Abstract
In recent years, the IMF has released a growing number of reports and other documents covering economic and financial developments and trends in member countries. Each report, prepared by a staff team after discussions with government officials, is published at the option of the member country.
Malawi’s performance under the SMP has been strong, supported by the implementation of prudent fiscal and monetary policies. All quantitative targets were met and implementation of structural reforms has improved significantly. The authorities are committed to sound economic and financial policies and a policy of zero tolerance against corruption. They request the support of the Executive Board for a three-year PRGF arrangement, as well as additional interim assistance under the HIPC Initiative.
The overarching objectives of the authorities’ medium-term program, which is in line with their poverty reduction strategy and the recommendations of the EPA, is to reduce poverty by fostering an environment conducive to private–sector-led growth.
The major objective of fiscal policy during the program period will be domestic debt reduction to lower interest rates, debt service costs and create fiscal space for pro-poor expenditure to improve chances of reaching the MDGs by 2015. Efforts will be enhanced to strengthen public expenditure management and tax administration during the medium-term.
Under the new program, the independence of the central bank will be strengthened, monetary policy will be targeted to low and stable inflation, the exchange rate will be fully market determined and reserves increased close to three months of import cover.
The authorities are committed to creating an environment conducive for private-sector-led development. They have revised their privatization master plan, which includes full privatization of many state owned enterprises, and closure of some, promotion of public-private partnerships and mergers, and commercialization.
The trade regime will continue to be liberalized, and regional integration will be enhanced. Efforts to support diversification of the economy will continue, with medium-term agricultural policies to ensure food security for all Malawians.
Introduction
1. The Malawian authorities appreciate the candid exchange of views during discussions of their performance under the staff-monitored program (SMP) and an economic program for 2005-08 to be supported under a new PRGF arrangement. They agree with the thrust of the staff assessment, which gives a fair account of recent economic developments in Malawi and the challenges ahead. The authorities request the support of Executive Directors for a new PRGF-supported program and additional interim assistance under the HIPC Initiative.
2. Malawi’s performance under the SMP has been strong; a performance that is attributed to the implementation of prudent fiscal and monetary policies reflecting the authorities’ renewed commitment to macroeconomic stability. All quantitative targets were observed, and implementation of structural reforms has improved significantly, reflecting renewed commitment and the formulation of more realistic program objectives as recommended following the Ex-Post Assessment (EPA) of the Fund’s involvement in Malawi.
3. The authorities are determined to continue with good financial management and create an environment conducive to private sector development. In the short to medium term, the authorities are focusing on domestic debt repayment, strengthening of public expenditure management and procurement procedures, and private sector development. The authorities are fully committed to the steadfast implementation of these principles to assist them achieve the objectives set out in their Malawi Poverty Reduction Strategy of 2002.
Recent Economic Developments
4. Economic growth accelerated in 2004, following of a rebound in tobacco production. However, the prospects for 2005 have been dampened somewhat due to an early drought, which led to a decline of about 25 percent in maize harvest, causing a potential humanitarian crisis. Core inflation fell to 13¼ percent at end-2004 from over 20 percent at end of the previous year. The early drought in 2005 is expected to push food prices up temporarily later in the year. The real effective exchange rate remained stable since August 2003. The deficit on the external current account, however, widened during 2004, despite a large increase in tobacco production, as auction floor prices were lower than anticipated under the SMP and deliveries slowed down. Imports increased strongly in line with strong economic expansion, as well as on account of higher world petroleum and fertilizer prices. Nevertheless, the authorities managed to maintain the level of foreign reserve cover at 1.4 months of imports, but realize that this will have to be increased in the future.
The Medium-Term Reform Strategy
5. The overarching objective of the medium-term program is to reduce poverty by fostering an environment that is conducive to private-sector-led growth. The medium-term program is in line with Malawi’s poverty reduction strategy (MPRSP), the Ex-Post Assessment’s recommendations, and the experienced gained during implementation of the SMP. The approval of a new PRGF arrangement will help unlock the much needed donor support, including under the HIPC Initiative, to enable Malawi reach the MDGs by 2015.
Fiscal Policy
6. The most important objective of fiscal policy during the program period will be domestic debt reduction and improved fiscal management. Borrowing over the past several years has pushed their net debt to more than one-quarter of GDP. In this connection, the target is to reduce domestic debt to 15 percent of GDP or less by 2008. With these measures, it is expected that domestic debt service will fall to near 5 percent of GDP in 2005/06 from over 7 percent of GDP in 2004/05. External debt service, which is currently about 1½ percent of GDP, is expected to decline moderately upon reaching the completion point next year. This will also allow interest rates to decline in line with the improved track record of sound fiscal policies and an improvement in confidence. Over time, the authorities will aim to lengthen the maturity structure of debt stock, and make their budget more stable and predictable. The authorities are calling development partners to provide assistance with measures that will reduce their domestic debt, which is exerting a heavy fiscal burden to the government.
7. Efforts to strengthen public expenditure management will continue during implementation of the program, based on a two-pronged approach. In the near term, efforts will be increased to restore the management systems that have worked well, including accurate monthly expenditure returns, respect for funding ceilings, and the application of approved accounting standards. Over the medium term, the authorities will be implementing an integrated financial management system.
8. With regard to tax policies and tax administration, the authorities have recently completed a general review with the objective of making the system more competitive and business friendly. While they would like to reduce the overall tax burden, they realize that there is little room to do so now, given the current level of spending and their determination to lower the debt burden. Over the medium-term, efforts will be increased to rationalize and restructure government activities to make room for private sector growth.
Monetary and Exchange Policy
9. The authorities intend to further strengthen the independence of the Reserve Bank of Malawi in order to enhance credibility of monetary policies. The objective of monetary policy is to bring inflation to 5-8 percent range, over the medium-term. They believe that within this range, inflation would be less likely to distort saving and investment decisions. The Reserve Bank of Malawi will continue to target broad money stock as the nominal anchor to control inflation. It will use a combination of open market operations and foreign exchange sales to influence liquidity conditions.
10. With regard to the exchange rate system, the authorities remain committed to a fully market determined exchange rate. In this regard, they will continue to smoothen seasonal fluctuations of the exchange rate and refrain from attempting to influence its underlying value, recognizing that the most important ingredient for exchange rate stability is sound economic policies, especially prudent fiscal policy. They will strive to increase their level of international reserves to above three months of import cover.
Structural Reforms and Privatization
11. Malawi is fully committed to creating an environment for private sector development and privatization of some of the remaining state enterprises to bolster their efficiency, improve services and potentially provide revenue to government. The delay of privatization was necessary to assure Malawians that the sale of state owned enterprises is beneficial and less costly to the public and that resources will not be wasted. The Government has, however, revised their divesture master-plan, which makes provision for out-right sale of a number of state owned enterprises, closure of some; promotion of public-private partnerships and mergers, and commercialization of those state-owned enterprises where full privatization would lead to social concerns.
External Policies
12. The authorities are aware that heavy reliance on tobacco as the main export commodity leaves Malawi extremely vulnerable to external shocks and local weather conditions. In this connection, they have included in their growth strategy initiatives to bolster non-tobacco exports. A key element in the authorities’ diversification strategy is creating a liberal trade regime and regional integration. In this context, a revised Trade Agreement was signed with Zimbabwe in March 2005, while negotiations with COMESA and SADC to further trade liberalization are at an advanced stage. In addition, the authorities are studying the impact of the proposed COMESA Common External Tariff on industry competitiveness, revenue and employment.
13. The authorities are seriously concerned about the erosion of trade preferences on their diversification efforts. They see for example, the pending elimination of the EU sugar regime in 2008 could adversely impact on the second largest export of Malawi. Although textiles and clothing exports are of lesser importance, the authorities have been closely monitoring the expiration of the global quota restrictions on textiles and clothing in December 2004.
Food Security
14. The objective for food security policy is to ensure that all Malawians have sufficient food for healthy and active life. Unfortunately, the country’s dependency on rain-fed agriculture, with changing weather patterns, growing population, and the increased incidence of HIV/AIDS, have increased Malawi’s vulnerability to food insecurity. In going forward, the authorities’ medium-term agricultural policies will be based on market principles. In this connection, the authorities will continue to improve the functioning of markets, including removing practices that restrict free competition in produce, food and input markets. The strategy is to improve the availability of fertilizer and other inputs at reasonable market prices and on time to ensure farmers have easy access to markets for products. The authorities are also looking at ways to promote agricultural irrigation involving the private sector and local communities, better agricultural research and extension services, and transport and other infrastructure. They are also committed to ensuring that pubic resources to support the agricultural sector will be provided based on fiscal sustainability in the long term.
HIPC Completion Point
15. Malawi has a large unsustainable external debt burden that, in NPV terms at end-2004, exceeded 200 percent of exports. It will therefore be important for Malawi to reach completion point under the HIPC Initiative and lock in debt relief from creditors. The authorities are making strong efforts to meet the requirements for reaching this objective and anticipate that Malawi would be in a position to reach the completion point mid-2006.
Conclusion
16. In conclusion, the authorities appreciate the continued engagement by the Fund Management, which has been very fruitful. We want to reiterate the strong commitment of the authorities to reforms and to addressing the economic challenges facing Malawi. The authorities believe that as a result of continuing efforts they have demonstrated their commitment towards sound policies, and would like a stronger engagement with the Fund and the international community under a PRGF-supported program. They therefore look forward for a favorable consideration of their request by the Executive Board.