Introduction

1. The Malawian authorities appreciate the candid and constructive discussions with staff during the Article IV consultations. They value Fund advice and broadly share the thrust of staffs appraisal of macroeconomic challenges and related policy priorities. They appreciate the earlier support received under the Rapid Credit Facility and the debt relief under the CCRT, alongside the general allocation of SDRs.

2. Malawi’s economy continues to face challenges, including from the impact of the pandemic and frequent weather-related shocks that have raised uncertainty and dampened growth and social outcomes. Notwithstanding the improved harvests in 2021 in parts of the country, over half the population continues to live below the poverty line. Poverty in Malawi is exacerbated by low productivity in the agriculture sector, limited non-farm economic activity, volatile economic growth, and the limited coverage of safety net programs.

3. Exogenous shocks alongside declines in donor support over the past five years of the previous administration, amplified macroeconomic imbalances and setback progress on human and social development. Against this backdrop, the new administration has been working to address governance issues it inherited and reset its relationship with the Fund, and is engaged in negotiations with staff on how best to secure macroeconomic stability, including how to contain the fiscal deficit while boosting growth, and measures needed to place public debt on a sustainable footing. They have requested a new Extended Credit Facility (ECF) program to help them address these challenges and support their pursuit of the key objectives of Vision 2063, while catalyzing critical donor support. They continue to work on the resolution of outstanding legacy issues in order to pave the way for progress on program negotiations currently underway.

Recent Economic Developments, COVID-19 Vaccine Deployment and Outlook

4. Real GDP is projected to recover from 0.9 percent in 2020, to 2.2 percent in 2021 and 3.5 percent in 2022. The expansion in economic activity is mainly attributed to favorable weather conditions and the support of agricultural input subsidies which contributed to a good harvest and increased tobacco production for export. However, the economy remains heavily impacted by the COVID-19 pandemic. After a severe second wave that largely subsided aroundMarch 2021, a third wave beginning in June led to a sharp increase in case numbers in the third quarter.

5. The government of Malawi commenced the first phase of vaccinations, targeting 20 percent of the eligible population, in March 2021. The authorities have administered at least 1,476,957 doses of CO VID vaccines so far which translates to about 3.2 percent of the population fully vaccinated. Given this slow rollout, the target of vaccinating 60 percent of the population by December 2022 remains a challenge, owing in part to limited quantities of vaccines. As part of further efforts to ramp up vaccination, the government is also scaling up communication to address vaccine hesitancy.

6. Headline inflation has been trending upward, rising from 7.6 percent in December 2020 to 9.8 percent in October 2021, mainly driven by increases in food, fuel, and agricultural input prices. With ongoing supply chain disruptions related to COVID-19, food inflation remains above 10 percent despite a good harvest. In the external sector, current account deficits continue to constrain gross international reserves.

7. The outlook remains subject to downside risks due to uncertainties, including around the pandemic and recent emergence of the Omicron coronavirus variant. The medium-term outlook is also clouded by ongoing climate change risks that could exacerbate imbalances while deepening economic scarring and poverty. This is because of the impact of climate change on the Malawi economy that is heavily dependent on agriculture, employing nearly 80% of the population primarily in small holder production. The high vulnerability to climatic shocks has significant economic and welfare implications and in light of this macro-criticality, attention to climate risk, adaptation and resilience building could be beneficial for the next Article IV cycle report. In recent years, Malawi has seen a rise in the frequency, intensity and unpredictability of climate shocks. Extreme weather patterns can generate a cycle of crop failure and food insecurity as seasonal dry and rainy conditions are less predictable and more intense. Floods are a major risk, with the two cyclones in 2019 having caused significant loss of life, scarring and population displacement, contributing to the humanitarian situation.

Fiscal Policy and Debt Sustainability

8. The authorities see the need for fiscal adjustment to ensure fiscal and debt sustainability and have been exploring options while embarking on revenue mobilization and expenditure management measures to narrow the fiscal deficit. In this context, the Domestic Revenue Mobilization Strategy (DRMS) was prepared with support from Fund TA and other development partners, to strengthen tax administration and help expand the tax base. Some of the measures identified in the DRMS are already being implemented, including the introduction of an import withholding tax in the FY 2021/22 Budget.

9. On debt management, the authorities have been consulting closely with staff on stabilizing debt and are currently engaging creditors to help address debt sustain ability. They are cognizant of risks and note staff’s call for a fast pace of adjustment that will help reduce the risk of debt distress to “moderate” in the medium term. The new PFM Act also makes provision for the creation of a Debt Retirement Fund to be funded via new revenue measures that are under development. The authorities have also scaled down the number of development projects to be funded in the FY 2020/21 budget to limit pressures on the budget and manage domestic debt. They plan to review these projects on a continuous basis. In addition, the commitment control system has been strengthened to operate strictly within budget provisions, in line with the authorities’ arrears clearance strategy.

10. Still on expenditure, the authorities have fast-tracked the implementation of the new Integrated Financial Management and Information System (IFMIS) to strengthen expenditure control, particularly for managing multi-year commitments to avoid accumulation of arrears across all Ministries, Departments and Agencies (MDAs). Further, the new Affordable Input Program (AIP), which replaced the Farm Input Subsidy Program (FISP), will be reviewed following a year of implementation, with the review largely focused on enhancing efficiency and reducing the fiscal outlay overtime, without compromising the objectives of the scheme.

Monetary, Financial Sector and Exchange Rate Policies

11. The banking sector remains well capitalized, liquid and profitable, though the pandemic and central bank policy response, necessitate risk monitoring. Throughout the pandemic, the Reserve Bank of Malawi (RBM) maintained an accommodative monetary stance. At the onset it lowered the Liquidity Reserve Requirement and the Lombard Rate and activated an Emergency Liquidity Assistance framework to support banks in the event of worsening liquidity conditions. It also granted a debt moratorium and allowed restructuring of loans to SMEs impacted by the pandemic. To strengthen the monitoring of financial sector risks RBM has requested Fund technical assistance, and has intensified banking supervision efforts with daily liquidity risk monitoring and enhanced offsite monitoring.

12. The RBM recognizes the need for greater exchange rate flexibility and is engaged in technical discussions with staff on the least disruptive approach to adjustment. The authorities also concur with staff that the monetary policy stance needs to be stronger to counteract inflationary pressure expected from greater flexibility in the exchange rate, and plan to gradually transition towards an inflation targeting framework by 2025. Given significant debt, however, they are also concerned at the impact of tighter monetary policy on government debt service and the cost of borrowing.

Governance

13. The new administration has been upfront on the need to address governance weaknesses from the previous administration and has prioritized transparency and efficiency in all aspects of government. The authorities reported the possible provision of inaccurate information by the previous administration to the Fund; and have been working closely with staff to resolve this legacy issue. RBM has started submitting appropriate data of higher frequency and improved quality, with measures to avoid similar occurrences in the future. The authorities are undertaking actions more broadly to address legacy issues related to weak governance, including a special audit of foreign exchange reserves of the RBM to be completed before the end of the first half of 2022. The RBM and the Ministry of Finance have also scaled up internal reconciliation exercises and increased the frequency of reporting to the Fund. They have also started implementing TA recommendations around economic governance, including reporting data on gross international reserves in line with the Data Template on International Reserves and Foreign Currency Liquidity.

14. The authorities are making progress on CO VID audits, seeking to address capacity constraints. Quarterly statements on commitments and payments of CO VID-19 related activities across all MDAs have been produced and published for FY19/20 andFY20/21. Additionally, publication of COVID-19 related procurement details on the Public Procurement and Disposal of Assets Authority (PPDA) website, including on beneficial owner(s) of companies awarded contracts, is progressing. The authorities are also taking measures to strengthen institutions that have a constitutional mandate to fight corruption, including the Anti-Corruption Bureau, the Financial Intelligence Authority and the PPDA.

Growth and Structural Reforms

15. Malawi has significant under exploited mineral, water and tourism potential that could make significant contributions to growth, revenues and development in the future. An analysis of the key transformative structural reforms that would help to unlock this potential may be worth considering in the next Article IV cycle. In the meantime, the authorities are exploring possible investment and growth potential in the mining sector, in addition to prioritizing the export diversification agenda. If successful, this could generate positive growth spillovers and higher export receipts.

16. The authorities agree with staff on the need to prioritize investment under current fiscal constraints. In this regard, they aim to reprioritize capital expenditure and prioritize policies to achieve higher productivity including accelerating human capital investment to foster equity and inclusive growth. This includes incorporating technical and vocational skills fit for the labor market, including entrepreneurship, in their human investment, in line with Vision 2063.

17. The authorities are prioritizing building resilience to climate change considering the country’s vulnerability to frequent weather shocks and lingering threats to food security. In this context, they updated the government strategy on climate change in February 2021 to address three key pillars, namely (i) human capacity building to strengthen skills development for the advancement of green, low emission and climate resilient development (ii) institutional capacity and iii) climate change financing. They look forward to financial and technical support from development partners to support the implementation of their climate strategy.

Conclusion

18. The authorities remain committed to finding the means to ensure the macroeconomic stability essential to support sustainable higher growth, and to addressing legacy issues. They value engagement with the Fund and stress the urgency of a successful conclusion to negotiations for a new multi-y ear ECF program needed to support stabilization efforts and place the country on a more sustainable path, arresting further deterioration in macroeconomic and socio-economic conditions. The catalytic role played by Fund support will also be critical to help close sizeable financing gaps, and in particular to help mobilize much-needed donor funding Meanwhile, the authorities remain steadfast in implementing prior actions to lay the groundwork for the Fund-supported program.