Malawi: Request for Disbursement Under the Rapid Credit Facility—Press Release; Staff Report; and Statement by the Executive Director for Malawi

1. The COVID-19 pandemic’s economic impact has deepened against a backdrop of rapidly accelerating cases since June. As of September 16, there were around 5700 confirmed cases and 178 deaths (Text Figure 1). The authorities, with the support of the World Health Organization and other development partners, continue to strengthen the health system and implement a response plan. A partial lockdown1 was instituted after the first confirmed cases in April, but the number of cases accelerated during June-August. The effects of the partial lockdown and a considerably worsened global and regional economic situation (compared to IMF Country Report 20/168) are intensifying already hefty economic pressures.

Abstract

1. The COVID-19 pandemic’s economic impact has deepened against a backdrop of rapidly accelerating cases since June. As of September 16, there were around 5700 confirmed cases and 178 deaths (Text Figure 1). The authorities, with the support of the World Health Organization and other development partners, continue to strengthen the health system and implement a response plan. A partial lockdown1 was instituted after the first confirmed cases in April, but the number of cases accelerated during June-August. The effects of the partial lockdown and a considerably worsened global and regional economic situation (compared to IMF Country Report 20/168) are intensifying already hefty economic pressures.

Context

1. The COVID-19 pandemic’s economic impact has deepened against a backdrop of rapidly accelerating cases since June. As of September 16, there were around 5700 confirmed cases and 178 deaths (Text Figure 1). The authorities, with the support of the World Health Organization and other development partners, continue to strengthen the health system and implement a response plan. A partial lockdown1 was instituted after the first confirmed cases in April, but the number of cases accelerated during June-August. The effects of the partial lockdown and a considerably worsened global and regional economic situation (compared to IMF Country Report 20/168) are intensifying already hefty economic pressures.

Text Figure 1.
Text Figure 1.

Malawi: COVID-19: Cumulative Cases and Deaths

Citation: IMF Staff Country Reports 2020, 288; 10.5089/9781513559612.002.A001

Sources: Malawian authorities; IMF staff estimates.

2. The authorities have requested emergency Fund financial assistance under the Rapid Credit Facility (RCF) to help address urgent balance of payments needs. This facility would supplement an RCF for 47.9 percent of quota (SDR 66.44 million) approved by the Board on May 1, 2020 (IMF Country Report 20/168); and debt relief under the IMF’s Catastrophe Containment and Relief Trust (CCRT) covering up to two years’ debt service to the Fund (SDR 32.842 million) approved on April 13, 2020.2 The new government cancelled the existing Extended Credit Facility (ECF) on September 24, 2020 and expressed interest in discussing a new ECF arrangement once a broader reform agenda is in place and the impact of COVID-19 subsides. The authorities have requested debt servicing relief from bilateral creditors under the G20 Debt Service Suspension Initiative (DSSI) and discussions are ongoing. The projections in this report assumes the full amount of the DSSI is received from all creditors in line with agreed term sheets.

3. In June 2020, Lazarus Chakwera won the Presidential election, securing 59 percent of the vote. This election followed the Constitutional Court’s February 2020 ruling nullifying the May 2019 presidential election results—won by incumbent Peter Mutharika—given their finding of systematic irregularities in the election proceedings. President Chakwera has appointed a new Cabinet, including Felix Mlusu as Minister of Finance and Vice President Saulos Chilima as Minister for Economic Planning, Development and Public Sector Reforms. Wilson Banda was appointed the new Governor of the Reserve Bank of Malawi (RBM) and heads of several agencies and board members of major state-owned enterprises were replaced.

Recent Economic Developments and Outlook

4. A good harvest and an acceleration in domestically-financed government spending more than offset the pandemic’s economic effects and a slower execution in foreign-financed capital spending in 2020H1.

  • Prior to the pandemic’s acceleration in June, domestic economic activity benefitted from the strongest maize harvests in recent years (Text Figure 2)—agricultural trade markets in Malawi remained open through the partial lockdown—stepped-up implementation of domestically-financed development projects (including post-cyclone reconstruction), clearance of domestic arrears, and spending to hold elections. Nevertheless, the partial lockdown, political uncertainties, and continued electricity outages have weighed on manufacturing and wholesale and retail trade.

  • Exports, mainly agricultural products (including tobacco and tea), struggled due to reduced global demand, border closures, and heightened trade transit costs resulting from economic disruptions in neighboring countries—despite the U.S. partially lifting its suspension of tobacco imports from Malawi.3

  • Import declines due to lower international fuel prices and reduced private sector and foreign-financed project imports (see next bullet) were partly curbed by increased public sector imports (including in health care).

  • The global economic slowdown, amplified in the region by border closures and halting of activity by lockdowns, weighed on remittances, tourism, and foreign direct investment. Project-related inflows slowed in line with lower execution of foreign-financed development projects due to disruptions related to the COVID pandemic. This slowdown was broadly balanced by inflows of COVID-19 related aid from development partners.

  • Inflation declined to 7.6 percent in August 2020 reflecting the good harvest and lower international fuel prices. Non-food inflation remained under 5 percent, where a broadly stable exchange rate against the U.S. dollar helped contain rising non-fuel import costs. With inflation within the RBM’s target band, the RBM maintained its policy rate at 13.5 percent.

  • The banking system remains well capitalized, liquid, and profitable but non-performing loans (NPLs) have risen recently from 4.8 percent at end-June 2019 to 6.6 percent at end-June 2020. Private sector credit growth has been subdued (2 percent in 2020H1) due to low credit demand. To ease banking system liquidity constraints during the pandemic, the RBM has implemented several measures (detailed in IMF Country Report 20/168)—including lowering reserve requirements and a moratorium on debt service for small and medium enterprises (SMEs) until end-2020. The government’s payment of domestic arrears (0.9 percent of GDP) has also helped. The June 2020 stress test showed that overall, the banking system is resilient to interest rate and income risk shocks but vulnerable to shocks from concentration risk.

  • The domestic primary deficit expanded to 2.5 percent of GDP in FY 2019/20 (3.4 percent of GDP deterioration relative to pre-pandemic expectations, Text Table 1). Although revenue performance was better than anticipated in IMF Country Report 20/168, there were significant shortfalls relative to pre-pandemic expectations—especially in domestic, customs, and VAT import revenues attributed to lower activity from border closures, the lockdown, political uncertainties, and delays in ITAS implementation. Spending on health care (including wages for new medical staff and risk allowances) and maize purchases were stepped-up in response to the pandemic. However, the bulk of the spending overruns relative to the pre-pandemic budget were on clearing domestic arrears payments, preparations to hold new elections (including on security equipment reflected in generic goods and services), and higher salaries for striking university staff. The deficit was financed with development partners’ support (mainly budget support from the World Bank) and domestic sources (large banks, pension funds, and insurance companies).

Text Figure 2.
Text Figure 2.

Malawi: Maize Production and Prices

Citation: IMF Staff Country Reports 2020, 288; 10.5089/9781513559612.002.A001

Sources: Malawian authorities; IMF staff estimates.
Text Table 1.

Central Government Operations, FY 2019/20 (Percent of GDP)12

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Sources: Malawian authorities; IMF staff estimates.

The fiscal year starts in July and ends in June.

Pre-COVID refers to projections under the 2nd and 3rd reviews of the 2018–21 ECF arrangement (IMF Country Report 19/361); RCF I refers to projections in IMF Country Report 20/168; RCF II refers to projections in this report.

The discrepancy (under-financing) is due to payment of June salaries and invoices for development projects in July 2020.

5. The macroeconomic outlook, however, has deteriorated (compared to IMF Country Report 20/168) in line with a global and domestic intensification of COVID-19.

  • Growth is expected to fall to 0.6 percent in 2020 and to 2.2 percent in 2021 (0.4 and 0.3 percentage points below projections in IMF Country Report 20/168). Following a robust performance in 2020H1—owing to a strong harvest and substantial government spending—economic activity in 2020H2 is suffering from a further deterioration of the global outlook-resulting in substantially lower exports—a worsening economic impact of the pandemic, and a longer persistence of the shock (Text Figure 3). These factors are also expected to take a toll on domestic balance sheets with a continued rise in non-performing loans. A gradual economic recovery is expected during 2022–25 with growth averaging 6.4 percent.

  • The rapid rise in unemployment and loss of incomes and purchasing power will increase poverty and food insecurity—especially for non-farm lower income households. Real per capita income in 2020 will be more than 2 percent lower than in 2019.

  • Inflation is anticipated to remain in single digits at 9.1 percent in 2020—reflecting contained food inflation—and 9.5 percent in 2021 (assuming an average harvest next year and higher international oil prices); and moderate towards 5 percent over the medium-term. Non-food inflation is expected to remain around 5 percent in the near term—with pressures from higher import costs offset by substantially reduced activity in transportation and services—and moderate towards 3–4 percent over the medium-term.

  • The current account deficit (excluding official transfers) is anticipated to widen, reaching 20.5 and 20.3 percent of GDP—a deterioration of 2.4 and 2.3 percentage points relative to IMF Country Report 20/168. This reflects expectations of higher COVID-19 related imports, lower remittances, exports, and tourism given reduced global growth. Import contraction, due to a slowdown in domestic economic activity, will only partially mitigate these effects.

  • The domestic primary deficit is projected to be 4.4 percent of GDP in FY 2020/21. Staffs projections of pandemic-related revenue shortfalls (Text Table 2) are 0.9 percent of GDP larger than in the draft budget due to the authorities’ more optimistic revenue projections (largely based on a faster resumption of economic activity in 2021); and they are 0.3 percent of GDP less than in IMF Country Report 20/168, reflecting a base effect from larger than expected FY 2019/20 revenues. The projections of pandemic-related revenue shortfalls in Text Table 2 (for RCF I, RCF II, and the draft budget) do not include non-pandemic revenue measures that will result in additional revenue losses—including a doubling of the personal income tax (PIT) threshold (costing 0.8 percent of GDP and included in the budget and staffs projections). On the spending side, social spending has increased by 2.4 percent of GDP—mainly due to the new Agricultural Input Program (AIP, detailed in ¶8). Consequently, public debt is projected to reach 78 percent of GDP in 2021.

  • Financing a larger fiscal deficit will be challenging. Domestic liquidity is expected to be mainly channeled towards financing the government (given waning private sector credit demand). However, liquidity is expected to tighten as households and businesses use their savings to compensate for reduced incomes during the pandemic and banks’ cope with rising NPLs; while increased donor financing will mainly finance imports (particularly in health care). Consequently, foreign financing will play a larger role, especially health care and broader social spending-related project grants from development partners (including the World Bank and the EU), budget support from the African Development Bank, and part of the RCF financing.

Text Figure 3.
Text Figure 3.

Malawi: Contributions to Re GDP Growth, 2020–21 (Percent)1

Citation: IMF Staff Country Reports 2020, 288; 10.5089/9781513559612.002.A001

Sources: Malawian authorities; IMF staff estimates.1 Pre-COVID refers to projections under the 2nd and 3rd reviews of the 2018–21 ECF arrangement (IMF Country Report 19/361); RCF I refers to projections in IMF Country Report 20/168; RCF II refers to projections in this report.
Text Table 2.

Malawi: COVID-19 Fiscal Financing Needs, FY 2020/21

(Percent of GDP)1,2

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Sources: Malawian authorities; IMF staff estimates.

RCF I refers to projections in IMF Country Report 20/168; RCF II refers to projections in this report.

Financing needs are in comparison to pre-pandemic projections in IMF Country Report 19/361.

Revenue shortfall excludes losses from non-pandemic polices—including losses from doubling of the PIT threshold (0.8 percent of GDP) and reduced transfers from the off-budget fund holding the rural electrification levy (0.3 percent of GDP).

6. Compared to IMF Country Report 20/168, an additional external financing gap projected at $243 million (2.9 percent of GDP) has emerged in 2020 (Text Table 3), after taking into account 0.1 percent of GDP in CCRT debt relief (until mid-October 2020); an absence of ECF disbursements in the remainder of 2020; the full amount of the DSSI is received from all creditors in line with agreed term sheets; and assuming reserves in months of imports declines to 3.1. The overall balance of payments deteriorates from a previously projected deficit of 2.0 percent of GDP to a deficit of 4.5 percent of GDP. This mainly reflects a projected current account deficit of 20.5 percent of GDP (described above). Together, the two RCF disbursements are expected to fill 46 percent of the financing gap in 2020 with the rest covered by financial support from other development partners including the World Bank, African Development Bank and the European Union. $30 million of financing under this RCF will be provided directly to the Treasury as direct budget support. Notably, large balance of payments needs, related to the pandemic are expected to persist in 2021, with the external financing gap for 2020–21 totaling 7.7 percent of GDP or about $655 million.

Text Table 3.

Malawi: COVID-19 External Financing Needs, 2020 (Millions of U.S. dollars)1

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Sources: Malawian authorities; IMF staff estimates.

Financing needs from the pandemic are estimated relative to projections under the 2nd and 3rd reviews of the 2018–21 ECF arrangement (IMF Country Report 19/361).

Scheduled disbursements in 2020 totaled SDR 40.81 million (US$57.4 million or 0.7 percent of GDP). The accelerating spread of the pandemic and urgent nature of the current balance of payments needs makes it difficult to conclude any ECF reviews and the authorities have asked to cancel the existing ECF. In May, when RCF I was approved by the Board, staff assumed the spread of the pandemic would be limited in 2020H2, which would have permitted discussions on the combined 4th and 5th reviews under the ECF arrangement.

This reflects financial support from the second tranche of debt relief under the IMF CCRT. The first tranche is recorded as a grant in the balance of payments table and corresponds to the amount of SDR 7.202 million for the period April 14-October 13, 2020.

7. The outlook remains highly uncertain and subject to considerable downside risks. Some of the downside risks mentioned in IMF Country Report 20/168 have started to materialize, such as a more significant spread of COVID-19 within Malawi and slower than envisaged global and regional economic recovery. Further delays in economic normalization, beyond 2021, would result in longer disruptions to international trade and related transit costs as well as inflows from tourism, remittances, and FDI. Rapidly rising inequalities and food insecurity could lead to social discontent. A climate shock could further aggravate the situation, including through reduced agricultural production that would depress economic activity and raise inflation.

Policy Issues

The new government has prioritized limiting the pandemic’s social and economic impact and preserving macroeconomic stability—including debt sustainability—while developing a long-term growth strategy founded on improved governance, resilience, and broad-based economic growth.

8. The authorities continue actively implementing measures to mitigate the impact of the pandemic and preserve macroeconomic stability. These measures include:

  • Strengthening the health system. Key investments already underway include developing testing capabilities, equipping treatment centers, importing medical equipment and supplies, continued payment of risk allowances and salaries for additional medical staff, and raising public awareness—requiring at least 0.4 percent of GDP in FY 2020/21. Development partners, who finance and administer nearly half of total health care provision in Malawi (mostly off-budget), have also increased their outlays (Text Table 4).

  • Stepping-up social spending.

    • Social assistance under the social cash transfer program (SCTP) has been increased to help the most vulnerable. This program-administered by the government—is financed by development partners (on-budget) except for one district that is financed by the government.

    • The new Affordable Input Program (AIP, a key element in the FY 2020/21 budget), replacing the Farm Input Subsidy Program (FISP), is expected to reach four times as many smallholder farmers. This measure is intended to provide additional support for rural households (especially given the high incidence of poverty in rural areas) and to ensure future food security (where the likelihood of climate shocks is very high), which will in turn help contain inflation.

    • Education outlays and transfers to universities have been increased (in the FY 2020/21 budget) to facilitate their re-opening—largely providing access to clean water (for washing hands) and facilitating e-learning—recognizing the fundamental role productive youth will play in the near and long term economic recovery from the pandemic.

  • Supporting the private sector. Measures to provide relief to households and businesses (all in place since Spring 2020 and relevant items reflected in the FY 2020/21 budget), include certain tax waivers, reduced waiting time for pension gratuity payments, loan restructuring, a moratorium on debt service for SMEs (until end-2020, IMF Country Report 20/168 provides details)—the RBM is not providing provisioning relief to banks with these restructured or on-moratorium loans—and waiving fees on mobile money transactions to encourage cashless transactions.

Text Table 4.

Malawi: Major COVID-Related Fiscal Measures, FY 2019/20–20/21

(Percent of GDP)1

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Sources: Malawian authorities; IMF staff estimates.

RCF I refers to projections in IMF Country Report 20/168; RCF II refers to projects in this report.

Reduced waiting time for pension gratuity payments is an administrative measure that is costless.

The government-financed increase in SCTP related to mitigating the impact of the pandemic is zero in FY 2019/20 and MK 6 billion in FY 2020/21. In FY 2020/21, each SCTP recipient’s transfer will be permanently raised by 29 percent (for both the government and foreign-financed portions).

Waivers on import duties of personal protective equipment and disinfectants; income tax on salaries on non-resident medical personnel; and tourism levy.

9. Staff and the authorities agreed on a temporary relaxation of the FY 2020/21 stance to accommodate the deteriorated economic outlook as well as the need for fiscal consolidation over the medium-term. The new government is still formulating medium-term measures that would be consistent with the new long-term growth strategy under development (¶14). For FY 2020/21, the draft budget (presented in mid-September) continues to be discussed by Parliament. Until the budget is approved, a provisional budget (approved by Parliament on June 30, 2020), which allows for essential spending, is in effect. The targeted domestic primary deficit (4.4 percent of GDP) is 3.1 percent of GDP larger than in IMF Country Report 20/168; and 6.4 percent of GDP larger than prior to the pandemic (IMF Country Report 19/361)—the widening deficit is largely the result of revenue shortfalls and the measures outlined above (¶5 and ¶8) as the government seeks to respond to the intensification of the COVID-19 crisis. In fiscal policy discussions centered around:

  • Doubling of the PIT threshold. Staff strongly advised against this regressive measure, which disproportionately benefits the wealthy; and encouraged the authorities to consider (i) adjustments to the PIT rate schedule that increase progressivity of income taxation and partially recoup the intended revenue loss and (ii) broader use of tax deferrals and less frequent filing with a view to support businesses.

  • VAT refunds. To help provide liquidity to the private sector, staff recommended paying VAT refunds soon after their approval (0.3 percent of GDP)—substantial payment lags of approved refunds have occurred in recent years—and clearing the stock of unpaid refunds (0.1 percent of GDP as of end-June 2020). Balancing revenue constraints and spending priorities, the authorities have budgeted to pay 0.2 percent of GDP.

  • Improving non-tax revenue collection. As pandemic conditions permit, fees and charges will be increased, collections digitalized, and tolling fees implemented through new toll plazas. Tight control of fees and charges are needed to limit corruption vulnerabilities and prevent fragmentation of the budget.

  • Continuing to develop revenue administration measures that ensure business continuity during the pandemic. Implemented measures include use of e-payment platforms; specific teams engaging remotely with large taxpayers to assess the impact of COVID-19 on their operations; continuing desk review for audits already in progress and completing the full audit as soon as conditions permit; for the largest importers, applying documentary customs checks; use of pre-clearance facilities for imports; and remote monitoring usage of exempted and duty suspended goods.

  • Rolling-out the Integrated Tax Administration System (ITAS, four modules). Progress has been slowed by capacity constraints resulting from the pandemic but the authorities are working towards finalizing its remaining modules by early 2021.

  • Implementing the AIP. Staff supports the objective of supporting vulnerable rural households to alleviate poverty and food insecurity. Administration of the AIP using e-vouchers based on a farmer registry that is linked to the National ID system provides a transparent targeting mechanism and measures to ensure good governance of the program are elaborated in ¶13. However, staff stressed that targeted cash transfers (e.g., the SCTP) are more effective in supporting rural households. Staff also expressed concerns over the narrow focus of the program on maize as opposed to the FISP which also supported other crops; risks if the farmer registry and the National ID system are not sufficiently linked; and literacy constraints of beneficiaries that could affect the functioning of the e-voucher system. The authorities agreed to consider future reforms to improve the program’s efficiency and effectiveness.

  • Rationalizing the wage bill. Progress is being made in reviewing the existing payroll with a view to eliminating ghost workers and other fraudulent claims (while safeguarding the jobs of recently hired health care and education employees) by early 2021. Staff supports these measures but noted that the resultant savings are unlikely to offset the wage bill impact from the substantial FY 2020/21 public sector salary increase (0.9 percent of GDP) that will likely be permanent. The increase appears generous, where public sector employees are already benefitting from the doubling of the PIT threshold (which reduces their effective PIT rate). The benefit to economic growth and development from this salary increase is also likely to be more limited than if the resources were used to further boost targeted cash transfers to the more vulnerable (who have a higher marginal propensity to consume domestically).

  • Reprioritizing non-essential spending on goods and services and development projects in non-health areas. This process is being guided by placing less priority on projects with historically lower implementation rates and low efficiency in line with staff’s advice.

  • Further reprioritizing non-essential spending would be applied as a contingency measure, should COVID-19 related revenue shortfalls and spending exceed the approved budget.

10. The RBM stands ready to provide additional liquidity if needed to preserve financial stability. The RBM intends to maintain the policy rate, reserve requirements, and Lombard rate at their current levels. However, should liquidity pressures increase, the RBM will carefully consider further easing of monetary policy taking into account inflation developments. The RBM is prepared to use existing facilities to provide liquidity to commercial banks as needed to limit potential disruptions in the financial sector. Emergency Liquidity Assistance (ELA), if needed, is anticipated to be used by small banks; large banks maintain sufficient liquidity and capital buffers. Staff and the RBM agreed that any extensions of the moratorium on debt service will be considered on a case-by-case basis (rather than a blanket extension). Banking supervision has been intensified with daily liquidity risk monitoring and enhanced offsite monitoring (involving regular preliminary risk assessment summaries, bilateral meetings and supervisory letters where needed). To contain credit risks, the RBM has stepped up collection and virtual discussions with banks of relevant information; and banks and supervisors are collecting information about the borrowers and exposures subject to the moratorium (¶8).

11. Staff and the authorities agreed that greater exchange rate flexibility should be gradually pursued—keeping in mind its limited near-term benefit to exports and risks to inflation. The bilateral exchange rate against the U.S. dollar has been broadly stable in recent months, although it has depreciated by 2 percent since July. The depreciation has helped reduce the premium between rates offered by the RBM and forex bureaus, which rose as the pandemic began and foreign exchange flows from tourism collapsed. While greater exchange rate flexibility would normally help buffer shocks,, in the current pandemic environment (including border closures and heightened trade transit costs), a depreciation of the exchange rate will not boost exports or tourism but it could substantially raise the import bill for essentials goods and services—subsequently raising inflation and eroding purchasing power against a backdrop of declining incomes. In the meantime, the RBM is studying obstacles to FX market development and developing an action plan to deepen the market and channel the RBM’s role to dampening excess volatility and accumulating reserves (IMF Country Report No. 18/336).

12. The authorities are committed to ensuring that all government spending to manage and contain the impact of the COVID-19 pandemic is transparent and efficient—in line with their commitments in IMF Country Report 20/168 (Text Table 5). Regular publication of procurement documentation (tenders, bids, and names of awarded companies, products or services procured and their costs) on the Public Procurement and Disposal of Assets (PPDA) website (https://www.ppda.mw/#) has been expanded to include the names of the beneficial owners of the awarded companies. The PPDA conducts and publishes an ex-post validation of delivery on a contract-by-contract basis. The Ministry of Finance is on-track to (i) publish quarterly statements on commitments and payments of COVID-19 related activities within 90 days after the end of each quarter, beginning with FY 2019/20Q4; (ii) publish specifics of COVID-19 related salary costs in the monthly salary report (within 3 weeks after the end of each month, beginning with the September 2020 report, includes costs of hiring additional medical staff and risk allowances); (iii) include COVID-related spending in their budget funding and cash management analysis; and (iv) publish funding earmarked for COVID-19 related spending, including revenues from any new taxes and disbursements of development partner grants and loans (within 3 weeks after the end of each month, beginning with revenues for September). The National Audit Office (NAO) is preparing for its first quarterly audit of COVID-19 related spending (to be completed within 180 days after the end of each quarter, beginning with FY 2019/20Q4), which will be provided to the Minister of Finance for submission to Cabinet. The NAO also plans to conduct a comprehensive post-COVID-19 audit of relevant spending by the government and the Agricultural Development and Marketing Corporation (ADMARC) that will be published and submitted to Parliament (within 180 days of the pandemic’s conclusion). Concurrent to these COVID-19-related measures, the authorities continue to advance improvements in broader fiscal oversight such as budgeting processes, cash management, financial reporting, bank account reconciliation, and SOE oversight.

Text Table 5.

Malawi: Enhanced Transparency Measures Related to COVID-19 Spending

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Sources: Malawian authorities; IMF staff estimates.

13. Broader measures to strengthen transparency and governance are also underway. The Accountant General’s office is committed to regularly posting on the Ministry of Finance website the consolidated annual financial statements and monthly bank reconciliation compliance reports (LOI ¶5). To ensure the AIP’s success, independent teams (e.g., Farmers Union of Malawi) will monitor the AIP’s implementation and the National Audit Office will perform quarterly audits of the program.

14. The new government is in the process of formulating their long-term economic reform strategy, which will seek to enhance poverty-reducing and resilient growth while maintaining macroeconomic stability. The authorities have indicated that the strategy will include the following priorities:

  • Ensuring sufficient fiscal space for critical resilience building and social and development spending, while lowering debt vulnerabilities. To this end, continued improvements are being made in spending efficiency and a domestic revenue mobilization strategy is being finalized, for implementation from FY 2021/22. The strategy is expected to include implementing income tax on a worldwide basis, addressing BEPS issues and strengthening withholding taxes, rationalizing income tax exemptions, adopting comprehensive VAT reforms and property taxation, modernizing excise taxes, strengthening taxation of the informal sector and implementing a wide array of tax administration measures aimed at improving tax compliance. It also aims to substantially increase non-tax revenue and improve own-revenue generation capacity by SOEs and statutory bodies by rationalizing service delivery and improving costing.

  • Improving governance, with a focus on addressing corruption and increasing transparency and accountability. Fiscal reforms span tax administration, procurement, public financial management (including implementation of a new IFMIS drawing on FAD advice), public investment management, oversight of state-owned enterprises, and debt management. In agriculture, reforms will target improving productivity (including through the AIP and allowing exports of maize) and the efficiency of ADMARC.

  • The RBM will continue gradually transitioning towards an inflation targeting framework by 2025; and, once the crisis abates, study and address obstacles to FX market development in order to implement greater exchange rate flexibility to buffer shocks while keeping reserves at an adequate level.

  • Strengthening resilience to climate change and promoting more broad-based private sector development and export diversification. This includes implementing priority resilience building projects; improving healthcare, gender equality, and education; enhancing the business environment; improving agricultural productivity and reforming agricultural regulations and market intervention systems; and raising access to finance by addressing structural challenges such as improving property rights.

Access, Modalities, and Capacity to Repay

15. The authorities are requesting a disbursement under the RCF “exogenous shock” window equivalent to 52.1 percent of quota (SDR 72.31 million or US$101.8 million). This request is based on additional urgent balance of payments needs caused by the sudden exogenous shock stemming from an intensification of the COVID-19 pandemic. The disbursement would help the authorities weather the shock while safeguarding macroeconomic stability and catalyzing additional budget support. The RCF disbursement will bolster international reserves—where 30 percent of the disbursement will be made available as budget support to finance the authorities’ response to the COVID-19 pandemic. In particular, the authorities have expressed their intent to use this budget support for purchases of urgent health supplies and efforts to protect the most vulnerable. A memorandum of understanding has been signed between the Ministry of Finance and the RBM that clarifies the responsibilities for repaying Fund resources. The authorities have expressed a strong interest in discussions on a new Extended Credit Facility.

16. The authorities are actively seeking additional support from development partners, beyond what has already been disbursed or committed (including $204 million in 2020 from the World Bank, African Development Bank, EU, DFID, and GAVI, UN, Irish Aid, GIZ, and KfW). Absent additional support in 2020 or a widening of the financing gap should downside risks materialize, the rest of the external financing gap will be closed with a further drawdown of international reserves, leaving reserves coverage under 3.1 months of imports—below the staff assessed adequate level of 3.6. Discussions are underway with development partners, including the World Bank, to meet the financing gap in 2021, and the Fund’s engagement is expected to have an important catalytic role in this regard.

17. Malawi’s capacity to repay the Fund remains strong. With this RCF disbursement and cancellation of the current ECF arrangement, outstanding PRGT credit would reach 221 percent of quota and total PRGT disbursements over a twelve month-period would reach 123 percent of quota. These are all below allowable limits based on the IMF Executive Board decisions to temporarily: (i) double the annual access on emergency financing under the “exogenous shock” window of the RCF to 100 percent of quota on April 6, 2020; and to (ii) increase the limit for PRGT disbursements over a twelve month period from 100 to 150 percent of quota on July 13, 2020. Malawi has a strong track record in meeting its obligations to the Fund and debt servicing risks are mitigated by the country’s low indebtedness and the availability of concessional financing. Support under the CCRT will also ease the near-term burden.

18. Malawi is at moderate risk of external debt distress and high overall risk of debt distress (Annex I) based on an update of the April 2020 Debt Sustainability Analysis (IMF Country Report No. 20/168)—staff assess Malawi’s debt to be sustainable. The present value of external debt to exports is projected to breach the benchmark under the most extreme shock scenario (which assumes a 6 percent decline in exports in 2021 should recovery from the COVID-19 shock be slower than expected)—all other indicators remain below the relevant benchmarks in the baseline scenario. The present value of total public debt to GDP is projected to remain above the benchmark over the projected period. This mainly reflects increases in domestic debt due to significantly larger primary deficits on current policies, especially during FY 2020/21-FY 2021/22. The main reasons behind this development are the revenue shortfalls and higher health and social spending as a result of the intensification of COVID-19 across Malawi, doubling of the PIT threshold, a substantial increase in the public sector wage bill, and introduction of the AIP—all of which raise risks to debt sustainability compared to the April 2020 Debt Sustainability Analysis.

19. The authorities are committed to undergo an updated safeguards assessment before Board approval of any subsequent arrangement to which the safeguards policy applies. This would include an authorization for Fund staff to hold discussions with the RBM’s external auditors, and to have access to the RBM’s most recent external audit reports. The last safeguards assessment was undertaken in July 2018. Most safeguards recommendations have been implemented, including enactment of a new RBM Act in 2019 that strengthens the RBM’s governance and autonomy as well as progress towards implementation of a comprehensive ELA framework but limited progress has been made in addressing concerns over the RBM’s reserve management practices.

Staff Appraisal

20. The accelerated spread of the pandemic in Malawi and deteriorated global and regional economic situation has created additional external financing needs since the RCF disbursement approved on May 1, 2020. These additional urgent balance of payments needs are estimated at 2.9 percent of GDP, bringing the total external financing gap in 2020 to 5.0 percent of GDP. Economic growth is expected to decline from 4.5 percent in 2019 to 0.6 percent in 2020—with real per capita income falling by 2 percent. The resulting shortfall in tax revenues and increased spending to contain and manage the spread of the pandemic are contributing to a widening of the FY 2020/21 domestic primary deficit to 4.4 percent of GDP (whereas a 2 percent of GDP surplus was targeted prior to the pandemic). Tightening domestic liquidity has created a fiscal financing gap, which has been partially filled with budget support from the African Development Bank.

21. Staff welcomes the authorities’ continued efforts to contain and manage the spread of the pandemic. The relaxation of the FY 2020/21 stance is appropriate to accommodate the deteriorated economic outlook and critical measures to address the impact of the pandemic— including increased spending on health care, social assistance, and measures to ensure future food security. While the risk of external debt distress remains moderate, with high overall risk of debt distress, the new government is committed to formulating medium-term measures—including strengthening domestic debt management and implementation of a comprehensive domestic revenue mobilization strategy soon after the pandemic passes—to preserve debt sustainability and reduce debt over time. These measures will be aligned with the new long-term growth strategy under development. This said, staff is concerned about the recent decision to grant a large public sector salary increase that will likely be permanent and could constrain the fiscal space available going forward for important development initiatives. Measures to support financial stability (including support for SMEs) appear to be effective and should be continued, while further strengthening banking supervision remains key to enabling the early identification of potential risks. The authorities are undertaking the necessary steps to fulfill the commitments in IMF Country Report 20/168, including in ensuring that all government spending to manage and contain the impact of the COVID-19 pandemic is transparent and efficient.

22. Staff supports the authorities’ request for a disbursement under the Rapid Credit Facility in the amount of SDR 72.31 million (52.1 percent of quota). Staff’s support is based on the urgent balance of payments needs arising from a sudden exogenous shock stemming from the intensification of the COVID-19 pandemic in Malawi, a worsened global and regional outlook, and the authorities’ existing and prospective policies to address this external shock and the balance of payments difficulties, and the additional financing secured from other development partners since the first RCF disbursement. The proposed second disbursement under the RCF will close the immediate external and fiscal financing needs with a limited drawdown in international reserves. While there is significant uncertainty surrounding the outlook, Malawi is assessed to be at moderate risk of external debt distress and its capacity to repay the Fund remains strong. The authorities are committed to pursuing reforms in support of higher, more resilient, and broad-based medium-term growth and governance reforms while preserving macroeconomic stability; and have expressed their intent to request a new multi-year ECF arrangement that is aligned with their new long-term economic reform program. However, the accelerating spread of the pandemic and urgent nature of the current balance of payments needs makes it difficult to discuss design of a new ECF arrangement at this time.

Table 1.

Malawi: Selected Economic Indicators, 2018–25

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Sources: Malawian authorities and IMF staff estimates and projections.

The fiscal year starts in July and ends in June. The current financial year, 2020, runs from July 1, 2019 to June 30, 2020.

Domestic primary balance is calculated by subtracting current expenditures (except interest payment) and domestically-financed development expenditures from tax and nontax revenues.

The 2nd and 3rd Reviews under the Extended Credit Facility (ECF) Review were completed on November 22, 2019. The first Rapid Credit Facility (RCF) disbursement was approved by the Board on May 1, 2020; and the second disbursement is scheduled for Board discussion on October 2, 2020.

Table 2a.

Malawi: Central Government Operations, 2018/2019–2024/2025

(Billions of Kwacha)

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Sources: Malawi Ministry of Finance and IMF staff projections.

Farm Input Subsidy Program prior to FY20/21

This includes promissory notes issued for the repayment of domestic arrears accumulated before FY2014/15.

Other external loans include program loans other than budgetary support and G20 DSSI debt relief.

Domestic primary balance is calculated by subtracting current expenditures (except interest payment) and domestically-financed development expenditures from tax and nontax revenues.