Public Information Notice No. 01/7

Public Information Notice: IMF Concludes Article IV Consultation with Malawi

January 23, 2001

On December 21, 2000, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Malawi.¹

Background

Malawi is a predominantly agricultural country, with most of the population of about 11 million dependent on subsistence farming. Tobacco is the major export. It is one of the poorest countries in the world, ranking 7^th lowest in terms of per capita GDP out of 206 identified in the World Bank's World Development Report 2000/01. Per capita GDP was US$163 in 1999. Income is unequally distributed, and about half of the population lives below the poverty line. The HIV/AIDS pandemic has compounded Malawi's development problems. Malawi is a member of the Southern African Development Community (SADC) and the Common Market for Eastern and Southern Africa (COMESA), both of which launched free trade agreements this year, and is a participant in the Regional Integration Facilitation Forum (RIFF). During the first half of its 1995-99 Poverty Reduction and Growth Facility (PRGF)² arrangement, Malawi achieved a high annual GDP growth rate (averaging 10 percent) and a substantial reduction in 12-month consumer price inflation (to a low of 7 percent in 1996 from 75 percent in 1995). Subsequently, however, inflation picked up and growth slowed. 12-month inflation was 35 percent in November, 2000 and growth between 1999 and 2000 is estimated at 3.2 percent.

Although external shocks, in the form of periodic droughts and fluctuations in tobacco prices, played a part in these variations in economic performance, problems have been compounded by occasional weakening in the implementation of macroeconomic policies. During the early part of the PRGF arrangement, the fiscal deficit was reduced dramatically (from 15 percent of GDP, including grants, in fiscal year 1994/95 to 3 percent in fiscal year 1996/97) and the monetary stance was tightened. The benefits of these policies were, however, dissipated in fiscal year 1997/98 by slippages involving excess public spending, the accumulation of domestic spending arrears, and an increase in the fiscal deficit to above 8 percent of GDP. Subsequently, control over fiscal and monetary developments improved, although the accumulation of domestic spending arrears, and sharp changes in the real exchange rate, continued to hinder economic management. During fiscal year 1999/2000, the fiscal deficit was 5 percent of GDP, while broad money growth was 34 percent through 1999.

Developments in Malawi's external current account have been influenced largely by the effect of exchange rate movements on import demand and the performance of the tobacco sector. Sharply lower imports, following a substantial depreciation of the kwacha in August 1998, led to a temporary reduction in the current account deficit (excluding grants) to 12 percent in 1998 from 14 percent of GDP in 1997. This was reversed in 1999, with a rise in the deficit to 17 percent of GDP before official transfers.

Malawi deepened and broadened its structural reform program in the latter half of the 1990s. Government monopolies and controls on agricultural marketing and trade were abolished; the ground was laid for eliminating restrictions on petroleum importation and allowing prices to reflect market forces; external tariffs and nontariff barriers were reduced; and substantial progress was made in improving tax administration. An ambitious program for privatization was also launched. Structural reforms were further consolidated in 2000 with resumption by the private sector of oil importation, a decision by the authorities to refrain from further intervention in the maize market, and the establishment of an independent revenue authority.

The authorities have formulated an interim Poverty Reduction Strategy Paper (PRSP), which focuses on economic growth and targeted action to address poverty within a stable macroeconomic environment. It seeks to reprioritize public expenditures, create an environment conducive for private sector development, implement a comprehensive and cost-effective social safety net; and combat the HIV/AIDS pandemic.

The authorities' economic program will be supported by the first annual arrangement of the PRGF (see Press Release 00/125). It is based on objectives for real GDP growth of 3 percent for 2001; end-2001 inflation of 10 percent; and an increase in the level of gross reserves to 4.7 months of imports. The program provides for a balanced budget in the fiscal year 2000/01, while at the same time allowing increased shares of anti-poverty and other priority spending, particularly on education and health (including expenditure on AIDS). Targets are specified for reserve money, domestic financing of the government deficit, and net foreign assets of the monetary authorities. Issues of further structural reform and governance are addressed.

Executive Board Assessment

Directors noted with concern that, although Malawi's economic performance had improved in the latter half of the 1990s, macroeconomic stability had proved elusive, growth had been inadequate, and a large proportion of the population remains in poverty. While acknowledging Malawi's high vulnerability to external shocks, Directors observed that the country's economic problems have been compounded by occasional inconsistencies in the implementation of macroeconomic and structural policies, including the recent relaxation in monetary policy, which has contributed to currency pressures and a resurgence in inflation.

Directors welcomed the authorities' renewed commitment to implementing a comprehensive stabilization and reform program, for which they are requesting Fund support under the Poverty Reduction and Growth Facility (PRGF). They noted that the program is appropriately based on sound financial policies, reprioritized public spending, deeper structural reform, and a comprehensive and cost-effective social safety net. In addition, Directors urged intensified action to arrest the spread and debilitating effects of HIV/AIDS.

Directors noted the ambitious inflation target under Malawi's economic program for 2000-01 and stressed that achievement of this target would require the steadfast implementation of policies. They urged the authorities to adhere firmly to agreed monetary targets. Directors also emphasized that monetary policy must be underpinned by continued fiscal restraint, with a target of achieving fiscal balance in fiscal year 2000/01. They observed that this would critically depend on the authorities' determination to resist pressures on wages and salaries and on other recurrent expenditure.

Directors agreed that much will be required from the new system for controlling and monitoring the expenditure of line ministries, since a repetition of the excess levels of commitments and consequential arrears of the recent past could derail the program. Directors also welcomed other elements of the 10-point plan of the Minister of Finance and Economic Planning to improve budgetary management, particularly the undertakings to eliminate nonemergency extrabudgetary outlays; increase fiscal transparency; and invoke disciplinary measures under the new spending control mechanisms. They urged the authorities to improve expeditiously the monitoring and control of parastatals, and avoid the subsidization of maize or petroleum, which has caused substantial overspending in the past. Directors stressed the importance of improved targeting of government spending towards the poor, including food security, health and education; and welcomed the authorities' commitment to monitor and publish performance on a quarterly basis.

Directors welcomed the authorities' commitment to strengthen the structural reform program. They noted that the pace of privatization could be accelerated by improving the attractiveness of public sector assets to potential buyers through firmer action to liberalize markets and reduce cartelization, and emphasized the importance of enhancing competition in the financial sector by fully privatizing the two dominant commercial banks with safeguards against connected lending. Directors also emphasized that the gains to small holder agriculture from the liberalization of tobacco growing and marketing should not be put at risk by burdensome restrictions on tobacco buyers.

Directors welcomed recent initiatives to improve governance; including the strengthening of the offices of the Anti-Corruption Bureau, Department of Public Prosecution, Ombudsman, Auditor-General, and the Public Accounts Committee. They strongly urged the authorities to follow through vigorously on all investigations and prosecutions.

Directors noted that Malawi provides the core minimum data needed for surveillance and program monitoring, but observed that there are significant weaknesses with respect to the quality, timeliness, and coverage of economic statistics that hamper a more comprehensive assessment of economic developments. Directors urged the authorities to sustain efforts to improve data collection and dissemination, particularly in the area of fiscal statistics.