Introduction

1. Our authorities appreciate the constructive policy discussions during the recent Article IV consultations and program negotiations. They broadly concur with the staff assessment and its conclusions, and value the Fund’s policy advice as they pursue their national development agenda.

2. Malawi has made significant progress in achieving macroeconomic stability following two successive years of weather related shocks and challenges in public finance management. While growth is recovering and inflation has declined into single digit territory, more needs to be done to meaningfully tackle poverty through higher, more inclusive, and resilient growth. In this context, the authorities recently launched the third Malawi Growth and Development Strategy (MGDS III) for 2018–23. The strategy aims at boosting productivity, enhancing competitiveness, and building resilience through growth-enhancing investment and economic diversification.

3. To achieve the objectives of the MDGS III, our authorities request for a three-year arrangement under the Extended Credit Facility (ECF). The arrangement will support economic policies and reforms to entrench macroeconomic stability, and catalyze concessional financing for infrastructure development. The authorities have completed all five prior actions, and look forward to Executive Directors’ support for approval of a new three-year ECF arrangement.

Recent Economic Developments and Macroeconomic Outlook

4. Real GDP growth in 2017 is expected to have recovered to 4 percent, from 2.3 percent in 2016. The recovery has been supported by a rebound in agricultural output and a pick-up in construction activity and the wholesale and retail sectors. The manufacturing sector, however, continues to be weighed down by prolonged electricity outages. This notwithstanding, in the medium-term, growth is expected to reach 6 percent, propelled by improved confidence, more robust agricultural production, increased electricity generation and transportation, as well as improved access to finance.

5. Inflation, which has been trending downwards from a peak of 23.5 percent in July 2016, reached 7.1 percent by end-2017 owing to the stabilization of food prices, tight monetary policy, and a stable exchange rate. Inflation is expected to remain in single digit territory in 2018 and reach 5 percent in the medium term, aided by the continued implementation of tight monetary policy and low food and petroleum products’ prices.

6. On the external front, the current account deficit improved to 10.0 percent of GDP in 2017, from 13.6 percent in 2016, following lower maize imports after a bumper harvest and a rebound in exports. In turn, favorable balance of payments developments, improved confidence, and tight monetary policy have contributed to the stability of the nominal exchange rate of the Malawi kwacha against the U.S. dollar. The premium between the exchange rates of the Reserve Bank of Malawi (RBM) and forex bureaus remains very small, reflecting availability of foreign currency and that the exchange rate is market determined. Foreign currency reserves have been above three months of import cover. Going forward, improvements in competitiveness, export diversification, and fiscal restraint as well as an improvement in GDP growth are anticipated to gradually narrow the current account deficit to around 7.5 percent in the medium term.

Fiscal Policy and Public Financial Management

7. The authorities are committed to pursue fiscal consolidation while protecting growth-enhancing and pro-poor expenditures and ensuring debt sustainability. In this regard, they will enhance domestic revenue mobilization by continuing with broad-based tax reforms and rationalizing expenditures. Planned tax reforms include streamlining tax incentives, fully repealing the industrial rebate scheme, introducing a thin capitalization or earnings stripping rule, and redesigning turnover taxation to increase its effectiveness. All tax policy reforms and initiatives will continue to be guided by a shift in reliance from taxation of labor and investment to consumption. Furthermore, the Malawi Revenue Authority (MRA) is planning to launch the integrated tax administration system (ITAS), branded “msonkho-online” within the year, which is expected to enhance overall tax administration in the country.

8. On the expenditure side, controls have been enhanced to avoid further accumulation of arrears, and limit recourse to domestic financing, particularly from the RBM, as well as curb non-concessional borrowing. In this connection, the authorities have tightened commitment controls and established a system to track the stock of commitments. In addition, compliance officers from the Internal Audit Department have been placed in all key ministries, departments, and agencies (MDAs), with a plan to deploy them to all MDAs, to check and ensure that payments are only made to transactions that have supporting documentation. While budget implementation during the first half of FY2017/18 was challenging due, in part, to lower than projected revenue collections, the authorities remain committed to improving the fiscal position by end June 2018 through expenditure cuts.

9. To bolster growth, infrastructure bottlenecks in electricity, transportation, telecommunications, and water supply and irrigation will be addressed. The authorities, therefore, plan to raise, as soon as possible, needed infrastructure investments, particularly for key MGDS III flagship projects, in the above areas, while maintaining macroeconomic stability and debt sustainability. This is expected to be achieved through efficiency gains from improved public investment management and procurement, as well as partnering with the private sector and development partners. Health, education, and other social spending is anticipated to be increased through efficiency gains in on-budget spending.

10. Approval of the ECF arrangement will go a long way to catalyze the much-needed foreign financing for infrastructure. In this context, the authorities are committed to limit external borrowing to high priority projects to safeguard debt sustainability. They will improve investment planning— including rigorously prioritizing the MGDS III pipeline projects based on credible cost/benefit analyses, growth, poverty-reduction, and debt sustainability considerations. Furthermore, the Debt Management Committee will assess all borrowing to ascertain loan concessionality, taking into consideration the entire borrowing plan within the medium-term debt strategy.

11. Considerable progress has been made in public finance management reforms, including in establishing a fully functional Cash Management Unit; requiring all MDAs to submit five detailed fiscal reports as a condition for receipt of regular monthly funding; and fully reconciling the government cashbook with the bank account, a crucial step towards stronger public finance management. Furthermore, the authorities intend to continuously work on improving the procurement framework to enhance transparency, control, and accountability, following the enactment of a new Public Procurement Law. They will start by publishing all procurement information on the Ministry of Finance’s website, and using performance contracts to hold controlling officers accountable for not adhering to relevant rules and procedures. Over time, they will consider gradually moving to an e-procurement system.

Monetary and Exchange Rate Policies

12. The authorities are committed to maintaining tight monetary policy to reign in on inflation. In addition, the RBM has demonstrated strong commitment to stabilizing monetary conditions and bolstering the external reserves position using policy instruments at its disposal. To maintain positive real interest rates in the financial system, monetary policy will also aim to ensure that the policy rate remains above the rate of inflation through open market operations. Our authorities acknowledge the 2017 AREAER reclassification of the de facto exchange rate arrangement and reiterate their commitment to a flexible exchange rate regime.

13. Furthermore, the RBM is committed to develop an interest rate-based monetary policy framework and gradually transition from the current monetary aggregate targeting framework to a full interest rate-based monetary framework and to inflation targeting over the medium -term. 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) received so far in this area and look forward to further TA.

14. Safeguarding financial sector stability and resilience remains a key priority for the authorities. To this end, the authorities are enhancing both on-site and off-site supervision of banks and will continue to enforce compliance with all prudential norms, including asset classification and provisioning in the context of the recently introduced IFRS9. They remain committed to strengthening the regulatory framework of the financial system to mitigate risks. In this respect, they will re-submit to Parliament amendments to the Banking Act of 2010 and Financial Services Act of 2010 for eventual enactment. These amendments, which were informed by IMF technical assistance recommendations, aim to align the legal framework for bank resolution with best practices and provide more options for dealing with problem banks. By end-2018, the authorities plan to gazette regulations related to the revised AML/CFT framework, enacted in 2017. These will strengthen the asset declaration system and support the authorities’ anti-corruption efforts.

Structural Reforms

15. In pursuit of the objectives of the national development strategy, the authorities realize that far reaching structural reforms will be necessary to complement macroeconomic policies and reduce poverty. In this regard, they are committed to continue with reforms to address governance challenges. These include further strengthening public finance management, procurement, improving the investment climate, as well as pursuing reforms in the agricultural sector on the farm inputs subsidy program (FISP). To enhance inclusive growth, they will step up efforts to improve financial intermediation to raise access and affordability of credit to the private sector. The authorities are also committed to adhere to the automatic fuel pricing mechanism which has positively contributed to macroeconomic stability.

Conclusion

16. The authorities reiterate their commitment to entrenching macroeconomic stability, reducing poverty, and attaining higher sustainable inclusive growth. To this end, they will continue to implement an appropriate policy mix of prudent fiscal and monetary policies, complemented by structural reforms. Finally, our authorities value Fund support and look forward to an approval of an ECF arrangement to support implementation of their national development strategy.