Improving the Domestic Impact of Mega-Projects

1. Improving the Domestic Impact of Mega-Projects Global Experience and Options for Mozambique Antonio Nucifora, Peter Nicholas, and Boris Utria World Bank March 2010Namaacha

2. Improving the Domestic Impact of Mega-Projects • The context: Opportunities and challenges • Improving the project preparation cycle • How to ensure domestic participation: Funding from the budget? • Macroeconomic impacts and how to manage them • Natural resource ‘curse’ and policies to avoid it • Concluding questions Mozambique

3. Rovuma Basin – Gas (and Oil?) Moatize Power Cahora Bassa Mpanda Nkuwa Moatize Coal Benga Coal Benga Power Refinery Forestry Potential Petroline Moma - Titanium Gas Fields Refinery Chibuto - Titanium Moamba Power Station Mozal Maputo Metallurgical Complex Mozambique Mozambique 3

4. Mega-projects:Opportunities and challenges • Mozambique has gained strong reputation as investor friendly, and S&P and Fitch have given a stable outlook on their B+ credit ratings • Increasing investor interest in Mozambique is translating in multi-billion dollar investments • Mega-projects contributions to budget can be cash-cow to finance infrastructure investments • Looking ahead: Need to balance reputation as investor-friendly destination with maximizing domestic fiscal, ownership, employment, social and environmental benefits of mega-projects Mozambique

5. Improving the project preparation cycle Mozambique

6. Improving the project cycle: current status • Weaknesses in current project cycle set up • Gaps exist in legal and regulatory framework (e.g. length of concessions, electricity royalties, etc.) • Ad hoc process of inter-ministerial coordination • MOF often called in when discussions are advanced • Large investors report that GOM delegations are often not adequately prepared/staffed Mozambique

7. Improving the project cycle: Legal & Regulatory Framework • Lack of a comprehensive framework law for mega-projects, concessions and PPPs to provide guidelines for project selection and risk allocation • who is the contracting authority • maximum timescales for approval of contracts • which bodies need to provide approvals and at what stage • how concession and other agreements might be regulated and/or monitored • different procurement options which are available Mozambique

8. Improving the project cycle: Institutional process • Need to develop a clearly structured process for mega-project screening, tendering, negotiations and post-implementation monitoring • Clear demarcation of responsibilities between ministries • Guarantee key role of MOF in negotiation and monitoring of mega-projects, concessions and PPPs • Assess and prioritize key human resource needs, such as financing expertise Mozambique

9. Improving the project cycle: Institutional process • Need to facilitate private sector participation • Strengthen capacity to respond to big investors • Develop greater in-house GOM capacity to initiate projects and respond robustly to unsolicited proposals • Need instrument to provide financial support for project development and transaction activities to line ministries • Need to develop a framework for assessing: • the overall benefits of proposed investments • financing options • if a broader tendering process would be beneficial for unsolicited bids (for example, a 'Bonus System’ or 'Swiss Challenge System' of competitive bidding) Mozambique

10. Improving the project cycle: Institutional process • Would it be better to have a dedicated and adequately staffed unit? • Should responsibility for specific project cycle activities continue to be decentralized, or should it be moved to a centralized ‘Mega-project, PPPs and Concessions Unit’? • Is it better to develop needed skills within each interested ministry or would a specialist centralized unit be an appropriate institutional solution? Mozambique

11. How to ensure domestic participation in megaprojects? Mozambique

12. Should there be any domestic participation in mega-projects? • It is essential that domestic private interest be invited competitively and transparently • Avoid concerns regarding Politically Exposed Persons • It will take time for Mozambican individuals, corporate and institutional investors to build up the financial resources to invest in M-P • GOM has expressed interest in financial participation in a number of upcoming projects • Protect national interest: control of strategic assets • Socio-political: wider domestic share ownership • International investor see local participation as extremely important risk mitigant Mozambique

13. How can domestic participation in mega-projects be financed? • Option 1: GOM to invest directly and finance domestic participation in mega-projects • But should GOM use its limited resources (or borrow) to fund shareholdings in mega-projects? • Need to take into account the opportunity cost in terms of other possible uses of public funding • Direct public investment in mega-projects should generally be the least preferred option and driven only by strategic considerations • Precise form of vehicle and appropriate structure for such public investments would depend on Mozambican law Mozambique

14. How can domestic participation in mega-projects be financed? • Option 2: Reserving shares through ‘a call option’ to buy shares in the future • When issuing concessions, GOM could reserve equity for Mozambicans to buy in the future • Concession agreement could indicate that a given percentage of the shares will have to be divested to Mozambican entities (citizens, companies, stock market, pension funds, etc) at a date in the future at the price then current • This is like a ‘call option’ on a share issue to increase Mozambican private participation in the future • Future sales of shares should be at market value Mozambique

15. How can domestic participation in mega-projects be financed? • Option 3: ‘Warehousing’ shares until there is sufficient local demand to purchase the shares (at a market rate) • (a) third party private companies might be prepared to undertake the warehousing role • (b) the warehousing role could also be played by one or more development finance institutions (DFIs) • (c) the Mozambican government itself could borrow to finance the warehousing • Private sector or DFI’s to act as the warehouse would avoid need for GOM to use its scarce resources (or borrow) to fund the shareholding Mozambique

16. Setting up a Multi-Investment Warehousing Facility? • Public ownership would best not be held by the national utility, to ensure good corporate governance and avoid conflict of interest • Keep clear role and objectives of government ownership • If national utility is involved in financing they may become involved in operational / management decisions • There is conflict of interest when the company is both seller and buyer/investor and off-taker • A purely financial vehicle would not have that problem • Better to keep warehousing on case by case basis or to set up specialized vehicle? Mozambique

17. How a Mozambican Holding Company might be structured Mozambique

18. The Singapore example: TEMASEK public holding company • Singapore’s State holding company provides a good model of both strategy and governance • Temasek holds full or partial stakes in Singapore’s largest companies, particularly power and utilities • Invests in areas with strong public good features, with occasional participation in catalytic investments outside infrastructure • Managed by independent board and professional and accountable management team • Full disclosure of materials and related party transactions • Publication of audited financial statements Mozambique

19. Singapore’s Public Holding Company: TEMASEK Mozambique

20. Macroeconomic and Budgetary Impacts of Mega-Projects Mozambique

21. Recent Steps to Increase the Fiscal Benefits of Mega-Projects • GOM wants to increase mega-projects domestic benefits, notably fiscal contribution to budget • Given increased confidence of investors, GOM has rightly reduced fiscal incentives and standardized fiscal terms of all new projects • New legal frameworks for the mining and petroleum fiscal regimes in 2007 • Revised Fiscal Benefits Code in 2009 Mozambique

22. Next Steps to Increase the Fiscal Benefits of Mega-Projects • Need proper legal framework to minimize fiscal risk and limit quasi-fiscal activities resulting from GOM participation in mega-projects • Need mechanisms to ensure that additional resources are budgeted in an efficient and transparent manner, and properly monitored • Consider reducing fiscal benefits for investment projects, in parallel with reduction in corporate tax rates Mozambique

23. Are incentives useful to attract investment? • Most of the literature argues against incentives • Survey on impact of incentives in Mozambique (Bolnik, 2009) • Random sample of 60 companies that qualified in 2005, 2006 and 2007 for CIP fiscal benefits • Critical factors influencing investment decision • growing domestic market (38 times) • lack of local competition (16 times) • political stability (14 times) • business environment (12 times) • and access to neighboring markets (9 times) • just one respondent cited “incentives”

24. Are incentives useful to attract investment? • Survey on impact of incentives in Mozambique • Fiscal benefits are not decisive for most investments • 85% of investors stated their decision did not depend on receiving income tax breaks, giving 80% redundancy rate • for import duty relief on capital goods the corresponding redundancy rate was 73% • Very few of these projects could be categorized as “footloose” • Only 12 percent of the investors considered locations outside Mozambique—and none of them regarded tax breaks as critical • Fully 90 percent of the investments—and 80 percent of those critically influenced by tax breaks, were driven by domestic market opportunities

25. Reform Fiscal Policy to Boost Competitiveness of SMEs • Fiscal climate could be significantly improved by reducing simultaneously fiscal incentives and the number and level of tax rates—without compromising government revenues • Enlarge tax base to create level playing field for all potential investors • Considerably simplify tax administration • Allocate investment to their most productive use • Reduce room for discretion and corruption • Improve fiscal regime for investment by small / medium entrepreneurs—the very entrepreneurs that are needed to sustain growth and job creation

26. Potential Further Improvements in Macro-Fiscal Impact of M-P • Enhancing revenue forecasting and the efficiency of spending • Developing and implementing a macro-fiscal model for the mega-projects • Improving the efficiency of spending as part of an effort to avoid Dutch Disease • Strengthening transparency and accountability • Adopting practices to closely monitor the collection and distribution of mega-project fiscal revenues • EITI membership is a great start • Adopt same principles / approach throughout the value chain for all natural resources projects Mozambique

27. Potential Further Improvements in Macro-Fiscal Impact of M-P • Fine-tuning the monetary policy framework • Tailoring Central Bank intervention policy mix to facilitate absorption of capital inflows from M-P • Improving central bank liquidity management and monetary policy operations to effectively manage surplus liquidity associated with M-P inflows • Developing exchange rate policy with a medium term focus • In the short-term, mitigate appreciation pressures on the exchange rate associated with M-P inflows • What exchange rate policy would optimize the resource flows associated with mega-projects over the medium-to-long term? Mozambique

28. Revenue Transparency and Good Governance Mozambique

29. Natural Resource Wealth and Economic Growth: ‘The Curse’ Mozambique

30. The ‘Natural Resource Curse’What is it? • Many studies find that abundance of natural resource has strong negative impact on growth • For example (Sachs and Warner 1995, 2001) • Cross-section of countries in the period 1970-90 • Ten percentage point increase in the ratio of natural resource exports to GDP associated with 0.4% - 0.7% lower annual per capita GDP growth • Three main explanations for resource curse: • ‘Dutch disease’: appreciation of real exchange rate and loss of competitiveness • Rent seeking: Natural resource rents are easily appropriable (bribes, distortions in public policies, …) • Institutional and policy quality deterioration Mozambique

31. The ‘Natural Resource Curse’: Key Role of Good Governance • Consensus emerging that outcome depends on quality of country’s institutions and policies (Collier and Goderis 2007) • Time series of 130 countries over the 1963-2003 • Divide their sample into good and bad governance countries (ICRG rating >than 75 is ‘good’) • Negative impact on growth only in countries with bad governance; positive relationship in countries with good governance Mozambique

32. Key policy implications for the use of natural resources • Mozambique has so far avoided the resource curse, reflecting ‘enclave nature’ of existing M-Ps • Four types of policy can help Mozambique address the challenges of natural resource based development • Good governance and transparency • Fiscal regime for the natural resources sector • Sound fiscal policy stance • Adopting appropriate fiscal rules for saving enough from natural resource revenues) • Policies to allocate public expenditures to promote long run growth and minimize Dutch disease Mozambique

33. Conclusions Mozambique

34. How to maximize benefits from mega-projects • Strengthening the project preparation cycle • Carry out full review of legal framework, institutional and project cycle process? • Would a framework law for PPPs, Concessions and Mega-projects be useful ? • How can the assessment of State liabilities be improved • Should there be a centralized unit? • Ensuring Mozambican participation • Should it be financed from the budget or should alternatives be used (call option, warehousing)? • If from budget, what principles should guide the operation of a Mozambican Holding Company? Mozambique

35. How to maximize benefits from mega-projects • Macroeconomic and budgetary impacts • Need a macro-fiscal model to forecast fiscal revenues and predict the resource envelope for government spending over the medium-term? • In there need to offer investors fiscal benefits? Should GOM consider a reduction in fiscal benefits, in parallel with reduction in number and level of tax rates? • What exchange rate policy would optimize the resource flows from mega-projects over the medium-to-long term? • Revenue transparency and good governance • Should GOM consider adopting EITI-like principles / approach throughout the value chain for all natural resources projects? Mozambique

36. Obrigado! World Bank - Mozambique March 2010 Namaacha Antonio NuciforaSenior Economist, PREM, World Bank, MozambiqueTel: +258-21-48-2371Fax: +258-21-492893Email: anucifora@worldbank.org