Introduction

The Malawi authorities thank the Executive Board and Management for their continued engagement and support. They are grateful for the constructive dialogue with staff in addressing the policy challenges to sustaining economic recovery and poverty reduction. Not long ago, Malawi’s economy was on the brink of collapse facing chronic foreign exchange shortages, rapidly rising inflation exacerbated by more and more imports being priced at the parallel market exchange rate. Under a new leadership since April 2012, my authorities have been implementing tough but critical macro and structural reforms aimed at turning around the economy. Among other things, they devalued the Kwacha by close to 50 percent with subsequent floating of the exchange rate, and they adopted an automatic adjustment mechanism for retail prices of fuel.

They continue to focus on implementing tough but critical macroeconomic and structural reforms aimed at accelerating the economic reform program supported by the current ECF arrangement. While the policy initiatives cover a broad range of areas, they continue to adjust their policies to address the emerging challenges, including the ramifications from the recent public financial management scandal which has resulted in postponement of significant donor disbursements. Through their commitment to adjust policies as well as policy guidance from the Fund, the authorities are confident that they stand a good chance of shoring up their economy’s growth to its normal trajectory and achieving macroeconomic stability. That said, they broadly agree with the thrust of the staff report as it presents a balanced assessment of recent developments and policy challenges and opportunities going forward.

Recent economic developments and outlook

Considerable progress has been achieved since the economic reforms commenced in the first half of 2012. However, the embezzlement of public resources in Malawi through fraudulent transactions carried out in the government’s Integrated Financial Management Information System (IFMIS) and uncovered in late September 2013, has put at risk the gains made since May 2012. During a quarterly reconciliation exercise between the Ministry of Finance and the Reserve Bank of Malawi, officials observed cash movements that exceeded the authorized levels of funding. In subsequent investigations, they discovered that there had been a breach in the IFMIS security system and that several unauthorized transactions had been undertaken. In response, the Malawi President acted quickly by reconstituting her cabinet in October, and also, directed the vendor to assess and fix the software used by IFMIS, as well as recover information that appeared to have been lost before the system could resume operation. After strong firewalls had been placed and access controls had been strengthened, the use of IFMIS was allowed to resume in November.

An Action Plan to address the weaknesses in public financial management that was endorsed by the government and development partners is currently being implemented. To monitor progress in the timely implementation of the Action Plan, a Ministerial Committee that meets weekly and chaired by the Minister of Finance has been established. The President also welcomed assistance from the Government of the United Kingdom to conduct a forensic audit by an internationally reputable firm which has commenced its work and is on track to provide its initial findings by end-January 2014. In addition, through the office of Director of Public Prosecutions (DPP) and Anti-Corruption Bureau (ACB), the authorities are paving the way to recover the misappropriated funds and identify and prosecute those involved in the looting of government resources. To this end, adequate technical and financial support is being provided, both from the government and development partners. So far, dozens of arrests of individuals linked to the fraud has been made; through the ACB and DPP, 81 companies have been identified; of which 60 of them have already been profiled; more than 35 individuals and 12 cases have been committed to the high court; and 8 cases are ready for trial and the DPP has served disclosures to defendants. My authorities want to assure Directors that due process will be followed in accordance with the law to ensure that those responsible are brought to court.

With regard to the macroeconomic environment, while the fiscal scandal has put a dent in the recovery momentum, there are signs that the reforms are aiding the economy to better weather the shock. Inflation rose steadily from 12.4 percent in April 2012 to a peak of 37.9 percent in February 2013, due to the implementation of foreign exchange market liberalization measures and the Automatic Pricing Mechanism for fuel and utilities, as well as high prices of maize. A combination of improved availability of food after the harvest and consistent implementation of a tight monetary policy stance, as well as a rise in foreign exchange reserves has resulted in inflation decelerating from its peak. Foreign exchange reserves stood at 2.1 months of imports in mid-December 2013, up from 0.7 months of imports recorded in June 2012. However during October and November, the depreciation of the kwacha, a weak fiscal balance and an increase in food prices, reversed the disinflation trend observed since March 2013. In November 2013 inflation increased to 22.9 percent, as the Kwacha depreciated sharply largely due to the loss of significant donor support resulting from the fiscal scandal, though the level of official reserves was at its highest, in recent years.

The monetary policy stance continues to be prudent. The Bank Rate has remained at 25 percent since January 2013. The liquidity reserve ratio (LRR) was maintained at 15.5 percent during 2013. In the December 2013 Monetary Policy Committee meeting, the authorities decided to introduce measures to strengthen the LRR instrument by changing its composition, effective January 1, 2014. Although the LRR was not changed, the exclusion of vault cash from the LRR together with the requirement that eligible financial institutions will be prohibited from drawing down balances at the central bank to below 12 percent at all times has effectively increased the LRR. In addition they introduced a Lombard Facility, whose rate will be set at a spread of 2 percentage points above the Bank Rate to assist banks to manage their liquidity better.

While real GDP growth for 2013 is estimated at 5 percent, there are downward risks emanating from agriculture and mining. Nonetheless, all sectors of the economy are expected to register positive growth rates in 2013; and in particular, a significant rebound in growth is expected in manufacturing.

Program performance

In spite of the daunting challenges, my authorities continue to demonstrate a steadfast commitment to pursuing prudent macroeconomic and structural policies within the context of the ECF program. They adhered to most of the ECF program’s quantitative targets for end-March and end-June 2013. The continuous performance criterion on new nonconcessional external debt was missed inadvertently resulting from the use of an out-of-date discount rate. While the net international reserves target for end-September 2013 was met by a wide margin, targets related to the fiscal and net domestic assets of the RBM were missed as a result of the fraud discussed above, as well as due to higher interest payments than programmed, peace keeping operations and spending on social services in advance of grant receipts. My authorities, in consultation with staff, have already started to implement remedial measures to address the slippages. The December 13, 2013 outturn discussed in staff’s supplement to the Board is a testament to their commitment to stay the course.

It is against this backdrop that my Malawi authorities solicit the Executive Board’s support in completing the third and fourth reviews under the ECF arrangement and waiver for the nonobservance of performance criterion as indicated above. Moreover, they seek approval of their request for re-phasing of test dates and associated disbursements to better align the ECF review cycle with Malawi's budget calendar.

Fiscal policy

The authorities remain committed to pursuing sound fiscal management with a view to maintaining medium to long-term fiscal sustainability. In light of the large fiscal gap created by the overspending in the first quarter and suspension of budget support by donors in response to the fraud, the authorities are implementing policy adjustments to avert a resurgence of inflation and to preserve international reserve levels. While domestic revenue continues to perform better than expected, expenditure compression is still needed to close the emerging fiscal gap. The authorities put in place expenditure measure that include reductions in the travel budget and in other lower priority expenditure items, postponed domestically financed development projects while preserving social spending.

The authorities are also instituting appropriate fiscal policy measures to strengthen domestic revenue collection while ensuring that fiscal discipline is restored. In this regard, the Malawi Revenue Authority (MRA) has embarked on modernization efforts to strengthen VAT enforcement as well as an initiative to improve taxpayer compliance.

MRA also has given taxpayers a three-month window to disclose and pay without interest and penalty for outstanding tax liabilities.

On the public financial management front, my authorities would like to assure the Executive Board that they will continue to work with the IMF and the World Bank to address weaknesses in expenditure control which have resulted in excessive domestic borrowing and government payment arrears in the past. Through a Multi-Donor Trust Fund the authorities are implementing the Financial Reporting and Oversight Improvement Project. In addition, the authorities, with financial support from the German government, plan to commission a forensic audit going back to 2005 when the IFMIS system was introduced.

Monetary and exchange rate policy

Given the prevailing high levels of inflation, the RBM will continue with its tight monetary policy stance until overall inflation is brought down to single digits. This objective will be pursued through the use of a range of instruments such as open market operations, the Bank Rate, and foreign exchange operations.

My authorities consider that the current flexible exchange rate regime has served the country well. As a result, central bank intervention in the foreign exchange market will be limited to smoothening out market volatility and building international reserves. In particular, the RBM’s participation in the foreign exchange market will be guided by the need to accumulate and maintain reserves at about 3 months of import cover while at the same time endeavoring to minimize large swings in the Kwacha exchange rate.

Financial sector

Malawi’s financial system remains broadly sound. In addition to the policies outlined above, the RBM intends to upscale its oversight and supervision of financial institutions. It will also continue with its efforts aimed at improving the functioning and efficiency of financial markets and fostering the development of financial markets.

Conclusion

The economic policy reforms that my authorities have been implementing since May 2012 are showing some positive results and they are determined to stay the course. The swift response by my authorities in instituting appropriate corrective policy measures to address the fiscal slippages underscores their commitment to implementing the ECF program. My authorities consider the Fund’s and other development partners’ policy advice and financial assistance critical to improve the well being of Malawians through policies that promote sustained growth and poverty reduction.