## _cr06445

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### PRGF arrangement and program status
- PRGF arrangement: SDR 38.2 million (55 percent of quota) approved August 5, 2005; SDR 10.3 million disbursed.
- Outstanding Fund purchases and loans at end-May: SDR 53.8 million (78 percent of quota).
- All quantitative end-December 2005 performance criteria met; end-December 2005 indicative target on reserve money met.
- Structural performance criterion (budget ceiling module) partially implemented; structural performance criterion for end-March 2006 (travel policy) not fully met—authorities request waivers.
- Malawi requests third disbursement under PRGF: SDR 4.9 million.
- Economic developments and 2006/07 authorities’ program described in Supplement to the MEFP.

### Executive summary — macroeconomic outcomes (2005/06)
- Growth and inflation:
  - Real GDP growth expected: 5.3 percent.
  - Overall 12-month inflation fell from a peak of 17 percent in February 2006 to 15.3 percent at end-June 2006; nonfood inflation contained.
- Debt and fiscal performance:
  - Domestic debt likely fell to 20 percent of GDP.
  - End-December 2005 indicative target on discretionary government spending missed due to additional food-crisis spending.
  - Two fiscal structural benchmarks (publishing budget and arrears reports) met with delay.
- Complications in second half 2005/06:
  - Deeper-than-expected food security crisis, foreign exchange shortages and import arrears, disruptions to tobacco auctions, payroll overcompensation, RBM liquidity management after LRR reduction.

### Ensuring food security — fiscal impact and response
- Extent and costs:
  - Food crisis made about half the population vulnerable.
  - Budgetary expenditures on food and fertilizer subsidies exceeded first-review plans by MK4.5 billion (1.7 percent of GDP).
  - Donor funds and higher maize sales covered about three-quarters of additional spending; net budget cost ~MK0.9 billion.
- Outcomes:
  - 2006 bumper maize crop ended the food crisis; maize prices began falling toward seasonal norms.

### External sector, exchange rate policy, and arrears
- Prior policy and problems:
  - Early 2005/06 informal administrative procedures fixed the exchange rate, pressuring external reserves and creating unpaid import invoice backlog.
  - Contributing factors: food operations, higher-than-envisaged oil imports, lower tobacco prices, exporters’ reluctance to repatriate earnings.
- Measures and results:
  - RBM’s April 2005 Guidelines rationed FX to prioritize fuel, maize, fertilizer, and essential imports.
  - Since mid-January 2006 authorities implemented a more flexible exchange rate policy; by end-June 2006 exchange rate had depreciated by about 12 percent.
  - Increased RBM FX sales and policy flexibility helped reduce import payment arrears; backlog estimates revised down through improved measurement and audits.
  - Backlog of unpaid import invoices: estimated US$67 million in January 2006 (includes some double counting) → US$12.7 million end-June 2006 → eliminated by late July 2006.
  - Parallel market premium indicators: midpoint spread fell from about 7 percent in early January 2006 to about 4 percent in early July 2006; both selling- and buying-rate premiums fell by 2 percentage points.

### Monetary policy, liquidity, and inflation management
- Operational anchor: reserve money target for price stability; projected reserve money growth deceleration to 17 percent in next fiscal year.
- Inflation dynamics:
  - Overall inflation: 17 percent peak (Feb 2006) → 15.3 percent (end-Jun 2006).
  - Nonfood inflation performance exceeded expectations.
- Liquidity management:
  - Liquidity Reserve Requirement (LRR) reduced in February 2006 (LRR values cited: 27.5; 20.0; 20.0; 20.0 in program table).
  - Following LRR reduction, authorities tightened reserve money target; RBM used repurchase agreements and external reserve sales to contain reserve money growth.
  - Yields on treasury bills fell quickly after lower LRR announcement.
- Financial deepening: lower LRR supported higher deposit rates and lower interest spreads; credit to private sector figures noted in monetary tables.

### Fiscal discipline, 2005/06 performance, and policy for 2006/07
- 2005/06 fiscal performance:
  - Stronger-than-programmed first half; weaker second half due to scaled-up food security operations and expenditure slippages.
  - Wage bill: wage increase implemented in February 2006 after compiling employee database and wage schedule; estimated overpayments ~MK700 million clawed back.
  - Tax revenues outpaced expectations; preliminary data indicate revenue performance about ½ percent of GDP better than programmed.
  - Overall fiscal deficit (including grants) unchanged from program: 2 percent of GDP. Large statistical discrepancy ~1 ¼ percent of GDP complicates comparisons.
  - Domestic borrowing: 0.4 percent of GDP for fiscal year, about 1 percent of GDP more than programmed.
  - Underlying balance projected at -0.2 percent of GDP (likely to be revised upwards once statistical discrepancy clarified); overall underlying balance for 2005/06 will be substantially lower than programmed—fertilizer subsidy largest contributor.
- 2006/07 fiscal strategy and targets:
  - Reduce domestic debt; aim to reduce domestic debt to about 16½ percent of GDP by end-2006/07.
  - Program targets nominal debt repayments of 0.4 percent of GDP.
  - Overall deficit (including grants) projected to decline to about 1¼ percent of GDP.
  - Underlying balance projected to improve to a surplus of about 1 percent of GDP.
  - Specific measures:
    - Tax cuts (individual income tax) will reduce tax/GDP ratio by about ½ percentage point but expected to be offset by expenditure restraint.
    - Pension reforms: 2006/07 pension bill expected MK4.8 billion (1.5 percent of GDP) versus estimated 1.2 percent of GDP in 2005/06; reforms are a prior action for second review.
    - Fertilizer subsidy projected at 2.4 percent of GDP (versus 2.6 percent of GDP in 2005/06).
    - Wage bill (excluding Health SWAp) to stay below 7.5 percent of GDP.
    - MK 2 billion allocated to domestic arrears clearance in 2006/07.
    - Parliament building initial costs MK0.7 billion in 2006/2007; total projected MK6 billion over several years.
    - Development spending increase: almost 3 percent of GDP, mostly foreign-financed (absorptive capacity concerns noted).

### Outlook, HIPC/MDRI, and debt relief implications
- Macroeconomic outlook 2006/07:
  - Preliminary crop estimates suggest real GDP growth rebound ~7 percent; inflation expected to fall to single digits (projection 7.9 percent by December 2006 cited in Supplement).
  - External reserves projected to rise to almost two months of imports by end of fiscal year with continued flexible exchange rate and reserve protection.
  - External prospects clouded by disruptions to tobacco auctions; exports of tobacco lower in volumes and prices versus 2005 auction season.
- HIPC completion point and MDRI:
  - Completion of second PRGF review establishes minimum six months of satisfactory performance required for HIPC completion point.
  - Government circulated third APR for mid-2004 to end-2005; draft MGDS submitted to Cabinet May 2006.
  - Government has implemented all but two HIPC completion-point triggers; intends to request waivers for student enrollment in teacher training and percentage of recurrent expenditures on health.
  - Fiscal program for 2006/07 incorporates MDRI-related debt relief flow of about US$50 million from Fund, IDA, and AfDB.
  - Fund debt relief to be transferred from RBM to budget on a flow basis.
  - If necessary, supplementary budget will allocate remaining surplus MDRI funds to pro-poor spending.
  - Staff and Bank recommend Malawi reach HIPC completion point upon completion of second review; reaching completion point would qualify Malawi for MDRI relief.

### Risks to program implementation and contingent liabilities
- Macroeconomic vulnerabilities:
  - Susceptible to crop shortfalls and higher world oil prices; terms-of-trade decline almost 18 percent in 2005.
  - Crop shortfalls could reduce tobacco earnings, require costly food operations, and threaten low external reserves.
- Fiscal and contingent liability risks:
  - Risk of wage bill overruns; need to keep payroll management reforms ongoing and update civil service database.
  - Pension projections may be optimistic given questionable demographic data.
  - Parliament building, MDC restructuring, MARDEF, and ADMARC pose contingent liability risks (examples: MARDEF loan scheme up to 1.5 percent of GDP; government-guaranteed MDC debt ~0.5 percent of GDP).
  - Weak accounting systems threaten undetected arrears accumulation.
  - Absorptive capacity constraints may reduce development spending effectiveness.

### Structural reforms, public financial management (PFM), and financial sector
- PFM action plan:
  - Ministry of Finance to develop action plan prioritizing reforms, describing donor support, and identifying remaining TA needs; structural benchmark end-Oct. 2006.
  - IFMIS and centralized payment system phased in; budget ceiling module superseded by centralized payment system implementation.
  - Structural benchmarks: publish monthly fiscal reports and quarterly arrears reports (implemented with delay).
- Banking supervision and financial deepening:
  - Impact analysis of commercial bank balance sheets completed (structural benchmark).
  - New asset classification directives issued; liquidation of Finance Bank initiated.
  - FSAP expected early 2007; Fund staff to identify strategic areas for focus.
- RBM governance and safeguards:
  - Safeguards update Jan 2006 identified weaknesses; board reconstituted March 2006; audit committee reestablished; rotation policy for external auditors adopted.
  - SADC model law to guide central bank independence reforms.

### Reporting, monitoring, and technical assistance
- Reporting requirements: frequent RBM and Ministry of Finance data submissions specified in TMU (daily/weekly/monthly/quarterly/annual frequencies).
- New data requirement: detailed backlog of import applications by bank and delivery/grace period categories.
- Technical assistance: numerous Fund missions and TA engagements cited across FAD, MFD, STA, LEG, and others; FSAP expected early 2007.
- IMF Executive Board action: second PRGF review completed and disbursement SDR 4.9 million approved (Press Release No. 06/186; August 31, 2006); total disbursed to date: SDR 15.3 million.

*Source: IMF staff report and MEFP materials (2006).*

### 2006. The staff met with Minister of Finance Goodall Gondwe, Governor of the Reserve Bank

### 2006. The staff met with Minister of Finance Goodall Gondwe, Governor of the Reserve Bank of Malawi (RBM) Victor Mbewe, and other senior government officials.

### PRGF arrangement and program status
- A PRGF arrangement (SDR 38.2 million, 55 percent of quota) was approved on August 5, 2005 (Country Report 05/285), of which SDR 10.3 million has been disbursed.
- At end-May, Malawi had outstanding Fund purchases and loans totaled SDR 53.8 million (78 percent of quota).
- All quantitative end-December 2005 performance criteria were met.
- The structural performance criterion was only partially implemented and the structural performance criterion for end-March 2006 was also not fully met; the authorities request waivers for nonobservance of these two performance criteria.
- Malawi is requesting the third disbursement under the current PRGF arrangement (SDR 4.9 million).
- Economic developments and policy implementation for the second half of 2005/06 (July-June) and the authorities program for 2006/07 are outlined in the attached Supplement to the Memorandum of Economic and Financial Policies (MEFP).

### Executive summary — macroeconomic outcomes (2005/06)
- Real GDP growth is expected to be 5.3 percent.
- Overall end-of period inflation exceeded expectations because of a slower-than-projected decline in food prices; nonfood inflation was contained.
- Domestic debt likely fell to 20 percent of GDP.
- All quantitative performance criteria through December 2005 were met; the end-December 2005 indicative target on reserve money was met.
- The end-December 2005 indicative target on discretionary government spending was missed due to additional spending related to the food crisis.
- The budget ceiling module (a structural performance criterion) was superseded by the introduction of a centralized payment system in November 2005 and thus only partially implemented.
- The structural performance criterion related to the government travel policy (scheduled end-March 2006) was only partially met and is now a structural benchmark expected to be met by end-September, 2006.
- Two fiscal structural benchmarks related to publishing reports on the budget and on expenditure arrears were met, but with a delay.
- Several developments complicated program implementation in second half 2005/06: a deeper-than-expected food security crisis, foreign exchange shortages and import arrears, disruptions to tobacco auctions, overcompensation/excess payroll funding, and RBM liquidity management following a reduction in the liquidity reserve ratio.

### Ensuring food security — fiscal impact and responses
- The food security crisis made about half the population vulnerable to food shortages; government and donor hunger relief averted a humanitarian crisis.
- Estimates of humanitarian needs increased after late-2005 due largely to an unanticipated trebling of maize prices.
- Government expanded food security operations; logistical difficulties increased costs (particularly transportation).
- Budgetary expenditures on food and fertilizer subsidies were MK4.5 billion (1.7 percent of GDP) above levels envisaged at the first review.
- Donor funds and higher maize sales supported about three-quarters of this additional spending, resulting in a net budget cost of about MK0.9 billion.
- The 2006 bumper maize crop ended the food crisis; maize prices began to fall back toward seasonal norms.

### Addressing foreign exchange imbalances and exchange rate policy
- First-half 2005/06: authorities used informal administrative procedures to fix the exchange rate, exerting downward pressure on external reserves and creating a backlog of unpaid import invoices.
- Contributing factors to the backlog included food security operations, higher-than-envisaged oil imports, lower tobacco export prices, and exporters’ reluctance to repatriate earnings.
- RBM’s April 2005 Guidelines for Foreign Exchange Trading Activities rationed access to foreign exchange, directing commercial banks to prefer fuel, maize, fertilizer, and other essential imports.
- Staff assessment: authorities maintained an exchange restriction (evidenced by private external payment arrears) and a multiple currency practice under Article VIII (significant spread between commercial bank exchange rate and foreign exchange bureaus).
- No evidence that the existing restriction was intensified or that the multiple currency practice was modified since PRGF approval.
- Since mid-January 2006, authorities implemented a more flexible exchange rate policy:
  - By end-June 2006, the exchange rate had depreciated by about 12 percent.
  - Increased RBM foreign exchange sales and the more flexible policy helped reduce arrears on import payments.
  - Refinements in measuring the invoice backlog and audits led authorities to significantly lower backlog estimates.
  - Data point to a reduction in the spread between commercial bank and foreign exchange bureau rates, suggesting backlog reduction was not achieved through increased parallel market activity.

### Monetary, fiscal, and structural policy priorities
- Macroeconomic stability is the main objective for 2006/07.
- Fiscal restraint is crucial to avoid adverse debt dynamics; reducing the domestic debt burden is the cornerstone of the fiscal strategy.
- A flexible exchange rate policy should be maintained to protect international reserves.
- Tax cuts, notably in individual income tax, will reduce the tax/GDP ratio by about ½ percentage point, but are expected to be more than offset by expenditure restraint, improving the underlying fiscal balance.
- Planned pension reforms aim to put the pension system on a sustainable track over the medium term.
- RBM actions to contain reserve money growth followed a reduction in the liquidity reserve ratio in February 2006.

### Outlook, risks, and recommendations
- Economic outlook for 2006/07 is favorable: agricultural output should rebound significantly (per latest crop estimates), pushing inflation to single digits.
- External prospects are clouded by recent disruptions to the tobacco auction.
- External reserves are projected to rise to almost two months of imports by end of the fiscal year with continued flexible exchange rate management and reserve protection.
- Better management of the exchange system should prevent recurrence of arrears on payment for current international transactions.
- Given forward-looking policies and Malawi’s steady track record, the Fund and Bank staffs recommend Malawi reach the HIPC completion point on completion of the second review under the PRGF arrangement; reaching the HIPC completion point would also qualify Malawi for debt relief under the MDRI.

*Source: IMF staff report and MEFP materials (2006).*

### 10. The program objective for net foreign assets will likely be met for end-June 2006.

### 10. The program objective for net foreign assets will likely be met for end-June 2006.

### Net foreign assets and external sector developments
- Program objective for net foreign assets likely met for end-June 2006.
- Notable program achievement despite:
  - Increased foreign exchange sales to lessen the backlog of unpaid import invoices.
  - Weaker tobacco inflows owing to disrupted auctions.
- Exchange rate and receipts:
  - Authorities’ decision to let the exchange rate depreciate, combined with stronger export receipts from tea, helped protect international reserves.
- Backlog of unpaid import invoices:
  - In January 2006, backlog was an estimated US$67 million (estimate included some double counting).
  - By end-June 2006, backlog was an estimated US$12.7 million.
  - By late July 2006, the backlog was eliminated.
- Parallel market premium indicators (data limitations noted):
  - Difference in mid-point of buy and sell rates offered by the RBM and by foreign exchange bureaus fell from about 7 percent in early January 2006 to about 4 percent in early July 2006.
  - The premium on the mid-point selling rate and on the mid-point buying rate both fell by 2 percentage points over the same period.
- Tobacco sector:
  - Despite resumption of tobacco auctions, both volumes and prices are down compared with the 2005 auction season.
  - Decline in exports of processed tobacco is less dramatic because many such exports in 2006 were bought at auctions held in late 2005.

*Meeting Monetary Policy Goals*

### Monetary policy and inflation
- Main monetary policy goal: price stability; framework relies on reserve money as a nominal anchor.
- Inflation:
  - Overall 12-month inflation fell from a peak of 17 percent in February 2006 to 15.3 percent at end-June 2006.
  - Inflation remained higher than anticipated because of a delayed response in food inflation to the bumper crop.
  - Performance on non-food inflation exceeded expectations; pass-through of late-2005/early 2006 oil price increases and effect of exchange rate depreciation were weaker than anticipated.
- Reserve requirements and liquidity management:
  - Following reduction in the LRR, authorities tightened the reserve money target to reduce excess liquidity and contain inflationary risks.
  - Yields on treasury bills fell quickly after the lower LRR announcement due to lack of creditworthy projects.
  - Repurchase agreements using RBM bills and external reserve sales contained reserve money growth during the fourth quarter of 2005/06; broad money growth remained largely in line with targets.
- Financial deepening:
  - Reducing the LRR supports improving monetary policy implementation and deepening the financial system.
  - Lower LRR contributed to higher deposit rates and lower interest rate spreads.

### Fiscal discipline and 2005/06 performance
- Fiscal performance:
  - Stronger-than-programmed second quarter followed by weakened performance in second half of 2005/06.
  - Factors supporting early-year performance: AfDB’s refund of debt service, delays in food security outlays, postponement of planned civil service salary increase.
  - Scaled-up food security operations and some expenditure slippages hurt second-half performance.
- Wage bill and payroll management:
  - Key challenge: keep annual wage bill on target (a performance criterion).
  - Government implemented 2005/06 wage increase in February 2006 after completing a database of all government employees (a performance criterion) and formulating a wage schedule (structural benchmark).
  - Some employees were mistakenly overcompensated causing a third-quarter overrun; claw backs and savings corrected the overrun. Estimated annual wage bill is within program limits.
- Other expenditure and revenue:
  - Spending on goods and services and subventions exceeded program projections.
  - Tax revenues outpaced expectations, particularly in fourth quarter of 2005/06; preliminary data indicates revenue performance about ½ percent of GDP better than programmed.
- Overall fiscal balances and discrepancies:
  - Overall fiscal deficit (including grants) is unchanged from the program: 2 percent of GDP.
  - A large statistical discrepancy—about 1 ¼ percent of GDP—obscures comparisons; could reflect unrecorded spending or shortfalls in non-tax revenues or privatization receipts.
  - Domestic borrowing was 0.4 percent of GDP for the fiscal year, about 1 percent of GDP more than programmed.
  - Underlying balance currently projected at -0.2 percent of GDP, but likely to be revised upwards once the statistical discrepancy is clarified.
  - Underlying balance for 2005/06 will be substantially lower than programmed; single largest contributor to the shortfall is additional spending on the fertilizer subsidy.

### Policies for 2006/07 — macro objectives and commitments
- Key macroeconomic objectives remain consistent with the approved PRGF arrangement.
- Preliminary crop estimates suggest agricultural output should support a rebound in real GDP growth of about 7 percent and further dampen inflation.
- Further reducing domestic debt and restoring external reserves will be key program objectives.
- Political context: government committed to program implementation but holds a minority in parliament and faces intense political pressure.

### Reaching the HIPC Completion Point
- Malawi will become eligible for relief under the MDRI upon reaching the HIPC completion point.
- Reasons for recommending completion point:
  - Completion of the second review establishes minimum six months of satisfactory performance under the PRGF arrangement required to reach the HIPC completion point.
  - Government circulated the third Annual Progress Report (APR) for mid-2004 to end-2005 to Fund and Bank Boards; APR available on Fund’s website. Bank and Fund staffs prepared a Joint Staff Advisory Note on the APR.
  - Government submitted a completed draft of its second poverty reduction strategy paper, the Malawi Growth and Development Strategy (MGDS), to the Malawian Cabinet in May 2006; Cabinet commissioned a needs assessment to strengthen implementation chapter; government expects to resubmit MGDS and then submit to Bank and Fund staffs.
  - Government has implemented all but two HIPC completion-point triggers; intends to request waivers for triggers relating to student enrollment in teacher training institutions and the percentage of recurrent expenditures on health.
- Fiscal implications of MDRI:
  - Fiscal program for 2006/07 incorporates a flow of MDRI-related debt relief from the Fund, IDA, and AfDB of about US$50 million.
  - Fund debt relief will be transferred from the RBM to the budget on a flow basis.
  - Savings on debt service due to MDRI-related debt relief from IDA and AfDB should be largely offset by reduced program commitments.
  - If necessary, a supplementary budget will allocate any remaining surplus MDRI funds to pro-poor spending activities.
- Monitoring:
  - Authorities are working with Fund staff and stakeholders to redefine pro-poor spending for 2006/07 due to frequent past revisions complicating tracking.

### Reducing inflation and restoring external reserves
- Monetary anchor:
  - Government committed to monetary policy anchored by a reserve money target to achieve price stability.
  - Projected reserve money growth deceleration to 17 percent in the next fiscal year.
  - A strong agricultural crop expected to push inflation below 10 percent.
  - A more modest rise in world oil prices is expected to help lower inflation by reducing pass-through to domestic petroleum prices.
- External reserves targets:
  - Gross reserves should be about 1.7 months of imports at end-June 2007, up from 1.3 months at end-June 2006.
  - Net foreign assets expected to rise steeply as Fund debt relief under the MDRI will reduce debt owed to the Fund.
  - Malawi’s external position unlikely to benefit from additional MDRI-related debt relief from IDA and AfDB because reductions in program support would offset reduced liabilities.
- Exchange rate and policies:
  - Government affirmed commitment to a flexible exchange rate regime.
  - Higher external reserves will enable RBM to smooth seasonal exchange rate fluctuations.
  - Policies that contain inflation and reduce domestic debt are required to bring about sustainably lower interest rates.

### Consolidating debt reduction and fiscal strategy
- Domestic debt reduction cornerstone:
  - Achieved by expenditure restraint (wages, goods and services, pensions), together with lower interest payments and food security outlays offsetting effects of personal income tax cuts and lower program grants.
- Targets and projections:
  - Program targets nominal debt repayments of 0.4 percent of GDP.
  - Aim to reduce domestic debt to about 16½ percent of GDP by end-2006/07.
  - A shrinking debt stock and declining inflation should allow interest rates to drop somewhat.
  - Government to strengthen cash management so some government deposits offset ways-and-means advances at the RBM.
  - Savings on domestic interest costs to support priority expenditures.
- Fiscal projections for 2006/07:
  - Overall deficit (including grants) projected to decline to about 1¼ percent of GDP.
  - Underlying balance projected to improve substantially from 2005/06 to a surplus of about 1 percent of GDP.
- Specific budget measures:
  - Food security: spending much lower than in 2005/06 but remains integral; bumper maize crop used to replenish Strategic Grain Reserve; ADMARC to sell maize at full cost recovery; government will import fertilizer for resale with a slightly lower subsidy of 2.4 percent of GDP (compared with 2.6 percent of GDP in 2005/06).
  - Wages: no formal across-the-board wage adjustments; only a few categories (e.g., judiciary) to receive 2006/07 increases; 2006/07 wage bill estimates, excluding Health SWAp, will stay below 7.5 percent of GDP (in line with 2005/06 wage bill).
  - Pensions: authorities agreed to substantially reduce the pension system’s replacement rate, lower the pension accrual rate, and introduce a discount factor to the pension share paid out as a lump-sum gratuity; plan to index pension benefits to inflation.
    - 2006/07 pension bill expected to be about MK4.8 billion, or 1.5 percent of GDP (versus an estimated 1.2 percent of GDP in 2005/06).
    - Over the medium term, pension costs should stay below 2 percent of GDP.
    - Reforming the pension system is a prior action for completing the program’s second review.
  - Recurrent spending containment: spending on other goods and services should increase at the nonfood inflation rate rather than nominal GDP growth rate; measures include improved civil service housing policies, restrictions on government vehicle use, administrative measures, and planned full implementation of IFMIS to prevent new utility arrears.
  - Domestic arrears clearance: MK 2 billion allocated to arrears clearance in 2006/07; government considering securitization of part of arrears (program includes an adjuster for such an initiative).
  - Parliament building: initial costs contained to MK0.7 billion in 2006/2007; total costs projected to reach MK 6 billion over several years, with one donor indicating readiness to provide support.
  - Development spending: budget incorporates a substantial increase in development spending—almost 3 percent of GDP—mostly foreign-financed; concerns noted about absorptive capacity to implement planned spending.

### Risks to program implementation
- Macroeconomic vulnerabilities:
  - Economy vulnerable to crop shortfalls and higher world oil prices.
  - Crop shortfalls could disrupt tobacco export earnings, lead to food shortages, require costly food security operations, and threaten low external reserves.
  - Malawi suffered a terms-of-trade decline of almost 18 percent in 2005 and is vulnerable to continued declines in 2006/07 if world oil prices rise or tobacco export prices decline dramatically.
- Budget and contingent liability risks:
  - Need to guard against recurrence of wage bill overruns.
  - Pension projections may be optimistic due to questionable historical demographic data; may require recalibration.
  - Construction of parliament building could create future cost overruns.
  - Weak accounting systems may not capture accumulation of new expenditure arrears.
  - Constraints on absorption capacity may threaten quality of increased development expenditures.
  - Contingent liabilities that could require offsets:
    - MARDEF: risk government may lose funds transferred into loan scheme (up to 1.5 percent of GDP) and be pressured for additional transfers.
    - ADMARC: recurrent risk of operational spending overruns, contingent liabilities if allowed to borrow commercially, and pressures to sell maize below cost recovery.
    - Restructuring of Malawi Development Corporation: failure to make payments on government-guaranteed debt valued at about 0.5 percent of GDP may impose budget cost.

### Structural reforms and public financial management
- Medium-term agenda being developed in context of MGDS; PRGF-supported program focuses on macro-relevant reforms in PFM and the financial sector for 2006/07.
- PFM improvements:
  - 2004 Assessment and Action Plan highlighted needs: budget comprehensiveness, internal control and reconciliation in budget execution, and audited financial reports.
  - Government and donors developing an action plan to address PFM weaknesses (structural benchmark for end-October 2006).
  - Phasing in new IFMIS and centralized payment system marks an important first step.
  - Fund staff to work with authorities to implement action plan; capacity building critical and Malawi expected to request technical assistance from Fund and other donors.

*Source: _cr06445 - 10. The program objective for net foreign assets will likely be met for end-June 2006.*

### 33. Medium-term challenges include successfully deepening financial intermediation

### 33. Medium-term challenges include successfully deepening financial intermediation

### Financial sector deepening and credit markets
- Medium-term challenges include successfully deepening financial intermediation and developing credit markets.
- To strengthen banking supervision, the government completed an impact analysis of commercial bank balance sheets using asset classifications consistent with international best practices (a structural benchmark).
- In carrying out this analysis, the authorities relied on substantial technical advice from MFD.
- The government expects to receive a Financial Sector Assessment Program (FSAP) in early 2007.
- Fund staff will begin identifying key strategic areas to focus the assessment, both from the point of view of stability and development of the financial system.

### Strengthening the Reserve Bank of Malawi (RBM) governance and functioning
- Strengthening the RBM’s functioning would improve overall governance in the financial sector.
- A late-2005 follow-up safeguard assessment mission from the Fund identified several remaining weaknesses in the RBM’s operations, particularly in transparency and accountability.
- A key issue was that the extended lack of a board of directors left the RBM vulnerable to mismanagement.
- In March 2006, the government reconstituted the board, which then reestablished the audit committee.
- The Southern African Development Community (SADC) will guide the government’s efforts to strengthen the independence of the central bank.
- The government plans to adopt a version of a forthcoming SADC model law as soon as possible.

### Staff appraisal: macroeconomic performance and program implementation
- Malawi is expected to meet its growth target for 2005/06.
  - The recent food crisis was described by authorities as the most severe in 50 years.
  - Increased spending on food security was appropriate and averted a humanitarian crisis.
- Macroeconomic performance through December 2005 was broadly satisfactory.
  - Malawi met all quantitative performance criteria under the PRGF-supported program.
  - Met the indicative target on reserve money, but missed the target on discretionary government spending.
  - Weak exchange rate management marred program performance.
  - Implementation of structural measures was uneven.
  - Authorities contained a wage bill overrun and fought inflation amid higher world oil prices.
- Staff support waivers on two structural performance criteria.
  - The budget ceiling module was superseded by the implementation of the centralized payment system in November 2005.
  - The authorities were not satisfied with earlier travel policy proposals and now expect to develop and implement a new travel policy by end-September 2006 (a structural benchmark).
- Exchange rate policy and reserves
  - Authorities began to improve exchange rate management policies; implemented a more flexible exchange rate policy since January 2006.
  - Resulting depreciation of the kwacha, coupled with tighter domestic policies, was appropriate.
  - A more flexible exchange rate policy, better measurement of unsatisfied foreign exchange demand, and increased RBM foreign exchange sales eliminated the backlog of arrears on import payments within the banking system.
  - To protect Malawi’s relatively low reserve cover, the authorities need to continue to implement a flexible exchange rate policy.
- Program implementation in second half of 2005/06
  - Malawi expected to meet all but two end-June quantitative targets.
  - Discretionary government spending and borrowing targets will be missed primarily because of scaled-up spending on food security.
  - Government announcement to fix minimum prices on tobacco grades disrupted tobacco auctions and reduced foreign exchange inflows; staff urges avoidance of similar policy missteps.
- Prospects for the coming fiscal year
  - A strong agricultural harvest should help GDP growth rebound and inflation should continue to fall.
  - To reduce poverty over the medium term, Malawi must realize even higher growth rates in 2007/08 and beyond.
  - Despite some uncertainty related to tobacco markets, external prospects have improved.
  - Program objectives for 2006/07 are realistic.
  - Staff welcomes the government’s continued commitment to reducing the domestic debt burden.
  - Authorities should be prepared to reduce excess liquidity in the banking system to meet inflation objectives.

### Structural reform emphasis and governance
- Emphasis on structural reforms in public financial management and in the financial sector is appropriate.
- Strengthened expenditure management will help ensure resources freed up by debt relief are used effectively.
- Governance of the financial sector is important; staff welcomes steps taken to address recommendations of the Fund’s safeguard assessment.

### Risks and vulnerabilities
- Projected foreign exchange reserve cover is still relatively low, leaving the economy vulnerable to domestic and external shocks.
- Strong policy implementation is critical to mitigate these risks.
- Fiscal risks:
  - History of poor payroll management could lead to wage overruns.
  - Pension outlays rely on assumptions using questionable demographic data and could be higher than programmed.
  - To reduce these risks, authorities need to:
    - Continue implementing payroll management reforms.
    - Continually update the civil service database.
    - Improve retiree and worker mortality data.
- Potential contingent liabilities to the budget need management by ensuring proper governance in the administration of ADMARC and MARDEF.

### Staff recommendations and conclusion
- On the basis of performance through end-December 2005 and in the second half of the fiscal year, and the authorities’ continued commitment to program implementation, staff recommend completion of the second review under the PRGF arrangement.
- Given Malawi’s track record under the PRGF and satisfactory implementation of the HIPC completion point triggers, the Fund and Bank staffs recommend that Malawi advance to the HIPC completion point, making it immediately eligible for additional debt relief under the MDRI.

*Source: IMF staff report excerpt, _cr06445 - 33. Medium-term challenges include successfully deepening financial intermediation_*

### Part I (foreign financed)5.99.310.011.410.512.510.811.3

### _cr06445 - Part I (foreign financed)5.99.310.011.410.512.510.811.3

### Fiscal operations and balances (Central Government, 2002/03–2008/09)
- Part I (foreign financed) rows (series of values): 5.99.3 10.0 11.4 10.5 12.5 10.8 11.3
- Part II (domestically financed) rows (series of values): 1.4 1.8 1.1 1.4 1.5 2.2 2.5 2.5
- Net lending: 0.0 0.0 0.3 0.0 0.0 0.2 0.0 0.0
- Overall balance (including grants): -11.6 -7.8 -5.6 -2.0 -2.0 -1.3 -0.4 0.0
- Spending directly related to privatization 1/: 0.0 0.0 0.0 0.8 1.0 0.0 0.0 0.0
- Augmented balance: -11.6 -7.8 -5.6 -2.8 -3.0 -1.3 -0.4 0.0
- Total financing: 11.3 7.9 5.2 2.8 4.2 1.3 0.4 0.0
- Foreign (net): -0.5 0.2 2.2 2.1 2.3 1.8 2.2 2.6
  - Borrowing: 3.1 3.8 5.1 5.8 5.9 3.6 3.6 3.7
    - Program: 0.0 0.7 2.3 1.2 1.2 0.4 0.8 1.1
    - Project: 3.1 3.1 2.8 4.6 4.6 3.3 2.8 2.6
  - Amortization: -3.4 -4.0 -3.6 -3.7 -3.6 -1.9 -1.3 -1.1
- Domestic (net): 11.8 7.7 3.0 -0.6 0.4 -0.4 -1.8 -2.6
  - Financial instruments (banking system / nonbanks): Banking system 8.7 3.5 1.8 -1.7 -1.0 ......... ; Nonbanks 3.3 4.1 1.2 1.1 1.4 .........
- Privatization and other financing: -0.2 0.0 0.0 1.3 1.5 0.0 0.0 0.0
- Discrepancy (- is overfinancing): 0.3 -0.1 0.3 0.0 -1.2 0.0 0.0 0.0
- Memorandum items:
  - Net domestic debt: 20.4 24.8 23.8 19.3 20.0 16.5 12.8 8.6
  - Underlying balance 2/: -1.7 -0.9 2.3 1.8 -0.2 1.0 0.6 0.4
  - Overall balance (excluding grants): -18.3 -19.9 -18.0 -20.8 -21.2 -19.0 -15.2 -15.0
  - Pro-poor spending: 7.0 6.6 6.6 9.3 12.8 .........
  - Arrears (Stock): ......4.4...............
  - MDRI debt stock relief, World Bank: ...............78.6......
  - MDRI debt service relief, World Bank: ...............1.1 1.2 1.1
  - MDRI debt stock relief, AfDB: ...............17.1......
  - MDRI debt service relief, AfDB: ...............0.1 0.1 0.1

Notes:
- 1/ Includes for 2005/06 transactions related to the sale of MTL: retrenchment costs and the capital injection less debt repayment.
- 2/ Definition of underlying balance provided in source (domestic primary balance excluding maize operations and the Health SWAp).

### Reserve money and monetary authorities' balance sheet (selected items, 2004–06, millions of Malawi kwacha unless otherwise indicated)
- Reserve money (selected quarterly/period values): 16,728 17,967 16,196 19,580 20,894 20,115 20,904 20,610 17,890 17,500 22,750 20,194 21,163 22,067
- Currency outside banks (selected values): 11,505 10,993 9,976 13,050 ... 12,785 ... 11,946 ... 11,793 ...
- Cash in vault: 1,440 1,861 1,567 1,866 ... 1,787 ... 2,331 ... 1,915 ...
- Commercial bank deposits with RBM: 3,782 5,114 4,653 4,664 ... 5,543 ... 6,333 ... 3,793 ...
- Net foreign assets (NFA): 3,369 2,919 158 4,060 8,507 9,142 7,223 6,915 3,935 3,455 7,606 7,251 12,844 9,187
  - NFA (millions of U.S. dollars): 30.9 26.8 1.4 33.0 69.2 73.7 58.7 55.9 32.0 25.8 61.8 59.0 104.4 74.7
- Gross foreign assets: 123.7 119.3 90.4 112.4 163.8 159.4 142.2 131.1 109.6 108.3 137.2 126.4 133.4 113.9
- Foreign liabilities: -92.8 -92.5 -88.9 -79.4 -94.6 -85.8 -83.5 -75.3 -77.6 -82.5 -75.4 -67.4 -28.9 -39.2
- Net domestic assets: 13,359 15,048 16,038 15,520 12,387 10,972 13,681 13,695 13,955 14,045 15,145 12,943 8,319 12,880
  - Credit to government (net): 11,237 12,046 20,297 22,181 19,415 11,957 20,376 11,393 13,006 12,706 12,613 9,647 10,877 12,504
  - Other items (net): 2,120 3,001 -4,261 -6,662 -7,031 -986 -6,697 2,299 947 1,337 2,529 3,294 -2,560 374
  - Open market operations: -5,937 -5,582 -13,592 -16,907 -17,441 -1 0,061 -17,483 -7,881 -7,266 -6,088 -6,621 -4,658 -5,140 -4,445
  - Encumbered reserves: 1,013 1,013 1,037 799 800 807 800 3,472 492 869 492 492 492 492
  - IMF MDRI Relief (item): ... ... ... ... ... ... ... ... ... ... ... ... ... -6,468 -5,395
- Seasonally adjusted reserve money (memorandum): 16,380 17,761 19,474 19,382 20,060 19,813 20,847 20,428 21,636 21,074 22,658 19,989 20,846 21,872
  - Quarterly change (seasonally adjusted reserve money): -11.7 8.4 9.6 -0.5 2.4 2.2 3.9 3.1 5.5 3.2 4.7 -5.1 4.3 4.9
  - Annual change: ... 30.8 34.4 4.5 24.9 21.0 16.3 15.0 10.5 8.2 16.2 3.1 5.2 7.1
- Money and quasi-money (broader aggregates): 43,452 45,666 44,552 50,625 52,347 51,081 53,010 52,207 50,331 54,079 59,740 60,078 61,644 63,724
  - Money: 24,556 25,443 24,400 28,977 ... 29,171 ... 30,203 ... 29,941 ...
  - Quasi money: 18,896 20,222 20,151 21,648 ... 21,910 ... 22,004 ... 24,138 ...
  - Of which: foreign currency deposits: 7,501 7,120 7,284 8,246 ... 7,564 ... 6,475 ... 9,300 ...
- Monetary authorities' NFA (summary): Monetary authorities 3,369 2,919 158 4,060 8,507 9,142 7,223 6,915 3,935 3,455 7,606 7,251 12,844 9,187 (NFA in U.S.$ noted above)
- Commercial banks' NFA (selected): 5,989 4,674 2,934 4,994 4,576 3,333 5,289 2,982 3,776 5,962 5,621 4,145 4,945 4,022
  - NFA (millions of U.S. dollars) for commercial banks: 55.0 42.9 26.3 40.6 37.2 26.9 43.0 24.1 30.7 44.6 45.7 33.7 40.2 32.7
- Net domestic assets (broad money decomposition): 34,094 38,073 41,460 41,571 39,264 38,607 40,498 42,311 42,620 44,661 46,513 48,682 43,855 50,515
  - Credit to private sector: 11,942 13,926 13,227 16,497 15,325 18,201 16,356 17,500 17,903 16,500 20,121 19,766 20,335 15,391

### Monetary indicators and memorandum items
- Seasonally adjusted broad money: 42,659 45,616 47,310 48,585 50,749 50,211 52,950 52,144 54,546 57,271 56,892 57,657 60,594 63,648
  - Quarterly change: 4.2 6.9 3.7 2.7 4.3 3.3 4.3 3.9 4.3 9.8 4.3 0.7 5.1 5.0
  - Annual change: ... 29.7 23.8 18.6 20.5 17.7 16.1 14.3 13.0 21.1 18.0 18.7 20.7 22.1
- Seasonally adjusted credit to private sector: 11,975 13,651 13,893 16,744 15,594 18,274 15,906 17,189 18,652 17,430 20,516 20,062 20,416 15,118
  - Quarterly change: 12.6 14.0 1.8 20.5 2.0 9.1 2.0 -5.9 10.0 1.4 10.0 15.1 1.8 -26.0
  - Annual change: ... 42.6 40.2 57.4 28.3 52.6 17.4 25.9 35.4 25.5 22.0 19.8 11.7 -12.1
- Money multiplier (selected): 2.60 2.54 2.75 2.59 2.51 2.54 2.54 2.53 2.81 3.09 2.63 2.98 2.91 2.89
  - Seasonally adjusted money multiplier: 2.62 2.52 2.47 2.50 2.55 2.51 2.55 2.53 2.55 2.71 2.55 2.88 2.88 2.88

### Balance of payments (selected aggregates, 2002–09; millions of U.S. dollars)
- Current account balance (including grants): -216.2 -134.2 -177.5 -121.9 -98.6 -169.5 -42.1 -26.7 -66.7
- Merchandise trade balance: -305.7 -351.0 -423.9 -473.4 -429.2 -497.8 -455.7 -437.8 -510.7
  - Exports: 421.1 440.6 470.0 524.2 557.6 572.0 592.9 611.4 630.3
    - Of which: Tobacco: 232.7 205.6 229.5 266.6 296.9 295.1 303.4 312.0 321.3
  - Imports: -726.8 -791.6 -893.9 -997.6 -986.8 -1,069.8 -1,048.6 -1,049.2 -1,141.0
    - Of which: Petroleum: -63.0 -78.5 -95.9 -137.2 -156.3 -177.5 -187.9 -186.9 -190.2
    - Emergency Maize: -102.8 -5.5 0.0 -63.7 -6.0 -40.0 0.0 0.0 0.0
- Services balance: -154.0 -88.2 -84.7 -83.9 -90.4 -84.6 -74.5 -76.4 -72.2
  - Interest public sector (net): -20.2 -25.5 -27.7 -25.6 -24.8 -18.9 -3.6 -0.8 8.4
    - Receipts: 2.5 1.5 0.7 0.7 3.7 3.0 5.3 9.1 14.4
    - Payments (amounts due before HIPC debt relief): -22.7 -27.0 -28.4 -26.3 -28.5 -22.0 -8.9 -9.8 -6.1
  - Other factor payments (net): -24.5 -16.1 -16.9 -17.2 -18.6 -18.7 -19.7 -20.9 -22.2
  - Nonfactor (net): -109.3 -46.6 -40.1 -41.0 -47.0 -47.0 -51.2 -54.7 -58.4
    - Receipts: 49.7 40.0 40.6 41.5 42.2 42.5 43.4 45.4 47.8
    - Payments: -76.6 -86.6 -80.7 -82.5 -89.2 -89.5 -94.6 -100.2 -106.3
- Unrequited transfers (net): 243.4 305.1 331.0 435.4 420.9 412.9 488.1 487.4 516.3
  - Private (net): 8.1 141.1 117.6 151.3 130.7 132.5 136.4 139.4 145.3
    - Private receipts: 21.6 156.4 127.8 161.6 141.2 143.0 147.3 150.5 156.6
    - Private payments: -13.4 -15.3 -10.2 -10.4 -10.6 -10.6 -10.8 -11.1 -11.3
  - Official (net): 235.3 164.0 213.4 284.1 290.2 280.5 351.7 348.0 371.0
    - Official receipts: 235.3 164.0 213.4 284.1 290.2 280.5 351.7 348.0 371.0
- Balance of payments assistance (selected): 12.8 41.7 64.3 97.2 81.8 46.1 98.9 22.1 98.2
  - Japan HIPC Initiative: 11.0 16.8 0.0 0.0 0.0 0.0 0.0 0.0 0.0
  - Donor humanitarian grants: 135.4 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
  - Project related: 76.1 87.5 149.2 172.8 208.5 234.4 252.7 255.8 272.8
- Capital account balance (incl. errors and omissions): 61.4 95.9 152.2 92.1 75.0 111.2 89.1 80.3 107.5
  - Medium- and long-term flows: 23.8 10.9 16.2 21.0 52.9 50.0 58.9 56.5 71.6
  - Disbursements (selected): 81.0 96.7 95.3 97.5 136.9 113.3 90.8 85.9 99.9
  - Amortization (amounts due before HIPC debt relief): -57.2 -68.6 -74.8 -76.5 -84.0 -63.4 -31.9 -29.4 -28.2
  - Foreign direct investment and other inflows: 37.6 43.2 44.1 26.5 29.8 29.8 32.3 34.0 35.7
- MDRI debt forgiveness (selected items): MDRI debt forgiveness on debt due after current year 1844.0 375.7 (values shown in table)
- Overall balance (selected): -154.8 -38.2 -25.3 -29.8 -23.6 -58.3 46.9 63.6 40.8
  - Financing (- increase in reserves): 154.8 38.2 25.4 29.9 23.6 58.3 -46.9 -63.6 -40.8
    - Central bank financing and gross reserves movements summarized in table
- Debt relief (selected): 28.9 47.5 47.0 59.7 55.9 46.2 29.9 25.9 27.0
- Memorandum items:
  - Gross official reserves (Millions of U.S. dollars): 162.0 122.6 128.6 159.2 187.6 117.9 210.5 303.3 366.1
  - Months of imports 3/: 2.2 1.5 1.4 1.8 2.0 1.2 2.2 2.9 3.3
  - Usable gross official reserves (Millions of U.S. dollars): 103.4 115.6 119.3 131.2 183.2 113.9 206.5 299.3 362.1

### Gross financing requirements and sources (2002–09, U.S. dollars, selected)
- Gross financing requirements: -405.7 -385.3 -487.4 -520.7 -530.5 -2,353.4 -900.2 -500.8 -533.7
- External current account deficit (excl. official transfers): -451.6 -298.1 -391.0 -406.0 -388.9 -449.9 -393.8 -374.7 -437.7
  - Trade balance on goods and services: -415.0 -397.7 -464.0 -514.4 -476.2 -544.8 -506.9 -492.4 -569.1
- Official debt amortization: -63.4 -77.9 -88.5 -95.4 -111.3 -1,890.3 -409.7 -29.4 -28.2
  - of which IMF repurchases and repayments: -6.2 -9.3 -13.7 -18.9 -27.3 -14.2 0.0 0.0 0.0
  - MDRI debt repayment (item): -18 12.7 -377.9 (values shown in table)
- Sources of financing (total): 405.8 385.3 487.5 520.7 530.5 2,338.8 898.0 500.8 533.7
  - Private capital (net): 37.6 67.8 131.7 71.1 22.2 29.8 32.3 33.8 35.9
  - Gross official assistance: 339.3 270.0 308.8 389.9 452.4 418.7 460.0 441.2 470.9
    - Official grants: 235.3 164.0 213.4 284.1 290.2 280.5 351.7 348.0 371.0
    - Loan disbursements: 104.0 106.0 95.3 105.8 162.2 138.2 108.3 93.3 99.9
  - Debt relief (including MDRI): 28.9 47.5 47.0 59.7 55.9 1,890.3 405.6 25.9 27.0
- Memorandum items (percent of GDP): Gross financing requirements: -20.9 -21.7 -25.6 -25.0 -24.6 -107.1 -39.1 -20.1 -19.8
  - Current account balance, excluding official transfers: -23.3 -16.8 -20.5 -19.5 -18.0 -20.5 -17.1 -15.1 -16.3
  - Gross official assistance: 17.5 15.2 16.2 18.7 21.0 19.0 20.0 17.7 17.5

### Quantitative targets (June 2005–March 2006, selected)
- Ceiling on net domestic assets of the monetary authorities (PC): Stock 15,520 with adjusters and target adjustments shown in table (values include -3,133, 0, -3,133, -4,466, -1,839, 2,070, 231, -1,781, -1,564, -1,278, -, 2,842, -1,197)
- Ceiling on reserve money (IT): 19,580 with adjuster 1,314 and other test-date adjuster details provided in table
- Ceiling on central government's net domestic borrowing (PC): Stock 53,923 with cumulative flows and adjusters (examples: -783 -188 -971 -1,644 -599 1,578 979 -88 180 474 653 6,857)
- Ceiling on central government wages and salaries (PC): Test values include 4,809 4,802.3 9,934 -21 9,913 9,592 14,914 174 15,087 15,356
- Ceiling on central government discretionary expenditures (IT): Test values include 15,123 401 15,524 12,311.3 29,424 -844 28,580 29,768 40,873 -387 40,486 47,078
- External targets (selected):
  - Floor on net foreign assets of the monetary authorities (PC): 33.0 36.1 0.0 36.1 40.7 25.7 -16.8 8.9 22.9 -1.0 -10.0 -11.0 -7.2
  - Ceilings on accumulation of external payments arrears and on new nonconcessional external debt: 0.0 (evaluated continuously)
- Memorandum items (selected millions of Malawi kwacha and U.S. dollars): Balance of payments support 60.2 0.0 ... 35.7 105.2 -16.8 ... 88.4 116.4 -10.0 ... 91.4; Health SWAp wage expenditures and ORT expenditures and net movements in special accounts given in table.

*Sources: Malawian authorities; Reserve Bank of Malawi; IMF staff estimates and projections.*

### 1. Ceiling on net domestic assets of the monetary authorities 2/

### _cr06445 - 1. Ceiling on net domestic assets of the monetary authorities 2/

### Monetary targets and reserve money
- 1. Ceiling on net domestic assets of the monetary authorities 2/ (PC 3/)
  - 15,520
  - -375
  - -2,577
  - -7,201
  - -2,640
- 2. Ceiling on reserve money (IT)
  - 19,580
  - 3,170
  - 613
  - 1,582
  - 2,486
- Liquidity Reserve Requirement
  - 27.5
  - 20.0
  - 20.0
  - 20.0
- Program exchange rate
  - 123
  - 123
  - 123
  - 123
  - 123
- PC - performance criteria; IT - indicative target
- Notes:
  - Targets are defined in the technical memorandum of understanding (TMU).
  - Targets are subject to an adjuster for BOP support.
  - Targets for end-September are indicative.
  - Targets are subject to an adjuster for donor-funded health expenditures.
  - Targets are subject to adjusters for maize revenue and cash payment of arrears.
  - Evaluated on a continuous basis.

### Fiscal targets (Millions of Malawi kwacha)
- II. Fiscal Targets
- 3. Ceiling on central government's net domestic borrowing 2/ 4/ 5/ (PC 3/)
  - 53,923
  - -1,661
  - 1,081
  - 3,206
  - 6,010
- 4. Ceiling on central government wages and salaries 4/ (PC 3/)
  - ...
  - 20,448
  - 20,448
  - 26,158
  - 31,956
- 5. Ceiling on central government discretionary expenditures 4/ (IT)
  - ...
  - 53,054
  - 59,209
  - 73,897
  - 90,413
- Memorandum items (Millions of Malawi kwacha):
  - Health SWAp wage expenditures
    - 730
    - 730
    - 977
    - 1,230
  - Health SWAp ORT expenditures
    - 3,873
    - 4,660
    - 4,413
    - 7,050
  - Net Movement in special accounts
    - 1,693
    - 1,387
    - 3,590
    - 1,915
  - Net movement in NAC account
    - 00
    - 0   0
  - Maize revenue
    - 1,157
    - 1,051
    - 1,091
    - 1,411
  - Net movement in Health SWAp account
    - 536
    - 335
    - 2,498
    - 503
  - Cash payment of arrears
    - 2,000
    - 2,000
    - 2,500
    - 3,000

### External targets (Millions of U.S. dollars)
- III. External Targets
- 6. Floor on net foreign assets of the monetary authorities 2/ (PC 3/)
  - 33.0
  - 28.8
  - 25.9
  - 71.4
  - 41.7
- 7. Ceiling on the accumulation of external payments arrears 6/ (PC 3/)
  - ...
  - 0.0
  - 0.0
  - 0.0
  - 0.0
- 8. Ceiling on new nonconcessional external debt with a maturity of one year or more 6/ (PC 3/)
  - ...
  - 0.0
  - 0.0
  - 0.0
  - 0.0
- 9. Ceiling on new nonconcessional external debt with a maturity of less than one year 6 (PC 3/)
  - ...
  - 0.0
  - 0.0
  - 0.0
  - 0.0
- Memorandum item: Balance of payments support (In millions of U.S. dollars)
  - 144.5
  - 137.8
  - 159.0
  - 167.4
- Swap receipts
  - 5,139
  - 5,792
  - 7,955
  - 8,883
- Swap payments
  - -4,603
  - -5,457
  - -5,457
  - -8,379
- IMF debt relief transfers from the RBM to the CG
  - 4.5
  - 8.7
- Debt service payments to the WB and the ADB
  - 7.0
  - 0.4

### Performance criteria, structural benchmarks, and prior actions
- Prior Actions for completion of the Second Review under the PRGF arrangement
  - 1. Parliament approval of 2006/07 budget in line with macroeconomic framework specified in the TMU (para. 34)
    - August 2006 — Implemented
  - 2. Implement adjustment formula to the current pension system. (TMU para 35)
    - Performance Criteria
- Performance Criteria (status)
  - 1. Make budget ceilings module in payment system fully operational (TMU, para. 36)
    - End-Dec. 2005 — Not implemented
  - 2. Develop and implement new travel policy, which includes mechanisms for monitoring adherence (TMU, para. 37).
    - End-Mar. 2006 — Not implemented
- Structural Benchmarks (status)
  - 1. Develop detailed schedule of wage adjustments by grade for 2005/06
    - End-Sep. 2005 — Implemented in February 2006
  - 2. Publish monthly fiscal reports with one month lag (TMU, para. 38)
    - End-Dec. 2005 — Implemented with a delay
  - 3. Prepare quarterly reports (with one month lag) on status of arrears.(TMU para. 38)
    - End-Dec. 2005 — Implemented with a delay
  - 4. Strengthen cash management and expenditure monitoring procedures by preparing reports as indicated in the TMU (para. 40 )
    - End-Mar. 2006 — Not implemented
  - 5. Complete impact analysis of tighter credit quality classifications on commercial bank balance sheets (TMU, para. 39)
    - End-Mar. 2006 — Implemented
  - 6. Reduce import backlog of commercial bank foreign exchange applications for import-related payments, as defined in the TMU (para. 46)
    - End-Mar. 2006 — Implemented
  - 7. Eliminate import backlog of commercial bank foreign exchange applications for import-related payments (TMU para. 46)
    - End-Jun. 2006 — Implemented
  - 8. Develop and implement new travel policy, which includes mechanisms for monitoring adherence (TMU, para. 37)
    - End-Sept 2006
  - 9. Formulate an action plan to address weaknesses in the area of PFM (TMU para. 45)
    - End-Oct. 2006

### Schedule of disbursements under the Three-Year PRGF Arrangement (In millions of SDRs)
- Amounts and conditions necessary for disbursement:
  - 5.4190 — Aug-05 — Executive Board approval of three-year PRGF arrangement
  - 4.9245 — Feb-06 — Completion of 1st review and observance of end-Sep. 2005 PCs
  - 4.9245 — Aug-06 — Completion of 2nd review and observance of end-Dec. 2005 PCs
  - 6.6800 — Dec-06 — Completion of 3rd review and observance of end-Jun. 2006 PCs
  - 6.6800 — May-07 — Completion of 4th review and observance of end-Dec. 2006 PCs
  - 4.7710 — Nov-07 — Completion of 5th review and observance of end-Jun. 2007 PCs
  - 4.7710 — May-08 — Completion of 6th review and observance of end-Dec 2007 PCs
  - Total proposed: 38.1700 1/ (Equivalent to 55 percent of Malawi's quota (SDR 69.4 million).)

### Indicators of Fund credit, 2005–18 (selected figures)
- Fund credit outstanding (In millions of SDRs)
  - 52.6
  - 51.3
  - 49.3
  - 48.7
  - 44.6
  - 42.0
  - 39.2
  - 32.8
  - 24.4
  - 16.8
  - 9.1
  - 3.1
  - 0.5
  - 0.0
- Fund credit outstanding (In millions of U.S. dollars)
  - 80.4
  - 78.5
  - 75.6
  - 74.6
  - 68.3
  - 64.4
  - 60.0
  - 50.3
  - 37.3
  - 25.7
  - 14.0
  - 4.7
  - 0.7
  - 0.0
- Proposed disbursement (In millions of SDRs)
  - 5.4
  - 16.5
  - 11.5
  - 4.8
  - 0.0
  - 0.0
  - 0.0
  - 0.0
  - 0.0
  - 0.0
  - 0.0
  - 0.0
  - 0.0
  - 0.0
- Fund total charges and interest
  - 0.816
  - 1.0
  - 0.8
  - 0.7
  - 0.6
  - 0.6
  - 0.6
  - 0.6
  - 0.5
  - 0.5
  - 0.5
  - 0.4
  - 0.4
  - 0.4
- Net use of Fund resources, after HIPC assistance
  - -6.4
  - -1.0
  - -2.8
  - -1.2
  - -4.7
  - -3.2
  - -3.5
  - -6.9
  - -9.0
  - -8.1
  - -8.1
  - -6.5
  - -3.0
  - -0.9
- Fund credit outstanding in percent of Exports of goods and nonfactor services
  - 14.2
  - 12.8
  - 11.9
  - 11.4
  - 10.1
  - 8.7
  - 7.5
  - 5.8
  - 4.0
  - 2.6
  - 1.3
  - 0.4
  - 0.1
  - 0.0
- Memorandum items:
  - Quota (in millions of SDR)
    - 69.4 (repeated for projection years)
  - Export of goods and nonfactor services (in millions of U.S. dollars)
    - 566
    - 614
    - 636
    - 657
    - 678
    - 738
    - 799
    - 862
    - 929
    - 1,001
    - 1,079
    - 1,163
    - 1,254
    - 1,352
  - Gross official reserves (millions of U.S. dollars)
    - 159
    - 118
    - 211
    - 303
    - 366
    - 447
    - 512
    - 542
    - 575
    - 609
    - 646
    - 685
    - 726
    - 769

### Supplement to MEFP — FY2005/06 update and policy measures
- Key points from the Supplement to the Memorandum of Economic and Financial Policies (August 7, 2006):
  - Implementation and reviews:
    - The first review of the PRGF-supported program was completed on February 6, 2006.
    - The Government requests completion of the second review and the third disbursement of SDR4.9245 million.
    - Requests waivers for nonobservance of structural performance criteria relating to the budget ceilings module and the new travel policy.
    - The Government expects the new travel policy to be implemented by end-September 2006 and agrees it should be a structural benchmark for the third review.
  - FY2005/06 performance:
    - Government met all quantitative performance criteria for end-December 2005 and the indicative target on reserve money, but missed the indicative target on discretionary government spending due to food security outlays.
    - Food crisis increased budget expenditures by MK 4.5 billion, offset by MK 3.6 billion in higher donor support and commercial maize sales receipts.
    - A database of all government employees was compiled (performance criterion); a wage schedule was completed (structural benchmark).
    - Identified payroll errors led to an estimated overrun of approximately MK 700 million; overpayments were clawed back in the fourth quarter.
  - Macroeconomic outlook and policies:
    - Prospects for 2006: GDP growth around 8½ percent; inflation projected to decline to 7.9 percent by December 2006.
    - Exchange rate depreciation by end-May 2006 of over 12 percent since mid-January 2006.
    - Objective of monetary policy: price stability anchored by a reserve money target; continued flexibility of interest and foreign exchange rates.
    - Liquidity Reserve Requirement reduced in February 2006 to lower intermediation costs; steps taken to mop up excess reserves and shift toward indirect instruments (treasury and RBM bills).
    - Import backlog reduced from approximately US$78 million in early 2006 to US$54 million at end-March 2006 (structural benchmark), to US$12.7 million by end-June 2006, and subsequently eliminated in late July 2006.
    - Through end-2006, additional IMF debt relief under the MDRI expected to allow reserves to about two months import coverage.
  - Fiscal policy and FY2006/07 budget:
    - Fiscal performance through the second quarter better than programmed due to AfDB refund (interim HIPC assistance), delays in food security outlays, and postponed wage increases.
    - Third quarter negatively affected by large increase in food security transactions.
    - FY2005/06 wage increase implemented retroactive from December 2005; payroll adjustments addressed unauthorized compensation.
    - For the full fiscal year, target for domestic borrowing will not be fully achieved largely because of increased food security transactions and other expenditures; buoyant tax revenues and AfDB debt relief refund will offset part of the additional expenditures.
    - FY2006/07 budget aims to repay domestic debt, include tax cuts in individual income tax, and achieve an improvement in the underlying balance to over 1 percent of GDP and reduce domestic debt to about 16 percent of GDP.
    - Passage of a budget in line with the program is a prior action for the second review.

*Source: Malawi — Supplement to the Memorandum of Economic and Financial Policies and related tables (August 7, 2006).*

### 14. Expenditures will be contained in the following key areas:

### 14. Expenditures will be contained in the following key areas:

### Expenditure containment: Wages, Pensions, Recurrent Expenditures
- Wages: seek to limit wage increases to compensate for overruns in the previous two fiscal years; objective to bring the wage bill as a percent of GDP to a lower level as that programmed for FY2005/06.
- Pensions: under the current formula, pension costs are expected to increase significantly in FY06/07 because of the October 2004 wage reform.
  - Policy action: adjust the pension formula, mainly by adopting a lower accrual rate to limit the increase in the pension bill for FY06/07 (a prior action), with a view to ensuring the long-term viability of the existing pension system.
- Recurrent Expenditures: new policies developed and implemented on housing, the use of government vehicles, and administrative measures to prevent new utility arrears.

### Other important budget items: maize, fertilizer, arrears repayment, parliament building
- Maize:
  - Operations remain integral to the budget.
  - Expecting a bumper crop; operations limited to replenishing 60,000 tons in the Strategic Grain Reserve, with donor support as well as own resources, and continuing sales of maize through ADMARC depots (40,000 tons).
  - Maize will be sold at market prices to ensure full cost recovery.
- Fertilizer:
  - Aim to import 150,000 tons of fertilizer for sale at a subsidized price.
  - Total cost of the subsidy is projected at MK 7.3 billion.
- Arrears Repayment:
  - In 2005, Cabinet approved a policy paper to address the large stock of domestic arrears; policy now being implemented.
  - Budget allocation increased to MK2 billion for domestic arrears reduction.
- Parliament Building:
  - Budget will include MK 0.7 billion for preliminary construction costs.
  - Early estimates suggest total cost could be MK 6 billion spread over several budget cycles.
  - Commitment to ensure costs are manageable and to identify donor support; ensure all expenses properly budgeted.

### Malawi Development Corporation (MDC)
- MDC restructuring in process, reflecting poor performance and failure to service debts.
- Privatization commission will prioritize and liquidate assets sufficient to cover outstanding debt.

### Structural reforms — overview
- Structural reform agenda for FY2006/07 and beyond highlights public financial management (PFM), central bank independence, and the financial sector.
- Reforms aligned with the Malawi Growth and Development Strategy (MGDS).

### Public Financial Management (PFM)
- Context: MDRI and possible future scaling-up of donor flows make improving PFM systems imperative.
- 2004 performance: Malawi met about one-third of the benchmarks in the Assessment and Action Plan for HIPCs. Areas for improvement included budget comprehensiveness, internal control and reconciliation in budget execution, and audited financial reports.
- Action plan: being developed with donors to prioritize reforms, describe existing donor support, and identify remaining technical assistance needs; expect completion by end-October 2006 (structural benchmark).
- IFMIS and centralized payment system:
  - Phased in a new Integrated Financial Management Information System (IFMIS) and centralized payment system to improve expenditure control and tracking.
  - IMF technical assistance and the U.S. Millennium Challenge Threshold program will support implementation, including setting up a Government Finance Statistics module.
- Implication for other structural items:
  - Will not devote further resources toward implementing the budget ceiling module (a performance criteria) or measures to strengthen management and expenditure monitoring procedures (structural benchmark) as payments will now largely pass through the centralized payment system (IFMIS).
  - Published reports on the budget and expenditure arrears (structural benchmarks), albeit with some delay.

### Financial Sector and Central Bank Independence
- Banking supervision:
  - Completed an impact analysis of commercial bank balance sheets (a structural benchmark) using asset classifications consistent with international best practice.
  - Implemented new directives governing classification and provisions.
  - Begun liquidation procedures for Finance Bank; expect process to be completed within six months. Finance Bank was closed and placed under RBM management in mid-2005; lack of a suitable buyer led to liquidation decision.
  - Anticipate receiving an FSAP in early 2007.
- Safeguards and governance at RBM:
  - Implemented recommendations from the safeguards assessment: reconstituted the Board of Directors of the RBM in March 2006; re-established an audit committee; formally adopted a rotation policy for external auditors.
  - Expanded disclosures in the financial statement, including disclosures on the amount of foreign reserves under the control of the Treasury.
- Central bank independence:
  - Final recommendation of the safeguards assessment to be guided by the regional SADC initiative.
  - A SADC model law is expected to be finished shortly; aim to adopt a version for Malawi as soon as feasible.
  - Law should ensure the Board of Directors, including the Governor and the Deputy Governor, can be removed only for legal cause and after due process.

### HIPC Completion Point
- Objective: reach the HIPC Initiative completion point by mid-2006.
- Progress on completion point triggers, poverty reduction strategy, and debt reconciliation.
  - HIPC triggers: implemented most triggers; expect to request two waivers—one for student enrolment in teacher training institutions and one for the percentage of recurrent expenditures spent on health. Performance on health spending has significantly improved since the implementation of the Health SWAp.
  - Poverty-reduction strategy: Malawi Poverty Reduction Strategy expired in mid-2005; development efforts henceforth guided by MGDS submitted to Cabinet in May 2006. Finalized the third Annual Progress Report covering July 2004 to end-2005.
  - External debt: reconciled and confirmed with creditors debt data used at the HIPC decision point for end-1999, and debt data for end-2005.
- MDRI debt relief:
  - At completion point, qualify for debt relief under the MDRI.
  - IMF debt relief will be transferred to the government on a flow basis as the debt service falls due.
  - Budget will incorporate debt relief under the MDRI from the World Bank and also from the AfDB later in the fiscal year.
  - Any increase in resource inflows will be incorporated in a supplementary budget.
  - Resources expected to be used to help Malawi meet the Millennium Development Goals.
  - Revised definition of pro-poor expenditures in cooperation with donors, civil society, and other stakeholders to better target use of resources.

### Program monitoring
- PRGF-supported program to be monitored quarterly based on quantitative and structural measures in tables 1 and 2; targets defined in the Technical Memorandum of Understanding (TMU).

### Box 1 — Food Security in FY05/06 (summary of operations and fiscal impact)
- Logistical difficulties and higher purchase and transportation costs hampered food security efforts during the crisis.
- Early 2006: increased food security operations to meet higher estimates of food needs before new crop harvested starting in late March.
- Additional imports and distribution actions:
  - Imported additional maize for sale at subsidized prices through Admarc and distributed food supplements at no cost to the most vulnerable.
- Budget impact:
  - Budget expenditures estimated to have increased by MK 4.5 billion (to about MK 17.5 billion), the larger part financed by donors (mostly the UK) and higher sales receipts.
  - Net cost to the budget estimated to have increased by MK 0.9 billion from MK 3.6 billion to MK 4.5 billion.
- Humanitarian SGR relief:
  - Relief efforts through the Strategic Grain Reserve did not change significantly since late 2005; higher purchase and transportation costs fully met by donors.
  - Distributed about 167,000 tons of maize, of which 40,000 tons were purchased using own resources.
  - Purchase and distribution of food supplements fully funded by donors.
- Commercial sales:
  - Budget allowed purchase and sale of 50,000 tons at subsidized prices by Admarc using own resources; under pressure this rose to 68,000 tons by November and to 93,000 tons.
  - Subsidy cost to the budget increased by MK 0.7 billion to MK 1.2 billion.
- Fertilizer and seeds:
  - Budget allowed for 137,000 tons of fertilizer to be imported and sold at subsidized prices; later increased by 10,000 tons (i.e., 147,000 tons total).
  - Scheme allowed for sale of 6,000 tons of seeds.
  - Higher costs increased estimated subsidy costs for fertilizer and seeds by MK 1.5 billion to MK 6.9 billion.

### Malawi: Government Maize Transactions in FY2005/06 (selected figures, thousand metric tons)
- Carry over: 51 (SGR 31; Commercial 20)
- Purchases for FY05/06: 209 (SGR 136; Commercial 73)
  - SGR replenishment FY05/06: 29 (other SGR purchases 105; of which GoM 40)
  - Commercial purchases: 73
- Total distribution: 260 (SGR 167; Commercial 93)

### Quantitative targets and selected numeric program details (selected figures preserved exactly as in source)
- Ceiling on central government's wages and salaries (end-Dec. 2005 actual): 15,356
- Ceiling on central government's wages and salaries (Proj. End-Jun. 2006 test date): 26,158; End-Sep. 2006 target: 31,956
- Ceiling on central government's discretionary expenditures (Proj. End-Jun. 2006 test date): 59,209; End-Sep. 2006 target: 73,897; End-Dec. 2006 target: 90,413
- Floor on net foreign assets of the monetary authorities (Millions of U.S. dollars) (Proj. End-Jun. 2006 test date): 25.9; End-Sep. 2006 target: 71.4; End-Dec. 2006 target: 41.7
- Balance of payments support (In millions of U.S. dollars) (Memorandum items): 144.5; 137.8; 159.0; 167.4 (columns shown)
- Cash payment of arrears (Memorandum items): 2,000; 2,000; 2,500; 3,000 (columns shown)
- Program exchange rate: 123 (columns shown)
- Liquidity Reserve Requirement: 27.5; 20.0; 20.0; 20.0 (columns shown)

### Prior actions, performance criteria and structural benchmarks (selected items and status)
- Prior actions (for completion of the Second Review under the PRGF arrangement):
  - Parliament approval of 2006/07 budget in line with macroeconomic framework specified in the TMU (para. 34) — August 2006 — Implemented.
  - Implement adjustment formula to the current pension system. (TMU para 35) — Status: Performance Criteria.
- Performance Criteria (examples):
  - Make budget ceilings module in payment system fully operational (TMU, para. 36) — End-Dec. 2005 — Not implemented.
  - Develop and implement new travel policy, which includes mechanisms for monitoring adherence (TMU, para. 37) — End-Mar. 2006 — Not implemented.
- Structural Benchmarks (examples):
  - Develop detailed schedule of wage adjustments by grade for 2005/06 — End-Sep. 2005 — Implemented in February 2006.
  - Publish monthly fiscal reports with one month lag (TMU, para. 38) — End-Dec. 2005 — Implemented with a delay.
  - Prepare quarterly reports (with one month lag) on status of arrears (TMU para. 38) — End-Dec. 2005 — Implemented with a delay.
  - Complete impact analysis of tighter credit quality classifications on commercial bank balance sheets (TMU, para. 39) — End-Mar. 2006 — Implemented.
  - Reduce import backlog of commercial bank foreign exchange applications for import-related payments (TMU, para. 46) — End-Mar. 2006 — Implemented.
  - Eliminate import backlog of commercial bank foreign exchange applications for import-related payments (TMU para. 46) — End-Jun. 2006 — Implemented.
  - Develop and implement new travel policy, which includes mechanisms for monitoring adherence (TMU, para. 37) — End-Sept 2006 — (status listed).
  - Formulate an action plan to address weaknesses in the area of PFM (TMU para. 45) — End-Oct. 2006 — (status listed).

*Source: _cr06445 - 14. Expenditures will be contained in the following key areas:*

### APPENDIX I—ATTACHMENT II

### APPENDIX I—ATTACHMENT II

### Coverage
- Central government: all units exercising authority over the entire economic territory; nonprofit institutions controlled and financed by the central government are excluded for the purposes of this memorandum.
- Monetary authorities accounts include the Reserve Bank of Malawi (RBM) and the central government’s holdings of international reserves.
- Monetary aggregates are based on the three-bank monetary survey.

### I. QUANTITATIVE PERFORMANCE CRITERIA

A. Floor on Net Foreign Assets (NFA) of the Monetary Authorities
- Definition: NFA = gross foreign assets minus gross foreign liabilities; valued in U.S. dollars; monetary gold valued at the fixed RBM accounting rate. Counterpart entry to central government international reserve assets classified as negative “net credit to central government”.
- Gross foreign assets (reserve assets) include: (1) monetary gold holdings of the RBM; (2) holdings of SDRs; (3) the reserve position in the IMF; (4) central government (treasury) holdings with crown agents; (5) holdings of convertible, liquid, and unpledged claims on non-residents (deposits abroad, foreign securities). Exclusions: foreign currency claims on residents; capital subscriptions in international institutions; assets in nonconvertible currencies; encumbered or pledged gross reserves; transfers of foreign currency claims to monetary authorities just prior to reporting dates with reversals soon after.
- Gross foreign liabilities include: (1) outstanding liabilities of the RBM to the IMF; (2) all short-term foreign currency liabilities of the RBM to non-residents with original maturity up to, and including, one year.
- Adjustment clauses:
  - Balance of payments support: floor on NFA adjusted upward (downward) by the full amount by which cumulative receipts from balance of payments support are greater (less) than the program baseline. Downward adjustment capped at US$10 million. Balance of payments support measured as cumulative flow from June 30, 2005. Definition: all grants and foreign financing not linked to additional budgetary expenditure; excludes external project financing (including EU food security funding and Tokyo-Mitsubishi account) and IMF loan financing.
  - Debt service payments: floor on NFA adjusted upward (downward) by full cumulative amount by which debt service payments to the World Bank and the ADB fall short of (exceed) the program baseline. Cumulative amount measured from June 30, 2006.

B. Ceiling on Net Domestic Assets (NDA) of the RBM
- Definition: NDA = reserve money minus net foreign assets valued at the program exchange rate (end-March 2006) of MK123 per US$1.
- Reserve money: currency issued by the RBM and balances of commercial banks’ accounts with the RBM; includes required reserves held for Malawi kwacha deposits and other domestic currency reservable liabilities and other demand and time deposits held with the RBM.
- Adjustment clauses:
  - Balance of payments support: ceiling on NDA adjusted downward (upward) by full amount by which cumulative receipts from balance of payments support are greater (less) than the program baseline. Upward adjustment capped at US$10 million. Balance of payments support converted to Malawi kwacha using the program exchange rate.
  - Liquidity reserve requirement: ceiling on NDA adjusted downward for a decrease in the reserve requirement ratio and upward for an increase. Adjuster = (one minus percentage of reserve assets held at the discount houses) × (program baseline required reserve ratio − new required reserve ratio) × (amount of reservable deposit liabilities in commercial banks as at end of the quarter prior to the change).
  - Debt service payments: ceiling on NDA adjusted downwards (upwards) by full cumulative amount by which debt service payments to the World Bank and the ADB fall short of (exceed) the program baseline. Cumulative amount measured from June 30, 2006.

C. Ceiling on Central Government’s Domestic Borrowing (CGDB)
- Definition: CGDB = sum of (i) net borrowing from the RBM (ways and means advances, loans, holdings of local registered stocks, holdings of treasury bills minus deposits), (ii) net borrowing from commercial banks (advances, holdings of local registered stocks, holdings of treasury bills minus deposits), (iii) net borrowing from nonbanks (holdings of local registered stocks, holdings of treasury bills, supplier credits minus government deposits held at the Malawi Savings Bank), and (iv) holdings of promissory notes. Treasury bills and local registered stocks valued at cost. Excluded: promissory notes issued to cover RBM’s operational losses in 2002 and 2003. Ceiling measured as cumulative flow from June 30, 2005.
- Definitions of arrears:
  - June 2004 domestic arrears: all domestic arrears for which the obligation to pay was established on or before June 30, 2004.
  - Domestic arrears: overdue central government payment obligations (wages and salaries, pensions, transfers, domestic interest, goods and services, court obligations, legally established compensation, payments to MRA for tax refunds). Wages/salaries/pensions/transfers/court/compensation: arrears when unpaid more than 30 days beyond due date. Domestic interest: arrears when not paid on the due date. Goods and services: arrears if not paid within 30 days of invoice date or within contractually agreed grace period.
- Adjustment clauses:
  - Balance of payments support: ceiling on CGDB adjusted downward (upward) by full amount by which cumulative receipts from balance of payments support are greater (less) than the program baseline. Upward adjustment capped at US$10 million.
  - Securitization of arrears: ceiling on CGDB adjusted upward by full amount by which pre-2005 domestic arrears are securitized.
  - Cash payment of arrears: ceiling on CGDB adjusted downward by full amount by which payments for verified pre-2005 domestic arrears are less than the program baseline. Only payments charged against the Accountant General vote and reported by the Accountant General are recognized.
  - Maize revenue: ceiling on CGDB adjusted upward (downward) by full amount by which cumulative receipts from sale of commercial maize through ADMARC and deposited in the RBM maize account is less (greater) than the program baseline.
  - Donor pool account for health SWAp: ceiling on CGDB adjusted downward (upward) by full amount by which the change (in kwacha) of the stock in the U.S. dollar–denominated donor pool account for the health SWAp at the RBM is larger (smaller) than the change (in kwacha) of the stock in that account in the program baseline. Change measured relative to stock as of June 30, 2005. Stocks stated with a positive sign.
  - National Aids Commission (NAC) accounts: ceiling on CGDB adjusted downward (upward) by full amount by which the change (in kwacha) of the stock in the accounts of the NAC held in the Malawi banking system is larger (smaller) than the change (in kwacha) of the stock in those accounts in the program baseline. Stock determined on basis of quarterly financial reports of the NAC. Change measured relative to stock as of June 30, 2005. Stocks stated with a positive sign.
  - Transfer of IMF debt relief from the RBM: ceiling on net CGDB adjusted downwards (upwards) by full amount by which the cumulative debt relief provided by the IMF under the HIPC Initiative and the MDRI at the HIPC completion point and transferred by the RBM to the Government of Malawi exceeds (falls short of) the program baseline. Cumulative amount measured from June 30, 2006.
  - Debt service payments: ceiling on net CGDB adjusted downwards (upwards) by full cumulative amount by which debt service payments to the World Bank and the ADB fall short of (exceed) the program baseline. Cumulative amount measured from June 30, 2006.

D. Ceiling on Central Government Wages and Salaries
- Definition: includes all payments classified as personnel emoluments in government budgets and accounts, including payments on arrears of personnel emoluments and allowances. Ceiling measured as cumulative flow from June 30, 2005.
- Adjustment clause:
  - Donor-funded wages and salaries in the health sector: ceiling adjusted upward (downward) by full amount of donor-funded supplementary wages and salaries for the health sector that is greater (less) than the program baseline.

E. Ceiling on External Payments Arrears
- Definition: external payment arrears consist of external debt-service obligations (principal and interest) not paid at the time due as specified in contractual agreements, except on external debt subject to rescheduling or restructuring.
- Continuous performance criterion: nonaccumulation of external payment arrears on external debt contracted or guaranteed by the central government, the RBM, or other agencies on behalf of the central government or the RBM.

F. Ceiling on Nonconcessional External Debt
- Definition: debt definition per Executive Board Decision No. 6230-(79/140) of August 3, 1979, as amended by Decisions No. 11096-(95/100), October 25, 1995; and 12274-(00/85) August 24, 2000. For program purposes, short-, medium-, and long-term debt is nonconcessional if grant element < 35 percent (Decision No. 11248-(96/38), April 15, 1996).
- Coverage: contracting and guaranteeing by the central government, the RBM, or other agencies on behalf of the central government or the RBM, on debt with nonresidents. Applies to debt and commitments contracted or guaranteed for which value has not been received. Ceiling measured cumulatively from June 30, 2005.
- Maturity classifications:
  - Short-term debt: outstanding stock with original maturity of one year or less.
  - Medium- and long-term debt: outstanding stock with maturity of more than one year.
- Exclusions from the limit:
  - Use of Fund resources.
  - Any kwacha-denominated treasury bill and local registered stock holdings by nonresidents.
  - Debts classified as international reserve liabilities of the RBM.
  - New debt issued to restructure, refinance, or repay existing debt up to amount actually used for those purposes.
  - Normal import financing (financing considered “normal” when credit is self-liquidating).
  - Arrangements to pay over time obligations arising from judicial awards to external creditors.

### II. QUANTITATIVE INDICATIVE TARGETS

A. Ceiling on Reserve Money
- Definition: reserve money = currency issued by the RBM + balances of commercial bank accounts with the RBM. Includes required reserves held for kwacha deposits, other domestic currency liabilities, and other demand and time deposits held with the RBM.

B. Ceiling on Central Government Discretionary Expenditures
- Definition: expenditures excluding (i) wages and salaries, (ii) interest payments, and (iii) foreign-financed development expenditures (development Part I expenditures) related to specific projects.
- Included: statutory nonvoted expenditures for pensions and gratuities, compensation and refunds; other recurrent expenditures (ORT); domestically financed development expenditures (development Part II); net lending; recurrent and development Part II expenditures with donor cash financing; maize purchases for the Strategic Grain Reserve; purchases financed from the Japan debt relief account; expenditures in the health sector financed from the donor pool account in the RBM for the health SWAp.
- Measurement: ceiling measured as cumulative flow from June 30, 2005.
- Adjustment clause:
  - Donor-funded central government discretionary expenditures in health sector: ceiling adjusted upward (downward) by full amount of donor-funded central government discretionary health sector expenditures greater (less) than the program baseline. For resources from the U.S. dollar–denominated donor pool account for the health SWAp at the RBM, donor-funded central government discretionary health sector expenditures deemed made = ‘outflows from the donor pool account to finance expenditures, expressed in Malawi kwacha’ minus ‘donor financed supplementary wages in the health sector’.

### III. STRUCTURAL PRIOR ACTIONS, PERFORMANCE CRITERIA AND BENCHMARKS

- FY2006/07 budget:
  - The FY2006/07 budget passed by parliament should be in line with the program.
- Pension formula:
  - Adjustments to the formula used to calculate an individual’s benefit should allow for a total cost of pensions lower than MK4.8 billion in 2006/07.
- Budget ceiling module (payments system at the RBM):
  - Fully operational budget module requires completion of:
    1. All bank accounts reconciled between the RBM and commercial banks.
    2. All data reconciled between RBM holding accounts and fiscal data according to Ministry of Finance ledgers.
    3. Accountant General’s office provides RBM with list of check numbers for outstanding checks issued against the 2004/05 budget; these checks entered into the payment system to identify float from 2004/05 into fiscal year 2005/06 for the CCA system.
  - RBM to produce tables by CCA category listing funded amounts against total reimbursement for the current fiscal year.
  - Future: Accountant General to develop concordance between budget votes, cost centers, and RBM holding accounts into which CCAs are credited, and produce tables by budget vote.
- Travel Policy:
  - Ministry of Finance to develop and implement (by issuing a circular) a travel policy to ensure accountability and control for all expenditure on travel.
- Publication of Fiscal Reports:
  - Ministry of Finance to publish monthly: the GFS fiscal table, the arrears clearance report, and the report on pro-poor expenditures.
- Impact Analysis (credit classification):
  - Collect information on credits overdue 30 days or more but less than 180 days. Based on this, complete analysis tightening credit quality classification to 90 days for substandard, 180 days for doubtful, and one year for loss.
- Strengthening cash management:
  - Prepare and implement two reports:
    1. Budget execution report based on new monthly table by ministry and expenditure type (PE, ORT, and development, including below-the-line accounts like advances and imprests) showing:
       - approved budget per vote/ministry;
       - funding released to ministries per funding table;
       - commitments made as reported by ministries on commitment control system reports;
       - expenditures as reported by ministries on expenditure returns;
       - payments made according to CCA system.
    2. Amended funding table indicating allocation of funding based on three sources: the MG1 account, automatic payment by standing instruction (e.g., regular foreign payments or withholding), and foreign financing sources.

*Source: APPENDIX I—ATTACHMENT II, Malawi: Technical Memorandum of Understanding*

### 41.      PFM action plan: The Ministry of Finance will develop an action plan that

### PFM action plan: The Ministry of Finance will develop an action plan that

### Public financial management (PFM) action plan
- The Ministry of Finance will develop an action plan that prioritizes reforms, describes existing donor support, and identifies remaining areas of need for technical assistance in the area of public financial management.

### Treatment in the fiscal accounts and balance of payments of certain central government (CG) accounts held abroad
- Bank of Tokyo-Mitsubishi account (Japan):
  - Purpose: set up for the delivery and administration of Japanese debt relief.
  - Accounting treatment:
    - Disbursements of cash debt relief into the account are accounted as grants with corresponding amounts of foreign financing (increases in the deposit account).
    - Withdrawals from the Bank of Tokyo-Mitsubishi account are accounted as central government expenditures with corresponding amounts of foreign financing (decreases in the deposit account).
    - Expenditures financed from this account are included in spending agencies budgets under current expenditures, or as development Part II expenditures (development expenditures financed by the Government of Malawi).
    - Flows are valued at the end-month exchange rate.
- European Union grants for food security and the food reserve account:
  - Purpose: provide a cash reserve to the Government of Malawi for the purchase of food stuff (in particular maize) at times of food shortages.
  - Accounting and operations:
    - Access to foreign or domestic accounts to administer these resources is determined by agreements between the European Union and the Government of Malawi.
    - Deposits into the account held abroad are recorded as grants with corresponding amounts of foreign financing (increase in deposit accounts).
    - Withdrawals from the account held abroad are recorded as increase in foreign financing.
    - If resources are transferred to Malawi, they are to be held in a bank account in the banking system until needed, and are counted as part of net credit to government.
    - Withdrawals from foreign or domestic accounts for payments to suppliers are recorded as an appropriate expenditure item (e.g., purchase of food stuffs), and a decrease in the respective deposit account.
    - If the food reserve account operates like a revolving fund, all cash inflows are accounted as appropriately classified revenue, and an increase in the deposit account.
    - The balance in the foreign and domestic food reserve accounts is reported separately in the monetary data.

### Reporting of certain transactions in the fiscal accounts
- National AIDS Commission (NAC) operations:
  - Financial operations of the NAC are included in the fiscal accounts according the NAC’s financial reports.
  - Expenditures are typically classified as development Part I expenditures.
  - Government ministries and departments that execute NAC-financed projects report these activities to NAC for inclusion in the NAC’s financial reports.
- Donor pool funded expenditures in support of the Health SWAp:
  - A U.S. dollar-denominated account at the RBM holds donor pool resources until expenditures need to be financed.
  - Donor funded expenditures for the Health SWAp from pooled resources are deemed to have been made in the amount of outflows from the donor pool account to finance expenditures (typically either to Malawi government No. 1 account in Malawi kwacha, or to pay directly for imports by the health sector).
  - Attribution to personnel emoluments, other recurrent transactions, and development Part II is made on the basis of cash flow projections and established donor commitments (e.g., supplementary wages and salaries for professional health cadres).
  - Typically, expenditures for other recurrent transactions are estimated as the residual of outflows less expenditures for wages and salaries less expenditures for development Part II.

### Reporting requirements and data submissions
- Monitoring requirements: information listed in the reporting tables must be reported to the IMF within the specified timeframes.
- New data requirement: a list of the backlog of import applications for foreign exchange will include data by bank and amounts separated by three categories: imports not yet delivered, imports delivered but within the grace period, and imports delivered but outside of the grace period.
- Selected numeric items and frequencies (as presented):
  - Table 1 (Malawi: Program Balance of Payments Support and Debt Service Obligations, FY2005/06 and FY2006/07) — Balance of payments support (Grants, IDA, UK, Norway) and Loans (IDA, ADB):
    - Balance of payments support (Grants) entries include: 60.2, 35.7, 20.0, 52.7, 3.0, 3.0, 28.1, 21.9, 116.3, 119.5, 91.4, 21.2, 0.0
    - EU entries: 18.8, 0.0, 0.0, 17.5, 0.0, 0.0, 28.1, 21.9, 51.7, 45.6, 17.5, 0.0, 0.0
    - IDA grants/loans entries: 0.0, 0.0, 20.0, 29.9, 0.0, 0.0, 0.0, 0.0, 20.0, 29.9, 29.9, 0.0, 0.0
    - UK entries: 38.2, 35.7, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0, 38.2, 35.7, 35.7, 17.5, 0.0
    - Norway entries: 3.2, 0.0, 0.0, 5.3, 3.0, 3.0, 0.0, 0.0, 6.4, 8.3, 8.3, 3.7, 0.0
    - Loans totals and IDA loan entries: 0.0, 0.0, 25.0, 0.0, 25.0, 0.0, 0.0, 24.5, 25.0, 25.0, 24.5, 0.0, 8.4
    - Total row: 60.2, 35.7, 45.0, 52.7, 28.0, 3.0, 28.1, 46.4, 141.3, 144.5, 116.0, 21.2, 8.4
    - Cumulative total row: 60.2, 35.7, 105.2, 88.4, 116.4, 91.4, 144.5, 137.8, 141.3, 144.5, 116.0, 159.0, 167.4
    - Debt service payments: IDA 5.1, 0.2; AfDB 1.9, 0.2; Total 7.0, 0.4; Cumulative 7.0, 7.4
    - Pass-through of debt relief from the RBM to the GoM: IMF 4.5, 8.7; Cumulative 4.5, 13.2
  - Table 2 (Malawi: Program Maize Revenue, Health SWAp, and NAC Funds, FY2005/06 and FY2006/07) — selected figures (In millions of Malawi kwacha):
    - Maize revenue quarterly receipts: 170, 300, 334, 454, 391, 298, 0, 0, 1,344, 1,157, 1,051, 40, 320
    - Health SWAp revenues and expenditures and components (selected):
      - Revenues entries: 754, 1,496, 1,840, 585, 883, 1,576, 2,159, 2,136, 5,466, 5,139, 5,792, 2,163, 928
      - Expenditures entries: 1,193, 1,563, 1,227, 0, 1,164, 980, 1,882, 2,913, 4,930, 4,603, 5,457, 0, 2,923
      - Wage expenditures entries: 177, 138, 181, 199, 184, 159, 408, 234, 730, 730, 730, 247, 253
      - ORT expenditures entries: 1,016, 1,417, 1,046, -199, 980, 793, 1,474, 2,649, 4,200, 3,873, 4,660, -247, 2,637
      - Change in account balance entries: -439, -68, 613, 585, -281, 595, 277, -778, 536, 536, 335, 2,163, -1,995
    - Inflows to RBM (US$ millions): 10, 21; Cumulative total: 10, 31
    - National AIDS Commission (NAC) revenues and expenditures:
      - Revenues entries: 1,269, 455, 1,309, 1,928, 1,340, 264, 1,364, 564, 5,282, 3,320, 3,211, 1,413, 1,445
      - Expenditures entries: 1,269, 768, 1,309, 1,706, 1,340, 506, 996, 231, 5,282, 3,320, 3,211, 1,413, 1,445
      - Change in account balance entries: 0, -313, 0, 222, 0, -241, 368, 333, 0, 0, 0, 0, 0
      - Inflows to RBM (US$ millions): 10, 10; Cumulative total: 10, 20
  - Reporting items and frequencies (selected entries from Table 3):
    - Gross international reserves, exchange rate, and foreign exchange purchases and sale — D/RB/M 2F E
    - Reserve money, OMO transactions, and RBM conversion of treasury bills — D/RB/M 2F E
    - Treasury bill and RBM bill auction results — W/RB/M W 2F E
    - RBM balance sheet and broad money estimate — W/RB/M 7F E
    - Backlog of import applications for foreign exchange — W/RB/M 7F E
    - Four-bank monetary survey — M/RB/M M 30 30 E
    - International Reserve and Foreign Currency Liquidity Data Template — M/RB/M M 30 30 E
    - Central government domestic borrowing — M/RB/M M 30 30 E
    - Fiscal table (GFS) including revenue, expenditure, and financing — M/MOF M 30 30 E
    - Bank statements of both the Health SWAp and government maize account held at the RM — RB/M M 30 30 E
    - Annual audited financial statements of the ten major parastatals and MSB — A/MOFA 90 Mar. 30 H
    - Consumer price index and monthly statistical bulletin — M/NSO M 30 30 E
    - Balance of payments, and quarterly statistical bulletin — Q/NSO Q 45 T 15 E
    - National accounts, balance of payments, and quarterly statistical bulletin — A/NSO BA 45 Mar. 15 E
    - Frequency code legend: D-Daily, W-Weekly, M-Monthly, Q-Quarterly, BA-Bi-annual, A-Annual; F-Friday, 30-Every 30th, T30-Every third 30th; E-Electronic, H-Hard copy
    - Footnotes:
      - 1/ Detailed information on the amounts, currencies, terms, and conditions, including debt contracted or guaranteed by the RBM or any other agency on behalf of the central government.
      - 2/ To be reported by DAMD, including a detailed explanation.
      - 3/ Ten major parastatals listed.

### Appendix II — Selected IMF relations and macro figures (as of June 30, 2006)
- Membership status:
  - Joined 07/19/1965; Article VIII (December 7, 1995)
- General Resources Account (SDR million and percent quota):
  - Quota 69.40 — 100.0
  - Fund holdings of currency 77.96 — 112.33
  - Reserve position in Fund 2.29 — 3.30
- SDR Department (SDR million and percent allocation):
  - Net cumulative allocation 10.98 — 100.0
  - Holdings 0.75 — 6.80
- Outstanding purchases and loans (SDR million, percent quota):
  - PRGF arrangements 37.37 10.84 58.35 15.63
- Financial arrangements (PRGF approvals and drawings):
  - PRGF 8/5/2005 — 8/4/2008 — Amount Approved 38.17 (SDR million) — Amount Drawn 10.34 (SDR million)
  - PRGF 12/21/2000 — 12/20/2004 — Amount Approved 45.11 — Amount Drawn 12.88
  - PRGF 10/18/1995 — 12/16/1999 — Amount Approved 50.96 — Amount Drawn 50.96
- Projected obligations to the Fund (millions of SDRs; based on existing use of resources and present SDR holdings):
  - Principal and Charges/Interest and Total by year (presented as columns): 
    - Principal: 2006 8.55; 2007 13.41 5.37 4.10 2.58 (layout preserved as in source)
    - Charges/Interest: 0.54 0.74 0.50 0.48 0.46
    - Total: 9.09 14.14 5.88 4.58 3.04
- HIPC Initiative implementation (selected):
  - Decision point date 12/21/00
  - Assistance committed (NPV terms) — Total assistance (US$ million) 643.00
  - Of which: Fund assistance (SDR million) 23.14
  - Delivery of Fund assistance (SDR million): Amount disbursed 11.57; Interim assistance 11.57; Completion point 0.00; Total disbursements 11.57
- Safeguards assessments (RBM):
  - A safeguards update completed in January 2006 found that new vulnerabilities had emerged in governance and financial reporting.
  - Recommendations included:
    - (i) reconstitution of the RBM board of directors, which was dissolved in August 2005, and subsequent reestablishment of an audit committee;
    - (ii) expansion of explanatory notes in the financial statements to include advances to the government and a letter of credit financial commitments;
    - (iii) strengthening of the central bank law provisions on the appointment and dismissal of board members.
- Exchange arrangements:
  - The exchange rate of the Malawi kwacha is a managed-float.
  - On June 27, 2006, the exchange rate was MK 138.99 = US$1.00.
- Technical assistance (selected mission entries and dates):
  - 9/01 1½ weeks FAD Ministry of Finance — Expenditure tracking and fiscal ROSC Mission
  - 11/01 2 weeks MAE RBM — Monetary operations and further developing financial markets Mission
  - 02/02 2 weeks FAD Ministry of Finance — Expenditure policy Mission
  - 05/02 6 months FAD Ministry of Finance — Expenditure management Advisor
  - 07/02 2 weeks STA NSO, RBM — GDDS Anglophone project on national accounts statistics Mission
  - 08/02 2 weeks STA RBM — Monetary and financial statistics Mission
  - 02/03 2 weeks MAE RBM — Monetary operations, payments system, banking supervision Mission
  - 01/05 2 weeks LEG/MFD RBM — AML/CFT Mission
  - 03/05 2 weeks FAD Ministry of Finance — Tax Policy Mission
  - 12/05 2 weeks MFD RBM — Monetary operations, banking supervision, payments systems, and forex bureaus Mission
- Resident Representative:
  - Mr. Thomas Baunsgaard since August 16, 2004.

*Source: IMF country document content provided.*

### 3.      The World Bank has been active in Malawi since 1966. Total lending and grants to

### The World Bank has been active in Malawi since 1966

### World Bank and IFC engagement: scale, active projects, sectoral allocation
- Total lending and grants to Malawi as of June 2006: US$2,705 million.
- Amount disbursed as of June 2006: US$2,498 million.
- As of June 2006:
  - Number of active projects: 13.
  - Net commitment: US$393.6 million.
  - Undisbursed balance: US$144 million.
- Sectoral breakdown:
  - Rural: 19 percent.
  - Transport: 8 percent.
  - Public and Private Sector Development and Finance: 38 percent.
  - Social Sectors: 36 percent.
- IFC investments in Malawi:
  - Two investments, totaling US$1.16 (US$0.64 million in loans and US$0.52 million in equity).
  - 44 percent in capital markets and the balance in health.
- Stated future IFC focus: expanded assistance for the private sector, especially in manufacturing, mining, and tourism.

### Education and Health (Bank leads)
- Multi-Sectoral AIDS Project:
  - Financing: US$35 million in grants.
  - Approved: FY04.
  - Objectives: reduce HIV transmission and mitigate impact; capacity building in public, private, and civil society organizations; educational prevention work; increased support for AIDS orphans.
  - Timeline: scheduled to begin in 2004 and run through 2008.
- Health Sector Support Project for Malawi:
  - Financing: US$15 million in grants.
  - Approved: December 2004.
  - Purpose: improve effectiveness, efficiency, and equity of essential health care delivery via a Sector Wide Approach.
  - Components:
    - Component 1: Increase access to quality essential health services through the Essential Health Package (EHP), prioritizing poorest and vulnerable populations.
    - Component 2: Increase staff availability via continuation of six-year emergency training plan, recruitment campaign, financing/filling vacancies, volunteers/contractual staff, and other stop-gap strategies.
    - Component 3: Improve effectiveness and efficiency of health system and referral network to support EHP delivery.
  - Supplementary Malaria Booster project: focus on monitoring and evaluation.
- First Education Sector Support Project:
  - Financing: US$32.2 million in grants.
  - Approved: May 2005.
  - Components (six):
    - Improve quality and expand teacher development and training at all levels.
    - Improve conditions of learning at selected secondary schools staffed with trained or newly trained teachers.
    - Provide School Health and Nutrition package to all primary schools, including distribution of vitamin A and iron-folic acid to school children under 10-years-old, de-worming, treatment of malaria and fever, and promotion of good practices.
    - Supply basic learning materials directly to schools and strengthen community participation in school management.
    - Capacity Building and Policy Development: (i) national education policy consolidation and capacity building; (ii) support decentralization policy implementation in education.
    - Support physical implementation and management of fiduciary and procurement issues.

### Social Protection and Community Development
- Malawi Social Action Fund (MASAF):
  - Role: long-term poverty-reduction project supporting decentralization and community capacity building.
  - Objectives: empower individuals/households/communities to manage risks related to health, education, sanitation, water, transportation, energy, and food insecurity; support critically vulnerable populations.
  - Current Project: MASAF III.
    - Financing: US$60 million, of which US$27 million is in the form of an IDA grant.
    - Approved: FY03.
  - Activities: encourage community social safety nets (e.g., skills training for AIDS orphans), facilitate delivery of social services, stimulate community saving and investment.

### Infrastructure
- Road Maintenance Project:
  - Financing: US$30 million.
  - Approved: FY99.
  - Objectives: sustainable improvements in road infrastructure; strengthen institutional framework; reform road sector; address backlog of maintenance and rehabilitation.
- Integrated Infrastructure Services Project:
  - Approval date: June 27, 2006.
  - Primary support: rural energy and transport.
- Pipeline projects mentioned:
  - Water (FY07).
  - Roads (FY08).

### Private Sector
- Privatization and Utility Reform Project (PURP):
  - Financing: US$28.9 million.
  - Approved: FY00.
  - Aim: improve quality and access to economic and physical infrastructure (telecommunications, water, power) by promoting private-sector involvement; support divestiture work and strengthen public enterprises.
  - Status: being restructured to address slow implementation, respond to new challenges, incorporate lessons learned, and improve effectiveness.
- Regional Trade Facilitation Project:
  - Aim: contribute to poverty alleviation through private-sector-led growth by improving access to financing for productive transactions and cross-border trade.
  - Mechanism: set up insurance mechanism against losses caused by political risks, with participating governments as ultimate risk takers to create disincentive to claims.
  - Expected effects: widen scope for private sector activity by extending credit maturities (over one year), create more stable business environment with consistent predictable coverage, and lower risk premium through better risk management.

### Agriculture
- Community-Based Rural Land Development Project:
  - Financing: US$27 million.
  - Board approval: April 2004.
  - Purpose: acquire idle land and transfer it to small farmers to improve food security and commercial opportunities; based on MASAF experience and in partnership with Government and DFID.
  - Rationale: urgent need for more equitable land distribution to provide food security for small farmers.
- Irrigation, Rural Livelihoods, and Agriculture project:
  - Financing: US$40 million.
  - Approved: November 2005.
  - Objective: raise agricultural productivity and net incomes of poor rural households in target districts by providing integrated support—irrigation, advisory services, marketing and post-harvest assets/services, and capacity building.
- Note: Structural Adjustment Credit, FIMAG, also supports agricultural policy reforms (see paragraph 19).

### Environment
- Mulanje Mountain Biodiversity Conservation Project:
  - Financing: US$7 million.
  - Approved: FY01.
  - Objectives: raise awareness about conservation, strengthen Forest Department and local community capacity for conservation, encourage community participation in forest reserve management.
  - MASAF linkage: promotes environmentally sound community development initiatives and funds community resource management projects.

### Poverty Monitoring
- Bank support to National Statistical Office (NSO):
  - Role: technical assistance for poverty monitoring tasks in the PRSP.
  - Through PRSP Trust Fund, Bank assisted government in conducting Second Integrated Household Survey: design, collection, processing, dissemination of household and community-level indicators.
  - A Poverty Assessment is being finalized to provide in-depth analysis of new household data.

### Areas in Which the Bank and the Fund Share the Lead
- Poverty Reduction Strategy (PRSP):
  - Government finalized PRSP: April 2002.
  - Joint IDA-IMF staff assessment presented: July 19, 2002.
  - Boards endorsed strategy: August 2002.
  - First Annual Progress Report (APR) approved: October 2003—indicated MPRSP implementation was limited.
  - Second APR and Joint Staff Assessment Note (JSAN) for July 2003–June 2004 submitted to Boards: July 2005—also indicated limited implementation.
  - Third APR (period July 2004–June 2005) expected: mid-2006.
- Debt Sustainability and Enhanced HIPC Initiative:
  - “Malawi: Decision Point Document for the Enhanced HIPC Initiative” presented to Board: December 8, 2000.
  - Total debt relief assistance equivalent: around $1.0 billion in nominal terms (US$643 million in net present value terms).
  - Debt relief delivery: 55 percent relief on annual debt service due, delivered between January 2001 and December 2020.
  - IDA share: accounts for 51 percent of the entire external debt (and 69 percent of multilateral debt).
- Budgetary Planning, Revenues Administration, and Public Expenditure Reforms:
  - Structural adjustment credits channel Bank assistance to public expenditure management.
  - Fiscal Management and Accelerating Growth (FIMAG):
    - Financing: US$50 million structural adjustment credit.
    - Disbursement: two tranches of US$25 million each released.
    - Focus areas: (i) strengthening public expenditure management, (ii) privatizing state-owned enterprises, (iii) supporting small-holder agriculture and land reform, and (iv) addressing HIV/AIDS.
  - Financial Management, Transparency, and Accountability Project (FIMTAP):
    - Financing: US$24 million.
    - Approved: FY03.
    - Objective: improve civil service and public expenditure management for better allocation and utilization of public resources.
- Civil Service and Wage Reform:
  - Government began implementing study recommendations at the end of 2004, including streamlining allowances, consolidating allowances in income tax base, rationalizing salary grades, and moving toward a unified salary structure.
  - These reforms are supported under the IMF Staff Monitored Program.
- Emergency Assistance:
  - Emergency Recovery Project approved: September 2005.
  - Purpose: support restoration of assets and production following drought-induced emergency in early 2005; enable critical private sector imports to restore assets, investment, and production with minimal disruption.

### Areas in Which the Fund Leads
- Macroeconomic Stability, Fiscal Policy, and Monetary Policy:
  - Challenges identified: history of repeated fiscal slippages and unpredictable monetary policies; rapidly rising level of domestic debt; persistently high level of real interest rates.
  - Fund engagement: work with authorities through financial support and technical assistance to address these challenges.

### Appendix IV — Statistical Issues: scope and deficiencies
- ROSC Data Module (published February 17, 2005):
  - Findings: legal and institutional framework broadly adequate, but shortcomings in scope, accuracy, and reliability of data; scope for strengthening Statistics Act provisions.
  - Need to assign responsibility:
    - Government finance statistics compilation to the Ministry of Finance.
    - Monetary statistics compilation to the Reserve Bank of Malawi.
- GDDS participation:
  - Malawi participating in Fund’s General Data Dissemination System (GDDS).
  - Metadata posted on Dissemination Standards Bulletin Board (DSBB) since December 2002.
  - Fiscal sector and socio-demographic data for health and education updated: March 2004.
  - Other sectors updated: February 2005.
  - Long-term technical assistance program (2004-07) on national accounts provided under a project by Statistics Norway.

### Real Sector Statistics: national accounts, prices, and trade
- General:
  - Real sector statistics need substantial improvements in source data, quality, and timeliness.
  - NSO requires additional resources to meet national accounts quality standards.
- National accounts:
  - NSO compiles national accounts; final estimates are comprehensive (covering GDP from the production side at constant prices, GDP by expenditure at current prices, gross national income and its components, national disposable income and use of disposable income, and the capital and financial accounts).
  - Source data inadequate due to gaps in coverage (especially medium- and small-scale establishments and informal sector activities).
  - Relevant surveys and financial statements are not used to prepare estimates of changes in inventories and household final consumption expenditures.
  - Statistical techniques and validation processes are deficient.
  - Publication lag: national accounts published in Statistical Yearbook and Quarterly Statistical Bulletin with significant lag.
- Prices:
  - Consumer price index (CPI) available on a timely basis.
  - CPI basis: 1997/98 household survey; data collected monthly by regional price collectors.
  - Suggested improvements: use geometric mean as elementary aggregate index formula; apply systematic, comprehensive, and consistent quality adjustment approaches.
- Trade:
  - Preliminary trade estimates available with a lag of two to three months.
  - Trade data received electronically from six major ports.
  - Concerns: adjustment of imports from c.i.f. to f.o.b. prices is not appropriate; no reconciliation with neighboring countries.

### Government Finance Statistics: practical deficiencies affecting program monitoring
- Reporting and data issues:
  - Some fiscal data reported on a cash basis to AFR; administrative records are manual but systems designed to provide adequate information.
  - Serious quality problems and inconsistencies complicate program monitoring:
    - Tax revenue data timely, but reconciliation with deposits in the MG Account No. 1 is not always possible.
    - Nontax revenue collected by line ministries is not properly accounted for in Ministry of Finance fiscal reports and includes capital revenue.
    - Recurrent expenditure data suffer from shortcomings related to insufficient bank reconciliation at line ministries; fiscal reports show spending based on funding data (Credit Ceiling Authority), while line ministries submit spending reports based on recorded expenditure—sizable discrepancies can occur for wages and other recurrent transactions, partly due to widespread reallocation across budget lines.
    - Domestically-financed development expenditure is based on funding releases to line ministries; externally-funded expenditure is based on reported project grants and loans. Timing and financing modality differences (e.g., donor prefinancing before reimbursement) lead to substantial differences between expenditure flows and financing data—resulting in substantial errors in reporting of capital spending.
    - Many donor projects are not incorporated in the budget, so corresponding expenditure is not captured; some externally funded development expenditures are likely recurrent, potentially inflating reported capital expenditure.
    - Expenditure arrears data likely incomplete; Commitment Control System reporting appears partial and ministry-level data are inconsistent; previously unknown arrears have been cleared through the “special activities” vote, calling into question arrears and clearance data accuracy.
    - Budget classification and chart of accounts may be adequate for administrative, economic, functional and program classifications, and an activities-based budget classification (ABB) is used for budget presentation. However, pro-poor expenditures protected under the PRSP are identified only in the ABB classification and no bridge table exists to map ABB into the program classification used for expenditure reporting and accounting—therefore pro-poor expenditures cannot be monitored.
    - Financing estimates are based on monetary and debt data rather than government records of financing. Reporting on treasury bills directly issued to the RBM at times has been slow.

*Source: _cr06445 - 3.      The World Bank has been active in Malawi since 1966.*

### 7.      The authorities have received significant technical assistance from the Fund and other

### The authorities have received significant technical assistance from the Fund and other donors

### Technical assistance, public financial management, and statistical reporting
- The authorities have received significant technical assistance from the Fund and other donors to strengthen expenditure monitoring and reporting, accounting, and statistical reporting, but results have been disappointing.
- The new government has pledged to strengthen public financial management and fiscal reporting, and renewed efforts are being made to establish a work plan, including effectively utilizing donor technical assistance.
- Malawi does not report government finance data for inclusion in the Government Finance Statistics Yearbook (GFSY) or the International Financial Statistics (IFS).
- A STA mission visited Lilongwe in August 2005 to review progress on major issues raised during previous missions.
- The mission reiterated the importance of:
  - continued efforts to implement an Integrated Financial Management Information System (IFMIS),
  - improving the coverage and sectorization of government financial operations,
  - correctly classifying transactions according to international guidelines.
- The mission assisted the authorities with the compilation of annual fiscal data for 2003/04 in accordance with the GFSY Questionnaire, but such data have yet to be reported for inclusion in the publication.
- The mission proposed and discussed with the authorities a migration plan and timetable to adopt the GFSM 2001 methodology.

### Monetary and financial statistics (MFS)
- The Reserve Bank of Malawi (RBM) reports monetary and financial statistics (MFS) to STA on a regular basis.
- An MFS mission in April-May 2004 noted significant progress implementing recommendations from the August-September 2002 mission.
- Notable achievement: the improved coverage of the monthly monetary survey now accounts for more than 90 percent of the banking sector.
- Outstanding recommendations include:
  - sectorization of the domestic economy,
  - classification of financial instruments to ensure full adherence to the Monetary and Financial Statistics Manual methodology.
- The mission completed development of an integrated database to be used by the RBM, STA, and AFR for publication and operational needs.
- Standardized forms (SRF) for reporting monetary data to STA are being adopted; authorities submitted SRF test data, but there has been no further progress after STA provided comments on these test data in October 2005.

### External sector statistics
- Concepts and definitions used to compile balance of payments statistics are in broad conformity with BPM4 guidelines; the NSO has made progress in the transition to BPM5 methodology.
- The most recent data reported to STA for publication in the Balance of Payments Statistics Yearbook pertains to 2002.
- Following exchange control liberalization, compilation relies on balance of payments surveys for major components: services, direct investment flows, and other private sector financial transactions.
- Primary sources (surveys and/or International Transaction Reporting System reports) are supplemented with secondary sources:
  - foreign trade statistics from the MRA (customs declarations),
  - debt statistics from the MOF,
  - net foreign assets from the RBM,
  - information on grants from main donors.

### Data availability and quality (as of July 5, 2006) — selected entries preserved verbatim
- Exchange Rates: Date of Latest Observation 27/06/06; Date Received 27/06/06; Frequency of Data D; Frequency of Reporting W; Frequency of Publication M.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of Latest Observation 12/05; Date Received 01/06; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Reserve/Base Money: Date of Latest Observation 06/06; Date Received 06/06; Frequency of Data D; Frequency of Reporting W; Frequency of Publication M; Data Quality – Methodological Soundness LO, LO, LO, LO; Data Quality – Accuracy and Reliability LO, O, O, O, O.
- Broad Money: Date of Latest Observation 1/06; Date Received 6/06; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Central Bank Balance Sheet: Date of Latest Observation 4/06; Date Received 6/06; Frequency of Data W; Frequency of Reporting W; Frequency of Publication Q.
- Consolidated Balance Sheet of the Banking System: Date of Latest Observation 4/06; Date Received 1/06; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Interest Rates: Date of Latest Observation 4/06; Date Received 6/06/06; Frequency of Data W; Frequency of Reporting W; Frequency of Publication W.
- Consumer Price Index: Date of Latest Observation 05/06; Date Received 06/06; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M; Data Quality – Methodological Soundness O, LO, O, O; Data Quality – Accuracy and Reliability LO, LO, LNO, LO, LO.
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: Date of Latest Observation 11/05; Date Received 12/05; Frequency of Data M; Frequency of Reporting M; Frequency of Publication I.
- Stocks of Central Government and Central Government-Guaranteed Debt: Date of Latest Observation 12/03; Date Received 07/04; Frequency of Data M; Frequency of Reporting NA; Frequency of Publication NA.
- External Current Account Balance: Date of Latest Observation 11/04; Date Received 04/05; Frequency of Data A; Frequency of Reporting Q; Frequency of Publication A; Data Quality – Methodological Soundness LO, LO, LNO, LO; Data Quality – Accuracy and Reliability LNO, LNO, LO, LO, LO.
- Exports and Imports of Goods and Services: Date of Latest Observation 2005; Date Received 6/06; Frequency of Data A; Frequency of Reporting A; Frequency of Publication A.
- GDP/GNP: Date of Latest Observation 2005; Date Received 6/06; Frequency of Data A; Frequency of Reporting A; Frequency of Publication A; Data Quality – Methodological Soundness LO, LO, LNO, LO; Data Quality – Accuracy and Reliability LNO, LNO, LNO, LO, LO.
- Gross External Debt: Date of Latest Observation 12/03; Date Received 07/04; Frequency of Data M; Frequency of Reporting NA; Frequency of Publication NA.

### IMF Executive Board second PRGF review and disbursement (Press Release No. 06/186; August 31, 2006)
- The Executive Board completed the second review of Malawi's three-year PRGF arrangement and approved a disbursement equivalent to SDR 4.9 million (about US$7.3 million).
- Total disbursements under the arrangement to date: SDR 15.3 million (about US$22.7 million).
- The three-year arrangement was approved on August 5, 2005, for a total amount of SDR 38.2 million (about US$56.8 million) to support the government's economic program for 2005-2007.
- Key Board comments (Mr. Takatoshi Kato, Deputy Managing Director and Acting Chair):
  - Malawi’s economy has performed well under the PRGF-supported program even in the face of a severe food crisis; increased public spending was required to avert a humanitarian catastrophe, but overall fiscal performance was satisfactory.
  - Implementation of structural measures remains uneven.
  - Monetary policy has been restrained, helping to reduce inflation.
  - A more flexible exchange rate policy has helped to clear arrears on import payments; sustaining this policy is important to prevent a return to arrears and to protect Malawi’s relatively low level of international reserve cover.
  - Program objectives for 2006/07 are realistic; emphasis on structural reforms in public financial management and the financial sector is appropriate.
  - Continued commitment to fiscal discipline and reducing the domestic debt burden will be critical for long-term fiscal sustainability.
  - Need to strengthen expenditure management to ensure resources freed by debt relief are used effectively, and to advance structural reforms in public financial management and the financial sector.
  - Urgent priority: realization of higher growth rates to reduce poverty over the medium term; maintain prudent monetary policy and vigilance on inflationary pressures.
  - Further progress needed on governance, transparency, and tackling corruption, including ensuring independence of institutions of governance.

### Authorities’ statement and recent economic developments (Statement by Peter Gakunu and Joseph L. Masawe; August 30, 2006)
- Authorities request completion of the second review, the third disbursement under the PRGF arrangement, and waivers for non-observance of structural performance criteria on the budget ceilings module in the payment system and the new travel policy.
- Government efforts to implement the budget ceilings module were overtaken by the roll-out of IFMIS and the centralized payment system.
- Authorities remain committed to macroeconomic policies under the PRGF arrangement and note that all HIPC completion point triggers were satisfactorily implemented.
- Preliminary information for 2005/06:
  - GDP growth will reach 5.3 percent, in line with projections.
  - The food crisis remained severe, worsening beyond projected levels and affecting macroeconomic targets.
  - Crop estimates for 2006 are encouraging and could result in a significant rebound in GDP growth to around 7 percent.
  - A tight monetary policy stance assisted by the expected good harvest should be able to bring down inflation to around 7.9 percent over the same period.

### Fiscal policy — performance, measures, and controls
- Fiscal performance through the second quarter was encouraging, mainly following better than projected revenue performance.
- During the fourth quarter of 2005/06, tax revenues outpaced projections.
- Recent fiscal data: tax revenue for 2005/06 fiscal year was 0.7 percent of GDP higher than projected.
- Good revenue performance was further boosted by receipt of debt service refunds from the AfDB as part of interim HIPC assistance.
- During the third quarter, food security outlays were stepped up to avoid a humanitarian crisis, following shortfalls in donor inflows.
- Measures implemented to control expenditure included:
  - updating the employee database,
  - completing the wage schedule for government employees.
- These measures led to significant reduction in wage overrun, although the government still could not meet its domestic borrowing target due to increased food security outlays.
- New policies implemented on housing, use of government vehicles, and administrative measures to prevent new utility arrears.
- A draft travel policy has been completed; a Cabinet paper is being prepared and implementation is expected beginning October 2006.
- IFMIS phased in along with a centralized payment system; IFMIS implementation enabled publication of reports on the budget and expenditure arrears (also a program benchmark).
- Government commits to zero tolerance on corruption and recognizes that the Anti-Corruption Bureau (ACB) should operate without undue political interference.

### Monetary and financial policies and developments
- Monetary policy is directed towards price stability; market-determined interest and exchange rates were maintained.
- Reserve money is the operational target of the Reserve Bank and was closely monitored.
- RBM continued to accumulate foreign reserves as targeted under the program.
- To reduce the wide spread between commercial banks’ deposit and lending rates, the Reserve Bank lowered the liquidity reserve ratio (LLR) for banks in February 2006.
  - The lowering of the LLR was aligned with shifting away from direct instruments toward more market-based instruments.
  - The move led to a temporary increase in banking system liquidity, neutralized through increased liquidity mop up by the RBM.
- Authorities maintained a flexible exchange rate regime, intervening only to smooth short-term volatility.
  - Exchange rate volatility primarily caused by market shallowness and seasonality in foreign exchange inflows driven by agricultural export seasonality.
- Efforts to reduce backlog of unpaid import invoices were intensified, though constrained by limited foreign exchange availability.
- Authorities state they do not practice exchange restrictions; backlogs were due to unavailability of foreign exchange rather than deliberate restrictions.
- Import demand rose due to increases in oil prices and increased food security imports following the countrywide drought.
- Import backlog estimates:
  - By end June 2006, the backlog was estimated at US$ 12.7 million.
  - By mid July, it had been eliminated.
  - As of August 25, 2006, RBM report showed no import backlog in the banking system.
- Spread between commercial banks’ exchange rate and foreign exchange bureaus is attributed to market transaction costs and retail differences, not multiple currency practice.
- Financial intermediation measures:
  - An impact analysis of commercial bank balance sheets using asset classification (a structural benchmark) was completed.
  - Based on the new classification, authorities issued new directives governing classification and provisions.
  - Liquidation procedures initiated for the Finance Bank (closed and placed under RBM in mid 2005 due to lack of a suitable buyer).

### Policies for 2006/07 and way forward
- Government policies will continue to focus on implementing PRGF arrangement objectives.
- Expectations and targets:
  - GDP growth expected to substantially improve in the coming year,
  - inflation expected to be further subdued.
- Fiscal policy thrust:
  - improve the tax regime,
  - control expenditure,
  - seek to limit wage increases to compensate for prior overruns,
  - restructure the Malawi Development Corporation (MDC) via the privatization commission.
- As per the Assessment and Action Plan for HIPC, authorities will work to attain greater budget comprehensiveness, internal control, budget reconciliation, and auditing.
- Government will closely monitor IFMIS implementation and ensure the Government Finance Statistics module is in place in the few months ahead; Fund and U.S. Millennium Challenge Threshold program assistance is acknowledged.
- Monetary policy primary objective: pursue price stability through reserve money programming to help bring inflation down and improve macroeconomic variables.
- Authorities remain committed to a flexible exchange rate policy and will strengthen exchange rate management to ensure it remains truly flexible.
- Measures to strengthen and deepen financial markets will continue to be implemented.

### HIPC Completion Point, MDRI, and use of savings
- Authorities appreciate staff assistance in meeting requirements for the HIPC Completion Point, which will enable Malawi to receive further debt relief under the MDRI.
- The 2006/07 fiscal program includes a flow of MDRI-related debt relief from the Fund, IDA and the World Bank and AfDB amounting to US$ 50 million.
- Once approval is given for Malawi to reach the completion point under the enhanced HIPC Initiative and considered for topping up, savings will be used to increase pro-poor spending.
- Authorities commit to cooperate with the Fund in continuous monitoring to ensure all savings and additional resources from these initiatives are properly utilized.

### Joint Staff Advisory Note (JSAN) and PRSP progress
- The third Annual Progress Report (APR) of Malawi’s Poverty Reduction Strategy (MPRS) for July 2004 to December 2005 has been circulated to IMF and World Bank Boards.
- Authorities appreciate Fund and Bank staff comments in the JSAN and commit to improving future reviews and ensuring broader public participation.

### Conclusion and authorities’ request
- Authorities affirm commitment to successful implementation of the PRGF-supported economic program.
- Despite exogenous shocks (additional spending for food shortages; higher oil prices), the government implemented measures to keep the program on track.
- Going forward, priorities include maintaining macroeconomic stability to reduce poverty, supporting structural reform, enhancing revenue, streamlining expenditure, bringing down inflation, strengthening the financial system, and deepening financial markets.
- Authorities look forward to reaching the HIPC Completion point and request completion of the second review under the PRGF arrangement on the basis of performance and measures implemented during the review period.

*Source: IMF staff report and related statements (content as provided).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06445.pdf_