Understanding Mozambique's budget credibility issues and solutions

Mozambique ranks in the bottom 20 of the human development index and faces multifaceted development challenges. Over 62.8% of its population (18.9 million people) lives below USD 0.7. Most Mozambicans depend solely on the public services provided by the government, like other low-income countries with limited access to private services. This implies that the government shoulders the significant responsibility of providing essential services such as education, health, and social protection.

Fiscal deficit and budget credibility affect development goals

Mozambique’s state budget, similar to other low-income countries’, is characterised by a significant deficit year after year. This is due to the need for substantial investments in infrastructure and social services, coupled with limited revenue generation capabilities. This budget structure tends to decline every year and veer towards unsustainability. The state budget spending constraint is lessened through budget support aid and internal and external debt channels. 

Each, however, comes with costs: external aid is typically associated with conditionalities; internal debt tends to crowd out private investment, and external debt exposes the country to heightened financial and economic risks (including exchange rate fluctuations and a heavier debt service burden). In other words, in either form, excessive public debt can limit the country’s growth. 

For countries prioritising economic growth and development, constrained fiscal space can hinder their attempts to achieve their growth goals. In this scenario, every monetary unit allocated to the state budget becomes critical for driving the countries’ development.

The Public Expenditure and Financial Accountability (PEFA) report provides key indicators that evaluate the state budget's credibility, performance, and transparency essential for sustaining good long-term fiscal management and sustainability. PEFA defines budget credibility as the extent to which the government's budget is realistic and implemented as intended. Realistic and reliable budgets are crucial for good fiscal management, providing direction on budget priorities, feasibility, and transparency. However, consistent discrepancies in the government's planned budget can have serious implications for various actors in the economy.

Challenges faced by the state, firms, and households due to low budget credibility

We can consider the implications of non-credible budgets across different state actors, examining how reduced credibility affects dimensions such as reliability, predictability, and feasibility for each actor. However, it is important to recognise the complexity of the relationship between actors and budget dimensions, making it difficult to isolate these effects.

State-level challenges

• Reduced transparency and visibility of government priorities: A non-credible budget reduces transparency and limits the visibility of government priorities. Although resources are allocated in line with signed conventions and treaties in education, health, and agriculture, among others, it becomes nearly impossible to determine genuine intention and commitment to fulfilling these obligations.
• Undermined capacity to assess investment feasibility: Complementary or interdependent public investments become less feasible without actual execution of the allocated budget. Accurate assessment of public investments’ feasibility hinges on the successful implementation of the proposed investments.
• Resource misallocation: Resources are allocated to activities that are not executed, while other executable activities receive less or no resources, eroding public trust, hampering economic development, and perpetuating socioeconomic disparities.

Firm-level challenges

• Constrained forecasting of government spending: A lack of budgetary credibility hampers the ability to forecast government spending, hindering efforts to align business with the government’s consumption spending, and investment needs, as outlined in the national plan and budget. 
• Increased burden on business resources: Uncertainty surrounding government spending patterns inhibits firms' investment decisions and stifles economic growth. Moreover, limited insight into government plans might push firms into substitute for public services required for their activities (for example, water, sanitation, roads, or electricity), which might strain business’s resources and dampen competitiveness, hindering private sector development.

Household-level challenges

• Increased likelihood of budget underspending or overspending: Both underspending or overspending can result in resource misallocation. This limits households’ access to state benefits, leading to lower quality public services and increased pressure to self-finance public services. 
• Exacerbation of socioeconomic hardships: Uncertainties in budget execution limit access to essential services and erode confidence in government institutions.

The discussion on budget credibility extends to budgeted revenue and the government’s accuracy in forecasting revenue collection. Inaccuracies in revenue projections can severely hinder budget execution, as insufficient resources may be available to fund allocated expenditures.

Structure of Mozambique’s budget credibility

Publicly available data on Mozambique’s state budget, encompassing both planned spending and actual execution, provides a foundation for assessing budget credibility. PEFA reports offer multi-year indicators and insights into budget credibility for Mozambique and other countries. PEFA identifies several potential shortcomings in Mozambique’s budget credibility, such as:

• Deviations in the budget: These may be linked to weaknesses in the initial budgeting process and challenges in maintaining fiscal discipline. 
• Sector specific variability: Sectors receiving external funding, particularly social sectors like health and education, often experience higher variability. Social sectors like health and education often show better execution rates compared to infrastructure projects, which face delays and budget overruns.
• Revenue shortfalls: Actual revenues consistently fall short of projections. This discrepancy can be attributed to overly optimistic revenue forecasts and tax collection challenges.
• Mid-year budget adjustments: The reports highlight that mid-year budget adjustments are common but often fail to improve overall budget creditability. These adjustments are typically reactive, addressing immediate fiscal pressures rather than strategic realignments.

While PEFA provides valuable insights into budget credibility challenges, shortfalls, and recommendations, they do not delve into the origins of these budget discrepancies, as this is considered beyond the reports’ scope. Consequently, although the PEFA reports identify issues with budget credibility, they offer limited clarity on the underlying factors or sector-specific credibility patterns within the budget structure.

Decomposing the budget credibility provides a deeper understanding of budget quality and areas for improvement in credibility and estimation. By breaking down the state budget, we can identify how different components contribute to overall credibility. Our study on decomposing budget credibility highlights the following sources of budget lowered credibility:

• Consistent under-execution: Mozambique's expenditure consistently falls short of planned levels without corresponding revenue reductions.
• Sector disparities: Similar to findings in PEFA reports, our study indicates that while social sectors like education and health exhibit relatively credible budgets, overall budget credibility masks significant disparities between sectors. Public works and social protection for example demonstrate notably lower credibility.
• Resource reallocation: Budget discrepancies indicate that resources originally allocated for investments were redirected to fund current expenditures.
• Mid-fiscal year adjustments: Aligned with the PEFA reports, there is no strong evidence that mid-fiscal year budget adjustments improve budget reliability. In some cases, this mid-fiscal year adjustments exacerbate budget discrepancies.
• Investment expenditures: Investment expenditures, especially externally funded ones, show higher volatility and lower credibility.

The dynamics of revenue shortfalls and expenditure overruns

Within Mozambique's budgetary framework, key social sectors disproportionately face budgetary constraints, affecting service delivery and socioeconomic outcomes. Although PEFA reports (2015, 2021) indicate an improvement in Mozambique's budget credibility from 2010 to 2018, recent crises like the COVID-19 pandemic and the hidden debt crisis reveal persistent vulnerabilities in the country's debt management framework.

The State Budget Account reports detail budget inconsistencies and offer explanations for some non-executed budgets. The CGE’s typically attribute these discrepancies to revenue shortfalls and expenditure overruns. Key justifications provided by CGE’s include:

Revenues Shortfalls

• Slower-than-expected economic growth leads to lower tax revenues and other government income.
• Inefficiencies and challenges in the tax collection system often result in lower revenues than anticipated.

Expenditure Overruns

• Unplanned expenditures due to natural disasters, health crises (such as COVID-19), or other emergencies often lead to budget overruns.
• Unexpected inflation or changes in the exchange rate can increase the cost of goods and services purchased by the government.
• Delays or shortfalls in disbursements from external donors for funded projects.
• Administrative and logistical issues leading to delays in the start or completion of projects.

The government of Mozambique has plans that could potentially mitigate vulnerabilities on the Public Finance Management (PFM) structure. These plans involve creating a reserve fund under a sovereign fund scheme to supplement the state budget. According to the IMF, the Mozambican government has initiated various measures aimed at enhancing budget credibility and fiscal management, such as:

• Wage bill rationalisation: Implementing measures to streamline the wage bill and curb irregularities within the civil service to improve fiscal discipline and efficiency.
• Tax collection strengthening: Modernising tax administration and reforming VAT regulations to enhance revenue generation and ensure fiscal sustainability.
• Transparency and accountability measures: Introducing robust monitoring mechanisms, conducting regular audits, and enhancing reporting systems to promote transparency, accountability, and oversight in budget management.

Improving credibility going forward

Our study reveals a consistent pattern of under-execution in Mozambique’s expenditure budget without corresponding under-execution in its revenue budget. The investment budget is a primary contributor to the overall low budget credibility. These findings suggest the following avenues to improve the current public finance budget credibility:

• Sectoral focus: Given their weight on the budget and contribution to overall budget credibility, prioritising low discrepancies in social sectors low is crucial to ensuring high state budget credibility. Targeted investments and streamlined budget allocation in education, health, social protection, and social work can amplify their impact, fostering inclusive growth and development.
• Enhanced investment management: Addressing the discrepancies in public investment execution demands a multi-pronged approach. Strengthening oversight mechanisms, particularly for externally financed projects, can mitigate diversion risks, and ensure alignment with long-term development goals.
• Budget adjustments reassessment: Reassess the efficacy of mid-fiscal-year budget adjustments in bolstering budget reliability. While traditionally viewed as corrective measures, our findings suggest a need for a nuanced approach, with a focus on strategic reallocation rather than ad-hoc adjustments.
• Improve monitoring of budget financial execution: The introduction of decomposed budget credibility indicators at sectorial, budget unit and economic expenditure levels will allow the Ministry of Finance to better identify quick-wins, hotspots and, on the other hand, best practices, to improve transparency and predictability of public expenditure.

Budget credibility is crucial for Mozambique's economic development and public trust. An efficient budget ensures transparency, predictability, and accountability, which are essential for sustainable growth. However, Mozambique often faces discrepancies like under-execution of expenditures and revenue shortfalls, leading to resource misallocation. Improving fiscal management, strategic budget adjustments, and investment oversight can address these issues and foster sustainable development.

A version of this article was first published by UNU-WIDER.