983,593 1,638,225 954,868 1,493,09 84

Oils, soap. and toiletries 250,023 259,209 509,232 280,538 370,786 661,274 128

Severage 2,265,548 - 2,266,548 3,139,640 59,038 8,198,678 141

Light Engineering 1,594,706 406,997 2,001,773 967,855 410,743 1,378,598 09

Ploat)e Products 172,659 527,595 700,254 185,076 484,498 649,689 93

Salt 174,776 - 174,770 250,132 - 260,132 143

Wood Furniture - 332,788 332,788 - 314,942 314,942 95

Agriculture - 241,954 241,954 - 98,821 93,821 39

TOTALS 9.30S.229 3.644.999 12.960.228 9.740,SS4 4,010,309 13.760.8S83 1O

xN

0

- 58 -

Annex 2.06

MOZAMBIQUE

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Financing of Enterprises Under the Small Medium Enterprise Fund(1988)

No ofProvince Controlling Ministry/Agency Enterprises US$

Maputo Construction and Water 18 665,000Industry and Energy 15 400,000UDIC 11 245,000IDIL 5 150,000Other 13 275,000

Sofala General 16 480,000

Tete General 2 50,000

TOTAL 80 2,265.000

5 9 -

ANNEX 2.07Page 1 of4

I0ZANBIQUE

SMALL AND HDUM4 ENTERPRISE DVEOMSIN PROJECT

IRPoaT TAIF RATES - 1989

Product Rate 2minimum Maximm

Animals on the hoof 4 25Meat and parts, edible Free 34Fish, crustaceans, mollusks 6 22Milk, dairy products, eggs from fowlsnatural honey 10 24

Products of animal origin, unspecified 12 24Live plants and floricultura products Free 34Horticultural products, plants, roots andtubers, food Free 20

Fruits, citrus and melon rinds 10 22Coffee, tee, mate and spices 2 27Cereals 1 41Milled products: malt, starch and potatostarches, gluten, insulin 1 12

Oil seeds and fruits, miscellaneous seeds andfruits, industrial medicinal plants,straw and hay Free 25

Vegetable raw materials for dyeing and tanninggums, resins and other vegetable juices,and extracts 12 50

Materials for weaving and shaping andnonspecified products of vegetable origin 12 25

Fats and fatty oils, animal and vegetablesproducts from their breakdown, prepared foodfats, animal or vegetable origin waxes 8 25

Meat, fish, crustacean and mollusk preparedfoods 25 36

Nonspecified sweets and sugars 1 4Cocoa and its prepared products 8 40Prepared products from cereals, wheats orpotato starches, pasta products 1 8

Prepared foods from horticultural products,fruits, and plants or plant parts 12 36

Miscellaneous food prepared products 12 Mt 250/kgBeverages, alcoholic liquids and vinegars 1 Mt 300011tWaste and discards from food industries, foodsprepared for animals 10 24

Tobacco 6 30Salt, sulfur, soils and stones, plasterslimes and cements 1 35

Metallurgical ores, slag and ashes 10 10

- 60 -ANNEX 2.07

Page 2 of 4

Mineral fuels, mineral oils and products oftheir distilliation, bituminous materials,mineral waxes 5 10

Inorganic chemical products, inorganic compoundsor organic compounds from precious metalsradioactive elements, rare earth metals andisotopes 2.5 21.25

Organic products 8.75 20.85Pharmaceutical products 12 25Fertilizers 1.8 12Tanning and dyeing extracts, tannin and itsderivatives, coloring materials, paints andvarnishes, mastic, writing inks 5 46.5

Essential oils and resinoids, perfume ortoiletry products, cosmetics 10 50

Soaps, active organic products, preparations forlyes, lubricant preparations, artifical waxes,prepared waxes, products for maintenance andcleaning, candles for lighting and similarartifacts, modeling clays and wax for dentists 9 24

Abuminoid materials and glues 9 21.5Powders and explosives, pyrotechnic articles,matches, pyrophoric alloys, inflammable materials 7 23

Photography and cinematography products 17 35Miscellaneous products of the chemical industries 2.5 15Artifical plastic materials, ethers and celluloseesters, artifical resins and products of suchmaterials 5 25

Natural synthetic or artificial rubber andrubber products 5 25

Hide and skins 15 23Leather products, strap saddle and travelarticles, purses, wallets, coin purses,cartridges and similar artifacts, gutproducts 11 40

Hides with fur for decoration and respectiveproducts, artificial hides with fur fordecoration 5 50

Wood, charcoal and wood products 5 50Cork and cork products 26.5 Mt 123/kgMat and basket products 4.5 19Raw materials for manufacture of paper 1 1Paper, paper board and cardboard, cellulosepulp, paper, paper board and cardboardproducts 16 30

Bookstore articles and graphic arts products 1 23Silk, silk refuse and silk waste 23 23Synthetic or artifical textiles, continuous 23 23Threads and yarns, with metals 40 60Wools, furs and hairs 10 20Flax and ramie 5 25

- 61 -ANNEX 2.07

Page 3 of 4

Cotton 5 25Synthetic or artifical textiles, discontinuous 20 36Other vegetable textile fibers, paper threadsand respective tissues 5 20

Tapestry carpets, velvets, plushes, velvetizedfabrics with loops and enflocked fabrics, ribbons,lace work, tulles, fixed mesh fabrics (netting),open work and seizing, embroicery 15 50

Pulps and felts, roping and other rope articles,special fabrics, impregnated or lined fabrics,technical textile material articles 5 35

Elastic mesh and respective artifacts 10 50Clothing and clothing accessories, fabric 10 50Other fabric artifacts 5 40Used clothing, rags and cuttings 5 40Footwear, leggings and analogous artifacts,parts of such objects 15 30

Hat wear and artifacts for similar use andrespective parts 15 30

Umbrellas, parasols, canes, whips, long thinwhips and their parts 10 35

Prepared decorative feathers and respectiveproducts, artificial flowers, fur products,fans 23 63

Stone, plaster, cement, amianthus, micaproducts and similar materials 5 36

Ceramic products 13 26.5Glass and its products 10 30Natural pearls, gems and similar items, preciousmaterals, metals veneered with previous metaland respective products, false and ornamentaljewelry 10 27

Coins Free FreeCast iron, malleable iron and steel 8 25Copper 8 30Nickel 8 15Aluminum 8 15Magnesium and beryllium (glucinium) 8 25Lead 8 25Zinc 8 15Tin 8 15Other common metals 8 25Tools, flatware and cutlery, of common metals 8 35Miscellaneous common metal products 8 35Boilers, machinery, apparatuses and mechanicalinstruments 1 50

Machinery and electrical apparatuses and objects forelectrical engineering uses 1 43

Vehicles and meterials for railways, nonelectricsignaling devices for communication routes 1 2

- 62 -ARMBX 2.07

Page 4 of 4

Automobiles, tractors, velocipedes and other landvehicles Free 28

Air Navigation 1 1Ocean and River navigation 1 24Instruments and apparatuses and optical photographicand cinematographic products, measuring, verificationand precision apparatuses, medical and surgicalinstruments and apparatuses Free 33

Clockworks 5 13Musical instruments, apparatuses for recording andproducing sound. parts and accessories of suchinstruments and apparatuses 5 30

Weapons and munitions Free 30Furniture, medical and surgical furnishings,stuffed furniture articles and similar items 30 30

Materials for shaping or modeling, prepared oras a product 6 30

Brooms, brushes, mops, feather dusters,tassels, sieves and strainers 11 23

Toys, games and articles for recreation andsport 20 55

Miscellaneous products Free 50Art and collectible objects, antiques Free 18

Source: Goverrment of Mozambique - Decree No. 20/88, December 1988

;~~~~~~~~~~~~~~~~~

- 63 - ANNEX 2.08Page of I of 2

MOZAMBIQUESMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Mozambi %ue Industrial Sector SanPIeShor. Rn oestic Reourc Co naysis

Calculated R ult 1

LaborComarator 2/ IaPrts Cost Labor

Short Run CIF Ave rae Tot la TUiT CostORC Maputo Cap city Prod. Prod. Doaestic

Product Ratio Price Utilization Cost Coot Content(US$) (3) (1) (3) (3)

SIc 31

Cashew Nuts 0.6 1 S 5Sugar (1) 1.5 0.28/kg. 6 2 29Sugar (2) 2.0 0 28/kg. 6 a a3Spaghetti (1) 0.5 0.60/kg. 60 64 a 9Spaghetti (2) 0.6 68 2 6Cream Crackers 0.5 1.25/kg. 40 50 5 9Extra Laundry Soap 0.7 0.67/kg. 65-60 s0 2 5

SIC 32

Cotton Diapers 0.6 0.60 *a. 20

SIc a3

Swn Timber (1) 1.2 !/ 21 10 I1S:wn Timber/Port. Bd. (2) 0.6 80-85 40 10 17

SIC 34

Cardboard from Kraft Paper 0.6 86W0/ton 50 75 I 5Cardboard Paeking Boxes 0.6 01080/ton 65 1 2

SIC 3s

1100 x 20 SE Truck Tyre 0.5 *225/unit 38X (Actual) 67 14 410.9 10S (Proj.) 76 16 24

Paraffin Candles (50 9.) 0.6 80.80/dozen 25 66 - _Vinegar (60 Acetle Acid) <1.0 61.00/1 8 _ _

SIC 86

Cement, Bagged Approx. 1 #67/ton Low 73 (1 (I(From Imported Cl'nker)

SIC 86

Electric Transmission 0.$(Avq.) 81180/ka 75 74Cable (4 spec.) 62270/k-(Price F08 Oporto) 62960/ks

8O60/kmReplae ment Auto Radiator. 0.8 U42/kg 76 81 45 6OBicycle: One Sped 0.4 S90/unit is 59 5 18Refrigerator (it ft. 8 ) 0.c 1169/unit 50 78 -Mech. Water Pump 0.8 1440/unit 60-70 70 -

1. All Calculations based on official exchonge rate/CIF prices prevailing at thedPte of priri atlon o product co t d t ca

2 d Pra f eIng CIF o puto prTe upon whTch DRC ata cul.tTon was based3. Export product. calculated vis net FOREX effect. CIF price not rquired.

ANNEX 2.08Page 2 of 2

- 64 -

Mozeubique Industrial Setor Sn pl-Short Run Dom.stlc Reoure Cost nolvoao

-Etmated Results ILI

LaborEstimated CoWps rator 3 I rts Cost LaborShort Run CIF Averge Tot I T-GaT Cost

ORC Maputo CapacTty Prod. FProi D6o ticProduct Ratio Price Utilization Cost Cost Content

CUSS) (3) (3) (%) (3)

SIC 81

Refined Cotton Seed Oil >1 Crude Oil- 8350/ta 15-20 17 2 2Rotterdam

SIC 82

Cotton Textiles (1) )1 o0.O0/yd.o soCotton Textiles (2) >1 40Synthetic Textiles )1 *1.20/yd.o 68Cotton/Spring Mattress <1 J84/unit 80 18 12 15

(Double) (probable)Garments - Local Fabric >1Garments - Imported Feb. <1Canvas Tennis Shoes - >1 U4.20/pair 84 16 24Low Cut (probable)Canvas Tennis Shoes - >1 95.50/pair 26 14 19High Cut (probable)Leather Shoes <1 (Note: Comparability unable to be verified)

SIC 84

Writing Paper from Recycle >1 (probable) s0

SIC 8S

Bicycle Inner Tube (Olued) >1 22.50/unit 58 16 85110 MM (40) PVC Pipe <1 32.60/meter 76 <1 <1

(probable)3/4' PVC arden Hose t0.0/me"tr 78 (1 <12-1/2 l Polyethylene Bottlo 30.40/unit 78 (1 <1Size 88 PVC Ladies Sandals t0.90/pair 78 (1 <1Paint (Latex Emulsion) (1 (prob.) 22.60/liter 10 70 9 80Paint (Industrial Enamel) (1 * ba is0/litr 10 72 7 25Paint (Maritime) <1 * 28.10/liter 10 71 8 27

SIc 86

close >1 30.70/kg. LoW - - -

SIC 88

Sewing machine - sloc. >1 8218/unit 50 60 - _Sewing machine - mach. Approx. 1 1107/unit 50 55 - -Metal Fabrication - <1 (prob.; 70 8S 81 48Aggregate Costs(Tanks, Wagons)

1. In ll-u of production cost and/or CIF price data to calculate DRC ratio, repreosntsbeat estimto based upon supplementary esurces of Information (e.g. comparativeInput prices, ete.)

2. Represnts hypothetical prlce for DRC ratio equal to 1 rather than actual priceunlese denoted by an asterisk (a). May be ud as baallne i reference for assoeingefficiency oneo ectual CIF Maputo price Is known. Where denoted by en asterisk,e.posanto an a.4stml m*A^s+^A eVTU #rPl n+. 4Ma oif Ink*paorm

- 65 - ANNEX 2.09

MOZANBIQUE

SMALL AND NEDIUM ENTERPRISE DEVELOPMENT PROJECT

Small Enterprise Credit Scheme (IDIL/Friedrich Ebert Foundation)Investment Project Revolving Fund

Yearof Appli- No. of Govt.Agency Planned Actual Datecation Location Projects Responsible Cost Cost Implemented

------ DMOOO-------

1984 Niassa 6 Seila 92 74 1985, 86

1985 Tete 1 MCA 120 185 a/Zambezia 4 SEILA 50 46 1986Gaza 1 M.Agric. 70 a/Maputo 2 MCA, SEILA 40 a/ 1985 b/Niassa 4 SEILA 120 97b/ 1985,86 b/

1986 Haputo 8 MCA, M.Agric. 316 226b/ 1986,87 b/SEnLA

Cabo Delegado 3 SELk 125 122 1986,87,88Inhambane 4 MCA. SEILA 269 177b/ 1986,87 b/Zambezia 2 M. Agric. 55 a/ a/Gaza 1 MCA 85 75 1987-anica 1 MCA 380 a/ a/Sofala 1 SEILA 120 a/ a/Tete 4 MCA. SEILA 282 68a/ 1987 bNiassa 3 SEILA 86 69b/ 1987,88 b/

1987 Maputo 4 SEILA, MCA 125 85b/ 1987, 88Niassa 4 SEILA 15 22b/ 1988Inhambane 1 SEILA 20 17 1987Nampula 1 SEILA 10 a/ a/Cabo Delgado 17 SEILA 381 324b/ 1988

1988 Maputo 9 MCA,SEILA, 81 a/ a/M.Agric.

Inhambane 3 SEILA 18 a/ a/Zambezia 1 SEILA 50 a/ a/Cabo Delgado 29 SEILA 144 a/ a/Niassa 1 SEILA 17 a/ a/Tete 12 MCA, SEILA 137 a/ a/

1989 Maputo 1 SEILA 14.5 a/ a/Niassa 2 SEILA 17 a/ a/Inhambane 1 SEILA 15 a/ a/Cabo Delgado 3 SEILA 44 at a/

a/ Data not available (Projects not implemented).b/ Some data not available (i.e. one or more projects not implemented).

ANNEN: 2.1b- 66 - Page 1 of 6

MOZAMBigut

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

BULLETIN OF THE REPUBLIC

Official Publication of the People's Republic of Mozambique

SUPPLEMENT

Decree No. 6/88: Instituto Nacional de Desenvolvimento da Industria Local

(IDIL)

SUMMARY

The Council of Ministers:

Decree No. 6/88:

Establishes the National Institute for Development of LocalIndustry and adopts its Organic Statute.

COUNCIL OF MINISTERS

Decree No. 6/88of April 18

In furtherance of the National Economic and Social Directivesof the Fourth Congress of the Frelimo Party, the Office of theSecretary of State for Light Industry and Foods was assigned the taskof encouraging, promoting, supporting, directing and controlling theestablishment, rehabilitation and developuent of local industry forthe purpose of supplying foodstuffs and staples to the population andsubstituting some imports.

The small industry sector is extremely important for thenational economy and needs to be developed throughout nationalterritory, particularly in rural areas.

Accordingly, it is necessary to establish an agency at theinstitutional level to implement the sector policy objectives that thegovernment has set for development of local industry and to give thisagency the needed flexibility to establish small processing companies.Pursuant to these terms and in accordance with Article 54.d of theConstitution of the Republic, the Council of Ministers decrees:

Article 1. The National Institute for Development of LocalIndustry is hereby established, and its Organic Statute, attachedhereto, which is an integral part of this decree, is hereby adopted.

ANNEX 2.10

- 67 - Page 2 of 8

Article 2. The National Institute for Development of LocalIndustry shall be under the direction of the Office of the Secretaryof State for Light Industry and Foods.

Adopted by the Council of Ministers.

Be it published.

The Prime Minister, Mario Fernandes da Graca Machungo.

Organic Statute of the National Institutefor Development of Local Industry

CHAPTER INature and Powers

Article 1Nature and System

1. The National Institute for Development of Local Industry,designated herein as the IDIL, is a socioeconomic unit having its ownlegal personality and administrative and financial autonomy.

2. The IDIL is regulated by the provisions of this statute,by the standards applicable to the state business system and by allother applicable legislation.

Article 2Duration and Headquarters

1. Its duration shall be undetermined.2. The IDIL shall have its headquarters in Maputs, and, upon

authorization from the Office of the S9cretary of State for LightIndustry and Foods, may open or close delegations or others types ofpermanent representations in any place within national territory.

Article 3Establishment Fund

1. The establishment fund for the IDIL comes fromappropriations, transfers of monies and other revenue of the state orother corporate bodies under public law.

2. The initial establishment fund consists of the sums setout in its accounting books.

3. The establishment fund of the IDIL may be increased bymeans of appropriations out of the state budget as well as the othersums and revenue provided for in the preceding article, and also byincorporation of free reserve funds.

ANNEX 2.10Page 3 of 8

- 68 -

Article 4Purpose and Powers

For the attainment of its purpose, the IDIL has the following powers:- Implement government policy objectives for the local

industry sector, specifically through the following responsibilities:

a) Promote research and public information in connection withappropriate technology for small industries;

b) Study and propose technical and economic support measuresfor low-resource industrial producers;

c) Furnish vocational training and instruction in the areas oforganization and technology for small industrial producers;

d) Study and propose, when necessary, measures to protect theprices of goods produced by local industrial companies;

e) Participate with national and foreign agencies in releasingpublic information on the findings of research and technologytransfer;

f) Organize meetings, seminars and gatherings dealing with theproblems involved with comprehensive development of small industry;

g) Centralize the acquisition and recording of information forthe small industry sector for the ultimate establishment of a databank?

h) Promote the establishment of small processing companiesbased on local resources and needs, in close connection with localauthorities;

i) Issue opinions, when necessary, on ways of obtaining creditfor small producers;

J) Promote directly, or through part ownership or associationwith businesses, the production of equipment and spare parts for localindustry;

1) Purchase shares and underwrite financial participations asnecessary to achieve its purpose and exercise, pursuant to law, allrights pertaining to thes( participations;

m) Provide consulting services to small industry, identifyopportunities for new companies or reorganization or reconversion ofestablished ones and prepare the applicable feasibility studies;

n) Promote the procurement of financing and other means ofattracting resources in domestic and external markets;

o) Enter into agreements to establish effective ties withother national agencies, both public and private, in pursuit of theobjective of comprehensive development of local industry;

p) Perform all other duties entrusted to it under the terms ofcurre.at law or by contract.

ANNEX 2.10Page 4 of 8

- 69 -

CHAPTER IIOrgans and Structure

Article 5Organs

The organs of the IDIL are:1. The Board of Directors.2. The Executive Directorate.3. The Consultative Council.

Article 6Composition and Functions of the Board of Directors

1. The Board of Directors has the following members:

a) The President of the IDIL;b) The National Director for Local Administration;c) The National Director of Rural Development;d) The National Director of Finance;e) The Director of the Cabinet for Promotion of Employment;f) The Executive Director of the IDIL.

2. The chairman of the Board of Directors is designated bythe Prime Minister of the People's Republic of Mozambique, followingnomination by the Secretary of State for Light Industry and Foods.

3. The Board of Directors decides by a majority of itsmembers, and the chairman shall have the deciding vote.

4. The Board of Directors shall meet on a regular basis twiceper year and on a special basis whenever its chairman or more thanhalf of its members so request. Special meetings may also be convenedat the request of the Executive Directorate.

5. The IDIL is represented by the chairman of the Board ofDirectors, for both internal and external matters.

6. The chairman of the Board of Directors is replaced in hisabsence or impediment, by the executive director.

Article 7Method of Committing the IDIL

1. The IDIL is committed by the signature of the chairman ofthe Board of Directors or the executive director.

2. For all simple business matters, the signature of adepartment head shall suffice.

3. The directorate functions on the basis of group workmethods that ensure joint participation of the members in matters ofdecision-taking, execution and control.

4. The several members of the directorate are, however,individually responsible for implementation of all matters in theirarea of activity.

ANNEX 2.10Page 5 of 8

- 70 -

Article 8Responsibilities of the Board of Directors

The Board of Directors has the following responsibilitiess

a) Approve the work plans of the IDILIb) Approve the budget and accounts of the IDILIc) Approve the internal regulations and the staff regulations;d) Appoint and remove department heads following proposal by

the executive director;e) Perform all other duties entrusted to it by the Secretary

of State for Light Industry and Foods, by law or by contract;f) Convene the meeting of the Executive Directorate whenever

advisable;g) Decide on increases or reductions in the establishment fund

and submit the decision to the Minister of Finance for approval.

Article 9Composition of the Executive Directorate

1. The Executive Directorate is composed of the executivedirector and the department heads.

2. The executive director is appointed and removed by theSecretary of State for Light Industry and Foods.

3. The department heads are appointed and removed by theBoard of Directors following nomination by the executive director.

Article 10Composition and Functions of the Executive Directorate

1. The Executive Directorate is responsible for all actsnecessary to directing and managing the IDIL, and shall perform, withthe fullest powers, all acts pertaining to attainment of itsobjectives, and in particular;

a) Implement the work plans approved by the Board ofDirectors;

b) Direct, coordinate and supervise the activities of theIDIL;

c) Hire, discipline and remove IDIL personnel in accordancewith the established personnel plan;

d) Propose the approval of annual and multi-year workprograms.

2. The executive director may delegate his responsibilitiesto IDIL personnel and set the limits on them in each case.

Article 11Composition and Functions of the Consultative Council

1. The Consultative Council is composed of:

a) The executive director;

ANNEX 2.10Page 6 of 8

- 71 -

b) The heads of IDIL department:7c) One representative from the small industrial companies of

each province, who is designated by the pertinent professional agencyor association or elected directly by its members.

2. For specific matters, technical experts and scientists maybe invited to attend and offer their opinions; such persons shall beinvited by the executive directcr.

3. The Consultative Council may nold meetings that includerepresentatives of small industries from a single province.

Article 12Responsibilities of the Consultative Council

The Consultative Council has the following responsibilities:

a) Study the basic problems associated with developing smallindustry and contribute actively to their proper solution;

b) Prepare the list of small industry projects in progress orto be conducted by the IDIL;

c) Review and give opinions on proposed measures aimed atsupporting, encouraging and promoting small industries;

d) Perform all other duties entrusted to it by the Board ofDirectors;

e) Propose specific measures to enhance the technical qualityof products made by small industry;

f) Participate in the preparation and application of measuresintended to raise the professional awareness of producers, developtheir scientific and technical know-how, enhance hygiene and technicalsafety in small industrial plants and improve living and workconditions.

Article 13Departments

1. The IDIL has the following departrtents:

a) Aiministrative Departmenttb) Technical and Production Department;c) Organization and Management Department;d) Training Department;e) International Relations Department.

2. New departments may be established upon proposal by theexecutive director and approval by the Board of Directors.

CHAPTER IIIPersonnel

Article 14Personnel

1. The personnel plan of the IDIL shall be approved by theBoard of Directors upon proposal by the executive director.

ANNEX 2.10

-72- Page 7 of 8

2. Vacant positions hall be filled in accordance with theneeds of the service and following rules to be approved by the Boardof Directors.

3. The IDIL personnel shall be governed by the legal systemin effect for individual labor contracts.

4. Public employees may exercise functions within the IDILIthey shall be subject to the service commission system in all mattersthat relate to their staff assignment of origin.

CHAPTER IVEconomic and Financial Management

Article 15Economic and Financial Management

All goods, rights and others valuables that the IDIL acquiresor contracts in the exercise of its powers shall constitute its networth.

Article 16Income and Expenses

1. The IDIL has the following income:

a) Appropriations, part-ownerships and grants conveyed to itby the state and other corporate bodies under public law;

b) Income from charges for services rendered;c) Proceeds from the sale of manuals, information bulletins

and other publications;d) All other earnings, goods and rights resulting from its

activities or which are conveyed to it by law or contract;e) Appropriations and grants conveyed to it by individuals or

corporate bodies, national and foreign;f) Dividends resulting from its own assets, national persons

or corporate bodies.

2. The IDIL has the following expenses:

a) Charges for its own operations;b) The costs of purchasing, maintaining and keeping in good

repair the assets or services necessary for its functions and theperformance of its powers

Article 17Use of Funds and Reserves

Surplus funds shall be used to establish at least thefollowing reserves:

a) Research fund;b) Investment fund;c) Workers' social fund.

ANNEX 2.10Page 8 of 8

- 73 -

CHAPTER VFinal Provisions

Article 18Final Provisions

1. All acts and contracts entered into by the IDIL as well asall acts revoking, rectifying or amending them may be privatedocuments.

2. When the acts are subject to recordation, the privatedocument must contain authenticated recognition bf the signatures.

3. The documents that the IDt., !ises to formalize any legalbusiness as well as documents it issuei. in conformity with thecontents of its legal document shall in all cases be invested withexecutory authority in connection with all persons indebted to theIDIL, regardless of other formalities required by law.

Article 19Doubts

Any doubts arising from application of tb*s law shall beresolved by instruction of the Secretary of State for Light Industryand Foods.

- 74 -

ANNE 2.11

MOZAMBIQUE

SMALL AND MEDIUM EqTERPRISE DEVELOPMENT PROJECT

f~~~~~~~~~~1

ii~~~~~~~~~-rI i ' I IIl

- 75 -

ANNEX 2.12

HOZANBIQUE

SMALL AND NIDIUM ENTERPRISI DEVELOPMENT PROJECT

INSTITUTO RACIONAL DA DESEWOLVIMERTO DEINDUSTRIAU LOCAL (IDIL)

Provisional 1989 Budget Suimary(Excluding IDA and other external assistance)

Operating Expenditure (Mt 000)

Salaries a/ 19858.0Personnel costs 3400.0Maintenance 5300.0Administration 8900.0Service payments b/ 13612.0other materials 1800.0Service payments to consultants c/ 10000.0

Total Expenditure 62870.0

Operating Receipt

Project preparation services AL 10000.0International agency subventions el 3000.0Expected results of participations 2000.0Profits from sales of materials,

equipment f/ 6300.0

Total Receipts 21300.0

State Operating Subvention Rtequired 41570.0

Capital Expenditure (State Subvention) 242.e3.0

Sources Based on IDIL projections

a/ Salaries relating to domestic staffing of 28.

b/ This inc'.udes local and overseas travel and communications costs.

c/ Possible costs of hiring outside technicians to support enterpriseestablishment/operations.

d/ Projected earnings from project preparation services for an estimated 50projects, at av6rage fee of Mt 200,000 per project.

- 76 -

ANNEX 2.13

SMALL AND MEDIUM ENTERPRISE 03"EULOPHENT PROJECT

INSTITUTO RACIONAL DA DRSDWOLVINHENTO DEINDUSTRIA LOCAL (IDIL)

External Donor Financing of IDIL Investments

Source Items USS

UNIDO(Project Moz/015/86) Vehicles and Office Equipment 125,000

HIVOS Computers, Office Equipment 24,000

ILO/SIDA (Training Vehicles and Office'Improve your Business') equipment 49,000

SIDA Furnishing and office equipze'nt 108,000

- 77 -

ANNEX 2.14MOZAMBIQUE

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Leaal Status of Enterprises

State Private Cooperative Intervened Mixed Total

Petroleum 1 1 2 *Paints 3 3 6Toiletries 15 1 6 22Industrial chemicals 8 2 10Plastics 1 6 7 14Rubber 2 3 6 11Metal processing 1 6 7 14Engineering 3 3Ship repairs 2 1 3Metal fabrication 2 5 1 9 17Light engineering 2 45 4 8 3 62Electrical 4 3 1 8

engineeringRefrigeration 4 5 9Construction 14 1 2 1 18

materialsCement 3 3Glass 1 1Wood products 8 10 1 19Furniture 2 33 2 10 47Paper cartons 1 2 4Printing 3 15 13 31Textiles 3 15 6 24Garments 7 23 11 8 49Leather 7 1 13 21Sugar 2 4 6Edible oils 5 2 7Flour. 6 27 8 41

confectionerySalt 4 19 1 24Cashew nuts 9 5 14Meat products 3 3Dairy 3 1 2 6Processing 15 12 1 28Drinks 8 14 22Animal feeds 6 6Other foods 3 4 4 11Tobacco 6 6Other 1 1 2Pharmaceuticals 1 1

Total 114 294 21 140 6 575Percentage of

Tctal 19.8 51.1 3.7 24.3 1.1 100.0

Sources UNIDO

- 78 -

ANNEX 2.15

MOZANBIQUE

SMALL AND MEDIUM RNTERPRISE DEVELOPM PROJCT

UNIDO STUDYMain Problems Affecting the Firms

Priority of ImportanceProblem 1* 2* 3*

Code Definition No of Z No. of X No of 2firms firms firms

p1 Lack of raw materials(imported and local)and subsidiary inputs 30 55.5 6 11.1 1 1.9

p2 Lack of spare parts andtools 1 1.9 9 16.7 5 9.2

p4 Power cuts a/ 5 9.2 17 31.5 7 18.0

p5 Machinery (out of order,obsolete, old) 4 7.4 11 20.3 5 9.2

p6 Work force (lack of super-visory staff and skilledworkers) 3 5.6 6 11.1 10 18.5

p7 Lack o. transport equipment(for pasengers and goods) - - - - 6 11.1

p8 Technical assistance needs - - - - 5 9.2

p9 Other 7 13 1 1.9 3 5.6

P1 0 No response 4 7.4 4 7.4 12 22.3

TOTAL 47 87.0 54 100.0 54 105.0

Sources Responses of firms surveyed. UNIDO 'Industrial Situation in Mozambique,1987"

a/ This was a temporary problem of the economy with little impact atpresent, except in Beira.

The conclusion to be drawn from the results obtained is that taemanagement of the industrial firms surveyed considered the main problemsaffecting their operations to be the following, in decreasing order ofimportance.

1. Lack of raw (imported and local) subsidiary materials;2. Power cuts;3. Defective, old, and obsolete machinery with frequent breakdowns.

- 79 - ANNEX 2.16MOAiqUE

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

EXPORT RETENTION RATES

Puumds ~~~~~ hit huat fi~~~~~~~i~iIjiifietemcee1*| z

t. inrt tu

1. Casbh inte

C ^o de I:"bt p (private)

ledo C eii (private) 45 e4 32

. ravs (ftsiettei)

taproes bembticua de Peace eopaSc6 (States) 1 14 ttripel (ptivate with nized caPital) is 14 Si

Premo., (private with md capital) 71 14 SiCipeea (privett) - 23 2iSpeoea (private) - - 3frtieo tut.e onte (privatte) so soOrgeatsecoea Paest Cebrta (privae - -Nasopese (Private with eased capital) - - soPeaces do Wu (private) - 30

S. Cttet OA stel

Cottet coweaie (setet) of aupulas, Cabe 9el48aetl.hhae. oetl. Mantes. ZeabSaim. Tote sad nSi*& PsediaS P*eet AS

Ceneabi Joto ettdeira deo eatee (private) 30 25.3 25

4. Coors OA Coar l

Palm 4e Qoirtts (private) 3 20 *5Copra Producers Asoeietio (vartoa private sod

state eterpritt of Zaebiata) 20 39.7 31Stote Setretrciat for tight teduetn * d food

(govermet eiy eteb subsequently allocatsthe reacntes to t ail l sop enterprisee) S0 2S 5

5. tea

ktoch (seats) 10 X A

S. Othet bruach of actiLvitt

Iabor da 01"btqee (private with asied eaptatl) Moy I" SO IctoJaa etasee de Uombiqua - totertfaste

0etote)o-teret s.reot shops 10 S00 S00Ibditse (state) - phtrecutirtels. etc. 1oo 10o 100"ama (atate)-samlptectous stones 100 30 100

It. _ag___iife to (pertast of receipts tocouttle wtea c

cata (state), CooetrufVsm t?cnica (private) andConstrutrsa de 1_eep (private)--catreuettei O W10 1eo

lfloss (tete)--9teoett7 *ee toaoefor (eised MOtal)-_ed 100 100 100

Other epeifite ptojects (fisoced by 8 tearked greatetrom W, 603a5, the Petharlaode. uSVA USIAD) 100 10 100

L.t Otert too" (reseltiug from eotrectual agreemuts).

Copesebla do Pipellts lbmbique Slebhbwe-CPIU (privatewithb miad Capital)-petroleve products pipeltne 100 10W 100

Igereua b cieal de Udrocarboege-tU (stete)--petrole.s 100 100 100AdUt.itraet do Parque timbtirlOte do tstado - Afl--houstal 3o 30 I5Loome is freige areray for iovesteeot in exportiug fires

(eaperimotal) 100 100 t0o

So ooekU. of Nosambique.

p lus 10 percent fto peritted Slee Is treeay convertible currency io the letcl market.

- 80 - ANNEX 2.17MOZAMBIQUE

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Fixed Consumer Prices, 1980-April 1988

I 6

!~~~~~r u s u osFI

cu c SW 30o 0 3.0 1.0 um0 340 10.0 273.m 2M3M0

saw (kw) 10 30.0 NO.0 3O0 ... y ... ... y

ti, me ... ... 740 2401740 a.40 1A4vm40 3.3140 U."vuD m1O3Ie. 13.3 U.S 13.3 13.3 4.OM. 04." 704070 2043O440 W50/0. 2711.thIsa 7.0 to 9.0 1.3AD 1."40 340/D.0 6.m0/240 45.0/2740 W.301 ma *.F) *- 9.D W"UD 2011 40r w4*m t2WX *MD

7.0 740 7.0 740 7.0 5./43.0 3.043.0 *040/3.0 .m4WM

fttatom 9* 940 940 340 ... ... ..km (b.tat) a.3 1.o V.3 18.3 5.3 pMI 3m_m Crqto 3.0 1440 18.0 "is 3.C 13.0 12340 1240 36D

cd.3 nil v. ... ... ... ..

Guaoots 2D0.0 26.3 2.30t.3 333 330 1330 2O00Mbla di Wui ... 5.3a .3 3.3 30 0 0t 3m m0.0Solt co4 40 7t4D 70 7t0A1 740 V7AD VAD ... y ... 6/

Pra* am (Ut n 9gm 140 10 140 140 55A. - .Ombnud 1Mk (MU m0) 1240 1AD 0 230 230 23.0 50 3u5.0 ...fUP (dom* 0430 4A0 4.0 XIAO AD 40 *. *-- ...ad, side 1 140 i3sm V04D 3340 33.04 1,43AD 1,40040 040.-.h&I VW& 1 0D0 O.g "DAD 30 5 3340 1,353.A0 1,40 1,53. 1334Chid= t5470 73.0 740 1OAD D0om 7mm.0 780. 78040 ...11d4 atde 1 3.0 13.0 1340 DS401 3940 6040 96A3 96.0 96340"AN, sides 2340 304D 30D40 AD 63AD 2040 3540 33540 33.0

_a (m) 3.0 3.0 23. 3.3 3.3 3.3 3.7 =A 04Dbr (0. 1) 36.0 5. 3O40 N4D 6540 2040D 25fAD 333.0 M3Mtim mod1s23 ) ... ... ... lDAO I.3 5A. 50C*pmatin (P*J 23. 4000 4.0 ADA40.0 230 I 34D 033040btdm (bm* 10 1.4 lJO 24D 2AO 0 6.0 - -

9t ~ ~ 1. 1VAO 17AD 17AO 17AO VAO0A 145.0 143.0 429m0gm 1 vimA VAIg ISOA vISOA vim4 OD M IAD 101AD l 4l

SASS (13 WJ M30 40 300 340 30.0 Mo. W,3 2,0130 1,0154 1,01341. _ (i) 27AD 27A4 24AD 2V40 2VAD ... 21. 1AD81 24140

Imop ... ... ... all IDAO .3104. 66.10am tfr , ... ... ... ... OD3 3AM IA3.

Gezali ... ... .4. 7.. 13.3 t.3A 3.303..0 I3A 1340 12.S 12. 9

set 3. 340 104D I40 18. dO0D4 ...8...

Sum aai 308227. Rmgq" WA mahusy .1

0 - late" itue dmhmoica, ia.1.fq a cm at Idbmq u. lat mw.

y Qtot o. _ -Z w.1 .' *m an pim mm *Di.U.d Imr mlim teor (1365 W, ISpASat meaI (3941).

Prim &Dm otm NW M d a' arm -Ra *i Ut.

- 81 -

AMNE 3.01Page 1 of 3

NOZANBIQE

SHALL AND NEDIUM ENTERISE DEVELOHE PROJECT

Structure of Inter at Rates. September 1989Ministerial Order

Pursuant to the provision of numeral 5 of Resolution 11180 ofDecember 31, concerning credit and interest rate policy, the Minister ofFinance and the Governor of the Bank of Mozambique order the following:

1. The following interest rates are hereby fixed for lendingtransactions:

I. Central Bank discount rate: 12 percent p.a.

Percentage ceilings on use (percentage of demand deposits):

(a) Liscount: Ceiling up to 6 percentTerm: Up to 3 weeks

(b) Discounts Addition up to 6 percentTerm: Up to 2 weeks.(In this case the rate shall be 2 points higher).

II. Level 1

Covers the following economic sectorss

- Agriculture and forestry- Farm marketing- Cooperative (agricultural, consumer and others)- Food industry- Electricity, gas, steam and water

Working Capital Investment

To To To To To Over90 180 365 2 3 3days days days years years years

(in percent)

15 16 17 22 (single rate)

-82 -AMN= 3. 01

Page 2 of 3

SII. Level 2

Covers the following economic sectors:

- Manufacturing (light and heavy)- Extractive Industries- Construction, public works and housing- Export- Fishing- Railroad and maritime transportation and other public

transportation of passengers and freight (enterprises andassociations).

Working Capital Investment

To To To To To Over90 180 365 2 3 3days days days years years years

(in percent)

20 22 24 25 26 27

IV. Level 3

Covers the following economic sectors:

- Wholesale and retail trade, restaurants, hotels, tourismand other

- Passenger and freight transportation (individualoperations)

- Other activities not included in Levels 1 or 2 andindividuals.

- 83 -ANVU 3.01Page 3 of 3

- Working Capital Investment

To To To To To Over90 180 365 2 3 3days days days years years years

(in percent)

28 30 32 33 34 35

2. Investments in construction and freight transportation made by[sic] the commerce and tourism sector and the housing sector by individualsmay benefit from Level 2 interest rates.

3. Surplus inventories of essential goods in the consumer goodscommerce and industry sector may benefit temporarily from credit support atthe rates set in Level 2.

The Bank of Mozambique will determine by public announcement whichgoods are to be financed in these terms and the loan terms therefor.

4. The interest rate system fixed herein may also be applied to loansoutstanding on the Jate of entry into force of this ministerial order if thepertinent contracts provide for modification of the interest rate in theevent a different ceiling is legal establisied.

5. Disputes arising from interpretation and implementation of this[ministerial order shall be settled by) joint order of the Minister ofFinance and the Governor of the Bank of Mozambique.

6. This ministerial order shall enter into force on September 6, 1989.

MaputoSeptember 6, 1989

Signed SignedEneas da Conceicao Comiche Abdul Magid OsmanGovernor, Bank of Mozambique Minister of Finance

- 84 -AM=E 3.02

SMALL AND MDUM INTERPRISE DEEOIHM PROJECT

Distribution of bank credit to the economy. Mt billicn.

Sector 1984 1985 1986 1987 1988

Total loans outstanding al(excl lending to Govt) 92.9 110.9 125.4 151.8 216.7BM 72.0 87.4 99.2 119.6 150.6BPD 18.8 20.7 22.4 27.3 51.1BST 2.1 2.8 3.8 4.9 9.3CCADR - - - 5.7Agriculture 29.4 34.8 63.1 75.6 104.7- BM 12.0 15.4 42.3 49.7 58.9- BPD 17.1 19.0 20.7 25.2 40.7- BST 0.3 0.4 0.1 0.7 0.7- CCADR - - - - 4.4Industry 38.1 47.1 21.4 23.9 34.1- BM 35.1 43.9 18.1 20.3 23.8- BPD 1.7 1.7 1.7 1.9 4.6- BST 1.3 1.5 1.6 1.7 4.4- CCADR - - - - -Construction 1.5 3.3 8.6 10.2 15.2Transport 9.4 11.6 15.6 21.1 26.3Domestic trade 6.6 6.6 16.9 11.0 23.7Foreign trade 7.9 7.5 - 9.0 10.8Other - 0.9 2.1

a/ Includes both domestic credit and foreign funds onlent by the bankingsystem.

Source: IMD/ Bank of Mozambique.

- 85 -

ANNEX 3.03

MOZAMBIQUE

SMALL AND MEDrOM ENTERPRISE DEVELOPHEN? PROJECT

Estimated Subsidies to State Enterprises

(Unit: 1000 contos)

Sectors 1987 1988

Agriculture 6,051,2 3,289,9

Sugar 2,633,3 1,555,9Cotton 951,6Copra 1,500,0 816,0Other 966,3 918,0

Transportation and Comunication 706.9 605,0

Railways 649,7Shipping 57,2 582,4Road haulage 22,6

Mineral Resources 656.1 1,022,9

Coal 466,6 827,9Other 189,5 195,0

Other Sectors 1,639,2 1,852,7

Electricity 865,6 1,185,9Building materials 750,9 657,3Various 22,7 9,5

TOTAL 9,053,4 6,770,5

Source: Ministry of FinanceMaputo

- 86 -

AMX 3.04

NOWIIIOQUE

SMALL AND EDIUD RNTERPRXSE DVELORPUNT PROJECT

&at* Branch networks. (Jue 1986)

(Nme)

Type aM BPD BSm T*sl

Provincial head office (filial) 10 10 3 23

District branch (a8encia) 17 22 1 40

Deposit office (delgacao) 13 46 3 62

Savings collection post (posto decaptacao de poupanca) -- 70 -- 70

TOTAL 4r 148 7 195

Source: BM, BPD, BSTM

- 87 - ANNEX 8.05

MOZBQUK!-

SMALL AND MEDIUM EN1EPPRISE DEVELOPMENT PROJECT

Distribution of deposIt. by bank and term: 1980-19MSeloncsr end of periodsource: IF RED, various yars and W Stati1stical Offte, 1989.Unit: blillons, Mt, current price.

1980 1981 1932 1988 1984 1906 1093 1987 1986

Total 1/ 28.2 88.5 41.0 65.0 56.5 68.6 79.1 129.5 179.4dmoand deposits ... ... ... ... ... ... 74.7 116.9 169.4time depolts ... ... ... ... ... ... 4.4 12.6 10.0

Su 2/ 14.8 18.9 28.5 26.4 26.0 29.7 86.7 76.0 105.6demand deposts ... .... ... B8.8 68.9 102.6time deposits 8/ ... ... ... ... ... ... 0.4 7.1 2.8

EPD ... ... ... ... 22.4 80.0 84.8 44.5 60.7demand deposits ... ... ... ... 19.8 26.2 80.9 89.2 65.7time deposits ... ... ... ... 2.6 B.8 8.9 6.8 7.0

am ... ... ... ... 6.1 6.8 7.6 9.0 13.1demand deposlts ... . . . 5.9 6.7 7.5 9.8 12.9time deposits ... ... ... ... 0.2 0.1 0.1 0.2 0.2

femo: for SPD.BSTM only 11.9 14.6 16.1 22.5 29.6 38.8 42.4 68.6 738.demand deposit 9.2 11.5 14.9 18.6 25.7 82.9 88.4 48 66.6time deposits 2.7 8.1 8.2 8.9 2.8 8.9 4 5.5 7.2

1/ The distribution of total deposits between demand and ti- deposit. for the period 1980-83Is avallable only for BPD and OSMT combined.

2/ BSM acepts only deposits by entrepries, with the exceptlon of deposits by own employees anddeposits In foreign currency.

8/ Includes deposits in 'oreign currency.

___ _ __ _ _ _ __ _ _ _s.________-_----------------

- 88 -

ANNEX 3.06Page 1 of 3

MOZAMBIOUESMALL MEDIUM ENTERPRISE DEVELOPMENT PFROJECT

Evolution ot Loon Asset Structure andAationalisation of Arrears (BM)

TABLE NO. 1

BM -- EVOLUTION OF LOAN ASSET STRUCTURE (IN MILLIONS)

12/31/86 12/31/87 12/31/88

TOTAL CREDIT *) 99,200 % 119,600 % 150,581 %

RESCHEDULED 0 0 15,430 13 38,265 25TO BE ASSUMED BY GOVERNMENT 40,600 41 40,600 34 21,862 15NEWLY COMING DUE 12,900 13 27,750 23 50,338 33RESCEEDULABLE ARREARS 1) 41,200 42 29,240 24 31,081 21DOUBTFUL ACCOUNTS 2) 4,500 5 6,580 6 9,035 6

') Statistical sample representing about 90 percent of total creditto the economy.

1) May be rescheduled to the extent that companies are able to obtainfunds for preparation of rehabilitation programs and/or the currentsecurity situation is overcome.

2) Entities that left the country and/or economic units that weredestroyed or no longer have a viable future. Securities to beregularized with existing provisions and/or to be created foruncollectible credit.

SOURCE: BM - DEPARTMENT OF CREDIT OPERATIONSDPCC/ 1989-03-24

TABLE NO. 2

BM -- LOAN ASSET STRUCTURE BY SECTOR AS OF 12/31/88 (IN MILLIONS)

DESCRIPTION AGRICULTURE MANUFACTURING CONSTRUCTION TRANSPORTS COMKERCE TOTAL

AMOUNT % Amount % Amount % Amount % Amount I Amount I

RESCHEDULED 11,373 19 6,719 28 1,877 17 17,086 67 1,210 4 33,265 25

TO BE ASSUMED BY GOVERNMENT 25,272 26 921 4 5,19A4 48 475 2 0 0 21,862 15

NEWLY COMING DUE 13,591 23 8,054 34 755 7 5,537 22 22,401 71 50,338 33

RESCHEDULABLE ARREARS 16,124 27 6,483 27 2,269 21 1,446 6 4,759 15 31,081 21

DOUBTFUL ACCOUNTS 2,521 4 1,620 7 700 6 950 4 3,244 10 9,035 6

TOTAL 58,881 100 23,797 100 10,795 100 25,494 100 31,614 100 150,581 100

I BY SECTOR 39.1 15.8 7.2 16.9 21.0 100.0

SOURCE: BM -- DEPARTMENT OF CREDIT OPERATIONSDPCC/ 1989-03-24

0.'hOtt '

TABLE NO. 3

BM -- LOAN ASSET STRUCTURE BY SECTOR AS OF 12/31/88 (IN MILLIONS)

DESCRIPTION RESCHEDULED ASSUMED BY GOVT NEWLY DUE RESCHED. ARREARS DOUBTFUL ACCOUNTS TOTALAmount % Amount % Amount 8 Amount % Amount S Amount .%

AGRICULTURE 11,373 30 15,272 70 13,591 27 16,124 52 2,521 28 58,881 39MAIWUACTURING 6,719 18 921 4 8,054 16 6,483 21 1,620 18 23,797 16CONSTRUCTION 1,877 5 5,194 24 755 1 2,269 7 700 p 10,795 7TRANSPORTS 17,086 45 475 2 5,537 11 1.446 5 950 1. 25+494 17COMMERCE 1,210 3 0 0 22,401 45 4 759 15 3,244 36 31,614 21

TOTAL 38,265 100 21,862 100 50,338 100 31,081 100 9,035 100 1505.8s. 100

% BY CATEGORY 25.4 14.5 33.4 20.6 6.0 100.0

SOURCE: BM -- DEPARTMENT OF CREDIT OPERATIONSDPCC/ 1989-03-24 0

TABLE NO. 4

BM -- DEBTS TO BE ASSUMED BY GOVERNMENT (IN MILLIONS)

AMOUNT GRANTED 40,630 XAmount already liquidated 8,768Amount transferred as rescheduled 10,000Amount to be regularized 21,862

SOURCE: BM -- DEPARTMENT OF CREDIT OPERATIONSDPCC/ 1989-03-24

- 91 - . ANNEX 3.07MOZAMBIQUE

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Subsectoral Breakdown of Bank Credit (Provisional)

------ December 1987 ------ -------December 1988-----Working Fixed Working Fixed

Item Capital Capital Total Capital Capital Total

Total 133,570 18,269 151,039 175,798 10,896 216.691BM 105,166 14,117 119,503 131.341 19,240 150,501BPD 23,323 4,011 27,331 34,888 16,255 51,143BSTM 4,781 141 4,922 9,094 212 9,306CCADR -- -- -- 475 5,189 5,661

Agriculture 72,174 3,420 75,591 92,519 12,160 104,709BM 48,293 1,403 49,696 57,396 1,405 58,881BPD 23,247 959 25,206 34,047 6,679 40,726BSTM 634 50 692 633 73 706CCADR -- -- -- 413 3,923 4,396

Industry 20,980 2,962 23,942 26,859 1,193 34,051BM 19,259 1,030 20,289 21,741 2,056 23,797BPD 76 1,819 1,975 807 3,808 4,615BSTM 1,6A5 83 1,728 1,309 139 4,417CCADR 2 1,190 1,192

Construction 8,725 1,487 10,212 10,628 1,505 15,213IM 8,591 1,487 10,001 10,338 457 10,795BPD 0 0 0 0 4,120 4,128BSTM 131 131 290 0 290CCADR -- - -- -- -- -

Transport and Communi-cations 11,279 9,839 21,118 11,639 14,661 26,300BM 11,119 9,837 20.956 11,166 14,328 25,491BPD 0 2 2 31 257 291BSTM 168 -- 160 139 -- 439CCADR -- -- -- 0 26 76

Local Trade 10,657 360 11,017 22.767 911 23,681BM 9,122 360 9,482 20,053 914 20,967BPD 0 0 0 0 0 0BSTM 1,535 -- 1,535 2,714 0 2,714CCADR -- -- -- 0 0 0

Foreign Trade 9,079 0 9.079 10,647 0 10,617BM 9,079 0 9,079 10,647 0 10,64iBPD 0 0. 0 0 0 0BSTM 0 - 0 0 0 0CCADR -- -- -- -- -- 0

Other Credits 676 203 879 710 1,303 2,093BM 0 0 0 0 0BPD 0 203 203 0 1,385 1,383BSTM 676 0 676 710 0 710CCADR 0

Source: Directorate of Statistics and DocumentationMaputo, March 17, 1989

MOZAMBIQUE - 92 -ANNEX 3. 08SMALL ANlD MED)IUM ENTERPRISE DEVELOPMENT PROJECT

1111_ n

i L0XL ]

XiJC

iiL Co A

0~~F~--i

0XS t1~~~I1t+~~~1i

- 93 -ANNEX 3.09

MOZAMBIQUE

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Banco Popular de Desenvolvimento

Structure of Loan Authorization Responsibility (1988)

OtherLevel State Sector Sectors Units Costof Decision W.C. Inv. W.C & Inv. Nature of Fee

Administrador 400,000 80,000 80,000 By single operations.Administrador 500,000 100,000 100,000 By accumulated

resporsibility.

Director 200,000 35,000 35,000 By single operation250,000 45,000 45,000 By accumulated

responsibility.

Managers ofBranches 100,000 20,000 20,000 By single operation.

200,000 30,000 30,000 By accumulatedresponsibility.

Managers ofAgencies -- -- 10,000 By single operation.

-- -- 15,000 By accumulatedresponsibility.

WC Working Capital. INV a Fixed Investment

Notes: 1. Managers of Green Zone agencies l vld theequivalent responsibility as Branch Managers.

2. Accumulated responsibility means credit balance,whether paid or unpaid (due or not due) onoperations of the same beneficiary.

3. All authority is limited by the overall creditplan.

4. For the state sector financing related toenterprise deficit in which the Ministry ofFinance is concerned, come under the authority ofthe Administrative Council.

- 94 ANNEX 3.10MOZAMBIQUEPaeIo2

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT Page 1 of 2

toz.ibu : S uwy Rccntt d the knm. de fksenwv to id tlBanco Standard lotte de fI z*que. 19U4-09

(In .illhos of feticas)

....................... ......... .................................. . *.. ................................................

1984 l98 1986 98 1988 1989March June Seot. Ce:. Ibtch June

------------------------------- ...................................... ................... ............................... ............... .................. ........ .............

Reserves 7689 13621 17t13 292t2 32509 3671? ... 99666Cash 172 1366 1688 2068 198t 2382 ... 321?Deposits iith WIl/ 5969 12255 157h 2717t 30520 39335 ... 91t99

foreign as3ets 55 59 60 85 9% 97 ... 13t

Clautes n the overnment 7931 8435 893S 8990 9990 8990 .. 12037

Clains on the econ 23293 25257 27663 33917 36935 923 .. 51996Banco Pouar 20070 1902 23797 288z0 30347 35300 ... 498

On public enterpriss 15759 1818 19668 23795 24807 23662 ... 29560On private sector 9316 3722 t129 SOOS SS50 11618 ... 13288

Banco Standard tprivate) 3173 33S5 3966 5017 6S88 7029 ... 918i

UnclossItied assets 28840 tS67 4999 22956 291G 3Q003 . 8. 938Claim on banks 278 358 t21 7924 7255 10078 16987fixed and stocks 2U9 231 237 332 370 S50 ... 220?Transitory accounts 28338 3978 9291 19700 16521 20195 .. 2929Othtr assets

Rsseth * Liabilities 6T775 5193b 58520 95090 10266S 118936 ... 157271

foreign hbilities - 1 1 6 6 6 ... 8

Oend and savins detpsts (70 32839 383 47999 999t 58862 ... 5798an Popular 19824 26160 30913 3925 39367 9008 ... 38527

auce Standard 5928 6679 7530 8789 96t2? l851 ... .2221

lue and foreig curretncdepsits 2777 3909 409 Sin3 503 5783 ... 7035

on opar 2581 3803 3917 5265 S238 5618 ... 6865Dance Standard 196 106 102 168 165 165 ... 170

Everment deposits 8200 8000 8000 13230 18S67 18567 ... 23768

Credit fron the 11/ 59 9 S91 190 190 110 190 ... 171

Caital accounis 2117 2260 23" 2770 27m 2767 ... 39S

Untlassified liabilities 29299 1336 $i53 2S50 26783 32111 ... 71550Depsits of other bans - - -

Trantory accounts 27603 3902 3969 5948 6219 7863 ... 6511Casitr's thecks 364 696 1249 3052 3501 3751 ... 20991Rccounts payable 86 11 - 261 9173 9m ... 13263lestritted desits 199 161 - - --Contingent liabilities (it) --

Other liabilities 47 66 330 1623 12 (,j 275s2 31285.. . .. .... . .......... . _. _._ ........ . __ ........... .... . ..

Source: Data provided by the Bank of lozambique.11 R1, Bank of tozaibique.

- 95 - ANNEX 3.10Page 2 of 2

MOZAMBIQUESMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

hfnzbafe: SWury km of the ln of ftwh, 19s44

(In millions of ietules)

...... ...... .. ............................. . .. ........... . .... . .............. ... . ............... . _ ..... _

1984 1985 1906 1987 1988 1989rIbch June Sept. Otc. hatch June

.... .. _...... ....... _ .... _._......__ ...... . __.. _ _.. _...___=...... ..... _

roreign assets 3962 2i21 3140 6100S 73698 in926 105131 128949

Claus on Governent 7235 74382 S3099 89S69 102110 189903 119998 12981m

Clam dt the ecgipv 78731 91905 10S3C1 136121 145531 154569 16053 18353?

Claim on e banks 1766 IS0 873 673 673 673 2679 2679

Unclassified assets m7726 74351 77519 176708 285733 2142015 ... 2932656r1xed ad stocks 213 Z11 201 279 267 00 ... 692Adjusttent account3 331 - -- 1274 14G0 1439 ... 6644transitory accounts 76881 71140 74474 630771 719375 733737 ... 1010737Other assets 2 -- 2844 11333r8 133U66 10139 ... 191683

Assetr u Liabilities 233963 2449S9 743222 2053579 2902 2488286 3377692

Resrue n y 62863 73843 86167 133037 145060 IS7555 ... 202468Curreny issued 287I 311S7 33904 36640 3935 45365 4153 64599Bankers' deposits 6064 12698 16001 25544 3287 1737 ... 41529DeOnd deposts 2904 29981 36262 66653 7431 8453 .. 963N

Tlie and foreigncureny deposits ... ... 437 7099 13708 13040 ... 18395

Hedim- and long-tern foreignliabilities 227 34248 36791 413880 4fl34 435152 555431 61207

Short-tern forcignliabilities 3030 2264 3139 4169 5 S7370 61557 62550of uhich: SRf - - - 6029 19666 19230 23417 24410

6ovuermnt deposits 4954 47769 20576 3675 4132 50112 54317 62507

Capital acounts 9472 10485 12374 25861 2 2890 30744 26036

Unclasfiedlbilities 81831 76330 83738 1391458 1659M 1746157 ... 2393589lestntted deposits 2000 2009 2010 2000 2000 2000 2000 2000Rdjtent accunts - 1015 1165 12514 II5 924 ... 4096Transitory aounts 781% 71541 7179S 28494 26294 5 266067 ... 347629Caser's checks 163S 1774 2664 7499 9272 10522 ... 1343CfntinWt liabilities

(net)Other liabilities - - 5794 1140951 1377639 141S524 ... 1990021

Source: Dta prouided by the ak ot Hozbique.

- 96 -

ANNEX 3.11

MOZAMBIQUE

Small and Medium Enterprise Devulopment Project

Provisional Balance Sheets (Summary)

Banco Popular De Desenvolvimento(Mt Million)

Assets 1987 November 1988

External assets 60 139Cash 1,596 1,860Deposits in Bonk of Mozambique 22.154 30,946Other Deposits 3,832 8,857

Lending: Total 34,749 53,370of Which State: 7,557 7,527Monetary Institution -- 8,698State Enterprises 23,795 28,689Private Enterprises 2,82/ 6,727Cooperatives 214 270Other Lending 356 1,459

Other Assets 9,704 21,825

TOTAL 72.095 116,997

Liabilities

Demand Deposits (total) 56,652 95,388of Whi-ch State -- 39,508

State Enterprises -- 5,258Other -- 50,622

Time Deposits 5,265 6,880

Checks Payable 2,381 5,570Other Liabilities 6,053 7,452Capital and Reserves 1,744 1,707

TOTAL 72,095 116,997

Source: BPD

- 97 -ANNEX 3.12

Page 1 of 5

MOZAMBIQUE

SMALL AID HIDIlDI RHTEPRISE D8VkLOPNENT PROJECT

PROPOSAL FOR TEE FINm NCiAL REUA ILITAflON OP D'S L)A PORTFOLIO(Extracts from BPD Document)

General situation.

BPD is concerned, as always, with safeguarding present and futurereturns on the financial resources it administers. Its starting point forthis purpose will be the introduction of changes in the treatment of doubtfuldebts, and legal recognition, whenever necessary, of the liability borne bygovernment organizations and indebted enterprises. These are importantstages in the necessary process of collection.

The negative growth that has occurred over recent years has beencombined with increased borrowing by enterprises from the financial system.particularly BPD. Debts as of December 31, 1987 totalled 36.3 millioncontos, of which 33.3 million contos had fallen due. Of the 36.3 millionconto debt, 20.7Z had been incurred before the country achieved independence,and this, including annual interest, currently amounts to 10.0 millioncontos.

As regards debts arising £-.er the country's independence, itshould be noted that certain enterprises were terminated and/or reorganizedon a different scale. gowever, their debts were not redistributed amongthe new enterprises, and no agency was appointed or legally identified asresponsible for settling such debts. In this context, BPD's main concern isnot with the total volume of these debts (trends in which over recent yearshave not paralleled changes in the levels of deposits received by the Bank),but with the following issues:

- identification of the organizations or agencies responsible formaking payments on existing debts, particularly those incurred bythe following types of enterprises

(a) those that have been terminated or divided up;

(b) those that are in deficit and/or are not economically viable;

(c) those that have been absorbed by other enterprises ororganizations;

- negotiation and preparation of a plan for the repayment ofliabilities owed to the Bank.

* -98 -MN=E S.12

Page 2 of 5

Loan to the NCanm

1.1 Agriculture

As a result of government action, the agricultural propertiesestablished under the colonial system were restructured and turned intogovernment-owned enterprises (and some into cooperatives), becoming largereconomic units. In order to ensure that the plan was executed in accordancewith the new forms of agricultural property, the Bank was called upon tofinance the new economic units. However, the government sector ofagriculture, which was to be viewed as the main producer of the foodsurpluses that were absolutely necessary for strengthening industrialization,met with serious setbacks, so that almost all its enterprises developeddeficits and/or became unviable.

These issues have been discussed in the various reports that havebeen duly presented, and explain why the debt of the government sector ofagriculture stood at 23.8 million contos as of December 31, 1987, of which23.1/million contos was outstanding.

It should be emphasized that the development strategy that has nowbeen prepared was never intended to bring about the enterprises' economic andfinancial recovery; it was because the financing provided for governmententerprises by the Bank had been approved by their supervisory agencies, andhad been guaranteed by the Ministry of Finance, that the !:ank continued tomaintain these debts.

The survey of borrowers showed the following breakdown of debtsfor this sector:

- Enterprises with debts that 19.6 million contoscannot be restructured

(a) terminated 0.7 million contos

(b) divided up and/orabsorbed into others 7.1 million contos

tc) other (including those that arenot viable and whose deficitshave been assumed by OGE) 11.8 million contos

- Enterprises with debts that canbe restructured 4.0 million contos

- Other enterprises (not in needof debt restructuring) 0.2 million contos

- 99 -hillE 3.12

Page 3 of S

It should be noted that the 28.8 million cc.tos in debts does notinclude the amounts owed by private landowners whose assets were absorbedinto government-owned economic units, the total being 0.2 million contos(which cannot be restructured).

1.2 ItadustrZ

The sector's debts as of 1987 totaled 1.8 million contos, of which1.7/million were owed by textile enterprises (Texmanta, Riopele, Texmoque andTextil do POngue. These enterprises faced (and still face) serious economicand financial problems, with the following consequences:

- Riopele T&xtil was paralyzed because of a lack of rawmaterials, particularly thread and fiber for the manufactureof textiles, having recommenced production only a few monthsago.

- Texmolue continues to be semiparalyzed, because of the lackof any power supply.

- Texmanta has not yet started up.

The efforts made by a number of managers and workers to changethe unfavorable trends affecting their enterprises have made it possible toconsider restructuring this sector's debts.

Conclusions

The loan portfolio has been adversely affected by the countryseconomic circumstances. This situation is aggravated by unfavorable trendsaffecting the Bank's financial inflows and by the lack of opportunities forit to apply its excess liquidity to lending, so as to offset these losses.It is thus clear that there is an overwhelming and urgent need to reversethis trend. The following essential measures must be adopted in order tosolve the problem:

- Debts incurred in the following areas, and that cannot berestructured, must be included in the annual governmentbudgets:

(a) the government sector of agriculture(plus the debts of private individualswhose assets have been transferred tothe State) 19.8 million contos

(b) rental housing 4.1 million contos

- 100 -ANNEX 3.12

Page 4 of 5

Ic) public sector 8.6 million contos

- Inclusion of the following amounts in thedebts of individuals and enterpriseswhose debts can be restructured:

(a) enterprises and small-scaleentrepreneurs 1.7 million contos

(b) enterprises and small-scaleprivate farmers 4.2 million contos

- Inclusion in the Bank's annual budgets,through the creation and application ofany revenue that the institution maygenerate, as lending risk 0.4 million contos

As a result of the physical inventory of contractual interestrates applicable to debtors (both enterprises and individuals), a weightedaverage rate of 8.182 per year was obtained. Consequently, the interest ratefor restructuring the Bank's internal debts has been set at 8? per year, andthis is also applicable to the approval periods that are to be negotiated orhave already been agreed.

It should be mentioned, in passing and by way of conclusion, that79.0? of the total debt cannot be rescheduled, while 4.2Z consists of 'goodcredit."

(In ml IIIone of conto!QCan be rescheduled Nor ml TotaI

ApplIcation No Yes Repayment Debt

1. Eco 20.2 S.8 1.8 27.4griculture ii 42 1 .2 2S.4

state 1. .2.Other 0.4 0.2 1.0 1.6Industry - 1.7 0.1 1.8Variouse 0.2 - - 0.2

2. Population - - 0.2 0.2

s. state 7.7 - - 7.7APIE TT - - 4.TPublic Sector 8.6 - - 3.6

Total 27.9 6.9 1.6 86.$

IV. PROPOSALS

- The preparation and immediate implementation of a plan for settlingthose debts that cannot be rescheduled and that arise from thefollowing causess

(a) the reorganization of agencies within the State apparatus;

-101 - EU.2AM=g 3.12

Page 5 of 5

(b) financing guaranteed by the Ministry of Finance;

(c) the nationalization of property belonging to the followings

- individuals who left the country after the proclamation ofnational independence (i.e. laud and means of production);

- individuals and enterprises, whether Mozambican or not, whoseactivities were incompatible with the principles establishedby the Government (i.e. income-producing real estate);

- that a period of 15 years and an annual interest rate of 8Zshould be established as a maximum period for the State tosettle completely those amounts for which, according to thisreport, it should assume responsibility.

Settlement of the remaining amounts of loans that can berescheduled has already been guaranteed by the debtor enterprises, inaccordance with agreements already signed and resulting from negotiationscarried out by BPD over the last few months.

Source: BPD, MaputoMay 1988.

- 102 -

SMALL NS rMW EhTmhISE OEVRAPUEW

Ltds Arrsr

A. aeo SUmaes Tett

Eatt.mts Fo t.s. Aqgut IWS

Sector Collectable Uncollectable Total

Agriculture 226.9 39.8 266.7Travel agents tf28.9 18.8 47.6Distribution 68.3 11.0 79.3Cashew Sector '183.8 - 183.8Garments/textiles 15.1 - 15.1Construction 51.9 28.2 80.1CUF Group 313.3 - 313.3Hotels, restaurants 10.7 2.0 12.7Food industry 2.1 2.3 4.4Timber 51.2 7.6 58.8Vehicles, machinery 157.2 8.4 165.6Metals 44.3 2.4 46.7Repairs 4.0 8.5 12.5Other 102.2 71.5 173.7Fishing 80.4 - 80.4Personnel/staff 36.2 129.8 166.1Chemicals 22.1 3.3 25.4Retaielrs 10.0 4.3 14.3Printers 21.8 0.1 21.9Enterprises under

bank responsibility 29.8 - 29.8

Total (in original) 1460.3 338.0 1798.3

TOTAL LENDING(overdrafts plus billsdiscounted) 4137.6

- 103-

j5l. lasso 1o,ur 4. m I smoLvmto

(I ttLe. with eff et Deember 1967)

(la Mullnee of comes)

Oms be rescheduled eRonal TotalAPPULeszte no Tet Uepamt D.bt

i X t. 20.25 27.46ritulux ALl 4.2 12 2.4

Istae 19.6 4.0 0.2 23.6Other 0.4 0.2 1.0 1.6

hIhattg - 1.7 0.1 -IaGN ouz0.:2 a 0.2

2. PolmULia - 0.2 0.2

i. a M, l 2.7 . 7APIS 4.1 . 4.1PublIl Sector 3.6 - 3.6

total 27.9 5.9 1.5 35.5

source lD.

- 104 -AMNU 3.14

SMLL AND MMDIU UNTlRPRISZ DEVELOfIENT PROJECT

Industrial credit survey; Summary of Credit Responses

(1) (2) (2)(1) (2) Sector and Govt. W.C. F.C. TOTAL Avg. Avg. Est. Eat. Est.

Oro. TOT TOT W.C. F.C. W.C. F.C. TOT

14 6 food/tobacco-SEILA 1184 1672 2706 140 200 840 1200 2040S ... l products * 6290 1518 7608 1260 800 - -- -

9 2 .t I producte-M 8406 126 4761 S00 180 1000 m8 18606 offI co uppl II, 2569 l1Se 8727 430 190 -- -- -

a air condltlon-MIE 8sso 1069 4919 680 180 -- -- --a 1 petroleum-MIE -- 302 802 -- 15O - 150 1SO8 5 prlntIng-UM so0 720 1800 190 140 760 s56 1820

12 4 construction-IKA 1411 1650 8061 800 240 1200 960 21604 1 agriculture-MA -- 8s5s 86s5 - 1200 -- 1200 12006 1 other-SEILA 2805 6614 6419 560 1120 560 1120 1680a othar-UIE -- 4685 4686 -- 2000 =

76 20 TOTAL 22185 28188 45268 4860 5650 9910

SmISI IndustrIee

it 4 food-CCM 70 726 796 10 100 40 400 44010 6 metl products-CCM 486 286 721 110 70 660 420 10808 a coemutIce-CC So01 897 898 100 60 0oo 240 5405 2 clothlng-CCM 10 489 589 SO 1SO 100 8oo 4002 1 furniture-CCU -- 20 20 -- 20 -- 20 205 * ho.g/tannery-SEILA 78 88 181 1S 1S -- - -

8 2 others-CCM 28 67 95 80 70 60 140 200

44 18 1268 2017 8800 1160 1880 2540

120 88 TOTAL AMOUNT 28898 25150 48566 5520 6980 12450

Note: exchange rate assumed at Mt 500 = $1, in the case of localcosts.

WC = Working Capital

FC = Fixed Capital

The above figures do not include Cia. Industrial de Matola which has a $10million project as it is considerably in excess of the average investment.

(1) = total enterprises responding

(2) - enterprise not providing complete information for whichestimates were made.

- 105 -

ANNEX 3.15MOZAMBIQUE

SHALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

tosambique Monsetary and Credit Developw.tst, 1934-88

1984 1985 1986 1987 196Marth June De.

(Frog.) 1/

l4alances, and of period (tn billions of eticais)

Not foreign assets 1.0 0.6 0.4 23.0 20.4 41.5 37.4Assets i T TI 1T7f WY wr Liabilities -3.0 -2.3 -3.1 -36.1 36.7 38.9

Domette eredit 124.2 144.2 1A8.9 217.5 240.0 242.7 291.5Credit to Government (not) MY 3 T 32 i 9 67 3E1 unCredit to the economy 102.0 117.2 136.0 170.2 181.2 190.4 224.2 2/

Foreign funds on-lent / (27.2) (34.2) (36.6) (56.3) (57.5) (64.6) (56.3) 2/Domeitic-source eredit (74.6) (82.9) (99.2) (113.9' (123.7) (125.6) (167.9)

money and quasi-moey 63.6 9A6. 111.4 170.4 186.7 185.3 244.4Curtency In cieculation 01 5T 3A 6 6r r 1r 9Demand end savlnp deposits 53.6 8 2.6 75.1 124.0 140.4 134.7Time deposits 2.6 3.9 4.1 9.8 9.9 6.7

Foreign borrodig 27.2 34.2 38.6 420.0 472.6 499.9 -657.6Fot domestie on-lelndin 31 1YT lr.T 'W T1 T.SAt / end other - - - 8.3 ... ...

Valuation adjustments - -382.4 -432.1 -432.1 -605.8

Other Item (net) 14.4 14.0 21.1 32.5 33.0 31.1 32.5Capital accounte 14.4 28.6 2 8. 6 2 8 6 . .Other assets end lisbilittes 2.8 1.3 6.7 3.9 4.4 2.5

Flows during yest 51

Yet foreign asecst 2.6 -0.4 -0.2 41.3 -. 1S.7

Domsttc credit 21.3 19.9 24.7 48.8 22.5 25.2 74.0Credit to Govermnt (not) 'T7 *. 8 5i. W 5.1 20.0Credit to the ecoaomq 12.6 15.2 18.8 34.2 11.0 20.7 54.0 2/

Foreign funds on-lent 3/ (1.5) (7.0) (2.6) (19.6) (--) (6.6) ( .) 21Domstic-eource credit (11.1) (8.2) (16.3) (14.7) (11.0) (11.9) (54.0)

Honey and quasi-money 11.1 12.9 13.0 52.6 15.4 14.1 74.0

Foreign borrowlin 1.5 7.0 2.6 25.6 - 28.3For dometic on-lending 1.5 ... 7.: ISAY a nd other - - - 6.3 . ...

Other item (net) 11.3 -0.4 7.0 11.5 0.5 -1.4

Rates of change o (In percent)

Domestic credit 20.7 16.1 17.1 26.8 11.3 11.6 344vCredit to Govenmnt (net) 64.1 21.4 21.7 43.6 24.3 10.5 42.3Credit to the conom 14.1 14.9 16.1 25.3 6.5 11.9 31.7 2/

Domestic-sourco credit 12.4 8.0 13.9 6.7 5.8 7.0 31.7

Honey and qunsi-oney I.S.4 15.4 13.5 47.3 9.6 8.7 43.0

Sources: Bank of Nossabique: and staff estimates.

1/ lased on progtm flows end revigod <nd-1986 stoeks.Ti Flus forelgn funds borrowed and on-lent during year.I Amounts borrowed abroad by lank of Mogaubique on-lont domestically: excluded from prostgm credit

bencmrks.4/ lacledsstled from other itel (net) tn 1987 progrs presentatton. SAP, Structural Adjustment Faclilty.t nowe and resulting percent changes exclude valuation changes resulting from mticeal devaluations,

mainly on external accounts but including foreign curroncy deposits.6/ Ownge in roletion t to total credit to the econoy.

- 106- ANNE 3.16

MOZAMBIQUE

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

' I

I ~~IIY.{ w

.} WE

II 1ill HhimFl

- 107 -ANNEX4.01

Page 1 of 2

SMALL AND EDIW ENTUPRISE DZVULOM ? PROJECT

PROJECT COST ESTIMATES($ Million)

Item Local Foreign Total X ofCost Cost Cost Total

(1) Enterprise Financing Cipon.nt

Civil works, machinery,equipment, spares, materials 10.00 34.07 44.07Consultants services 0.50 1.50 2.00

Sub Total 10.50 35.57 46.07 91.80

(2) Institutional Strenthening

ComponRent

IDILAdvisers - 0.36 0.36Equipment, facilities 0.05 0.07 0.12

Apex UnItIIKAdviser - 0.36 0.36Equipment, facilities 0.05 0.20 0.25Materials 0.05 0.10 0.15

Consultants ServicesStudies (financial/indus) - 0.24 0.24Training 0.05 0.48 0.53PFI accounts upgrading - 2.00 2.00

Policy Study (Businessenvironment) - 0.12 0.12

SUB TOTAL 0.20 3.93 4.13 8.20

tOUTI. 10.70 39.50 50.20 100.00

- 108 -

ANNEX 4.01Page 2 of 2

SMALL AND MEDUM NTERPRISE DEVELOPMENT PROJECT

PROPOSED FINANCING PLAN

Local Foreign Total X ofCost Cos8. Cost Total

(1) Enterprise Financing CaomPoent

IDA - 28.57 28.57European Investment Bank - 7.00 7.00Enterprises 5.50 - 5.50Participating Banks 3.00 - 3.00Government 2.00 - 2.00

Sub Total 10.50 35.57 46.07 91.80

(2) Institutional StrenatheningComponent

IDA - 3.43 3.43UNDP - 0.50 0.50Government 0.20 - 0.20

Sub Total 0.20 3.93 4.13 8.20

(3) Totals 10.70 39.50 50.20 100.00

of which:

Total IDA - 32.00 32.00 63.70Total Cofinancing (EIB, UNDP) - 7.50 7.50 14.90Total Banks and Enterprises 8.50 - 8.50 17.00Total Government 2.20 - 2.20 4.40

Total 10.70 39.50 50.20 100.00

- 109 -

ANNEX 5,01Page 1 of 6

HOZUKBIQU5

SMALL AND MEDrI BNTRRPRES DEVELOPMENT PROJECT

PARTICIPATION AGREEMENT

(BANK OF MOZAMBIQUE PROVISIONAL DRAFT) 11

Under the terms of the Credit Agreement relating to the Small andMedium Enterprise Development Project, signed on , hereinafterreferred to as the 'Credit Agreement,' between the International DevelopmentAssociation, hereinafter referred to as 8IDA,6 and by the People's Republicof Mozambique (PRM), represented by the Bank of Mozambique, hereinafterreferred to as *BM (Central)," the IDA made available to the PRM a Line ofCredit, hereinafter referred to as the "IDA Line of Credit.'

The objectives of the IDA Line of Credit are as follows:

- to contribute to the country's economic development byfinancially supporting small- and medium-scale enterprises,particularly those that promote the use of domestic resourcesand that contribute to creation of jobs, import substitutionand increased exports;

- to support rehabilitation, modernization and expansion ofexisting enterprises, as well as establishment of newenterprises; and

- to strengthen the institutional means needed for developmentof small- and medium-scale enterprises, namely, bankinginstitutions.

The IDA Line of Credit will be managed by the Unidade deGestao de Projecto, hereinafter referred to as the UGP,established within the BM (Central), and it is intended

- to refinance the loans granted in meticais by theparticipating financial institutions to the small and mediumscale enterprises, taking into consideration coverage of thecost of the investment, and the cost of consultancy servicesrequired by enterprises receiving loans for investment.

Under the Credit Agreement, and in order to allow access of theBank, in its capacity as a participating financial institution, to

the financial operations under the IDA Line of Credit, the BM (Central), an

I/ This is a framework with which the Government will draft the finalParticipation Agreement with the PFIs, for IDA approval.

- 110 - ASX5.O1Page 2of 6

association under public law hav:ng the nature of a public enterprise,headquartered in this city of Maputo, represented by , acting inhis capacity as , being duly authorized for this purpose; andthe Bank, hereinafter referred to as , herebystipulate and set out in this document the following Participation Agreement,the provisions of which expressly, and by mutual agreement, are as followss

1. The following terms will be used, for the purposes of thisParticipation Agreement, with the following meanings:

- Final Beneficiary, abbreviated as PBs

means the firm that, as established under the terms of currentlaw in the People's Republic of Mozambique, employs no morethan 200 workers and presents a subproject to be financedunder the IDA Line of Credit, subject to exceptions coveredunder Annex 1, para 5.2, to this agreement.

- Credit:

means the amount provided under the investment projectfinanced over a set term by the PPI and included in thesubproject which, as such, will be partially refinanced by theBM (Central) through the mechanisms provided for under thisParticipation Agreement.

- Participating Financial Institution, abbreviated as PFI:

means the entity that signs a Participation Agreement togetherwith the Bank of Mozambique (Central).

- Project:

means the Small and Medium Enterprise Development Projectfinanced by the IDA Line of Credit.

- Eligible Sectors:

means the raw material and intermediate product industrialmanufacturing activities, agri-business, equipment repairservices, and product conservation, transport, storage,distribution and commercial service activities which may beundertaken as subprojects financed under the IDA Line ofCredit.

- Subproject;

means an investment project -- involving an initial investmentin fixed assets, associated permanent working capital, andconsultants' costs for which the subloan under the projectcannot exceed the equivalent of US$1 million.

- 111 -

ANNX 5.01Page 3 of 6

- Unidade de Gestao de Projecto, abbreviated as UGPs

means the organizational (apex) unit created by the BM(Central) responsible for coordination, management, controland inspection of the Project financed by the IDA Line ofCredit.

2. Responsibilities of the BM (Central)

2.1 The EM (Central) will discount, upon presentation of theappropriate documentation, up to 90 (ninety) percent of the valueof the term loans granted by the PFI to finance the investmentproject presented by FBs that satisfy the conditions set out forthis purpose in thiu Agreement, in its annexes and in instructionsand circulars that the BM (Central) may issue during execution ofthe Project.

The rediscounting operation (having a repayment term equal to theterm granted to the FB) will include the lump-sum item relating tothe investment project covered under the Credit, provided that itdoes not exceed the sum referred to in paragraph 1.

2.2 The amounts discounted under this Agreement will be excluded fromany eventual credit limits that are already in place or that maybe established by the BM (Central).

2.3 The credits discounted under the provisions of this Agreement willnot be submitted for any other form of authorization by the BM(Central) beyond the authorization resulting from the analysiscarried out by the UGP.

2.4 The BM (Central) will give the FBs, through the PFI, access toforeign currency necessary to cever the cost of investmentprojects.

2.5 The BM (Central) and the Ministry of Commerce have agreed on aspecial procedure for authorizing imports corresponding to theoperations referred to in clauses 2.3 and 2.4, intended to ensurea high degree of efficiency in these procedures.

3. Responsibilities of the PFI

3.1 The PFI will grant credit to the FBs for the purpose of financingfixed assets, permanent working capital and consultancy servicesunder the following conditions, provided that they meet establishedeligibility requirements:

(a) interest rate: the interest rate that is in effect in thebanking system for credits under identical conditions andthat is adjustable, in the event that any changes occur; and

- 112 -ANNEX S.01

Page 4 of 6

(b) repayment terms from three to 12 years, including a graceperiod of from one to four years.

3.2 The charges to be paid by the FBe will be only those resultingfrom application of the conditions referred to in the precedingclause, including fees for filing, postage and taxes normallyimposed by the banking system.

3.3 The PFI will submit to the rediscounting operation under theconditions stipulated in this Agreement, its annexes and ininstructions and circulars that the DM (Central) may issue duringexecution of the Project.

3.4 The PFI will irrevocably authorize the BM (Central) to make thenecessary disbursements and reimbursements, provided that theyresult from payment obligations in its favor.

3.5 The PFI will maintain in its custody, in proper order and fullyavailable to the BM (Central), the loan notes representing thedebt contracted by the FBs.

3.6 The PFI will designate a qualified member of its staff who willcoo-4inate the operations proposed, and who will keep the statusof che transactions constantly up to date, and undertake thenecessary liaison with the UGP.

3.7 The PFI wll actively promote utilization and publicity of the IDALine of Credit, including all its branches.

3.8 The PFI will assist the FBs in preparation of credit applications.

3.9 The PFI will evaluate the subprojects presented to it by the FBsand will submit them to the UGP, provided that it considers themto be viable as defined in the conditions for eligibility in theLine of Credit.

3.10 The PFI will ensure that the funds granted as a loan will beutilized only for the purposes for which they were granted, byproceeding to make the corresponding disbursements only uponpresentation of the respective justifying documentation.

3.11 The PFI will assume all commercial risk for the loans granted anddiscounted by the BM (Central).

3.12 The PFI will furnish to the UG? all necessary information relatingto the operations carried out under the IDA Line of Credit, underthe terms of clauses 3.17 and 3.18.

- 113 -ANNEX 5.01

Page 5 of 6

3.13 The PFI will furnish to the DM (Central) the balance sheets andannual reports, accompanied by the auditors' opinion, as requiredby the IDA and the BM (Central).

3.14 The PFI will reimburse the DM (Central) for the amounts of creditdiscounted under the terms of the amortization schedule agreed onwith the FB, even if the PFI has not timely received thecorresponding sums.

3.15 The PFI will imnediately regularize with the DM (Central) all theamounts corresponding to early payments by the FBs.

3.16 The PFI will pay to the BM (Central) the following rates ofinterest on the amounts rediscounted and owed, subject to review.

(a) for credits with a repayment term of seven years or less, therate of interest will be (73) percent of the rate used by thePFIs; and

(b) for credits with a repayment term greater than seven years.the rate of interest will be (65) percent of the rate usedby the PFIs.

3.17 The PFI will make supervision visits to the FBs and will establishand keep up to date an adequate system for recordkeeping andcontrol, in order to monitor execution of each operation beingcarried out, including the status of the loan.

3.18 The PFI will prepare supervision reports in accordance with theforms proposed by the BM (Central). The reports shall be submittedon a quarterly basis during the implementation phase of theinvestment project and on a semi-annual basis thereafter and untilthe loan is fully repaid.

4. Inspection and Suspension

4.1 The UGP may, either independently or jointly with the PFI andlorthe IDA, supervise execution and operation of the subprojects.

This provision must be included in the contract that will besigned by the PPI and the FB for issuance of the respective credit.

If the FBs have not appropriately utilized the funds, the PFI mustconsider the operation to be cancelled and immediately proceed torecover the funds, returning the corresponding amounts to the BM(Central).

4.2 In the event that the PFI does not comply with any of itsresponsibilities, the BM (Central) may temporarily or definitivelysuspend the participation of the PFI from the operations of the IDALine of Credit.

- 114 -ANNEX 5.01

Page 6 of 6

5. Effective Date and Duration of the Agreement

5.1 This Participation Agreement takes effect beginning from the dateof signature and remains in effect until full compliance with theresponsibilities arising under the Agreement by both partieshereto.

5.2 Changes in this Agreement will be valid, provided that they aremade in writing and signed by both parties hereto.

6. Final Provisions

6.1 In the event of doubt or omission relating to Interpretation ofthis Agreement, the parties will attempt to reach an amicablesolution.

In the absence of a solution, and particularly when definitivesuspension is invoked, the parties will accept the decision, takenupon majority vote, of an arbitration board comprised of threearbitrators appointed by the Ministry of Finance (which willappoint the chairman), the BN (Central), and the PFI, and theparties agree, in principle, not to bring the matter to a judicialforum.

6.2 With regard to any omissions, this Agreement will be governed bythe provisions of applicable current law.

6.3 The following annexes are incorporated as part of the presentAgreement:

- Annex 1: Policies and Procedures to be followed under theCredit Agreement;

- Annex 2: Instructions for Preparation of the EvaluationReport;

- Annex 3: Form for Rediscount Application;

- Annex 4s Model Contract between PFI and FB.

Maputo

- 115 -

ANNEX 5.02Page lof 4

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

(BANK OF MOZAMBIQUE PROVISIONAL DRAFT) 11

POLICIES AND PROCEDURES TO BE FOLLOWEDSMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

FINANCED BY THE IDA LINE OF CREDIT

1. The following steps are hereby established in the procedure to befollowed in granting credit:

1.1 The FB will present the subproject and the respective financingapplication to the PFI on the forms prepared by the PFI.

1.2 The PFI will analyze the subproject, appraising it in accordancewith the techniques described in clause 5 of the present Annex.

1.3 If the financing application is approved by the PFI, and providedthat the subproject satisfies the evaluation criteria referred tounder clause 5.3 of this Annex, the PFI will submit the followingdocuments to the UGP:

(a) an evaluation report prepared in accordance with therequirements in Annex 2, accompanied by the file on thefinancing application presented by the FB; and

(b) a rediscount request for the operation filed on the formestablished in Annex 3.

1.4 The UGP will determine whether the subproject presented iseligible, and, within a reasonable period (which should not exceed10 working days), whether all established criteria have been met.The UGP will:

(a) approve the rediscount request submitted by the PFI, providedthat the import component of the investment project is equalto US$100,000 or less;

(b) prepare a report on its approval regarding the documentspresented, provided that the import component of theinvestment project is greater than US$100,000 but equal to orless than US$250,000, and will, if approved, authorise therediscount request; and

1/ This is a framework with which the Government will draft the finalParticipation Agreement with the PFIs, for IDA approval.

- 116 -

ANNBX 5.02Page 2 of 4

(c) prepare a report on its determination regarding the documentspresented, provided that the subloan requirement for theinvestment project is equal to or greater than US$250,000, andshall submit the file for a decision by the World Bank.

1.5 The first three subprojects presented by the PFI to the UGP mustbe authorized by the World Bank, following presentation cf therespective files, including the appraisal report.

1.6 The PFI will enter a loan agreement with the FB inmediately afterhavingv been informed by the UGP of the approval of the rediscountrequest, and this will initiate execution of the subproject.

1.7 In the cases provided under paragraph (a) of clause 2.4, the above-mentioned authorization is not necessary.

1.8 The P.l must present -- through the UGP -- upon irrevocablerediscount by the EM (Central), the legal documentation relatingto the debts owed by the FB, within a period of no more than 10days after the loan takes effect.

2. With regard to the procedures to be followed for utilization of theIDA Line of Credit for financing the investment project, the following stepsare he:eby establisheds

2.1 On behalf of the FB, the PFI will present to the Import Departmentof the BM (Central), a request for payment abroad or a transfer tothe beneficiary of the funds delivered.

2.2 The PFI must certify that:

(a) the operation is provided for and approved in the respectivesubproject;

(b) applicable regulations were followed in the respectiveprocurement; and

(c) all the elements necessary for execution of the order forpayment or transfer are included in the respective files.

2.3 The request referred to in clause 2.1 of this Annex must beaccompanied by the following documents:

(a) bill or pro forma invoice, depending on whether the supplieshave been delivered or not;

(b) the import license (IL) or payment authorization ticket (PAT),if any, in cases of the supply of goods or services; and

- 117 -

hANZX 5.02Page 3of 4

(c) a statement of the number of the joint BH (Central)/PFIaccount in which the entries are made for expenditures of theoperation and the amount of the payments abroad or transfersof funds delivered.

2.4 The Import Department of the BH (Central) will submit the filereferred to under clause 2.1 of this Annex to the UGP, which willapprove the operation.

2.5 The UGP will transmit to the PFI the records of entries andnegotiating documents regarding the execution of the operations,and the PFI must inform the FB for this purpose, namely concerningthe acquisition of merchandise and the signing of the respectivedebt instruments, if any.

3. For the purposes of the provisions of items 1 and 2 of this Annex,the IDA Line of Credit will finance the following expenses:

3.1 100 percent of the expenditures in foreign exchange relating to thedirect importation of equipment, including assembly, and goods onthe basis of the CIF price of the respective bill;

3.2 _ percent of the invoice price, not including theCirculation Tax and the Consumption Tax, of the expenditures dueto procurement for construction and rehabilitation of factorybuildings, warehouses and offices; and

3.3 _ _ percent of the invoice price, not including the CirculationTax and the Consumption Tax, relating to the procurement of goodsand merchandise in the domestic market.

3.4 100 percent of the cost of consultancy services relating to thesubproject.

4. With regard to the methods of procurement of fixed and workingcapital, the PFI will be responsible for instructing the FB in order toensure that such procurement will be carried out at the lowest cost and toobtain the best quality. If the supplies are of a value greater thanUS$100,000, the purchase contract must be-aiiarded to the best of threeoffers, if possible, and the corresponding contracts must be signed and sentto the UGP. If the value is greater than US$500,000, the purchase contractmust be put out to international competitive bidding. It will be theresponsibility of the UGP to be present at the proceedings and to verify thatthese conditions are complied with.

5. The following eligibility and evaluation criteria are herebyestablisheds

5.1 The PFI shall initiate evaluation of the financing requestsrelating to subprojects only if the requests and the respective FBs

1AMN=X 5.02Page 4 of 4

qualify under the definitions set out in clause 1 of theParticipation Agreement.

5.2 On an exceptional basis, subprojects may be considered if theydemonstrate a high economic/financial profitability and if, incompliance with the financing objectives of the Credit, they donot significarktly exceed the amount referred to in the definitionof final beneficiary under Section 1 of the ParticipationAgreement. The PFI, in its report submitted to the UGP, must dulyset forth the reasons that, in its opinion, may justify exceptionalapproval of the investment. Total value of approvals under thisexception cannot exceed 25Z of the total credit.

5.3 Only those investment subprojects thpt satisfy the followingconditions will be submitted to the UGP:

(a) they must achieve an internal rate of return of at least 12percent, calculated in constant prices;

(b) they must achieve an economic rate of return calculated inconstant prices of at least 12 percent. in those cases inwhich the import component of the subproject equals or exceedsUS$250,000;

(c) the FB demonstrates adequate financial capacity to meet theliabilities already assumed as well as the liabilities arisingfrom implementation of the subproject; and

(d) the subproject does not involve unacceptable environmentalcosts.

6. The PFI will monitor and financially supervise the subprojects.It will be the responsibility of the PFI to carry out the followingactivities, among others:

6.1 Determine whether the funds were duly utilized and take anymeasures necessary to achieve this objective.

6.2 Monitor the economic and financial status of the project, until theFB's obligations relating to the loans taken for financing thesubproject have been fulfilled.

-119 - ANNEX5.OS

Page I0f 7

I ~~~~~~~~~~MOZAMBIQUE

SMALL AND MEDIUJ ENTERPRISE DEVELOPMENT PROJECT

(BANK OF MOZAMBIQUE PROVISIONAL DRAFT)

INSTRUCTIONS FOR PREPARATION OF THESUBPROJECT APPRAISAL REPORT

1. For the purposes of this Annex, the definitions of terms appearingin clause 1 of the Participation Agreement are the same. In addition, theterms mentioned below will be used with the following meanings:

- Appraisal Report:

means the document prepared by the PFI under the terms of thisAnnex, on the basis of information collected together with the FB,in which the PFI demonstrates the eligibility of the subproject tobe financed by the IDA Line of Credit;

- Permanent Working Capital:

means the valuable goods under the heading of raw materials andintermediate goods included in the permanent operating fund, whichin no case can exceed the amount for inputs nc,essary for twelvemonths of operation;

- Level "Am Subproject:

means a subproject in which the investment cost equals or exceedsthe equivalent of US$250,000;

- Level 'B' Subproject:

means a subproject in which the investment cost is between theequivalent of more than US$100,000 and US$250,000; and

- Level IC" Subproject:

means a subproject in which the investment cost does not exceedthe equivalent of US$100,000.

2. The PFI must submit to the UGP the subprojects promoted by the FBthat satisfy the following conditions. The FB must:

2.1 carry out its activity in an eligible sector;

2.2 employ normally no more than 200 workers;

- 120 -ANNEX 5.03Page 2 of 7

2.3 present a subproject that qualifies under any of the levelsreferred to under clause 1 of this Annex and that is consideredviable by the PFI; and

2.4 demonstrate the appropriate financial and technical/managerialcapacity for implementation of the subproject.

3. The PFI will prepare an appraisal report to demonstrate that thesubproject is eligible for financing under the IDA Line of Credit. Thereport will accompany the rediscount request to be presented to the UGP.

4. This document outlines the instructions that must be followed inpreparation of the appraisal report, and is incorporated as a part of theParticipation Agreement between the BM (Central) and the PFI.

5. The PFI is liable to the BM (Central) for the information containedin the appraisal report, even if it is furnished by the FB.

6. The information provided by the FB must correspond strictly to theinformation appearing in their accounting records prepared in accordance withapplicable regulations.

7. If it is not possible to resort to the information referred to inthe preceding clause, and for level *C' subprojects, significant informationneeded for preparation of the appraisal report may be obtained by the FB'scompletion of the forms used by the PFI for the same purposes.

8. The appraisal report should contain, in the following order, theinformation stipulated in form RAV 1, as an annex, accompanied by thecorresponding tables:

8.1 for level 'A" subprojects, tables 1, 2, 3, 4, 5, 7, 8, 9 and 11must be attached to the appraisal report;

8.2 for level 'BO subprojects, tables 1, 2, 3, 4, 5, 8, 9 and 11 mustbe attached to the appraisal report; and

8.3 for level IC' subprojects, tables 1, 2, 3, 6, 8, 10 and 11 must beattached to the appraisal report.

9. In the process of appraisal of subprojects, special attention shouldbe given to the following aspects:

9.I Description of the subproject (table 1):

(a) estimates of the values of purchase of the fixed and workingcapital must be based, to the extent possible, on recentshopping, reasonably documented with price quotes or pro-formainvoices;

-121-

ANNEX 5.03Page 3 of 7

(b) local shopping and use of importers having acknowledgedexperience should be encouraged as a way to shorten the timefor implementation of the subproject; and

(c) scheduling of the investment project's implementation mustbe realistically planned, bearing in mind related aspects,namely, the experience of the FB and supplier contingencies;

9.2 Information on supply (table 2):

(a) correct completion of table 2 is considered to be of extremeimportance for the subsequent processes involved in importlicensing; and

(b) information on suppliers is provided for illustrativepurposes, subject to subsequent confirmation within the sphereof enforcement of the procurement regul.ations established forthis purpose;

9.3 Information on production, sales and employment (table 3):

(a) realistic analysis of the objectives of the subproject shouldbe carried out, taking as a basis the recent past of the firmand the potential installed capacity;

(b) indicators relating to group I (CURRENT) must be provided forthe previous year or, if that year is not considered to berepresentative, for the average of the two most recent years;

(c) under the heading of winputs' should be included the rawmaterials, intermediate goods and most significant spareparts;

(d) the statement of the values relating to potential capacityshould be for the capacity that would arise from a uniformtechnological flow, and should not in any event exceed 80percent of the theoretical installed capacity;

(e) if the objective of the subproject is equipment modernization,proposing to make the equipment compatible with out-of-datecapacities, the potential capacity without the benefit of thesubproject should also be stated; and

(f) significant increases in production and sales should beparticularly evaluated vithin the scope of chapter II.2 ofthe appraisal report, analyzed and compared with demand forthe markets involved and the prices effective in those marketsand used by the FB.

- 122 -ANNEX 5.03Page 4 of 7

9.4 Operating account and budget for the subproject (tables 4, 5 and6):

(a) the values to be entered in these tables must correspondstrictly to the increases recorded as a consequence ofimplementation of the subproject;

(b) constant prices referring to the year in which implementationof the investment project will be completed must be used;

(c) estimates on price changes from the time of presentation ofthe investment project until it has been implemented must bestated;

(d) duties and taxes to be entered under the respective headingswill be those that result from the respective charges, notincluding the taxes on circulation and consumption that mayaffect the FB's final proscct;

{e) the basis that has been used to calculate the management fundmust be presented; and

(f) an analysis for the purposes of this item must refer to aperiod that starts in the year of implementation of theinvestment project up to at least two years after completereimbursement of the loan taken for that purpose, but in noevent can it be less than five years.

9.5 Economic return (table 7):

(a) the UGP will periodically announce the values relating to theopportunity cost of foreign exchange;

(b) the valuation of substituted imports will be carried out usingthe respective CIF prices and the sales for export at thecorresponding FOB prices;

(c) in the valuation of the foreign currency component of fixedcapital, of raw materials and associated materials, thecriterion referred to under the preceding paragraph will beapplied;

(d) headings 2.3 and 3.2 (Water, Energy and Fuel) will have aweight of 80 percent) for the purposes of the adjustmentprovided in this table;

(e) headings 2.5 and 3.5 (Maintenance and Repair) will have aweight of 60 percent for the purposes of this table; and

- 123 - ANM= 5.03

Page 5 of 7

(f) relating to the period for analysis, the provisions of thepreceding paragraph (f) will be followed.

9.6 Repayment Schedule (table 8):

(a) both capital owed and the reimbursement of capital andinterest relating to existing liabilities refer to loansassumed by the FB outside the scope of the subproject; and

(b) special attention should be given to the relationship betweenthe proposed repayment schedule, the financial capacity of theFB (see tables 9 and 10) and the sensitivity of the subprojectto changes in the most significant variables.

9.7 Financial plan of the FB (tables 9 and 10):

(a) the values to be entered refer to the information recordedby the FB and corresponding to its overall activity; and

(b) the observations made in section 9.4 remain valid for thepurposes of the analysis to be made under this item.

9.8 Environmental assessment (table 11)

(a) guidelines vill be prepared on the procedure for thisassessment; and

(b) in most cases, a checklist approach will be used, while onlywhere particular hazards are likely to occur, will a specialstudy take place.

- 124 -ANNMX 5.03Page 6 of 7

PFISUBPROJECT APPRAISAL REPORT

RELATING TO FIRM OF

I. GENERAL INFORMATION ON THE FINAL BENEFICIARY

1. Name.

2. Headquarters address.

3. Location of the manufacturing installation (if other than headquarters).

4. Legal status (privately owned, limited liability, corporation,cooperative, state intervention) and composition of capital.

5. Date firm established (or intervention order, if appropriate).

6. Statement of the start up of operation and interruptions, if any, aswell as the respective reasons.

7. Economic activities performed and statement of the range of products.

8. Economic and financial situation of the firm:

- for firms presenting level "A" or 3B subprojects, the analysismust include the balance sheet and operating account for the most recentfull year and the balance sheet and operating account expected for thecurrent year (without taking into consideration the results ofimplementation of the subproject);

- for firms presenting level *CO subprojects, the analysis mustinclude the following documents (actual data from the most recent fullyear and projected data for the current year), if the balance sheets andoperating accounts are unavailable: value of sales; number of workersand wage account; receivables and schedule for receiptst debts alreadycontracted, respective costs and reimbursement schedule; value of realestate, broken down by uniform group; stocks (amounts and values);expenses for raw materials, energy and intermediate goods.

9. Position in the domestic and export markets (over the last two fullyears and potential).

10. Production determinants: specifically, name the technologicalmanufacturing process and the main bottlenecks in the firm's normalactivity.

- 125 -ANNEX S.03Page 7of 7

II. INFORMATION ON ITHE SUBPROJECT

1. Objectives: Briefly describe the objectives of the undertaking, statingthe opportunity for reconversion, expansion or replacement of equipmentand factory installations and other projected actions that arecomplementary to the subproject.

2. Description of the Subprojects

2.1 Briefly describe the subproject, including its components and theinvestment schedule.

2.2 Present the most significant economic and financial data of thesubproject.

3. Evaluation of the Subprojects

3.1 Evaluation of the economic and financial impact of the subproject:

-- for all subprojects, determine the internal rate of returnand the number of jobs created; and

-- for level "A subprojects, determine the economic rate ofreturn.

l..2 Analysis of the conduct of the subproject in the event of changesof some of its variable factors, by calculation of the ratesreferred to under 3.1 for the following casess

(a) 10 percent decrease in sales volume;

(b) 10 percent increase in investment value; and

(c) decrease in the volume of sales and increase in investmentand operating outlays (10 percent for both).

III. FIRM'S CAPACITY FOR IMPLEMENTATION OF THE SU!PROJECT

1. Financial Capacity of the Firms evaluation of the firm's capacity tofulfill all its existing responsibilities to third parties, whethercontracted before or during implementation of the subproject.

2. Capacity of Managements evaluation of the experience and qualificationof the firm's technical staff.

Form RAV1

- 126 -ANNEX 5.04Page 1 of 4

NOZNMBIQU5

SMALL AND MEDIUW ENTERPRISE DEVELOPHENT PROJECT

('ANK OF MOZAMKIQUE PROVISIONAL DRAFT)

INSTRUCTIONS FOR THE REDISCOUNT REQUEST AND APPRAISAL FRAMEWORK

1. With regard to presentation of the proposal for rediscounting thatwill accompany the evaluation report for each subproject, the PFIwill use form RAV2. duly completed.

2. During execution of the operations for utilization of the IDA Line ofCredit relating to the component of the investment project, the PFIwill inform the UGP of the recording of the corresponding debt by useof form RAV3.

3. The certificate will be numbered in accoLdance with the practice ofthe PFI, preceded by the project code.

- 127 -ANNEX 5.04Page 2 of 4

REDISCOUNT PROPOSAL

1. Under the terms of the Participation Agreement signed onthe PFI hereby submits to the BM (Central) the rediscountproposal for up to the amount of MT (in numerals and words),equal to the amount of approximately US$ (in numerals and words),relating to the loan contract that it will enter with the FB

- up to the amount of MT (_ in numerals andwords), the objective of which is to provide financial support to executionof the subproject of (rehabilitation, modernization,expansion of a manufacturing unit, located in).

2. The loan will be reimbursed under the following conditions:

(a) interest rate:(b) grace period:(c) repayment period:(d) timing of payments:

3. It is expefted that the amount mentioned in the preceding item willexpended in the following phases:

Utilization l l lI No. | Date | Amount l

I 1 1 1 112 1 l l13 l l l

I s I !II 6 l l l17 l l l18 l l l

l ... l l l

4. In addition, we wish to state that, in the case that the presentrequest obtains your approval, we recognize that you will credit ourrediscount account for the corresponding amounts rediscounted.

Date and signature

Form RAV2

- 128 -

ANNEX 5.04Page 3 of 4

REQUEST FOR REDISCOUNT OF NOTES

1. Pursuant to your authorization no. ofrelating to subproject (code number), we hwve in ourpossession the notes captioned below, representing the loan granted by thisbank to (FB), under the conditions of the respectivecontract and at the rate of interest currently in effect (rate ofinterest), and relating to your credit no. ofin our rediscount account no. ___

2. We hereby state that we agree to the irrevocable debit to our accountno. _ of the values relating to the notes and correspondinginterest accrued -- at a rate of interest equal to of the rateused by (PFI) with the FB -- on the respective due dates.

No. of Note I Note Amount I Due Date

I ! I II I I~~~ I

I I ~I II I ~I I

i i I I

Date and signature

Form RAV3

- 129 -AM=U 5.04

Page 4of 4

PROJECT APPRAISAL FRAMEWORK

TABLE 1 Description of subprojectTABLE 2 Data on suppliersTABLE 3 Information on production, sales, and employmentTABLE 4 Record of subp'.oject operationTABLE 5 Budget plan of subprojectTABLE 6 Budget plan of subproject. Financial rate of returnTABLE 7 Budget plan. Economic rate of returnTABLE 8 Repayment scheduleTABLE 9 Financial plan after implementationTABLE 10 Financial plan after implementationTABLE 11 Environmental assessment

Details of the appraisal methodology are available in the project file.

ANNE 5.05

MOZAMBIQUE

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Terms of Reference for Interdepartmental Commi8sion

1. An Interdepartmental Comvission (CI) would be created by initiativeof the Bank of Mozambique, througlh an invitation letter addressed to thevarious entities involved in the Small and Medium Enterprise DevelopmentProject, that is, the Ministry of Finance, Ministry of Commerce, Ministry ofIndustry and Energy, National Planning Commission, Representatives of thePrivate Sector and other ministries responsible for regulating industrial andcommercial enterprises would be invited at the discretion of Bank ofMozambique.

2. The CI will have the following functions:

(i) familiarization with the operating procedures of the projectand monitoring of its progress;

(ii) coordination of sectoral objectives and sectoraldistribution of lending;

(iii) advising on project policy in various areas, includingapplication of eligibility criteria, import licencing,foreign ex.hange allocation for recurrent imports; and

(iv) monitoring project execution in various areas includingdisbursements, debt service, cofinancing.

3. During the preparation phase, the CI will meet every three months,and every time judged necessary by one of its members. The meetings will becalled by the representative of the Bank of Mozambique.

ANNMX S.06

MOZAMBQUC

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

Unidade de Gestao de Prolecto (UGP)

Preliminary Operatinp; Budget(Mt million) at

Operating Costs Year cl 1 2 3

Local Personnel b/ 10.0 10.0 10.0Administration, Supplies 6.0 8.0 8.0Utilities 3.0 4.0 5.0Fuel, transport, travel 2.0 4.0 4.0Repairs, ma.ntenance 3.0 4.0 6.0Depreciation of vehicles, equipment dl 7.0 7.0 7.0

Subtotal Costs 31.0 37.0 40.0

Operating Income

0.5Z annual spread on interest on averageoutstanding loan balance el 8.9 32.2 64.3

Net Income -22.1 -4.8 +24.3

al Conversion rate US$1.0 = Mt 715 (early 1989)

b/ 1 manager, 2 advisers, 2 administrative officers, 2 support staff

cl Full years starting from date of Credit effectiveness

dl Total purchase value approx US$50,000 equivalent depreciated over 7 years.

e/ Assumed disbursement schedule (US$ million)

Annual Cumulative Annual(Net) (Net) Average

(Net)

Year 1 5.0 5.0 2.5Year 2 8.0 13.0 9.0Year 3 10.0 23.0 18.0Year 4 10.0 33.0 28.0Year 5 10.0 43.0 38.0

- 132 - ANNEX 5.07Page 1 of 2

MOZAMBIQUESNALL AND NEDIUM ENTERPRISI DEVELOPlENT PROJECT

Information Requirements for Project CompletionReport and Supervisions

The UGP is responsible for preparing an analytical review of theProject within three months of the Credit closing date. IDA would providea suitable format prior to the first supervision mission. These reports areprepared for all investment and adjustment operations financed by the WorldBank. The object is to provide an account of the project's objectives,design, implementation and impact.

For subproiects

Quantitative data on:

- subproject approvals, including basic data on eachsubproject (production, capacity, employment);

- subloan disbursements and disbursement schedule for eachsubproject;

- total subproject financing and costs for each subproject(by local and foreign cost);

- environmental assessment for each subproject;

- initial estimated preinvestment economic and financialrates of return for subprojects, estimated operatingprofitabilitv, including measures of return on assets,income, debt service coverage, for subproject and totalenterprise at date of appraisal;

- technical and operational performance ratios of eachsubproject to be detailed;

- debt service history, subsequent to subloan disbursement, of eachsubproject;

- physical implementation data.

For the UGP (apex unit)

- annual budget of the UGP

- report on operations

- future work program

-133 -

ANNEX 5.07Page 2 of 2

For overall proiect

- status of covenants agreed under the project

- consolidated procurement and disbursement report

- cofinancing report

- consolidated debt service report, arrears analysis, andcollection program

- consolidated report on environmental impact of subprojects assisted.

- 134 -ANNEX 6.01

MOZAIBIQUE.

SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

DRAFTTERMS OF REPERCE

ADVISER TO TEE UGPIUNIDADE E GESTAO DX PROJECTO

These terms of reference should be read in conjunction with the documentation relatingto the operation of the line of credit, Annexes 5.01 to 5.05, of the Staff AppraisalReport.

As adviser to the manager of the UGP and reporting to ............ the terms ofreference for the post are as follows.

1. Prior to credit effectiveness:

Undertake the initial preparation for the establishment of the UGP in the Bank ofMozambique, including;

- preparation of necessary legal documentation and instructional material for theoperation of the credit.

- advise on staffing and selection of staff for the UGP, and advise on the workprogram.

- finalise preparation of appraisal/supervisuon formats for subprojects, incooperation with training staff.

- establish project accounting and reporting system, for submission to projectsteering committee (Comissao Interdepartamental) and for IDA project completionreport and supervision missions.

- carry out training and promotional seminars for staff of participating banks andcentral bank to ensure understanding of credit procedures.

- prepare promotional literature for potential borrowers explaining methods ofobtaining access to the scheme.

- advise on finalisation of terms and conditions of onlending, eligibility criteria,and other operational details.

2. After effectiveness of proposed credit:

Advise on the operation of the UGF, in line with guidelines as as set out in Annexes5.01 through 5.05 of the Staff Appraisal Report, including:

- adherence to subproject eligibility criteria;- adherence to sound appraisal methodology for subprojects;- establishment of acceptable supervision/followup schedules for sunbprojects;- adherence to lending guidelines;- adherence to loan security criteria;- monitoring of subproject design, ensuring acceptable use of funds;- establishment and maintenance of procurement monitoring procedures to ensure

appropriate procedures by participating private and public sector agencies;- maintenance and monitoring of project accounting system for submission to CI and

IDA, as above, and any other required information;- monitoring of special account for disbursement under IDA credit;- preparation of progress reports as required on credit approvals, disbursements, debt

service, procurement, etc;- ensuring adequate liaison with CI;- generally providing services to ensure the efficient management of the Credit.

- 135 -APPENDIX 6.02Page 1 of 3

MOLAMBIQURSMALL AND MEDIUM ENTERPRISI DEVILOPEINT PROJRCT

DRAFT TOMS OF REFERENCE

Technical assistance for upgrading of accountsof the commercial banks

Oblective

To upgrade the accounts of the commercial banks (Bank ofMozambique and Banco Popular De Desenvolvimento) to international auditingstandard.

Approach

(a) Carry out, in cooperation with local bank staff, adiagnostic review of existing accounting practice in the commercial banls,in the context of the relevant Government resolutions and the new plan ofaccounts introduced in 1989. The review will cover procedure used, content,format and quality of the full range of financial statements, and theirappropriateness.

(b) Formulate an action program for the upgrading of accounting.including an estimate of resource requirements in terms of ongoingtraining, equipment, and technical assistance.

(c) Following approval by the Bank of Mozambique, in cooperationwith local bank staff, implement the action program with regard to thepreparation of a range of financial statements for submission for the nextfiscal year. and the preparation of an appropriate training manual for useby local bank staff.

(d) Provide advisory and training services in accounting tolocal bank staff during implementation of the action program to ensure themaximum level of skill transfer.

Timing

The action program would need to be completed by March 1, 1991.Implementation would proceed thereafter, with audit quality financialstatements ready by the end of the following fiscal year.

- 136 - AME 6.02

Page of 2

SMALL AND MEDIUM INTMRPRISE DVLOMNT PROJECT.

DRAFT TERlS OF REMC

Technical Assistance for Study of the RestructrinR ofthe Bax&ina System

1. Obiectives

The objective of a technical assistance input would be as follows:

- to assess the existing situation with regard to capitalisation, portfolioquality, earnings, deposit structure and liquidity of institutions engagedin commercial banking, and the extent of adherence to standard operatingperformance ratios;

- to assist the Bank of Mozambique in preparing a medium-term program leadingto financial restructuring of the commercial banking institutions, witha delineation of the role of the commercial banking system vis-a-vis theCentral Bank; and

- to assist the Bank of Mozambique in formulating guidelines for the futureoperation of the financial system.

2. Technical Inputs

Consultant(s) specialising in banking reform and financial reorganisation wouldbe hired over a period of about 3 months to carry out the study, and submitconclusions and recommendations to the Government and IDA.

3. Work Program

The scope of work would consist, inter alia, of the following:

To assist the Bank of Mozambique in carrying out the following study program,relating to public sector and private sector, as appropriate:

- review of the current classification of lending portfolios, existingaction, and identification of possible future options in terms ofrescheduling, debt transfer to the Government, collection and write-offs;

- ; slysis of liabilities, including domestic and foreign liabilities of thebanking system, and classification and determination of possible optionsfor rationalisation, in cooperation with the Ministry of Finance;

- projection of bank lending to the economy and to Government, andrequirements for equity backing for loan assets remaining on balance

- 137 - ANNEX 6.02Page 3 of 3

sheets, with introduction of loss provisions. Identification of possibleoptions for provision of additional equity;

assessment of bank operating expenditure and revenue and formulation ofproposals for maintenance of earnings, with attention to treatment ofaccrued interest, interest rate spreads, and other pertinent issues;

introduction of operating guidelines for commercial banks, including equityleverage ratios, arrears targets, liquidity ratios, term structure ofassets and liabilities, loss provisions, etc; and

formulation of alternative options for rehabilitation of the sector, anddraft action program for restiucturing, phased over about 3 to 5 years.

- 138 - Aunx 6.03

NDORAIZQU.

SMALL AND DIDI IRTUPIMSE DZEVLOHNT POJECT

DRAFT OUTLINE T3M OF URNZUBRCZ

I.D.I.L. SMAL BUSINESS ADVISORY SERVICS

1. Obiectives

The objective of the assistance is to establish a small business consultancy service underIDIL capable of upgrading business performance mainly in the area of accounts, financialanalysis, management, and marketing.

Two advisory centres would initially be set up, and each would consist of one specialistadviser and two local counterparts. The following is an outline of the terms of referencefor the specialist satvisers.

1. To establish a business consultancy capability, with the folloving programs

- provide financial/administrative, ecmnomic, legal, and marketing advice andconsultancy services on an ongoing basis to local enterprises, covered by fees wherepossiblet

- assist in -preparation of projects leading to loan applications for submission to banksunder the proposed IDA or other lines of credit;

- organise promote and/or conduct training courses in areas such as accounting, financialcontrol. business planning, general management, marketing, systems and methods;

- prepare technical, financial and economic feasibility sttudies;

- carry out project identification studies and opportunity surveys;

- provide project implementation and followup support.

2. To establish operating Procedures. includinga

- setting up ongoing 'outreach' program to small enterprises;

- establishing system of service costing and charges, based on competing costs andprocedures of consultancy services in the private and public sector;

- establishing database and accounting/reporting systems;

- developing local consultancy staff capability and advising on staffing, and resourcesfor expansion of service.

-139 -AMNU 6.04

Page I of 3

mI0mWIQoz

SALL ANID MDnIU ENERIS D LOPH? PROJCT

Proposed Small Business Advisory Service (IDIV.)

Terms of Reference and Provisional Budget(May 1989)

A. Preparatory Phase

1. Identification of objectives and services to be offered.2. Identification of target group of enterprises.3. Creation of databank for enteLprises requiring assistance.4. Elaboration of working links with commercial banks.5. Definitions of criteria and forms of payment for services.6. Preparation of national "clearing house service for technicians.

B. Operational Phase

Main activities:

1. Assist small-scale entrepreneurs in preparation of loanapplications.

2. Advise small-scale entrepreneurs on financial, economic,management, marketing and legal aspects of business.

Working methods:

- on-the-spot advice to enterprises- seminars/workshops- formal training courses* - in-office analytical work- outside surveys and research

- 140 -AM=U 6. 04

Page 2 of 3

C. Provisional Budget: (Mt at Mt 700 - US$1.0)(1989 prices)(Maputo and Beira)

Operation Expenditure (Mt million)

Year 1 Year 2 Year 3Personnel and TravelForeign Advisers Cost (estimated)

salaries benefits it 168.0 84.0 -

travel (external) 12.0 6.0 -(local) 0.5 0.8

Local Costssalaries benefits b/ 5.0 7.0 12.0travel (external) 0.5 1.0 2.5

(local) 0.8 1.0 2.0Administration 6.0 8.0 10.0Utilities 2.5 3.5 5.0Promotion, training 19.0 19.0 19.0Maintenance 4.0 4.0 4.0

Total Local Costs 37.8 43.5 54.5

Operating RevenueFee income c/ 36.0 54.0 72.4

Operating revenue lesslocal Operating Cost -1.8 +10.5 +17.9

a/ 2 advisers s US$10,000 p.m. (18 month overall tenure)b/ 4 counterparts to adviser building up over years 1 and 2 at

Mt 100,000 per month. 8 local consultancy staff in year 3 (locationMaputo and Beira)

c/ Based on range of services. In the case of successful loanapplication processed by DIL fee - 1.5Z of loan amount.Unsuccessful local application charged small lump sum fee relatedto size of loan. General advisory work charged on time basis, atmedian Mt 100,000 per enterprise. In year 3 assumption of 80successful loan appraisals, 40 unsuccessful appraisals and generaladvice to 100 additional enterprises.

-141 -AMNU 6.04

Page 3 of 3

Proposed Total Investment in Esuipment

Investent Maputo Beira TOTAL

3 vehicles 8,866 17,732* 26,5984 motorbikes 2,728 2,728 5,456*1 Photocopier - 2,046 2,046*3 Air Conditioners 1.705 3,410 5,1151 overhead projector - 409 409*1 slide projector - 341 341*2 micro-computers 6,820 6,820 13,640*3 calculators - 273 273*1 PBX (telephone) 3,410 3,410*Furniture - 3,410 3,410

20,119 40,579 60,698

Total for IDA Financing 43,307

* proposed for IDA financlng

- 142 -

ANNEX 7.01

HOSO^IQUESMALL AND HIDIUK ERPitSE DEVELOREN PROJCT

hPPROXIKATE PROJECTED ID& DISBURSDIINTS(USS million or equivalent)

(IDA Fiscal Year)1990 1991 1992 1993 1994 1995 1996 Total

Enterprise fiumaclng - 2.00 4.00 6.00 6.00 7.00 3.57 28.57

Technical Assistance, - 2.58 0.50 - - - - 3.08Equipmfnt

Training - 0.10 - - - - - 0.10

Refund of PPFs 0.25 - - - - - - 0.25

TOTAL 0.25 4.68 4.50 6.00 6.00 7.00 3.57 32.00

- 143 -AM=ZX 7.02

NOZANBIQUBSMULL AND MHDIUM ENTERPRISE DEVELOPMENT PIOJECT

Disbursement Arran aements

The table shows the allocation of the Credit by each category ofexpenditure, and percentage of expenditure for items to be financed in eachcategory:

Amount of the Percentage ofCredit Allocated Expenditures

Category US$ to be Financed

Part A of the Project, Subloans for:

(a) Goods 15,000,000 1002 of foreignexpenditures and702 of localexpenditures

(b) Civil and 10,300,000 1002 of totalengineering works expenditure

(c) Consultants' services 1,500,000 100? of total(part B4) expenditure

Part B.1 of the Project (UGP)s

(a) Goods and services 310,000 100Z of totalexpenditure

(b) Operating costs (office supplies) 100.000 100Z of foreignexpenditures and701 of localexpenditures

Part B2 (a) and (b) of the Project:Consultants' services and training 340,000 1002 of total

expenditure

Part B2(c) of the Project (PFI accounts)sGoods and services 2,000,000 100? of total

expenditure

Part B3 of the Project (IDIL):Goods and Services 425,000 1002 of total

expenditure

Refunding of PPF 250,000 1001 of amountadvanced

Unallocated 1,775,000TOTAL 32,000.000

- 144 -

AhlXEX 7.03

MOZAMBIQUESMALL AND HEIW ETRPRS DNVEPMNT PROJEC

Procurement Arrangements

Source ICB a/ Direct Co- Other TotalContracting financing ProceduresILS/LCB b/

Enterprise FinanceIDA 8.00 20.57 28.57Cofinance (required) 7.00 7.00Enterprises 5.50 5.50Government 2.00 2.00Local Banks 3.00 3.00

Institutional Strengthenint

Equipment, materials, 0.37 0.37consultants, advisers 0.12 2.96 -c 3.08Training 0.38 0.10c/ 0.48Local Contribution 0.20 0.20

TOTAL 8.00 31.44 7.50 3.26 50.20

Notes since the type of subprojects are not known in advance, these costbreakdowns are indicative only.

a/ ICB - International Competitive Bidding. This would apply to contracts of above$500,000.

b/ ILS (International and Local Shopping), and LCB (Local Competitive Bidding) areapplicable to contracts below US$500,000, with public bid offering for civil workscontracts. Direct contracting will apply to goods and works contracts of less thanUS$100,000.

c/ Contracts would be awarded in accordance with IDA guidelines for procurement ofconsultants.

-1- ANNEX -

MOZAMBIQUE

Small and Medium Enterprise Development Project

Selected Documents in Project File

A. BPD report on status of lending portfolio.

B. Breakdown of lending by Feidrich Ebert Foundation/IDIL.

C. Monthly provisional balance sheets of BPD and BSTM.

D. General Financial data on banks.

E. General data on industrial production.

F. Lending to Enterprises Under the SHE Fund.

G. Subproject Appraisal Framework.

H. Business Environment Study.