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Malawi - Fifth and Sixth Reviews Under the Extended Credit Facility Arrangement, Request for Waivers for Non-Observance of Performance Criteria, Extensions of the Arrangement, Modification of Performance Criterion, and Rephasing of Disbursements-Staff Report; Press Release; and Statement by the Executive Director for Malawi
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Malawi: Fifth and Sixth Reviews Under the Extended Credit Facility Arrangement, Request for Waivers for Non-Observance of Performance Criteria, Extension of the Arrangement, Modification of Performance Criterion, and Rephasing of Disbursements—Debt Sustainability Analysis

Author(s):
International Monetary Fund. African Dept.
Published Date:
March 2015
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Background

1. The last Low Income Country Debt Sustainability Analysis (LIC DSA, IMF country report no. 14/37) conducted in late 2013 concluded Malawi’s external public debt faced moderate risk of distress. All external public debt and debt burden indicators for Malawi were envisioned below their respective thresholds under the benchmark and other scenarios. The baseline envisioned strong enough fiscal and public financial management (PFM) policies that would result in resumption in donor budget support by the end of the 2013/14 fiscal year, but this did not materialize.

2. The country policy and institutional assessment (CPIA) score for Malawi has deteriorated, changing the category of its policies and institutions to weak, and tightening debt thresholds for DSA analysis. The CPIA score of Malawi peaked at 3.4 in 2007 but has continuously deteriorated since then and reached a level of 3.1 by 2013, compounded by erosion in the effectiveness of public financial management systems, controls and oversight mechanisms. Relative to the previous DSA, weak policies and institutions as measured by this index resulted specifically in lower thresholds for external public debt relative to the ones used in the previous DSA.1

3. Malawi’s public and publicly guaranteed (PPG) gross debt changed from 57% of GDP in 2012 to 72.1% of GDP in 2013 and is expected to reach about 76% of GDP in 2014, reflecting continued increases in both, domestic and external public debt. The increase in debt reflected in part (two-thirds of the change from 2012 to 2013) recourse to domestic financing in the wake of external financing shortfalls arising from the suspension of external budget support by donors in the wake of weaknesses revealed by a large public financial management scandal. Popularly known as “cashgate”, this scandal involved multiple cases of embezzlement of public funds by a number of officials of the government. The increase in total public debt in 2014 also resulted in part from the recognition of significant past payment arrears. A decline in government current expenditures as ratio to GDP and improved domestic revenue performance were insufficient in offsetting the ongoing lack of direct budget support from development partners. A detailed decomposition of the dynamics of domestic and external public debt is discussed below.

Text Table 1.Malawi: Composition of total public Debt, 2012–14(Percent of GDP)
201220132014
External debt37.744.047.3
Domestic Debt19.528.128.5
Total public Debt57.272.175.8
Sources: Malawian Authorities and IMF Staff Estimates.
Sources: Malawian Authorities and IMF Staff Estimates.

4. Gross domestic debt increased from MK206.6 billion (19.5% of GDP) at the end of 2012 to MK515 billion (28.5% of GDP) at the end of 2014. As illustrated in Figure A1, this increase is largely due to (i) the rise in the use of ways and means advances from the Reserve Bank of Malawi in 2013 and 2014, following the drop in external financing in the wake of the “cashgate” scandal; (ii) the recognition in late 2014 of pre-audited arrears amounting to MK157 billion (8 percent of GDP) accumulated from previous fiscal years; (iii) the issuance of promissory notes in the amount of MK29 billion (1.6 percent of GDP) by the government to the central bank (RBM) in April 2014 to cover losses arising from the 2012 devaluation of the exchange rate. 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, helped by (i) the repayment of accumulated domestic arrears; (ii) the decline in new ways and means advances as the government’s fiscal position improves; and (iii) a projected slower pace of new issuance of Treasury bills and Treasury notes over the long term (due to a lower government deficit).

Figure A1.Composition of the Stock of Gross Domestic Debt

Sources: Malawi authorities and IMF staff calculations

5. Malawi’s external public debt increased from US $1.15 billion in 2012 (37.7% of GDP) to US $1.45 billion on 2013 (44% of GDP) and is estimated to have reached US $1.86 (47.3% of GDP) billion in 2014.. The increase of 2013 reflects a continuation of strong external borrowing that resumed in 2012. In terms of GDP half of the increase of the change from 2012 to 2013 can be attributed to exchange rate effects.2 External support was then subdued in late 2013. During 2014 external public debt increased further, but about half of the increase was due not to accumulation of new debt, but to the sale of existing domestic debt to PTA bank, a regional development bank serving the members of the Common Market of East and Southern Africa (COMESA). The debt was reclassified as external based on the residency criterion despite the debt being denominated in local currency. In terms of source of financing, as illustrated in Table 1 below, most of Malawi’s debt is from multilaterals.

Text Table 2.Composition of Total Public and Publicly Guaranteed External Debt(US$ Millions)
201220132014
ActualActualShareProj.Share
Total1149.51447.38100%1857.4100.0%
Multilaterals882.71015.270%1365.274%
IMF180.9198.214%218.212%
IDA322.9416.529%456.525%
ADF171.2190.913%210.911%
IFAD77.675.65%75.64%
Other Multilateral1130.11349%424.023%
Bilateral266.8412.528%472.525%
France10.410.81%10.81%
Belgium2.22.20%2.20%
People’s Republic of China175.5252.417%282.415%
India78.7106.27%136.27%
Others040.93%40.92%
Commercial019.71%19.71%
Sources: Malawian authorities and staff estimates

The 2014 stock includes US$250 million resulting from the sale of existing government debt to a regional development bank.

Sources: Malawian authorities and staff estimates

The 2014 stock includes US$250 million resulting from the sale of existing government debt to a regional development bank.

Table 1.Malawi: External Debt Sustainability Framework, Baseline Scenario, 2011–14(In percent of GDP, unless otherwise indicated)
ActualHistorical6/Standard6/Projections
201120122013AverageDeviation2014201520162017201820192014–2019

Average
202420342020–2034

Average
External debt (nominal) 1/21.042.849.752.140.239.337.136.535.829.116.2
of which: public and publicly guaranteed (PPG)16.937.744.047.335.334.131.931.530.724.011.1
Change in external debt0.521.96.92.4−11.9−0.9−2.2−0.6−0.8−1.4−1.8
Identified net debt-creating flows4.08.63.70.6−0.8−1.0−1.3−1.3−1.4−1.4−1.1
Non-interest current account deficit5.83.21.55.54.34.62.42.02.22.01.91.30.51.0
Deficit in balance of goods and services14.720.518.014.913.712.311.69.28.77.66.6
Exports25.133.442.541.037.435.933.834.235.136.136.4
Imports39.853.860.555.851.048.245.443.443.843.743.0
Net current transfers (negative = inflow)−10.9−20.2−20.4−16.33.3−14.9−14.8−15.0−13.8−12.7−12.0−9.5−6.8−8.5
of which: official−6.4−14.0−13.2−6.6−7.7−7.7−7.4−6.4−6.0−4.4−2.6
Other current account flows (negative = net inflow)1.93.04.04.63.64.64.45.55.23.10.7
Net FDI (negative = inflow)−1.1−1.9−2.4−2.11.3−2.0−2.0−1.7−1.7−1.6−1.6−1.2−0.8−1.0
Endogenous debt dynamics 2/−0.77.34.6−2.0−1.3−1.3−1.8−1.7−1.7−1.4−0.8
Contribution from nominal interest rate0.10.30.30.51.20.70.30.30.30.30.2
Contribution from real GDP growth−0.9−0.5−2.5−2.5−2.5−2.0−2.1−2.0−2.0−1.7−1.0
Contribution from price and exchange rate changes0.17.56.8
Residual (3–4) 3/−3.413.33.11.9−11.10.1−0.90.70.60.0−0.7
of which: exceptional financing−2.2−2.2−2.6−4.4−4.1−3.6−3.1−2.8−2.1−1.5−0.7
PV of external debt 4/33.537.032.930.525.523.523.119.111.3
In percent of exports78.990.488.285.075.468.965.852.831.1
PV of PPG external debt27.832.228.025.320.318.518.014.06.2
In percent of exports65.478.674.970.560.154.151.338.717.1
In percent of government revenues107.4120.3106.192.870.967.264.548.722.2
Debt service-to-exports ratio (in percent)1.42.04.64.78.013.28.34.13.13.42.2
PPG debt service-to-exports ratio (in percent)1.42.04.64.78.013.28.34.13.13.42.2
PPG debt service-to-revenue ratio (in percent)1.52.97.57.111.317.49.85.03.94.33.1
Total gross financing need (Billions of U.S. dollars)0.30.10.10.20.20.30.20.10.10.10.2
Non-interest current account deficit that stabilizes debt ratio5.2−18.6−5.32.214.42.94.42.62.72.62.4
Key macroeconomic assumptions
Real GDP growth (in percent)4.31.95.25.52.85.75.55.76.05.95.85.86.06.06.0
GDP deflator in US dollar terms (change in percent)−0.3−26.5−13.7−0.111.55.59.99.25.54.01.35.91.92.22.0
Effective interest rate (percent) 5/0.50.90.60.70.21.22.72.11.00.80.91.40.91.01.0
Growth of exports of G&S (US dollar terms, in percent)3.6−0.315.714.015.27.55.811.05.211.510.38.58.18.68.4
Growth of imports of G&S (US dollar terms, in percent)−7.81.32.110.515.62.96.09.25.35.28.46.27.78.48.0
Grant element of new public sector borrowing (in percent)44.950.452.754.353.252.151.346.637.843.6
Government revenues (excluding grants, in percent of GDP)23.723.125.926.826.427.328.627.628.028.628.128.8
Aid flows (in Billions of US dollars) 7/0.50.70.60.30.50.50.50.50.50.40.3
of which: Grants0.30.50.30.20.30.30.40.30.30.30.3
of which: Concessional loans0.30.20.20.10.20.20.20.20.10.10.0
Grant-equivalent financing (in percent of GDP) 8/9.18.37.87.36.55.43.41.52.8
Grant-equivalent financing (in percent of external financing) 8/62.476.280.483.282.584.080.591.180.1
Memorandum items:
Nominal GDP (Billions of US dollars)5.64.23.84.34.95.76.47.07.511.024.2
Nominal dollar GDP growth4.1−25.1−9.211.516.015.511.810.17.212.08.08.38.1
PV of PPG external debt (in Billions of US dollars)0.91.21.41.41.31.31.31.51.6
(PVt-PVt-1)/GDPt-1 (in percent)8.33.70.5−2.1−0.40.81.80.3−0.40.2
Gross workers’ remittances (Billions of US dollars)0.00.00.00.00.00.00.00.00.00.00.0
PV of PPG external debt (in percent of GDP + remittances)27.832.228.025.320.318.518.014.06.2
PV of PPG external debt (in percent of exports + remittances)65.478.674.970.560.154.151.338.717.1
Debt service of PPG external debt (in percent of exports + remittances)4.64.78.013.28.34.13.13.42.2
Sources: Malawian authorities; and IMF staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r - g - ρ(1 + g)]/(1 + g + ρ + gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Sources: Malawian authorities; and IMF staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r - g - ρ(1 + g)]/(1 + g + ρ + gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

6. The scope of debt covered in the present DSA encompasses public and publicly guaranteed debt.

Underlying DSA Assumptions

7. Macroeconomic and policy developments during 2013 and 2014 resulted in several areas of underperformance, relative to the projections in the 2013 DSA. Donors withdrew budget support in 2013 and this when combined with weak commitment controls (which were exacerbated in the run up to elections), contributed to increased domestic borrowing, domestic payment arrears and an acceleration in inflation. Economic activity remained resilient, with real GDP estimated at 5½–6 percent range in 2014. The ready availability of foreign exchange and fuel, as a result of policy reforms introduced in May 2012, appears to have supported the expansion of economic activity. The exchange rate came under considerable depreciation pressure in the latter stages of 2014. This was in part a seasonal phenomenon, as the rate usually weakens after the end of the tobacco buying season in August. However, it was particularly acute this time, owing to the unattractive level of real interest rates. The exchange rate begun to stabilize since the stance of monetary policy was tightened in November and the RBM acquired foreign exchange from the debt restructuring operation with PTA.

8. The baseline scenario and macroeconomic outlook have been revised accordingly. For 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 is also expected to remain tight, to support the disinflation process. Tighter policies, and lower than expected worldwide growth, led to revisions in GDP growth forecasts for 2014 and 2015 to 5.7 percent and 5.5 percent, respectively (from 6.1 percent and 6.5 percent in the previous DSA). Long-term GDP growth is assumed at 6 percent. The baseline scenario also maintains the assumption of a gradual reduction in the external current account deficit through export diversification and reliance on grants and concessional financing in the medium term. The merchandise trade balance is expected to improve during 2014 and 2015 relative to the previous DSA, on account of favorable terms of trade and the continued depreciation of the Kwacha. Inflation is programmed to return to single digits by 2016. Targets on international reserves have been met during the program, and a 3 months of import cover is expected to be attained and sustained (or improved) by end-2015. The key macroeconomic assumptions are summarized in Box 1.

Box 1.Baseline Macroeconomic Assumptions

Real GDP is projected to grow at an annual rate of about 6 percent over the longer term, led by the agriculture, trade, manufacturing and mining sectors, and supported by a more competitive exchange rate, structural reforms, and gradually recovering donor support.

Inflation is 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 as the emphasis of monetary policy switches from accumulation of international reserves to price stability.

The exchange rate is projected to remain constant in real terms after 2015.

Tax revenue is projected to continue increasing with ongoing reforms in tax administration and policy.

External public debt and financing sources. Debt will be contracted mainly from multilateral creditors on concessional terms, with borrowing from bilateral sources also on broadly similar terms. Budget support from development partners is assumed to remain subdued for FY 2014/15 and into the medium term. Project support in the short and medium term is assumed to remain strong (but lower than previously considered). Foreign direct investment is still assumed to be in the 3–4% of GDP range in the short to medium term as strong reforms bring back confidence, while the longer term levels are as in previous DSA analyses, in the range of 1–2% of GDP.

The current account balance will remain at a sustainable level, as improvements in the trade of goods and services balances partially offset the decline in grants.

Text Table 3.Macroeconomic Forecasts and Assumptions (Previous and Current DSA)
Primary deficitChange in public debt
Real GDP growth(percent of GDP)(percent of GDP)
YearPreviousCurrentPreviousCurrentPreviousCurrent
20135.05.21.21.912.014.9
20146.15.7−1.3−1.6−13.53.7
20156.55.5−0.4−0.9−5.5−15.5
20166.55.7−0.9−3.1−4.3−3.3
20176.26.00.1−2.4−3.2−6.2
20186.35.90.1−0.9−5.1−1.1
20195.95.81.2−1.2−3.1−1.9
20205.85.91.0−0.5−3.5−1.9
20215.95.91.4−0.6−2.3−1.9
20225.96.01.4−1.1−1.9−2.2
Avg 2023–20345.96.01.21.0−0.2−2.0
Sources: Malawian authorities and IMF staff calculations and projections.
Sources: Malawian authorities and IMF staff calculations and projections.

External Public Debt Sustainability

9. 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 for Malawi remain below their new tighter limits. Malawi’s external public debt continued expanding through 2013 and, in present value terms, is estimated to reach 32.2% of GDP by the end of 2014. The resulting breach in the corresponding debt threshold (of 30%) is, nevertheless, expected to be marginal and short lived. As illustrated in Figure A2 below, this breach was due to the aforementioned restructuring of existing domestic debt to PTA bank. The interest rate would be lower by 1000 basis points as a result of the restructuring, resulting in lower debt service costs. PTA bank finances letters of credit for exports in Malawi on a regular basis and thus benefits from the resulting liquidity. In addition to this restructuring operation, the depreciation of the exchange rate during the last quarter of 2014, which appears to have subsided in recent times, also played an important role in causing the breach in the PV of debt to GDP threshold.3

Figure A2.Malawi’s Public and Publicly Guaranteed External Debt

Sources: Malawian Authorities and IMF Staff Calculations

Table 2.Malawi: Public Sector Debt Sustainability Framework, Baseline Scenario, 2011–34(In percent of GDP, unless otherwise indicated)
ActualEstimateProjections
201120122013Average5/Standard Deviation5/2014201520162017201820192014–19 Average202420342020–34 Average
Public sector debt 1/40.057.272.175.860.256.950.749.747.737.517.4
of which: foreign-currency denominated16.937.744.047.335.334.131.931.530.724.011.1
Change in public sector debt4.917.214.90.03.7−15.5−3.3−6.2−1.1−1.9−1.6−1.5
Identified debt-creating flows3.510.21.0−7.2−9.9−5.3−5.7−2.1−3.1−2.2−0.9
Primary deficit2.00.21.9−0.63.2−1.6−0.9−3.1−2.4−0.7−1.4−1.7−0.50.3−1.1
Revenue and grants28.334.634.031.432.033.034.232.532.331.329.3
of which: grants4.711.68.14.65.65.75.64.94.32.71.2
Primary (noninterest) expenditure30.334.835.929.831.129.931.831.830.930.829.5
Automatic debt dynamics1.710.2−0.9−5.7−9.0−2.3−3.4−1.5−1.7−1.7−1.1
Contribution from interest rate/growth differential0.7−2.3−1.9−2.5−1.1−0.8−1.7−1.6−1.9−1.7−0.8
of which: contribution from average real interest rate2.2−1.60.91.42.82.41.51.30.80.50.3
of which: contribution from real GDP growth−1.5−0.7−2.8−3.9−3.9−3.3−3.2−2.8−2.7−2.2−1.1
Contribution from real exchange rate depreciation1.012.51.0−3.2−7.9−1.4−1.70.10.2
Other identified debt-creating flows−0.3−0.20.00.00.00.00.00.00.00.00.0
Privatization receipts (negative)0.00.00.00.00.00.00.00.00.00.00.0
Recognition of implicit or contingent liabilities0.00.00.00.00.00.00.00.00.00.00.0
Debt relief (HIPC and other)−0.3−0.20.00.00.00.00.00.00.00.00.0
Other (specify, e.g. bank recapitalization)0.00.00.00.00.00.00.00.00.00.00.0
Residual, including asset changes1.47.013.910.9−5.62.0−0.51.11.10.6−0.7
Other Sustainability Indicators
PV of public sector debt19.555.960.753.048.139.136.735.127.412.5
of which: foreign-currency denominated0.027.832.228.025.320.318.518.014.06.2
of which: external27.832.228.025.320.318.518.014.06.2
PV of contingent liabilities (not included in public sector debt)
Gross financing need 2/5.63.69.87.16.66.03.63.52.02.22.4
PV of public sector debt-to-revenue and grants ratio (in percent)56.4164.6193.3165.4146.0114.3112.9108.787.642.7
PV of public sector debt-to-revenue ratio (in percent)84.7216.2226.7200.8176.4136.6133.1125.495.844.6
of which: external 3/107.4120.3106.192.870.967.264.548.722.2
Debt service-to-revenue and grants ratio (in percent) 4/12.69.823.227.623.527.517.512.910.58.68.0
Debt service-to-revenue ratio (in percent) 4/15.114.830.432.428.533.320.915.312.19.48.3
Primary deficit that stabilizes the debt-to-GDP ratio−2.9−17.1−12.9−5.314.60.33.80.40.61.11.8
Key macroeconomic and fiscal assumptions
Real GDP growth (in percent)4.31.95.25.52.85.75.55.76.05.95.85.86.06.06.0
Average nominal interest rate on forex debt (in percent)1.42.31.51.60.42.75.34.12.01.71.72.91.92.1
1.9
Average real interest rate on domestic debt (in percent)12.5−7.24.76.58.13.75.07.27.17.75.5
6.04.15.1
4.5
Real exchange rate depreciation (in percent, + indicates depreciation)6.675.32.85.325.3−7.5
Inflation rate (GDP deflator, in percent)4.017.727.313.78.220.916.58.76.86.86.511.05.65.55.7
Growth of real primary spending (deflated by GDP deflator, in percent)−2.616.98.62.45.9−12.410.11.712.95.82.83.59.35.05.7
Grant element of new external borrowing (in percent)44.950.452.754.353.252.151.346.637.8
Sources: Malawian authorities; and IMF staff estimates and projections.

[Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.]

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Sources: Malawian authorities; and IMF staff estimates and projections.

[Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.]

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Another noticeable change, relative to the dynamics of debt in previous DSA, is that, due to the short maturity (3 years) of the loan with PTA, noticeable peaks in debt service emerge during 2015–16.4 An illustration of debt service trends in the baseline, and excluding PTA is presented in Figure A3. Restrained fiscal and monetary policies, together with PFM reforms envisioned in the current ECF (Extended Credit Facility) program should contribute to a downward trend in key debt indicators.

Figure A3.Malawi’s Public and Publicly Guaranteed External Debt Service

(Debt Service as Ratio of Exports)

Sources: Malawian Authorities and IMF Staff Calculations

10. Except for the present value of external public debt to GDP, debt burden indicators remain below their indicative thresholds under bound tests conducted to show the impact of temporary shocks. The strongest impact on the present value of external public debt to GDP requires the combination of shocks to growth, exports and non-debt creating flows (See Table 4a, case B5). In turn, a shock to exports (Table 4a, case B2) is the only shock that could bring a marginal breach in the debt to exports ratio while none of the bound tests considered results in a breach of threshold for the present value of debt to revenue ratio.

Table 3.Malawi: Sensitivity Analysis for Key Indicators of Public Debt 2014–34
Projections
20142015201620172018201920242034
PV of Debt-to-GDP Ratio
Baseline6153483937352713
A. Alternative scenarios
A1. Real GDP growth and primary balance are at historical averages6152494139383218
A2. Primary balance is unchanged from 20146152504240393523
A3. Permanently lower GDP growth 1/6152483938373432
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2015–206153514341403727
B2. Primary balance is at historical average minus one standard deviations in 2015–2016154524341393115
B3. Combination of B1-B2 using one half standard deviation shocks6154524341403419
B4. One-time 30 percent real depreciation in 20156164574542403117
B5. 10 percent of GDP increase in other debt-creating flows in 20156158534341393115
PV of Debt-to-Revenue Ratio 2/
Baseline1931651461141131098850
A. Alternative scenarios
A1. Real GDP growth and primary balance are at historical averages19316214812011911710263
A2. Primary balance is unchanged from 201419316315012312312211179
A3. Permanently lower GDP growth 1/193162145115115113107109
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2015–2019316615412312512411691
B2. Primary balance is at historical average minus one standard deviations in 2015–2011931681591261251219851
B3. Combination of B1-B2 using one half standard deviation shocks19316715712512612310867
B4. One-time 30 percent real depreciation in 201519320117313212812310057
B5. 10 percent of GDP increase in other debt-creating flows in 20151931811601261251219851
Baseline28242818131098
A. Alternative scenarios
A1. Real GDP growth and primary balance are at historical averages25242718131197
A2. Primary balance is unchanged from 201425242718131197
A3. Permanently lower GDP growth 1/25242818131198
B. Bound tests
B1. Real GDP growth is at historical average minus one standard deviations in 2015–20252429191411108
B2. Primary balance is at historical average minus one standard deviations in 2015–201252428181311106
B3. Combination of B1-B2 using one half standard deviation shocks252428191311107
B4. One-time 30 percent real depreciation in 2015252634211512117
B5. 10 percent of GDP increase in other debt-creating flows in 2015252429181311106
Sources: Malawian authorities; and IMF staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.

Sources: Malawian authorities; and IMF staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.

Table 4a.Malawi: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2014–34(In percent)
Projections
20142015201620172018201920242034
PV of debt-to GDP ratio
Baseline322825201918146
A. Alternative Scenarios
A1. Key variables at their historical averages in 2014–2034 1/3233343131323635
A2. New public sector loans on less favorable terms in 2014–2034 23227242323232113
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2015–2016322926211918147
B2. Export value growth at historical average minus one standard deviation in 2015–2016 3/323030252222177
B3. US dollar GDP deflator at historical average minus one standard deviation in 2015–2016323538312727219
B4. Net non-debt creating flows at historical average minus one standard deviation in 2015–2016 4/323028232120156
B5. Combination of B1-B4 using one-half standard deviation shocks323542353231249
B6. One-time 30 percent nominal depreciation relative to the baseline in 2015 5/323934282524188
PV of debt-to-exports ratio
Baseline7975716054513917
A. Alternative Scenarios
A1. Key variables at their historical averages in 2014–2034 1/7987949089909997
A2. New public sector loans on less favorable terms in 2014–2034 27973676766645736
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2015–20167975696052503717
B2. Export value growth at historical average minus one standard deviation in 2015–2016 3/79851008979755522
B3. US dollar GDP deflator at historical average minus one standard deviation in 2015–20167975696052503717
B4. Net non-debt creating flows at historical average minus one standard deviation in 2015–2016 4/7980786961584318
B5. Combination of B1-B4 using one-half standard deviation shocks7980887870664819
B6. One-time 30 percent nominal depreciation relative to the baseline in 2015 5/7975696052503717
PV of debt-to-revenue ratio
Baseline120106937167644922
A. Alternative Scenarios
A1. Key variables at their historical averages in 2014–2034 1/120124124107111114124125
A2. New public sector loans on less favorable terms in 2014–2034 2120104887982817247
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2015–2016120109967469665023
B2. Export value growth at historical average minus one standard deviation in 2015–2016 3/1201121098782785824
B3. US dollar GDP deflator at historical average minus one standard deviation in 2015–2016120132139108100967234
B4. Net non-debt creating flows at historical average minus one standard deviation in 2015–2016 4/1201131038176735423
B5. Combination of B1-B4 using one-half standard deviation shocks1201341551241161118233
B6. One-time 30 percent nominal depreciation relative to the baseline in 2015 5/1201461249789866430
Table 4b.Malawi: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2014–34 (continued)(In percent)
Projections
20142015201620172018201920242034
Debt service-to-exports ratio
Baseline581384332
A. Alternative Scenarios
A1. Key variables at their historical averages in 2014–2034 1/5916116468
A2. New public sector loans on less favorable terms in 2014–2034 258444343
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2015–2016581384332
B2. Export value growth at historical average minus one standard deviation in 2015–2016 3/5916105453
B3. US dollar GDP deflator at historical average minus one standard deviation in 2015–2016581384332
B4. Net non-debt creating flows at historical average minus one standard deviation in 2015–2016 4/581384342
B5. Combination of B1-B4 using one-half standard deviation shocks581494353
B6. One-time 30 percent nominal depreciation relative to the baseline in 2015 5/581384332
Debt service-to-revenue ratio
Baseline71117105443
A. Alternative Scenarios
A1. Key variables at their historical averages in 2014–2034 1/712211376811
A2. New public sector loans on less favorable terms in 2014–2034 2711655444
B. Bound Tests
B1. Real GDP growth at historical average minus one standard deviation in 2015–201671218105443
B2. Export value growth at historical average minus one standard deviation in 2015–2016 3/71117105453
B3. US dollar GDP deflator at historical average minus one standard deviation in 2015–201671427158674
B4. Net non-debt creating flows at historical average minus one standard deviation in 2015–2016 4/71117105453
B5. Combination of B1-B4 using one-half standard deviation shocks71324147685
B6. One-time 30 percent nominal depreciation relative to the baseline in 2015 5/71624137564
Memorandum item:
Grant element assumed on residual financing (i.e., financing required above baseline) 6/3737373737373737
Sources: Malawian authorities; and IMF staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assu an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Sources: Malawian authorities; and IMF staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assu an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Stress Tests

11. Standard stress tests indicate that a somewhat weaker debt outcome is possible under certain conditions (Figure 1). Specifically, the present value of debt to GDP ratio remains above its indicative threshold when key variables are kept at their historical levels. This behavior is mostly due to the inclusion of 2012 in the historical period, which effectively allows the exchange rate depreciation in that year to continue to impact nominal GDP in U.S. dollars. The staff considers this to be an unlikely outcome due to authorities’ actions to reduce fiscal dominance.

Figure 1.Malawi: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2014–34

Sources: Malawian authorities; and IMF staff estimates and projections.

1/ The most extreme stress test is the test that yields the highest ratio on or before 2024. In figure b. it corresponds to a Combination shock; in c. to a Exports shock; in d. to a Combination shock; in e. to a Exports shock and in figure f. to a GDP deflator shock

Public Debt Sustainability

12. Total public debt has increased substantially and, in present value terms, stands seventeen percentage points of GDP higher than the recommended benchmark. Domestic debt has expanded in recent years, in part to cover for the decline in traditional budget support from development partners, but also due to weaknesses in public financial management that gave rise to arrears and budget overruns.5 By 2013 the present value of total public debt stood at 55.9 percent of GDP, and is expected to peak at 60.7 percent by the end of 2014, partly due to new uncovered arrears (157 billion KW), and in part due to issuance of securities to recapitalize the central bank (29 billion KW). The strong PFM reforms, monetary and fiscal policies envisioned in the present ECF program should contribute towards restoring donor confidence (and bring back external financing), and keeping expenditures within the available fiscal envelope. Domestic debt as a share of GDP is set to decline with fiscal consolidation and the maintenance of a positive primary balance. Standard stress tests suggest that the debt dynamics would deteriorate relative to the baseline (Figure 2 and Table 2). The strongest impact on the indicators arises from a one-time real depreciation shock—again through compression of nominal GDP in U.S. dollars—and an export shock, which is illustrative of the risk inherent in the undiversified nature of Malawi’s sources of foreign exchange.6

Figure 2.Malawi: Indicators of Public Debt under Alternative Scenarios, 2014–34

Sources: Malawian authorities; and IMF staff estimates and projections.

1/ The most extreme stress test is the test that yields the highest ratio on or before 2024.

2/ Revenues are defined inclusive of grants.

13. External financing risks exist, but are projected to be addressed by additional fiscal restraint and so should not have an impact on debt. Budget financing needs required, as in FY2013/2014, an expansion of domestic debt for fiscal year 2014/2015. Fiscal tightening is expected to be the policy response to unexpected negative financing shocks (either from delayed or lower donor support, or lower tax revenue). Additional domestic borrowing would bring additional pressures on the exchange rate and erode perceptions of government commitment to policy reforms, ultimately damaging macroeconomic performance and should be avoided. The authorities should look for additional cuts in domestically financed development expenditure and in goods and services to meet additional shortfalls in external financing. Risks to this include the delicate balance of maintaining macroeconomic stability, versus maintaining core public services–especially for the poor–should government struggle to raise sufficient domestic revenue and/or fail to see a resumption of budget support. Similarly, the government may have to continue confronting political economy challenges of reducing expenditure in politically charged areas, such as fertilizer subsidies, wages and salaries, etc.

14. Malawi’s external public debt remains at moderate risk of debt distress. However, rapid accumulation of debt and deterioration in the strength of the policy and institutional framework (as measured by the CPIA score) urge prudent debt management policies to guarantee the sustainability of debt.

15. Authorities’ views. The authorities recognized that Malawi’s external public debt to GDP ratio has been growing and is expected to reach 32.2 percent of GDP in net present value terms at end-2014. Nonetheless, they noted that this is not expected to worsen the debt dynamics significantly, as external public debt remains mostly concessional. They pointed out that external public debt service burden remains low, with a debt service ratio in 2014 of only 4.7 percent of exports of goods and services. However, they acknowledged that domestic debt burden is becoming more worrisome and that domestic debt accumulation increased, in part, due to the fact that the “cashgate” scandal resulted in annual shortfalls in external disbursements amounting to almost 6.6 percent of GDP. Furthermore, the authorities noted that their PFM systems proved too weak to enforce the discipline needed to follow the adjustment path agreed under the program. By the end of the 2013/14 fiscal year, domestic financing had increased to about 6 percent of GDP. The authorities emphasized efforts to regularize these and additional payment arrears accumulated from previous years and reforms geared towards strengthening commitment controls.

16. The authorities viewed 2015 as a year to consolidate debt and lay the groundwork for a period of sustained noninflationary growth. In this regard, they envisaged real growth in 2015 to reach 5.5 percent (one percentage point lower than anticipated in the December 2013 MEFP) and 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 restraint and a reliance on concessional foreign borrowing for the majority of financing needs will allow some reduction in the stock of domestic debt relative to GDP to take place. Strong debt management in the near-to medium term will be implemented to ensure that debt is sustainable and the right balance of costs and risks is achieved. They underscored that improvements in debt management would be achieved by resuscitating the Debt Management Committee whose membership will be at senior level, which will look at each borrowing, to ascertain its concessionality and to insure debt sustainability. They reaffirmed their commitment to implementing the Debt Management Reform Programme, that was agreed with IMF and World Bank that is aimed at strengthening the debt management capacity of the Debt and Aid Management Division.

Conclusions

17. Malawi’s debt situation remains at a moderate risk of distress, based on an assessment of external public debt, but with a heightened overall risk of debt distress, reflecting significant vulnerabilities related to domestic debt. Risk of export related shocks remains, given Malawi’s limited sources of foreign exchange and reliance on rain-fed agriculture. Additional risks include the loosening of policies as a response to the decline in the volume of donor support, which could further erode donor confidence and jeopardize the resumption of aid. Risks of negative financing shocks in the form of 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. Recent events point to the need for taking steps to arrest the decline in the quality of institutions (as reflected in the CPIA score), to ensure capacity to manage the debt load of the country.

The new thresholds for the 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); and 200 percent as a ratio to revenue (down from 250 percent). Similarly, the thresholds for debt service indicators changed from: 20 to 15 percent, as a ratio to exports, and from 20 to 18 percent as a ratio to revenue.

The year-on-year Kwacha-Dollar exchange rate depreciated by about 30% in 2013. External debt is converted in Kwacha using end of period exchange rate, which was about 15% higher than the average exchange rate.

The DSA template employs end of period exchange rate to compute present value of flows of debt service. Of course, not all debt service occurs at the end of the period. In times with sharp exchange rate movements, this artificially inflates external debt indicators. Indeed, Figure A2 shows if one used average exchange rates the threshold for PV of PPG external debt would not be breached.

It is important to note that restructuring of debt is not subject to the zero-limit on non concessional external debt.

It is important to note that, relative to the previous DSA for Malawi, the current analysis reflects bringing a large amount of arrears that were previously off-budget on to the budget through securitization.

In this analysis, the combination bound test B5 (Tables 4a and b) was modified to exclude the non-debt creating flows component. This component was removed as Malawi lacks the access to capital markets required to replace lost grants and foreign investment with borrowing, and would instead be forced to respond with expenditure and import compression.

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