Alleviating Mozambique's Poverty Crisis: Why Cash Transfers Outperform VAT Cuts

The UNDP report reveals that Mozambique's cost-of-living crisis, exacerbated by global inflation and local conflicts, has pushed an additional one million people into extreme poverty by 2022. Targeted cash transfer programs are recommended as more effective solutions than VAT reductions in alleviating poverty.

A working paper by the United Nations Development Programme (UNDP), authored by Salome Ecker from King’s College London, Sofia Terragni from Voluntas, Alex Warren-Rodriguez from UNDP Zimbabwe, and Eduardo Ortiz-Juarez from King’s College London, delves into the worsening cost-of-living crisis in Mozambique and its impacts on poverty, with a focus on possible policy responses. The paper highlights how Mozambique’s poverty situation has been severely aggravated by global inflationary shocks, particularly in food, energy, and transport, following the outbreak of the war in Ukraine in 2022. The economic crisis has built on pre-existing vulnerabilities from the COVID-19 pandemic and conflicts in the northern provinces, leading to a significant spike in extreme poverty. As of December 2022, the report estimates that one million more Mozambicans were living in extreme poverty compared to December 2021, bringing the total number of people in extreme poverty to 21.7 million, or 71% of the population. The majority of these newly impoverished individuals, around 60%, were concentrated in urban areas, where the reliance on market-purchased goods like food and energy was greater than in rural areas.

Inflation Hits Poorest Households the Hardest

The report points out that the inflationary shock disproportionately impacted the poorest segments of the population, given that basic goods such as food and energy make up a higher proportion of their household expenditure. In rural areas, where households rely more on subsistence farming and auto-consumption, the inflationary pressures were somewhat mitigated. However, rural areas still experienced significant hardship, with an estimated 7.5% decline in total expenditure due to inflation, compared to a 3.8% decline in urban areas. Overall, the crisis deepened the existing inequalities between rural and urban populations, and it especially hit those just above the poverty line, pushing many into extreme poverty. The analysis shows that while food prices peaked globally in mid-2022 and slightly declined afterward, inflation in Mozambique continued to rise, driving up the cost of living for millions.

Limited Impact of VAT Reduction on Poverty

The Mozambican government responded to the crisis by introducing a one percentage point reduction in Value Added Tax (VAT) in December 2022 as part of an Economic Acceleration Package. However, the authors argue that the VAT reduction had only a limited impact on poverty alleviation. The VAT reduction, although seen as a relief measure, did not significantly help the poorest, primarily because essential goods like food and energy were already VAT-exempt. Consequently, the policy provided minimal relief to the most vulnerable households. According to the analysis, the VAT reduction lifted only 38,000 people out of poverty, representing less than 4% of the inflation-driven increase in extreme poverty. Moreover, urban households, which had higher absolute expenditures and benefited more from the VAT reduction, saw greater savings compared to rural households. This unequal benefit, coupled with the fact that rural subsistence farmers relied heavily on non-market consumption, made the VAT reduction an ineffective tool for mitigating poverty in rural areas.

Cash Transfers: A More Effective Solution

Instead, the report highlights that cash transfer programs targeted at the poor would be a much more effective way to address the crisis. Simulations conducted by the authors suggest that a well-designed cash transfer program could lift nearly three times as many people out of extreme poverty as the VAT reduction, at the same fiscal cost. A hypothetical cash transfer program of approximately MT 1,650 per household, focused on the poorest urban areas in provinces like Nampula, Cabo Delgado, and Zambezia, would reduce extreme poverty by 11% and support 106,000 people per month. This targeted approach would be especially beneficial for urban households, where poverty has been rising most rapidly. Furthermore, the analysis underscores that such a cash transfer program would provide greater gender equity. Female-headed households, which were found to be disproportionately disadvantaged by the VAT reduction due to their reliance on VAT-exempt goods, would see a more significant benefit from cash transfers. While the VAT reduction saved female-headed households an average of only MT 36 per month, a targeted cash transfer program would deliver much higher relief, reducing poverty more effectively.

Structural Challenges and Economic Vulnerabilities

The report also discusses the structural challenges that Mozambique faces, which have exacerbated the cost-of-living crisis. Mozambique’s dependence on imports for basic goods like food and fuel makes it vulnerable to global price fluctuations, and its high external debt over 100% of GDP in 2022 limits the government’s fiscal capacity to respond to economic shocks. The country’s heavy reliance on foreign debt also increases inflationary pressures through exchange rate fluctuations and further reduces its ability to withstand future crises. Additionally, extreme weather events, such as tropical storms and droughts, and the ongoing conflict in the northern province of Cabo Delgado have compounded the economic challenges, with millions of people displaced and requiring food aid by the end of 2022.

The Path Forward: A Call for Targeted Policy Measures

The report calls for more targeted and effective policy measures to alleviate the rising poverty in Mozambique. While the VAT reduction provided some relief, it was insufficient to address the scale of the crisis, particularly for the poorest and most vulnerable populations. The authors recommend a shift towards cash transfer programs that focus on urban areas and the most affected provinces, as well as long-term investments in domestic production capacity to reduce Mozambique’s reliance on imports. By addressing both the immediate and structural drivers of inflation and poverty, the country could build greater resilience to future shocks and create a more equitable and sustainable path to economic recovery.