Malawi
Recent Economic Developments

This paper describes economic developments in Malawi during the 1990s. Malawi’s economy began to deteriorate in late 1991 as a result of a series of exogenous shocks. These shocks included two major droughts, a severe weakening in the terms of trade, and a suspension of donor nonhumanitarian aid owing to concern over governance. As a consequence, the average real GDP growth fell from 6 percent a year in 1989–91 to -3 percent a year in 1992–94. Savings and investment also fell considerably.

Abstract

This paper describes economic developments in Malawi during the 1990s. Malawi’s economy began to deteriorate in late 1991 as a result of a series of exogenous shocks. These shocks included two major droughts, a severe weakening in the terms of trade, and a suspension of donor nonhumanitarian aid owing to concern over governance. As a consequence, the average real GDP growth fell from 6 percent a year in 1989–91 to -3 percent a year in 1992–94. Savings and investment also fell considerably.

MALAWI - Basic Data

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Sources: Data provided by the Malawian authorities; and staff estimates.

Fiscal year beginning April 1.

Twelve-month change as percent of beginning period of money stock.

I. Introduction

After three years of good performance, Malawi’s economy began to deteriorate in late 1991 as a result of a series of exogenous shocks. These shocks included two major droughts, a severe weakening in the terms of trade, and a suspension of donor non-humanitarian aid due to concern over governance; as a consequence, the average real GDP growth fell from 6 percent a year in 1989-91 to minus 3 percent a year in 1992-94 (Chart 1). Savings and investment also fell considerably. At the same time, the improvement in the Government’s financial position that had taken place through 1991 was reversed, leading to a major expansion of liquidity and a progressive acceleration of inflation. The latter also reflected the effect on prices of food shortages caused by the recurrent droughts, the significant adjustments in administered prices, and a large depreciation of the Malawi kwacha, especially after the floatation of the currency in February 1994. As a result of the external shocks and inadequate policy adjustments, the external accounts deteriorated markedly.

CHART 1
CHART 1

MALAWI: SELECTED ECONOMIC INDICATORS, 1981-95

Citation: IMF Staff Country Reports 1996, 068; 10.5089/9781451827910.002.A001

Sources: Data provided by the Malawian authorities; and staff estimates.1/ Twelve-month change as percent of beginning-period broad money stock.2/ Fiscal year, beginning April 1 of previous year.

To address the increasingly deteriorating economic and financial conditions, the authorities adopted an adjustment program during 1994. However, their efforts were hampered by the unusually large magnitude of exogenous shocks, uncertainties related to the political transition to a multiparty system, as well as weak institutional capacity. In particular, in the run up to the first multiparty election in May 1994, there was a major breakdown of expenditure control, leading to an unprecedented increase in government outlays, including large wage increases for civil servants.

In early 1995, Malawi redoubled its efforts by adopting a comprehensive program that aimed at (a) a recovery in real GDP growth to an average of more than 4.5 percent a year during 1996-98; (b) a sharp deceleration in the rate of annual inflation, to 5 percent by the end of 1998; (c) a reduction in domestic and external imbalances to attain a more sustainable balance of payments position by 1998; and (d) the accommodation of pressing social needs within the constraint of fiscal sustainability. To achieve these objectives, the program included measures to attain a major fiscal adjustment and macroeconomic stabilization, and structural reforms in the area of civil service, privatization, agricultural production and marketing arrangements, and trade and exchange system.

Real GDP growth rebounded to 9 percent in 1995, reflecting better weather conditions as well as improved incentives in the agricultural area, particularly to smallholder farmers. There also were a sharp turnaround in the fiscal policy stance and a tightening of monetary conditions that resulted in a considerable improvement in the external position. Although inflation remained very high until January 1996, due mainly to increases in food prices as a result of a below average harvest and the liberalization of maize marketing, it decelerated considerably in February-April 1996.

Significant progress has also been made with respect to structural reforms. The liberalization of agricultural marketing in early 1995 was of particular significance as it included the elimination of the monopsony position of ADMARC in the market for smallholder production (maize, tobacco, etc.)- Civil service reforms gained momentum with the discharge of about 20,000 nonestablished civil servants during April-September 1995 and the completion of a civil service census in late 1995; the results of the census will serve as the basis for further reforms to restructure the civil service and the Government’s establishment. A legal and institutional framework was established for privatization, and the Government completed the preparation of a program to privatize/divest up to 90 public enterprises. Other structural reforms included the elimination of the fertilizer subsidy and the decontrol of fertilizer prices, the introduction of a book-entry system for treasury bills, the eliminations of various import and export licensing requirements, and the acceptance of the obligations of Article VIII of the Fund’s Articles of Agreements in December 1995.

II. The Domestic Economy

The Malawian economy is largely based on agriculture. This sector accounts for about 35 percent of GDP, employs over 80 percent of the labor force, and produces the bulk of the country’s exports. It had been characterized by a dual structure consisting of a few thousand commercially oriented estates and a large smallholder sector of nearly 2 million farmers who are mainly engaged in subsistence production, but over the past decade an intermediate subsector of about 30,000 to 40,000 commercially oriented smallholders has emerged. Maize, the staple food, accounts for 80 percent of the cultivated land in the smallholder sector. The main agricultural export crop is tobacco, followed by tea, sugar, and coffee.

The other key sectors in the economy are government services (13.7 percent of GDP in 1995), manufacturing (13.4 percent), and distribution (11.1 percent). Both manufacturing and distribution are closely linked to agriculture. Malawi is heavily dependent on foreign trade with the value of exports and imports on average exceeding 60 percent of the overall GDP during 1991-95.

1. Real sector developments

a. Production

After several years of steady growth, Malawi’s economy was affected by a series of droughts starting in late 1991. As a result, average real GDP growth fell from 6 percent a year in 1989-91 to minus 3 percent a year in 1992-94. With smallholder production accounting for a quarter of GDP, much of the change in real GDP during the period was accounted for by a fall in smallholder production that is particularly susceptible to weather fluctuations. In contrast, real growth in the estate sector, which accounts for about 10 percent of GDP, is less susceptible to changes in the weather conditions because of access to better land and inputs (Table 1).

Table 1.

Malawi: Gross Domestic Product by Economic Activity at Constant 1978 Factor Cost, 1991 – 95

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Source: Department of Economic Planning and Development; and staff estimates.

Including small scale manufacturing, construction and distribution.

Real GDP growth rose markedly in 1995 (9 percent) reflecting a recovery from the drought of the previous year as well as the supply response to improved incentives, particularly to smallholder farmers, that stemmed from the liberalization of agricultural production and marketing arrangements (see Section 2 below).

Sectors with links to agriculture, such as distribution, manufacturing, and transport and communication, have declined or stagnated over the period 1991-95, mainly on account of the drought. Distribution and transport and communication declined by 11-13 percent in real terms from 1991 to 1995, while manufacturing production was flat over the period. The only non-agricultural sector which recorded a significant increase in production was electricity and water which, measured at the 1978 constant prices, grew by an average of 6 percent a year during 1991-95.

Monetary GDP, which excludes smallholder agricultural output that is self-consumed, has risen as a share of overall GDP from 66.1 percent in 1980-85 to 69.1 percent in 1991-95 (Table 2). This development reflects the expansion of the non-agricultural sector, the increase in production by the estates, and the impact of the recent liberalization of agricultural marketing and production which has led smallholder farmers to raise their production of cash crops.

Table 2.

Malawi: Gross Domestic Product by Expenditure at Constant 1978 Market Prices, 1991 – 95

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Source: Department of Economic Planning and Development; and staff estimates.

Calculated as a residual

Smallholder production less ADMARC and private traders’ purchases.

GDP less nonmonetary consumption.

b. Saving and investment

National saving rates fell sharply, from an annual average of 13.2 percent of GDP in 1986-90 to 5.8 percent in 1991-94, as a result of the severe economic shocks and macroeconomic instability (Table 4). About two-thirds of this decline was due to a shift in public saving from 2.4 percent of GDP a year in 1986-90 to minus 2.7 percent a year in 1991-94 as a result of a major increase in current expenditure; average private saving declined from 10.8 percent of GDP to 8.5 percent of GDP during the period, reflecting the impact of droughts. Domestic saving, which excludes net factor income and net transfers, also showed a similar trend, falling from an average of 9.3 percent of GDP in 1986-90 to just over 1 percent in 1991-94. In contrast, foreign savings, defined as the current account including official transfers, increased from an average of 4.2 percent of GDP in 1986-90 to 10 percent of GDP in 1991-94.

Table 3.

Malawi: Gross Domestic Product by Expenditure at Current Market Prices, 1991 – 95

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Source: Department of Economic Planning and Development; and staff estimates.

Including drought–related free maize imports for 1992 through 1995 and excluding maize for refugees.

Smallholder production less ADMARC and private traders’ purchases.

GDP less nonmonetary consumption.

Table 4.

Malawi: Saving and Investment, 1991 – 95

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Source: Department of Economic Planning and Development; and staff estimates.

Including official transfers, drought related free maize & refugee maize.

With the recovery in economic activity in 1995, national savings are estimated to have risen from 4.0 percent of GDP in 1994 to 11.3 percent of GDP. Most of the increase in national savings came from an increase of domestic savings which rose from minus 2.4 percent of GDP in 1994 to 3.3 percent of GDP in 1995. The increase in domestic savings in turn was mainly attributable to an improvement in public savings from minus 6.9 percent of GDP in 1994 to 0.2 percent of GDP in 1995. The higher savings in 1995 have enabled domestic private investment to increase significantly.

Gross investment fell during 1991-94 from 20 percent of GDP in 1991 to 12-13 percent in 1993-94. While public investment remained fairly stable at around 8-9 percent of GDP over the period, private fixed capital formation had declined from 9 percent in 1991 to an average of 2 percent in 1993-94. The reasons behind this decline included the high interest rates for the non-food sectors of the economy (see Section V below), low investor confidence on account of macroeconomic instability, the recurrent drought, uncertainties during political transition to democracy, and other external shocks. This decline in investment has been reversed in the past year, with fixed capital formation rising from 11 percent of GDP in 1994 to 13.6 percent of GDP in 1995. Whereas public investment declined slightly, private investment rose significantly from 1.8 percent of GDP in 1994 to 4.7 percent of GDP in 1995.

2. Sectoral developments

a. Agriculture

In recent years, important progress has been made in liberalizing agricultural production and marketing as restrictions on smallholder production of certain cash crops and on private traders in crop marketing were increasingly relaxed. By 1995, all restrictions on the domestic trading of agricultural commodities were lifted, ADMARC’s monopsony position in the market for smallholder production was eliminated, and thus all agricultural output prices are now entirely market determined. With the removal of licensing requirements on exporting beans and groundnuts, all crops, except maize, can be freely exported.

In the case of maize, however, a price band of MK 1.25-2.5 per kilogram replaced the system of fixed producer and consumer prices in early 1995, and resulted in an initial increase of 74 percent in the producer price at the lower end of the band. Prices can move freely within this band. ADMARC’s role is to defend the floor and ceiling prices set by the Government. Thus, ADMARC has moved from being the sole player in the market for smallholder production to the buyer/seller of last resort.

In principle, under the Memorandum of Understanding agreed between the Government and ADMARC, the latter as a parastatal organization was supposed to be reimbursed by the Government for any financial losses incurred in defending the floor and the ceiling prices. In practice, the policy did not work as well as intended because ADMARC was asked to play a role incompatible with its own financial interests. Wary about financial losses (as it always occurred historically) and not being compensated by the Government, ADMARC did not use much of its financial resources on maize trading, nor did it move into the market in a timely fashion. As a result, a significant amount of maize was purchased by private traders during the early part of the 1995 marketing season at prices as low as MK 0.7-0.8 per kilogram, substantially below the floor price. Subsequently, ADMARC bought 86,000 metric tons of maize, compared with average purchases of 200,000 metric tons in previous years, but this amount was inadequate to stabilize the maize price during the post-season. Moreover, ADMARC was reluctant to adjust upward its selling price of MK 1.80 per kilogram even within the price band due to concern about political repercussions. As a result of these developments, half way into the post-season, the price of maize in some areas went as high as MK 7 per kilogram. Despite acute shortage in the market, ADMARC only started to sell meaningful amounts of maize after the Government decided to raise the maize price to the upper end of the price band (MK 2.5 per kg) in December 1995.

The market for inputs was liberalized in 1994, but private traders have held back because of the cumbersome licensing and approval procedures and high transaction costs. To improve farmer’s access to inputs and new technologies, the Government has removed the licensing requirement for importers and sellers of fertilizers, eliminated fertilizers subsidies, and relinquished control over introducing new seed varieties. Private traders are now free to trade in all seeds including hybrid maize and tobacco. In an effort to help peasant farmers to recover from the droughts, the Government has, with assistance from donors, implemented an agricultural inputs program. During 1994/95, 23,000 metric tons of fertilizer and 3,500 metric tons of hybrid seed were distributed free of charge to some 730,000 households. This program is estimated to have increased maize production by some 200,000 metric tons in that year.

The production and marketing of tobacco, Malawi’s main export commodity, has also undergone some major changes. In the 1993/94 season, tobacco sales at the auction floors were conducted in U.S. dollars following the floatation of the kwacha in February 1994. With the depreciation of the Malawi kwacha and the effect of higher world prices, the average tobacco auction prices in local currency in 1995 more than tripled from their levels in 1991. This development was also aided by the decision in early 1995 to use the Reserve Bank of Malawi dollar/kwacha exchange rate, displayed daily at the tobacco auction sites. In February 1995, smallholders were permitted to sell their tobacco on the auction floor or to private traders in competition with ADMARC. In the past few years, the Government has expanded the smallholder burley tobacco quota system and intermediate buyers program.

Notwithstanding the above agricultural liberalization measures, due to poor infrastructure and high transportation costs in the remote areas in the countryside, there was concern that private traders may not move into these regions. Thus, in the foreseeable future it is likely that ADMARC will continue to play an important, albeit declining, role in distributing agricultural inputs as well as marketing smallholder production.

Overall, farmers, particularly smallholders, have benefitted from these reforms through diversification into other agricultural and non-agricultural activities and a reduced vulnerability to the effects of drought, especially with the increased (but still limited) use of hybrid seeds. Smallholder production of cash crops has increased significantly in response to the removal of production restrictions (Table 5). All this has led to an improvement in their household incomes. Another visible result of these reforms has been the increased presence of private traders, including in the market for maize which previously was dominated by ADMARC. Instead of selling and buying directly from ADMARC like in the past, farmers are holding on to more of their own stocks for future consumption and selling more to private traders. While the market for maize is still thin, as indicated by the large margin between producer and consumer prices, it is expected to develop rapidly with new entrants.

Table 5.

Malawi: Agricultural Production by Principal Crops, 1991–95

(In thousands of metric tons)

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Sources: National Statistical Office, Monthly Statistical Bulletin: and data provided by the Malawian authorities.

The production of maize experienced major shortfalls in three out of the five-year period 1990/91 - 1994/95 on account of the recurring drought. In 1991/92, smallholder production of maize fell by 60 percent to 657,000 metric tons as a result of a major drought; with the above normal rainfall in the following year, it recovered to a record high of 2,034,000 metric tons but fell again in 1993/94 to 817,000 metric tons. In 1994/95, improved weather conditions helped the production to rise to 1,328,000 metric tons, although still below its normal level of 1.5-1.6 million metric tons because weather conditions had not returned to normal. The increase in smallholder sector output in 1994/95 also reflected the benefits of a free inputs program that was implemented with donors assistance to help alleviate the impacts of the drought.

These large fluctuations in maize production reveal the vulnerability of smallholder farmers to droughts. The large share of the low yielding and drought sensitive maize grown, the limited use of fertilizers, and poor irrigation facilities have rendered small farmers extremely vulnerable to adverse weather conditions. Hybrid maize, which is high yielding and more drought resistant, accounts for only 28 percent of the maize planted in Malawi, even after including the large estates, which use this type of seed more intensively than smallholders. As the smallholder farmers increase their production of cash crops, receive more income, and have more access to credit (see Section V), they will be able to afford more fertilizer, hybrid maize seeds, and better irrigation facilities. This would reduce their vulnerability to drought and raise their yields which currently are below the rest of the region.

Tobacco is the main export commodity of Malawi, accounting for over 70 percent of the country’s exports. Mainly in response to the liberalization of the burley tobacco quota system and higher prices, smallholder production of tobacco has risen rapidly, from 18,700 metric tons in 1991 to an estimated 35,400 metric tons in 1995. The composition of smallholder tobacco production has also changed significantly, as farmers shifted away from the less profitable types of tobacco—such as flue cure—to burley tobacco. As shown in Table 5, the marketed production of burley tobacco has risen significantly from 70,100 metric tons in 1991 to 101,000 metric tons in 1995, while that of other types of tobacco has remained steady or has even fallen. Estate tobacco production has shown signs of decline in recent years as it became more profitable for estates to lease land to smallholder farmers while concentrating on tobacco marketing.

Tea is Malawi’s second largest export commodity and is produced mainly by the estate sector. Tea production has fluctuated widely due to the drought conditions. The marketed production of tea fell 31 percent to 28,100 metric tons in 1992 on account of the drought, recovered to 40,000 metric tons in 1993, but fell again, to 30,000-35,000 metric tons in 1994-95. Sugar is produced by only two estates: SUCOMA and Dwangwa. Except for a poor crop in 1993, sugar production has increased from 191,100 metric tons in 1991 to 224,000 metric tons in 1995, mainly because it is grown on irrigated land. In September 1994, domestic sugar prices were liberalized helping make sugar more readily available in the markets. In 1995, the LONHRO Sugar Corporation started to encourage smallholder farmers to produce sugar by providing them with irrigated land, and as a result, smallholder farmers produced 60,000 tons of sugar cane. Sugar exports received a boost in 1995, when the United States renewed its quota of 13,000 metric tons and Portugal established a new quota allocation of 16,500 metric tons—the second largest quota from the European Union.

Cotton is grown by smallholders and is an important input for the textile industry. Cotton production fell sharply in 1994 due to decreases in planted acreage and yield. Smallholder farmers have been shifting away from cotton production as a result of a fall in cotton prices and in ADMARC guaranteed purchases. Except for 1992, smallholder production of groundnuts has remained at around 30,000 metric tons a year.

b. Industrial production

Industry in Malawi is made up mainly of the processing of agricultural produce, textiles, building and construction materials, and electricity and water. About 85 percent of industrial activity is accounted for by manufacturing, and nearly a quarter of industrial output is exported.

Industrial production in Malawi has stagnated over the period 1991 to 1995. The total index of industrial production declined from 138.6 in 1991 to an estimated level of 125.4 in 1995 (Table 7). Growth in manufacturing production has been stagnant in recent years due to foreign exchange constraints, increasing competition from imports as a result of lower tariffs, and the disruption of transportation routes. In addition, high inflation, limited access to land for industrial uses, delays in government approval of projects, and the high level of economic concentration have contributed to inefficiencies and slow industrial growth.

Table 6.

Malawi: Average Auction Prices for Tobacco and Tea, 1991–95

(In Malawi kwacha per metric ton)

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Sources: National Statistical Office, Monthly Statistical Bulletin; data provided by the Malawian authorities: and staff estimates.

Weighted average of auction prices in Lilongwe and Limbe.

Weighted average of London auction prices for Malawian tea.

Table 7.

Malawi: Index of Industrial Production, 1991–95 1/

(1984=100)

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Sources: National Statistical Office, Monthly Statistical Bulletin; and data provided by the Malawian authorities.

The index is based on the monthly production of about 50 firms, each with more than 100 employees. These firms account for approximately 75 percent of the net output of all manufacturing firms with 20 or more employees, and for over 60 percent of the net output of the manufacturing sector.

Based on data for January to October.

Total manufacturing output shrank by 14 percent as most domestic manufactured goods registered a decline during 1991-95. In particular, building and construction fell by over 30 percent over the period, and the production of footwear, clothing and textiles shrank by about 50 percent, mainly due to strong competition from the market for second hand clothing. With the exception of the two drought years 1992 and 1994, exports of manufactured goods have remained virtually unchanged.

Electricity and water were the only other industrial outputs to have expanded during 1991-1995, by an average of 4 percent growth a year. 1/ This increase reflects the growing coverage of electricity services and the expansion program being carried out by the Blantyre and Lilongwe Water Boards to meet the growing demand for water in the cities.

c. Transportation

Malawi’s heavy dependence on neighboring countries for access to sea ports has been a major constraint on economic growth. The most direct routes to the sea via Beira and Nacala have been interrupted since the late 1970s by the civil war in Mozambique; they were closed completely in 1985 and were reopened with limited service in 1989. As a result, much of Malawi’s trade was diverted to Durban (South Africa) and Dar Es Salaam (Tanzania). This diversion of traffic increased significantly the transport distances (to 1,789 km and 2,667 km, respectively) and raised the transport costs to an estimated 40 percent of total import costs compared with 25 percent when the Nacala and Beira lines were fully operational.

However, this trade diversion is being reversed with peace in Mozambique and the joint efforts with Malawi to rehabilitate the Nacala railroad. The poor condition of the 77 km Mozambique section of the Nacala corridor between Entralagos and Cuamba represents a major bottleneck for this route. Malawi Railways, the state owned public enterprise managing the country’s railways, has worked with the Mozambican authorities on the rehabilitation of this key section and, as a result of the improvements, the trip time from Blantyre to Nacala has been cut down by more than a half—to 30 hours—in 1995. There have also been discussions on extending the Nacala line westward across Malawi to the Tete region in Mozambique to exploit the mineral resources that have been discovered; such a development would significantly improve this railway.

3. Employment and prices

a. Employment

Data on wages and employment are limited and outdated, with the last employment survey done in 1992. From 1990 to 1992, formal employment increased steadily, with the ratio between the private and government sectors being roughly four to one. 1/ Agriculture, forestry and fishing remained the dominant employment sector accounting for around 50 percent of total formal employment. Manufacturing recorded steady growth in the number of paid employees during 1990-92, and accounted for 13 percent of employment. However, wholesale and retail trade, and hotels and restaurants registered a drop in paid employment over that period.

b. Prices

The National Statistics Office (NSO) compiles a monthly consumer price index (CPI) which is based on the retail prices of six categories of goods from both urban and rural areas. The weights are based on a household expenditure survey conducted every five years, with the last one in 1991/92. Food is the largest component of the CPI (55.5 percent), clothing and footwear is the next largest (11.7 percent); other components include housing (9.6 percent), household operation (8.4 percent), transport (6.5 percent), miscellaneous items (5.6 percent), and beverages and tobacco (2.7 percent).

Inflation has increased sharply over the past five years, rising from an annual average of 8.2 percent in 1991 to 83.1 percent in 1995 (Table 8). A close look at the breakdown of the composite price index reveals that the rate of increases in food prices was consistently higher than that in nonfood prices. The 12-month inflation rate at December 1994 was 75 percent for food and 52 percent for nonfood items; they were 89 percent and 51 percent, respectively, at December 1995.

Table 8.

Malawi: National Consumer Price Index, 1991 – 95

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Sources: National Statistical Office, Monthly Statistical Bullentin; data provided by the Malawian authorities; and staff estimates.

The main reasons behind this surge in inflation were the scarcity in food supply caused by the recurring droughts and the excessive liquidity expansion associated with large expenditure overruns and large fiscal deficits, particularly during the run-up to the first multi-party elections in 1994. The depreciation of the Kwacha during 1994 and large adjustments in administered prices, including those of petroleum, fertilizer, electricity, and water, also contributed significantly to recorded inflation. From end-1993 to end-1994, the nominal exchange rate depreciated by 70 percent from MK 4.9 per U.S. dollar to MK 15.3 per U.S. dollar. In January 1995, all fuel subsidies were removed, and prices were increased as follows: petrol (27.5 percent, after a 67 percent increase in December 1994), diesel (85.3 percent), and kerosene (131 percent). In August 1995, fertilizer prices were raised by 170 percent to 300 percent as a result of the removal of the subsidy and the increase in the international price of urea. There also have been several tariff rate increases on electricity and water: in 1995, ESCOM raised electricity rates twice, by 40 percent in January and 45 percent in July; the Blantyre Water Board also raised their tariff rates by 40 percent and 30 percent in July and December 1995, respectively.

Although tightened financial policies helped bring down inflation from a monthly high of 11 percent in October 1994 to 1.5 percent in August 1995, inflation rebounded beginning in September, mainly due to increases in food prices following the liberalization of maize marketing and the impact of maize shortages. By end 1995, the 12-month inflation rate reached 75 percent. Inflation in 1995 may have been overstated because of a bias in the way the National Statistics Office of Malawi (NSO) calculates the CPI. A closer look at the data reveals that most of the increase in inflation in the latter part of 1995 was due to the rise in food prices, in particular for maize which makes up about 28 percent of the CPI basket of goods. The CPI, as compiled by the NSO, includes maize prices from a handful of regional markets in which prices rose rapidly, but excludes official maize sold by ADMARC which accounted for a majority of the maize traded in the country. Starting around September 1995, the retail price for maize jumped markedly in several regional markets reflecting the perceived scarcity of grain. For example, in the northern rural region, the average maize price jumped from MK 1.40 per kg in July 1995 to MK 4.14 per kg in December 1995—an increase of 195 percent—while the ADMARC price rose from MK 1.8 per kg to MK 2.5 per kg early December.

With good harvest expected in Malawi as well as in the region in 1996, maize prices are projected to fall significantly during the course of the year. Indeed, the monthly consumer price inflation fell sharply to an average of 1.4 percent during February-April 1996, largely on account of a slowdown in the increase of the price of maize.

III. Public Finances

1. The structure of the government budget

The Central Government in Malawi is defined as those government units covered by the general budget, which include the Presidency, the National Assembly, Judiciary, Office of the President and Cabinet, and ministries and departments. The budget is divided into two parts—recurrent and development expenditure; the fiscal year runs from April 1 to March 31. All tax and nontax revenue and the balance of payments grant receipts are registered in the revenue account, which is used to finance the recurrent expenditure that supports the ongoing administrative and other functions of the Government. The Ministry of Economic Planning and Development (EP&D) coordinates and formulates the development budget. Outlays for development expenditure, mostly capital expenditure and net lending, are financed from the Development Fund, which comprises a budget allocation, proceeds from project-related foreign grants, short-term loans, and long-term borrowing. All expenditure and revenue require parliamentary approval except for statutory expenditure, which includes public debt service, pensions, and the salaries of the President and the Judiciary.

2. Overall fiscal developments during 1991/92-1995/96

After sustained improvement during the five-year period through 1991/92, the government financial position deteriorated considerably during 1992/93-1994/95, with the budget deficit before grants rising sharply from 6.3 percent of GDP in 1991/92 to 14.4 percent in 1992/93 and further to an average of over 16 percent during 1993/94-1994/95 (Table 9). While major recurrent droughts were the main reason for the worsening of public finances, inadequate expenditure control and lower tax collections, due to both lower tax rates and weak tax administration, were also important contributing factors. With improved revenue collection and, more importantly, major effort to cut and control expenditure, the fiscal deficit after grants improved markedly in 1995 to 5.7 percent of GDP.

Table 9.

Malawi: Central Government Operations, 1991/92–1995/96 1/

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Sources: Ministry of Finance; and staff estimates and projections.

Fiscal year is April/March.

For 1995/96, includes pension and gratuities payments, expenditures on maize marketing and agricultural inputs program.

For 1995/96, includes maize imports and expenditures on fertilizer stocks replenishment.

Statistical discrepancy between fiscal and monetary accounts. For 1992/93, includes some extra budgetary outlays on maize operation.

As illustrated in Table 9, the deterioration in public finances in 1992/93 was primarily due to an increase in expenditure. Whereas revenue and grants declined slightly, expenditure increased by over 7.5 percentage points of GDP, much of which were drought-related outlays in connection with the government’s efforts to deal with the major drought in 1991/92. During the same period, there were major social-political unrests in the form of demonstrations and strikes, leading to a 68 percent wage increase for the civil service. In the absence of an effective expenditure system, large unidentified expenditure also emerged. Furthermore, due to donors’ concerns with governance, all non-humanitarian balance of payments assistance support was cut off in May 1992. Consequently, the fiscal deficit after grants rose from 3 percent of GDP in 1991/92 to 12 percent in 1992/93, resulting in large bank financing and rapid growth in liquidity.

With improved weather conditions in the 1992/93 crop season, the fiscal conditions improved markedly in 1993/94. Despite a continued drop in domestic revenue, the budget deficit before grants fell to 8.4 percent of GDP in 1993/94, largely reflecting a reduction of drought-related outlays equivalent to some 5 percentage points of GDP. Development expenditure also declined significantly, along with other recurrent spending and the civil service wage bill. A tightening in expenditure control also helped reduce unidentified expenditure. The improved fiscal conditions, together with an increase in donor balance of payments support, allowed the Government to repay the banking system the equivalent of 1.5 percentage points of GDP in 1993/94.

However, the improvement in budgetary conditions was short-lived. Toward the end of 1993/94 and in the period leading up to the elections in May 1994, political pressures, exacerbated by yet another drought, led to a major breakdown in expenditure control. Unprecedented growth in spending during the first quarter of 1994/95 (April/June) alone contributed to bank financing of MK 670 million (4.9 percent of GDP). In light of the rapidly deteriorating financial conditions, the new Government, which took office in late May, put together an adjustment program to enhance revenue collection, reduce expenditure, and improve expenditure control.

Despite these efforts, the intended fiscal adjustment did not materialize mainly due to difficulties in customs collection and expenditure control. Revenue continued its downward trend, falling to just over 16 percent of GDP in 1994/95, owing to inadequate collection of domestic tax and nontax revenue and a major shortfall of customs duties and import surtax. 1/ Meanwhile, expenditure reached an unprecedented 42.3 percent of GDP, exceeding the level in the previous year by a large margin in every category. As a result, the deficit before grants rose to almost 26 percent of GDP in 1994/95 and the deficit after grants to 15 percent. Despite generous donor support, both in terms of grants and loan financing, total domestic borrowing by the Government rose to 7.5 percent of GDP.

Faced with a continued deterioration in public finances, the Malawi Government redoubled its efforts in early 1995, by adopting strong remedial measures in the context of the 1995/96 budget, including new revenue measures yielding up to 3 percent of GDP and considerable steps to strengthen expenditure control. Important measures were also taken to improve tax administration such as a major program to reform the customs and excise department that was assisted by an IMF long-term customs advisor. More significant, however, were the implementation of a cash budget system and the introduction of an improved local purchasing order (LPO) tracking system to ensure that the purchases of goods and services by ministries and departments were in line with their expenditure allocation.

As a result, fiscal performance improved considerably in 1995/96. With strong customs revenues and increased collection of company tax, non-PAYE individual income tax, and nontax fees and charges, revenue rose to more than 19 percent of GDP in 1995/96. At the same time, expenditure was contained within the targeted level, resulting in a reduction of the overall deficit before grants from 25.8 percent of GDP in 1994/95 to 14.2 percent in 1995/96. This, together with substantial donor grants, led to a decline in the deficit after grants from 15 percent of GDP in 1994/95 to 5.7 percent in 1995/96. However, due to a significant shortfall in external financing, recourse to domestic (nonbank) financing continued in a large scale. By the end of March 1996 domestic debt had increased to MK 3.9 billion, compared with MK 2.4 billion a year earlier. Measured as a percentage of GDP, however, it fell from 17.6 percent to 16.8 percent, reflecting a one-time increase in nonmonetary GDP that resulted from the one-off upward adjustment of the price of maize (about 80 percent of which is consumed in the subsistence sector) in the later part of 1995 and early 1996, following the liberalization of maize marketing.

3. Tax reform, tav administration, and revenue trend

a. Tax reform

The Malawi tax system has undergone continuous reform in the past decade. The Government’s goal is to create an efficient and equitable tax structure that is conducive to trade, investment, and growth, while maintaining adequate revenue levels. Major reforms in the second half of 1980s, effectively transformed the surtax to a value-added type of tax on manufactured and import goods.and rationalized some aspects of the income taxes on individuals and corporations. One salient feature of the reforms during 1990/91-1994/95 was a consistent reduction in tax rates, including those of the surtax, personal and corporate income taxes, and import duties.

In an attempt to offset the revenue impact of the above rate reductions, the Government of Malawi adopted measures to broaden the tax base. These measures included extending the surtax to certain services and some previously exempt raw materials, expanding dutiable import items to include jet fuel and other petroleum products, and including the fringe benefits as taxable income. In addition, the tax structure was rationalized by eliminating surtax suspensions, reducing the list of inputs which receive tax credit, and limiting the eligibility of bonded warehouses and the deductibility of income tax, all of which were easy targets for abuse. However, the above measures, were insufficient to offset the revenue impact of the reduction in the tax rates, and the expected improvement in tax administration did not materialize (see below). As a consequence, tax revenue as a percentage of GDP declined from 16.3 percent in 1991/92 to 14.7 percent in 1994/95.

Faced with sustained revenue losses, major tax policy changes were introduced in 1995/96 to boost revenue. The most important measures were the imposition of a temporary 10 percent levy on tobacco, sugar, and tea exports, an increase of corporate income tax from 35 percent to 38 percent, and a drought levy of 1-3 percent on personal income depending on the brackets (see Appendix). In addition, there were numerous adjustments of the surtax, excise tax and import duty rates, as well as adjustments of nontax fees and charges.

Malawi: Major tax reforms in 1990/91-1994/95

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Except for a few luxury items where the applicable rates remained at 40-45 percent.

b. Tax administration

In conjunction with the tax reforms during 1990/91-1994/95, measures were taken to improve the tax administration system and to strengthen procedures for revenue collection. As mentioned above, the tax structure was also rationalized to promote compliance. Despite these efforts, tax administration appeared to have weakened during the period. A low point was reached in 1994 when a major depreciation of the kwacha hardly had an impact on customs revenue because of significant undervaluation of imports, inadequate inspection and border patrol, lack of enforcement, as well as fraud and corruption.

Against this background, Malawi launched a major customs reform program in 1995/96, with assistance from the IMF, the UNDP, and ODA. The program included (i) a number of short-term revenue enhancement measures, such as disallowing installment and deferred payments, prohibiting standing delivery orders to eliminate the clearance of goods without presentation and payment of a bill of entry (except those specific cases defined in the Customs Act), and reconciliation between bill of entry and the Clean Report of Findings (CRF) issued by the preshipment inspection agency SGS; (ii) the strengthening of enforcement activities, such as using daily RBM exchange rates for valuation, closing down some of the large number of bonded warehouses, increasing penalties for noncompliance, improving refund surveillance and auditing, and removing corrupt officers; (iii) the introduction of an enhanced preshipment inspection scheme; (iv) the implementation of management information and revenue reporting systems; (v) a pilot project of an automated transit control system tracking goods transported in and out of Malawi; (vi) the initiation of an ASYCUDA system for import and export declaration processing; and (vii) a technical training program.

Significant progress has been made in implementing the above reform measures, which have resulted in a considerable improvement in revenue collection in the second half of 1995/96. Nevertheless, owing to lack of financial resources, inadequate physical infrastructure and staffing constraints, the overall capacity of the Customs and Excise Department and the Income Tax Department remains weak. In this regard, the Government has prepared an infrastructure strategy paper to revamp the organizational structure of the two tax collection departments and to upgrade the physical and human infrastructure. In addition, a feasibility study has been completed to establish an autonomous national revenue authority by 1997. The 1996/97 budget also allocated more funding to the Income Tax and the Customs and Excise Departments to allow better staffing, training, and equipment in order to increase their capacity to enforce tax compliance while reducing tax arrears, corruption, and fraud.

c. Revenue trend

Domestic revenue as a share of GDP declined steadily from 19.6 percent in 1990/91 to just over 16 percent in 1994/95. The decline is almost equally distributed between tax and nontax revenue. While personal income tax revenue remained relatively constant in terms of GDP, corporate tax revenue decreased considerably due to both a decline in the corporate income tax rate and generous tax concessions and deductions for certain types of investments (Table 10). Reversing the trend in the second half of the 1980s, taxes on goods and services also declined significantly as a result of the progressive reduction in surtax rates, which was only partially offset by a modest expansion of tax base. Despite year-to-year fluctuations in line with import levels, import duties had been largely stable at around 3-3.5 percent of GDP. With regard to nontax revenue, most of the decline was due to a reduction in departmental receipts, such as fees and charges, whose values were eroded by high inflation.

Table 10.

Malawi: Central Government Revenue, 1991/92–1994/95

(In millions of Malawi kwacha)

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Source: Ministry of Finance; and staff estimates.

Pay-as-you-earn deductions.