Public Information Notice No. 98/88

Public Information Notice: IMF Concludes Article IV Consultation with Malawi

December 30, 1998

On December 17, 1998, the Executive Board concluded the Article IV consultation with Malawi¹ and approved a loan of SDR 20.42 million under the third annual ESAF arrangement (for further details, see press release number 98/63).

Background

Malawi’s economic performance improved substantially during 1995–96 under the program supported by the first annual arrangement under the ESAF: real GDP growth rebounded to a yearly average of 12 percent; the 12-month rate of inflation declined from 95 percent in mid-1995 to 10 percent at end-1996; the balance of payments improved, with gross official international reserves rising from practically zero at end-1994 to 3½ months of imports of goods and nonfactor services at end-1996; and the fiscal deficit (excluding grants, commitment basis) declined from 13½ percent of GDP in 1995/96 (April–March) to 7½ percent of GDP in 1996/97.

Subsequently, policy implementation weakened, especially during the second half of the second–year ESAF program: real GDP growth slowed to 5 percent in 1997, owing to a slowdown in agricultural growth, the overall fiscal deficit in 1997/98 widened to 11½ percent of GDP owing to a lack of spending discipline; the monetary program went off-track after mid-1997, owing to large domestic borrowings by the government; the kwacha came under pressure and was devalued several times; the end-of-period inflation more than doubled to 15¼ percent; and external performance worsened (because of domestic demand pressure and reduced capital inflows), with gross official international reserves declining just to over two months of imports of goods and nonfactor services at end-1997. The implementation of structural reforms also slackened considerably, most notably in the area of public service reform and privatization.

In order to re-establish a track record of macroeconomic management, the authorities embarked in April 1998 upon a six-month economic program and requested that IMF staff monitor its implementation, to which IMF management agreed. A staff-monitored program is an informal agreement between national authorities and the IMF staff to monitor the implementation of an economic program belonging to the authorities and considered by the IMF’s management and staff to be capable of achieving its targets if consistently implemented; such a program does not require nor imply endorsement by the IMF Executive Board.

Malawi’s staff-monitored program—which was based on a supplementary budget for April-June 1998 and the budget for FY 1998/99 (July-June) targeted—(i) a real GDP growth of 4¾ percent during 1998; (ii) abatement of the 12-month rate of inflation to 12 percent by year’s end; and (iii) improved external performance, with gross official reserves rising to the equivalent of 4¼ months of imports of goods and nonfactor services by end-1998. The program also called for the resumption of key reforms in the macroeconomic and structural areas.

Under the staff-monitored program, the authorities succeeded in regaining control over the budgetary situation: revenue collection recovered; and expenditure control and monitoring were strengthened under the oversight of a newly constituted cabinet committee and through strict implementation of a cash budget. The monetary program, however, came under severe strain, owing to a shortfall in export receipts and anticipated external budgetary support, as well as lower-than-planned government borrowing from the private sector. To cope with the difficult economic situation, the kwacha was allowed to depreciate by 40 percent (in foreign currency terms) in late August 1998; subsequently, a market-determined exchange rate regime was reinstated and monetary policy was tightened considerably. In the circumstances, inflation (12-month rate) is expected to intensify to 36½ percent by end-1998.

Following completion of the staff-monitored program, substantial adjustments were made in the prices of maize and petroleum products along with a reform of the marketing arrangements, in order to create an incentive structure suitable for increased maize production, and to eliminate subsidies on petroleum products. The price increases came into effect promptly on October 6. Soon thereafter the authorities developed a medium-term policy framework paper for the period 1998/99-2000/2001 and agreed on an annual program for 1998-99 (October-September).

The 1998–99 program, which will be supported by the third annual arrangement under the ESAF, aims at achieving GDP growth rates of 3½ percent and 5 percent in 1998 and 1999, respectively; lowering the 12-month rate of inflation to 36½ percent by end-1998 and 7 percent by end-1999; and strengthening the balance of payments, with gross official international reserves increasing to 4½ months of imports of goods and nonfactor services by end-1999. In addition, the program places emphasis on poverty alleviation and increasing the share of population with access to basic social services. In support of these objectives, the programs calls for continued fiscal consolidation and features a strong agenda of structural reformsincluding substantial prior actions relating to the pricing or marketing of maize, petroleum products, and electricity. The reforms also cover a variety of World Bank-assisted efforts in the fields of public sector resource management, privatization and social services, and significant improvements (with Fund assistance) in the institutional and statistical areas.

Executive Board Assessment

Executive Directors recalled Malawi’s strong record of policy implementation under the first annual ESAF arrangement, but expressed concern that slippages in carrying out the adjustment program had occurred toward the latter part of the second annual arrangement. They regretted that the emergence of major weaknesses in the fiscal area and rapid monetary expansion, coupled with worsening export prices and shortfalls in the disbursement of international support, had resulted in a substantial depreciation of the kwacha, an intensification of inflation, and a delay in launching a program that could be supported under the third annual arrangement.

Directors welcomed the authorities’ efforts to reestablish a track record of satisfactory policy implementation under the staff-monitored program, during April–September 1998. In particular, they commended the authorities for the progress achieved in the fiscal area, where major slippages had occurred under the second ESAF arrangement. In this regard, Directors welcomed the strengthening of revenue collection, the restoration of budgetary discipline, and the improvement in expenditure control and monitoring. Directors noted, however, that there had been delays in implementing remedial monetary measures in the wake of shortfalls in tobacco export receipts and the disbursement of external assistance. Accordingly, the exchange rate had depreciated substantially, contributing to large adjustments in commodity prices and an escalation of inflation.

Directors noted that the economy remains fragile, and they therefore welcomed the authorities’ resolve to proceed with a strong adjustment program, supported by the Fund under the third annual ESAF arrangement. In particular, they commended the authorities for the forceful steps that have already been taken in regard to the pricing and marketing of maize and petroleum products, and the adjustment of electricity tariffs. In view of the earlier slippages under the ESAF, Directors stressed the need for close monitoring of the program, and for keeping the bilateral donors fully informed. They also underscored the importance of more consistent policy implementation, and avoidance of stop-and-go policies.

Directors underscored the importance of fiscal consolidation through improved management of public sector resources, accelerated reform of the civil service, and intensified revenue efforts. They welcomed the authorities’ plans to seek a more effective prioritization of public expenditure by embarking on a full-fledged medium-term expenditure framework in the context of the 1999/2000 budget. Moreover, Directors urged the authorities to proceed expeditiously with privatization, contracting out, or liquidation of the activities that have already been identified through the functional review of ministries. On the revenue side, they urged sustained improvement in tax administration, and also encouraged the authorities to continue to increasereliance on domestic taxes by broadening and rationalizing the base of the domestic surtax, thereby paving the way for early introduction of the value-added tax.

Concerning monetary policy, Directors supported the authorities’ goal of reducing inflation to a single-digit level by end-1999. This policy will be the key to preserving the benefits of the recent large depreciation of the kwacha and creating a basis for stable growth. In this connection, Directors urged the authorities to act promptly when monetary conditions need to be tightened, especially in coping with unforeseen balance of payments pressures, including substantial shortfalls in the disbursement of international assistance. They also welcomed the authorities’ plans to begin addressing the problem of a relatively high statutory reserve requirement.

Directors urged the authorities to broaden and accelerate structural reforms. In this context, they stressed that proper pricing of maize, coupled with improvements in rural infrastructure and agricultural extension services, would help to create a sound incentive structure for the farmers. In view of the importance of maize in the consumption basket, they encouraged the authorities to work closely with the members of the international community to develop effective, well-targeted safety nets for the vulnerable groups. Concerning other structural reforms, Directors urged the authorities to speed up the reform of the civil service, as well as the privatization and restructuring of financial and nonfinancial public enterprises, focusing first on the largest government-owned banks, the public utilities, and other entities that are likely to have a substantial impact on Malawi’s overall economic performance.

Directors noted Malawi’s high debt burden, and called for innovative solutions, including through possible eligibility for the HIPC Initiative.

Directors urged the authorities to improve quickly, with the help of Fund technical assistance, the quality and availability of economic statistics, particularly in the areas of national accounts, fiscal, and balance of payments data. More generally, they urged the authorities to make full and effective use of technical assistance from the Fund and other sources, so as to help improve the administrative and policy implementation capacity of the country.