## _cr1583 - 52.06 million has been disbursed to date. The sixth and seventh tranches totaling

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### Disbursements and financing status
- 52.06 million has been disbursed to date.
- The sixth and seventh tranches totaling SDR13.02 million will be available upon the completion of the Fifth and Sixth review.
- Donor budget support remained suspended following the “cashgate” scandal, creating large external financing shortfalls equivalent to 5½ percent of GDP in FY13/14.

### Cashgate scandal: scope, accountability, and fiscal consequences
- Forensic audit quantified illicit transactions as MK20 billion or US$45 million.
- Concerns reported about proceeds from sale of the presidential jet (US$15 million) being used to service a non-concessional loan ($145 million) contracted in October 2013.
- Accountability actions and outcomes:
  - Five convictions to date with recovery of assets amounting to MK 183 million.
  - Authorities are pursuing convictions from 53 case files derived from the final forensic report.
  - A military officer arrested in connection with identified “out of scope” transactions.
- Fiscal consequences:
  - Suspension of donor budget support led to increased recourse to domestic financing and monetization of the deficit.
  - Emergence and re-audit/verification of domestic payment arrears: arrears from FY13/14 and previous years amounted to 8 percent of GDP (K157 billion referenced elsewhere).
  - Policy slippages in the run up to May 2014 elections and subsequent deterioration in macroeconomic indicators.

### Recent macroeconomic developments and outlook
- Growth and sectoral drivers:
  - Preliminary estimates indicate real GDP growth was close to 6 percent in 2014, supported by agriculture, wholesale and retail trade, and information and communication sectors.
  - Recent floods affected about half of one percent of arable lands; hydro-electricity generation was disrupted. Deaths and displaced persons estimated at 104 and 230,000 respectively; displaced persons represented 2 percent of the population in affected districts.
- Inflation and monetary conditions:
  - Inflation averaged 23.8 percent in 2014 and remained entrenched in the range 20–25 percent.
  - Policy rate increase of 250 basis points to 25 percent in November and directive to apply the current liquid reserve requirement (15.5 percent) to the foreign currency deposit equivalent in local currency tightened liquidity and stabilized the kwacha.
  - Elevated inflation and liquidity dynamics triggered public sector demands for wage increases, which authorities largely resisted.
- External sector and reserves:
  - Current account deficit (including net official transfers) widened by 3¼ percentage points to 5.1 percent of GDP in 2014, mainly due to a drop in official transfers by 6.6 percentage points of GDP despite an improvement in the merchandise deficit by 2 percentage points to about 10½ percent of GDP.
  - Exchange rate depreciated by 15 percent over 2014, with periods of large volatility.
  - Central bank reserves rose to 2.9 months of imports at end-2014 after a domestic debt restructuring and foreign exchange purchases during the tobacco season.
- Public debt and domestic operations:
  - Public debt rose sharply by 18.6 percentage points since end-2012 to 75.8 percent of GDP by end-2014.
  - Authorities restructured kwacha-denominated domestic debt amounting to 6 percent of GDP by selling it to PTA bank for US$250 million, lowering interest costs by 1000 basis points on the affected stock and materially boosting official reserve cover.

### Program implementation and missed performance criteria
- Overall assessment:
  - Performance under the ECF-supported program was uneven; several quantitative and continuous performance criteria were missed across the fifth and sixth reviews.
- Fifth review (end-December 2013 test date):
  - One out of three periodic performance criteria was not met: the ceiling on net domestic assets of the central bank (RBM).
- Sixth review (end-June 2014 test date):
  - Two out of three periodic performance criteria were not met: net domestic assets (NDA) of the RBM and net domestic borrowing (NDF) by the government were missed by substantial amounts.
  - The program met the end-June 2014 target for international reserves.
- Continuous performance criteria missed for both reviews:
  - Ceiling on new non-concessional external debt maturing in more than one year was breached due to three non-concessional loans:
    - (i) October 2013 supplier’s credit for military equipment;
    - (ii) April 2014 supplementary loan for rehabilitation of an inter-city road (US$4 million, grant element 28–29 percent reported);
    - (iii) February 2015 loan for construction of a cancer treatment center (US$13 million, 29 percent grant element).
  - Ceiling on non-accumulation of external payments arrears was missed due to arrears on the supply credit for military equipment; supplier credit original value reduced from $145.3 million to $33 million after renegotiation.
- Indicative targets and social spending:
  - Indicative targets for reserve money were missed, reflecting unsterilized build-up of international reserves and increased central bank financing of the budget.
  - Indicative ceilings on social spending were missed by a maximum of 4 percent due to external financing shortfalls.

### Policy priorities, remedial actions, and authorities’ commitments
- Core program objectives reaffirmed by authorities:
  - Maintain the flexible exchange rate regime and the automatic fuel pricing mechanism.
  - Attain single digit inflation and increase international reserves (target reserve cover at least three months of imports).
- Key policy actions agreed and prior actions taken:
  - Fiscal adjustment to ensure the FY2014/15 budget delivers on objectives; implement expenditure cuts and issue memo to Cabinet with new expenditure ceilings (prior action: status Met).
  - PFM reforms to address weaknesses revealed by “cashgate” and restore confidence in the budget process, including incorporation of main government accounts into IFMIS (prior action: status Met).
  - Monetary policy measures to rein in inflation and stabilize expectations, including amendments to RBM Act limiting credit to government (prior action: status Met).
  - Reforms to strengthen the regulatory framework for the financial sector; amendments to the Banking and Financial Services Acts submitted to Parliament (prior action: status Met).
- Program monitoring and targets:
  - Arrangement extended by 6 months; informal targets set for end-January on NDA, gross international reserves, and net domestic financing.
  - Authorities complied with most end-January 2015 informal macroeconomic targets set during December 2014 mission, supporting staff’s request for completion of the fifth and sixth reviews.

### Structural benchmarks, PFM strategy, and arrears regularization
- PFM reform sequencing and priorities:
  - Critical PFM reforms recast as prior actions to complete the current reviews; adoption of a new PFM strategy was made a prerequisite for donor resumption of budget support.
  - Key PFM strategy priorities include expanding IFMIS coverage to incorporate all government accounts; treasury cash flow management; bank reconciliation; enforcement of commitment controls via IFMIS purchase order module; reorientation of internal and external audit; capacity building; and rationalizing sanction regimes.
- Domestic arrears regularization methodology:
  - All arrears to be verified and audited.
  - Cash payments of MK 10 billion in FY14/15 planned for arrears accumulated in FY13/14.
  - Remaining arrears to be regularized through securitization in three tranches with maturities varying from one to three years across the current fiscal year and FY15/16 and FY16/17.
  - Strengthening commitment controls: deploy auditors in each ministry; incorporate all government accounts into IFMIS; periodic reports on stocks and flows of arrears.

### Monetary policy stance and financial sector reforms
- Monetary tightening and tools:
  - RBM raised policy rate by 250 basis points to 25 percent in Q4 2014 and applied the liquid reserve requirement (15.5 percent) to foreign currency deposits in local currency.
  - Objective: keep policy rate above inflation and maintain positive real interest rates to attract domestic savings and firm up confidence in the kwacha.
  - Improve liquidity forecasting and communication with market participants; use repos/reverse repos and multiple indicators besides reserve money.
  - Fiscal dominance measures: cancellation of automatic conversion of overdrafts into government securities; amendments to RBM Act imposing an upper bound on total government borrowing from RBM to 10 percent of the previous year domestic revenue (prior action).
- Financial sector resilience:
  - Migration to Basel II effective January 1, 2014; Tier 1 and total capital requirement ratios raised to 10 percent and 15 percent from 6 percent and 10 percent respectively.
  - Adoption of a prompt corrective action (PCA) framework in 2014.
  - Third-party diagnostic assessments completed in 2014; two weak banks identified; contingent liabilities of the two weak banks range between 0.4–0.6 percent of GDP.
  - Non-performing loans (NPLs) to gross loans rose from 5 percent in early 2012 to about 16 percent in late 2014 (series shows 15.8 percent).
  - Provisioning directive (ERAM) issued May 2014 imposing provisioning rate that increases by 16.67 percentage points per quarter on NPLs past due after 90 days.
  - External banking supervision advisor hired July 2014; RBM committed to monitor and enforce prudential norms.
  - Planned amendments to the AML/CFT Act, Penal Code and Corrupt Practices Act to align with FATF and UNCAC standards.

### Debt sustainability, DSA findings, and debt management actions
- DSA highlights:
  - New DSA (joint Fund and World Bank staff) indicates Malawi remains at moderate risk of debt distress.
  - Estimated present value of external debt reached 32.2 percent of GDP by end-2014; corresponding debt threshold is 30 percent of GDP (marginal and short lived breach).
  - Present value of total public debt stood at 55.9 percent of GDP at end-2013 and reached a projected peak of 60.6 percent of GDP at end-2014.
- Drivers and mitigation:
  - Breach driven largely by restructuring of domestic debt through sale to a regional development bank (PTA) and strong depreciation of the kwacha in Q4 2014.
  - PTA transaction: sale to PTA for US$250 million, short maturity of 3 years, reduced interest costs by 1000 basis points.
  - Need for bold actions to strengthen debt management to keep total public debt sustainable.
  - Authorities plan to resuscitate the Debt Management Committee (DMC) to prepare annual debt management strategy, review borrowing concessionality, and examine borrowing options.

### Program remedies, waivers, and staff recommendation
- Waiver requests and staff support:
  - Authorities requested waivers for non-observance of one periodic PC for the fifth review and two periodic PCs for the sixth review, and waivers for continuous PCs on contracting non-concessional external debt and accumulation of external payment arrears.
  - Staff support for waivers based on strong corrective actions taken by the new government and implemented prior actions in fiscal, PFM, monetary, and financial sector areas.
- Supported program modifications:
  - Staff supports the extension of the arrangement, rephasing of disbursements, modification of the continuous PC on new non-concessional external debt maturing in more than one year, and establishment of performance criteria for end-June 2015 and end-December 2015.
- Staff recommendation:
  - Staff recommends the completion of the fifth and sixth program reviews.

### Key program quantitative and monitoring figures (selected exact values preserved)
- Disbursements and schedules:
  - Total for the ECF arrangement: 104.10 / 150.00 (Millions of SDR / % of Quota).
  - Previous schedule entries include 13.02 / 18.76 / July 23, 2012 / Disbursed, and subsequent dated entries; proposed new schedule includes rephasing with 17.00 / 24.50 / September 15, 2015 and 22.02 / 31.73 / March 15, 2016.
- Monetary and reserve indicators:
  - Policy rate increased by 250 basis points to 25 percent.
  - Liquid reserve requirement: 15.5 percent.
  - Gross official reserves rose to 2.9 months of imports at end-2014.
- Macroeconomic projections and targets:
  - Real GDP growth projected to remain in the 5½–6 percent range; specific projections: 5.5 percent in 2015 and 6 percent by 2017 in various places.
  - Headline inflation expected to decline to low double digits by end-2015 and single digits by 2016 (targets include 12 percent by end-2015 or 12.5 percent; documents vary between 12 and 12.5 percent).
  - Current account deficit projected to narrow from 5 percent of GDP in 2014 to under 3 percent of GDP in 2017.
- Fiscal metrics (FY14/15):
  - Original FY14/15 overall deficit (including grants) of 5.4 percent of GDP (down from 8.7 percent in FY13/14).
  - Revised realistic overall deficit agreed at 5.9 percent of GDP with domestic financing of 1.9 percent of GDP.
  - Social spending in FY14/15 budget is 12.6 percent of GDP, 21 percent higher than in FY13/14 budget.
  - Domestic financing rose to about 6 percent of GDP by end-2013/14; payment arrears accumulated at 1.7 percent of GDP (and additional arrears uncovered).
- Banking sector indicators (selected series points preserved):
  - Non-performing loans to gross loans: series includes 15.8 (late 2014).
  - Regulatory total capital to risk weighted assets: series includes values such as 20.3, 20.1, 22.1, ... , 17.8.
  - Liquid assets to deposits and short-term liabilities: series includes 40.7, 43.0, ..., 59.2.
- IMF program repayment and capacity indicators:
  - Projected combined payments (US$ Millions) series: 25.0, 25.8, 22.9, 29.9, 17.9, 20.9, 28.0, 31.2, 15.6, 15.6, 13.6, 3.3.
  - Projected level of credit outstanding (SDR millions): series includes 147.6, 161.5, 145.8, 125.4, 113.5, 99.1, 76.9, 51.5, 32.6, 16.3, 3.2, 0.0.

*International Monetary Fund staff report excerpt, March 5, 2015.*

### 52.06 million has been disbursed to date. The sixth and seventh tranches totaling

### _cr1583 - 52.06 million has been disbursed to date. The sixth and seventh tranches totaling

### Disbursements and financing status
- 52.06 million has been disbursed to date.
- The sixth and seventh tranches totaling SDR13.02 million will be available upon the completion of the Fifth and Sixth review.
- Donor budget support remained suspended following the “cashgate” scandal, creating large external financing shortfalls equivalent to 5½ percent of GDP in FY13/14.

### Cashgate scandal: scope, accountability, and fiscal consequences
- Forensic audit quantified illicit transactions as MK20 billion or US$45 million.
- Concerns about the use of proceeds from the sale of the presidential jet (US$15 million) to service a non-concessional loan ($145 million) contracted in October 2013 were reported.
- Accountability actions and outcomes:
  - Five convictions to date with recovery of assets amounting to MK 183 million.
  - Authorities are pursuing convictions from 53 case files derived from the final forensic report.
  - A military officer has been arrested in connection with identified “out of scope” transactions.
- The scandal led to suspension of donor budget support and contributed to:
  - Increased recourse to domestic financing and monetization of the deficit.
  - Emergence and re-audit/verification of domestic payment arrears (arrears from FY13/14 and previous years amounted to 8 percent of GDP).
  - Policy slippages in the run up to May 2014 elections and a subsequent deterioration in macroeconomic indicators.

### Recent macroeconomic developments and outlook
- Growth and sectoral drivers:
  - Preliminary estimates indicate real GDP growth was close to 6 percent in 2014, supported by agriculture, wholesale and retail trade, and information and communication sectors.
  - Recent floods affected about half of one percent of arable lands; hydro-electricity generation was disrupted. The number of deaths and displaced persons are estimated at 104 and 230,000 respectively; displaced persons represented 2 percent of the population in affected districts.
- Inflation and monetary conditions:
  - Inflation averaged 23.8 percent in 2014 and remained entrenched in the range 20–25 percent.
  - A policy rate increase of 250 basis points to 25 percent in November and a directive to apply the current liquid reserve requirement (15.5 percent) to the foreign currency deposit equivalent in local currency helped tighten liquidity and stabilize the kwacha.
  - Elevated inflation and liquidity dynamics triggered public sector demands for wage increases, which authorities largely resisted.
- External sector and reserves:
  - The current account deficit (including net official transfers) widened by 3¼ percentage points to 5.1 percent of GDP in 2014, mainly due to a drop in official transfers by 6.6 percentage points of GDP despite an improvement in the merchandise deficit by 2 percentage points to about 10½ percent of GDP.
  - The exchange rate depreciated by 15 percent over 2014, with periods of large volatility.
  - Central bank reserves rose to 2.9 months of imports at end-2014 after a domestic debt restructuring and foreign exchange purchases during the tobacco season.
- Public debt and domestic operations:
  - Public debt rose sharply by 18.6 percentage points since end-2012 to 75.8 percent of GDP by end-2014.
  - In December, the authorities restructured kwacha-denominated domestic debt amounting to 6 percent of GDP by selling it to PTA bank for US$250 million, lowering interest costs by 1000 basis points on the affected stock and materially boosting official reserve cover.

### Program implementation and missed performance criteria
- Performance under the ECF-supported program was uneven, with several quantitative and continuous performance criteria missed:
  - Fifth review (end-December 2013 test date):
    - One out of three periodic performance criteria was not met: the ceiling on net domestic assets of the central bank (RBM).
  - Sixth review (end-June 2014 test date):
    - Two out of three periodic performance criteria were not met: net domestic assets (NDA) of the RBM and net domestic borrowing (NDF) by the government were missed by substantial amounts.
    - The program met the end-June 2014 target for international reserves.
  - Continuous performance criteria missed for both reviews:
    - Ceiling on new non-concessional external debt maturing in more than one year was breached due to three non-concessional loans: (i) October 2013 supplier’s credit for military equipment; (ii) April 2014 supplementary loan for rehabilitation of an inter-city road; (iii) February 2015 loan for construction of a cancer treatment center.
    - Ceiling on non-accumulation of external payments arrears was missed due to arrears on the supply credit for military equipment.
  - Indicative targets and social spending:
    - Indicative targets for reserve money were missed, reflecting unsterilized build-up of international reserves and increased central bank financing of the budget.
    - Indicative ceilings on social spending were missed by a maximum of 4 percent due to external financing shortfalls.

### Policy priorities and authorities’ commitments
- The new authorities reaffirmed commitment to the core policies and objectives of the original ECF-supported program, notably:
  - Maintaining the flexible exchange rate regime and the automatic fuel pricing mechanism.
  - Attaining single digit inflation and increasing international reserves.
- Key policy actions agreed and prior actions taken to bring the program back on track:
  - Fiscal adjustment to ensure the FY2014/15 budget delivers on objectives.
  - Public financial management (PFM) reforms to address weaknesses revealed by “cashgate” and restore confidence in the budget process.
  - Monetary policy measures to rein in inflation and stabilize expectations.
  - Reforms to strengthen the regulatory framework for the financial sector.
- Authorities implemented key prior actions in PFM, monetary, and financial policies and complied with most end-January 2015 informal macroeconomic targets set during the December 2014 mission, demonstrating ownership and supporting staff’s request for completion of the fifth and sixth reviews.

*International Monetary Fund staff report excerpt, March 5, 2015.*

### 9.      Progress in the implementation of structural benchmarks set at the time of the third

### Progress in the implementation of structural benchmarks set at the time of the third and fourth reviews

### Implementation summary and immediate corrective stance
- Progress on structural benchmarks at the time of the third and fourth reviews was uneven (MEFP ¶13 and Table 13).
- Most PFM-related benchmarks were not met because reforms were overtaken by the immediacy of taking short-term corrective actions (¶1).
- Critical PFM reforms and a key financial sector reform—submission of the Banking and Financial Services Acts to parliament—were recast as prior actions to complete the current reviews (Table 14).
- In monetary policy, amendments to the RBM Act limiting credit to government were made a prior action for completing the reviews.
- The kwacha depreciated by 22 percent between September and November 2014 reflecting seasonal shortages in foreign exchange and economic uncertainties.

### Macroeconomic outlook and risks
- Core program objectives emphasized: flexible exchange rate regime, automatic fuel pricing mechanism, attainment of single digit inflation by 2016, and reserve cover of at least three months of imports (MEFP ¶2 and ¶18).
- Growth and inflation projections and external balance:
  - Real GDP growth projected to remain in the 5½–6 percent range.
  - Headline inflation expected to decline to low double digits by end-2015.
  - Current account deficit expected to narrow from 5 percent of GDP in 2014 to under 3 percent of GDP in 2017.
- Downside risks highlighted:
  - Capacity and institutional weaknesses in policy design and implementation.
  - Absence of a recovery in donor financing.
  - Slower-than-expected growth in trading partners.
  - Possible deterioration in social conditions and adverse weather given reliance on rain-fed agriculture.
  - Risk of slower disinflation triggering demands for wage increases.
  - Weak international prices for tobacco, partially offset by lower oil prices.
- Authorities’ contingency: spending reprioritization and use of the flexible exchange rate as a shock absorber if risks materialize.

### Policy discussions and near-term program anchoring
- Authorities reiterated commitment to containing public expenditures within available resources, bringing inflation back to single digits, and increasing reserve cover to at least three months of imports (MEFP ¶2 and ¶18).
- Arrangement extended by 6 months; informal targets set for end-January on net domestic assets of the central bank, gross international reserves, and net domestic financing of the government to anchor policies.
  - Two of three targets were met: gross international reserves and net domestic assets of the central bank.
  - Net domestic financing was missed by (0.7 percent of GDP) due to shortfalls in donor dedicated grants (1.2 percent of GDP) for social protection in health, education, and agriculture sectors and some outlays in response to floods.
- Key near-term policy issues discussed:
  - Ensuring the FY2014/15 budget can deliver objectives despite unanticipated risks and potential shortfalls in external financing.
  - Managing fallout of the fiscal scandal by designing upfront policy actions to restore confidence in PFM and the budgetary process.
  - Tightening monetary stance to rein in inflation while avoiding a squeeze on private sector credit and growth.
  - Safeguarding financial sector stability by strengthening the regulatory framework.

### Preserving FY2014/15 budget objectives and fiscal stance
- Medium-term fiscal anchor: preserve debt sustainability and reduce inflation.
- Domestic fiscal balance projected path:
  - From 8 percent of GDP in FY13/14 to 4.1 percent in FY14/15 and under 2 percent by the end of the program period (Table 2b).
- FY14/15 budget and revisions:
  - Original FY14/15 overall deficit (including grants) of 5.4 percent of GDP (down from 8.7 percent in FY13/14).
    - Of this, 4.6 percent was expected to be covered by external financing and 0.8 percent by net domestic borrowing.
  - Major downside factors: higher-than-budgeted domestic interest expenses; further shortfalls in external financing (available budget support expected to amount to only half a percentage point of GDP, compared with over 6 percent in FY12/13); cost overruns in the fertilizer scheme; need to regularize past payment arrears.
  - Revised realistic overall deficit agreed at 5.9 percent of GDP with somewhat higher domestic financing of 1.9 percent of GDP—still 4 percentage points less than in the previous year.
  - Social spending in the FY14/15 budget is 12.6 percent of GDP, 21 percent higher than in the FY13/14 budget, with allocations to health, education and the fertilizer subsidy scheme accounting for 95 percent of outlays.

### Regularization of domestic arrears and commitment controls
- Issue: large stock of domestic arrears requires regularization (MEFP, ¶23).
- Approach:
  - Once verified and certified by the National Audit Office, arrears to be settled partly in cash and through issuance of promissory notes in three tranches with maturities varying from one to three years.
  - Staff support for regularization: pay recent arrears in cash within budget limits; securitize older arrears.
- Strengthening commitment controls to prevent new arrears:
  - Incorporation of all government accounts into IFMIS to facilitate account reconciliation and strengthen commitment controls.
  - Periodic preparation of reports on stocks and flows of arrears (Tables 14 and 15).

### Strengthening PFM systems in wake of the Cashgate scandal
- Prior PFM framework: three-year program (2011–14) with 9 components covering the PFM cycle; progress made on cash management, budget execution and commitment controls, but IFMIS inadequacies and account reconciliations were exposed by the scandal.
- New sequencing of reforms guided by FAD mission findings and the final forensic audit report; several FAD recommendations incorporated as prior actions or structural benchmarks (Table 14).
- Critical prior actions to reinforce commitment controls, facilitate account reconciliation and improve cash management were identified as jump-start measures for PFM reform.
- Adoption of a new PFM strategy (Box 2) after consultation with stakeholders; adoption and implementation were prerequisites for donor resumption of budget support.
- Key PFM strategy priorities from Box 2:
  - Improved fiscal reporting by expanding IFMIS coverage to incorporate all government accounts to improve data reliability, trial balance reports and monitoring of budget execution.
  - Treasury cash flow management: bank reconciliation via rationalization of government bank accounts; enforcement of commitment controls through IFMIS purchase order module; subjecting commitment process to internal audit in ministries.
  - Auditing: reorient internal and external audit to focus on key controls and reports, bank reconciliation, summary bank reports and IFMIS internal controls; revise functional reporting lines and hire international audit firms to address capacity gaps.
  - Strengthening overall PFM control environment via capacity building, awareness workshops, better access to PFM legal framework, review of human resource policies for accounting staff, and rationalizing sanction regimes.

### Monitoring, transparency and forensic audits
- Sustained PFM reform implementation critical to restoring confidence and donor engagement.
- Key structural benchmarks embedded in the PFM reform agenda and action plan (Table 15) emphasize increased reporting and transparency.
- An assessment by an international auditing firm confirming the status of implementation of forensic audit recommendations will be undertaken to evaluate commitment to reforms.
- With donor assistance, an international auditing firm has been contracted to conduct forensic audits on IFMIS during 2009–13 (MEFP ¶4).

### Reining in inflation and monetary policy measures
- Monetary tightening in Q4 2014:
  - RBM raised its policy rate by 250 basis points to 25 percent and increased the liquid reserve requirement on foreign currency deposits (MEFP, ¶7).
  - Effect: raised interbank and treasury bill rates to levels close to the policy rate; reversed speculative pressure against the kwacha when combined with increased reserve cover from the PTA bank transaction.
- RBM intentions and tools:
  - Ensure policy rate remains above the rate of inflation and that interbank and Treasury bill rates stay positive in real terms to maintain attractive real returns on domestic assets and firm up confidence in the kwacha.
  - Improve communication with market participants to convey commitment to price stability.
  - Refinements in liquidity forecasting and management to reduce lags in information flows on government daily cash flows, facilitating day-to-day liquidity management and structural liquidity decisions.
  - Existing instruments (repos and reverse repos) could be strengthened by using multiple indicators besides reserve money under the floating exchange rate regime.
- Fiscal dominance measures:
  - Cancellation of automatic conversion of overdrafts into government securities by the RBM.
  - Amendments to the RBM Act submitted to parliament imposing an upper bound on total government borrowing from RBM to 10 percent of the previous year domestic revenue in any given year (prior action). Note: previous limit was 20 percent of advances only and excluded other forms of credit.

### Safeguarding financial sector soundness and regulatory reforms
- Migration to Basel II directives effective January 1, 2014.
  - RBM raised Tier 1 and total capital requirement ratios to 10 percent and 15 percent from 6 percent and 10 percent, respectively.
- Prudential improvements with Fund TA: asset classification, provisioning, and liquidity norms improved.
- Adoption in 2014 of a prompt corrective action (PCA) framework to clarify triggers for early remedial action against distressed banks.
- Prior action: amendments to the Banking and Financial Services Acts to align bank resolution framework more closely to international best practice were submitted to Parliament for completion of the fifth and sixth reviews.
- Banking sector conditions and vulnerabilities:
  - Official indicators show all banks except two have higher capital adequacy ratios than required under the new Basel II standards.
  - Risk concentration is rising and loan quality deteriorating due to limited number of large borrowers, currency devaluation in May 2012, and sharp shortfalls in external financing in 2013–14.
  - Non-performing loans (NPLs) to gross loan ratio increased from 5 percent in early 2012 to about 16 percent in late 2014.
- Provisioning and supervision actions:
  - Directive issued in May 2014 based on the Expected Recoverable Amount Method (ERAM) imposing a provisioning rate that increases by 16.67 percentage points per quarter on NPLs past due after 90 days.
  - External banking supervision advisor hired and commenced work in July 2014 to enhance on- and off-site supervision.
  - RBM commitment to closely monitor and enforce compliance with all prudential norms (MEFP, ¶28).
  - Amendments to the AML/CFT Act, the Penal Code and the Corrupt Practices Act planned to address gaps identified in the forensic audit and better align the regulatory framework with the Financial Action Task Force standards and the United Nations Convention Against Corruption (MEFP ¶31 and benchmark).

*Source: IMF staff report chapter on Progress in the implementation of structural benchmarks set at the time of the third and fourth reviews.*

### 27.      Third-party diagnostic assessments of the health of the banking system were

### 27.      Third-party diagnostic assessments of the health of the banking system were

### Banking system diagnostic assessments (2014)
- Assessments completed during 2014 covered:
  - verification of asset quality
  - liquidity
  - off balance sheet liabilities
  - analysis of profit and loss
  - assessment of the adequacy of regulatory capital
- All major areas of concern have been communicated by the RBM to the Board of Directors of each bank for action.
- Two weak banks were identified during the evaluation:
  - The restructuring process has commenced for the weaker of the two banks, which envisages its sale or recapitalization (MEFP ¶26).
  - The second bank has a significantly stronger capital position and will be addressed through a capital injection by shareholders.
- Contingent liabilities to the government of the two weak banks range between 0.4–0.6 percent of GDP.
- In light of the assessments and in consultation with the Fund, the RBM intends to identify and design an appropriate strategy within the legal framework to address sector wide issues, particularly with regard to:
  - risk concentration
  - recognition and provisioning of NPLs
  - suitability of the legal and prudential frameworks (MEFP ¶24; and structural benchmark).
- Note on provisioning: The provisioning rate for NPLs then becomes 100 percent 18 months after the 90 days.

### Preserving debt sustainability
- New DSA (joint Fund and World Bank staff) indicates Malawi remains at moderate risk of debt distress.
- External public and publicly guaranteed debt developments:
  - Estimated present value of external debt reached 32.2 percent of GDP by the end of 2014.
  - Corresponding debt threshold is 30 percent of GDP; the resulting breach is expected to be marginal and short lived.
  - The breach is largely due to restructuring of existing domestic debt through a sale to a regional development bank (¶7) aimed at lowering debt service costs and raising international reserves cover.
  - Strong depreciation of the kwacha during the fourth quarter of 2014, which has subsided, also contributed to the breach in the PV of external debt to GDP threshold.
- Total public debt developments:
  - At end-2013, the present value of total public debt stood at 55.9 percent of GDP.
  - Present value of total public debt reached a projected peak of 60.6 percent of GDP at end-2014.
  - Domestic debt as a share of GDP is projected to decline with fiscal consolidation and maintenance of a positive primary balance.
- Actions to safeguard debt sustainability:
  - Need for bold actions to strengthen debt management in the near-to-medium term to ensure total public debt remains sustainable.
  - Authorities plan to achieve this objective through a resuscitated Debt Management Committee (DMC) acting as an apex advisory board on public debt management.
  - DMC responsibilities envisaged:
    - prepare an annual debt management strategy as part of the annual budget process and monitor it throughout the year (MEFP, ¶ 21)
    - review and recommend debt financing options—such as maturity structure and type of instrument
    - examine each borrowing to ascertain its concessionality and to ensure debt sustainability

### Program issues and prior actions
- Budget and PFM adjustments:
  - Adjustments to the approved budget were implemented through issuance of a circular to Cabinet with new expenditure ceilings; all Ministries and Development Agencies (MDAs) are aware of the new expenditure limits.
  - Two prior actions introduced to improve cash management, accounting and reconciliation of accounts.
- Monetary and financial sector prior actions:
  - Two prior actions to enhance effectiveness of monetary policy and promote financial stability:
    - submitting to parliament legislative amendments to limit RBM's credit to government
    - strengthening the regulatory framework of the banking system
  - In November the authorities hiked the policy rate and issued the directive on the liquid reserve requirement.
  - Informal quantitative targets for end-January 2015 on NDA, gross official reserves and NDF were set.
- Non-observed performance criteria (PCs) and waivers requested:
  - Authorities request waivers for:
    - non-observance of one periodic PC for the fifth review (end-December 2013 test date)
    - non-observance of two periodic PCs for the sixth review (end-June 2014 test date)
  - The ceiling on NDA of the RBM was not met in part because of shortfalls in external financing.
  - PCs on (i) NDA of the RBM and (ii) government NDF were not met due to continued difficulties in program implementation amid shortfalls in external financing and election uncertainties.
  - Key remedies: adequately financed budget and implementation of PFM reforms to restore fiscal discipline through better fiscal reporting, cash flow management, auditing, compliance and commitment controls.
- Non-concessional external debt and arrears PCs:
  - Authorities request waivers for nonobservance of continuous PCs on contracting non-concessional external debt maturing in more than one year, and on accumulation of external payments arrears for the fifth and sixth reviews.
  - The ceiling on non-concessional debt was missed due to:
    - contracting of a supplementary loan for rehabilitation of an inter-city road effective April 2014
    - contracting of a loan for construction of a cancer center in February 2015
  - Infrastructure loan details:
    - loan amount was $4 million with a grant element of 28 percent
    - staff views the deviation as minor, not threatening program objectives, and corrective actions have been undertaken (¶30)
  - Cancer treatment facility loan details:
    - would amount to US$13 million
    - negotiated with the OPEC Fund for International Development (OFID) and is at 29 percent grant element
    - authorities were unable to secure concessional funding from traditional development partners
    - given loan size and concessionality, debt dynamics are not envisaged to worsen significantly nor persistently; corrective measures to strengthen debt management have been undertaken (¶30)
- Arrangement extension and rephasing request:
  - Authorities request extension of the arrangement by six months to May 22, 2016 and rephasing of disbursements associated with the seventh and eighth reviews (LOI).
  - Rationale: delays in program implementation, sudden stop in donor support, election uncertainties and transition to a new government.
- Repayment capacity:
  - Malawi’s capacity to repay the Fund is assessed as adequate.
  - New disbursements under the ECF arrangement will have a negligible impact on debt and debt service ratios (Table 8).
  - Risk of debt distress remains moderate.
- Risks and mitigation:
  - Risks include policy slippages from lack of ownership of reforms and weak implementation capacity.
  - Adoption of prior actions in PFM, engagement of a long-term PFM advisor and Fund TA are intended to build capacity, strengthen systems, and timely identify emerging risks.

### Staff appraisal
- Impact of the “cashgate scandal”:
  - The scandal damaged Malawi’s macroeconomic outlook and led to the program going off track.
  - Program performance became uneven with several performance criteria for the fifth and sixth reviews not observed.
- Authorities’ commitments welcomed:
  - Confirmed strong commitment to core program policies and objectives, including:
    - flexible exchange rate regime as a shock absorber
    - automatic fuel pricing mechanism ensuring reliable supplies
  - Real GDP growth held up at around 5½-6 percent.
  - Objectives highlighted for monetary policy during the program period:
    - bringing inflation down to single digits
    - improving reserves cover to three months of imports
- Public financial management (PFM) reforms:
  - Implementation of PFM reforms is indispensable to restoring confidence and resumption of budget support.
  - Timely implementation of the remainder of the PFM strategy, including recommendations of the forensic audit and subsequent verification, is essential.
  - Sustained implementation of PFM reforms is critical to fostering full donor re-engagement.
- Monetary policy guidance:
  - Staff welcomes RBM’s commitment to tighten monetary policy as needed to place inflation on a downward path.
  - Given inflation persistence, RBM should remain vigilant and stand ready to further tighten policy if inflationary expectations do not subside.
  - Staff urges timely adoption of amendments to the RBM Act geared towards limiting fiscal dominance.
- Financial stability and legal framework:
  - Authorities encouraged to leverage diagnostic report findings to safeguard financial stability.
  - Staff urges enforcement of prudential norms and addressing weaknesses in the regulatory framework.
  - Adoption by parliament of the Banking and Financial Services Acts and amending the anti-money laundering framework are critical.
- Debt management recommendation:
  - Greater efforts are needed to strengthen debt management despite moderate risk of debt distress.
  - Authorities are encouraged to adopt a strong debt management strategy to ensure total public debt is sustainable and the right balance of costs and risks is achieved.
  - The Debt Management Committee should be strengthened and given necessary power to fulfill its mandate.

*Source: IMF staff report content unit "_cr1583 - 27.      Third-party diagnostic assessments of the health of the banking system were"*

### 42.      Staff recommends the completion of the fifth and sixth program reviews.

### _cr1583 - 42.      Staff recommends the completion of the fifth and sixth program reviews.

### Recommendation
- Staff recommends the completion of the fifth and sixth program reviews.

### Basis for recommendation
- Recommendation is based on strong policy implementation, including implementation of several prior actions since the new government took office.
- Recommendation is also based on the ambitious reform agenda articulated by the authorities in their MEFP.

### Support for waivers and corrective actions
- Staff supports the authorities’ request for waivers on missed PCs for the fifth and sixth reviews based on the strong corrective actions already taken.

### Supported program modifications and measures
- Staff supports:
  - the extension of the arrangement,
  - rephasing of disbursements,
  - the modification of the continuous PC on new non-concessional external debt maturing in more than one year,
  - and the establishment of performance criteria for end-June 2015 and end-December 2015.

*Source: _cr1583 - 42.      Staff recommends the completion of the fifth and sixth program reviews.*

### 2. Regulatory total capital to risk weighted assets

### 2. Regulatory total capital to risk weighted assets

### Capital ratios
- Regulatory total capital to risk weighted assets:
  - 20.3
  - 20.1
  - 22.1
  - 19.2
  - 19.5
  - 20.2
  - 21.1
  - 19.4
  - 19.0
  - 19.1
  - 18.3
  - 18.3
  - 17.8
- Total capital to total assets:
  - 15.8
  - 14.6
  - 15.3
  - 13.9
  - 14.7
  - 14.3
  - 15.5
  - 15.1
  - 15.2
  - 15.4
  - 17.1
  - 17.9
  - 18.7

### Asset composition and quality
- Non-performing loans to gross loans:
  - 3.9
  - 4.1
  - 5.0
  - 5.5
  - 6.5
  - 9.4
  - 11.6
  - 12.6
  - 13.6
  - 15.4
  - 15.7
  - 16.8
  - 15.8
- Provisions to non-performing loans:
  - 31.5
  - 36.9
  - 20.9
  - 30.5
  - 34.5
  - 26.8
  - 27.1
  - 30.5
  - 27.6
  - 29.1
  - 30.3
  - 28.3
  - 30.7
- Total loans and advances to total assets:
  - 52.9
  - 52.7
  - 52.1
  - 53.3
  - 54.6
  - 50.8
  - 46.6
  - 45.4
  - 41.1
  - 40.5
  - 41.7
  - 42.1
  - 41.3
- Foreign currency loans to total loans:
  - n.a.
  - 6.1
  - 6.0
  - 9.4
  - 8.2
  - 7.9
  - 11.1
  - 10.5
  - 12.8
  - 13.5
  - 15.2
  - 18.1
  - 17.1

### Earnings and profitability
- Return on assets (ROA):
  - 4.2
  - 3.5
  - 5.4
  - 5.1
  - 4.9
  - 5.0
  - 5.3
  - 4.7
  - 5.0
  - 4.8
  - 4.5
  - 4.9
  - 4.6
- Return on equity (ROE):
  - 29.4
  - 24.7
  - 38.0
  - 36.7
  - 35.1
  - 36.9
  - 40.5
  - 36.2
  - 38.7
  - 37.5
  - 31.9
  - 33.5
  - 30.8
- Non-interest expenses to gross income:
  - 50.2
  - 46.0
  - 45.4
  - 44.3
  - 44.3
  - 36.8
  - 37.6
  - 37.8
  - 38.0
  - 39.7
  - 43.9
  - 43.2
  - 42.1
- Interest margin to gross income:
  - 49.2
  - 46.0
  - 39.2
  - 37.9
  - 36.6
  - 36.8
  - 36.7
  - 38.9
  - 38.7
  - 39.7
  - 46.4
  - 43.1
  - 44.0
- Personnel expenses to non-interest expenses:
  - n.a.
  - 39.70
  - 48.82
  - 46.51
  - 46.23
  - 46.00
  - 45.09
  - 46.79
  - 46.46
  - 45.40
  - 46.9
  - 45.7
  - 47.4

### Liquidity
- Liquid assets to deposits and short-term liabilities:
  - 40.7
  - 43.0
  - 42.8
  - 42.5
  - 40.7
  - 45.4
  - 48.9
  - 48.6
  - 58.1
  - 59.1
  - 57.1
  - 57.6
  - 59.2
- Total loans to total deposits:
  - 73.2
  - 70.9
  - 70.3
  - 75.9
  - 76.4
  - 72.4
  - 67.0
  - 64.8
  - 57.9
  - 56.6
  - 60.1
  - 62.0
  - 61.0
- Liquid Assets to total assets:
  - 31.3
  - 33.4
  - 33.0
  - 32.6
  - 30.9
  - 34.5
  - 36.2
  - 35.6
  - 42.4
  - 43.7
  - 41.2
  - 41.4
  - 41.5
- Foreign exchange liabilities to total liabilities:
  - n.a.
  - 7.8
  - n.a.
  - n.a.
  - n.a.
  - 17.9
  - n.a.
  - n.a.
  - n.a.
  - 26.3
  - n.a.
  - n.a.
  - n.a.

### External financing requirement and sources (Table 6, selected figures)
- Total requirement (In millions of US dollars):
  - -612
  - -800
  - -746
  - -761
  - -721
  - -756
  - -775
- Current account, excluding official transfer:
  - -687
  - -737
  - -574
  - -497
  - -551
  - -590
  - -631
- Debt amortization:
  - -14
  - -17
  - -11
  - -62
  - -72
  - -73
  - -79
- Gross reserves accumulation (- increase):
  - 89
  - -46
  - -161
  - -202
  - -99
  - -93
  - -65
- Total sources (In millions of US dollars):
  - 612
  - 800
  - 746
  - 761
  - 721
  - 757
  - 775
- Expected disbursements (official):
  - 480
  - 684
  - 602
  - 470
  - 587
  - 643
  - 669
- Grants:
  - 357
  - 590
  - 506
  - 281
  - 383
  - 438
  - 469
- Medium- and long-term loans:
  - 123
  - 93
  - 97
  - 188
  - 204
  - 520
  - 0
- Private sector (net):
  - 132
  - 79
  - 13
  - 130
  - 51
  - 108
  - 115
  - 128
- IMF (net):
  - 0
  - 37
  - 12
  - -14
  - 26
  - -2
  - -23
- Gross official reserves:
  - 190
  - 215
  - 397
  - 599
  - 698
  - 791
  - 817
- Months of imports:
  - 1.0
  - 1.2
  - 2.0
  - 2.9
  - 3.0
  - 3.3
  - 3.4

### Disbursements under ECF Arrangement (selected entries)
- Previous schedule of disbursements (Millions of SDR), Amount / % of Quota / Date available / Status:
  - 13.02 / 18.76 / July 23, 2012 / Disbursed
  - 13.02 / 18.76 / December 15, 2012 / Disbursed
  - 13.01 / 18.75 / March 15, 2013 / Disbursed
  - 6.51 / 9.38 / June 15, 2013 / Disbursed
  - 6.50 / 9.37 / December 15, 2013 / Disbursed
  - 13.01 / 18.75 / March 15, 2014
  - 13.01 / 18.75 / September 15, 2014
  - 13.01 / 18.75 / March 15, 2015
  - 13.01 / 18.75 / September 15, 2015
  - Total for the ECF arrangement: 104.10 / 150.00

- Proposed new schedule of disbursements (Millions of SDR), Amount / % of Quota / Date available / Status:
  - 13.02 / 18.76 / July 23, 2012 / Disbursed
  - 13.02 / 18.76 / December 15, 2012 / Disbursed
  - 13.01 / 18.75 / March 15, 2013 / Disbursed
  - 6.51 / 9.38 / June 15, 2013 / Disbursed
  - 6.50 / 9.37 / December 15, 2013 / Disbursed
  - 6.51 / 9.38 / March 15, 2014
  - 6.51 / 9.38 / September 15, 2014
  - 17.00 / 24.50 / September 15, 2015
  - 22.02 / 31.73 / March 15, 2016
  - Total for the ECF arrangement: 104.10 / 150.00

### Indicators of capacity to repay the Fund (Table 8, selected projections)
- Projected payments based on existing drawings (SDR millions) — Principal:
  - 17.35
  - 17.86
  - 15.71
  - 20.41
  - 11.89
  - 12.49
  - 10.41
  - 10.41
  - 3.90
  - 1.30
  - 0.00
  - 0.00
- Charges and interest (existing drawings):
  - 0.00
  - 0.00
  - 0.00
  - 0.00
  - 0.11
  - 0.08
  - 0.05
  - 0.03
  - 0.01
  - 0.00
  - 0.00
  - 0.00
- Projected payments based on prospective drawings (SDR millions) — Principal:
  - 0.00
  - 0.00
  - 0.00
  - 0.00
  - 0.00
  - 1.30
  - 8.21
  - 10.41
  - 10.41
  - 10.41
  - 9.11
  - 2.20
- Combined projected payments (SDR millions):
  - 17.4
  - 17.9
  - 15.7
  - 20.4
  - 12.1
  - 14.0
  - 18.8
  - 20.9
  - 10.5
  - 10.5
  - 9.1
  - 2.2
- Combined projected payments (US$ Millions):
  - 25.0
  - 25.8
  - 22.9
  - 29.9
  - 17.9
  - 20.9
  - 28.0
  - 31.2
  - 15.6
  - 15.6
  - 13.6
  - 3.3
- Percent of exports of goods and services (combined projected payments):
  - 1.4
  - 1.3
  - 1.1
  - 1.2
  - 0.7
  - 0.7
  - 0.9
  - 0.9
  - 0.4
  - 0.4
  - 0.3
  - 0.1
- Percent of debt service:
  - 20.7
  - 23.6
  - 23.5
  - 30.6
  - 21.7
  - 21.1
  - 24.3
  - 26.1
  - 12.2
  - 11.5
  - 9.3
  - 2.2
- Percent of quota:
  - 25.0
  - 25.7
  - 22.6
  - 29.4
  - 17.5
  - 20.2
  - 27.1
  - 30.2
  - 15.1
  - 15.1
  - 13.1
  - 3.2
- Percent of gross official reserves:
  - 3.6
  - 3.3
  - 2.8
  - 3.5
  - 2.1
  - 2.4
  - 3.2
  - 3.4
  - 1.7
  - 1.6
  - 1.4
  - 0.3

- Projected level of credit outstanding (SDR millions):
  - 147.6
  - 161.5
  - 145.8
  - 125.4
  - 113.5
  - 99.1
  - 76.9
  - 51.5
  - 32.6
  - 16.3
  - 3.2
  - 0.0
- Projected level of credit outstanding (US$ Millions):
  - 213.0
  - 234.3
  - 213.0
  - 184.4
  - 168.3
  - 148.6
  - 115.3
  - 77.2
  - 48.9
  - 24.4
  - 4.8
  - 0.0
- Percent of exports of goods and services (credit outstanding):
  - 11.5
  - 11.4
  - 9.9
  - 7.7
  - 6.4
  - 5.1
  - 3.7
  - 2.3
  - 1.3
  - 0.6
  - 0.1
  - 0.0

- Memorandum items (selected):
  - Exports of goods and services (millions of U.S. dollars):
    - 1847
    - 2049
    - 2156
    - 2403
    - 2650
    - 2909
    - 3151
    - 3401
    - 3673
    - 3969
    - 4292
    - 4644
  - Debt service (millions of U.S. dollars):
    - 120.5
    - 109.6
    - 97.5
    - 97.8
    - 82.4
    - 99.0
    - 115.2
    - 119.9
    - 128.3
    - 135.6
    - 145.9
    - 150.0
  - Quota (SDR millions):
    - 69.4 (repeated entries)
  - Gross official reserves (millions of U.S. dollars):
    - 697.9
    - 790.7
    - 817.4
    - 859.0
    - 868.1
    - 856.1
    - 881.4
    - 906.6
    - 931.9
    - 962.4
    - 991.3
    - 1021.1
  - GDP (millions of U.S. dollars):
    - 4943
    - 5709
    - 6382
    - 7030
    - 7539
    - 8122
    - 8751
    - 9442
    - 10183
    - 11002
    - 11896
    - 12848

### Quantitative targets (Tables 9–12, selected items)
- Table 9 / 2013 targets (millions of kwacha), examples:
  - Ceiling on net domestic assets of the RBM (PC): 108,487 / 110,839 / 72,920
  - Ceiling on reserve money (IT): 106,902 / 106,902 / 126,570
  - Ceiling on central government's net domestic borrowing (PC): -18,605 / -16,253 / -2,492
  - Floor on social spending (IT, cumulative): 185,511 / 185,511 / 181,764
  - Floor on net international reserves of the RBM (PC, US$ millions): 53 / 46 / 270
- Table 10 / 2014 targets (millions of kwacha), examples:
  - Ceiling on net domestic assets of the RBM (PC): 113,035 / 115,595 / 117,434
  - Ceiling on reserve money (IT): 134,392 / 134,392 / 169,100
  - Ceiling on central government's net domestic borrowing (PC): 52,018 / 54,578 / 81,548
  - Floor on net international reserves of the RBM (PC, US$ millions): 169 / 161 / 262
- Table 11 / Informal quantitative targets (selected actuals and status):
  - Ceiling on net domestic assets of the RBM (millions of kwacha) — Actual End-Sept 2014: 132,004 / Status: Met
  - Ceiling on central government's net domestic borrowing (millions of kwacha) — Actual End-Sept 2014: 8,527 / Status: Not Met
  - Floor on gross official reserves (US$ millions) — Actual End-Sept 2014: 450 / Status: Met
- Table 12 / 2015 targets (millions of kwacha), selected:
  - Ceiling on net domestic assets of the RBM (PC): 71,574 / 87,033 / 73,959 / 83,792
  - Ceiling on reserve money (IT): 223,402 / 243,828 / 248,213 / 260,545
  - Ceiling on central government's net domestic borrowing (PC): 59,083 / 37,030 / 40,407 / 58,162
  - Floor on social spending (IT, cumulative): 205,055 / 257,430 / 54,725 / 146,687
  - Floor on net international reserves of the RBM (PC, US$ millions): 475 / 487 / 531 / 537

*Source: Reserve Bank of Malawi; IMF staff estimates.*

### 9. Prohibition on the imposition or intensification of restrictions on the making

### 9. Prohibition on the imposition or intensification of restrictions on the making

### Memorandum items — key balances and program exchange rate
- Net foreign assets of the RBM (US$ millions): 378; 390; 433; 440
- Budget support (US$ millions): 0 1807
- Budget support (millions of kwacha): 0; 8000; 0; 3224
- Debt service payments to the World Bank andAfDB (US$ millions): 8.22; 12.12; 3.90; 7.80
- Debt service payments to the World Bank and AfDB (millions of kwacha): 3,304; 4,872; 1,568; 3,136
- Health SWAp receipts (millions of kwacha): 15,668; 15,668; 2,114; 14,993
- Education SWAp receipts (millions of kwacha): 1,743; 3,384; 0; 0
- NAC receipts (millions of kwacha): 0 0164332
- Program exchange rate (kwacha per US$): 402; 402; 402; 402

### Structural benchmarks (set at Third and Fourth Reviews) — selected measures, target dates, and status
- Public financial management
  - Upload into IFMIS the audited manual transactions undertaken when IFMIS was suspended. Target: End-Jan. 2014. Rationale: Enable better spending control and improve reporting. Status: Not met. Some manual transactions uploaded but others pending.
  - Clear the backlog of reconciliation of all government-controlled accounts at the RBM and commercial banks of transactions made until November 30, 2013. Target: End-Dec. 2013. Rationale: Improve spending controls. Status: Not met.
  - Begin daily reconciliation of all government-controlled accounts at the RBM and commercial banks of transactions made until November 30, 2013. Target: March 1, 2014. Rationale: Improve spending controls. Status: Not met.
  - Submit to Fund staff final forensic audit report. Target: End-Jan. 2014. Rationale: Establish basis for improving PFM. Status: Not Met. Final report submitted in September 2014.
  - Provide Ministries, Departments and Agencies with quarterly spending ceilings consistent with quarterly fiscal targets in the program, and enforce ceilings. Target: Quarterly. Rationale: Keep spending within available resource envelope. Status: Not met.
  - Verify existing stock of government domestic arrears at end-September 2013. Target: End-Dec, 2013. Rationale: Establish baseline for monitoring flow and stock of new arrears. Status: Met.
  - Report on the flow and stock of arrears at the end of each quarter starting with July-September 2013, within two months of the end of the quarter. Target dates: February 2014, May 2014, August 2014. Rationale: Monitor re-emergence of new arrears. Status: Not met.
- Monetary policy
  - Government authorizes RBM to stop automatic conversion of overdrafts into government securities. Target: End-Dec, 2013. Rationale: Reduce fiscal dominance. Status: Met.
- Financial sector
  - RBM to publish a financial stability report on a semi-annual basis (March, September), with a lag of no more than four months. Target: Semi-annual; July 2013 and January 2014. Rationale: Promote financial stability. Status: Met.
  - Submit to parliament amendments to the Banking Act and Financial Services Act along the lines recommended by March 2013 Fund (LEG) TA mission. Target: 31-Dec-13. Rationale: Enhance RBM's bank resolution powers and tools. Status: Not met.
  - Adopt a prompt corrective action framework for banks. Target: 31-Dec-13. Rationale: Strengthen enforcement of prudential regulations. Status: Met.
  - Complete third party diagnostic assessments of the most vulnerable banks. Target: End-Feb, 2014. Rationale: Financial stability. Status: Not met. Diagnostic reports completed in July 2014.
  - Complete the third party diagnostic assessments of all banks. Target: 30-Jun-14. Rationale: Financial stability. Status: Not met. Reports for the remaining banks were completed in October 2014.

### Prior actions (as listed) — actions taken and status
- Fiscal policy
  - Implement expenditure cuts necessary to limit net domestic financing under the program ceiling for the fiscal year 2014/15 and issue a memo to cabinet outlining new expenditure ceilings. Target date: End-February 2015. Rationale: Ensure consistency between the budget and the program. Status: Met.
- Public financial management
  - Ministry of Finance to issue a letter to the central bank to transfer revenues to main government account (MG1). Target date: End-February 2015. Rationale: First step towards better cash management and reconciliation of accounts. Status: Met.
  - Incorporate the main government bank accounts in IFMIS, including MG1 account and six operational accounts (salaries; other recurrent transactions; development; statutory; advances; deposits). Target date: End-February 2015. Rationale: Integrate key accounts into IFMIS progressively to ensure improved accounting, cash management and reconciliation of accounts. Status: Met.
- Monetary policy
  - Submit to parliament legislative amendments to limit RBM's credit to government to a 10 percent of the previous year's revenue. Target date: End-February 2015. Rationale: Reduce fiscal dominance to enhance effectiveness of monetary policy. Status: Met.
- Financial sector
  - Submit to parliament amendments to the Banking Act and Financial Services Act in line with March 2013 Fund (LEG) TA mission recommendations. Target date: End-February 2015. Rationale: Promote financial stability by enhancing RBM's bank resolution powers and tools. Status: Met.

### Structural benchmarks, 2015 — selected measures and target dates
- Public financial management (selected)
  - Publish detailed monthly budget execution data by vote on the Ministry of Finance's website no later than 6-weeks after execution. Target: End-March 2015. Rationale: Foster greater fiscal transparency and monitoring.
  - Reconcile all government bank accounts MG1 and six operational accounts and ways and means for all 2014 transactions signed by the Accountant General and Secretary of the Treasury. Target: End-March 2015. Rationale: Strengthen cash planning, reconciliation of accounts, and improve accounting system integrity.
  - Review all bank accounts and close redundant and dormant accounts and provide an updated list from the central bank certified by the Accountant General. Target: End-March 2015. Rationale: Strengthen cash planning, reconciliation of accounts, and improve accounting system integrity.
  - Prepare a report on the flow and stock of arrears at the end of each quarter starting with end-September 2014 and within two months of the end of each six months. Target: End-June 2015. Rationale: Monitor emergence of arrears.
  - Produce and publish monthly summary bank account control reports. Target: End-September 2015. Rationale: Improve transparency and control.
  - Issue reports by international audit firms on bank reconciliations and summary bank account control reports. Target: End-September 2015. Rationale: Improve transparency and restore public confidence.
  - Issue a report by an International firm confirming the status of implementation of forensic audit recommendations in the PFM domain. Target: End-December 2015. Rationale: Foster greater transparency.
- Financial sector (selected)
  - Prepare a strategy to address banking sector wide issues raised by the third-party diagnostics assessments, including the high loan concentration among banks. Target: End-March 2015. Rationale: Safeguard financial stability.
  - RBM to obtain from all undercapitalized banks detailed, quarterly monitorable recapitalization and restructuring plans showing how they will reach the minimum capital adequacy level within one year. Target: End-April 2015. Rationale: Safeguard financial stability.
  - RBM to obtain from all banks with significant deficiencies reported by the diagnostic assessments plans to address the deficiencies within one year. Target: End-June 2015. Rationale: Safeguard financial stability.
  - RBM to develop contingency plans to intervene and resolve banks if they do not submit or comply with acceptable recapitalization plans. Target: End-June 2015. Rationale: Safeguard financial stability.
  - Submit to parliament amendments to the AML/CFT Act, the Penal Code, and the Corrupt Practices Act in line with the FATF standard and UNCAC. Target: End-June 2015. Rationale: Ensure enhanced customer due diligence for domestic PEPs; reporting of suspicious transactions when funds are suspected proceeds of criminal activity; adequate transparency of legal persons and arrangements; adequate criminalization of acts of corruption as predicate crimes to money laundering; criminalization of self-laundering; appropriate administrative sanctions for failure to comply with AML/CFT requirements.
  - RBM issue a detailed report on compliance with regulations on loan classification and provisioning and concentration limits in line with existing directives. Target: End-September 2015. Rationale: Safeguard financial stability.
  - RBM, in its supervisory capacity, to follow-up on possible breaches of compliance with the AML legal framework by banks revealed by the audit report, applying supervisory actions mandated by the AML legal framework, including sanctions. Target: End-December 2015. Rationale: Ensure compliance with AML standards.

### Appendix I — Progress in Implementing the Government’s Short-Term Action Plan (selected achievements and status)
- Investigation and Prosecution
  - Assets profiling and restrictions: Assets (e.g., houses, vehicles and farms) of several public officials have been profiled.
  - 60 out of 81 companies identified in investigations have been profiled.
  - Restrictions imposed on access to 50 bank accounts.
  - Restrictions imposed on disposal of properties of several persons/entities under investigation.
  - Prosecution activity: 53 case files being used to pursue prosecutions. Three convictions to date and MK185 million in assets recovered.
  - Joint investigative teams established among ACB, DPP, Financial Intelligence Unit and Malawi Revenue Authority.
- Auditing
  - Preliminary forensic audit covering April-September 2013: preliminary report submitted to government on February 21 2014; submitted to Parliament on February 24, and final report made public on October 30, 2014.
  - Comprehensive forensic audit including forensic audit of arrears: Price Water House Coopers identified to carry out the Forensic Audit covering July 2009 to March 2014 (with German Agency for International Cooperation support).
  - Auditor General to table all reports from investigations and special audits in Parliament for action by the Public Accounts Committee. Preliminary and final forensic audit reports submitted to Parliament.
- Accounting, IFMIS and controls
  - Security features enhanced; physical access to IFMIS server room secured; stronger controls limiting system administrator access.
  - Draft Service Level Agreement (SLA) negotiated; new SLA for January to June 2014.
  - ICT Security Officer recruited and commenced duties on November 1, 2014.
  - IFMIS Manager at Deputy Director level appointed; IFMIS Advisor recruited with support of Germany.
  - Circulars issued: OA/1/15/13/270 dated 19th September 2013 by the Secretary to the Treasury; circular issued by Accountant General.
  - Reconciliation of the backlog done to end December 2013. Internal audit investigated un-reconciled items for July 2012 to December 2013 and will continue for June 2012 to July 2012.
  - Daily bank reconciliation: Not done. FAD TA mission provided recommendations.
  - Accountant General’s Department started circulating daily IFMIS-generated electronic check list to the RBM and commercial banks; commercial banks clearing checks through IFMIS-generated check lists.
  - Cash Management Committee revived and chaired by the Secretary to the Treasury.
  - Instructions issued to RBM and capping began in January 2014 to enforce funding ceilings with IFMIS and the RBM.
  - Two independent firms/consultants recruited with EU support to provide oversight and pre-audit services; some improvements in internal controls noted but more needed.
  - Internal audit report issued in December 2013 on manual payments; all manual payments captured into IFMIS and reconciliation underway.
- Administrative and institutional measures
  - Disciplinary action: 2 principal secretaries and 18 accounting personnel suspended.
  - Staff rotation and redeployment: some officers posted to other ministries; 16 IT personnel posted out of the Accountant General’s Department.
  - Training and enforcement of the Malawi Public Service Code of Conduct: training program drawn by PSRMU; sessions conducted in March 2014 including Training of Trainers (31 participants); High Level Consultation (44 participants); Ethics training for 135 participants; participants required to sign commitment to compliance.
- Legal and institutional reforms
  - Amend Money Laundering Act: amendments proposed and discussions ongoing between FIU/MoF and Ministry of Justice. Now a benchmark.
  - Assets Declaration bill: passed by parliament and signed into law by the President; Assets Declaration Act assented to and gazetted.
  - Acceleration of Public Finance and Economic Management Reform Program through Financial Reporting and Oversight Improvement Project: GWAN assessment, IFMIS support through Softec/Epicor suppliers, business re-engineering, training for accounting and auditing personnel, procurement of equipment for accounting, payroll management, internal audit and external audit functions.

*Sources: IMF staff and Malawian authorities.*

### Appendix II. Letter of Intent

### Appendix II. Letter of Intent (March 4, 2015)

### Context and program objectives
- Executive Board completed third and fourth reviews under the three year Extended Credit Facility (ECF) arrangement on January 17, 2014, and extended the arrangement to November 2015.
- Government reaffirms commitment to ECF objectives: strong inclusive growth, single digit inflation, and an increase of reserves to at least three months of import cover.
- Policy stance to be maintained:
  - Preserve flexible exchange rate regime and automatic fuel pricing mechanism.
  - Tight monetary policy to place inflation on a clear downward trajectory and maintain positive real interest rates.
  - Fiscal program for FY2014/15 calibrated to support disinflation and restore private sector confidence.
- Request: completion of the fifth and sixth reviews and release of the sixth and seventh tranches totaling SDR 13.02 million; extension of the arrangement by 6 months to May 22, 2016 and rephasing of remaining disbursements.

### Impact of the “Cashgate” scandal and PFM response
- Large scale theft of public funds uncovered in late 2013 (“cashgate”) led to suspension of donor budget support valued at about 5 percent of GDP, severe PFM weaknesses, and a dire fiscal situation.
- Consequences observed:
  - Increased recourse to domestic financing; domestic payment arrears emerged.
  - Inflationary pressures persisted and the exchange rate depreciated sharply.
- PFM remediation and audits:
  - Government Action Plan adopted October 2013; independent assessment (March 2014) on 39 actions: 22 of 66 actions met, progress on 10, 1 not met, 6 unassessable. Internal assessment (October 2014): 48 actions met, progress on 12, 6 yet to be met.
  - External forensic audit interim report (February) and final report delivered October 2014.
  - Engagement of Price Waterhouse Coopers International to audit Epicor System for 2009–March 2013 with GIZ assistance; private auditors engaged for sub-IFMIS systems (State Residences, Malawi Defense Forces, Malawi Police).

### Recent economic developments and near-term outlook
- Growth:
  - Real GDP growth projected to increase from 5.2 percent in 2013 to about 6 percent in 2014, led by agriculture, wholesale/retail trade, and information and communication sectors.
  - All major sectors projected to register positive growth except mining (suspension of uranium production at Kayerekera since June 2014).
- External sector:
  - Exports set to grow by 7 percent during 2014, driven by tobacco recovery and continued growth in tea, sugar, cotton, and nontraditional commodities.
  - Imports expected to grow slowly at about 3.7 percent during 2014.
  - International reserve levels reached 2.9 months of import cover in December (below target of three months).
- Fiscal and financing shocks:
  - Annual shortfalls in external disbursements amounting to almost 6.6 percent of GDP.
  - Domestic financing rose to about 6 percent of GDP by end-2013/14; payment arrears accumulated at 1.7 percent of GDP (and additional arrears uncovered from previous years).
- Inflation and monetary policy:
  - Disinflation stagnated; inflation at end-2014 was 23 percent (year-on-year).
  - RBM policy rate: lowered by 250 basis points to 22.5 percent in July 2014; raised back to 25 percent on October 30th.
  - Liquid reserve ratio (LRR) current 15.5 percent; directive applied LRR to foreign currency deposits in local currency effective November 10, 2014 to absorb liquidity.
- Financial sector and credit:
  - Bank loan interest rates remained elevated, sharply reducing private sector credit growth.
  - Non-performing loans rose to 15.8 percent of gross loans.
- Exchange rate:
  - Kwacha depreciated by 15 percent in 2014 (seasonal and financing-related pressures).
- Public debt and debt service:
  - External public debt to GDP ratio expected to reach 32 percent of GDP (net present value) at end-2014.
  - Debt service ratio in 2014: 4.7 percent of exports of goods and services.
  - Total public debt expected to reach 75.8 percent of GDP at end-2014 (domestic debt burden increasing).

### Program performance, missed performance criteria, and remedial actions
- Requests for waivers due to nonobservance of performance criteria:
  - Waiver requested for one periodic performance criterion (end-December test date, fifth review) and two periodic PCs (end-June 2014 test date, sixth review) related to net domestic assets of the central bank and net domestic borrowing—missed mainly because of external financing shortfalls and electoral uncertainties.
  - Continuous ceilings on external payments arrears and on non-concessional debt were breached after contracting and nonpayment on a supplier’s credit for military equipment.
    - Supplier credit transactions value reduced from US$145.3 million to US$33 million via renegotiation; further remedial measures for debt management capacity undertaken.
    - Outstanding arrears normalized as explained in Government’s February 19 letter (response to IMF February 12 letter).
    - Waiver requested for nonobservance of PCs on contracting of non-concessional external debt with maturity >1 year and on accumulation of external payments arrears that resulted in non-complying disbursements.
  - Continuous ceiling on new non-concessional external debt maturing in more than one year was breached due to contracting of two non-concessional loans:
    - Supplementary loan for inter-city road rehabilitation that became effective in April 2014 (described as relatively small, US$4 million).
    - Loan contracted in February 2015 for construction of a cancer treatment center in Lilongwe negotiated with the OPEC Fund for International Development, amount (US$13 million) with a 29 percent grant element; agreed after exhausting efforts to secure more concessional financing.
    - Waiver requested for nonobservance of the continuous ceiling on new non-concessional external debt with maturity >1 year.
- Prior actions completed before fifth and sixth reviews:
  - Implementation of expenditure cuts to limit net domestic financing under program ceiling for FY2014/15.
  - Issuance of a letter to the central bank to transfer revenues to the main government account.
  - Inclusion of main government accounts (MG1 and six operational accounts) in the information management system.
  - Submission to Parliament of legislative amendments to limit RBM’s credit to government to 10 percent of previous year’s revenue.
  - Submission to Parliament of amendments to the Banking Act and the Financial Services Act per March 2013 Fund TA recommendations.

### Debt management and governance measures going forward
- Strengthening concessionality monitoring and debt management:
  - Resuscitation of the Debt Management Committee with senior civil servant membership to ascertain concessionality of every borrowing proposal and ensure compliance with the Public Financial Management Act.
  - Government will discuss all new loan proposals with IMF staff before Cabinet or Parliament consideration and ensure transparency of grant element disclosures.
  - Continue implementing the Debt management reform programme agreed with IMF and World Bank to strengthen debt management capacity.

### Requests and commitments
- Requests:
  - Waivers for missed PCs noted above.
  - Completion of fifth and sixth reviews and release of sixth and seventh tranches totaling SDR 13.02 million.
  - Extension of the arrangement by 6 months to May 22, 2016 and rephasing of remaining disbursements.
- Government commitments:
  - Continue implementing MEFP policies and take additional measures as appropriate in consultation with the IMF.
  - Provide IMF with requested information on progress in implementing policies and achieving program objectives.
  - Authorizes IMF publication of this letter, the MEFP, and the Technical Memorandum of Understanding.

*Source: Letter of Intent and attached Memorandum on Economic and Financial Policies (March 4, 2015).*

### 8.      As a result of these developments, a majority of the periodic quantitative targets for end-

### _cr1583 - 8.      As a result of these developments, a majority of the periodic quantitative targets for end-

### Program performance and quantitative targets
- A majority of the periodic quantitative targets for end-December 2013 (fifth review test date) and end-June 2014 (sixth review test date) under the program were missed.
- Exception: the performance criterion (PC) on net international reserves (NIR) was met comfortably for both test periods.
  - For end-December 2013: RBM refrained from exchange rate intervention after a strong tobacco season in August 2013, preferring to maintain reserves at the cost of some exchange rate depreciation.
  - For end-June 2014: NIR target met due to carry-over from the earlier decision and another strong tobacco season in mid-2014.
- Incomplete sterilization of purchases increased system liquidity and pushed NDA and reserve money of the RBM above program targets in both December 2013 and June 2014.
- PC on net domestic borrowing by government:
  - Met for December 2013 test date.
  - Breached the end-June 2014 program ceiling due to acute spending pressures and additional borrowing in the second half of the fiscal year.
- Indicative target on social spending was missed, in part because of lower spending on the Farm Input Subsidy Program (FISP).

### Nonconcessional external debt and arrears
- Continuous ceiling on accumulation of nonconcessional external debt was missed due to:
  - Contracting in October 2013 of a medium-term nonconcessional suppliers’ credit.
  - Contracting in April 2014 of a supplementary loan for rehabilitation of the Liwonde-Naminga road.
  - Contracting in February 2015 of a loan for construction of a cancer treatment center in Lilongwe.
- Continuous ceiling on external payments arrears was missed as of October 2013 due to arrears incurred on the supplier’s credit loan.
- Paramount suppliers’ credit in 2013 to acquire military equipment:
  - Original value reduced from $145.3 million to $33 million after renegotiation to include only equipment delivered or in production.
  - Proceeds from sale of presidential jet in 2013 were used to make partial restitution of overdue payments on this agreement.
- Supplementary loan for Liwonde-Naminga road:
  - Amount: US$4 million.
  - Grant element: 29 percent.
  - Government rationale: small size, contractor already engaged, strategic importance, avoid higher costs from delay, unwillingness of other lenders to provide concessional financing.
- Loan for National Cancer Centre:
  - Amount: US$13 million.
  - Lender: OPEC Fund for International Development.
  - Grant element: 29 percent.
  - Government efforts: sought inclusion under Health SWAP 1 and concessional funding from development partners; after exhausting options only OFID agreed to finance.
  - Justification: rising new cancer cases, high cost of chemotherapy (~$1400 per treatment), radiotherapy as more affordable modality, national/regional referral centre, learning centre and partnerships with nursing and medical schools.

### Structural reforms, audits, and anti-corruption actions
- Government verified stock of government domestic arrears for 2013/14 and previous years:
  - Total stock of arrears stands at K157 billion (8 percent of GDP).
  - Because of large amounts and claimants referenced in forensic audit, Auditor General asked to repeat entire audit.
  - Further verification needed for arrears accumulated during FY13/14 concerning whether infrastructure works were actually carried out.
- RBM authorized to stop automatic conversion of overdrafts into government securities, significantly reducing treasury bills held by the central bank, but with little effect on advances.
- Financial sector measures:
  - RBM regularly publishes a quarterly financial stability report.
  - Adopted a prompt corrective action framework for bank resolution.
  - Amendments to the RBM Act were submitted to Parliament (prior action).
  - Third party diagnostics completed for every bank in the system.
- Forensic audit of “Cashgate” period:
  - Full report made publicly available.
  - Prosecutions and recoveries begun: 53 case files used for prosecutions.
  - To date: five convictions and MK 183 million recovered.
  - External asset recovery expert (financed by the U.K.) assisting to increase recoveries.
  - Investigative agencies collaborating: Anti Corruption Bureau, Financial Intelligence Unit, Financial Fraud Unit of the Malawi Police Force, Malawi Revenue Authority.
  - Government will request Fund technical assistance to amend legal framework gaps (Penal Code, Corrupt Practices Act, PFM Act, Anti-Money Laundering framework).
- Procurement and audit reforms:
  - Harmonized procurement across public sector and will audit “out of scope” transactions in each ministry.
  - Private sector auditors to complement centralized Ministry of Finance audit function.
  - Controlling officers to attend workshops on responsibilities and sanctions under the PFM Act; appointment letters with revised terms of reference to be issued.
  - An audit firm report confirming implementation status of forensic audit recommendations to be issued (end-December benchmark).

### IFMIS, reconciliations, and administrative progress
- IFMIS and manual transactions:
  - Most manual transactions from October-November 2013 uploaded into IFMIS.
  - Completion delayed pending validation; few votes remain to be finalized.
  - Deadline for completing this assignment set to end-February 2015.
- Daily reconciliation of government accounts with RBM:
  - Begun January 2014 but technical problems with Epicor-based IFMIS impeded final adjustments.
  - A 15 member team assigned to manual reconciliation from 10th November, 2014; expected finalization by end of February, 2015.
  - Central Internal Audit Unit to finalize follow-up backlog work by end-February, 2015.
- Budget ceilings:
  - Departments and Agencies not provided quarterly spending ceilings due to constrained resource envelope; monthly ceilings continue.
  - Intention to move to quarterly ceilings to increase spending efficiency as soon as feasible.
- Administrative delays encountered in submitting amendments to the Banking Act and Financial Services Act to Parliament.

### Macroeconomic performance, outlook, and key objectives
- Recent policy actions:
  - Policy rate raised from 22½ percent to 25 percent to tighten monetary stance.
  - Supporting liquidity operations to translate rate increase into upward shift in other key interest rates and establish sharply positive real interest rates economy-wide, with attention to treasury bill rates.
  - Accelerated PFM reforms to regain control of fiscal operations and prevent unauthorized spending and further arrears.
- Overriding short-term goals:
  - Increase reserve cover to at least three months of imports.
  - Reduce inflation to single digits.
  - Stabilize macroeconomic situation, regain control over fiscal systems, and safeguard financial sector stability.
- Growth and inflation projections:
  - Real growth in 2015 expected to reach 5.5 percent (one percentage point lower than anticipated in December 2013 MEFP).
  - Real growth to gradually increase to 6 percent in 2017.
  - Inflation to decline to 12 percent by end-2015 and to single digit levels towards end-2016.
- Reserves and current account:
  - Aim: international reserves of at least 3.3 months of import cover by 2016.
  - Expectation: current account deficit to decline by about 1.7 percentage point of GDP by the end of 2015 under macro stability and higher confidence.
- Short-term trade-offs and expectations:
  - Restrictive policy position necessary to stabilize economy, with a near-term cost to growth.
  - Lower international food and fuel prices and a stronger currency expected to help bring inflation to single digits over the next 12 to 15 months.
  - Maintenance of positive real interest rates expected to improve attractiveness of the kwacha and help limit intra-year exchange rate volatility.
  - Anticipated gradual recovery in private sector confidence, investment, and consumption, with activity accelerating towards the end of the calendar year and sustainable low inflation in 2016 and beyond.

### Fiscal policy details and adjustments for FY2014/15
- Overall aim: support strong disinflation effort and re-establish private sector confidence by controlling fiscal expenditure and safeguarding debt sustainability.
- Transparency measure: begin regular monthly publication of detailed fiscal operations.
- Adjusted budget impact: about a 2¾ percentage points of GDP improvement in the overall balance relative to last year when fully executed.
- Revenue and grants:
  - Total revenue conservatively estimated at 33 percent of GDP, about ½ percentage points higher than last year.
  - Tax revenue projected at 0.5 percentage point of GDP below the outturn for last fiscal year to reflect uncertainties.
  - Offset by an increase in foreign—mostly project—grants.
  - Malawi Revenue Authority (MRA) undertaking a Modernization Program (“Innovation and Modernization”) to improve tax compliance, promote enhanced ICT (electronic fiscal devices (EFD), cargo scanners), and widen tax registration net.
- Expenditure:
  - Total outlays programmed at 38.9 percent of GDP, a decline from last year of 2 percentage points of GDP.
  - Majority of adjustment: 5½ percentage points of GDP falls on current expenditure.
  - Savings of 0.6 percentage points of GDP from not funding elections this year.
  - Containment of nominal increase in public sector wages; overall wage bill to decline by more than ½ percentage points of GDP.
  - Domestic interest payments at 4.6 percent of GDP; expected decline of almost 1½ percentage points of GDP with sharply reduced recourse to new domestic financing.
  - Subsidies and other current transfers to continue absorbing a large share of current outlays to safeguard social spending, particularly FISP and a new program for assisting poorest citizens with housing construction.
  - Falling world prices for fertilizers allowed budgeting for both programs within the share of GDP expended on the FISP alone last year.
  - Capital spending to increase by 3.2 percentage points to 9.6 percent of GDP.
- Financing:
  - Domestic borrowing to be sharply reduced from almost 6 percent of GDP in FY2013/14 to about 2 percent this fiscal year.
  - Net domestic debt stock (excluding domestic arrears) to fall from 22.2 percent of GDP in 2013 to 19.4 percent in 2014.
  - Foreign assistance mainly limited to project loans and funds disbursed under Sector-Wide Assistance Programs.
- Debt management measures:
  - Resuscitate the Debt Management Committee at senior level to review each borrowing for concessionality and ensure debt sustainability.
  - Continue implementing the Debt Management Reform Programme agreed with IMF and World Bank to strengthen Debt and Aid Management Division capacity.

*Source: _cr1583 - 8.      As a result of these developments, a majority of the periodic quantitative targets for end-*

### 23.      With IMF assistance we have finalized a methodology to regularize the large stock of

### _cr1583 - 23.      With IMF assistance we have finalized a methodology to regularize the large stock of

### Domestic arrears regularization
- All arrears will be verified and audited.
- Of the arrears that accumulated in FY13/14 we have made arrangements in our fiscal program for cash payments of MK 10 billion in FY14/15.
- Remaining arrears accumulated in FY13/14 and those incurred before will be regularized through securitization in three equal tranches during the current fiscal year and in FY15/16 and FY16/17 budgets.
- Measures to prevent new unauthorized payment obligations:
  - Deploy auditors in each ministry.
  - Strengthen commitment controls.
  - Hold controlling officers accountable under the PFM Act for willful breach of voted allocations.

### Monetary and financial sector policies
- Objective: use monetary policy to place inflation on a clear declining trajectory by ensuring the central bank rate remains well above the rate of inflation.
- Tools and actions:
  - Use liquidity operations in the interbank and Treasury bill markets to ensure attainment and maintenance of sharply positive real interest rates.
  - Improve communication with commercial banks and market participants to signal commitment to regaining price stability.
  - Amendments to the RBM Act submitted to Parliament as a prior action to establish an upper bound on total government borrowing—regardless of instrument—from the RBM in any given year to limit fiscal dominance.
  - Continued adherence to the flexible exchange rate regime.
- Expected outcomes:
  - Gradual increase in transparency and credibility of monetary policy.
  - Lower inflationary expectations and increased confidence in the kwacha as attractive real returns on domestic assets are maintained, mitigating depreciation pressure.

### Financial sector resilience and supervision
- Basel II migration and capital requirements:
  - Migrated to Basel II in early 2014.
  - Raised Tier 1 and total capital requirement ratios to 10 percent and 15 percent from 6 percent and 10 percent, respectively.
  - All banks, except two, now have higher capital adequacy ratios than required under the new standard.
- Prudential and supervisory enhancements:
  - Improved prudential norms in asset classification and provisioning with Fund TA.
  - Adopted a prompt corrective action (PCA) framework.
  - Third party diagnostic assessments completed and reviewed; major areas of concern communicated by the RBM to boards of directors of respective banks.
  - RBM to review measures taken by banks through on-site and off-site supervision and to design sector-wide strategies within the legal framework.
- Restructuring of the two weakest banks:
  - Restructuring process underway; transaction advisor completed due diligence on one bank and submitted options including sale or recapitalization.
  - Next steps: dispatch the Information Memorandum to bidders and select preferred bidders.
- Capacity strengthening:
  - External bank supervision advisor hired and commenced work in July 2014.
  - Enhancement of on-site and off-site supervision; close monitoring and enforcement of prudential norms.
- Loan concentration risk:
  - Loan concentration is a major risk and has continued to rise.
  - RBM will closely monitor loan concentrations and will strictly limit waivers for exposures exceeding the loan concentration limit.
- Regulatory framework improvements:
  - Amendments to the Banking Act of 2010 and Financial Services Act of 2010 submitted to Parliament (prior action) to align bank resolution framework with best practices and provide more options for dealing with problem banks.

### Anti‑Money laundering initiatives
- Response to forensic report on Cashgate:
  - Address gaps in the regulatory framework by amending the AML/CFT Act, the Penal Code and the Corrupt Practices Act, aligning them with Financial Action Task Force standards and the United Nations Convention Against Corruption.
  - RBM will re-evaluate its capacity to monitor and supervise AML compliance by banks and apply appropriate supervisory sanctions for breaches.

### Public financial management (PFM) reform
- PFEM RP and revised PFM strategy:
  - Government continues to implement the Public Finance and Economic Management Reform Programme (PFEM RP).
  - With IMF technical assistance, revised process for strengthening PFM systems to address fiscal reporting, bank reconciliation, enforcement of commitment control, improvement of other internal controls, and strengthening the overall PFM control environment.
  - Emphasis on enforcement and compliance of existing PFM rules; adoption of a “getting the basics right first” approach.
  - Aim to ensure efficient and effective resource utilization and maximization of value for money in public expenditure.
  - Ministry of Finance, Economic Planning and Development to establish means to identify and correct fiscal infractions and enhance capacity to report and deal with laxities in MDAs.
- IFMIS and EPICOR:
  - Government implemented EPICOR (version 7.5.5) based IFMIS; Business Processes Review and Reengineering (BPR) revealed weaknesses: inadequacy of security features, over customization, limited staff manpower affecting segregation of duties, poorly defined and designed process interfaces, among others.
  - Defined functional requirements for a credible system with robust security and control features and interfaces with other government systems.
  - Decision to procure a new IFMIS instead of upgrading to version 10.
  - Identified five best IFMIS systems to assess, including EPICOR version 10.
  - IFMIS Steering and Technical Committees established with ToRs; implementation plan developed.
  - Procurement processes expected to commence in January 2014.
  - Anticipated new system operational timeline: we believe with proper planning and technical expertise the new system will be up and running in July 2016.
- Internal audit and controls:
  - Central Internal Audit Unit moved to the Ministry of Finance, Economic Planning and Development from the Office of the President and Cabinet.
  - Recruited more internal auditors with diverse specializations; engaged Cowater International of Canada to enhance capacity in risk based internal audit and provide IT Audit training.
  - Plan to place an internal auditor in every MDA reporting to the Ministry of Finance; engaging private internal auditors for skills transfer.
  - Engaged an experienced advisor in the Ministry of Finance to follow up on reported fiscal malpractices and assist in strengthening the PFM framework.
- Cash flow and budget monitoring:
  - Revitalised cash management committee meetings.
  - MDAs restricted to spend within approved budgets; extra-budgetary funding not allowed.
  - Ministry of Finance to submit monthly expenditure reports to all MDAs indicating monthly and cumulative expenditures and available balances.
  - Re-oriented Budget/desk officers to monitor budget performance and required to submit monthly budget performance reports; tracking of accumulation of arrears by MDAs.
  - Plan to enforce legal mandates of the Minister and Secretary to the Treasury to apply sanctions as required by the PFM legal and regulatory frameworks.
- PFM action plan and benchmarks:
  - Developed a PFM strategy to operationalize agenda and put in place institutional structures to monitor and control progress.
  - Action plan includes key recommendations of the FAD technical assistance mission, including transfer of revenues to the government’s main account (prior action) to facilitate reconciliation of government accounts.
  - Key benchmarks: closure of redundant and dormant accounts, preparation of reports on the stock of arrears, and audit by an international firm of the status of implementation.

### Program issues, monitoring, and performance criteria
- Review outcomes and missed targets:
  - Fifth review (end-December 2013 test date): periodic performance criterion (PC) on net domestic assets (NDA) and the indicative target (IT) on reserve money and social spending were not met, in part because of shortfalls in external financing.
  - Sixth review: periodic PC on NDA, net domestic financing (NDF), and the IT on reserve money and social spending were not met owing in part to continued difficulties in program implementation, continued shortfalls in external financing and election uncertainties.
  - For the fifth and sixth reviews, the continuous PC on contracting of nonconcessional external debt with maturity more than one year was not met due to contracting of nonconcessional loans.
  - RBM intensified open market operations to meet September 2014 informal targets on NDA and gross reserves agreed with staff; NDF target was missed.
  - Additional informal targets set for end-January 2015 on gross reserves, NDA and NDF: gross international reserves and NDA were met but NDF was missed due to shortfalls in donor dedicated grants for social sectors.
- Waiver requests:
  - Request for a waiver for nonobservance of the performance criterion for the fifth review on NDA.
  - Request for a waiver for nonobservance of the performance criteria for the sixth review on NDA and NDF.
  - For the fifth and sixth reviews, request waivers for nonobservance of performance criteria on nonconcessional external debt maturing in more than one year and on the accumulation of external payments arrears.
- Monitoring and future reviews:
  - Program implementation will continue to be monitored with quantitative targets and structural benchmarks (TMU Tables 3 and 6).
  - PCs established for June 2015 and December 2015.
  - Seventh review expected to be completed by mid-September 2015 based on the end-June 2015 test date.
  - Sixth review expected to be completed by mid-April 2016 based on the end-December 2015 test date.

### Technical Memorandum of Understanding — coverage and reserve definitions
- Coverage:
  - The central government includes all units of government that exercise authority over the entire economic territory. Unless otherwise indicated, the central government does not include local governments, the Reserve Bank of Malawi (RBM), or any other public entity with autonomous legal personality.
  - The accounts of the monetary authorities include those of the Reserve Bank of Malawi (RBM).
  - Monetary aggregates under the program are based on the twelve-bank monetary survey.
- Definition of budget support:
  - Budget support includes all grants and foreign financing not directly linked to additional budgetary expenditure.
  - Excluded: external project financing to fund particular activities, including food security funding from the European Union; loan financing from the IMF; and donor inflows from the U.S. dollar–denominated donor pool accounts for the health SWAp, education SWAp, agricultural SWAps, and National AIDS Commission (NAC) held in the Malawi banking system.
  - Budget support is measured as a cumulative flow from the beginning of the fiscal year and recorded in the original currency of disbursement, then converted into U.S. dollars using the program cross exchange rates listed in Table 6.
- Floor on Net International Reserves (NIR) of the RBM:
  - Definition: NIR of the RBM is defined as gross reserve assets minus gross reserve liabilities. For evaluation purposes, values of all foreign assets and liabilities converted into U.S. dollars at each test date using program cross exchange rates.
  - Program exchange rate of the Malawi Kwacha to the U.S. dollar is set at MK 402 = US$1.
  - Gross reserve assets defined per the International Reserves and Foreign Currency Liquidity Guidelines (BPM6, paragraph 6.64) as external assets immediately available and controlled by RBM for meeting balance of payments financing needs, for intervention in exchange markets to affect the currency’s exchange rate, and for other related purposes.
  - Gross reserve assets of the RBM include:
    - (i) monetary gold holdings of the RBM;
    - (ii) holdings of SDRs;
    - (iii) the reserve position in the IMF;
    - (iv) foreign convertible currency holdings;
    - (v) foreign currency denominated deposits held in foreign central banks, the Bank for International Settlements, and other banks;
    - (vi) loans to foreign banks redeemable upon demand;
    - (vii) foreign securities; and
    - (viii) other unpledged convertible liquid claims on nonresidents.
  - Gross reserve assets exclude:
    - (i) any foreign currency claims on residents;
    - (ii) capital subscriptions in international institutions;
    - (iii) foreign assets in nonconvertible currencies;
    - (iv) transfers of foreign currency claims to RBM by other institutional units in Malawi just prior to reporting dates with accompanying reversals of such transfers soon after those dates;
    - (v) assets obtained through currency swaps of less than three months duration; and
    - (vi) gross reserves that are in any way encumbered or pledged, including, but not limited to:
      - (a) assets blocked when used as collateral for third party loans and third-party payments, or pledged to investors as a condition for investing in domestic securities;
      - (b) assets lent by RBM to third parties that are not available before maturity, and are not marketable; and
      - (c) foreign reserves blocked for letters of credit.

*Source: IMF staff report text (Attachment II. Technical Memorandum of Understanding, March 2015).*

### 7.      Gross reserve liabilities of the RBM are defined as the sum of the following:

### 7.      Gross reserve liabilities of the RBM are defined as the sum of the following:

### Definition of Gross Reserve Liabilities
- Gross reserve liabilities of the RBM are defined as the sum of:
  - (i) outstanding medium and short-term liabilities of the RBM to the IMF;
  - (ii) all short-term foreign currency liabilities of the RBM to nonresidents with an original maturity of up to, and including, one year; and
  - (iii) all foreign currency denominated liabilities to residents (including, for instance, foreign currency denominated deposits of domestic banks and other residents with the RBM).
- SDR allocations are excluded from gross reserve liabilities of the RBM.

### Adjusters Applied to NIR Program Ceiling
- The program floor on NIR will be adjusted if budget support, inflows from donor accounts for the social sectors, and external debt service to the World Bank and the African Development Bank (ADB) deviate from programmed levels:
  - Budget support:
    - The floor on the NIR of the RBM will be adjusted upward by the full amount by which the cumulative receipts from the budget support are greater than US$10 million above the program baseline (as defined in Table A).
    - The floor on NIR of the RBM will be adjusted downward by the amount by which the cumulative receipts from budget support are less than the program baseline. This downward adjustment of the NIR floor will be subject to the limitations outlined in paragraph 9.
  - Donor pool accounts for the social sector, including health and education SWAps, and National AIDS Commission (NAC):
    - The floor on the NIR of the RBM will be adjusted downward by the amount by which the donor inflows from the U.S. dollar–denominated donor accounts for SWAps and NAC held in the RBM are smaller than the program baseline (as defined in Table B). This downward adjustment of the NIR floor will be subject to the limitations outlined in paragraph 9.
    - These donor inflows are measured as the cumulative receipts by the budget from the beginning of the fiscal year. They will be recorded in the original currency of disbursement and then converted to U.S. dollars using the above defined program cross exchange rates.
  - Debt service payments:
    - The floor on NIR of the RBM will be adjusted upward (downward) by the full cumulative amount by which debt service payments to the World Bank and the African Development Bank fall short of (exceed) the program baseline (as defined in Table C).
    - Debt service payments will be measured as the cumulative payments from the beginning of the fiscal year. They will be recorded in the original currency of payment and then converted to U.S. dollars using the above defined program cross exchange rates. This downward adjustment of the NIR floor will be subject to the limitations outlined in paragraph 9.

### Program Baseline (US$, cumulative within the fiscal year)
- Table A. Program Baseline: Projected Budget Support, March–December, 2015 (In millions of USD, cumulative within the fiscal year)
  - Mar-15 Jun-15 Sep-15 Dec-15
  - Budget support 0.0 17.7 0.0 0.0
  - 1 Fiscal year runs from July 1 to June 30 of the following year
- Table B. Program Baseline: Projected Inflows from Donor Accounts for the Social Sector, March–December, 2015 (In millions of USD, cumulative within the fiscal year)
  - Mar-15 Jun-15 Sep-15 Dec-15
  - Donor inflows 47.7 51.4 6.8 37.9
  - 1 Fiscal year runs from July 1 to June 30 of the following year
- Table C. Projected Debt Service Payments to World Bank and AfDB, March–December, 2015 (In millions of USD, cumulative within the fiscal year)
  - Mar-15 Jun-15 Sep-15 Dec-15
  - Debt service 8.2 12.1 3.9 7.8
  - 1 Fiscal year runs from July 1 to June 30 of the following year

### Cumulative Adjustment Limit to NIR Program Target
- Notwithstanding adjustments in paragraph 8, the total downward adjustment to the NIR program target from the combined impact of:
  - (i) shortfall of budget support relative to program projections;
  - (ii) shortfall of inflows to donor accounts for the social sector relative to program projections; and
  - (iii) any excess of debt service payments to the World Bank and the ADB relative to program projections;
- will be subject to a cumulative limit of US$15 million.

### C. Net Foreign Assets (NFA) of the RBM
- Definition:
  - NFA of the RBM are defined as its gross foreign assets (GFA) minus its gross foreign liabilities.
  - Gross foreign liabilities are equal to gross reserve liabilities as defined above (paragraph 7), plus any other foreign liabilities not listed in that paragraph.

### D. Gross Foreign Assets (GFA) of the RBM
- GFA are defined as gross reserves assets as defined in paragraph 6, plus:
  - (i) any foreign currency claims on residents;
  - (ii) capital subscriptions in international institutions;
  - (iii) foreign assets in nonconvertible currencies;
  - (iv) transfers of foreign currency claims to RBM by other institutional units in Malawi just prior to reporting dates with accompanying reversals of such transfers soon after those dates;
  - (v) assets obtained through currency swaps of less than three months duration;
  - (vi) gross reserves that are in any way encumbered or pledged, including, but not limited to:
    - (a) assets blocked when used as collateral for third party loans and third-party payments, or pledged to investors as a condition for investing in domestic securities;
    - (b) assets lent by RBM to third parties that are not available before maturity, and are not marketable;
    - (c) foreign reserves blocked for letters of credit.

### D. Reserve Money of the RBM (RM)
- Definition:
  - Reserve money is defined as the sum of currency issued by the RBM, including currency outside banks, the vault cash of commercial banks, and balances of commercial banks’ accounts with the RBM.
  - Commercial banks’ accounts with the RBM include required reserves held for local currency and foreign currency deposits, other domestic currency liabilities, and other demand and time deposits held with the RBM.

### E. Ceiling on Net Domestic Assets (NDA) of the RBM
- Definition for program purposes:
  - NDA of the RBM are defined in kwacha terms as reserve money less NFA of the RBM at the program exchange rate.

### Adjusters Applied to NDA Program Ceiling
- The program ceiling on NDA will be adjusted if budget support, inflows from donor accounts for the social sector, and external debt service to the World Bank and the ADB deviate from programmed levels:
  - Budget support:
    - Cumulative receipts from budget support will be measured in the foreign currency of disbursement and converted to kwacha using the program exchange rates.
    - The ceiling on NDA will be adjusted downward by the amount that cumulative receipts from budget support exceed the sum of the program baseline (Table D) and the kwacha equivalent of US$10 million.
    - The kwacha equivalent of US$10 million will be calculated as US$10 million multiplied by the program exchange rate.
    - The ceiling on NDA will be adjusted upward by the amount that cumulative receipts from budget support (in kwacha) fall short of the program baseline, with this upward adjustment subject to limitations in paragraph 15. The kwacha equivalent of the upward adjustment will be calculated as the US dollar value of the adjustment multiplied by the program exchange rate.
  - Donor pool accounts for the social sector:
    - Cumulative receipts from donor accounts will be measured in the foreign currency of disbursement and converted to kwacha using the program exchange rates.
    - The ceiling on NDA will be adjusted upward by the amount by which donor inflows to the budget (in kwacha) from the U.S. dollar–denominated donor accounts for the SWAps and NAC held in the RBM fall short of the donor inflow to those accounts in the program baseline (Table E). This upward adjustment will be subject to limitations in paragraph 15. The kwacha equivalent will be calculated as the US dollar value of the adjustment multiplied by the program exchange rate.
  - Debt service payments:
    - Cumulative debt service payments will be measured in the foreign currency of payment and converted to kwacha using the program exchange rates.
    - The ceiling on NDA will be adjusted downward (upward) by the full cumulative amount by which debt service payments to the World Bank and the ADB fall short of (exceed) the program baseline (Table F). The upward adjustment to the NDA ceiling will be subject to limitations in paragraph 15.
  - Additional adjustment for changes in the liquidity reserve requirement:
    - The ceiling on NDA will be adjusted downward for a decrease in the reserve requirement ratio on domestic deposits, and adjusted upward for an increase in the ratio.
    - The adjustment will be spread equally over two quarters, starting in the quarter in which the reserve requirement ratio is reduced.
    - The adjuster will be calculated as: (one minus the existing required fraction of reserve assets) multiplied by (the program baseline required reserve ratio minus the new required reserve ratio) multiplied by (the amount of average reservable deposit liabilities in commercial banks during the last month before the change in regulation).
    - The program baseline required reserve ratio was 15.5 percent at end-June 2014.

### Program Baselines (kwacha, cumulative within the fiscal year)
- Table D. Program Baseline: Projected Budget Support, March–December, 2015 (In billions of kwacha, cumulative within the fiscal year)
  - Mar-15 Jun-15 Sep-15 Dec-15
  - Budget support, at the program exchange rate 0.0 8.0 0.0 0.0
  - Budget support plus kwacha equivalent of US$10 mil, at the program exchange rate 0.0 0.012.2 0.0 0.0
  - 1 Fiscal year runs from July 1 to June 30 of the following year
- Table E. Program Baseline: Projected Inflows from Donor Accounts, March–December, 2015 (In billions of kwacha, cumulative within the fiscal year)
  - Mar-15 Jun-15 Sep-15 Dec-15
  - Donor inflows, at the program exchange rate 20.0 21.6 2.9 15.9
  - 1 Fiscal year runs from July 1 to June 30 of the following year
- Table F. Program Baseline: Projected Debt Service Payments, March–December, 2015 (In billions of kwacha, cumulative within the fiscal year)
  - Mar-15 Jun-15 Sep-15 Dec-15
  - Debt service, at the program exchange rate 3.3 4.9 1.7 3.1
  - 1 Fiscal year runs from July 1 to June 30 of the following year

### Cumulative Adjustment Limit to NDA Program Target
- Notwithstanding adjustments in paragraph 14, the total upward adjustment to NDA from the impact of:
  - (i) a shortfall of budget support relative to program assumptions;
  - (ii) a shortfall of inflows to the donor accounts for the social sector relative to program assumptions; and
  - (iii) an excess of debt service payments to the World Bank and the ADB relative to program assumptions;
- will be capped at the kwacha equivalent of US$15 million. The kwacha equivalent of US$15 million will be calculated as US$15 million multiplied by the program exchange rate.
- The adjustment to the NDA ceiling for changes in the liquidity reserve requirement is independent of the other adjustments and is not subject to limitation.

### F. Ceiling on Central Government Net Domestic Borrowing (CGDB)
- Definition of CGDB:
  - CGDB is defined as the sum of:
    - (i) net borrowing from the RBM (including ways and means advances, loans, holdings of local registered stocks, government bonds, and holdings of treasury bills and treasury notes minus deposits);
    - (ii) net borrowing from commercial banks (including advances, holdings of local registered stocks, and holdings of treasury bills and treasury notes minus deposits);
    - (iii) net borrowing from nonbanks (including, but not limited to, holdings of local registered stocks and holdings of treasury bills and treasury notes);
    - (iv) holdings of promissory notes.
  - Excluded from the CGDB ceiling are:
    - (i) promissory notes issued to cover exchange rate valuation losses of RBM; and
    - (ii) government securities issued in 2014 and 2015 to clear government domestic arrears up to a maximum exclusion of MKW 157 billion.
  - Treasury bills and locally registered stocks will be valued at cost rather than face value.
  - The ceiling is measured as the change in the stock of CGDB cumulative from the beginning of the fiscal year, including promissory notes and securities transferred to the RBM from the treasury since the beginning of the fiscal year.
  - Transfers from extra-budgetary funds will not be considered revenues for this performance criterion; instead they will be treated as domestic borrowing from the private sector.
  - Asset sales or privatization revenues will be accounted for under financing as a separate category.

### Adjusters Applied to CGDB Program Ceiling
- The program ceiling on CGDB will be adjusted if budget support, inflows from donor accounts for the social sector, and external debt service to the World Bank and ADB deviate from programmed levels:
  - Budget support:
    - Cumulative receipts from budget support will be measured in the foreign currency of disbursement and converted to kwacha using the program exchange rates.
    - The program ceiling on CGDB will be adjusted upward by the full amount by which cumulative receipts from budget support are less than the program baseline (Table D). This upward adjustment will be subject to limitations in paragraph 20.
    - In the event of excess budget support, the ceiling on CGDB will be adjusted downward by the amount that cumulative receipts from budget support exceed the sum of the program baseline (Table D) and the kwacha equivalent of US$10 million.
  - Donor pool accounts for the social sector, including health and education SWAps, and NAC:
    - Cumulative receipts from donor pool accounts will be measured in the foreign currency of disbursement and converted to kwacha using the program exchange rates.
    - The ceiling on CGDB will be adjusted upward by the amount by which donor inflows to the budget from the U.S. dollar–denominated donor accounts for health, education, and other SWAps, and NAC held in RBM fall short of the program baseline (Table E). This upward adjustment will be subject to limitations described in paragraph 19.
  - Debt service payments:
    - Cumulative debt service payments will be measured in the foreign currency of payment and converted to kwacha using the program exchange rates.
    - The ceiling (floor) on CGDB will be adjusted downward (upward) by the full cumulative amount by which debt service payments to the World Bank and the ADB fall short of (exceed) the program baseline (Table F). This upward adjustment to CGDB will be subject to limitations described in paragraph 20.

### Cumulative Adjustment Limit to CGDB Program Target
- The total upward adjustment to CGDB from:
  - (i) a shortfall of budget support relative to the program baseline;
  - (ii) donor inflows to donor accounts for the social sector relative to the program baseline; and
  - (iii) an excess of actual debt service payments to the World Bank and the ADB relative to the program baseline;
- will be capped at US$15 million. The kwacha equivalent of US$15 million will be calculated as US$15 million multiplied by the program exchange rate.

### G. Ceiling on External Payment Arrears
- Definition:
  - External payment arrears consist of debt-service obligations (principal and interest) of the central government or the RBM to nonresidents that have not been paid at the time they are due, as specified in contractual agreements, except on external debt subject to rescheduling or restructuring.
  - This performance criterion will be monitored on a continuous basis.

### H. Ceiling on Non-concessional External Debt
- Definition of non-concessional external debt for program purposes:
  - Debt definition per Executive Board Decisions No. 6230–(79/140) August 3, 1979, as amended by Decisions No. 11096–(95/100) October 25, 1995; 12274–(00/85) August 24, 2000; and 14416–(09/91) August 31, 2009.
  - Short-, medium- and long-term debt is non-concessional if it includes a grant element of less than 35 percent, as indicated in Decision No. 11248–(96/38), April 15, 1996. The grant element is calculated using a discount rate of 5 percent.
  - The ceiling on non-concessional debt applies to contracting and guaranteeing of debt with nonresidents by the central government, the RBM, public enterprises, and other official sector entities, unless an explicit selective exclusion is made per paragraph 24.
  - This performance criterion is monitored on a continuous basis. The ceiling applies to debt and commitments contracted or guaranteed for which value has not been received. The ceiling is measured cumulatively from the beginning of the fiscal year.

### Definitions of Maturities
- Short-term debt: outstanding stock of debt with an original maturity of one year or less.
- Medium- and long-term debt: outstanding stock of debt with a maturity of more than one year.

### Exclusions from Non-concessional External Debt Limit
- Excluded from the limit:
  - (i) the use of IMF resources;
  - (ii) any kwacha-denominated treasury bill and local registered stock holdings by nonresidents purchased from the secondary market;
  - (iii) debts classified as international reserve liabilities of the RBM;
  - (iv) new debt issued to restructure, refinance, or repay existing non concessional external debt as of December 31, 2014, up to the amount actually used for those purposes;
  - (v) normal import financing; and
  - (vi) arrangements to pay overtime obligations arising from judicial awards to external creditors—a financing arrangement for imports is considered to be “normal” when the credit is self-liquidating.

### Quantitative Indicative Targets and Structural Benchmarks
- Reserve money of the RBM:
  - Reserve money is defined in paragraph 12 above. The program baseline for reserve money is defined in Table G. No adjusters are applicable to reserve money targets for program purposes.
  - Table G. Projected Stock of Reserve Money, March–December, 2015 (In billions of kwacha, cumulative within the fiscal year)
    - Mar-15 Jun-15 Sep-15 Dec-15
    - Reserve money 223.4 243.8 248.2 260.5
    - 1 Fiscal year runs from July 1 to June 30 of the following year
- Social spending:
  - Using functional classification of expenditure, social spending is defined as the sum of central government spending on health, education, the farm input subsidy program, the cement and iron sheet program, and government social protection (comprising government expenditures by the Ministry of Gender, Children, and Social Welfare, the Ministry of Disability and Elderly Affairs, the local development fund, and the Poverty and Disaster Management Cost Center under the Office of the Vice President).
  - The social spending allocations in the government budget will not be subject to downward adjusters under the program.
  - Quarterly social spending under this definition is presented in Table 8.

*Source: _cr1583 - 7.      Gross reserve liabilities of the RBM are defined as the sum of the following:*

### 27.      Domestic arrears: Domestic arrears are defined as overdue payment obligations of the

### _cr1583 - 27. Domestic arrears: Domestic arrears are defined as overdue payment obligations of the

### Definition and classification of domestic arrears
- Domestic arrears are overdue payment obligations of the central government to residents, including:
  - wages and salaries, pensions, transfers;
  - domestic interest;
  - goods and services;
  - obligations arising from court cases;
  - legally established compensation claims;
  - tax refunds.
- Timing rules for when payments are considered in arrears:
  - Payments on wages and salaries, pensions, transfers, court-established obligations, and compensations are in arrears when they remain unpaid for more than 30 days beyond their due date.
  - Domestic interest payments are in arrears when the payment is not made on the due date.
  - Payments for goods and services are deemed to be in arrears if they have not been made within 90 days of the date of invoice, or—if a grace period has been agreed—within the contractually agreed grace period.

### Program monitoring: structural benchmarks and prior actions
- Structural benchmarks are reported in Tables 5 and 6 of the document.
- Prior Actions (Table 5) with target date and status:
  - Implement expenditure cuts necessary to limit net domestic financing under the program ceiling for the fiscal year 2014/15 and issue a memo to cabinet outlining new expenditure ceilings.
    - Target date: End-February 2015
    - Macro Rationale: To ensure consistency between the budget and the program.
    - Status: Met
  - Ministry of Finance to issue a letter to the central bank to transfer revenues to main government account (MG1).
    - Target date: End-February 2015
    - Macro Rationale: First step towards better cash management and reconciliation of accounts.
    - Status: Met
  - Incorporate the main government bank accounts in IFMIS, including MG1 account and six operational accounts (salaries; other recurrent transactions; development; statutory; advances; deposits).
    - Target date: End-February 2015
    - Macro Rationale: Integrate key accounts into IFMIS progressively to ensure improved accounting, cash management and reconciliation of accounts.
    - Status: Met
  - Submit to parliament legislative amendments to limit RBM's credit to government to a 10 percent of the previous year's revenue.
    - Target date: End-February 2015
    - Macro Rationale: Reduce fiscal dominance to enhance effectiveness of monetary policy.
    - Status: Met
  - Submit to parliament amendments to the Banking Act and Financial Services Act in line with those recommended by March 2013 Fund (LEG) TA mission.
    - Target date: End-February 2015
    - Macro Rationale: Promote financial stability by enhancing RBM's bank resolution powers and tools.
    - Status: Met

### Structural benchmarks for 2015 (selected, Table 6)
- Public financial management measures and target dates:
  - Publish detailed monthly budget execution data by vote on the Ministry of Finance's website no later than 6-weeks after execution.
    - Target date: End-March 2015
    - Macro Rationale: To foster greater fiscal transparency and monitoring.
  - Reconcile all government bank accounts MG1 and six operational accounts and ways and means for all 2014 transactions signed by the Accountant General and Secretary of the Treasury.
    - Target date: End-March 2015
    - Macro Rationale: To strengthen cash planning, reconciliation of accounts, and improving the integrity of the accounting systems.
  - Review all bank accounts and close redundant and dormant accounts and provide an updated list from the central bank certified by the Accountant General.
    - Target date: End-March 2015
    - Macro Rationale: To strengthen cash planning, reconciliation of accounts, and improving the integrity of the accounting systems.
  - Prepare a report on the flow and stock of arrears at the end of each quarter starting with end-September 2014 and within two months of the end of each six months.
    - Target date: End-June 2015
    - Macro Rationale: To monitor emergence of arrears.
  - Produce and publish monthly summary bank account control reports.
    - Target date: End-September 2015
    - Macro Rationale: To improve transparency and control.
  - Issue reports by international audit firms on bank reconciliations and summary bank account control reports.
    - Target date: End-September 2015
    - Macro Rationale: To improve transparency and restore public confidence.
  - Issue a report by an International firm confirming the status of implementation of forensic audit recommendations in the PFM domain.
    - Target date: End-December 2015
    - Macro Rationale: Foster greater transparency.
- Financial sector measures and target dates:
  - Prepare a strategy to address banking sector wide issues raised by the third-party diagnostics assessments, including the high loan concentration among banks.
    - Target date: End-March 2015
    - Macro Rationale: To safeguard the stability of the financial system.
  - RBM to obtain from all undercapitalized banks detailed, quarterly monitorable recapitalization and restructuring plans showing how they will reach the minimum capital adequacy level within one year.
    - Target date: End-April 2015
    - Macro Rationale: To safeguard the stability of the financial system.
  - RBM to obtain from all banks with significant deficiencies reported by the diagnostic assessments to submit plans to address the deficiencies within one year.
    - Target date: End-June 2015
    - Macro Rationale: To safeguard the stability of the financial system.
  - RBM to develop contingency plans to intervene and resolve banks if they do not submit or comply with acceptable recapitalization plans.
    - Target date: End-June 2015
    - Macro Rationale: To safeguard the stability of the financial system.
  - Submit to parliament amendments to the AML/CFT Act, the Penal Code, and the Corrupt Practices Act in line with the FATF standard and UNCAC.
    - Target date: End-June 2015
    - Macro Rationale: To ensure enhanced customer due diligence for domestic politically exposed persons; reporting of suspicious transactions where funds may be proceeds of criminal activity; transparency of legal persons and arrangements; adequate criminalization of acts of corruption as predicate crimes to money laundering; criminalization of self-laundering; and appropriate administrative sanctions for failure to comply with AML/CFT requirements.
  - RBM to issue a detailed report on compliance with regulations on loan classification and provisioning and concentration limits in line with existing directives.
    - Target date: End-September 2015
    - Macro Rationale: To safeguard the stability of the financial system.
  - RBM, in its supervisory capacity, to follow-up on possible breaches of compliance with the AML legal framework by banks revealed by the audit report, by applying supervisory actions mandated by the AML legal framework with regard to any breaches of compliance, including sanctions.
    - Target date: End-December 2015
    - Macro Rationale: To ensure compliance with AML standards.

### Monitoring and reporting (selected)
- The document includes multiple quantitative target tables (Tables 1–4) and memorandum items that set program ceilings, floors, and memorandum data to monitor fiscal, monetary, and external sector performance.
- The technical memorandum of understanding (TMU) defines targets and presentation conventions (e.g., stocks for performance criteria except the ceiling on government's net domestic borrowing; targets subject to specified adjusters; priority social spending definitions).
- Reporting requirements (Table 9) list frequencies and delivery modes for key indicators including gross international reserves, reserve money, RBM balance sheet items, treasury bill auction results, social sector receipts (Health SWAp, Education SWAp), fiscal GFS tables, new external loans, external debt service, and arrears statements.

*Source: IMF staff and Malawian authorities, as presented in the provided document excerpts.*

### 1.      The last Low Income Country Debt Sustainability Analysis (LIC DSA, IMF country report

### The last Low Income Country Debt Sustainability Analysis (LIC DSA, IMF country report no. 14/37)

### Summary of prior DSA and context
- The LIC DSA conducted in late 2013 concluded Malawi’s external public debt faced moderate risk of distress.
- The 2013 DSA baseline assumed resumption in donor budget support by the end of the 2013/14 fiscal year, but this did not materialize.
- Donors withdrew budget support in 2013; combined with weak commitment controls and the “cashgate” public financial management scandal, this led to increased domestic borrowing, domestic payment arrears, and acceleration in inflation.
- Economic activity remained resilient with real GDP estimated at 5½–6 percent range in 2014.

### CPIA score, thresholds, and implications
- The CPIA score for Malawi deteriorated from a peak of 3.4 in 2007 to 3.1 by 2013.
- The deterioration changed the category of policies and institutions to weak and tightened debt thresholds for DSA analysis.
- New thresholds for indicators related to the present value of public and publicly guaranteed external debt are:
  - 30 percent as a ratio to GDP (down from 40 percent);
  - 100 percent as a ratio to exports (down from 145 percent);
  - 200 percent as a ratio to revenue (down from 250 percent).
- Thresholds for debt service indicators changed from:
  - 20 to 15 percent, as a ratio to exports;
  - 20 to 18 percent as a ratio to revenue.

### Public and PPG debt levels and composition
- Text Table 1 — Composition of total public Debt, 2012–14 (Percent of GDP):
  - External debt: 2012 = 37.7; 2013 = 44.0; 2014 = 47.3
  - Domestic Debt: 2012 = 19.5; 2013 = 28.1; 2014 = 28.5
  - Total public Debt: 2012 = 57.2; 2013 = 72.1; 2014 = 75.8
- Public and publicly guaranteed external debt (Text Table 2 — US$ Millions; Actual/Share/Proj./Share):
  - Total: 2012 = 1,149.5 (100%); 2013 = 1,447.3 (100%); 2014 = 1,857.4 (100.0%)
  - Multilaterals: 2012 = 882.7 (70%); 2013 = 1,015.2 (70%); 2014 = 1,365.2 (74%)
    - IMF: 2012 = 180.9 (16%); 2013 = 198.2 (14%); 2014 = 218.2 (12%)
    - IDA: 2012 = 322.9 (41%); 2013 = 416.5 (29%); 2014 = 456.5 (25%)
    - ADF: 2012 = 171.2 (19%); 2013 = 190.9 (13%); 2014 = 210.9 (11%)
    - IFAD: 2012 = 77.6 (7%); 2013 = 75.6 (5%); 2014 = 75.6 (4%)
    - Other Multilateral: 2012 = 130.1 (13%); 2013 = 134.9 (9%); 2014 = 424.0 (23%)
  - Bilateral: 2012 = 266.8 (24%); 2013 = 412.5 (28%); 2014 = 472.5 (25%)
    - France: 2012 = 10.4 (1%); 2013 = 10.8 (1%); 2014 = 10.8 (1%)
    - Belgium: 2012 = 2.2 (0%); 2013 = 2.2 (0%); 2014 = 2.2 (0%)
    - People's Republic of China: 2012 = 175.5 (24%); 2013 = 252.4 (17%); 2014 = 282.4 (15%)
    - India: 2012 = 78.7 (10%); 2013 = 106.2 (7%); 2014 = 136.2 (7%)
    - Others: 2012 = 0 (0%); 2013 = 40.9 (3%); 2014 = 40.9 (2%)
  - Commercial: 2012 = 0 (0%); 2013 = 19.7 (1%); 2014 = 19.7 (1%)
  - Note: The 2014 stock includes US$250 million resulting from the sale of existing government debt to a regional development bank.

### Domestic debt dynamics and drivers
- Gross domestic debt increased from MK206.6 billion (19.5% of GDP) at end-2012 to MK515 billion (28.5% of GDP) at end-2014.
- Major contributors to the increase:
  - Rise in the use of ways and means advances from the Reserve Bank of Malawi in 2013 and 2014 after the drop in external financing.
  - Recognition in late 2014 of pre-audited arrears amounting to MK157 billion (8 percent of GDP).
  - Issuance of promissory notes amounting to MK29 billion (1.6 percent of GDP) by the government to the central bank in April 2014 to cover losses from the 2012 devaluation.
- Projections: Gross domestic debt as a percent of GDP is projected to gradually decline from 25 percent of GDP at end-2015 to 15 percent of GDP at end-2020, supported by:
  - Repayment of accumulated domestic arrears;
  - Decline in new ways and means advances as the government’s fiscal position improves;
  - Projected slower pace of new issuance of Treasury bills and Treasury notes over the long term.

### External public debt levels and drivers
- External public debt increased from US $1.15 billion in 2012 (37.7% of GDP) to US $1.45 billion in 2013 (44% of GDP) and is estimated at US $1.86 billion in 2014 (47.3% of GDP).
- About half of the increase from 2012 to 2013 in GDP terms can be attributed to exchange rate effects; the Kwacha-Dollar year-on-year depreciation was about 30% in 2013.
- In 2014, about half of the increase was due to the sale of existing domestic debt to PTA bank and reclassification as external based on residency despite local currency denomination.
- PTA loan features:
  - Short maturity of 3 years, creating noticeable peaks in debt service during 2015–16.
  - Restructuring to PTA reduced the interest rate by 1000 basis points relative to previous terms, lowering debt service costs.

### Macroeconomic baseline assumptions and forecasts
- Revisions relative to the previous DSA:
  - Fiscal year 2014/2015 government expenditures in goods and services, wages, and development are projected 2 percentage points of GDP lower than in the previous DSA.
  - Monetary policy expected to remain tight to support disinflation.
  - GDP growth forecasts revised: 2014 = 5.7 percent (from 6.1 percent); 2015 = 5.5 percent (from 6.5 percent).
  - Long-term GDP growth assumed at 6 percent.
- Box 1 — Baseline Macroeconomic Assumptions:
  - Real GDP: projected to grow at about 6 percent annually over the longer term.
  - Inflation: projected to decline from 24.2 percent by end of the period 2014 to 12 percent by December 2015 and to reach single digits by 2016.
  - Exchange rate: projected to remain constant in real terms after 2015.
  - Tax revenue: projected to continue increasing with ongoing reforms.
  - External public debt financing: mainly from multilateral creditors on concessional terms; bilateral borrowing on broadly similar terms.
  - Budget support: assumed subdued for FY 2014/15 and into the medium term.
  - Foreign direct investment: assumed at 3–4% of GDP in the short to medium term; longer term 1–2% of GDP.
  - Current account: expected to remain at a sustainable level through trade improvement partially offsetting decline in grants.
- Text Table 3 — Selected forecasts and comparisons (Previous vs Current DSA):
  - Real GDP growth:
    - 2013: Previous = 5.0; Current = 5.2
    - 2014: Previous = 6.1; Current = 5.7
    - 2015: Previous = 6.5; Current = 5.5
    - Long-run Avg 2023-2034: Previous = 5.9; Current = 6.0
  - Primary deficit (percent of GDP), Change in public debt (percent of GDP): see Text Table 3 for detailed year-by-year Previous vs Current comparisons.

### Debt sustainability assessment and stress tests
- External public debt:
  - Except for the present value (PV) of external public debt to GDP (which displays a marginal and temporary breach during 2014–2015), external debt indicators remain below the new tighter limits.
  - PV of external public debt is estimated to reach 32.2% of GDP by end-2014, breaching the 30% threshold marginally and temporarily.
  - Drivers of the breach: restructuring of domestic debt to PTA bank and end-2014 exchange rate depreciation.
  - Using average exchange rates (rather than end-period) would avoid a breach of the PV of PPG external debt threshold.
- Stress tests:
  - The strongest impact on PV of external public debt to GDP arises from combined shocks to growth, exports and non-debt creating flows (combination bound test B5).
  - A shock to exports (case B2) could bring a marginal breach in the debt-to-exports ratio.
  - None of the bound tests result in a breach of the PV of debt-to-revenue ratio.
  - Standard stress tests indicate a weaker debt outcome if historical levels are maintained (inclusion of 2012 exchange rate depreciation in the historical period keeps PV debt-to-GDP above threshold).
  - For total public debt, the present value stands seventeen percentage points of GDP higher than the recommended benchmark and is expected to peak at 60.7 percent by end-2014.
  - The strongest impact on public debt indicators arises from a one-time real depreciation shock and an export shock, reflecting vulnerability from undiversified foreign exchange sources.

### Risks, policy implications, and authorities’ views
- Risks and implications:
  - Rapid accumulation of debt and deterioration in policy and institutional strength (CPIA) urge prudent debt management policies.
  - External financing risks are present but projected to be addressed by additional fiscal restraint; additional domestic borrowing to cover external shortfalls should be avoided as it would pressure the exchange rate and damage policy credibility.
  - Authorities should prioritize cuts in domestically financed development expenditure and in goods and services to meet shortfalls, balancing macroeconomic stability with maintenance of core public services.
  - Political economy challenges exist in reducing expenditures in politically sensitive areas (e.g., fertilizer subsidies, wages and salaries).
- Authorities’ views:
  - Authorities acknowledged external public debt to GDP is growing and expected to reach 32.2 percent of GDP in NPV terms at end-2014, but noted external debt remains mostly concessional and debt service burden remained low with a debt service ratio in 2014 of only 4.7 percent of exports of goods and services.
  - They acknowledged domestic debt burden is more worrisome; “cashgate” resulted in annual shortfalls in external disbursements amounting to almost 6.6 percent of GDP.
  - Authorities emphasized efforts to regularize accumulated payment arrears and reforms to strengthen commitment controls and PFM systems.

*Source: IMF staff report text as provided.*

### 16.      The authorities viewed 2015 as a year to consolidate debt and lay the groundwork for a

### 16.      The authorities viewed 2015 as a year to consolidate debt and lay the groundwork for a

### Growth and inflation outlook
- Real growth in 2015 is envisaged to reach 5.5 percent (one percentage point lower than anticipated in the December 2013 MEFP).
- Real growth is expected to gradually increase to 6 percent in 2017.
- Inflation will decline to 12.5 percent by end-2015 and to single digit levels towards end-2016.

### Fiscal stance and financing
- The authorities plan fiscal restraint.
- The majority of financing needs will rely on concessional foreign borrowing.
- This approach is expected to allow some reduction in the stock of domestic debt relative to GDP.

### Debt management strategy and institutional reforms
- Strong debt management in the near-to medium term will be implemented to ensure debt sustainability and an appropriate balance of costs and risks.
- Improvements in debt management will be achieved by resuscitating the Debt Management Committee:
  - Membership will be at senior level.
  - The Committee will review each borrowing to ascertain its concessionality and to insure debt sustainability.
- The authorities reaffirmed their commitment to implementing the Debt Management Reform Programme, that was agreed with IMF and World Bank, aimed at strengthening the debt management capacity of the Debt and Aid Management Division.

*Source: _cr1583 - 16.*

### 17.      Malawi’s debt situation remains at a moderate risk of distress, based on an assessment of

### Malawi’s debt situation remains at a moderate risk of distress, based on an assessment of

### Debt risk assessment
- External public debt: risk classified as "moderate risk of distress."
- Overall risk of debt distress: "heightened," reflecting significant vulnerabilities related to domestic debt.
- Recent events point to the need to arrest the decline in the quality of institutions (as reflected in the CPIA score) to ensure capacity to manage the debt load.

### Vulnerabilities and downside risks
- Export-related shock risk: present, given Malawi’s limited sources of foreign exchange and reliance on rain-fed agriculture.
- Donor support risks: loosening of policies in response to decline in donor support could further erode donor confidence and jeopardize resumption of aid.
- Negative financing shocks: delayed or lower donor support, or lower than expected tax revenue, may require additional fiscal restraint but "should not compromise the medium-term debt sustainability of the country."

### Stress tests, scenarios, and projections (selected findings)
- Stress-test methodology: the "most extreme stress test" is defined as the test that yields the highest ratio on or before 2024; examples include Combination shock, Exports shock, and GDP deflator shock for various indicators.
- PV of PPG external debt (selected years, in percent of GDP):
  - 2014: 27.8
  - 2015: 32.2
  - 2016: 28.0
  - 2017: 25.3
  - 2018: 20.3
  - 2019: 18.5
  - 2024: 18.0
  - 2034: 14.0
  - memorandum lower horizon: 6.2
- PV of external debt (selected years, in percent of GDP):
  - 2014: 33.5
  - 2015: 37.0
  - 2016: 32.9
  - 2017: 30.5
  - 2018: 25.5
  - 2019: 23.5
  - 2024: 23.1
  - 2034: 19.1
  - earlier memorandum: 11.3
- Debt service ratios (selected):
  - Debt service-to-exports ratio (in percent): 2011: 1.4; 2012: 2.0; 2013: 4.6; 2014: 4.7; 2015: 8.0; 2016: 13.2; 2017: 8.3; 2018: 4.1; 2019: 3.1; 2024: 3.4; 2034: 2.2
  - PPG debt service-to-revenue ratio (in percent): 2011: 1.5; 2012: 2.9; 2013: 7.5; 2014: 7.1; 2015: 11.3; 2016: 17.4; 2017: 9.8; 2018: 5.0; 2019: 3.9; 2024: 4.3; 2034: 3.1
- Public sector debt (selected levels, in percent of GDP):
  - 2011: 40.0
  - 2012: 57.2
  - 2013: 72.1
  - 2014: 75.8
  - 2019: 37.5
  - 2024: 17.4
- Public sector debt composition (foreign-currency denominated, in percent of GDP):
  - 2011: 16.9
  - 2012: 37.7
  - 2013: 44.0
  - 2014: 47.3
  - 2019: 24.0
  - 2024: 11.1
- PV of public sector debt (selected, in percent of GDP):
  - 2012: 19.5
  - 2013: 55.9
  - 2014: 60.7
  - 2019: 27.4
  - 2024: 12.5
- PV of public sector debt-to-revenue (in percent):
  - Selected projection entries: 164.6; 193.3; 165.4; 146.0; 114.3; 112.9; 108.7; 87.6; 42.7
- Gross financing need (selected, in percent of GDP): 2011: 5.6; 2012: 3.6; 2013: 9.8; 2014: 7.1; 2019: 3.6; 2024: 3.5; 2034: 2.0; projections: 2.2; 2.4
- Total gross financing need (Billions of U.S. dollars): selected annual entries include 0.3, 0.1, 0.1, 0.2, 0.2, 0.3, 0.2, 0.1, 0.1, 0.1, 0.2
- Aid flows (in Billions of US dollars) and composition:
  - Aid flows (selected): 2011: 0.5; 2012: 0.7; 2013: 0.6; 2014: 0.3; 2015: 0.5; 2016: 0.5; 2017: 0.5; 2018: 0.5; 2019: 0.5; 2024: 0.4; 2034: 0.3
  - Of which: Grants (Billions of US dollars): 2011: 0.3; 2012: 0.5; 2013: 0.3; 2014: 0.2; 2015: 0.3; 2016: 0.3; 2017: 0.4; 2018: 0.3; 2019: 0.3; 2024: 0.3; 2034: 0.3
  - Of which: Concessional loans (Billions of US dollars): 2011: 0.3; 2012: 0.2; 2013: 0.2; 2014: 0.1; 2015: 0.2; 2016: 0.2; 2017: 0.2; 2018: 0.2; 2019: 0.1; 2024: 0.1; 2034: 0.0
- Grant-equivalent financing (in percent of GDP, selected projection entries): 9.1; 8.3; 7.8; 7.3; 6.5; 5.4; 3.4; 1.5; 2.8
- Government revenues (excluding grants, in percent of GDP): 2011: 23.7; 2012: 23.1; 2013: 25.9; 2014: 26.8; 2015: 26.4; 2016: 27.3; 2017: 28.6; 2018: 27.6; 2019: 28.0; projection averages: 28.6; 28.1; 28.8
- Key macro assumptions (selected):
  - Real GDP growth (in percent): 2011: 4.3; 2012: 1.9; 2013: 5.2; 2014: 5.5; 2015: 2.8; 2016: 5.7; 2017: 5.5; 2018: 5.7; 2019: 6.0; 2024: 5.9; 2034: 5.8; projections: 5.8; 6.0; 6.0; 6.0
  - GDP deflator in US dollar terms (change in percent): 2011: -0.3; 2012: -26.5; 2013: -13.7; 2014: -0.1; 2015: 11.5; 2016: 5.5; 2017: 9.9; 2018: 9.2; 2019: 5.5; 2024: 4.0; 2034: 1.3; projections: 5.9; 1.9; 2.2; 2.0
  - Effective interest rate (percent): 2011: 0.5; 2012: 0.9; 2013: 0.6; 2014: 0.7; 2015: 0.2; 2016: 1.2; 2017: 2.7; 2018: 2.1; 2019: 1.0; 2024: 0.8; 2034: 0.9; projections: 1.4; 0.9; 1.0; 1.0
  - Growth of exports of G&S (US dollar terms, in percent): 2011: 3.6; 2012: -0.3; 2013: 15.7; 2014: 14.0; 2015: 15.2; 2016: 7.5; 2017: 5.8; 2018: 11.0; 2019: 5.2; 2024: 11.5; 2034: 10.3; projections: 8.5; 8.1; 8.6; 8.4
  - Growth of imports of G&S (US dollar terms, in percent): 2011: -7.8; 2012: 1.3; 2013: 2.1; 2014: 10.5; 2015: 15.6; 2016: 2.9; 2017: 6.0; 2018: 9.2; 2019: 5.3; 2024: 5.2; 2034: 8.4; projections: 6.2; 7.7; 8.4; 8.0
  - Grant element of new public sector borrowing (in percent): selected entries: 44.9; 50.4; 52.7; 54.3; 53.2; 52.1; 51.3; 46.6; 37.8; 43.6

### Policy implications and recommended actions (as reflected in the assessment)
- Maintain fiscal restraint if faced with delayed or lower donor support or lower-than-expected tax revenue to avoid jeopardizing medium-term debt sustainability.
- Arrest the decline in institutional quality (CPIA score) to strengthen capacity to manage debt.
- Safeguard donor confidence through consistent policy implementation to secure resumption and stability of aid flows.
- Monitor and manage foreign-exchange vulnerability given reliance on rain-fed agriculture and limited foreign-exchange sources.

*Sources: Malawian authorities; and IMF staff estimates and projections. — Extracted from the IMF staff report and supporting tables and figures in the informational annex.*

### 1.   MW-DRM

### 1.   MW-DRM

### IMF and World Bank program documents and studies
- Listed materials and studies (as presented):
  - Malawi Capacity Procurement Building
  - MW - Gender Policy Notes
  - Malawi Policy Note Series
  - Malawi Primary Education PET-QSD study
  - Malawi Urbanization Review
  - Renewable Energy Resource Mapping
  - Growth   and   Competitiveness
  - Malawi Economic Monitor (MEM)
- Lending and project pipeline (titles as listed):
  - Ag. Commercialization & Rural Growth
  - Malawi: EITI Implementation Support
  - MW: Shire Valley Irrigation Project
  - Project to Improve Public Finance and Economic Management
  - Fiscal Management Development Policy Operation

- Timing and status notes (exactly as listed):
  - On-going
  - On-going
  - February, 2015
  - On-going
  - February, 2015
  - January, 2015
  - On-going
  - January, 2015
  - Dec ‘14/Jun ‘15
  - April 2015
  - May, 2015
  - August 2015
  - August, 2015
  - Ongoing
  - October, 2016
  - October, 2015
  - March, 2015
  - February  2015
  - April, 2015
  - March 2015
  - September, 2017
  - December 2015
  - Jan/Jul 2015
  - September, 2015
  - July, 2015
  - December  2015
  - February 2016
  - October 2015

### IMF work program in next 12 months (items and dates preserved)
- Fifth review of ECF-supported program — February 2014
- Sixth review of ECF-supported program — July/Aug 2014
- Additional dated entries shown: April 2014; October 2014

### Information exchange and requests between Fund and World Bank
- Fund request to Bank:
  - Updates on WB support to Malawi — Continuous
- Bank request to IMF:
  - Regular updates and exchange of views on medium-term macro projections including sharing detailed excel tables on Real, Monetary, Fiscal and External Sectors — Continuous

### Joint products and missions (next 12 months)
- Debt Sustainability Analysis (update) — December 2014; Feb/March, 2015

### Relations with the African Development Bank Group (AfDB)
- Historical and portfolio summary:
  - AfDB operations in Malawi date back to 1969.
  - Malawi Field Office opened in 2007 and officially launched in July 2008.
  - As at December 31, 2014, cumulative commitments worth UA 852.8 million (about US$ 1.3 billion) to finance 100 operations including 12 studies and 2 lines of credit.
- Country Strategy Paper (CSP) and priorities:
  - AfDB Board approved new CSP covering 2013–17 on 30th January 2013.
  - CSP aligned to MGDS II (2011–16), AfDB Long Term Strategy (LTS, 2013–22) and Regional Integration Strategy Paper for Southern Africa (Southern African RISP, 2011–15).
  - CSP focuses on two pillars: (i) addressing infrastructure bottlenecks to competitiveness and growth; and (ii) supporting actions to expand private sector investment and trade.
  - More than 50 percent of the indicative lending operations are regional and will be financed with ADF, XIII and XIV resources.
  - CSP mid-term review to be undertaken in 2015.
- Crisis response and budget support:
  - Following reengagement with IMF and approval of a new US$ 157 million Extended Credit Facility (ECF) arrangement for Malawi in July 2012, AfDB approved a new ADF Grant for the Crisis Response Budget Support operation in July 2012, amount UA 26 million (US$ 40 million).
  - RFSSP program designed with two components: (i) strengthened PFM transparency and accountability, and (ii) strengthened social protection system.
  - AfDB disbursed UA 4 million (US$ 6 million) as additional budgetary support in June 2013.
  - Appraisal completed for Protection of Basic Services Program of US $ 30 million, expected Board approval in the first quarter of 2015.

### AfDB ongoing operations (Box summary)
- Agriculture sector (three projects):
  - Agriculture Infrastructure Support Project (AISP)
  - Small-holder Irrigation and Value Addition Project
  - Climate Adaptation for Rural Livelihoods and Agriculture Project (grant from Global Environment Facility)
- Water and sanitation:
  - Water Sector Monitoring & Evaluation Strengthening Project (AWF grant)
  - Water and Sanitation Access project for the Urban Poor in the City of Blantyre
- Social sector and economic empowerment (three projects):
  - Local Economic Development project (infrastructure in Jenda, Malomo, Monkey Bay and Chitekesa)
  - Competitiveness and Job Creation Project in Private sector
  - Support to Higher Education Science & Technology Project (emphasis on TEVET, higher education, ICT)
- Transport sector:
  - Trunk Roads Rehabilitation Project, including Blantyre-Zomba road rehabilitation project (60 km) and Lilongwe Bypass construction Project (13km) as part of the Multinational Nacala Road Corridor.
- Portfolio performance as of end-December 2014:
  - Overall portfolio rated satisfactory with an average disbursement rate of 29%
- New operations approved in 2013 (with amounts preserved):
  - Mzuzu-Nkhata Bay Road Rehabilitation Project (US$ 33.20m)
  - Smallholder Irrigation and Value Addition Project (US$39.98m) funded by Global Agriculture and Food Security Project and the African Development Fund
  - Multinational Nacala Road Corridor Development Project Phase IV (US$65.9m)
  - Public Finance Management Institutional Support Project (about US $ 4.5 million) — Board approved in October, 2013
- Phase approvals:
  - Phase II of the National Water Development Programme (about US $ 35 million) — Board approved in April, 2014
- Non-lending support and technical assistance:
  - Private Sector Profile for Malawi (2012–2013)
  - Co-financed Public Expenditure Review with World Bank and partners
  - Grant to Private Public Partnership Commission (PPPC) for Capacity Building and Assessment of Legislative and Institutional Framework for PPPs in Malawi
  - Domestic Resource Mobilization Study for Malawi in 2013/2014
  - TA to the Reserve Bank of Malawi to strengthen capacity in macro-economic forecasting

### Statistical issues — Assessment of Data Adequacy for Surveillance (As of February 2015)
- General:
  - Although economic data provision has some shortcomings, it is broadly adequate for surveillance.
- National Accounts:
  - National accounts estimates are produced with a two-year lag due to untimely source data.
  - Progress on methodology in collaboration with a Norway-funded project.
  - East AFRTAC assisting with development of quarterly national accounts and improvements to a monthly index of industrial production.
  - Staff resources remain insufficient.
- Price Statistics:
  - A consumer price index (CPI) is available on a timely basis.
  - CPI base is 2012, drawing on the 2010/11 Integrated Household Survey; data collected monthly by regional price collectors (urban and rural price indices).
  - A 2013 East AFRTAC TA mission began development of import and export price indexes and a review of the new producer price index; additional resources are needed.
- Government Finance Statistics (key shortcomings and data quality problems):
  - Inadequate system of recording source data.
  - Specific issues listed:
    - Tax revenue data are received in a timely fashion, but not always reconcilable with deposits in the Malawi Government (MG) Account.
    - Nontax revenue, including capital revenues collected by line ministries, not properly accounted for in fiscal reports prepared by the Ministry of Finance.
    - Recurrent expenditure data suffer from shortcomings partly related to insufficient bank reconciliation between expenses records prepared by line ministries and financing information prepared by the Ministry of Finance.
    - Line ministries submit spending reports based on recorded expenses; Ministry of Finance estimates expenses based on funding data (from the Credit Ceiling Authority), producing sizable discrepancies for wages and other recurrent transactions, partly reflecting practice of reallocation across budget lines.
    - Domestically financed development expenditure estimates are based on funding released to line ministries; externally funded expenditure estimates are based on reported project grants and loans. Differences in timing and financing modalities (e.g., pre-financing before reimbursement) create substantial differences between flow of expenses and corresponding financing data.
    - Many donor projects are still not incorporated in the budget; corresponding expenditure not captured in government finance statistics.
    - Some externally funded development expenditures are likely recurrent and reported capital expenditure therefore overstated.
    - Data on expenditure arrears are likely incomplete; reporting from the Commitment Control System appears partial and ministry level data are not consistent from report to report.
    - Malawi’s current budget classification includes economic and program classification and program, but does not include an effective administrative/organizational classification.
    - Expenditure data is loosely mapped to functional classification based on CoFoG.
    - Budget classification and chart of accounts may be adequate for some classifications; an output-oriented activities-based budget classification (ABB) is used for presentation of the budget. Pro-poor expenditures protected under the PRSP are only identified in the ABB classification. No bridge table exists to map ABB into the program classification used for expenditure reporting and accounting, so pro-poor expenditures cannot be monitored.
    - Under the ECF program, the government is expected to develop a mechanism for properly monitoring social expenditures.
    - Government nomenclature program/subprogram used for functional classification seems appropriate but includes functions, programs, and administrative levels; unclear whether they are cleanly linked to CoFoG.
    - Absence of a financial administrative structure with vertical hierarchy of responsibilities inhibits use of Government Finance Statistics (GFS). Budget funds directed to organizations defined as cost centers; sub-votes introduced to a number of Ministries but warrants and sub-warrants not yet introduced.
    - Financing estimates are based on monetary and debt data, rather than on government records of financing. Reporting on treasury bills directly issued to the RBM at times has been slow.
  - Technical assistance and reforms:
    - 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 lagged.
    - Government pledged to strengthen public financial management and fiscal reporting and is working to establish a work plan, including utilizing donor technical assistance more effectively.
    - Authorities are working with East AFRITAC to modify chart of accounts and output-based structures to realign to the national strategy.
    - A GFS TA mission visited Lilongwe in June 2011 under EDDI funded by DFID; found annual and sub-annual data for budgetary central government compiled in GFSM 1986 format but not disseminated.
    - New chart of accounts aligned with GFSM 2001 introduced in 2011–12 budget cycle, applying to all general government units.
    - Bridge tables linking national classifications and GFSM 2001 classifications were prepared by the mission and should be revised and used to compile GFS in GFSM 2001 format. A follow up mission is included in the RAP for FY 2015.
    - Government finance data are reported for publication in the Government Finance Statistics Yearbook (GFSY).
- Monetary and Financial Statistics:
  - Reserve Bank of Malawi (RBM) has improved data reporting to the Fund.
  - Monthly monetary and financial statistics (MFS) are reported to STA on a continuous basis.
  - 2013 and 2015 missions assisted RBM staff in developing standardized report forms (SRFs) for central bank accounts (1SR), other depository corporations (2SR), monetary aggregates (5SR), and financial soundness indicators (FSIs).
  - Authorities expected to begin reporting SRF-based MFS and FSI data to STA by end-2015.
  - RBM revamped banks’ call report forms to include additional breakdowns of assets and liabilities by institutional sector.
  - Repurchase agreements data originally reported in ODCs balance sheet without breakdowns by holding sector are now reported in a separate annex providing necessary breakdowns of the holding sectors.

*Source: _cr1583 - 1.   MW-DRM (IMF country materials as presented in the source content).*

### annex on overdue and nonaccrual loans, leases, and other assets by sector, which was previously reported on a

### _cr1583 - annex on overdue and nonaccrual loans, leases, and other assets by sector, which was previously reported on a

### Monetary and Financial Statistics (MFS)
- The annex on overdue and nonaccrual loans, leases, and other assets by sector, which was previously reported on a quarterly basis, is now reported on a monthly basis.
- MFS data need improvements in terms of financial institution coverage:
  - The depository corporation survey (DCS) does not include data for one investment bank which accepts deposits included in broad money, hampering the accuracy of compiled data.
  - The 2013 and 2015 missions recommended inclusion of that bank in the DCS.
  - Missions also recommended inclusion in the DCS of saving and credit cooperatives (SACCOs) and their parent body—Malawi Union of Saving and Credit Cooperatives (MUSCCO).

### Financial Sector Surveillance
- With regard to FSIs, Malawi currently does not report data to the Fund for dissemination on the Fund website.

### External Sector Statistics and Balance of Payments (BOP)
- BOP statistics in Malawi are compiled by the Balance of Payments Section of the NSO and prepared in close coordination with the Malawi National Accounts (NA).
- Estimates are largely based on:
  - survey data for private enterprises,
  - trade statistics,
  - banking data,
  - information from Government Departments.
- Some surveys collect balance of payments and NA data together.
- Malawi reports the BOP and IIP in the sixth edition of the Balance of Payments and International Investment Position Manual (BPM6) format, reasonably compliant.
- The BOP Section collects data via three substantial surveys:
  - Foreign Private Capital (FPC) survey — collects data essentially for the financial account.
  - BOP survey — collects services and primary income data.
  - Non-Profit Institutions Serving Households (NPISH) survey — collects secondary income and capital account data.
- Implementation and achievement of prior TA mission recommendations (April 2012, November 2012, November 2013, and February 2014) depend on maintenance of funding and resources for the BOP Section; likely Government budget constraints could make funding difficult.
- Funding notes:
  - Funding for the 2015 FPC survey (data for 2013 and 2014) has been agreed for this Spring/Summer.
  - There was no funding for the BOP and NPISH surveys in 2014.

### Data Standards and Quality
- Malawi participates in the GDDS/PRSP and the monetary and financial statistics modules of the project.
- GDDS metadata have been posted on the Fund’s Dissemination Standards Bulletin Board (DSBB) since February 2007.
- Data ROSC was published on February 17, 2005.

### Tables of Common Indicators Required for Surveillance (As of January, 2015) — selected entries and frequencies
- Exchange Rates: Current; Frequency of Data: Current; Frequency of Reporting: D; Frequency of Publication: D
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities:
  - Date of latest observation: 10/2014; Date received: 01/2015; Frequency of Data: M; Frequency of Reporting: M; Frequency of Publication: M
- Reserve/Base Money:
  - Date of latest observation: 10/2014; Date received: 01/2015; Frequency of Data: M; Frequency of Reporting: M; Frequency of Publication: M
- Broad Money:
  - Date of latest observation: 10/2014; Date received: 01/2015; Frequency of Data: M; Frequency of Reporting: M; Frequency of Publication: M
- Central Bank Balance Sheet:
  - Date of latest observation: 10/2014; Date received: 01/2015; Frequency of Data: M; Frequency of Reporting: M; Frequency of Publication: M
  - Data Quality — Methodological soundness: LO, LO, LNO, O
  - Data Quality — Accuracy and reliability: LO, O, O, O, O
- Consolidated Balance Sheet of the Banking System:
  - Date of latest observation: 10/2014; Date received: 01/2015; Frequency of Data: M; Frequency of Reporting: M; Frequency of Publication: M
- Interest Rates:
  - Date of latest observation: 12/2014; Date received: 01/2015; Frequency of Data: M; Frequency of Reporting: M; Frequency of Publication: M
- Consumer Price Index:
  - Date of latest observation: 12/2014; Date received: 01/2015; Frequency of Data: M; Frequency of Reporting: M; Frequency of Publication: M
  - Data Quality — Methodological soundness and accuracy: O, LNO, O, O / LNO, O, O, O
- Revenue, Expenditure, Balance and Composition of Financing — General Government:
  - Date of latest observation: 10/2014; Date received: 11/2014; Frequency of Data: M; Frequency of Reporting: M; Frequency of Publication: I
- Revenue, Expenditure, Balance and Composition of Financing — Central Government:
  - Date of latest observation: 10/2014; Date received: 11/2014; Frequency of Data: M; Frequency of Reporting: M; Frequency of Publication: I
  - Data Quality — Methodological soundness and accuracy: O, LO, O, O / O, LO, O, O, LNO
- Stocks of Central Government and Central Government-Guaranteed Debt:
  - Date of latest observation: 10/2014; Date received: 11/2014; Frequency of Data: M; Frequency of Reporting: M; Frequency of Publication: M
- External Current Account Balance:
  - Date of latest observation: 10/2014; Date received: 11/2014; Frequency of Data: A; Frequency of Reporting: A; Frequency of Publication: A
- Exports and Imports of Goods and Services:
  - Date of latest observation: 10/2014; Date received: 11/2014; Frequency of Data: A; Frequency of Reporting: A; Frequency of Publication: A
  - Data Quality — Methodological soundness and accuracy: O, O, O, O / LO, O, LO, O, O
- GDP/GNP:
  - Date of latest observation: 10/2014; Date received: 11/2014; Frequency of Data: A; Frequency of Reporting: A; Frequency of Publication: A
- Gross External Debt:
  - Date of latest observation: 2014; Date received: 11/2014; Frequency of Data: M; Frequency of Reporting: I; Frequency of Publication: I
- International Investment Position:
  - Date of latest observation: 2010; Date received: 2014; Frequency of Data: I; Frequency of Reporting: I; Frequency of Publication: I

### IMF Press Release highlights (Press Release No. 15/133, March 23, 2015)
- The Executive Board completed the fifth and sixth reviews under Malawi’s ECF Arrangement and approved immediate disbursement of SDR 13.02 million (about US$18.1 million).
- Total disbursements under the arrangement were brought to SDR 65.08 million (about US$ 90.3 million).
- The Board approved waivers of non-observance of performance criteria related to:
  - net domestic assets of the Reserve Bank of Malawi (RBM),
  - net domestic borrowing by the government,
  - the ceiling on new non-concessional external debt maturing in more than one year,
  - the ceiling on non-accumulation of external payments arrears.
- The Board approved an extension of the current ECF arrangement by six months to May 22, 2016 and the rephasing of disbursements associated with the seventh and eighth reviews.
- Original three-year ECF arrangement amount: SDR 104.1 million (about US$ 144.4 million), approved on July 23, 2012.

### Executive and Authorities’ Statements — key findings and policy commitments
- IMF (Acting Chair Mitsuhiro Furusawa) observations:
  - Malawi’s macroeconomic outlook and program performance were significantly damaged by large-scale theft of public funds and policy lapses before elections.
  - Consequences included suspension of donor budget support, increased recourse to central bank financing, accumulation of domestic arrears, exchange rate depreciation, and high inflation.
  - New government committed to rebuilding trust, maintaining a flexible exchange rate regime and automatic fuel pricing mechanism.
  - Key objectives: bring inflation down to single digits and boost official foreign exchange reserves.
  - Urgent priority: address weaknesses in public financial management to restore donor confidence.
  - Central bank committed to tightening monetary policy as needed; measures taken in late 2014 helped reduce liquidity and stabilize the currency.
  - Improved prudential and regulatory frameworks and use of diagnostic assessments to design a banking-sector strategy.
  - Nonconcessional external borrowing in October 2013 led to noncomplying disbursements; authorities have taken corrective actions and the Board waived the nonobservance given these actions.
- Authorities’ statement (Mr. Mkwezalamba et al.):
  - Authorities appreciate IMF support and policy guidance and remain committed to ECF objectives, PFM reforms, and implementing forensic audit recommendations.
  - Cashgate (late 2013) disrupted stabilization and structural transformation; forensic audit and prosecutions have been pursued, with convictions and some asset recoveries.
  - Suspension of donor budget support exacerbated economic difficulties; programmed domestic borrowing ceiling was breached and large domestic payment arrears accumulated.
  - Despite challenges, authorities attained all but one informal quantitative targets for end-September 2014 and end-January 2015 on Net Domestic Assets, Net Domestic Financing and gross official reserves.
  - Prior actions for fifth and sixth reviews in fiscal policy, PFM, monetary policy and financial sector were fully implemented.
  - Remedial measures to prevent recurrence of missed continuous PCs include:
    - cancellation and replacement of the Supplier’s Credit Agreement with a suppliers’ agreement with a much reduced total value of the overall transaction of only US$33 million from US$145.3 million,
    - normalization of all outstanding external payment arrears,
    - resuscitation of the Debt Management Committee to enhance debt management capacity,
    - undertaking to share all new loan proposals with Fund staff.
  - Authorities requested waivers for non-compliance with the missed continuous PCs.
- Recent macroeconomic outlook and risks:
  - Medium-term outlook described as favorable with policies focused on strengthening macroeconomic position and sustaining growth.
  - Short-term priorities: restoring macroeconomic stability, reinforcing PFM systems, preserving financial sector stability.
  - Inflation targeted to decline from current levels to low double digits by end-2015 and then to single digit levels towards end-2016.
  - Real GDP projected to have grown by around 6 percent in 2014, driven by agriculture, wholesale and retail trade, and information and communication sector.
  - Downside risk: heavy torrential rains and worst floods in Malawi’s history affecting 15 of the 28 districts, causing over 172 people missing and 106 deaths; destruction of transport infrastructure, disruption of energy generation, loss of livestock, houses and agricultural land—risks to agricultural growth, food security, and public finances.
- Fiscal and debt management commitments:
  - Authorities committed to prudent fiscal policy to consolidate fiscal position while avoiding further build-up of domestic payment arrears.
  - FY2014/15 budget predicated on large fiscal adjustments with significant reduction in non-statutory recurrent expenditures and domestically financed capital spending due to dearth of external budgetary support and constrained domestic bank financing.
  - Policy measures on revenue: strengthen tax administration and minimize tax exemptions.
  - Policy measures on expenditures: further rationalize budget envelope while preserving allocations to growth-enhancing sectors.
  - Priority to regularize large stock of domestic arrears through cash payments and issuance of ‘zero coupon bonds’ over the next three fiscal years.
  - Commitment to preserve debt sustainability; country assessed at moderate risk of external debt distress but with heightened overall risk from domestic debt accumulation.
  - Continued reliance mostly on concessional external borrowing for critical development projects and measures to strengthen debt management and prevent misreporting.

*Source: IMF staff report and Press Release materials contained in the provided PDF content.*

### 11.  A centerpiece of the authorities’ near-term reform agenda is the strengthening of public

### _cr1583 - 11.  A centerpiece of the authorities’ near-term reform agenda is the strengthening of public

### Public financial management (PFM) strengthening and IFMIS
- A centerpiece of the authorities’ near-term reform agenda is the strengthening of public financial management systems to facilitate efficient government financial operations and restore public confidence in budget execution.
- Authorities commend the TA received from FAD.
- Significant progress accomplished:
  - strengthening commitment controls,
  - reconciling fiscal accounts,
  - improving cash management.
- Further consolidation will be sought through judicious implementation of the recently adopted PFM strategy, within the framework of the authorities’ Public Finance and Economic Management Reform Programme.
- In view of several operational and system deficiencies in the current Integrated Financial Management Information Systems (IFMIS), the authorities have initiated the process of procuring a new, well secured and efficient IFMIS.
- Interim actions:
  - current system being enhanced to ensure efficient government financial transactions continue,
  - prosecutions of alleged cases of fraud identified in the Forensic Audit report are being resolutely pursued.
- Follow-up:
  - an assessment of the implementation of these recommendations will be undertaken by a reputable international audit firm.

### Monetary and exchange rate policies
- The Reserve Bank of Malawi (RBM) has demonstrated a strong commitment to stabilizing monetary conditions and bolstering the external reserves position, using monetary policy instruments at its disposal.
- Policy actions in response to 2014 developments:
  - raised the policy rate by 250 basis points,
  - increased the liquidity reserve requirement on foreign currency deposits with commercial banks,
  - implemented a ‘currency swap’ arrangement involving purchase of government debt denominated in Kwacha by the Preferential Trade Area (PTA) Bank using US dollars.
- Outcomes of these actions:
  - tightening of monetary conditions through a rise in both the interbank and the treasury bills rate,
  - restoration of some order in the foreign exchange market,
  - strengthening of the foreign exchange reserves position.
- Fiscal dominance mitigation:
  - amendments to the RBM Act that impose tighter limit on total government borrowing from the central bank,
  - prohibition of the automatic conversion of overdrafts into government securities.
- Near-term policy stance:
  - RBM will maintain a tight monetary policy stance to return inflation to a downward path and to appropriately anchor inflation expectations.
  - The Bank’s liquidity forecasting and management framework will be further strengthened to closely monitor the build-up of excess liquidity in the banking system.
  - The current flexible exchange rate regime will be maintained.
  - RBM will continue limited interventions in the foreign exchange market to smooth short-term volatility and bolster the foreign reserves position.

### Financial sector policies
- Authorities committed to addressing risks from financial sector weaknesses.
- Actions taken and planned:
  - third party diagnostic assessments conducted on the banking system,
  - restructuring process to resolve issues with two banks identified as weak has commenced,
  - a comprehensive strategy is being developed to address banking sector-wide problems from the assessments.
- Regulatory and supervisory strengthening:
  - migration to Basel II Core Principles has been completed, with an increase in total capital requirement ratios of banks,
  - a prompt corrective action framework to strengthen and clarify existing triggers for early remedial action against distressed banks has been adopted,
  - RBM will intensify on-site inspection and off-site supervision, strictly enforce compliance with prudential norms, and closely monitor loan concentrations.
- Legislative measures:
  - enactment of amendments to the Banking and Financial Services Acts to ensure consistency with international best practices in bank resolution will be pursued.

### Request for waiver of non-observance of performance criteria
- The Malawi authorities deeply regret the misreporting associated with the third and fourth reviews and request a waiver for non-observance of a performance criterion (PC) under the ECF supported program.
- Misreporting details:
  - relates to the nonobservance of the continuous PCs on new non concessional external debt maturing in more than one year and external payments arrears.
- Context and consequences:
  - At completion of the third and fourth reviews, authorities did not report to the Fund that it had contracted new non-concessional external loans after the completion of the second review on April 8, 2013, aside from a non-concessional loan with China for which a waiver was requested, and that it had accumulated no external arrears during the review period.
  - The reported observance of the external payments arrears PC, and the corrective actions reported at that time, formed part of the basis for the Executive Board’s completion of the third and fourth reviews.
  - The information provided by the authorities was inaccurate, leading to non-complying disbursements.
- Corrective measures by the new administration (as outlined in the authorities’ response of February 19, 2015 to the Managing Director’s letter of February 12, 2015, (EBS/15/13)):
  - cancellation and replacement of the Supplier’s Credit Agreement with a suppliers’ agreement with a much reduced total value of the overall transaction,
  - normalization of all outstanding external payment arrears,
  - enhancement of debt management capacity following the resuscitation of the Debt Management Committee,
  - undertaking to share with Fund staff all new loan proposals to ensure conformity with program understandings.

### Conclusion and requests to the Executive Directors
- Authorities reiterate their commitment to implementing sound macroeconomic policies and far-reaching structural reforms, within the framework of the ECF arrangement.
- On the basis of progress in addressing weaknesses in public financial management and correcting underlying macroeconomic imbalances, the authorities solicit the Executive Directors’ support for:
  - completion of the fifth and sixth reviews under the ECF arrangement,
  - the request for waivers for non-observance of performance criteria,
  - extension of the arrangement,
  - modification of performance criterion,
  - re-phasing of disbursements.

*Source: _cr1583 - 11.  A centerpiece of the authorities’ near-term reform agenda is the strengthening of public*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1583.pdf_