Mission Concluding Statement 

Malawi -- 2002 Article IV Consultation, Concluding Statement of the IMF Mission

May 14, 2002

Malawi—2002 Article IV Consultation

Concluding Statement of the IMF Mission

May 14, 2002

1. In December 2000, the IMF Executive Board concluded the 2000 Article IV consultation, approved a three-year Poverty Reduction and Growth Facility (PRGF) arrangement and a decision point under the enhanced HIPC Initiative, and endorsed Malawi's interim poverty reduction strategy paper. Since then, IMF staff and the authorities have maintained a close dialogue, including by several visits of IMF staff to discuss the implementation of economic and financial policies. This year's Article IV consultation discussions focused in particular on fiscal policies, including expenditure management and the repeated and large recourse to budgetary funds by parastatals.

Background

2. Malawi is one of the poorest countries in the world with about half of the population living below the poverty line. Poverty in Malawi is widespread, growth has been low and its benefits unequally distributed. Most social indicators are worse than the average for sub-Saharan African. Hunger is common during the growing season of the basic crop, maize, and sporadic droughts and floods in some parts of the country compound food insecurity.

3. Malawi's current food situation is serious and large shortages are expected for later in the year. Urgent action is needed to prevent starvation and the authorities together with the international donor community are fleshing out an appropriate response. First and foremost, the estimate of the food deficit during the 2002/03 growing season will have to be firmed up quickly to ensure that sufficient food will arrive on time. Government interventions in the past may have contributed to the current crisis by eroding incentives for producing food. Therefore, appropriate delivery mechanisms are critical so as to not depress food production in the coming years.

4. As in other Southern African countries, the HIV/AIDS epidemic has reached crisis proportions in Malawi and is undermining its development efforts. At end-1999, the adult prevalence rate of HIV/AIDS was about 16 percent, making Malawi one of the worst affected countries in the world. As noted in the Malawi Poverty Reduction Strategy Paper (MPRSP), HIV/AIDS is not only a health issue; it also erodes growth by increasing the morbidity and mortality of the working age population. Estimates suggest that between 2000-2010, HIV/AIDS will reduce GDP growth by 1½ to 2 percentage points and growth of per capita GDP by 1 to 1½ percentage points per annum.

5. While Malawi now needs to address the impending food crisis to protect the poor, in the medium term, higher and sustainable economic growth is required to make a sizable dent in poverty. The MPRSP recognizes restoring and consolidating macroeconomic stability as the foundation for moving onto a higher growth path to create a conducive environment for entrepreneurial activity, in particular in the critical agricultural sector. However, to accelerate growth, also structural obstacles to private sector development will have to be tackled, including by reducing the high level of government intervention in the economy through parastatals; strengthening human resource development; and improving governance.

6. Over the medium term, the IMF mission would expect an increase in private savings and investment from removing obstacles to growth—boosting growth to over 5 percent. The recovery would come initially from a reduction in real interest rates and a rebounding of private sector credit. It would be further bolstered by the privatization of public utilities and the expected substantial expansion and improvement in the reliability of services. At the same time, the government would render its service provision more efficient, including by overhauling the wage policy for the civil service, and making its operations more transparent through improved public procurement procedures and expenditure control. This, together with visible progress in concluding high profile corruption cases, would renew the public's confidence in the public sector and reduce the cost of doing business. We would expect Malawi to further augment growth toward the end of this decade by reaping the benefits from its investment in human capital. However, Malawi's high prevalence rate of HIV/AIDS with the incidence concentrated among better-educated and professional workers will continue to depress its growth rate, in particular since it directly affects teachers, health, and agricultural extension workers who are at the core of implementing the MPRSP.

7. The MPRSP identifies the agricultural sector as the engine of the government's growth strategy. Broad-based growth would address the dual objectives of food security and income enhancement for the poor. While restoring macroeconomic stability is a sine-qua-non condition, agricultural growth in Malawi will have to come from the three key sources already identified in the mid-1990s: generating higher rural income growth through increased utilization of land; intensifying agricultural production; and shifting to higher value outputs. To tap these sources of growth, farmers must gain access to improved public services, lower cost inputs (particular fertilizers and seeds), expanded markets, and rural finance. The government's agricultural policy should be reviewed and geared towards achieving these objectives.

Recent developments

8. Growth, however, continues to remain depressed due to a stagnation in agricultural production and weak private sector activity. Overall, real output is likely to have been negative in 2001 and the mission projects growth below 2 percent for 2002.

9. To stimulate private sector development, the thrust of Malawi's macroeconomic stabilization program guided by the MPRSP process was to reduce inflation through prudent fiscal and monetary policies so as to bring down interest rates. The monetary stance was to be held tight to bring down inflation while fiscal policy was designed to contain domestic demand pressures to avoid a loss in external competitiveness. The expenditure envelope was to accommodate additional pro-poor spending from the enhanced HIPC Initiative, which were identified in the MPRSP, while simultaneously cutting nonpriority spending such as travel and representation. This was to be accompanied by parastatal reform, improvements in expenditure control and enhanced governance.

10. The disinflation program has been successful, as the Reserve Bank of Malawi (RBM) has maintained a tight monetary policy. Core inflation excluding maize and administered prices has declined from 40 percent in December 2000 to 8 percent in March 2002. Headline inflation fell from 35 percent to 18 percent over the same period.

11. However, the macroeconomic strategy was derailed as the implementation of fiscal policies was marred by a lack of spending discipline by government and premature changes in revenue policy. Government borrowing has resulted in high real interest rates of almost 50 percent, crowding out credit to the private sector. Large budgetary resources were diverted to bailing out parastatals—some of which incurred losses due to past government instructions to intervene in the market. Also excessive spending on low priority activities such as internal and external travel and weak spending discipline contributed to the fiscal slippages. The situation was further exacerbated when the authorities' expectation that an increase in nontax revenue would offset the loss from a reduction in income tax rates did not materialize and revenue collections weakened due to a decline in the profitability of firms and sluggish import-related taxes.

12. Structural reforms have gained momentum only recently when the increasing demands on budgetary resources from parastatals heightened the awareness of the need for action.

The Way Forward

13. The prolonged period of government borrowing and its effect on interest rates have not only depressed growth, but also increased domestic debt rapidly. Only a renewed strong commitment by government to fiscal discipline can restore confidence of the public in economic policies. We are encouraged that nonessential expenditure in the remainder of this fiscal year is being trimmed down and that government intends to submit to parliament a budget aimed at achieving significant adjustment. This will halt the increase in domestic debt, reduce interest rates and make the needed room for private sector development. We also fully support the authorities' intention to increase with the 2002/03 budget spending benefiting the poor such as on primary education, health, including the prevention and treatment of HIV/AIDS, and agricultural extension services.

14. The turnaround in fiscal policy will require a substantial reduction in nonpriority spending, reversing the expansion of the last two years, while protecting and increasing pro-poor programs. The mission urges the authorities to stay within their financial envelope for 2002/03 to avoid further crowding out of the private sector. This will require clear prioritization of expenditure in the spirit of the MPRSP, imply cuts in nonessential spending, and also entail measures to increase revenue. However, any emergency funds needed to alleviate the impending food crisis will need to be made available by the budget without any offsetting.

15. The turnaround in policies will have to be supported by enhancing discipline through strengthened expenditure management. We urge the authorities to present the 2002/03 budget in a format that clearly identifies pro-poor spending. At the same time, a tracking system for such expenditure will need to be fully operational by July 2002 to enable the MPRSP stakeholders to monitor budget implementation in this area and thus hold the government accountable in implementing the MPRSP.

16. However, the parastatal sector will continue to pose risks to the successful implementation of the 2002/03 budget. Government interventions in the food and other agricultural markets ultimately led to the National Food Reserve Agency (NFRA) and the Agricultural Development and Marketing Corporation (ADMARC) taking heavy recourse to budgetary financing, crowding out more productive spending. We are encouraged that the authorities are reviewing their food policy and strongly advise them to quantify and recognize any costs which have to be covered by the budget. While the Public Enterprise Reform and Monitoring Unit (PERMU) has started to monitor the performance of parastatals, there is still the expectation that government should be held responsible for nonperforming parastatals and the budget might have to pick up the losses of other parastatals which have not been operating under hard budget constraints. We encourage the authorities to increase transparency by clearly budgeting any subsidies to parastatals and, in the case of liquidations, consider alleviating the social impact of retrenchment.

17. The mission commends the RBM for its conduct of monetary and exchange rate policies and encourages it to step up financial sector reform. The RBM should continue its tight monetary policy to further reduce core inflation to 5 percent at end-2002. With the privatization of a major bank at end-2001 and a number of new banks having entered the market, the mission welcomes the RBM's intention to overhaul the financial sector regulatory framework.

18. The government has made good progress in liberalizing the trade regime while simultaneously meeting its commitments to regional trade arrangements. Recently import licenses and import bans were introduced on selected products in response to complaints by domestic producers about unfair practices of trading partners. We strongly encourage the authorities to remove, as planned, the remaining quantitative restrictions in July 2002. We welcome the government's decision to further liberalize the tobacco market. The government's strategy in tobacco marketing should be guided by increasing returns to smallholder farmers.

19. Lack of good governance has resulted in a misallocation of resources, increased the cost of doing business, created a general distrust in public sector activities, and weakened civil service morale. There is a need to recognize that corruption and weak governance in tandem with bad policies make financial aid ineffective, even counter-productive. Thus, we support the authorities' efforts to strengthen the legal framework and the institutions that combat corruption, mismanagement and fraud, and encourage them to swiftly bring to closure high profile corruption cases.

20. Malawi will have to engage in an overhaul of its economic databases. In particular, the failure of the information systems for crop estimates had tragic dimensions. Thus, we urge the authorities to improve their agricultural data as soon as possible. Moreover, statistics on national accounts, trade and fiscal data are very weak and hamper economic analyses.