Malawi
Request for a One-Year Exogenous Shocks Facility Arrangement: Staff Report; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Malawi
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International Monetary Fund
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Publication Date:
21 Jan 2009
eISBN:
9781451828207
Language:
English
Keywords:
ISCR; CR; fertilizer price; Malawi; IMF's executive board; government; IMF staff estimate; TOT shock; food price inflation; June fuel price increase; TOT worsening; International reserves; Foreign assets; Global; financial support
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This paper discusses a request from Malawi for a one-year exogenous shocks facility (ESF) arrangement to help it adjust to the large terms-of-trade shock it has suffered. Real GDP growth of Malawi has been high and is expected to remain solid. Inflation, though rising in recent months, is still moderate and is expected to ease over the medium term. The government’s near-term program aims to increase the import coverage of official gross reserves while preserving growth and food security. IMF staff supports the authorities’ request for a one-year high-access ESF arrangement.

Abstract

This paper discusses a request from Malawi for a one-year exogenous shocks facility (ESF) arrangement to help it adjust to the large terms-of-trade shock it has suffered. Real GDP growth of Malawi has been high and is expected to remain solid. Inflation, though rising in recent months, is still moderate and is expected to ease over the medium term. The government’s near-term program aims to increase the import coverage of official gross reserves while preserving growth and food security. IMF staff supports the authorities’ request for a one-year high-access ESF arrangement.

I. Background

A. Retrospective: A Successful PRGF-Supported Program but Minimal Reserves

1. Policy implementation during the 2005–08 PRGF arrangement constituted a sharp break from past performance. In the first part of the decade poor program implementation led to large fiscal slippages, an unsustainable domestic debt spiral, and low investment. Despite numerous attempts to bring the 2000–03 PRGF arrangement back on track, the economy remained in disarray, so the arrangement lapsed with only one review completed. The government that took office in mid-2004 has greatly improved economic policy.

2. The objectives of the PRGF arrangement were achieved except for the international reserve target. The main factors behind the low international reserve coverage were much higher imports than projected, large cumulative terms of trade declines, and less budget support than expected (Figure 1). Over-borrowing relative to the initial fiscal targets was a contributing factor.1 A lack of flexibility in the exchange rate interacted with these factors by pushing the burden of adjustment on to reserves. International reserves are too low considering Malawi’s vulnerabilities to weather, terms of trade (TOT), and aid shocks. At just over one month of prospective imports or 6.1 percent of GDP, Malawi’s reserves are among the lowest in Africa.

Figure 1.
Figure 1.

Malawi: External Developments, 2001–08

Citation: IMF Staff Country Reports 2009, 016; 10.5089/9781451828207.002.A001

Sources: Malawi authorities and IMF staff estimates.

Malawi: Initial Program Targets1 and Outcome 2005/06–07/08

article image
Source: Malawi authorities and staff estimates.

As of the time of the request for the three-year Poverty Reduction and Growth Reduction Facility (IMF Country Report No. 05/285).

B. Recent Developments: A Severe Terms of Trade Shock

3. Although Malawi’s macroeconomic performance remains generally strong, the economy is feeling the impact of higher import prices.

  • Real GDP growth is still high and inflation moderate, though rising. Consumer prices increased by 9.3 percent in the 12 months to September 2008, largely because of a 25 percent increase in fuel prices in June 2008 (Figure 2). Food price inflation continues to be subdued, though domestic maize prices reportedly shot up in some areas in the first half of 2008.

Figure 2.
Figure 2.

Malawi: Consumer Price Inflation 2003–08

(12-month percent change)

Citation: IMF Staff Country Reports 2009, 016; 10.5089/9781451828207.002.A001

  • The TOT deteriorated significantly in 2008, despite solid growth in tobacco prices and export volumes and the recent easing of world oil prices. It appears that tobacco exports in 2008 may be as much as US$632 million, up from US$365 million in 2007 and US$68 million higher than projected at the time of the 6th PRGF review. Nevertheless, high fertilizer prices and other world market prices for most of 2008 suggest that the negative impact on Malawi’s 2008 trade balance could be US$156 million, slightly down from the $188 million estimated earlier (Table 1). Fertilizer bid prices during procurement were almost 51 percent higher than had been expected when the 2008/09 budget was prepared.

  • The full TOT impact has not yet been felt because reserves have been buttressed by the seasonal concentration of tobacco proceeds in April-September. Still, gross reserves at the end of September were only US$175 million, 1.1 month of imports (Figure 3).

Figure 3.
Figure 3.

Malawi: International Reserves 2000–08

Citation: IMF Staff Country Reports 2009, 016; 10.5089/9781451828207.002.A001

Source: Malawi authorities and IMF staff estimates.
Table 1.

Malawi: Impact of the Change in Terms of Trade on the Trade Balance 2007–091

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In millions of US dollars unless otherwise noted. Assumes unchanged volumes.

Includes other raw materials and manufactured products.

4. Adjustment of macroeconomic policies in response to the TOT shock is well underway:

  • The government met the end-June 2008 indicative domestic borrowing target.

  • A tight budget for FY2008/09 has been approved despite significant political hurdles and a three-month delay caused by an impasse in Parliament; it is fully in line with staff recommendations during the 6th PRGF review.

  • Monetary tightening continues. Excess reserves in the banking system that rose to unprecedented levels in 2007 and early 2008 have largely been mopped up. As a result, interbank and treasury bill rates rose to more prudent levels; the 91-day t-bill interest rate was 13.26 percent at the end of September, up 459 basis points since early April (Figure 4).

  • Donors are augmenting their budget support to help finance the increased cost of the fertilizer and seed subsidy program.

Figure 4.
Figure 4.

Malawi: Monetary Developments, 2002–August 2008

Citation: IMF Staff Country Reports 2009, 016; 10.5089/9781451828207.002.A001

Sources: Malawi authorities and IMF staff estimates.

5. The government has also taken some administrative measures to address food security concerns. In an effort to reduce consumer prices and stop maize speculation, licenses that had allowed private traders to buy maize from smallholders have been revoked and prices fixed. Through a recent government directive, the state-owned Agricultural Development and Marketing Corporation (ADMARC) has been designated sole buyer of maize from smallholder farmers, as well as the predominant stockpiler and seller of maize in Malawi. The authorities have indicated that the directive is a temporary measure intended to ensure that public stockpiles of maize are adequate to meet food security needs. For the same reason, the government has also tightened the enforcement of maize import and export license requirements.

II. The ESF-Supported Program

6. During the ESF arrangement the main focus of the government’s program will be on adjusting to the TOT shock and starting to rebuild Malawi’s international reserve buffer. These goals are designed to support continuing financial and macroeconomic stability, growth, and poverty reduction. At the same time, the government is preparing a medium-term program to reform the money and foreign exchange markets. The main objectives of this program will be to remove the current multiple currency practice, introduce a more flexible exchange rate system, and modernize the monetary policy framework. Improving public financial management is crucial for ensuring financial stability, rebuilding international reserves, and achieving the Malawi Growth and Development Strategy (MGDS) targets. In the near term the government aims to strengthen budget control to ensure fiscal discipline in the run-up to the May 2009 general elections. Program conditionality is limited to areas critical for near-term adjustment to the shock.

A. Adjusting to the Terms of Trade Shock

7. The program aims to bring import coverage of gross reserves at the end of 2009 roughly back to where it was at the end of 2007, while preserving growth and food security. The TOT shock reduces real disposable income in Malawi, and domestic demand must decline accordingly to protect international reserves, unless additional external support becomes available. Thus, protecting, and ultimately building reserves, will require a combination of reduced domestic borrowing and monetary tightening. Staff emphasized that demand-switching measures—including structural reforms and quick pass-through of world market prices—that promote increased Malawi exports and reduced imports would help soften the impact of domestic demand compression on growth, employment, and poverty reduction. The June fuel price increase is helpful in that regard. It is equivalent to a 1½ – 2 percent decline in household real disposable income and a 1½ –3 percent depreciation of the real effective exchange rate.2

8. To help smooth the needed adjustment, the authorities are requesting a high-access one-year ESF arrangement of SDR 52.05 million (75 percent of the quota). They have also requested additional donor support, particularly to help finance the seed and fertilizer subsidy program, which is critical for sustaining both agricultural production and export and food security. A substantial increase in aid is expected for 2008/09 in response to Malawi’s solid performance during the PRGF arrangement and its substantial needs: support for projects, the National AIDS Commission, and the health sector-wide approach (SWAp) is projected to increase by US$147 million in FY2008/09 and budget support by US$120 million, including a top-up of US$42 million in response to rising fertilizer costs. Nevertheless, additional financial support to build reserves is much needed.

Growth and inflation outlook

9. Given the lags in the agricultural production cycle that dominates the economy, any slowdown in growth in 2008 resulting from the TOT decline should be moderate. However, the impact may be larger in 2009, particularly if there should be a major scale-back of fertilizer use. Growth is projected at about 8.7 percent in 2008, significantly higher than expected. The tobacco harvest was higher than projected, the maize harvest was solid, and growth in the first part of the year in other segments of the economy was better than envisaged, though it may have begun to slow. For 2009, growth of about 7.9 percent is expected, primarily because of the opening of the Kayelekera uranium mine; other segments of the economy are expected to slow.

10. Inflation is expected to ease over the medium term because world oil prices have been declining. Malawi is expected to remain relatively insulated from current worldwide increases in food prices because it has been relatively self-sufficient with maize, its staple food, in recent years.

Fiscal policy adjustment

11. Targeted domestic borrowing in 2008/09 is 1.4 percent of GDP lower than it was in 2007/08 (Figure 5). The government is adhering to the original domestic repayment target for 2008/09 despite a rise of US$70 million (1.7 percent of GDP) in fertilizer subsidy costs and higher than budgeted domestic interest payments (0.2 percent of GDP). The gap is being covered by higher-than-envisaged tax revenues (0.8 percent of GDP), about US$42 million (0.8 percent of GDP) of additional budget support, and spending cuts (0.4 percent of GDP). The program adjusters are set to allow the government to avoid some spending cuts if further budgetary support is forthcoming. On the other hand, the adjusters for shortfalls in budget support have been tightened to protect reserves.

Figure 5.
Figure 5.

Malawi: Fiscal Developments, 2002/03–2008/09

Citation: IMF Staff Country Reports 2009, 016; 10.5089/9781451828207.002.A001

Sources: Malawi authorities and IMF staff estimates

Continued tight monetary policy

12. Monetary policy has been tightened, and the authorities are prepared to tighten further if needed. The increase in short-term interest rates resulting from the tightening already done should over time help reduce credit growth to levels more consistent with the reserve situation. Broad money is targeted to grow slightly less than nominal GDP over the near term.3 Staff emphasized that uncertainty regarding future money demand, and the impact on the economy of the agreed monetary program, was large. The current high money growth may suggest either shifts in money demand or temporary liquidity hoarding. Thus, close monitoring of interest rate responses to the implementation of the program would be warranted. The authorities should stand ready to adjust, in close consultation with staff, the policy stance if needed.

Exchange rate policies

13. The government continues to place substantial weight on stabilizing the nominal exchange rate against the U.S. dollar, which has held steady since May 2006.4 The authorities believe exchange rate stability has helped signal their commitment to economic stability and anchored inflation expectations and the prices of traded goods. Staff reiterated that a traditional pegged exchange rate regime would not be appropriate for Malawi, especially given its precariously low reserves and vulnerability to exogenous shocks. The real effective exchange rate (REER) has been relatively stable for the last four years, helped by the weakening of the U.S. dollar (Figure 6). During this period, rising aid and productivity have supported the real exchange rate, but declining TOT have outweighed these factors, as indicated by slow reserve accumulation. While the TOT worsening seems to be reversing, the brisk appreciation of the U.S. dollar against the currency of many of Malawi’s trading partners may lead to a sizable appreciation of the Malawi REER. To the extent that this would hurt growth and poverty reduction in Malawi and make it harder to meet their medium-term reserve accumulation target, the authorities should be prepared to allow more exchange rate flexibility.

Figure 6.
Figure 6.

Malawi: Real and Nominal Effective Exchange Rate 2000–08

(Indices 2000m1=100)

Citation: IMF Staff Country Reports 2009, 016; 10.5089/9781451828207.002.A001

14. The highly regulated foreign exchange market is not designed to reveal a market-clearing exchange rate. This has caused a multiple currency practice and periodic foreign exchange shortages: parallel market spreads have recently increased sharply (Figure 7). The government plans to study the route to a more flexible foreign exchange rate regime free of the multiple-currency practice, drawing on the recent FSAP and on IMF input in the context of the Article IV discussions scheduled for Spring 2009. The goal is to develop plans that could be implemented later in 2009.5

Figure 7.
Figure 7.

Discount on Buy and Sell Rates: Feb. 2005–Nov. 2008

(percent)

Citation: IMF Staff Country Reports 2009, 016; 10.5089/9781451828207.002.A001

Near term reserve outlook

15. Gross reserves are expected to remain precariously low in the near term, despite policy adjustments and additional financial support. This is because the April–September tobacco export season has ended and major near-term increases in imports are expected. High oil import costs are expected to persist for several months despite the recent drop in world prices because of long pricing lags in import contracts. Imports are also expected to rise in the last quarter of 2008 where the bulk of fertilizer imports is concentrated. Thus, gross reserves are expected to decline to about US$209 million by end-December 2008, and decline further in the first quarter of 2009, before rising to about US$257 million by mid-June 2009. Program adjusters have been tightened to prevent reserves from declining any further. The authorities are ready to take additional measures if the short-term outlook for reserves appears to be significantly worse than currently projected.

B. Building Reserves Over the Medium Term

16. The authorities’ near-term policy is guided by their objective of increasing Malawi’s international reserves substantially over the medium term. Bringing reserves in line with regional averages for coverage of aid shocks, TOT shocks, or imports would mean a substantial increase, to about 2.5–3 months of prospective imports, or 10–11 percent of GDP. The authorities would prefer an even larger reserve buffer given Malawi’s vulnerability to shocks and large seasonal variations in net foreign exchange flows.

17. The challenge is to balance the desired reserve accumulation against much-needed growth in propoor spending and adequate credit to the private sector. Increasing reserves to the desired level would require a substantial increase in the saving-investment balance, adjusted for external concessional financing. With private investment low, forcing a substantial increase in the private sector saving-investment balance could hamper growth and thus poverty reduction. Therefore, to support the needed increase in international reserves, Malawi needs a substantial increase in the government saving-investment balance that is not financed by concessional external loans.6 To strike a balance between these competing goals, staff and authorities agreed that the government’s medium-term fiscal program should aim to further consolidate net domestic debt to allow for accumulating reserves over the medium term.

18. Building reserves will also require longer-term structural adjustments. Together with the World Bank and other partners, the authorities are working to ensure that the agriculture program will be both fiscally sustainable and meet food security objectives. They are also working to improve the functioning of the local grain market to reduce large seasonal variations in prices, both to ensure better prices to farmers in the harvesting season and to lower prices to consumers in the lean season. This should help improve food security and lower import needs.

C. Reforming Money and Foreign Exchange Markets and the Monetary Policy Framework

19. Over the medium to long term, the Reserve Bank of Malawi (RBM) needs a more coherent exchange rate and monetary policy framework. Key elements include a market-clearing exchange rate, probably under a managed float, and measures to anchor inflation expectations. This would require improving (i) the functioning of the interbank, foreign exchange, and securities markets, including through reform of the auction mechanisms; (ii) the monetary transmission mechanism, and understanding of it; (iii) RBM ability to forecast inflation and liquidity; and (iv) RBM policy instruments. The near-term focus will be on preparing the foundation for these reforms.

D. Strengthening Public Financial Management

20. The near-term PFM focus will be on improved monthly monitoring of budget execution. A project supported by technical assistance from East AFRITAC is underway to address the most urgent obstacles for reporting monthly budget execution. In the longer term, more far-reaching changes to the government accounting and reporting system are necessary. The authorities are also taking measures to improve revenue forecasting; project evaluation and costing; financial controls and audits; and procedures for amending budgets. These measures, which are important to support fiscal discipline and the achievement of fiscal targets, are detailed in the authorities MEFP (attached).

III. Program Monitoring

A. Access and Capacity to Repay the Fund

21. Access under the ESF would be set at 75 percent of quota (SDR 52.05 million), front-loaded with three drawings. Malawi’s financing needs caused by the unexpected TOT shock are exceptionally large despite the current sizable increase in donor support and prospective ESF-associated donor augmentation. In view of the projected seasonal dip in reserves, it is proposed that 50 percent of quota be made available on approval of the arrangement (Table 5a).

Table 1a.

Malawi: Selected Economic Indicators, 2006–10

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Sources: Malawian authorities; and IMF staff estimates and projections.
Table 1b.

Malawi: Selected Economic Indicators on a Fiscal Year Basis, 2005/06–2009/10

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Sources: Malawian authorities; and IMF staff estimates and projections.
Table 2a.

Malawi: Central Government Operations 2006/07–2009/10

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Sources: Malawian authorities and IMF staff estimates.

Excluding recapitalization of the RBM.

Table 2b.

Malawi: Central Government Operations, 2006/07-2009/10

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Sources: Malawian authorities and IMF staff estimates

Excluding recapitalization of the RBM

Table 3a.

Malawi: Monetary Authorities’ Balance Sheet, 2006–10

(MK millions, unless otherwise indicated)

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

Includes recapitalization of RBM with a transfer of T-bills in the amount of MK29.3 billion in January 2008

Defined as the increase in holdings at cost value of both treasury and RBM bills in the private sector.

Table 3b.

Malawi: Monetary Survey, 2006–10

(MK millions, unless otherwise indicated)

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Sources: Reserve Bank of Malawi; and IMF staff estimates and projections.
Table 4a.

Malawi: Balance of Payments, 2006–10

(Millions of US$, unless otherwise indicated)

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

For years before 2007 debt service due before HIPC debt relief

Months of prospective imports of goods and services.

Table 4b.

Malawi: GrossFinancing Requirements and Sources of Financing, 2006–10

(Millions of US$)

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Sources: Malawian authorities; and IMF staff estimates and projections.
Table 5a:

Malawi: Schedule of Disbursements Under the One-Year ESF Arrangement

(SDR Millions)

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Equivalent to 75 percent of Malawi’s quota (SDR 69.4 million).

22. Malawi has adequate capacity to repay the Fund. After HIPC and MDRI debt relief, including topping–up, Malawi’s stock of external debt fell from 104 percent of GDP at the end of 2005 to 14.3 percent a year later. Over the same period, the NPV of debt declined from 24.7 percent of GDP to about 6.7 percent of GDP, and from 190 percent of exports to 40.9 percent of exports. Repayment to the Fund will be negligible at about 0.1 percent of exports of goods and services.7 By helping avert a disruptive adjustment and mobilize additional donor financing, the ESF would support Malawi’s capacity to repay the Fund.

B. Program Monitoring and Conditionality

23. Program implementation and its economic results will be subject to two reviews based on end-December 2008 and end-June 2009 performance criteria. Quantitative performance criteria for December 2008 and June 2009 and indicative targets for December 2009 are set out in Table 1 of the attached MEFP and defined in the technical memorandum of understanding. The first review mission would be scheduled for March 2009.

C. Data Issues, Technical Assistance, and Capacity Building

24. Data provided are adequate for surveillance and program monitoring purposes. The quality and timeliness of the fiscal and monetary data needed to evaluate Malawi’s program performance have improved, although their shortcomings are still significant. The government is also doing better at disseminating monetary and fiscal policy data. The authorities are committed to building technical capacity within the government and the RBM. They are receiving technical assistance from the Fund in several areas, primarily PFM, the exchange rate, monetary management, and statistics.

D. Risks to the Program

25. The main risks stem from the external environment, low and declining reserves, and the presidential and parliamentary elections in May 2009. There are large uncertainties surrounding the impact on Malawi of the global financial crisis and the recent appreciation of the U.S. dollar. Malawi would be vulnerable to a softening of tobacco prices, less global demand for its exports, and a weakening of aid inflows. The large rise in aid in 2008/09, which is largely being spent, is increasing Malawi’s vulnerability to future aid volatility. The near-term reserve outlook leaves little room for further economic shocks or policy slippages. Hence, the government will need to resist unrealistic spending pressures in the election year. Continued commitment to reform at the highest political levels will be crucial as the elections approach. Malawi’s narrow export base and dependence on agriculture also leave it vulnerable to weather shocks. The authorities have expressed an interest in pursuing a follow-on arrangement with the IMF to address medium-term issues.

IV. Staff Appraisal

26. Malawi faces significant balance of payments financing needs. It is being hit hard by worsening terms of trade. Although the recent easing of world oil prices will over time help reduce pressure on the balance of payments, the near-term reserve outlook is challenging and could become even more challenging as the global financial crisis evolves.

27. The government’s near-term program appropriately aims to restore reserve coverage. The current substantial tightening of monetary policies and contraction of domestic borrowing should over time help relieve pressure on the balance of payments. High-access ESF financial assistance and associated donor augmentation should help maintain financial stability in coming months, but there is considerable uncertainty. The authorities need to be prepared to take additional measures if international reserves end up being consistently lower than projected. In this context, more exchange rate flexibility would help soften the impact on growth, employment, and poverty reduction from the required domestic demand compression.

28. Forceful measures are needed over the medium term to bring reserves up to levels that would adequately cover import needs and shocks to aid and the terms of trade. Accumulating reserves will require sustained restrained domestic borrowing, enhanced foreign exchange market flexibility, and structural measures to encourage exports and reduce imports. In that regard, the government’s plans for laying the foundation for reforming the foreign exchange and monetary markets are encouraging.

29. Improving PFM is important for ensuring financial stability, rebuilding international reserves, and achieving government goals. The authorities’ plans for improved monitoring of budget execution and strengthening budget preparation and control are particularly important in that regard.

30. Reforms to the agriculture support program are also needed to ensure that the program is fiscally sustainable and meets government food security objectives. Reforms to the local grain market that would promote private sector development, reduce seasonal price variations, and ensure better prices to farmers and access to profitable export markets should over time help improve food security, increase pro-poor growth, and help build reserves.

31. Given the authorities’ commitment to continued sound economic management and the clear balance of payment needs, the staff recommends Executive Board approval of the request for a new one-year high-access ESF arrangement. Staff believes the terms of trade shock meet the criteria specified in the PRGF-ESF Trust Instrument for users of ESF resources. The shock is exogenous and the primary cause of the large immediate, but temporary, worsening of the balance of payment.

Table 5b:

Malawi Indicators of Capacity to Repay the Fund, 2007–11

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

Assumes ESF disbursements of SDR 34.7 million in December 2008 and SDR 17.35 during 2009.

APPENDIX I:

Malawi: Letter of Intent

November 13, 2008

Mr. Dominique Strauss-Kahn

Managing Director

International Monetary Fund

Washington, D.C. 20431

U.S.A.

Dear Mr. Strauss-Kahn:

1. The Government of Malawi requests continued support from the International Monetary Fund for its economic objectives and policy framework for 2008–2009 through a new one-year arrangement under the high-access component of the Exogenous Shocks Facility (ESF). We request access of 75 percent of quota. This arrangement will support our efforts to adjust to the severe terms of trade shock that Malawi is facing, notably as a result of significant increases in fertilizer and fuel prices over the past year. Furthermore, maintaining a close engagement with the Fund will send a positive signal to domestic stakeholders and our development partners, notably concerning our determination to maintain macroeconomic stability and build on the positive results achieved during the recent, successfully completed, arrangement under the Poverty Reduction and Growth Facility.

2. In the attached Memorandum of Economic and Financial Policies (MEFP), we set out our macroeconomic framework and policy objectives for 2008/09 and the medium term. Our over-riding goal is to provide a consistent and coherent economic policy framework to underpin our development objectives while in the near term responding to the terms of trade shock. In that regard, our programme focuses on enhancing the sustainability of growth and development through policies that consolidate economic stability and reinforce resilience to shocks, including through rebuilding of international reserves; improve public finance management; and support private-sector-led growth.

3. The MEFP and Technical Memorandum of Understanding (TMU) present quantitative performance criteria and indicative targets through the period of the arrangement. We believe that the policies set forth in the MEFP are adequate to achieve the objectives of the programme, but we will take additional measures as needed to reach these goals. We will consult with IMF staff on the adoption of these measures, and in advance of revisions to the policies contained in the MEFP, in accordance with the agreed IMF policies on such consultation.

4. The Government of Malawi authorizes the IMF to make this letter, the attached MEFP, TMU, and the IMF staff report available to the public, including through the IMF internet website.

Sincerely yours,

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Attachment I: Malawi: Memorandum of Economic and Financial Policies of the Government of Malawi for 2008–09

November 13, 2008

I. Introduction

1. This memorandum summarizes the government of Malawi’s economic objectives and policy framework for September 2008–December 2009, for which the Government is seeking continued support from the International Monetary Fund through a new one-year arrangement under the Exogenous Shock Facility (ESF). Malawi is experiencing a serious terms of trade shock caused by higher fuel and fertilizer import prices. We aim to make continued progress with our development goals while responding to the immediate challenge of this shock.

2. Our program builds on the results achieved during the recent successfully completed PRGF arrangement. The economic strategy under the PRGF-supported program emphasized the need for reduced domestic borrowing, improvements in revenue performance, and judicious increases in public spending, in order to correct the severe macroeconomic imbalances that existed prior to 2005 and create the space for propoor and progrowth spending. We believe our policy execution during the PRGF arrangement was strong, in sharp contrast to previous arrangements. In the first part of the decade, weak program implementation led to large fiscal slippages, an unsustainable domestic debt spiral, and low investment. Despite numerous attempts to bring the 2000–03 PRGF arrangement back on track, the economy remained in disarray, and the arrangement lapsed after only one review. Since taking office in mid-2004, we have improved economic policies on a broad front.

3. Our reform program has produced good outcomes. The strengthening fiscal position since 2005 has supported macroeconomic stability, lower domestic debt and interest rates, and policy credibility. Reflecting these improvements, Malawi has experienced sizable external debt relief and increasing inflows of aid and private capital. Growth has been very strong, averaging 5.8 percent for 2004–07, and in 2007 inflation declined to its lowest level in a decade. Higher revenues and aid and lower interest payments on the public debt have translated into an increase in outlays for poverty-reducing and social expenditures and, with more rapid growth, into progress toward many of the millennium development goals (MDGs).

4. Public financial management (PFM) reforms have helped us make the most of the increased expenditures. We have improved PFM through implementation of the broad agenda described in our PFEM Action Plan. We have strengthened control over the wage bill and utility payments and implemented an Integrated Financial Management Information System (IFMIS) to improve control over expenditures more generally. We have issued a debt management strategy and cleared the 2004 stock of arrears. The most recent Public Finance Management Assessment for Malawi based on the Public Expenditure And Financial Accountability (PEFA), framework concluded that our PFM systems have substantially improved over the past three years and compare favorably to our neighbors.

5. While recent economic performance has been strong, the serious terms of trade shock has made addressing the remaining development challenges more difficult. Despite recent progress, poverty remains high and food security is a concern. The economy depends heavily on drought-prone agriculture. Meanwhile, implementing the Malawi Growth and Development Strategy (MGDS) will require increases in public investment and spending in areas such as health and education. In addition, international reserves, fluctuating between 0.7 and 1.4 months of prospective imports, remain uncomfortably low considering Malawi’s vulnerabilities. To address these and other challenges while maintaining financial and macro-economic stability, Malawi will continue to need external support.

II. Recent Developments

6. The economy continues to perform well but has started to feel the impact of higher import prices. Real GDP growth continues to be strong. The 12-month inflation rate, though increasing recently—mainly as a result of higher food and petroleum prices—remains moderate at 9.3 percent in September 2008. Government net domestic debt was brought down slightly, from 11.9 percent of GDP at the end of 2007 to 11.7 percent at the end of July 2008. Despite the seasonal concentration of tobacco proceeds (April–September), international reserves were only US$175 million (1.1 months of prospective imports) at the end of September 2008.

7. However, the full impact of much higher fuel and fertilizer import prices has not yet been felt. One result of the terms of trade shock is a net import bill in 2008 that is US$156 million or 3.8 percent of GDP higher than in 2007, at constant volumes. Meanwhile, higher fertilizer prices have hit the budget directly, raising costs by some KW10 billion relative to the assumptions in the budget.

8. We have been moving forward with structural reforms. A public financial management (PFM) unit under the Secretary of Treasury has been established in the Ministry of Finance to promote and coordinate the modernization of PFM systems. In addition, a cash management unit at the Accountant General Office has been formed to enhance the government’s capacity for cash flow planning.

9. We have also tightened control over monetary expansion. We have mopped up structural excess liquidity through issuance of RBM bonds (MK4.3 billion) and treasury bills (MK4.9 billion) and have managed short-term liquidity more actively. In addition, the scope of the liquidity reserve requirement has been widened to include the discount houses, effective April 2008. With these operations, interest rates have risen back to levels that help contain inflation in the face of the rise in import prices. Nonetheless, broad money growth remains high: broad money grew by 45.6 percent in the 12-month to August 2008—partly reflecting the effects of output growth on money demand.

10. The financial soundness of the RBM has been restored. Operating costs have been reduced, including through staff cuts, and the RBM has been recapitalized and is no longer making losses. The government has converted MK6.5 billion in promissory notes into interest-bearing and tradable treasury notes and transferred another MK23.2 billion in treasury notes (4.3 percent of GDP) to the RBM. Interest costs of MK4.6 billion (0.7 percent of GDP) are reflected in the 2008/09 budget.

11. We have also made progress in establishing credit reference bureaus, which will over time lower the too-high lending spreads. Information disclosure clauses have been introduced in commercial bank lending contracts, which should provide the basis for establishing functioning credit bureaus. This should help bring down the cost of lending by lowering the risks and promoting competition among banks through easier identification of sound borrowers.

12. We have also made progress in improving bank supervision and regulations. RBM has adopted a risk-based supervision approach to examining bank performance. For the time being the assessment of banks will still be based on CAMEL, with the risk-based assessment run in parallel with CAMEL. Following this change, the RBM will be able to assess more effectively all risks banks undertake in addition to credit risk, as was emphasized in the CAMEL method. Moreover, the RBM continues to assess the quality of bank loans during on-site and off-site examinations. Whenever a bank is found to be under-providing, the RBM directs it to make additional provisions. Related to this, the RBM is revising its Asset Classification Directive to take into account new developments such as International Accounting Standards. RBM, furthermore, has finalized draft amendments to the Banking Act and a Financial Services Bill (FSA) to strengthen the supervisory function of the regulators. The FSA will, in addition, provide for consolidation of supervisory responsibility for the financial sector in a single agency. The amendment to the Banking Act and the FSA are awaiting parliament approval before being passed into law. Finally, the RBM has taken steps to improve its capacity, including examining anti-money-laundering and combating of financing of terrorism–related transactions (training and additional staffing).

13. Sound governance and good economic performance have helped Malawi to attract considerable international support, both official and private, for investment and development. Recently Malawi was deemed eligible for support from the Millennium Challenge Account (MCA). Malawi has also witnessed portfolio inflows, although these are now receding, and foreign direct investment (FDI) in the mining sector.

III. Near-Term Objectives and Strategy

14. The large negative terms of trade shocks present a major challenge. Real GDP growth is projected to fall somewhat, to about 6.7 percent in 2009, because growth in maize and tobacco will be more constrained by capacity and possibly higher private sector fertilizer prices. Inflation is likely to come back down, however, as the recent decline in world market fuel price is passed through.

15. Our near-term objectives and strategy, for which we seek ESF support, aims to provide a consistent and coherent economic policy framework to maintain macroeconomic stability.

16. Key policies include:

  • Pursing a monetary and exchange rate policy that keeps inflation moderate and converging gradually toward our medium-term goal of 5 percent. Along with fiscal policy, this should support increasing foreign exchange coverage to give Malawi the resilience to withstand negative shocks that could otherwise derail growth and increase poverty;

  • Firmly implementing the 2008/09 budget, which will further reduce government net debt while increasing critical expenditures; and

  • Continuing to improve PFM, with a particular focus on monitoring budget execution, expenditure costing, and revenue administration.

17. We intend to slow monetary expansion in order to contain pressures on inflation and the exchange rate. Thus, for the remainder of FY2008/09, we will aim at an expansion of broad money that is below nominal GDP growth. Moreover, to improve control over monetary expansion, the program indicative base money targets, as well as the program ceiling on the net domestic assets (NDA) of the RBM, will be set on a monthly average basis for the last month of each quarter. The program ceilings on NDA of the RBM are set out in Table 1.

Table 1.

Malawi: Quantitative Targets1

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Note: PC - performance criteria; IT - indicative target.

Targets are defined in the technical memorandum of understanding (TMU). The fiscal targets are set cumulative from the end of the previous fiscal year. Fiscal targets from July 1, 2008 to end-June 2009 are therefore cumulative from end-June 2008.

Targets are subject to an adjuster for BOP support as per TMU.

Targets are subject to an adjuster for donor-funded health receipts as per TMU.

Targets are subject to adjusters for cash payment of arrears as per TMU.

Evaluated on a continuous basis.

Targets for end-December 2009 are indicative.

Monthly indicative gross reserve targets

2008 2008 2009 2009 2009 2009 2009 2009 Nov. Dec. Jan. Feb. Mar. Apr. May June 114 209 162 158 197 202 218 257

18. In the short term, monetary and exchange rate policies will be geared toward keeping inflation moderate and supporting the building of reserves. Reserve money continues to be the key intermediate target. We also place weight on stabilizing the nominal exchange rate against the U.S. dollar. We believe this has helped signal a commitment to economic stability and anchored inflation expectations and prices of traded goods. However, we realize that over time enhanced exchange rate flexibility is needed. In that regard we are commissioning a study to propose reforms to our foreign exchange rate management that would introduce increased flexibility and ensure alignment with underlying fundamentals, consistent with Malawi-specific circumstances. We will provide adequate foreign exchange to clear the market, while ensuring that over the medium term net purchases are sufficient to meet the reserve accumulation target. We will take additional measures should clear indications emerge that the program’s indicative monthly reserve targets will be missed. Likely measures would include further fiscal or monetary tightening.

19. The 2008/09 budget passed in September 2008 reflects the Government’s intention to maintain fiscal discipline and protect international reserves without crowding out credit to the private sector. Thus, domestic borrowing is being substantially reduced. The domestic borrowing target in the 2008/09 budget is 1.4 percent of GDP lower than the 2007/08 outcome. However, higher than budgeted prices for fertilizer imports implies increased spending of some MK11 billion, 1.8 percent of GDP. We intend to implement the 2008/09 budget in the face of this shock, aided by stronger than budgeted revenue growth and some expenditure cuts. We look to fill any remaining financing gap through an increase in donor support. We also recognize the uncertainty of other items in the budget and, to keep the budget on track, intend to follow execution closely and take rapid corrective measures when necessary. Prices for ADMARC sales of maize will be structured to avoid losses that could become a fiscal burden. In addition, ADMARC will not borrow further from the RBM. Moreover, because of the need to avoid contingent fiscal liabilities, the National Food Reserve Agency will not engage in commercially oriented trading activities.

20. Our fiscal policies will keep consolidated domestic debt below 13 percent of GDP, down from 14.5 percent in 2007. We will not contract or guarantee any external debt on terms below the 35 percent concessional threshold (as set out in the attached Technical Memorandum of Understanding). To ensure that borrowing is consistent with our debt sustainability objectives, we have issued new external debt management guidelines and will continue to strengthen debt management practices.

Structural Reforms to Improve Public Financial and Economic Management

21. We will take additional measures in the coming months to contain fiscal risks and reinforce public financial management. We are updating our PFEM Action Plan, originally formulated in 2006, with the support of our development partners and with input from various technical assistance projects. While past initiatives are beginning to show tangible results, it is obvious to us that more work is needed.

22. Credible budgets are critical to macroeconomic stability and sustainability, and thus remain a priority. We have strengthened the process of preparing the budget by clarifying the budget calendar and allowing more time for sectoral planning and negotiations; this should help improve the realism of expenditure estimates. We intend to take further measures to enhance budget credibility, such as by

  • Improving the quality of tax and nontax revenue projections of the Revenue Division of the Ministry of Finance, supported by the creation of a revenue database.

  • Strengthening the capacity of the Ministry of Finance to scrutinize budget submissions. We recognize the need to closely examine both expected expenditure for current programs and activities and the costing of new proposals. We therefore intend to initiate focused reviews of certain sectors—notably road construction—to gain a better understanding of the costs and benefits of various policy options.

23. We are also taking measures to strengthen budget monitoring and control by

  • Monitoring particularly closely all projects whose total multiyear cost exceeds 1.0 billion Kwacha. Through monthly execution reports, there will be an indication if the budgeted amount will be exceeded, in which case an explanation will be required. By January 2009, we will also prepare a report analyzing the reasons for the budget overruns for Development Part II expenditure in 2007/08.

  • Putting in place procedures for taking timely off-setting measures within each vote, and within the competence of the Government, if—based on the regular monitoring of budget execution by the Ministry of Finance—there are indications that there will be an end-of-year overrun. If such measures are not feasible or desirable, a comprehensive supplementary budget will be proposed in accordance with the law.

  • Strengthening external audits. We feel confident that the recent approval of a new Auditor General will allow timely submission of audited government accounts to parliament. We also intend to strengthen the capacity of the National Audit Office.

24. Improved systems for producing timely and accurate budget execution reports are critical for ensuring that spending is contained within the overall envelope. In that regard, we will continue to produce monthly reports on budget execution based on both funding and IFMIS data, complemented with cash flow data from the RBM. Recognizing the limitations of the current system, we will work to improve the accuracy of these reports by expanding the use of expenditure outturn data from the IFMIS and making more systematic comparisons between different data sources. We see the development of budget execution reports based on actual expenditure reconciled with banking data as being of the highest priority. We intend to

  • Prepare two monthly reports on budget execution showing revenue, expenditure, and financing items. The first report will be structured according to votes, with a break-down of Personal Emoluments; Other Recurrent Transfers; Development Part I; and Development Part II spending under each vote. The report will show (1) actual expenditure as recorded in the IFMIS; (2) total funded expenditure; and (3) actual payments as recorded by the RBM. This report will be comparable to the approved budget. The second report will be structured around major economic categories (at the level of detail of the fiscal table). The report will show (1) actual collected revenue; (2) funded expenditure (except for unfunded items); and (3) actual payments for debt service and other unfunded expenditure initiated directly by the RBM, and Development part I expenditure. These reports should be available within two weeks after the end of each month.

  • Beginning with the reports for the month of November, we will improve upon these reports by presenting not funding but actual expenditure for all items that are recorded in the general ledger in the IFMIS. The expenditure for Local Assemblies, which are not recorded in the IFMIS, will still be approximated by funding, presented in a separate column. Major differences between funding and actual expenditure as recorded in the IFMIS will be identified and explained.

  • Prepare by January 1, 2009, a plan for (1) importing of all expenditure outturn data, including from local assemblies, Part I development spending, and other unfunded expenditures (i.e., debt service payments and other payments initiated by the RBM) into the general ledger in the IFMIS; (2) daily reconciliation of the IFMIS and the payments data from the RBM and the production of budget execution reports based on outturns as recorded in the IFMIS.

25. We will continue our efforts to bring down the operating costs of the RBM. To that end we are reviewing minting and printing costs. We have conducted a tender and consulted with neighboring central banks and will work to reduce the cost of printing banknotes. We will further review the cost of minting coins and the bank note structure. These measures, together with staff cuts and the recent recapitalization, will preserve the RBM’s sound financial footing.

26. Further measures to strengthen the financial sector in 2008/09 will draw on the recommendations of the 2007 FSAP. Near-term priorities are to

  • Introduce a mergers and acquisition framework for the banking sector to clarify the conditions under which banks can merge.

  • Strengthen the way off-site supervision supports on-site supervision, including through stress testing.

  • Continue to improve the functioning of money and foreign exchange markets, making them more efficient and market-oriented. In particular we have eliminated the regulation preventing commercial banks from crossing the mid-rate in the foreign exchange market to ensure enhanced competition among banks and promote reduced spreads in the retail market.

IV. Program Monitoring

27. The Government believes that the policies set forth in this Memorandum of Economic and Financial Policies are adequate to achieve the objectives of its program, but it will take any further measures that may become appropriate for this purpose. Malawi will consult with the Fund on the adoption of these measures, and in advance of revisions to the policies contained in the MEFP, in accordance with the Fund’s policies on such consultation.

28. Program implementation will be monitored according to quantitative assessment criteria and indicative targets set out in Table 1. Quantitative performance criteria will be established for end-December 2008 and end-June 2009. The targets for end-March and end-September 2009, and the monthly targets for international reserves will be indicative. The definitions of the variables monitored as quantitative performance criteria are provided in the TMU. Program implementation and the economic results associated with the program will be subject to two reviews with the first review in March 2009 based on end-December 2008 assessment criteria, and the second in September 2009 based on end-June 2009 criteria.

Attachment II: Malawi: Technical Memorandum of Understanding for the Exogenous Shocks Facility (ESF) Arrangement

I. Introduction

1. This memorandum sets out the understandings between the Malawian authorities and the International Monetary Fund (IMF) regarding the definitions of quantitative and structural performance criteria, benchmarks, and indicative targets for the program supported by the ESF arrangement, as well as the related reporting requirements.

2. Coverage: The central government includes all units of government that exercise authority over the entire economic territory. However, in contrast to the System of National Accounts 1993 (SNA 1993) and Government Finance Statistics Manual 2001 (GFSM 2001) standards, nonprofit institutions that are controlled and financed by the central government are excluded for purposes of this memorandum. The accounts of the monetary authorities include those of the Reserve Bank of Malawi (RBM) and the central government’s holdings of international reserves. Monetary aggregates under the program are based on the eight-bank monetary survey.

II. Quantitative Performance Criteria and Benchmarks: Definitions and Data Sources

A. Floor on Net International Reserves of the Monetary Authorities

3. Definition of net international reserves (NIR) of the monetary authorities: The NIR of the monetary authorities is defined as reserve assets minus reserve liabilities. The values of all foreign assets and liabilities will be converted into U.S. dollars at each test date using the cross exchange rates for end-December 2007 for the various currencies and then converted into Kwacha using the U.S. dollar–kwacha exchange rate for year-end 2007.8

4. Gross reserve assets of the monetary authorities are defined in the International Reserve and Foreign Currency Liquidity Guidelines for a Data Template as external assets immediately available and controlled by RBM “for direct financing of payments imbalances, for indirectly regulating the magnitudes of such imbalances through intervention in exchange markets to affect the currency exchange rate, and/or for other purposes.” (BPM5, para. 424.).

5. This concept includes the following: (1) monetary gold holdings of the RBM; (2) holdings of SDRs; (3) the reserve position in the IMF; (4) central government (treasury) holdings with crown agents; and, (5) foreign convertible currency holdings; (6) deposits hold in foreign central banks, the Bank for International Settlements, and other banks; (7) loans to foreign banks redeemable upon demand; (8) foreign securities; and (9) other unpledged convertible liquid claims on nonresidents. Excluded are (1) any foreign currency claims on residents; (2) capital subscriptions in international institutions; (3) foreign assets in nonconvertible currencies; (4) transfers of foreign currency claims to RBM by other institutional units in Malawi just prior to reporting dates with accompanying reversals of such transfers soon after those dates; (5) gross reserves that are in any way encumbered or pledged, including, but not limited to, (i) assets blocked when used as collateral for third party loans and third-party payments, pledged to investors as a condition for investing in domestic securities, and (ii) assets lent by RBM to third parties which are not available prior to maturity, and are not marketable (including the outstanding balance of the loan to Zimbabwe).

6. Gross reserve liabilities of the monetary authorities are defined as the sum of the following: (1) outstanding liabilities of the RBM to the IMF; and (2) all short-term foreign currency liabilities of the RBM to nonresidents with an original maturity of up to, and including, one year. Reserve liabilities exclude medium and long-term foreign liabilities.

7. Adjustment clause on NIR—budget support: The floor on the NIR of the monetary authorities will be adjusted upward by the full amount by which the cumulative receipts from the budget support are greater than US$30 million above the program baseline (see Table 1). The floor on NIR of the monetary authorities will be adjusted downward by the full amount up to a maximum of US$10 million by which the cumulative receipts from budget support are less than the program baseline. Budget support is measured as the cumulative flow from the beginning of the fiscal year.

8. Definition of budget support: Budget support includes all grants and foreign financing that is not directly linked to additional budgetary expenditure. Excluded from this definition is external project financing to fund particular activities, including food security funding from the European Union and loan financing from the IMF, and donor inflows (in Kwacha) from the U.S. dollar–denominated donor pool account for the health sector-wide approach (SWAp) and National AIDS Commission held in the Malawi banking system.

9. Adjustment clause on NIR—donor pool account for the health SWAp account: The floor on the NIR of the monetary authorities will be adjusted downward by the full amount by which the donor inflows (in Kwacha) from the U.S. dollar–denominated donor pool account for the health SWAp held in the Malawi banking system is smaller than the donor inflow (in Kwacha) to those accounts in the program baseline. The downward adjustment will be capped at $10 million. Donor inflows for the SWAp account are measured as the receipts received (in Kwacha) by the budget from the SWAp account, a U.S. dollar-denominated account set up at the RBM. Donor inflow is measured from the beginning of the fiscal year.

10. Adjustment clause on NIR—debt service payments: The floor on NIR of the monetary authorities will be adjusted upward (downward) by the full cumulative amount by which debt service payments to the World Bank and the ADB fall short of (exceed) the program baseline (Table 1). The cumulative amount will be measured from the beginning of the fiscal year.

11. The total downward adjustment to NIR from a shortfall of (1) budget support and (2) donor inflows to the donor pool account for the health SWAp account relative to program assumptions and (3) an excess of debt service payments relative to the program assumption will be capped at $10 million.

12. For purposes of this target, as well as those for external debt and arrears, valuation will be in U.S. dollars using the above defined program exchange rates.

13. Data on NIR, including its components, will be reported by the RBM on a weekly and end-month basis.

B. Ceiling on the Monthly Average Net Domestic Assets of the Reserve Bank of Malawi

14. Definition of monthly average net domestic assets (NDA) of the RBM: NDA of the RBM are defined as the monthly average (based on weekly data9) for the final month of each quarter of reserve money less net international reserves at the program exchange rate. Reserve money consists of currency issued by the RBM and balances of commercial banks’ accounts with the RBM. It includes required reserves held for Malawi Kwacha deposits and any other domestic currency reservable liabilities and other demand and time deposits held with the RBM. The NDA program ceilings are the indicative money targets defined below (including a symmetrical 1 percent band) less the monthly average (based on weekly data) of net foreign assets (NFA) of the monetary authorities.

15. Definition of NFA of the monetary authorities: The NFA of the monetary authorities are defined as the above defined NIR plus other foreign assets of the RBM—including but not limited to (1) capital subscriptions in international institutions; (2) foreign assets in nonconvertible currencies; and (3) gross reserves that are in any way encumbered or pledged, less any medium- and long-term foreign liabilities of the RBM.

16. Adjustment clause on NDA—budget support: The ceiling on NDA of the RBM will be adjusted downward by the full amount by which the cumulative flow of receipts from budget support are greater than US$30 million above the program baseline. The ceiling on NDA of the RBM will be adjusted upward by the full amount up to a maximum of US$10 million by which the cumulative receipts from the budget support are less than the program baseline. The Kwacha value of the cumulative shortfall/excess will be calculated at the program exchange rate. Budget support is measured as the cumulative flow from the beginning of the fiscal year.

17. Adjustment clause on NDA—donor pool account for the health SWAp account: The ceiling on NDA of the RBM will be adjusted upward by the full amount by which the donor inflows (in Kwacha) from the U.S. dollar–denominated donor pool account for the health SWAp held in the Malawi banking system is smaller than the donor inflow (in Kwacha) to those accounts in the program baseline. The upward adjustment will be capped at US$10 million. Donor inflows for the SWAp account are measured as the receipts received (in Kwacha) by the budget from the SWAp account, a U.S. dollar-denominated account set up at the RBM. Donor inflow is measured from the beginning of the fiscal year.

18. Adjustment clause on NDA—debt service payments: The ceiling on NDA of the monetary authorities will be adjusted downward (upward) by the full cumulative amount by which debt service payments to the World Bank and the ADB falls short of (exceed) the program baseline (Table 1). The cumulative amount will be measured from the beginning of the fiscal year.

19. The total upward adjustment to NDA from a shortfall of (1) budget support and (2) donor inflows to the donor pool account for the health SWAp account relative to the program assumptions and (3) an excess of debt service payments relative to the program assumption will be capped at US$10 million.

20. Adjustment clause on NDA—liquidity reserve requirement: The ceiling on NDA of the RBM will be adjusted downward for a decrease in the reserve requirement ratio, and will be adjusted upward for an increase in the ratio. The adjustment will be spread equally over two quarters, starting in the quarter in which the reserve requirement ratio is reduced. The adjuster will be calculated as follows: (one minus the existing required percentage of reserve assets held at the discount houses) multiplied by (the program baseline required reserve ratio minus the new required reserve ratio) multiplied by (the amount of average reservable deposit liabilities in commercial banks during the last month prior to the change in regulation).

21. Adjustment clause on net domestic assets—debt service payments: The ceiling on NDA of the RBM will be adjusted downward (upward) by the full cumulative amount by which debt service payments fall short of (exceed) the program baseline (Table 1). The cumulative amount will be measured from the beginning of the fiscal year. Debt service payments will be converted to Malawi Kwacha using the above defined program exchange rates.

C. Ceiling on Central Government Net Domestic Borrowing

22. Definition of central government net domestic borrowing (CGDB): CGDB is computed as the sum of (i) net borrowing from the RBM (including ways and means advances, loans, holdings of local registered stocks, government bonds, and holdings of treasury bills minus deposits); (ii) net borrowing from commercial banks10 (including advances, holdings of local registered stocks, and holdings of treasury bills minus deposits); (iii) net borrowing from nonbanks (including, but not limited to, holdings of local registered stocks and holdings of treasury bills); and (iv) holdings of promissory notes. The treasury bills and local registered stocks are valued at cost rather than face value. The ceiling is measured as the change in the stock of CGDB since June 30, 2008, excluding promissory notes and securities transferred to the RBM from the Treasury since the beginning of the fiscal year.

23. Definition of June 2004 domestic arrears: June 2004 domestic arrears consist of all domestic arrears for which the obligation to pay was established on or before June 30, 2004.

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

25. Adjustment clause on CGDB—budget support: The ceiling on CGDB will be adjusted downward (upward) by the full amount by which cumulative Kwacha receipts from budget support are greater (less) than the program baseline. The upward adjustment will be capped at US$20 million. In the event of excess budget support, the ceiling on CGDB will be adjusted downward by the full amount less US$30 million. The Kwacha value of the cumulative shortfall/excess will be converted at the corresponding monthly average of the RBM mid rate. Cumulative receipts will be measured from the beginning of the fiscal year.

26. Adjustment clause on CGDB—donor pool account for the health SWAp account: The ceiling on CGDB will be adjusted upward by the full amount by which the donor inflows (in Kwacha) from the U.S. dollar–denominated donor pool account for the health SWAp held in the Malawi banking system are smaller than the donor inflows (in Kwacha) to those accounts in the program baseline. The upward adjustment will be capped at US$20 million. Donor inflows for the SWAp account are measured as receipts received (in Kwacha) by the budget from the SWAp account, a U.S. dollar-denominated account set up at the RBM. Donor inflow is measured from the beginning of the fiscal year.

27. Adjustment clause on CGDB—debt service payments: The ceiling on CGDB will be adjusted downward (upward) by the full cumulative amount by which debt service payments to the World Bank and the ADB fall short of (exceed) the program baseline (Table 1). The cumulative amount will be measured from the beginning of the fiscal year.

28. The total upward adjustment to CGDB from a shortfall of (1) budget support and (2) donor inflows to the donor pool account for the health SWAp account relative to the program assumptions and (3) an excess of debt service payments relative to the program assumption will be capped at US$30 million.

29. Adjustment clause on CGDB—securitization of arrears: The ceiling on CGDB will be adjusted upward by the full cumulative amount by which pre-2005 domestic arrears are securitized from the beginning of the fiscal year.

30. Adjustment clause on CGDB—cash payment of arrears: The ceiling on CGDB will be adjusted downward by the full amount by which cumulative payments from June 30, 2008, for verified pre-2005 domestic arrears are less than the program baseline. Only payments that are charged against the Accountant General vote and reported by the Accountant General will be recognized as payments for pre-2005 domestic arrears.

D. Ceiling on External Payments Arrears

31. Definition of external payment arrears: External payment arrears consist of debt-service obligations (principal and interest) to nonresidents that have not been paid at the time they are due, as specified in contractual agreements, except on external debt subject to rescheduling or restructuring. A continuous performance criterion applies on the nonaccumulation of external payment arrears on external debt contracted or guaranteed by the central government, the RBM, or other agencies on behalf of the central government or the RBM.

E. Ceiling on Nonconcessional External Debt

32. Definition of nonconcessional external debt: The definition of debt, for the purpose of the limit, is set out in Executive Board Decision No. 6230-(79/140) of August 3, 1979, and as amended by Decisions No. 11096-(95/100), October 25, 1995; and 12274-(00/85) August 24, 2000. For program purposes, short- and medium- and long-term debt is nonconcessional if it includes a grant element of less than 35 percent, as indicated in Decision No. 11248-(96/38), April 15, 1996. The ceiling on nonconcessional debt applies to the contracting and guaranteeing by the central government, the RBM, or other agencies on behalf of the central government or the RBM on debt with nonresidents. The ceiling applies to debt and commitments contracted or guaranteed for which value has not been received. The ceiling is measured cumulatively from the beginning of the fiscal year.

33. Short-term debt: Outstanding stock of debt with an original maturity of one year or less.

34. Medium- and long-term debt: Outstanding stock of debt with a maturity of more than one year.

35. Excluded from the limit is the use of Fund resources, and any Kwacha-denominated treasury bill and local registered stock holdings by nonresidents. Excluded from the limit are also (i) debts classified as international reserve liabilities of the RBM; (ii) new debt issued to restructure, refinance, or repay existing debt up to the amount actually used for the above-mentioned purposes; (iii) normal import financing; and (iv) arrangements to pay over time obligations arising from judicial awards to external creditors. A financing arrangement for imports is considered to be “normal” when the credit is self-liquidating.

III. Quantitative Indicative Targets

A. Ceiling on Reserve Money

36. Definition of monthly average reserve money: Reserve money is defined as the monthly average (based on weekly data) of the sum of currency issued by the RBM, including the vault cash of commercial banks, and balances of commercial bank accounts with the RBM. It includes required reserves held for Kwacha deposits, other domestic currency liabilities, and other demand and time deposits held with the RBM. The reserve money targets are the projected averages of June 2008, September 2008, and December 2008, within a symmetrical 1 percent band. The upper bound of the band serves as the indicative target.

IV. Reporting of Certain Transactions in the Fiscal Accounts

37. Donor pool–funded expenditures in support of the health SWAp. The Government of Malawi has embarked on an integrated program of service delivery in the health sector, the health sector-wide approach (health SWAp). In support of the health SWAp some donors are pooling resources (the donor pool), and release these resources through normal government procedures (i.e., recurrent budget or development Part II budget) to the health sector. In order to manage the inflows of donor resources a U.S. dollar-denominated account has been set up at the RBM that holds donor pool resources until expenditures need to be financed.

V. Reporting Requirements

38. Monitoring of the program requires that the information listed in Tables 2 and 3 below be reported to the IMF within the timeframe indicated.

Table 2:

Reporting Requirements

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D-Daily, W-Weekly, M-Monthly, Q-Quarterly, BA-Bi-annual A-Annual; F-Friday, 30-Every 30th, T30-Every third 30th; E-Electronic, H-Hard copy

Detailed information on the amounts, currencies, terms, and conditions, including debt contracted or guaranteed by the RBM or any other agency on behalf of the central government.

Agriculture Development and Marketing Corporation, Air Malawi, Electric Supply Company of Malawi, Malawi Development Corporation, Malawi Housing Corporation, Malawi Postal Corporation, Malawi Telecommunications Ltd., Northern Regional Water Board.

Table 3.

SWAp Statement of Sources and Uses of Funds

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1

To meet the original 2.4 months of imports reserve target for end-2007 an additional US$155 million (3.7 percent of 2008 GDP) in reserves would have been needed. For 2005–07 the cumulative terms of trade impact was US$217 million (5.1 percent of 2008 GDP), the cumulative shortfall in budget support was US$48 million (1.1 percent of 2008 GDP), while the cumulative over-borrowing relative to initial target was less than US$25 million (0.6 percent of 2008 GDP). The higher-than-projected imports were partly due to higher project aid than was initially assumed.

2

Measured as the price of traded goods (including fuel) compared to nontraded goods.

3

To enhance control over monetary policy, monetary targets are set on a monthly average basis, not end-of-period, as was done under the PRGF arrangement).

4

For this reason the exchange rate regime was recently reclassified as a de facto conventional peg.

5

The 2009 Article IV consultation will provide a fuller assessment of the exchange rate and the regime.

6

An increase in the government’s saving-investment balance that is not financed by concessional external loans is, in fiscal accounting terms, a reduction in government net domestic borrowing.

7

A new debt sustainability analysis is scheduled for the first part of 2009, in conjunction with the next Article IV consultation. Staff continuously monitors Malawi’s domestic and external debt using the Debt Sustainability Framework.

8

Unless otherwise defined, program exchange rates for 2008 between the U.S. dollar and other (non-Kwacha) currencies will be equal to the end-December 2007 rates. Consequently, the U.S. dollar/SDR exchange rate is set at 1.4685. Any other assets (e.g. gold) would be revalued at their end-December 2007 market prices.

9

For months with more than 4 exact weeks, the data for the final few days will be folded into the previous week’s data.

10

Includes all commercial banks in Malawi—and in particular the Malawi Savings Bank—not just the banks covered by the eight-bank monetary survey.

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Cover IMF Staff Country Reports
Malawi: Request for a One-Year Exogenous Shocks Facility Arrangement: Staff Report; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Malawi
Author:
International Monetary Fund
Volume/Issue:
Volume 2009: Issue 016
Publisher:
International Monetary Fund
ISBN:
9781451828207
ISSN:
1934-7685
Pages:
74
DOI:
https://doi.org/10.5089/9781451828207.002
Figure 1.

Malawi: External Developments, 2001–08
Figure 2.

Malawi: Consumer Price Inflation 2003–08

(12-month percent change)
Figure 3.

Malawi: International Reserves 2000–08
Figure 4.

Malawi: Monetary Developments, 2002–August 2008
Figure 5.

Malawi: Fiscal Developments, 2002/03–2008/09
Figure 6.

Malawi: Real and Nominal Effective Exchange Rate 2000–08

(Indices 2000m1=100)
Figure 7.

Discount on Buy and Sell Rates: Feb. 2005–Nov. 2008

(percent)