1. Our Malawian authorities appreciate the candid discussions with the country team during the mission on the first review under the Staff Monitored Program with Executive Board Involvement (PMB). They broadly share the thrust of staff’s appraisal and policy recommendations.

2. The Malawian economy has suffered from the adverse effects of multiple shocks that amplified pre-existing macroeconomic vulnerabilities, interrupted the post-pandemic recovery, and setback reform implementation. More recently, devastating climate events alongside spillovers from the prolonged war in Ukraine, weakened macroeconomic fundamentals. This has culminated in mounting inflationary pressures alongside cholera outbreaks and foreign exchange shortages, with dampening effects on growth performance. Despite the manifold challenges, our authorities remain closely engaged with staff to help restore macroeconomic stability, stay the course on the reform agenda, and move swiftly towards an ECF arrangement. More generally, the authorities seek to rebalance the economy to accelerate sustainable and inclusive growth to meet their development goals as articulated in the Malawi Vision 2063. Against this background, the authorities have renewed their commitment to build a track record of sound macroeconomic policies under the PMB to facilitate the transition to a medium-term Fund program. They view deeper Fund engagement as critical to building resilience to shocks, while addressing protracted balance of payments challenges by unlocking complementary donor support.

3. Program performance in the period under review has been mixed. As at end-December 2022, four out of six continuous Quantitative Targets (QTs) and one out of three Indicative Target (ITs) were not met. Program performance was partly affected by implementation challenges due to the difficulty of reversing the course late in the fiscal year as the PMB was approved in the third quarter of the fiscal year. Nevertheless, the size of the deviation was contained, despite the challenges compounded by climate shocks. The December 2022 QT on Net International Reserves (MR) was missed by a small margin while the March 2023 IT was met. The targets on Reserve Bank of Malawi (RBM) financing of government were missed largely due to the issuance of a promissory note in line with the legal obligation to recapitalize the central bank. Finally, targets related to the contracting or guaranteeing of external debt have been missed as the ceiling for those targets were set from the beginning of the program while the TMU defines them as starting at the beginning of the fiscal year. Since the beginning of the program, no non-concessional external debt has been guaranteed or contracted while new concessional debt has remained within the target. That said, revenue targets were met, as well as the targets on social spending.

4. To address the slippages, the authorities are implementing strong corrective actions, including their commitment to adhere to the FY23/24 budget through quarterly allotments. The allotments are aligned with realistic revenue projections, and efforts to rebuild foreign exchange reserves, enhance coverage, timeliness, and report the repository of guarantees and underlying contracts to the IMF.

5. Three out of seven structural benchmarks (SB) were met, including the SB on quarterly allotments as well as the SB on the strategy to clear arrears. The SB on publication of audited quarterly reports will be replaced by publication of monthly reports, which is a much stronger and more timely commitment. The authorities missed four SBs owing to challenges in eliminating previously budgeted expenditures and in reducing overreliance on the central bank for foreign exchange supplies. At the same time, delays in the external debt restructuring process, and the unanticipated consequences of the kwacha devaluation in May 2022, as well as the statutorily required recapitalization of the central bank contributed to the underperformance. Meanwhile, the authorities have requested a modification of the SB on the submission of amendments to the RBM Act to Parliament by end-October 2023 (second review), as consultation with Fund staff is still ongoing.

6. To keep the program on track, the authorities have taken strong remedial actions by completing prior actions to signal their commitment to a strong reform agenda. Both prior actions related to submission of the April and May Integrated Financial Management Information Systems (IFMIS) reports to IMF staff and resuming foreign exchange auctions to facilitate price discovery in the foreign exchange market, were met. The changes in the definition of some program targets should also facilitate the authorities’ monitoring of program performance. Against this background, the authorities seek Executive Directors’ support in completing the first review under the PMB program, and the associated requests.

7. Following a strong recovery from 0.9 percent in 2020 to 4.6 percent in 2021, real GDP growth declined to an estimated 0.8 percent in 2022. The prolonged effects of the war in Ukraine through higher fuel, fertilizer and food prices, and climate shocks continues to dampen growth performance. Reflecting the devastating effects of Cyclone Freddy on agricultural and electricity production, as well as damages to critical infrastructure, GDP growth has been downgraded from initial projections of 2.4 percent to 1.7 percent in 2023. The downward revision of growth forecasts also reflects the closure of schools and businesses, following the outbreak of cholera. However, in the medium term, expansion in output is projected to rebound to 4.6 percent, supported by more efficient implementation of policies, commissioning of new mines, and successful execution of the export diversification strategy. Nonetheless, the growth outlook remains subject to sizable downside risks, including from a protracted war in Ukraine, adverse weather events and the protracted debt restructuring process which could delay deeper reforms.

8. Meanwhile,inflationpickedupfrom9.3 percentin2021 to20.8 percentin2022,reflecting the depreciation of the exchange rate, as well as elevated import prices for fuel, food, and fertilizer. Nonetheless, the current account deficit narrowed significantly from 14 percent of GDP in 2021 to 3 percent of GDP in 2022, partly reflecting the compression of imports in the context of low external reserve buffers. Additionally, imports related to the cholera outbreak and humanitarian assistance in the wake of Cyclone Freddy in early 2023, exerted additional pressure on gross reserves. Asa result, official reserves continue to be extremely low, covering 1.5 months of imports of goods and services by end 2022.

9. Our authorities are stepping up fiscal consolidation efforts to achieve the medium-term objective of a primary balance of 0 percent of GDP and stabilize public debt. In this vein, they are implementing the Domestic Revenue Mobilization Strategy (DRMS) in a timely manner and rationalizing and prioritizing expenditures. Concurrently, they are introducing and implementing sound commitment controls and well targeted support to vulnerable households. In this regard, the authorities passed the FY2023/24 budget in line with the program macroeconomic framework and aligned spending to revenue projections to contain net domestic financing. They project a reduction of the domestic primary deficit excluding flows related to recapitalization of the RBM of about 1.3 percentage points of GDP in FY2023/24.

10. To boost fiscal revenues, the authorities have committed to decisively implement the measures announced in the DRMS. In particular, the DRMS aims to increase revenue by 5 percent of GDP over the next five years. To accelerate implementation, the authorities have incorporated the DRMS in the Malawi Revenue Authority’s (MRA) strategic plan and formulated a DRMS Monitoring Committee comprising officials from the Ministry of Finance and Economic Affairs (MoFEA), MRA, Accountant General, Immigration Department, Malawi Police Service, and Registrar General in FY2022/23. The measures that are being implemented as part of the DRMS include the introduction of PA YE brackets, implementation of advance income tax, new stamp duties and introduction of VAT on selected products. To strengthen tax administration, the authorities remain on track with the implementation of the Integrated Tax Administration System (ITAS).

11. The authorities will continue to implement expenditure rationalization measures, while preserving social support to cushion the most vulnerable households. They have implemented the first phase of reforms to the fertilizer and seed subsidy program (Affordable Input Program (AIP) by allowing the National Integrated Social Safety Net Program using the Unified Beneficiary Register, to reduce duplication of access, thereby making it more efficient and better targeted. Moreover, the authorities have taken measures to prevent cost overruns in the AIP from escalating fertilizer prices and exchange rate depreciation including through increments to farmer contribution, while capping the government subsidy. The authorities also plan to phase out the AIP in sub sequent reform stages. Importantly, they have moved farmers at the lower end of the income spectrum to social protection programs and those at the higher end of the spectrum to commercial agriculture programs, supported by development partners. Following the Personnel Audit completed in 2021, the authorities are undertaking actions to manage the public wage bill by removing ghost workers, freezing new hiring to the public service, except in critical areas such as health and education, while strengthening the payroll approval process.

12. To restore debt sustainability, the authorities will continue negotiations with creditors within their debt restructuring strategy. The strategy is designed to achieve debt sustainability and close the financing gaps, with the strategy focusing on resolving current external debt challenges, including solvency and liquidity concerns. The authorities are also seeking specific and credible assurances from official bilateral creditors and have contracted a debt advisor to support a credible process for restructuring public debt and ensuring their approach delivers by creating sufficient borrowing space to accommodate a UCT quality program. Moreover, the authorities will rely more on non-debt creating flows including grant financing to avoid worsening of debt dynamics. At the same time, they are committed to strengthening debt management, monitoring, recording, and reporting.

13. The RBM’s monetary policy stance continues to prioritize containment of inflationary pressures. In response to rising inflation, the RBM raised the policy rate by 400 basis points to 22 percent in April 2023. To further anchor inflation expectations, the RBM stands ready to tighten monetary policy as needed, while signaling commitment to contain reserve money growth in line with its monetary program. They are also utilizing various instruments including raising required reserves, RBM’s sales of government securities, and Open Market Operations (OMO) to mop up excess liquidity. At the same time, the RBM will take deliberate policy measures designed to support rebuilding of FX buffers, in a sustainable manner, and maintaining a market determined exchange rate. Specifically, the central bank will implement the agreed path towards accumulating foreign exchange reserves while limiting foreign exchange sales to the market. Moreover, the RBM will monitor short-term foreign currency drains to consistently keep track of external vulnerabilities. In parallel, the central bank is mitigating FX swap rollover risks and reducing swap costs by winding down FX swaps with non-residents, consistent with their plan to reduce the open swap position in the medium term. The RBM also resumed transparent foreign exchange auctions in June 2023 to promote price discovery and greater flexibility in the exchange rate and to foster the development of the interbank FX market (PA).

14. Malawi’s banking sector remains well capitalized, with sufficient profitability although liquidity remains tight in certain instances. That said, the authorities will continue to be vigilant to financial sector risks, including through enhanced oversight. To promote financial stability, they will closely monitor the banking system’s exposure to government securities and reassess loan and collateral quality needs of commercial banks.

15. The authorities have renewed their commitment to to ensure transparency in public procurement in accordance with the Public Finance Management (PFM) Act and appropriate procedures. Currently, they are working towards reversing the recent barter trade deal to follow the proper procurement and authorization procedures. Importantly, the authorities are taking the necessary steps to avoid recurrence of such incidences and have requested Fund TA on governance diagnostics to help identify vulnerabilities in regulation, legislation, and compliance. The government is also implementing a broader governance reform agenda through the adoption of a strategy to combat corruption as set out by the President, H. E. Lazarus McCarthy Chakwera in his 2023 State of the Nation Address. To build upon recent progress and enable future PFM reforms, efforts are currently underway to enhance the oversight of state-owned enterprises (SOEs) and implementation of the new IFMIS.

16. To strengthen the RBM’s autonomy, governance arrangements, and reserve management, a revised framework for the management of foreign reserves has been developed in accordance with recommendations of the 2021 Safeguards Assessment Report. In particular, the Reserve Bank Board established an Asset Liability Management Committee (ALCO). In consultation with Fund staff, they are committed to preparing and submitting the amendments to the RBM Act, as recommended in the 2021 Safeguards Assessment, to public consultation first then to the Parliament by end-October 2023.

17. Malawi remains susceptible to natural disasters, with the frequency and intensity of adverse weather events having increased in recent years. The recurring droughts, flooding and late-onset and erratic rainfall have disrupted food systems, undermined food security, and destroyed key infrastructure. Given the reliance on rain-fed subsistence farming of the country, the authorities recognize that climate adaptation finance is needed to develop resilient infrastructure and climate-smart agricultural practices. In this regard, they continue to work closely with key partners, including by developing a more efficient agricultural subsidy program to target the most vulnerable households. While agriculture remains fundamental to the economy, the authorities also aim to reduce dependance on agriculture through the implementation of the National Export Strategy.

18. Despite the multiple shocks and their negative repercussions on the economy, the authorities remain committed to reforms under the PMB. As such, they are undertaking strong corrective actions to strengthen program performance. In this vein, they re-affirm their commitment to implement the agreed macroeconomic adjustment and reforms to build the policy track record needed to support their future request for an Extended Credit Facility (ECF) arrangement. They look forward to continued engagement with the IMF as well as the Executive Board’s favorable consideration to proceed with their endeavors to stabilize macroeconomic conditions and place the economy onto a sustainable and inclusive development path.