Mozambique looks beyond mega projects

Mozambique’s government got a stark reminder last year that high economic growth would not necessarily lead to better livelihoods for all its people. In September, riots broke out in cities across the country, including the capital Maputo, after the price of bread was hiked by 30%. Calm was soon restored, but only after 13 people had died and almost 150 had been arrested.

The food riots happened despite a booming Mozambican economy over the past several years. Gross domestic product (GDP) expanded 7.4% in real terms between 2004 and 2010. The near future looks even brighter, with the economy forecast to rise 7.5% to 7.9% annually from 2012-16, making the country one of very few in the world expected to sustain a 7% growth rate over that period.

Mega project boom

Most of this growth has been caused by foreign direct investment in Mozambique’s so-called mega projects, such as its Mozal aluminium smelter and natural gas production in the south of the country.

These projects have provided Mozambique, which came out of a devastating 25-year civil war as recently as the early 1990s, with a big boost to its export revenues. These grew from about $700m in 2001 to a peak of $2.7bn in 2008. Exports slowed in the following two years but are expected to rise to more than $3bn in 2012. This is partly because aluminium prices have recovered from their slump during the global downturn.

But Mozambique also has more mega projects on the way. It is set to start exporting coal this year from its Moatize mine in Tete province, one of the world’s largest such reserves and in which Brazil’s Vale is investing $1.7bn. And a consortium led by US company Anadarko is considering building a liquefied natural gas terminal in the north of the country following the discovery of offshore fields. Many analysts are also optimistic that oil will soon be found.

Poverty still high

For a nation with a GDP as small as $10bn, the presence of natural resources has provided an enormous boost for Mozambique. But, as the food riots demonstrated, the wealth derived from these commodities has not spread to the bulk of the population.

The proportion of Mozambicans living in poverty fell from 69% in 1997 to 55% in 2003, according to the International Monetary Fund (IMF). But the decline has stalled since then and GDP per capita was still just $420 in 2009. “Per capita, Mozambique remains a poor country in comparison to its neighbours,” says Antonio Coutinho, managing director of Standard Bank Mozambique, the country’s third biggest lender by assets.

Mozambique’s economic growth has failed to benefit large swathes of the population to some extent because of the nature of extractive industries. Most do little to reduce unemployment, given that they are capital- rather than labour-intensive. “This is a sector that is set to grow and drive economic growth over the next few years,” says Victor Lopes, a sub-Saharan African economist at Standard Chartered. “But while mining may be lucrative, it doesn’t create a massive amount of jobs.”

The government also derives fewer revenues from the mining sector than many analysts think it could. Mineral industries accounted for less than 2% of total government revenues between 2000 and 2007. This compared with an average of 43% in other mineral-rich countries, according to the IMF.

The lack of tax revenues stems from the government having sought to entice foreign investors into the country just after the end of the civil war, which crippled much of Mozambique’s infrastructure, including its railways and telecommunications. Generous tax breaks were needed to lure foreign capital. “The anchor investments were given tax concessions,” says Yvonne Mhango, an economist at Renaissance Capital. “This was understandable because Mozambique had just come out of conflict. For anyone to go there, you had to give them some sort of carrot.”

The result was that the mining companies were understood to have been taxed only 5% of their profits between 2000 and 2007.

Renegotiation push

New tax rules for mining firms were introduced in 2007, as foreign companies became more comfortable with the prospect of investing in Mozambique. Yet there are increasingly loud calls among politicians and civil groups for the country to derive even more from mining. Central bank governor Ernesto Gove said earlier this year that the economy was strong enough for some existing contracts to be renegotiated.

Analysts doubt the government would act in a way that scares off future investments, however. “There may be some contract reviews,” says Mr Lopes. “But it doesn’t mean there will be resource nationalism. That is not the mood that prevails in the country. It will remain a destination that’s friendly towards investment.”

Perhaps the main cause of Mozambique’s struggle to reduce poverty is its lack of economic diversification. Manufacturing industries are undeveloped and uncompetitive, especially in comparison with South African exports. The services sector – including tourism and banking – is small. Maputo’s stock exchange, only set up in 1999, has a market capitalisation of $430m, paltry even by regional standards. Neighbouring Malawi, whose GDP of $5bn is half that of Mozambique’s, has a stock market with a capitalisation of $1.3bn.

Infrastructure lacking

Mozambique will base its economic growth over the coming years on its natural resources. It intends to develop their extraction further with the creation of several industrial free zones by 2014.

The government is, however, placing more emphasis on establishing a model of growth that does more to benefit the population at large. Improvement of infrastructure, from which the country suffers a shortage, is key to this. The World Bank estimates that Mozambique needs to spend $1.7bn annually over the next decade on its infrastructure, much of it on roads and railways. “They have a massive infrastructure deficit,” says Mr Lopes. “It’s more acute than many other countries in the region.”

Some of the necessary infrastructure can be built in conjunction with the development of mega projects. Vale, which has said that transporting coal to Mozambique's coast, rather that getting it out the ground, will be its most difficult logistical task in the coming years, plans to build a railway line to the northern port of Nacala through Malawi, which would be the most direct route from Moatize. Such activity could benefit the rest of the economy. The Moatize-Nacala corridor would pass through areas with plenty of untapped agricultural potential and which the government hopes could also use the railway to transport crops to the coast.

Agricultural development is another priority of the government. More than half of Mozambique’s 23 million people live in rural areas and agriculture accounts for about 30% of economic output. The country is considered to be among the 10 African countries with the greatest agricultural potential, thanks to its large size, climate and fertile soils. Yet it produces far less than it is capable of. Agricultural exports, mainly consisting of tobacco, sugar and cotton, even declined from almost $300m in 2006 to just over $200m last year.

Mozambique’s lagging agricultural sector leaves it heavily dependent on food imports. The government has taken measures to combat this. It launched a five-year poverty reduction programme in 2010, part of which involves boosting agricultural output and productivity, which is hampered by an absence of large-scale farming and irrigation.

Another hindrance is that agricultural land in Mozambique can only be leased, not bought. This means that titles cannot be used as collateral for mortgages, severely restricting farmers’ access to private funding. As such, bankers and economists have called for land reform. “That’s a huge burden that needs to be taken into consideration,” says Inaete Merali, head of Moza Banco, a Mozambican commercial lender established in 2008. “The government is analysing this because it is undermining the development of the sector. Banks will not risk their assets when there’s no collateral.”

Banks booming

The banking sector will be at the forefront of attempts to diversify Mozambique’s economy and make it more sophisticated. Having been immune to the global crisis, local banks have grown rapidly in the past few years, their assets increasing from 19% of GDP in 2008 to 28% last year. They have benefited from the country’s fast growth and because so many Mozambicans – 90%, according to most estimates – do not have bank accounts. “We’re buoyed by high growth rates and a low penetration of financial services in large parts of the country,” says Mr Merali. “That allows for expansion.”

Banks have also been exploiting the rise of Mozambique’s middle class. As disposable incomes have grown, so has demand for consumer credit. Paul Nice, chief executive of Barclays Mozambique, the country’s fourth largest lender, says that his bank’s retail lending has grown about five-fold in as many years. The same is true of other banks. “There’s huge demand for credit, whether it be for vehicle financing, for home loans or for personal loans,” says Standard Bank’s Mr Coutinho.

Corporate lending, which makes up about four-fifths of the big banks’ portfolios, has risen at an even faster rate. Local lenders lack the capacity to fund the mega projects, the multi-national companies that operate them turning to foreign institutions instead. But they are increasingly financing suppliers of the projects.

Manuel Marecos Duarte, head of Mozambique’s biggest bank, Millennium BIM, says that its lending has grown 43% annually in the past three years, mostly because of demand for credit from such companies. “The mining projects have provided a boost in local demand for services in construction, transport, catering and accommodation,” he says. “The good thing is that most of these services are based on a stream of revenues determined by a contract, which is an important risk-mitigating factor.”

Banks are also providing more trade financing to Mozambican importers and local currency funding to foreign firms operating in the country’s consumer sector, such as Nestlé, SABMiller and Coca-Cola.

Rural bound

Buoyant demand for credit has meant that Mozambique’s banks are very profitable. The four biggest have made returns on equity of between 30% and 35% in the past two years.

Given that they are almost entirely funded by equity and deposits, the banks are also well-capitalised. The overall sector had a capital adequacy ratio of 15.4% last year, according to the IMF. Loans amount to less than 80% of deposits, although this ratio has risen substantially in the past five years. Non-performing assets are also low, making up just 1.8% of total loans at the end of 2010.

Despite high concentration in the banking sector – the biggest four lenders own 90% of its assets – new entrants are able to succeed. Moza Banco, for example, became profitable after just one year. Mr Merali says that expanding into rural areas, in many of which there are no branches, is an important source of growth. “There’s huge potential for banking in this country as 90% of the population is still unbanked,” he says. “But we have to find intelligent ways of banking. In rural areas a lot of people have no documentation. So you have to figure out a way for them to open accounts.”

Lenders are wary of building expensive branches in remote, sparsely populated regions. Such investments often take six to seven years to realise returns, say bankers. But the government is starting to provide fiscal benefits for those moving outside urban areas as part of its attempts to reduce poverty and ensure that small businesses and the rural population have greater access to credit.

Portuguese to stay

Foreign banks have been enticed into Mozambique. The big four local firms – a group which includes BCI, as well as Millennium BIM, Standard Bank and Barclays – are all foreign-owned.

Lenders from Portugal, of which Mozambique was a colony until 1975, have made the biggest push. Banco Espírito Santo bought a 25% stake in Moza Banco last year, following its rivals Millennium BCP (which controls Millennium BIM), Caixa Geral de Depósitos (majority owner of BCI) and Banco BPI (holder of a 30% stake in BCI) into the country.

The high profitability of Mozambique’s banks means that there is little chance of Portuguese institutions selling their stakes because of their problems at home, say most analysts. Although many Mozambican banks have raised equity in the past two years – chiefly for expansion – they are mostly funded by local deposits, not their parents. “Portuguese banks have an incentive to maintain a presence in fast-growing economies,” says Mr Lopes.

Inflation worries

Mozambique’s banking system, and the economy as a whole, faces problems because of inflation and the government’s attempts to combat it. Having been as low as 3.3% in 2009, inflation rose to 12.7% last year after the government scrapped fuel subsidies and due to rising oil and food prices. As a result, the central bank raised interest rates from 12.5% to 16.5% between early 2010 and February this year. It also increased banks’ reserve requirements from 8% to 9%. The latter has caused credit growth to slow as many banks had excess reserves of less than a percentage point.

Bankers say that higher rates will put pressure on their profits rather than boost their net interest margins. “Our banking system is very traditional,” say Mr Merali. “The interest we pay depositors rises when rates rise. We are seeing that liquidity in the sector is becoming scarce. Banks are paying an obscene amount for taking deposits at the moment.”

This could force Mozambique’s lenders to move beyond a model of simply taking deposits and lending onwards. There will be an incentive for them to boost their fee-based revenues, including from their embryonic capital markets arms.

Such measures and the expansion of the banking sector in general will be needed if Mozambique is to diversify its economy and ensure that growth has a greater impact on the majority of the population. The mega projects will be crucial in the short term, luring foreign investors to the country and providing it with much needed foreign exchange. But in the longer run, Mozambique wants to move beyond just mega projects.