Tobacco crop in Chalenga, Malawi, where lower tobacco export earnings contributed to foreign exchange shortages in 2011 (photo: Antony Njuguna/Reuters)
ECONOMIC HEALTH CHECK
The loan, under a three-year Extended Credit Facility arrangement approved July 23, backs program objectives that include low inflation, increasing international reserves, and reforms to expand financial services and improve the investment climate in order to promote sustained inclusive growth.
In its regular review of Malawi’s economy, the IMF said recent policy measures implemented by the authorities will help boost export earnings and foreign assistance, slow down the growth of imports, and help the authorities build up international reserves to provide a buffer against external shocks. International reserves had fallen to precariously low levels by early 2012. After hovering around the equivalent of one month of imports during most of 2011, reserves fell to about half a month of imports by April 2012.
Malawi experienced a smooth transition to a new government following the sudden death of President Mutharika in April 2012. The new administration led by President Joyce Banda moved swiftly to address the country’s chronic foreign exchange problems that had resulted in severe shortages of critical imports, including fuel, inputs for production, and medicines.
The authorities devalued the kwacha, adopted a flexible exchange rate regime, and removed restrictions on foreign exchange transactions which had fostered the growth of a parallel market in foreign exchange. Concurrently, the authorities adjusted the prices of petroleum products and adopted an automatic adjustment mechanism to ensure that these prices reflect their true import costs, thus removing burdensome subsidies on the budget.
Malawi’s development partners have responded favorably to the new administration’s economic policies and repeal of laws that were seen as infringing on human rights and freedoms.
Poverty reduction goal
The new government has approved Malawi’s second Growth and Development Strategy which had been under preparation for some time. The strategy’s principal objective is poverty reduction through sustained growth and infrastructure development. The plan gives high priority to removing bottlenecks in energy and transport infrastructure that have been widely cited as impediments to investment and economic diversification in Malawi.
Foreign exchange problems intensified in Malawi last year due to reduced tobacco export earnings and cuts in external aid. Many donors reduced their financial support to the government budget when the authorities’ IMF-supported program went off track in the first half of 2011 and because of human rights and governance concerns. These problems contributed to a significant slowdown in growth.
After averaging 8 percent a year during 2007–10, real GDP growth fell to 4.3 percent in 2011. The recent policy changes have eased the private sector’s access to foreign exchange and substantially improved the prospects for a recovery in growth (see chart).
Wider budget deficit
The budget deficit widened significantly in the fiscal year to June 2012 , with most of the deficit being financed by borrowing from the Reserve Bank of Malawi. The resulting injection of money into the economy put pressure on the exchange rate in the parallel foreign exchange market and fueled inflation.
Inflation began to rise from early 2011, reflecting rising import costs and the fact that an increasing share of imported goods were being priced at the significantly depreciated parallel exchange rate. Following the devaluation in May and the increase in fuel prices, there was a spike in inflation: the year-on-year rate reached 20 percent in June. Fiscal and monetary policies are expected to put inflation back on a downward path by early 2013, while leaving room for increased growth and social spending.
Scale up social protection
In the 2012/13 budget, increased foreign assistance allows the government to scale up social protection programs to mitigate the impact of adjustment measures on the poor. These programs are intended to boost incomes of poor households through increased access to inputs or by paying them for public works aimed at building or maintaining community assets and infrastructure. Other social programs provide meals and bursaries to students.
Over the medium term, the program includes measures to enhance domestic revenue mobilization and reforms to strengthen the budget process and avoid the accumulation of arrears. In particular, the government intends to keep its spending plans within expected revenues and grants and in line with the priorities in the Malawi Growth and Development Strategy. The program also includes measures to expand financial services and to make the business environment more attractive to investors.
