Public Information Notice No. 04/132

Public Information Notice: IMF Concludes 2004 Article IV Consultation with Malawi and Discusses Ex Post Assessment of Performance Under Fund-Supported Programs

November 24, 2004

On October 29, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Malawi.¹

Background

Malawi benefited from a modest economic recovery in 2002 and 2003. Overall inflation decreased sharply from 40 percent in 2000 to less than 10 percent in 2003. However, higher-than-programmed budget deficits have led to a doubling of domestic debt since June 2002.

Real GDP grew by an annual average of 3 percent in 2002-03. Agricultural production rebounded from the drought in 2001, but the 2004 harvest was affected by a drought and President wa Mutharika has appealed for humanitarian assistance to alleviate the crisis. Macroeconomic imbalances, high interest rates, and infrastructure constraints have adversely affected the non-agricultural economy. Manufacturing—mainly agro-processing activities—and distribution (together one-third of GDP) stagnated in 2002-03 and industrial activity remains at a very low level.

Fiscal policy slippages over much of the 2002-04 period have resulted in a unsustainable domestic debt situation and a high level of public expenditures. Largely unbudgeted expenditure for maize imports of 3.9 percent of GDP were a major factor in 2002/03, while 2003/04 was impacted by above budget spending in a number of non-pro-poor expenditure areas. Compounded by shortfalls in external financing and high interest rates, this led to a large increase in domestic borrowing.

Malawi's external current account deficit (excluding grants) mirrored changes in the government balance and the emergency maize imports in 2002. The 2002 current account deficit of 25 percent of GDP—about one-half of which was related to maize imports—was financed through a drawdown in official reserves and external assistance. The real effective exchange rate depreciated in 2002/03 as changes in the nominal exchange rate outpaced inflation, while the nominal kwacha-U.S. dollar exchange rate has remained stable after a 20 percent depreciation in August 2003.

Progress in implementing structural reforms was mixed. Several parastatal corporations were privatized and reforms have been implemented in the telecommunication, electricity, and water sectors. ADMARC's monopoly in the marketing of maize has been abolished and some businesses sold off. Plans for the commercialization of some the remaining ADMARC operations are under way. The Anti-Corruption Bureau (ACB) has been strengthened through an amendment to the Corrupt Practices Act that would increase transparency. The new administration has declared a policy of zero tolerance on corruption and has already taken steps to enforce this policy.

The Reserve Bank of Malawi has maintained high nominal interest rates. However, owing to higher-than-programmed government spending, pressures on nonfood inflation reemerged in the first half of 2004.

Malawi's performance under the Poverty Reduction and Growth Facility (PRGF) arrangement, approved in December 2000, was disappointing. The authorities requested Fund staff to monitor their economic program to establish a track record that could lead to a new PRGF arrangement.

The 2004/05 budget limits the domestic borrowing to 2 percent of GDP, down from 12 percent in 2002/03 and 8 percent in 2003/04. The budget aims at reducing expenditures across government while accommodating priority spending in areas such as food security and wage reform. Monetary policy will aim to achieve 10 percent inflation by the end of 2005 and structural reforms will focus on financial management. Key risks are budget implementation and inflation.

As part of the Article IV consultation, an assessment of the IMF's Longer-Term Program Engagement in Malawi was prepared by the staff and discussed with the authorities.² The assessment concludes that under the last two arrangements covering 1995-2003, performance has generally fallen short of expectations because of a lack of ownership, weak planning, insufficient monitoring, and lax enforcement of regulations. Furthermore, external resources have not always been put to good use because of limited implementation capacity and governance issues. The assessment also concludes that the periods of fastest growth in Malawi had coincided with implementation of relatively prudent fiscal and monetary policies.

Executive Board Assessment

Directors noted that economic growth picked up in 2003-04, inflation has been brought down, and the exchange rate has been stable for more than one year. Directors commended the new government's ownership of economic policies and recent actions to address corruption at the highest levels.

Directors noted, however, that although Malawi has recently recovered from a severe drought and food emergency, it now finds itself in a precarious macroeconomic and social situation. Above budget spending and delays in donor assistance over much of the past two years have left Malawi with an unsustainable level of domestic debt, high interest rates, and low private sector investment. In addition, widespread poverty and the high incidence of HIV/AIDS continue to present vast challenges.

Directors welcomed the determination to act decisively in meeting budget objectives. Adherence to the fiscal objectives in the Staff-Monitored Program—which will require effective expenditure controls—is critical for restoring macroeconomic stability, and the recent passage of the 2004/05 budget was a key step in this direction. Directors urged the authorities to quantify savings stemming from the ongoing government restructuring, including the reduction in the number of ministries and the relocation of the president's office to Lilongwe.

Directors generally agreed that the budget for 2004/05 balances the critical objective of restoring sound macroeconomic policies with pressing social needs. In this context, they considered the government's target of restricted domestic borrowing as appropriate. Directors emphasized that determined implementation of the budget will be essential. They welcomed the Ministry of Finance's refusal of requests for resources above the budget and stressed that ministries should find savings and set priorities in order to operate within their budgets. Based on preliminary information, Directors noted that performance had been good through end-September.

Despite recent encouraging inflation trends, Directors expressed concern over the recent pace of monetary expansion. They urged the Reserve Bank of Malawi (RBM) to mop up excess liquidity before it translated into higher inflation. They welcomed, therefore, the RBMs willingness to raise interest rates if necessary. Directors viewed Malawi's exchange rate policy as broadly appropriate. A few Directors took note of the differential with the exchange rate in the parallel market and the low level of reserves.

Directors further underscored the importance of food security in Malawi and expressed concern about the possibility of a maize shortage this year. They generally concurred with the government's plan to replenish the strategic grain reserve and welcomed the government's appeal to the international community for assistance to supplement its efforts. Directors welcomed the inclusion of these initiatives in the budget, although some expressed concern over the costs and scope for corruption of the subsidy programs for maize and fertilizer. They urged the authorities to solidify medium—term agricultural plans, including in the area of land reform.

Directors welcomed recent progress in implementing key structural reforms. The long planned civil service pay restructuring is about to be implemented, and ADMARC, the government-owned agricultural product marketing company, was about to adopt a new, more targeted role in providing public services. However, Directors encouraged further progress in public enterprise restructuring, and expressed concern that monopolies or oligopolies remain dominant in many sectors. They observed that progress in other areas, including the audit of domestic arrears and passage of legislation to strengthen financial management, would also contribute to a more efficient government. Directors welcomed the government's focus on anti-corruption, and urged strong enforcement.

Directors considered improvements in public expenditure management to be critical. These are needed to ensure that the government achieves its policy objectives—particularly those related to growth and poverty alleviation—within the available resource envelope. Directors welcomed the government's strengthened enforcement of budget procedures and plans to rebuild capacity in the budget process and expenditure control.

Directors noted that Malawi's economic program faces a number of risks. The steps now being taken by the government should help minimize the chances of near-term food shortages and enhance the prospects for macroeconomic stability. More will need to be done to lay a solid foundation for medium-term growth and sustainable poverty reduction. Directors, therefore, emphasized the importance of the evolving medium-term strategy and welcomed its emphasis on the private sector.

Directors agreed with the general conclusions reached by the Ex Post Assessment on the lessons from past Fund engagement and the guidelines for future Fund support. In particular, they noted that inadequate ownership and weak capacity were key factors behind the poor record of program implementation, and asked the staff, going forward, to take into account the concerns raised about program design and donor relations.

Directors were hopeful that the SMP will provide an opportunity for the authorities to demonstrate budget discipline and the ability to achieve targets under their economic program. Considering Malawi's need for balance of payments assistance, most Directors agreed that strong performance relative to the end-December targets in the SMP would be an important prerequisite for a new PRGF arrangement.