For more information, see Malawi and the IMF

Malawi--Enhanced Structural Adjustment Facility
Policy Framework Paper, 1998/99-2000/01

I. Introduction
1. Malawi is a country characterized by widespread poverty: nominal per capita GDP is only US$220--less than half the sub-Saharan African average; income inequality is the highest in Africa; life expectancy, at 44 years, is 8 years less than the average for sub-Saharan Africa; the prevalence of HIV/AIDS and child mortality is among the highest in the region; less than half the population has access to safe water; and only two-fifths of the population is literate. A major source of the government's concern is that no appreciable progress has been made on the social indicators during the last 30 years.

2. Accordingly, Malawi's first democratically elected government, which took office in May 1994 during a period of major economic turmoil,1 pronounced its overarching objective to be the alleviation of poverty. Key to achieving this objective was the adoption of a set of prudent financial policies designed to restore and maintain macroeconomic stability. Complementary structural reforms were initiated to liberalize the economy and redirect public spending to priority areas such as health, education, and agriculture. It was believed that improved macroeconomic management, better infrastructure, and the increased role of market forces in resource allocation would induce the higher savings and investment needed to achieve the high growth rates required for lowering poverty.

3. Initially, implementation of such policies led to major successes in both macroeconomic management and structural reform. The overall fiscal deficit (excluding grants, commitment basis) declined from 28 percent of GDP in 1994/95 to 7 percent in 1996/97, inflation declined from 83 percent at end-1995 to under 7 percent at end-1996, and reserve cover increased to the equivalent of 3 months of imports of goods and nonfactor services by end-1996. At the same time, real GDP growth averaged 12 percent per annum in 1995-96, led by high agricultural growth, which was aided by favorable rainfall in that period, and the significant liberalization of production and marketing arrangements in the sector. The liberalization of agriculture brought the benefits of high growth accruing primarily to the smallholder farmers, most of whom belong to the poorest segment of the population. Other notable achievements in the area of structural reform included the introduction of free universal primary education, an initial round of civil service restructuring,2 and the passage of a well-conceived Privatization Act.


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II. Policy Implementation and Performance During 1997-98

4. The program for 1997-98 sought to consolidate the considerable gains of the previous two years. The principal macroeconomic objectives for 1997-98 were to (1) achieve a real GDP growth rate of 6 percent in 1997 and 5 percent in 1998; (2) contain the 12-month inflation rate at 12 percent during 1997 and 6 percent during 1998; and (3) further strengthen the external position by increasing the official reserve cover to the equivalent of a little more than four months of imports of goods and nonfactor services. Key to the attainment of the above targets was a reduction in the central government deficit (excluding grants) from 7 percent of GDP in 1996/97 (April-March) to less than 7 percent of GDP in 1997/98;3 meanwhile, budgetary allocations to the priority areas (education, health, agriculture, and infrastructure) would be increased. Furthermore, with the anticipation that the deficit would be financed entirely through donor support, this fiscal policy stance was expected to permit appropriate monetary restraint while accommodating adequate credit expansion for the private sector.

5. In the event, Malawi's Enhanced Structural Adjustment Facility (ESAF)-supported program went seriously off track, mainly owing to slippages in fiscal policy. During the fiscal year that ended in March 1998, total expenditure exceeded the program target by 4 percentage points of GDP while, primarily as a result of problems in income tax administration, there was a shortfall in total revenue of of 1 percentage point of GDP. Consequently, the overall budget deficit for 1997/98 reached about 11 percent of GDP, exceeding the program target by over 4 percentage points. The domestic primary balance also worsened substantially; instead of the position of approximate balance envisaged under the program, it widened to a deficit equivalent to about 4 percent of GDP. This deterioration contributed to a depreciation of the kwacha of almost 40 percent (in foreign currency terms) between July 1997 and March 1998, despite heavy intervention by the monetary authorities. As a result of these developments and a small maize harvest in 1997, the 12-month inflation rate rose from 6 percent at end-1996 to 20 percent by end-March 1998. Furthermore, largely because of the poor maize harvest, real GDP growth slowed to 5 percent in 1997, although economic activity continued to remain strong in the distribution, construction, and transport sectors.

6. In 1997, the pace of structural reform slowed markedly. In regard to the civil service, there was a notable delay in completing the functional reviews, streamlining government functions, and reorganizing staff positions. However, four ministries4 were eliminated in 1997, and the number of principal secretaries reduced by 12. Furthermore, the government retrenched only 3,194 nonestablished workers, well below the 7,000 envisaged under the program. Privatization of public enterprises was impeded by the exclusion, for the most part, of the divestiture of major entities and strategically important enterprises, such as the utilities and financial institutions, from the privatization program.

7. Faced with these difficulties, the government began in December 1997 to implement a set of corrective measures to regain control of the public finances, and, in April 1998, it adopted a six-month program that was monitored by the Fund staff. Under the program, the expenditure measures included across-the-board cuts in spending, strengthening of expenditure monitoring and control, and the appointment of a Special Cabinet Committee (SCC) on Budgetary Matters to help oversee the government's initiatives in these areas. These measures were supported by efforts to enhance revenue performance through the strengthening of tax administration and the collection of outstanding tax payments. Successful implementation of these policies resulted in the restoration of financial discipline and the achievement of a domestic primary surplus for the period April-September 1998 equivalent to 2 percent of (quarterly) GDP, compared with a program target of about 1 percent.

8. In addition, the government adopted a fiscal program for 1998/99 (July-June) that seeks to achieve approximate balance in the domestic primary budget position, compared with a deficit of 4 percent of GDP in 1997/98. The deficit of the recorded overall balance (excluding grants) would, however, increase to almost 15 percent of GDP.5 Achievement of these targets will require tax revenue to increase by about 2 percentage points of GDP over 1997/98; this increase would be driven by the pronounced impact of the depreciation of the kwacha on revenue deriving from the tradable goods sector and a broadening of the base for the surtax. Efforts to enhance tax revenue will also benefit from the Malawi Revenue Authority (MRA), which is expected to start operating in early 1999. At the same time, total expenditure is targeted to increase by almost 8 percentage points of GDP, reflecting mainly the inclusion in the budget for the first time of all off-budget, foreign-financed development expenditure. Moreover, allocations to the priority sectors in the 1998/99 budget have been protected from the general spending cuts. The revenue-enhancing and expenditure-control measures that the government adopted in the course of 1998 were instrumental in the achievement of the targets established under the staff-monitored program.

9. In the external sector, developments in 1998 reflect a major deterioration in the terms of trade, stemming from a decline in tobacco export prices of almost 20 percent from 1997 levels. To contain the impact of this shock, the Reserve Bank of Malawi (RBM) permitted the currency to depreciate by 40 percent (in foreign currency terms) during the month of August. This depreciation, the anticipated progress in fiscal consolidation, and the large inflows of donor assistance envisaged for the fourth quarter of the year are expected to raise international reserves to over three months of imports by end-1998. As a result of these developments, the 12-month inflation rate is targeted to be contained at 36 percent by end-1998, and real GDP is projected to grow by about 3 percent during the year.

10. Significant efforts have been made since early 1998 to accelerate the process of structural reform. The government undertook a major reform of budgeting procedures through an extension of the medium-term expenditure framework (MTEF) to all ministries. Moreover, an additional three ministries were eliminated in 1998,6 a detailed functional review of seven ministries was completed in October 1998,7 and a timetable for the implementation of the recommendations resulting from this exercise was prepared. In addition, the privatization program is being deepened with the preparation of a list of 20 enterprises for privatization, of which at least 15 will be brought to the point of sale by end-March 1999. Furthermore, plans for the divestiture of the assets held by the Malawi Development Corporation (MDC), the Agricultural Development and Marketing Corporation (ADMARC), and ADMARC Investment Holdings are being readied, and determined efforts are being made to complete the preparations necessary to increase private sector participation in the power and telecommunications sectors, and to finalize the concessioning of Malawi Railways. Moreover, the government has simplified considerably the processing of employment permit applications from non residents; decisions on such applications are now taken within 40 working days.


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III. Medium-term Policy Framework

11. The government's medium-term development strategy seeks to alleviate poverty through accelerated growth, restoration of financial stability, and increased access to basic social services. Consistent with this strategy, the government will seek to achieve an average annual real GDP growth of 5 percent through strong agricultural expansion and continued efforts to raise investment. As the subsistence economy--which accounts for some one-fourth of overall output in Malawi--becomes increasingly commercialized, and with further improvements in the infrastructure and marketing arrangements, smallholder output is expected to increase substantially over the medium term, contributing thereby to the reduction of rural poverty. At the same time, gross investment (as a ratio to GDP) will need to average about 19 percent of GDP, with private investment increasing by 1 percentage point of GDP over the period 1999-2001. Most of the increase in investment is expected to take place in the private sector, notably in agro-processing and light manufacturing industries.

12. To finance the targeted levels of investment, both public and private savings rates will need to increase significantly over the medium term. To this end, the efforts to restore financial stability and the timely implementation of structural reforms aimed at increasing investment opportunities for the private sector will be key. Accordingly, the medium-term strategy emphasizes reforms aimed at improving utility services, strengthening market competition in the agricultural and financial sectors, liberalizing further external trade, continuing to pursue the transparent privatization of state assets, and reforming the civil service with a view to enhancing its efficiency and effectiveness.

13. Since poverty in Malawi manifests itself not only in the low per capita GDP, but also in extreme inequality and limited access by a large part of its population to basic social amenities, the government will undertake initiatives to expand and consolidate primary health care services, and to increase opportunities for education. In addition, the government has instituted a Poverty Alleviation Program (PAP) which provides for targeted interventions to benefit the poor, while developing well-focused safety nets to address the needs of the vulnerable groups.

A. Macroeconomic Policies

14. Consistent with the strategy laid out above, the government's medium-term macroeconomic policies seek to achieve the following objectives: (1) attain an average real GDP growth rate of 5 percent over the period 1999-2001; (2) lower the 12-month inflation rate to 7 percent by end-1999, and the average inflation rate to 5 percent by 2001; and (3) strengthen the balance of payments, leading to an increase in the gross official international reserves to the equivalent of about 4 months of goods and nonfactor services by end-1999. Key to achieving these objectives will be the government's fiscal policy, which targets a reduction of the overall budget deficit (excluding grants) from 14 percent of GDP in 1998/99 to 12 percent in 2000/01, while improving further the prioritization of budgetary expenditures.

15. The targeted strengthening of the underlying budgetary position will be facilitated by increased revenue mobilization through improvements in tax administration and the establishment of the MRA in early 1999. Accordingly, tax revenue is expected to increase to an average of 15 percent of GDP over the period 1998/99-2000/01, about 1 percentage points of GDP higher than in 1997/98. The increase in tax collections will be associated with increased reliance on domestic taxes as Malawi continues to lower trade-related taxes. In the area of expenditures, the government will target a lowering of the level of current outlays by about 4 percentage points of GDP over the three-year period ending in June 2001, meanwhile, it will undertake sustained efforts, in the context of the MTEF exercise, to raise the share of recurrent spending allocated to the priority areas, notably health, education, agriculture, and maintenance of infrastructure.

16. Concerning the prioritization of expenditures, the government aims to achieve significant progress in the implementation of the MTEF process. In this connection, it will prepare three-year rolling budget estimates, starting in 1999/2000, that encompass current and development expenditure. In particular, the government will undertake an audit and review of the development budget to establish the quality of such expenditures, their consistency with overall sectoral targets, and their implications for medium-term recurrent expenditures. The preparation of budget estimates will be based on a detailed costing of programs, using cost coefficients, and it will permit allocations at the sub-sectoral level that will be closely geared to the targeted sectoral outputs. In preparing the estimates, the government will also set indicative three-year spending ceilings for each sector in the MTEF for 1998/99-2000/01. Finally, the government will continue to strengthen the existing arrangements for expenditure monitoring and control.

17. Over the medium term, monetary policy will be aimed broadly at achieving the government's inflation objective. The government will also seek to ensure that the stance of monetary policy is consistent with the overall growth and balance of payments objectives, in particular the need to accommodate the credit requirements of the private sector. The net domestic assets of the monetary authorities are expected to decline steadily, with an improvement in the government's net creditor position resulting largely from the programmed improvement in the government accounts. The maintenance of low inflation should also contribute to a lowering of nominal and real interest rates.

18. The external current account deficit (excluding official transfers) is targeted to decline from 19 percent of GDP in 1998 to just over 14 percent in 2001. It is expected that inflows of official assistance and private capital will be sufficient to finance these deficits, as well as to permit an increase in the level of gross official international reserves to the equivalent of approximately 4 months of imports of goods and nonfactor services, starting at end-1999. To facilitate achievement of these targets, the government will maintain a market-determined exchange rate system, and intervention by the Reserve Bank of Malawi will be guided by the international reserve targets.

19. The government's program of trade liberalization will be continued over the medium term. To this end, Malawi will fulfill its remaining obligations under the Cross-Border Initiative by further lowering the maximum import tariff rate from 30 percent to 25 percent in the context of the 1999/2000 budget. The government will also engage its major trading partners to ensure that there is full reciprocity in tariff reductions in accordance with the various bilateral and multilateral trade agreements. As regards quantitative restrictions, the policy of not requiring export and import licenses (except for health, security, and environmental reasons) will remain in place.

B. Medium-term Sectoral Policies

Agriculture

20. The government continues to view structural reform in the agricultural sector, which generates about 40 percent of Malawi's GDP and is the largest employer, as a central element in its medium-term strategy. Although the sector has diversified considerably in recent years, with increased opportunities for the private sector, especially the smallholders, the government retains an important presence in the sector; it is the largest trader in maize and--through various organizations--owns the bulk of the permanent storage facilities that could be used for commodities or inputs trade.

21. Accordingly, the government's strategy to further enhance the role of the private sector in agriculture rests crucially on the accelerated divestiture of its assets. To this end, the government will prepare a time-bound program for the commercialization and privatization of ADMARC by end-March 1999, and begin implementing the process shortly thereafter. Beginning with the 1999/2000 crop season, the government will no longer be involved in direct procurement, import, or sale of maize, and ADMARC will operate on purely commercial terms. In addition, to encourage private trade in agriculture, the government has decided to replace the Strategic Grain Reserve (SGR) with an autonomous National Food Reserve Agency (NFRA), which will operate under clearly defined rules. In particular, the government will ensure that the disposal of maize by the NFRA will be guided by the maize price band;8 sales of maize through tenders will take place only when the market price rises above the import parity level. In other areas, the government will privatize or otherwise restructure the ownership and management of the Malawi Rural Finance Company (MRFC) in 1999, and privatize or close several smallholder crop authorities. In addition, the Fertilizer Buffer Stock will be drawn down in stages to 20,000 tons by October 1999. In this context, the government is concerned about the need to stimulate fertilizer use among farmers, and to this end it has established a task force, with the participation of private traders, transport companies, and the railways, to study possible options to lower the price of fertilizer imports.

22. The government is also committed to intensifying its efforts to tackle long-term structural constraints facing the agricultural sector and the farming community. It recognizes the major challenges and opportunities they are facing with respect to improving soil fertility, increasing land and water use efficiency, strengthening farmer and rural community organizations, and strengthening safety nets to enhance the food security of extremely poor rural households. A precondition for satisfactory progress in these areas is the prompt inclusion of these activities in the prioritization of expenditures of the Ministry of Agriculture, as well as the conclusion of the ministry's annual work plan. The government will also need to take steps in the area of land reform following the issuance of the report of the Presidential Commission of Inquiry on Land Policy Reform in March 1999. In addition, the government is promoting several soil fertility initiatives, including the dissemination of legume seeds, the improvement of land husbandry, and diversification of crops. It is likely that the encouraging results arising from some pilot projects undertaken with village-level participation will lead to a gradual expansion of this strategy to other regions of the country.

Private sector development

23. The government's medium-term strategy also calls for rapid growth of the private sector in nonagricultural activities, which will have to supplement agriculture as the engine of growth in the economy. This approach will require dismantling the existing structure of ownership in the formal sector so as to subject it to the discipline of competition. At present, the formal sector is dominated by a handful of large enterprises, both financial and nonfinancial, with interlocked interests resulting from a significant ownership of these enterprises by large parastatals, such as ADMARC Holdings and the MDC, as well as by the government itself. The authorities intend to address this problem by divesting of the government's and the parastatals' assets in the formal sector of the economy. By 2003, all the assets of the MDC and ADMARC Holdings, as well as all of the government's holdings will be privatized. At the same time, an ongoing study is investigating the merits of various options for the future operations of Press Holdings, including its partial or complete restructuring and divestiture.

24. The government owns about 70 percent of the assets in the financial sector directly or indirectly, through its ownership of public holding companies such as ADMARC Holdings and the MDC. The two dominant banks control 90 percent of all banking assets. The level of efficiency in the sector is low, and interest rate spreads are large, partly because of the limited degree of competition. The privatization of these two banks is expected to remove a major impediment to attracting foreign banks, and thus also to improving the quality of financial services in Malawi. To ensure a uniform regulatory framework before undertaking the major privatization initiatives in the financial sector, the prudential regulatory framework will be reviewed by the end of June 1999; in addition, the government will determine the mode of privatization (sale of shares versus strategic partner) by the end of March 1999. To this end, consultants will be appointed by December 1998 and will complete their report by end-March 1999. Furthermore, as mentioned in paragraph 21, the MRFC is scheduled to be privatized in 1999. The Malawi Savings Bank (MSB) has been registered under the Companies Act. When the MSB's accounts are fully separated from those of the Malawi Post and Telecommunications Corporation (MPTC), its tax-exempt status will be reviewed.

Infrastructure

25. The absence of adequate infrastructure in Malawi remains a major bottleneck for growth in agriculture and industry. Transport costs in Malawi are among the highest in the region, by some estimates almost 2-3 times higher than those prevailing in South Africa and Zimbabwe. The poor state of telecommunications in Malawi is characterized by a telephone penetration rate that is just 60 percent of the average for sub-Saharan Africa, with waiting periods for a telephone reaching as high as ten years. Finally, in the power sector, the inability of the Electricity Supply Corporation of Malawi (ESCOM) to provide reliable power services results in substantial losses to industry.

Transport

26. To lower transport costs, the government will direct its attention to improving the quality of roads and railway services in the country. In the roads sector, the central element of the government's strategy is a significant increase in the budgetary resources devoted to the sector, supplemented by the imposition of user charges. To ensure efficient utilization of the resources, which will be channeled through the Road Fund, a National Roads Authority has been established to administer this fund and advise the government on policies and programs in this area. In addition, efforts in this direction will be supplemented by a major donor-funded investment program over the period 1998/99-2002/03 to address the acute maintenance and rehabilitation backlog in the sector. The government also intends to increase private sector participation in the roads sector. As regards railway and lake services, the government's strategy is essentially to improve efficiency through the privatization of Malawi Railways and Malawi Lake Services. Accordingly, these entities have been restructured, and their concessioning is expected to be completed by December 1998 and June 1999, respectively.

27. The Petroleum Control Commission (PCC) governs the import, distribution and pricing of petroleum. Set up in 1984 to ensure security of supply, the PCC has a monopoly on petroleum imports. Purchasing is done through international tender, and Malawi's high fuel prices are due partly to high costs incurred along the import chain. In order to foster competition and reduce such costs, the government intends to permit free entry into fuel importation by March 1999. An ongoing study (the Petroleum Supply Study) is evaluating the institutional arrangements and the legal framework of the PCC and will present its findings by December 1998. In the meantime, the government intends to revise the pricing structure so as to ensure full pass-through of import price and exchange rate adjustments to domestic prices.

Telecommunications

28. In the telecommunications sector, the government has adopted the ambitious targets of more than doubling the telephone penetration rate by 2000 and more than trebling the current rate by the year 2003. These goals will be achieved through increased private sector participation in the sector. Notable features of the government's strategy, which has been formally adopted as the new National Communications Policy and is being discussed in parliament, include decisions to award a second cellular license to a private operator by end-March 1999, to license both cellular operators in a way that will ensure fair competition between them in the marketplace, and to make the terms of the license public. Also by March 1999, the government will appoint appropriately qualified advisors to secure a strategic partner for Malawi Telecom and it will offer a share in the firm to that partner by end-June 2000.

Energy

29. In the power sector, the Electricity Act of 1998 lays the groundwork for initiating private investment in power generation, transmission and distribution. A new regulator, the Electricity Council, started operating in October 1998, providing the basis for fair competition between ESCOM and other private operators. To facilitate the attainment of this objective, the government has registered ESCOM as a corporate entity under the Companies Act. In order to make ESCOM financially viable, the government raised ESCOM's tariffs by 35 percent on November 1, 1998. The government has restructured ESCOM's debt, and has completed a plan to divide it into seven semiautonomous functional units to improve efficiency. Finally, the government is pursuing several alternative sources of energy, including interconnection with Cahora Bassa in Mozambique.

Social sector policies

Education

30. In the education sector, the sharp increase in primary enrollment rates since 1994/95--when the government eliminated fees on primary education--has led to a rise in the student-teacher ratio, and a concomitant decline in the quality of education.9 At the same time, the capacity in secondary schools has remained extremely low, and there is a dearth of nonformal education facilities for out-of-school youth and illiterate adults. Faced with these multiple requirements, the government is aware of the need to develop a clear prioritization of tasks within a consistent sector policy. Accordingly, by end-March 1999 it will update the investment framework originally prepared for the sector in 1995 and integrate this framework into the MTEF. In this regard, the government has designated education as a priority area and thus aims to raise the quality of education; to this end, it will continue its policy of ensuring adequate funding for instructional materials, providing infrastructure, and establishing a medium-term program for teacher development. In the area of secondary education, the government has commissioned a study to review tuition fees, and is in the process of building 31 more schools by 2003. It is also reviewing the management of distance secondary education, with a view to improving the quality of delivery. Finally, the government recognizes the role of the private sector in the delivery of primary and secondary education, and is developing a mechanism to regulate the management of private institutions.

Health and population

31. In view of the many health-related requirements, the government plans to complete by April 1999 a comprehensive Health Strategy and Investment Framework, which will be integrated into the MTEF. The strategy will emphasize primary health care services through the implementation of a cost-effective essential health package (EHP), including an expanded program of immunization, reproductive health, and nutrition. Furthermore, to raise the effectiveness of the EHP, the government plans to ensure an adequate supply of drugs by establishing community-run Revolving Drug Funds aimed at providing coverage to the 20 percent of the population without access to health facilities. About 1,120 such funds (about 40 percent of the total) will be operational by December 2000. These funds will help in guaranteeing continuity of drug supply, thereby enabling communities to deal with common diseases in their areas. To ensure the durability of these funds, fees will be charged according to family income. As regards funding, the health sector has been accorded priority status, although it is anticipated that budgetary allocations will not be able to fully satisfy the cost of the envisaged programs. Accordingly, the government will (1) introduce a graduated cost recovery system starting with the specialist referral hospitals and district facilities; (2) ensure payment by patients in private hospital wards; and (3) revise regularly the fee schedule for patients in private rooms to gradually achieve full cost recovery.

32. The incidence of HIV/AIDS in Malawi, which is among the highest in sub-Saharan Africa, has reduced life expectancy from 52 to 44 years. Thirteen percent of those aged between 15-45 years in 1997 were HIV positive. To address this problem, the government will intensify AIDS education as a part of the EHP, so as to slow the growth of infection rates through changes in behavior.

33. The objectives of the government's Population Policy, adopted in 1994, are to reduce fertility rates from 6.7 to 5.0 by 2002 by improving the contraceptive prevalence rate and reducing female illiteracy. With its population/family planning initiatives, the government will seek to increase the contraceptive prevalence rate from 18 percent to 28 percent by 2002, through increased knowledge and improved attitudes toward family planning. At the same time, the need for population planning will be met through targeted information and education campaigns. The success of such campaigns is inversely and critically linked to the level of female illiteracy (currently 69 percent), which the government is committed to lowering through its efforts in the education sector, notably by continuing its policy of charging zero fees at the primary level (see paragraph 30). These efforts are also supported by the government's explicit recognition of the central role of women in the socioeconomic development of the country, and its efforts to develop and implement, through the Ministry of Women, Youth, and Community Services, the first Women in Development (WID) Policy and plan of action. The WID policy is being replaced by a more comprehensive National Gender Policy, and the responsibility to advocate and lobby for women's issues has been transferred to the National Commission on Women in Development.

Water

34. In the water sector, despite Malawi's abundant resources, only 47 percent of urban households have access to clean water. The situation in rural areas is worse still. To reduce the dependence of the population on rainfall and unprotected wells, the government will continue to take measures to rehabilitate and construct groundwater basal systems and protect dams and reservoirs. Furthermore, to augment the supply of clean water, the government is implementing a national water development project totaling US$94 million and is also engaged in a nationwide initiative to construct boreholes. As a result of these initiatives, the government anticipates that 67 percent of all households will have access to clean water by 2001. Moreover, the government intends to raise the share of community-based management of the rural water supply to 75 percent by end-2001 from its current level of under 30 percent. To this end, it will decentralize rural water provision by contracting out drilling and construction, by having private agencies assist in training communities to assume responsibility for water, and by enabling local communities to contract construction work with private operators. In the urban areas, provision of water services has been decentralized through the creation of three commercially oriented regional water boards (see further details in the policy matrix). The government will seek to ensure their financial viability through the establishment of appropriate tariffs.

Poverty reduction and safety nets

35. The government will continue to address its need for targeted interventions and safety nets through initiatives under the PAP on several fronts. Particularly important among these is the implementation of the Malawi Social Action Fund (MASAF) project, a quick-disbursing instrument that supports developmental initiatives at the grassroots level. This project, which has been financing community-based social and economic infrastructure projects such as schools, rural health clinics, and safe water supplies, also has a labor-intensive public works program in the poorest rural areas, which is designed to be a pilot safety net project. Over the period 1996-98, MASAF I disbursed US$24 million for over 988 projects, and a continuation project (MASAF II) is expected to disburse another US$55 million over the period 1998-2002. The government is also aware of the need to develop a sustainable safety net strategy, and to this end it is embarking on a joint exercise with donors and local partners to review the options in light of their affordability, their impact on welfare, and the minimization of distortions. In this regard, the government also intends to introduce an expanded public works program during 1999. Other notable initiatives to provide targeted assistance include food-for-work programs, the distribution of "starter packs" of fertilizer and maize seeds during the 1998/99 agricultural season to needy farm households, and the economic empowerment of the poor through the continued provision of credit facilities to acquire inputs and set up small businesses. Finally, to enable better targeting of its initiatives, the government has set up a Poverty Monitoring System to monitor and evaluate the impact of policies on ameliorating poverty within the targeted socioeconomic groups.

Environment

36. In adopting the National Environment Policy (NEP) in 1996 and passing the Environmental Management Act in June 1996, Malawi indicated its concern for environmental management. The government has been implementing the NEP program, and in the next three years it plans to take the following key steps: (1) implement the regulations, established in 1997, guiding the use of environmental impact assessment for certain categories of private and public investments; (2) adoption of policies according to which local communities will share in revenues from the comanagement of natural resources; (3) periodically adjust tariffs charged by the water boards to maintain the economic pricing of water; (4) more strictly enforce estate conservation and afforestation covenants; (5) strengthen the regulation of industrial pollution; and (6) continue support for investment by sectoral ministries and local communities to address priority environmental issues.

The civil service, local government, and governance

37. Fulfilling the government's wide macroeconomic and sectoral agenda will require an efficient and well-motivated civil service to implement the required policies; hence, an increase in civil service salaries and a decompression of the wage structure are called for. Accommodating these requirements within tight expenditure ceilings will necessitate a comprehensive rationalization of the civil service, in line with the established priorities. To achieve this objective, the government carried out a strategic review and is carrying out a detailed functional review of all ministries; the recommendations of the reviews are being implemented in the four large ministries where the reviews have been completed. In this regard, the government has eliminated seven ministries, and will complete the rationalization of the civil service establishment by December 1999. The first part of this rationalization will entail, by end-March 1999, the elimination, privatization, or outsourcing of 30 functions that were identified during the functional reviews.

38. The government is pursuing the objective of decentralization with a view to giving local communities more control over their resources. This process should lead to a better allocation of public resources, as well as a more democratic, responsive, and accountable government. At the same time, the government also recognizes the need to strengthen local government in Malawi, which suffers from a proliferation of institutions with unclear and overlapping mandates, a weak resource base (exacerbated by insufficient and unreliable transfers from the central government), lack of financial management capacity, and weak human resources. Accordingly, the government is continuing to provide training for staff in the Ministry of Local Government and in urban and district councils, and to provide finance for infrastructural investments and maintenance equipment for the councils. The government is examining the recommendations of a recent study of the fiscal implications of decentralization. The study proposes a framework within which decentralization will be compatible with macroeconomic stability and the service delivery needs of the local authorities will be addressed. In this regard, the government plans to hold local government elections in 1999 and to delegate responsibility for taxing and spending to local governments. To increase the autonomy of local councils, revisions to the 1965 Local Government (Urban Areas) Act and the Local Government (District Councils) Act have been proposed, and enactment of the revised legislation is expected by the end of January 1999.

39. Concerning governance, the President of Malawi has requested the support of the World Bank in attacking the problem of corruption. An Anti-Corruption Bureau has been set up. A study on the reform of procurement procedures was completed in 1997 and awaits the government's decisions on the recommendations. Implementation of the civil service reforms, including the restructuring of performance incentives, will also be an important element in the drive against corruption.

C. External Financing Requirements

40. A detailed analysis of Malawi's medium-term balance of payments prospects has been prepared and assessed in the context of an updated debt sustainability exercise. The baseline projections suggest that, the servicing of the external debt, which is owed mostly to multilateral creditors, will remain onerous. The analysis also shows that Malawi's balance of payments projections are sensitive to the impact of adverse weather on export volume and maize imports, fluctuations in the terms of trade, the concessionality of contracted loans, and changes in the level and timeliness of international financial assistance. The government is determined to examine with Malawi's international partners practical ways of alleviating the onerous external debt servicing problem.

41. Over the period through end-March 2001, it is expected that the current account deficit (excluding official transfers) will decline from the current level by about 5 percentage points of GDP to nearly 14 percent. This development together with the need to raise gross official international reserves to the equivalent of about 4 months of imports of goods and nonfactor services starting at end-1999, implies that Malawi's external financing requirements during 1998-2001 will amount to US$1,602 million (see attached Table 2). This amount is expected to be covered in part by official transfers of US$575 million (including US$316 million already committed for 1998-99), and US$746 million in loans. Of the anticipated financing over the period, about 47 percent is expected to consist of budgetary/balance of payments support, including Fund assistance under ESAF arrangements. For 1998-99, Malawi's external financing requirement is estimated to be US$911 million, and is expected to be covered in large measure by grants of US$316 million, balance of payments loans of US$215 million, and project loans of US$163 million. The balance of payments loans primarily comprise of US$133 million from the World Bank, US$50 million from Japan, US$32 million from the AfDB, and the anticipated support from the Fund in the context of the ESAF arrangement. The major sources of grant aid are expected to be US$74 million from the UK, US$37 million from the European Union, and US$34 million from the USAID.



1During the period 1992-94, Malawi experienced two severe droughts, a breakdown in tax administration and expenditure control, a major terms of trade shock, a suspension of all donor assistance, a significant depreciation of the kwacha, and a sharp upturn in inflation.
2In excess of 20,000 nonestablished workers were retrenched ahead of schedule in 1995.
3As the national accounts data have been revised recently, the program targets are presented in relation to the revised GDP.
4Physical Planning and Surveys; Relief and Rehabilitation; Youth Sports and Culture; and, Housing.
5The domestic primary budget position is defined as budget revenue less total expenditure, excluding interest payments and externally financed development expenditure.
6Energy and Mining; Local Government; and National Heritage.
7These seven ministries together represent about three-fourths of the civil service.
8The lower and upper ends of the price band will be based on export and import parity prices, respectively.
9The hiring of some 22,000 untrained teachers in 1994-95 led to a decline in the pupil-teacher ratio from 72:1 to the still very high level of 60:1.

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