Recent Economic Developments

Malawi’s economy slowed considerably in 2011, after recording impressive growth rates which averaged 8 percent per year during the 2007–10 period. Real GDP grew at 4.3 percent in 2011 and is projected to grow at the same pace in 2012. The slowdown in growth was evident in manufacturing, transport, construction, retail and wholesale sectors which were adversely affected by foreign exchange shortages. Inflation has been rising since early 2011, with the year-on-year headline rate reaching 17.3 percent in May 2012 owing to rising import costs as more and more imports were being priced at the parallel market exchange rate in the run up to the May devaluation. Needless to say, the 49 percent devaluation and the subsequent pass-through to energy prices are affecting virtually all sectors of the economy. The authorities have taken a pro-active approach to dealing with the challenges facing the country. Their commitment to placing the economy on a steady path of recovery is demonstrated by their recent policy actions aimed at addressing critical foreign exchange shortages. The buildup of international reserves and the introduction of a more flexible exchange rate regime and liberalized foreign exchange market are important elements of their policy framework. They recognize that a responsive exchange rate is essential in aiding the economy to better respond to external shocks, similar to those experienced last year, while strengthening their ability to accumulate reserves and contribute to a high sustainable economic growth.

The immediate impacts of the policy interventions are being observed. The devaluation, the adoption of a floating exchange rate regime, and the lifting of several restrictions on foreign exchange transactions have virtually eliminated the parallel market. Intervention in the foreign exchange market by the Reserve Bank of Malawi has helped to clear some of the backlog of external payments while tightening liquidity conditions in the domestic market. all the same time, support for the policy changes from the private sector has been positive: exporters hailed the boost to their incomes in Kwacha terms, importers are optimistic about the prospects for increased availability of foreign exchange, and commercial banks have recorded an increase in purchases of foreign exchange from their customers. While adjustments in exchange rates have had a positive impact on the balance of payments, the BoP remains under increasing risk and vulnerability, particularly in light of export growth subsiding with the economic slow-down in major trading partners like the EU. In addition to the foreign exchange reforms, the Reserve Bank started tightening its monetary policy stance in April 2012 by removing excess liquidity using some of its holdings of treasury bills. After the devaluation, foreign exchange sales assisted in mopping up excess liquidity; Kwacha liquidity conditions tightened significantly. In May, the Bank raised its policy rate from 13 percent to 16 percent and increased it further to 21 percent on July 11, 2012. The adjustments are part of the measures aimed at strengthening monetary policy in the context of a liberalized exchange rate regime and are in line with the increasing trends in non-food inflation.

Policies to Address Imbalances

The authorities are keenly aware of the seriousness of the current macroeconomic imbalances manifested in rising inflation and low reserves as they are of the need to maintain their pro-growth policies and meet the long-term development challenges. They have thus continued to tackle the effect of the devaluation while simultaneously undertaking a broad range of concerted fiscal and monetary policies to address the vulnerabilities. They are committed to attaining and maintaining short term stability as they pursue long range structural transformation and reform. In this context they are committed to addressing inflationary pressures and building up of reserves as a matter of priority.

Fiscal Policy

The authorities have made a strong commitment to tighten fiscal policy by passing a budget for FY2012/13 that is in line with a deficit of 1.1 percent of GDP and consistent with their objective to reduce domestic borrowing, contain expenditure and strengthen revenue collection. The budget represents a sharp tightening compared to the 2011/12 budget with a deficit of 7.3 percent of GDP.

To this end, the authorities have eliminated the fuel subsidy program and are implementing a policy of monthly adjustment of pump prices. The domestic fuel price mechanism would build into the pump rice a small margin in order to repay the accrued negative balance in the Petroleum Stabilization Fund. In this regard, for the month of July 2012, MERA has revised downwards pump prices of three petroleum products by an average of about 7 percent, effective July 6, 2012, in line with the Automatic Pricing Mechanism (APM) following trends in the world petroleum products prices.

Taxes that are deemed to be punitive on businesses and regressive in nature would be removed, the range of items subject to VAT are being expanded and social protection programs such as FISP, public works, school feeding, and cash transfers have been increased to mitigate the effect of high prices on the poor in a more effective way while ensuring food security. The authorities have also resolved to rein in contingent liabilities and operational losses emanating from public enterprises and intensify monitoring. The authorities have indicated a willingness to cut lower priority expenditure, and in some instances even postpone investment spending if these do not compromise their commitment to the poor and achievement of the MDGs.

To ensure that risks to the budget are minimized, particularly in light of the large domestic arrears accumulation over the last few years, my authorities will tighten control over expenditure commitments and accelerate the implementation of the commitment module in the IFMIS. At the same time, the government has started clearing the accumulated domestic arrears and is looking into alternatives such as long-term Treasury bonds to settle some of these arrears.

My authorities will continue to pursue prudent fiscal policy aimed at safeguarding medium to long-term debt sustainability while, at the same time, creating the required fiscal space for investment in infrastructure and the social sectors. Their medium-term agenda will be defined by priorities set out in the MDGS II that emphasize increased budgetary allocations to the development of basic infrastructure and the efficient provision of social services, within a stable macroeconomic environment. In this regard, maintenance of prudent fiscal policies and consolidation of gains in macroeconomic stability will remain at the top of the authorities’ economic agenda. Furthermore, fiscal policy will be aimed at containing public debt and related interest payments to sustainable levels.

Monetary and Exchange Rate Policies

To anchor inflationary expectations, monetary policy in 2012/13 will continue to be consistent with the level of economic activities so as to curb inflation and anchor inflation expectations. The policy stance will be supported by fiscal consolidation and reduced access by government to direct credit from the central bank. To this end my authorities intend to amend the RBM act to place a limit on total borrowing by the Government from RBM. Going forward, the Reserve Bank will continue to pursue prudent monetary policies to strengthen the recovery process and consolidate the gains achieved so far. Monetary policy will be geared towards accumulating foreign exchange reserves and creating an interest rate structure conducive to economic growth.

The central bank will continue to maintain the current floating exchange rate regime and intervene in the market only to preserve orderly market conditions. While mostly abstaining from the foreign exchange market, the RBM will, however, continue to carry out limited foreign exchange interventions to mop up liquidity generated by donor financed spending.

Debt Management Policy

My authorities concur with staff’s assessment that Malawi remains at a moderate risk of debt distress. They are cognizant of the threat to debt sustainability in the event of shocks to the economy. It is in this regard that my authorities remain unwaveringly committed to the careful management of both external and domestic debt to enhance external stability and increase fiscal savings. They will source new borrowing from highly concessional windows and create the enabling environment to attract non-debt creating resource inflows. In addition, my authorities will continue conducting debt sustainability analysis on the basis of the Fund-Bank framework to ensure that all debt indicators fall and remain within their corresponding thresholds. Furthermore, to maintain the continued prudent management of public debt, debt management capacity is being enhanced and will carry on fiscal consolidation to slow down the growth in the domestic debt stock.

Conclusion

My authorities remain mindful of the importance of prudent fiscal and monetary policies to ward off inflationary pressures due to devaluation as well as fuel price adjustment and achieve and maintain macroeconomic stability. The authorities are committed to the implementation of their MDGS II which is succeeding in generating meaningful growth and reducing poverty. The growth strategy which focuses on developing agriculture and other productive sectors, building infrastructure, expanding the service sector and developing human resources has garnered solid support from Malawi’s development partners. In this respect, the authorities will take into consideration and address the main risks identified in the staff advisory note and the recommendations to strengthen the implementation of the MDGS II as they prepare the first Annual Progress Report. These partners are, in addition to their support for the MDGS II, also ready to provide and in some instances have already extended additional assistance to help mitigate the impact of the devaluation. My authorities recognize that the immediate priority for the coming months is to address the impact of the devaluation as well as fuel price adjustment and address the associated vulnerabilities. The new administration inherited an economy on the decline and the needed policy adjustments while unavoidable have exacerbated existing weaknesses and vulnerabilities. In this context and with bold actions taken so far and planned policy initiatives, the Malawi authorities request cancellation of the current ECF program and request access to Fund resources under an ECF in the amount of SDR 104.1 million (150 percent of quota) over a three-year period to meet in part the BOP financing needs and to provide a buffer against shocks until the policy adjustments and reform measures take hold. They also take the opportunity to confirm that they are committed to implement the policies as outlined in the MEFP. The authorities strongly believe that the various reform programs meant to revamp economic and financial management will help re-establish macroeconomic stability and improve growth prospects. During this time, they expect to secure support from other development partners to meet their overall financing needs. They believe that their commitments, as outlined in the MEFP and highlighted above, are adequate to achieve program objectives, but are prepared to take further measures, as appropriate, for this purpose. To ensure a strong performance under an ECF-supported arrangement, they will maintain a close policy dialogue with the IMF and pursue technical assistance, as necessary, from the IMF and other development partners in support of the reform agenda. They expect the ECF-supported arrangement would put them in a better position to undertake the broad long-term reforms that they believe necessary to resume and sustain the robust growth in the face of complex and difficult challenges. They value the Fund’s financial support as well as the advice and appreciate the encouragement the institution provides to other development partners in their engagement with Malawi