Introduction

1. Our authorities appreciate the candid and constructive policy advice from the Fund and broadly concur with the thrust of the staff appraisal and conclusions. The Extended Credit Facility (ECF) arrangement has been instrumental in supporting the overall national development objective of poverty reduction through sustainable economic growth and infrastructure development.

2. In 2015, the Malawi economy was severely hit by two consecutive weather-related shocks of heavy floods coupled with dry spells followed by the El Niño-induced drought in 2016. These shocks led to a decline in output, particularly in the agricultural sector, and rendered over 40 percent of the population food insecure. In turn, the shocks adversely affected policy implementation which also constrained meeting some ECF performance criteria on time. That said, the authorities express their gratitude to the Fund for the augmentation of access under the ECF arrangement in 2016 and to the international community for their financial and material support which enabled them to respond adequately to the humanitarian crisis.

3. The extension of the program to allow for the ninth review enabled the authorities to correct the policy slippages in pursuit of the original ECF objectives, namely, attaining strong inclusive growth, single digit inflation, and an increase of foreign reserves. The five prior actions which were a condition for completing the ninth review have all been fully met. Against this background, our authorities request for the completion of the ninth review under the ECF arrangement. They further request for waivers for non-observance of performance criteria.

Performance under the ECF Arrangement

4. While the program experienced multiple challenges over the last five years, the authorities remained committed to a successful implementation of the program, and took corrective measures to address the slippages. The weather-related shocks negatively affected economic activity which in turn had an adverse effect on domestic revenue mobilization. This situation was compounded by a sudden stop in budget support from development partners following the uncovering of a large-scale theft of public funds (“cashgate” scandal) in September 2013. These factors rendered budget execution and implementation of the ECF program very challenging. Nonetheless, the corrective measures taken by the authorities enabled them to regain fiscal control and momentum in implementing structural benchmarks. For the ninth review, all the five prior actions related to structural benchmarks in public financial management and the financial sector have been met.

5. However, our authorities request waivers for the nonobservance of three periodic performance criteria (PC) for end June 2016. The PC on the net domestic financing (NDF) of the central government and on net domestic assets (NDA) of the central bank were missed at end-June 2016. Following this, strong remedial actions were taken which brought domestic borrowing back on track. The PC on net international reserves was missed at end-June 2016 due to the El Niño-induced drought that affected the volume of exports. Subsequently, a large depreciation of the currency during the first half of 2016 took place coupled with improvements in the policy mix, including tighter monetary and fiscal policies.

Recent Economic Developments and Macroeconomic Outlook

6. Following the unusual combination of heavy floods and drought, GDP growth slowed down from 5.7 percent in 2014 to 3 percent and 2.3 percent in 2015 and 2016, respectively. Agricultural output dropped, especially the maize harvest which shrunk by over 42 percent from 2015 levels. At the same time, the reduction in hydroelectricity generation occasioned by water shortages inflated operational costs and led to low capacity utilization. In 2017, real GDP growth is expected to rebound to a range between 4–5 percent supported by a recovery in agriculture, construction, and the wholesale and retail sectors.

7. Inflation has been trending downwards for the last ten months, from a peak of 23.5 percent in July 2016 to 12.3 percent in May 2017 driven by declining food and nonfood prices owing to stabilization of maize prices and tight monetary policy. It is expected that single digit inflation will be attained by end-December 2018 aided by the continued implementation of tight monetary policy and low food and petroleum products’ prices.

8. With the decline in maize imports following improved harvest, conclusion of the humanitarian crisis, and a rebound in exports, the current account deficit is expected to narrow to 9.3 percent in 2017 from 13.5 percent of GDP in 2016. It is projected to remain at around 8 percent in the medium term, reflecting the growth trend, the high import content of public sector projects, and the slow pace of export diversification.

9. Medium term GDP growth is expected to increase to above 5 percent as macroeconomic conditions stabilize and investment and consumption levels rise. The authorities are aware that the prospects for higher medium term growth are constrained by electricity shortages, water supply, inadequate feeder roads, and access to credit. They are, therefore, committed to continue addressing these constraints as set out in their Economic Development Document (EDD) by, among other measures, increasing public investment in infrastructure and enhancing the business environment.

Fiscal Policy and Public Financial Management

10. The authorities aim to sustain the ongoing fiscal consolidation through enhanced domestic revenue mobilization by implementing broad based tax reforms, rationalizing expenditures, and enhancing controls to prevent the reemergence of domestic payment arrears while safeguarding social spending. In this connection, the draft FY2017/18 budget currently under discussion in parliament contains further measures to enhance revenue collection, including the introduction of an additional bracket for highly paid individuals, strengthening of tax compliance, and modernization of tax administration. The above tax measures are in addition to those implemented in the current financial year based on IMF tax policy recommendations which included expanding the coverage of VAT and eliminating several exemptions. The underlying principle in the tax reforms has been to shift away from the heavy reliance on taxes on factors of production to those on consumption.

11. On the expenditure side, the authorities will continue to exercise firm control on expenditures to limit domestic financing. In this respect, they will seek to contain the wage bill and the travel budget, and sustain the reforms on the fertilizer subsidy program. Review of the civil service pension scheme is also underway to ensure a fiscally sustainable migration to the new defined contributory pension scheme.

12. Considerable progress has been made in public finance management reforms. To enhance budget controls and better align spending with available resources, a fully functional Cash Management Unit has been established. In addition, ministries, departments and agencies (MDAs) are now required to submit five detailed fiscal reports (revenue return, expenditure report, commitment report, bank reconciliation of other recurrent transactions and development accounts, and a payroll return) before receiving their regular monthly funding. Furthermore, government bank accounts at the Reserve Bank of Malawi (RBM) were rationalized and all main accounts were incorporated into IFMIS. This has facilitated bank reconciliations and provided a safeguard against fraud. All redundant and dormant bank accounts have been closed, with the ultimate intention of introducing a Treasury Single Account.

13. While the risk of external debt distress remains moderate, domestic debt increased in recent years due to recourse to domestic financing after the sudden withdrawal of budget support and domestic revenue shortfalls. Domestic borrowing has now been brought under control and the authorities are committed to ensure that total public debt remains sustainable. In this regard, they have further strengthened the debt management framework to identify and address any risks associated with rapid debt accumulation.

Monetary and Financial Sector Policies

14. The RBM has demonstrated strong commitment to stabilizing monetary conditions and bolstering the external reserves position using policy instruments at its disposal. As reiterated to staff, they will continue to maintain a tight monetary policy stance to ensure that inflation remains on a downward trajectory with the objective of attaining single digit inflation by end December 2018. In addition, they will aim to maintain a minimum of 3 months of import cover in foreign exchange reserves. Complimented by greater fiscal discipline and improvements in the PFM systems, our authorities anticipate that the current policy framework is sufficient to keep inflation on a downward trajectory. Monetary policy will also aim to ensure that the policy rate remains above the rate of inflation and that positive real interest rates are maintained in the financial system. Underpinning these policies will be continued adherence to the flexible exchange rate regime and maintenance of the automatic fuel pricing mechanism.

15. Further, the RBM is committed to develop an interest rate based monetary policy framework and gradually transition from the current monetary targeting framework. This transition will require further capacity development in liquidity management, a deeper understanding of the monetary transmission mechanism, and improvements in inflation forecasting capacity. In this regard, the authorities appreciate IMF technical assistance (TA) so far received in this area and they look forward to further TA in the process. Meanwhile, the authorities will allow interest rates to play a significantly expanded role in the market, and the recent establishment of an interest rate corridor in the interbank market is expected to enhance RBM control over the interbank rate.

16. Safeguarding financial sector stability and resilience remains a key priority to the authorities. To this end, the authorities are enhancing both on-site and off-site supervision of banks as well as the regulatory framework and have adopted a prompt corrective action (PCA) framework to strengthen and clarify existing triggers for early remedial action against distressed banks. The authorities are also enforcing compliance with all prudential norms, including asset classification and provisioning. The new asset classification directive is based on the estimated recoverable amount method (ERAM) which imposes higher and graduated provisioning rates, and is expected to strengthen banking sector resilience and improve the ability to deal with adverse developments. Going forward, the authorities remain committed to taking additional steps to strengthen the banking sector and will effectively use AML/CFT tools to mitigate any risks of money laundering and corruption proceeds flowing into the financial sector.

Conclusion

17. The authorities reiterate their commitment to enhancing macroeconomic stability, reducing poverty, and attaining sustainable inclusive growth. To this end, they will continue to implement an appropriate policy mix to ensure fiscal sustainability and to ensure that inflation remains on a downward trajectory. Our authorities value Fund support in pursuing their national development agenda and look forward to the completion of this review and to further engagement with the Fund through a successor ECF arrangement.