Mozambique Will Be Rich! Or Will It?

The media hype about the recent resource bonanza has finally put this South African country on the international agenda. A country long ignored by private investors and with one of the most beautiful coastlines on earth, Mozambique has been bustling with people seeking a piece of the pie. Yes, there are enormous amounts of natural gas off the northern coast and vast reserves of coal in the interior of the country. Does this mean that Mozambique's perils are finally over and that it will become an energy hub for its region? Maybe.

Once natural resources are found, the road to prosperity is technically a straight on, if it wasn't for the large potholes on the way that have the power to capsize the whole nation.

Spending ten days in Maputo last March brought out just how eager the government is to utilize the revenues from natural gas production (and, to a lesser extent, from coal because it is less profitable) to propel Mozambique to the next level of development. There is some talk about establishing a sovereign wealth fund (SWF), but there seems to be a preconceived notion that a SWF would capture the profits abroad and keep them there without creating a significantly beneficial impact on the country.

Let me cut right to the chase: this is inaccurate.

A SWF and investment in much-needed infrastructure, education, and health care are not mutually exclusive. On the contrary, a SWF will increase the efficiency and purposefulness of development spending while making sure that no major potholes impede or undo this progress.

Studies have shown that countries that rely on exports of natural resources for government revenues are highly vulnerable to volatilities in the prices of these resources. Governments tend to increase spending during times of high commodity prices, while times of low prices lead to either painful spending cuts (that can lead to a recession) or soaring levels of debt. Aside from helping Mozambique reduce donor contributions to the budget -- which are projected to make up roughly 33 percent in 2013 -- the Mozambican SWF will have a built-in stabilization account. It will increase in times of high commodity prices and can be drawn upon in times of low prices.

Once Mozambique's natural gas hits the market, which is expected to occur in 2018/19, foreign exchange will start flowing in to an extent that will make it difficult for the central bank to maintain the national currency's price level. Without a SWF that can keep foreign exchange beyond the central bank's balance sheet, the Metical is prone to appreciate (also called the "Dutch Disease"), which will put farmers and other smaller industries out of business. From there, Nigeria-style social unrest is just waiting around the corner.

There is also discussion about Mozambique's absorption capacity, and it is true that this is another challenge that has to be addressed. Mozambique's economy is fairly small, with limited infrastructure, few paved roads, and one of the lowest electrification rates in the world. Even if there is the will and the means to start many projects at the same time, the country's limited capacity will inevitably lead to supply bottlenecks, which will increase prices and result in inflation. Rather than flooding the country with money that will then be eradicated in inflation, it should be held until feasible and profitable investments come around. A development account within the SWF will ensure that resource revenues are invested in long-term development projects that will diversify the Mozambican economy.

Last but not least, the ultimate goal of a Mozambican SWF is saving for future generations. Selling natural resources is similar to selling the family silver: a once durable asset is sold and turned into cash. To make sure that not only the current citizens but also their children and grandchildren benefit from this windfall part of the resource revenues have to be converted into financial assets that generate recurring revenues.

One thing is certain: the mere act of establishing a SWF will not guarantee what is stated above. For all the benefits of a SWF to take on it has to be very well structured and managed; better yet, it has to be enshrined in a revenue management law.

While this matter might not seem urgent, with natural gas production not projected to start until 2018, it is very important. The structure of the fund has to be in place before the potential tsunami of revenues hits the domestic economy. There is no time like the present.