Malawi—Letter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding

September 19, 2003

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, D.C. 20431


Dear Mr. Köhler:

1. On December 21, 2000, the Executive Board of the International Monetary Fund (IMF) approved a three-year arrangement for Malawi under the Poverty Reduction and Growth Facility (PRGF). The implementation of our poverty reduction and growth strategy supported by the arrangement has been slower than envisaged owing to serious slippages in macroeconomic policies, and recurrent droughts that severely complicated macroeconomic management and aggravated poverty conditions for our rural population. The government recognizes that the delayed implementation of macroeconomic and structural policy reform has also impeded Malawi's progress toward the completion point under the enhanced HIPC Initiative. To this end, the government has recently made serious efforts to improve macroeconomic management and accelerate the pace of structural reforms. These efforts culminated in the implementation of our track record program during the first half of 2003.

2. In light of the above, the government is committed to reestablishing macroeconomic stability and accelerating structural reforms. It is making serious efforts to put its macroeconomic program back on track. The attached memorandum of economic and financial policies (MEFP) describes Malawi's economic and financial policies for 2003/04 (July-June), which aim to consolidate the economic gains achieved in 2002/03 and facilitate the conclusion of the first review under the PRGF arrangement. The program is derived from the Malawi poverty reduction strategy paper and builds on the policy measures outlined in our letters of intent of July 19 and August 22, 2002, and of May 28, 2003. On this basis, and in light of performance under our track-record program implemented during January-June 2003, we request a waiver of the nonobservance of performance criteria specified in paragraphs 2 (a)( i) and (iii), and 2(b)(i)(1) and (2) of the arrangement with respect to the second disbursement. Specifically, in light of the corrective measures taken, waivers are being requested for the nonobservance of the following performance criteria: (i) the ceilings on the stock of reserve money; (ii) the ceilings on the net domestic financing of the central government; (iii) the commencement of full operations of a unit in the Ministry of Finance to monitor the activities of parastatals and the completion of a first quarterly report by December 31, 2000; and (iv) the compilation by the Ministry of Finance of monthly reviews which summarize the ministries' monthly reports on commitment levels and arrears and assess the prospects for meeting budget targets in 2000/01.

3. We also request that the first review under the PRGF arrangement be completed, and that a disbursement of SDR 6.45 million be approved upon completion of the review. Furthermore, we request that the current PRGF arrangement be extended through December 20, 2004, and that the remaining undrawn balance of SDR 32.23 million be disbursed in five equal installments of SDR 6.45 million each upon completion of subsequent quarterly reviews. We intend to repurchase early existing obligations of SDR 17.35 million under the Fund's emergency assistance policy in five equal installments, starting with the third disbursement under the PRGF arrangement available on November 15, 2003. Finally, following the completion of the first review, we request that debt relief from the IMF, under the enhanced HIPC Initiative, be resumed. The second program review will be completed no later than November 14, 2003.

4. The government of Malawi believes that the policies set forth in the attached MEFP are adequate to achieve the objectives of its program, but it will take any further measures that may become appropriate for this purpose. Malawi will consult with the IMF on the adoption of these measures, and in advance of revisions to the policies contained in the MEFP, in accordance with the IMF's policies on such consultation.

5. The government of Malawi authorizes the IMF to make this letter, the attached MEFP, and the IMF staff reports relating to our PRGF program, available to the public, including through the IMF internet website.

Sincerely yours,

I. Background and Program Implementation

1. Notable progress was made during 2002–03 in reducing inflation and implementing structural reforms. Moreover, the food shortage that occurred during that period was successfully contained through a large-scale humanitarian aid effort and government maize imports.

2. Growth over the past few years, however, was too low to reduce poverty. Real GDP contracted by more than 4 percent in 2001, and preliminary data indicate that growth remained below 2 percent in 2002. Growth in the manufacturing and services sectors is estimated to have remained negligible due to the low agricultural and agro-processing output and high real interest rates. Industrial activity shrank to its lowest level in more than a decade. Agricultural output is projected to rebound strongly during 2003; however, overall real GDP is expected to recover modestly as growth in other sectors continues to be negatively impacted by the persistent high real interest rates.

3. The disinflation program has been broadly successful, but real interest rates remain high, raising concerns about output losses. Since end-2000, inflation has fallen considerably. The official 12-month inflation rate declined to 8½ percent in June 2003, from 35 percent at end-2000, attributable largely to the sharp decline in food prices. Real interest rates, however, have remained at over 30 percent, owing to an expansionary fiscal policy and persistently high inflation expectations, which remain deeply entrenched because of a history of disinflation policy reversals.

4. The 2002/03 (July-June) budget approved by parliament envisaged strong fiscal adjustment by reducing the domestic deficit to 4¼ percent of GDP (excluding the costs of the 2002/03 maize operation), from 7¾ percent of GDP in 2001/02. However, certain pressures emerged that made it difficult to attain the budget's fiscal targets. First, the interest bill was higher by 1.7 percent of GDP, as the budget estimate relied on an understated debt stock and donor budgetary support was withheld. Second, adjustments in civil servants' allowances were underestimated adding about 1 percent of GDP to the wage bill. Finally, several line items were underfunded by about 2.7 percent of GDP. However, revenues were buoyant, exceeding budget projections by about 2.5 percent of GDP, reflecting in part to additional measures detailed below. The deficit was thus contained to 7.1 percent of GDP (excluding the 2002/03 maize operation), thanks to remedial revenue measures that were introduced in December 2002 and efforts to strengthen public expenditure management.

5. The following revenue measures were introduced, yielding additional revenue equivalent to 0.8 percent of GDP:

• the collection of interim dividends and overdue obligations on on-lending operations from parastatals in February 2003 (0.5 percent of GDP);

• the taxation of housing allowances of higher-ranked civil servants on February 1, 2003 (0.1 percent of GDP);

• an increase in the license fee and the frequency of the certificate of fitness (0.1 percent of GDP);

• the suspension of import duty remissions, except to NGOs, on January 1, 2003 (0.1 percent of GDP);
• an increase in the fee for the price stabilization fund for petroleum
• an increase in the road levy by 95 tambala per liter on February 1, 2003.

6. At the same time, measures were taken to reduce nonpriority expenditures. A circular from the Office of the President and Cabinet (OPC) was issued in December 2002 requiring cuts in outlays on travel, locally funded capital projects and foreign service allowances. In the event, these cuts proved difficult to put into effect or were offset by overruns in other current outlays. Nevertheless, the following measures succeeded in reducing outlays by effecting the remission to the treasury revenue collection previously used by ministries and government agencies:

• subvented parastatal organizations were funded only after they have presented evidence of remittances of the pay-as-you-earn (PAYE) tax to the Malawi Revenue Authority (MRA); and ministries were funded net of PAYE, with the Secretary to the Treasury remitting PAYE deductions directly to the MRA.

7. Control mechanisms were introduced in the payroll system to reduce ghost employees. Measures were taken to improve the system's security, establish a computer-assisted payroll audit system, and conduct pay parades in the ministries of education, agriculture, health, natural resources, defense and home affairs. All irregularities uncovered during these checks have been addressed.

8. Furthermore, the government took measures to enhance systems to control and monitor expenditure (Chapter 4.4.3.1),¹ and to improve the tracking of pro-poor expenditure, in order to implement the MPRSP priorities (Chapter 4.4.3.1) (see Table 3).

9. The apparatus for monitoring, control, and clearance of domestic budgetary arrears was strengthened. To this end,

• regular monitoring of the arrears by the Budget Division in the Ministry of Finance was instituted in April 2003, including through monthly reports to senior management and follow-up with line ministries; and
• the government continued to pay off any new expenditure arrears within the current budgetary allocations of line ministries, and decided not to carry out offsetting operations, and to clear arrears within the calendar quarter in which they are verified.

10. The 2002/03 food shortage was successfully contained through a combination of food aid and the government purchase of commercial maize. Budgetary outlays in 2002/03 related to the government's maize operation are now estimated at about 4.4 percent of GDP (including interest costs and operational losses, but net of proceeds from the sale of maize during the fiscal year). As part of the food crisis response, the government imported 235,000 metric tons (which together with carryover stocks of 16,000 metric tons totalled 251,000 metric tons of maize) to partly fill the then estimated food gap of about 600,000 tons. In retrospect, the estimated food gap proved to be on the high side. Moreover, as the government and donors seriously underestimated the capacity of the private sector to respond to food shortages, the government was only able to sell about 43,000 tons of maize during the fiscal year. Following its decision in 2003 to increase the maximum stock of maize to be held as Strategic Grain Reserve (SGR) to 100,000 tons, the government has designated 44,700 tons to the SGR.² Accordingly, as at end June 2003, about 163,300 tons were available for commercial sale. The government expects to sell this balance during fiscal year 2003/04. It has already received commitments from the European Union to finance the purchase of 10,000 tons of maize in support of the WFP's humanitarian relief effort, and 22,000 tons of maize to restock the SGR. It has also recently tendered a further 100,000 tons for commercial sale. The gross proceeds accruing to the budget from the above sale of maize during 2003/04 is estimated at about MK 1.5 billion (or about 0.9 percent of GDP). If the remaining 31,000 tons are also sold during 2003/04, additional revenue of about 0.2 percent of GDP could be realized.

11. While the overall fiscal target for the first half of 2002/03 (July-December) was missed by ½ percentage point of GDP (excluding the maize operation), despite the higher-than-budgeted revenue collection, during the second half of the fiscal year fiscal performance remained broadly on target. Our track-record program targets for end-March and end-June 2003 were achieved, thanks to continued better-than-projected revenue collection, and savings on interest charges because of a shift in these payments to the next fiscal year with the issuance of longer-maturity government debt. For the year as a whole, the domestic budget deficit (excluding the maize operation) amounted to 7.1 percent of GDP (11.5 percent of GDP, including the maize operation). Due to the large (11.5 percent of GDP) shortfall in external budgetary support, the budget relied heavily on domestic financing. The government intensified efforts to protect pro-poor spending, and, despite increased efforts to reduce expenditures, these programs were generally implemented as budgeted, reaching nearly 10.9 percent of GDP (including 3.7 percent related to the government's 2002/03 maize operation). Reports on pro-poor spending are now routinely published.

12. Monetary policy, which has been the cornerstone of the stabilization effort, slipped in the second half of 2002 and the first half of 2003. Attainment of the Reserve Bank of Malawi's (RBM's) policy objectives was greatly hampered by the higher-than-programmed reliance on domestic financing by the government budget, and by the fast decline in its foreign exchange reserve holdings, owing, in part, to the emergency purchase of food imports. For June 2002, the indicative target for reserve money, the RBM's operational monetary target, was exceeded by about 3 percent, and for December 2002 by 18 percent. For the greater part of the period January-June 2003, reserve money growth exceeded the RBM's operational target by 10-15 percent. This monetary expansion has contributed to a depreciation of the kwacha of 17 percent against the U.S. dollar since end-June 2002 and created the potential for inflationary pressure.

13. Progress was made in implementing structural reforms. Sunbird Tourism and many of government's minority shareholdings were divested through public offerings. The sale of the Lilongwe unit of Cold Storage was completed in early March 2003. Moreover, the government has reached an agreement with all concerned parastatals on the repayment of on-lending arrangements currently in arrears. Although several measures, including the privatization of Shire Bus Lines, Malawi Telecom Limited (MTL), and Malawi Property Investment Company (MPICO) have been delayed, progress is being made in preparing these enterprises for privatization by end-2003. The selected bidders for Air Malawi decided not to takeover the company. The preferred bidder for David Whitehead and Sons was announced in early February 2003, but the privatization process was interrupted by legal challenges by a creditor bank and company employees.

II. Policies and Measures for 2003/04

A. Macroeconomic Policy Objectives

14. Our poverty reduction strategy aims at reducing the incidence of poverty to 59 percent in 2005 from 65 percent in 1998. We have adopted a four-pronged strategy to achieve the higher and sustained economic growth necessary to make a substantial dent on poverty (Chapter 1.3): to promote sustainable pro-poor growth by offering the poor an opportunity to increase their living standards and providing the private sector with an enabling environment for investment;

• to develop human capital, as a healthy and educated population will be more productive, and to reduce income inequality, as it restricts the productive potential of the poor;
• to improve the quality of life for the most vulnerable by strengthening their resilience to shocks through social safety net programs; and
• to establish good governance, thereby ensuring that public institutions and systems protect and benefit the poor.

15. The medium-term macroeconomic framework envisages attaining sustained growth of 5½ percent, reducing inflation to below 5 percent, and depending upon the level of sustained donor support, rebuilding international reserves to about 3½ months of imports by end-2005. Initially, the return to macroeconomic stability will provide the basis for lower interest rates and a rebound in private sector activity. Moreover, policies to promote broad-based growth in agriculture are expected to provide food security and income enhancement for the poor. Strong fiscal adjustment in 2003/04 will provide room for the repayment of the government's domestic debt, and for the required increase in private sector credit and investment, while pro-poor expenditure should increase with the decline of the government's interest bill. Monetary policy, in conjunction with a flexible exchange rate regime, will remain geared to achieving the targeted reduction in inflation. The external current account deficit should narrow in line with higher public and private savings, and external debt relief under the enhanced Heavily Indebted Poor Countries (HIPC) Initiative will help Malawi progress toward long-term debt sustainability.

16. The economic and financial policies for 2003-04 described in this memorandum emanate from the MPRS and aim at consolidating the progress achieved so far under the program and making progress toward the key objectives of our poverty reduction strategy. The macroeconomic objectives for 2003-04 are the following: (i) a rebound in economic growth to 5-6 percent, driven by small-scale agricultural production, manufacturing, mining, and tourism; (ii) containing inflation at 9 percent in 2003 and 7 percent in 2004; and (iii) increasing international reserves to about three months of imports of good and nonfactor services by end-2004.

17. During 2003, the government conducted workshops with MPRS stakeholders to review the MPRS, including its macroeconomic framework, and to make recommendations for the 2003/04 budget. These workshops also reviewed the list of pro-poor expenditures (PPEs), with a view to establishing output-based monitoring in time for the 2003/04 budget (Chapter 6.2). The first annual review of the MPRS was completed in March 2003.

B. Fiscal Policy

18. Large fiscal deficits have been crowding out private sector investment and led to a rapid increase in domestic debt to 15½ percent of GDP at end-2002, from less than 9 percent of GDP at end-2000. A decisive turnaround in fiscal policy is needed to establish macroeconomic stability, halt the increase in the domestic public debt, and create an environment conducive to private sector-led growth (Chapter 5.2.2):

• Strong fiscal adjustment in 2003/04, will be underpinned by the full year impact of fiscal measures introduced in 2002/03, the new fiscal measures, and the avoidance of extra-budgetary outlays. Some of the fiscal measures introduced but partially implemented in 2002/03 will have been fully implemented or replaced in the new fiscal year. For instance, road tolls have been replaced by a further increase in the fuel levy.
• In the medium term, large primary surpluses, after grants, will reduce the domestic debt stock and debt-service costs, and will allow for a sizeable expansion in private sector credit. In this context, understandings will be reached on the macroeconomic framework and the budgetary targets for 2004/05 at the time of the discussions relating to the third review to be conducted in May 2004.

The strategy for 2003/04

19. For 2003/04, the government will target a domestic fiscal deficit (excluding maize operations) of 3.8 percent of GDP, to lay the basis for a sharp reduction in domestic debt in the medium term. Much of the fiscal adjustment will be achieved as a result of the full-year impact of the fiscal measures already implemented and additional revenue and expenditure measures equivalent to 3.1 percent of GDP to bring about a more sustainable position, as described below. Moreover, the government expects that its debt and associated servicing costs will be reduced by the resumption of donor budgetary assistance. Reflecting projected donor grants equivalent to 13 percent of GDP, the overall balance (including grants) will thus improve sharply. The projected deficit³ would be reduced further when the excess 163,300 tons of maize is sold (para. 11). The program provides for reductions in the stock of domestic arrears (which are estimated at MK 400 million as of end-June 2003); these arrears are to be reduced by MK 100 million by end-December 2003. Thereafter, the stock of these domestic arrears, as determined through the external audit, will be reduced according to a timetable to be agreed by end-January 2004.

20. Revenues are expected to rise to 21.8 percent of GDP from 20.5 percent of GDP in 2002/03. The full-year effect of the tax on housing allowances and of the increase of the road fee and of the fee for motor vehicles' certificate of fitness are expected to yield additional revenues of about 0.6 percent of GDP, which will compensate for the dividends that were received in 2002/03. The surtax rate has been reduced from 20 to 17.5 percent. While this in itself would have reduced the proceeds by 0.75 percent of GDP, it will be compensated by the expansion of the domestic surtax base, thanks to the registration of 700 additional traders-a 30 percent increase vis-à-vis last year (yielding 0.25 percent of GDP)-and of 17 nonlife insurance companies following the passage of the surtax amendment bill in March 2003 (yielding 0.5 percent of GDP).

21. The government has taken several administrative measures to build upon last year's progress on revenue collection, which are expected to yield 0.25 percent of GDP. First, the Malawi Revenue Authority (MRA) has hired 320 additional collectors (a 30 percent increase) and has been allocated MK 300 million for transportation and communications equipment. Additional administrative measures to boost revenue collection include the following: (i) a door-to-door trader verification campaign to ensure that the all surtax proceeds are remitted to the MRA; (ii) the provision that all declarations must be accompanied by a certified check to avoid the proliferation of bad checks; (iii) the migration to the automated system of customs declaration and administration (ASYCUDA) during 2003/04 with an advanced classification and valuation module; and (iv) the enhanced use of surtax turnover information for evaluation of income tax returns. Finally, duty waivers, remissions and mitigations will continue to be suspended.

22. Additional measures have been implemented to enhance revenue during 2003/04:

• Ad valorem excise tax rates on petroleum products have been doubled (to 40 percent for petrol and diesel, and to 20 percent on paraffin). This is expected to yield about 0.8 percent of GDP.
• The government will make use of any decrease in petroleum product prices to augment government revenue instead of lowering retail prices for petroleum products.
• The excise rate on alcohol products has been increased by 10 percent, yielding about 0.2 percent of GDP.

23. Overall expenditure is projected to remain at about 35.2 percent of GDP. The interest bill will rise significantly on account of the longer maturity government domestic debt issued during 2002/03, and the later-than-anticipated decline in projected real interest rates. Other current expenditure would decrease significantly, as expenditures for bailouts of parastatals and extrabudgetary commitments are avoided. These projections incorporate additional outlays for local, parliamentary, and presidential elections in 2004. They also include new expenditure measures aimed at generating savings for about 1.9 percent of GDP. These savings are realized through reductions in budgeted travel outlays, nonfilling of vacancies generated by attrition, avoidance of promotions, and postponement of new domestically financed projects and other nonpriority recurrent expenditures. Pro-poor expenditure on MPRS priorities is projected to reach 8.3 percent of GDP.⁴

24. The implementation of the budget will be carried out on a cash basis in such a way as to hold on a monthly basis domestic expenditures (including domestic interest) closely in line with the domestic revenues mobilized, with the least amount of new borrowing from the domestic banking system. When foreign budgetary aid is received, it will be used mostly to repay domestic debt. A major problem in controlling government expenditure has been the difficulty in controlling expenditure commitments at the treasury in the context of a decentralized expenditure management system. Line ministries have limited capacity for monitoring and enforcing expenditure commitments. In view of the fact that the Ministry of Finance has primary responsibility for fiscal management, the system of treasury agents in line ministries will be strengthened by placing senior Treasury personnel as agents under direct control of the Secretary to the Treasury, to control and ensure that expenditure commitments remain within authorized limits, and that payments by ministries conform with the treasury allocation.

25. Moreover, the government, with the assistance of the World Bank, developed a medium-term wage policy. The new wage policy, which resulted from a comprehensive consultancy, is aimed at improving the wage competitiveness, strengthening public sector performance, and lowering attrition rates (Chapter 4.4.3.2). Its major elements are the following:

• develop an action plan for a comprehensive revision of the public service pension scheme (September 2003);
• publish the Policy Statement on wage policy (October 2003);
• establish a Public Service Remuneration Board (by October 2003);
• engage a Pay Policy Advisor (by November 2003);
• rationalize salary grades and move towards a unified salary structure (by December 2003);
• consolidate allowances into the salary structure (December 2003);
• recruit of staff based on established position and only those budgeted for (on-going);
• enhance of salaries to attract and retain scarce and critical personnel (June 2004); and
• establish an upper limit for contract renewals as appropriate (June 2004).

26. The management of public finances was substantially improved by the coming into effect of the Public Finance Management Act (PFMA) and the Public Procurement Act (PPA) in June 2003. The PFMA replaces and improves upon the Finance and Audit Act, by adopting a more comprehensive concept of public finance management requiring the government to produce detailed economic, fiscal, and financial reports. The PPA creates a new office of the Director of Public Procurement (ODPP) and strengthens controls and safeguards on public procurement. A timetable and regulations for implementing these two acts are being elaborated with support from the World Bank.

27. In 1995, the government introduced the medium-term expenditure framework to improve public expenditure management by linking fiscal policy and resource allocation to medium-term strategic priorities identified under the MPRS. Although progress has been achieved in shifting resources to priority sectors, the implementation of the MTEF in line with the MPRS has been impeded by the suspension of external budgetary aid, significant extrabudgetary spending and continuing divergences between approved budgets and actual outlays. The government intends to strengthen the implementation of the MTEF by enforcing fiscal discipline and better prioritization of public expenditures in line with the MPRS.

28. During 2000, the government introduced two expenditure control and reporting systems aimed at the better tracking and recording of expenditures commitments and payments: the Commitment Control System (CCS) and the Credit Ceiling Authority (CCA). These systems, together with the quarterly funding reports, have provided the basis for expenditure reporting and control under a system of decentralized fiscal management. During 2002/03 we strengthened these systems by improving the tracking of the PPEs, and simplifying the requirements of the CCS to make it easier for controlling officers to comply. The government plans to strengthen these systems further by extending the Integrated Financial Management Information System (IFMIS), the accounting package, to more line ministries which should allow the Treasury greater overall control over commitments and payments. In the interim, the Accountant General has established a Performance Monitoring Unit which will work closely with the Budget Division of the Treasury to follow up on the implementation of the CCS system, the status of bank reconciliation, the submission of expenditure and commitment returns and the maintenance of records.

29. To assist in strengthening the expenditure systems, the government plans to seek technical assistance to review and strengthen these systems, and to improve expenditure recording and monitoring. The Ministry of Finance also plans to strengthen its capacity for economic and financial analysis and reporting. Line ministries have an urgent need to develop capacity for financial management and reporting.

C. Monetary Policy

30. The RBM will continue to rely on the broad money stock (M2) as the nominal anchor to control inflation, with the RBM's net domestic assets (NDA) and the banking system's net claims on the central government (NCG) as the operational targets. The RBM will rely on NDA and NCG as the principal instruments to achieve the monetary policy objectives. In addition, a floor will be placed on net foreign assets of the monetary authorities (NFA). The growth of broad money is to be limited to 15 percent in 2003 and 11 percent in 2004.

31. Consistent with the use of money as the nominal anchor, the exchange rate of the kwacha will continue to be market determined. The RBM's interventions will, therefore, be limited to meeting the NFA target and smoothing exchange rate movements.

32. Further actions will be taken to develop the financial sector and reduce the costs of financial intermediation, including by

• reducing the export surrender requirement from 40 percent to 20 percent by end-June 2004, with a view to eliminating it altogether by end-December 2004;
• lowering the liquidity reserve requirement from 30 percent to 10 percent by end-December 2004, while mopping up any resulting liquidity injection, as needed, by open market operations;
• implementing the timetable of measures for the review of the financial sector regulatory framework, which was developed through a consultative process (Chapter 5.2.2.3); and
• continuing to implement the recommendations of the safeguards assessment by addressing delays in issuing of annual financial statements of the RBM , and reconciling the foreign reserve balances on a daily basis by end-December 2003.

33. The government will continue to develop the microfinance framework to facilitate, in particular, small-scale agricultural development, agro-processing, and small-scale mining (Chapter 4.1.2.2). This emerged as a core national development priority during the MPRS consultations, on which the cabinet acted by approving in November 2002 a microfinance policy. The next step is to develop the regulatory framework for microfinance, which is expected to receive cabinet approval by end-2003.

D. External Sector

34. The external current account deficit (excluding official grants) should narrow sharply in 2003, to about 15 percent of GDP, and to about 13 percent in 2004, from some 24 percent of GDP in 2002. Most of the improvement reflects the discontinuation of maize imports as a result of the improved food situation and a noticeable recovery in exports. The current account deficit will be financed through disbursements of donor grants and of concessional loans from the World Bank, the African Development Bank, and other donors. Gross external reserves of the RBM are projected to rise to about 3½ months of import cover by end-2005.

35. Debt relief under the enhanced HIPC Initiative will support Malawi's goal to attain long-term debt sustainability. While the net present value of debt-to-exports (including Paris Club pledges beyond Cologne terms) is somewhat less favorable than estimated earlier, it is projected to decline to below 170 percent by the end of this decade. An acceleration of export growth as a result of greater efficiency in tobacco-marketing arrangements and increased market access under the U.S. African Growth and Opportunity Act (AGOA) and the European Union's Everything But Arms (EBA) Initiative could further improve this key debt sustainability indicator. The government will continue efforts to secure debt relief from all external creditors.

36. The government imposed at end-2001 temporary import restrictions in response to claims of unfair trading practices by Zimbabwe. On a temporary basis, the government will introduce tariffs on imports from Zimbabwe to replace the current system of quantitative restrictions by end-December 2003. The tariffs will be reviewed every six months. The implementation of tariffs will automatically abrogate the Malawi-Zimbabwe bilateral trade agreement. At the same time, Malawi will finalize a Trade Remedies Law.

E. Structural Reforms

37. The structural reform agenda—outlined in the MPRS—focuses on removing obstacles to growth (Chapter 4.1). The MPRS recognizes that structural reforms, in particular in the agricultural sector, are key to achieving macroeconomic stability and reducing poverty.

38. Reforms in the agricultural sector will aim at promoting the efficient utilization of land by improving incentives for efficient land use and developing transferable land rights, to be incorporated into a new land law to be submitted to parliament by end-December 2003, or by a date to be agreed during the upcoming review with the World Bank. The government also plans to introduce reforms in the tobacco-farming sector aimed at promoting direct exports, reducing taxation and facilitating contract farming. Furthermore, the government will have developed a new food security policy based on the development of agricultural markets and food safety nets by the end of 2003. These reforms are being supported by the World Bank and other multilateral and bilateral donors.

39. Other structural reforms during 2003-04 will focus on those elements of the reform agenda that have a potential to undermine macroeconomic stability. These include strengthening the oversight of parastatals, completing the divestiture or liquidation of parastatals that rely on the budget, and further enhancing governance:

• Strengthening oversight of public enterprises (Chapter 5.2.2.1). The Public Enterprise Reform and Monitoring Unit (PERMU) will continue to monitor and control the financial performance of public entities and coordinate reform efforts. Consistent with the longer term goal to strengthen public debt management, the new Public Finance Management Act, among other things, provides a basis for developing an effective system for the authorization of parastatal borrowing by the Ministry of Finance. In addition, based on the agreements reached with all parastatals on a repayment schedule for on-lending arrangements in arrears, payments to the government resumed at the beginning of February 2003. Any borrowing by parastatals must have Ministry of Finance approval.
• Completing the reform of those parastatals that relied heavily on budgetary resources in the past (Chapter 4.4.3.2).

a. ADMARC remains insolvent and its liquidity position stretched. To make ADMARC viable, a comprehensive plan for restructuring its core operations is being developed during 2003, in consultation with the World Bank, other donors and civil society. The restructuring plan, expected to be agreed by end-December 2003, will call for a clear separation of commercial operations from subsidized social operations. Subsidies for social operations will be budgeted and identified in a performance contract between the government and the management of the social operations.

b. Regarding ADMARC's noncore operations, the government will divest ADMARC's investment portfolio by liquidating the minority shareholding in National Bank and SUCOMA by December 2003 to settle overdraft facilities and use the remaining sales proceeds, if any, to retire domestic debt. The government is finalizing the privatization of ADMARC's former subsidiaries by completing the privatization of Cold Storage by end-August 2003. The government intends to transfer of the assets of David Whitehead and Sons to the buyers before the end of 2003. In preparation for the privatization of Grain and Milling, an information memorandum was prepared and receipt of bids closed on July 31, 2003. With respect to Shire Bus Lines, a preliminary assessment of costs associated with servicing unprofitable bus routes was completed in February 2003, and a passenger service obligation survey was completed by June 2003. Based on the findings of this survey, government is expected to move forward with the privatization by December 2003.

• Enhancing governance (Chapter 4.4). The government has increased the staffing levels of the Anti-Corruption Bureau, in particular the investigative branch, from 14 at end-2001 to 25 at end-2002. The government will continue to train magistrates and judges in interpreting the Corrupt Practices Act. Moreover, draft amendments to the Corrupt Practices Act are to be submitted to parliament end-October 2003. The amendment specifies a level of proof that ensures an expedient prosecution process, makes abuse of office an offense under the Corrupt Practices Act, and establishes a "whistle-blower" program.
• Following the completion of the audit of the NFRA in June 2003, the Anti-Corruption Bureau will review the audit findings and decide on the list of companies, institutions and individuals who may have violated the law by end-December 2003.

40. As the government's maize operations gave rise to governance issues in the past, special emphasis has been placed on carrying out the current food security operation transparently. First, a task force, comprising various government agencies, donors and NGOs, was established to monitor and control all aspects of the operation. Second, in November 2002 a memorandum of understanding that spells out the domestic distribution arrangement and ensures that the distribution is in conformity with the National Food Reserve Agency's (NFRA's) Trust Deed was agreed between government, NFRA and ADMARC. Third, CISANET, an agricultural umbrella NGO, is monitoring distribution at the retail level. Fourth, government is facilitating the monitoring of the food security operation by the general public by publishing on a monthly basis data on all aspects of the maize operation. Finally, in addition to the audits of the Auditor General and the investigation of the Anti-Corruption Bureau, an independent auditing firm conducted a forensic and operational audit of the NFRA, covering all NFRA transactions and operations between 1999 and mid-2002, and made recommendations on improving operational procedures.

41. The food crises have revealed deficiencies in our food security and agricultural policies, which are now being addressed, including through World Bank support. The task force on food security has produced an inception report and a new comprehensive and multisectoral food security policy is expected to be prepared by end-2003 (Chapter 4.3.2). The Food and Agriculture Organization (FAO) is developing a framework for improved agricultural statistics, and the responsibility for compiling crop estimates has been moved to the National Statistics Office (NSO). These actions will help address the failure of the famine early warning system, which gave rise to a delayed response to the food crisis in 2001/02, and improve the reliability of food production data, the lack of which hampered the calibration of the 2002/03 food security operations. Finally, the government is in the process of revamping agricultural policies, including land policy and tobacco marketing arrangements, with a view to improving rural livelihoods (Chapter 4.1.1).

F. Statistics and Transparency

42. The government is committed to improving its economic and financial statistics. An action plan for improving the quality of the statistical database will be implemented, with particular emphasis on the national accounts, consumer price index, trade and external accounts. Moreover, the relocation of the economics section of the NSO to Lilongwe was completed in March 2003 and the entire NSO office will be moved at an appropriate time. Malawi's statistical system will be assessed in the forthcoming Report on the Observance of Standards and Codes—Statistical Data Module—and the Fund will provide assistance in developing statistical systems to meet General Data Dissemination System (GDDS) recommended practices under the Fund's GDDS Anglophone Africa project.

G. Program Monitoring

43. Technical memorandum of understanding (TMU). The program will be monitored using the definitions, data sources, and frequency of monitoring set out in the accompanying TMU.

44. Performance criteria. Tables 1 and 2 set out the performance criteria and benchmarks for end-September and end-December 2003, with indicative targets for end-March and end-June 2004.

45. Program review. The second review under the PRGF arrangement will focus on the implementation of the government fiscal strategy, including the strengthening of expenditure control mechanisms. The fiscal outlook and policies for 2004/05 will be discussed and agreed in the context of the fifth review discussions.

Use the free Adobe Acrobat Reader to view Tables 1-4 (183 Kb PDF file)

Malawi—Technical Memorandum of Understanding

1. This memorandum sets out the definitions for quantitative targets and a structural benchmark under which Malawi's performance under the program supported by a Poverty Reduction and Growth Facility (PRGF) arrangement will be assessed. Monitoring procedures and reporting requirements are also specified.

I. Quantitative Performance Targets

2. Quantitative targets for September 30, 2003 and December 31, 2003 have been established with respect to

• ceilings on net domestic assets (NDA) of the Reserve Bank of Malawi (RBM);
• ceilings on the banking system's net domestic claim on the central government (NCG);

floors on the level of net foreign assets (NFA) of the monetary authorities;

• ceilings on the contracting and guaranteeing by the central government or the Reserve Bank of Malawi (RBM) of medium- and long-term external debt; and
• ceilings on the contracting or guaranteeing by the central government or the RBM of short-term external debt.

3. A performance criterion that is applicable on a continuous basis has been established with respect to the ceilings on the stock of external arrears of the central government and the RBM.

4. A structural benchmark is applicable to the clearance of new domestic budgetary arrears of the central government.

II. Institutional Definitions

5. The central government includes all units of government that exercise authority over the entire economic territory. However, in contrast to the System of National Accounts 1993( SNA 1993) and Government Finance Statistics Manual 2001 (GFSM 2001) standards, nonprofit institutions that are controlled and financed by the central government are excluded for the purposes of this memorandum.

6. The accounts of the monetary authorities include the balance sheet of the RBM and the central government's holdings of international reserves.¹

III. Limits on Monetary Aggregates²

A. Net Domestic Assets of the RBM

7. A ceiling applies on the net domestic assets (NDA) of the RBM. NDA of the RBM is defined as reserve money minus net foreign assets of the monetary authorities.

8. Reserve money consists of currency issued by the RBM and balances of commercial banks accounts with the RBM. It includes required reserves held for Malawi kwacha deposits and any other domestic currency-reservable liabilities and other demand and time deposits held with the RBM.

B. Limit on Net Foreign Assets of the Monetary Authorities

9. A floor applies to the level of net foreign assets (NFA) of the monetary authorities. NFA will be valued in U.S. dollars at a constant program exchange rate. Monetary gold will be valued at the fixed RBM accounting rate. NFA will be calculated as the difference between gross international reserve assets and international reserve liabilities.

10. Gross international reserve assets of the monetary authorities are defined as the sum of:

• monetary gold holdings of the RBM;
• holdings of SDRs;
• Malawi's reserve position in the IMF;
• central government (treasury) holdings with crown agents; and
• foreign currency assets in convertible currencies held abroad that are under the direct and effective control of the RBM and readily available for intervention in the foreign exchange market or the direct financing of balance of payments imbalances and are of investment grade or held with an investment-grade institution;
• but exclude any foreign currency claims on residents, capital subscriptions in international institutions, assets in nonconvertible currencies, and gross reserves that are in any way encumbered or pledged, including, but not limited to, reserve assets used as collateral or guarantee for third-party external liabilities.

11. International reserve liabilities of the monetary authorities are defined as the sum of:

• outstanding liabilities of the RBM to the IMF; and
• any foreign convertible currency liabilities of the RBM with an original maturity of up to and including one year;.
• but exclude liabilities arising from balance of payments support of original maturities of more than one year.

12. Balance of payments support shall comprise all grant and loan external financing that is not automatically linked to additional budgetary expenditure. Project financing to fund particular activities is excluded from this definition, including food security funding from the European Union. Loan financing from the IMF is also excluded from the baseline balance of payments support. Given the large magnitudes involved, debt relief under the HIPC Initiative will be included in the projection of baseline balance of payments support.

13. The program exchange rate for all international assets and liabilities, including encumbered reserves, is the end-of-period exchange rate of June 2003, i.e., MK 89.915 per US$1.

14. Adjusters. The ceiling on NDA of the RBM will be adjusted downward by the full amount by which the cumulative receipts from the baseline balance of payments assistance exceed the program targets. It will also be adjusted downward by the full amount by which new domestic arrears are accumulated and net credit to the central government by domestic nonbanks is increased beyond the nonbank borrowing undertaken in July 2003.³ The floor on the NFA of the monetary authorities will be adjusted downward by the amount of the shortfall in balance of payment assistance, with a maximum limit of US$30 million. The floor on NFA of the monetary authorities will be adjusted upward by the full amount by which the cumulative receipts from the balance of payments assistance exceeds the program targets.

IV. Limit on the Financing of the Central Government

15. A ceiling will apply on the banking system's net domestic claims on the central government (NCG). The banking system's NCG is computed as the sum of (i) net borrowing from the RBM (including ways and means advances, loans, holdings of local registered stocks, and holdings of treasury bills minus deposits), (ii) net borrowing from commercial banks (including advances, holdings of local registered stocks and holdings of treasury bills minus deposits), and (iii) holdings of promissory notes. The treasury bills and local registered stocks are valued at cost. Excluded are promissory notes issued to cover RBM's operational losses in 2002 and 2003.

16. Net credit from domestic nonbanks includes (i) holdings of local registered stocks by the private sector and other financial institutions, (ii) holdings of Treasury bills by the private sector and other financial institutions, (iii) supplier credits, and (iv) holdings of promissory notes. The treasury bills and local registered stocks are valued at cost.

17. Domestic budgetary arrears are defined as the net accumulation of new budgetary arrears since June 30, 2003.⁴

18. New budgetary arrears are defined as those payments delayed on central government commitments, including on wages and salaries, pensions, transfers, domestic interest, goods and services, and payments to the Malawi Revenue Authority (MRA) for tax refunds. Payments on wages and salaries, pensions, and transfers are in arrears when they remain unpaid for more than 30 days beyond their due date.⁵ Domestic interest payments are in arrears when the payment is not made on the due date. Payments for goods and services are deemed to be in arrears if they have not been made (i) within 30 days of the date of invoice, or—if a grace period has been agreed—(ii) within the contractually agreed grace period.

19. The account held with the Bank of Tokyo-Mitsubishi in Japan was set up for the delivery of Japanese debt relief. The net deposit in the account is calculated as the cash debt relief deposited by Japan⁶ minus withdrawals from the account⁷ valued at the end-month Yen-kwacha exchange rate.

20. The definition of external debt instruments is set out in Executive Board Decision No. 6230-(79/140) of August 3, 1979, and as amended by Decision Nos. 11096-(95/100), October 25, 1995, and 12274-(00/85) August 24, 2000. For the purpose of this memorandum, "other external debt instruments" of paragraph 16 include in particular special loans such as external supplier credits and external holdings of promissory notes, but excludes balance of payments support.

21. Amortization of external debt is defined as amortization of project loans, balance of payment loans, and other external debt instruments.

22. Adjusters. The ceilings on the banking system's NCG will be adjusted downward by the full amount by which the cumulative receipts from the baseline for the balance of payments assistance exceeds the program target. It will also be adjusted downward by the full amount by which new domestic arrears are accumulated and net credit to the central government by domestic nonbanks is increased beyond the nonbank borrowing undertaken in July 2003.⁸

V. Limits on External Debt

A. Limit on Medium- and Long-Term External Debt

23. A ceiling applies to the contracting and guaranteeing by the central government, the RBM, or other agencies on behalf of the central government on debt with nonresidents with original maturities of over one year. The ceiling applies to debt and commitments contracted or guaranteed for which value has not been received. The ceiling is measured cumulatively from July 1, 2003 for the end-September 2003 and end-December 2003 targets.

24. The definition of debt, for the purpose of the limit, is set out in Executive Board Decision No. 6230-(79/140) of August 3, 1979,⁹ and as amended by Decision Nos. 11096-(95/100), October 25, 1995, and 12274-(00/85) August 24, 2000.

25. Excluded from the limit is the use of Fund resources; adjustment lending from the World Bank, the African Development Bank, and other multilateral agencies; debts to restructure, refinance, or prepay existing debts; concessional debts; and any kwacha- denominated treasury bill and local registered stock holdings by nonresidents.

26. For program purposes, a debt is concessional if it includes a grant element of at least 35 percent, calculated as follows: the grant element of a debt is the difference between the net present value (NPV) of debt and its nominal value, expressed as a percentage of the nominal value of the debt (i.e., grant element is equal to nominal value minus NPV divided by nominal value). The NPV of debt at the time of its disbursement is calculated by discounting the future stream of payments of debt service due on this debt. The discount rates used for this purpose are the currency-specific commercial interest reference rates (CIRRs), as published by the OECD. For debt with a maturity of at least 15 years, the ten-year average CIRR will be used to calculate the NPV of debt and, hence, its grant element. For debt with a maturity of less than 15 years, the six-month average CIRR will be used. For the purposes of the program, the CIRRs published by the OECD for November 15-December 14, 2002 will be used (http://www.oecd.org/). For example, based on these CIRR rates, a U.S. dollar-denominated debt with a 10-year maturity would be considered concessional if the interest rate did not exceed 4.64 percent.

B. Limit on Short-Term External Debt

27. A ceiling applies to the contracting and guaranteeing by the central government, the RBM, or other agencies on behalf the central government of debt with nonresidents with original maturities of one year or less. The ceiling applies to debt and commitments contracted or guaranteed for which value has not been received. The ceiling is measured cumulatively from July 1, 2003 for the end-September 2003 and end-December 2003 targets.

28. The definition of debt, for the purpose of the limit, is set out in Executive Board Decision No. 6230-(79/140) of August 3, 1979, and as amended by Decision Nos. 11096-(95/100), October 25, 1995, and 12274-(00/85) August 24, 2000.

29. Excluded from the limit are (i) debts classified as international reserve liabilities of the RBM; (ii) debts to restructure, refinance, or prepay existing debts; (iii) kwacha-denominated treasury bills and local registered stocks held by nonresidents; (iv) normal import financing; and (v) convertibility guarantees of the kwacha by the RBM. A financing arrangement for imports is considered to be "normal" when the credit is self-liquidating.

VI. Limit on External Payment Arrears

30. A continuous performance criterion applies on the nonaccumulation of external payment arrears on external debt contracted or guaranteed by the central government or the RBM. External payments arrears consist of external debt-service obligations (principal and interest) that have not been paid at the time they are due, as specified in the contractual agreements.

VII. Clearance of New Domestic Budgetary Arrears of the Central Government

31. Should at any time during the program new domestic budgetary arrears of the central government (as defined in paragraph 17 above) be verified, then the government will clear these arrears by no later than the end of the fiscal quarter following the fiscal quarter in which these arrears were accumulated (structural benchmark).

VIII. Reporting Requirements for Technical Memorandum of Understanding

32. The authorities have committed themselves to using the best available data, so that any subsequent data revisions will not likely lead to a breach of a performance target. All revisions to data will be promptly reported to the Fund staff, particularly when the changes are significant. The likelihood of significant data changes will be communicated to Fund staff as soon as the risk becomes apparent to the authorities. All data will be reported electronically in the format and frequency set out below and within the period specified.

33. On a weekly basis within five working days of the end of the respective week, the balance sheet of the monetary authorities will be reported; and on a weekly basis (each Wednesday) with a two day lag, daily gross reserves, the daily U.S. dollar to kwacha exchange rate, daily net interventions of the RBM in the foreign exchange market, daily reserve money, the daily net volume on open market operations, and the results of treasury bill and RBM bill auctions will be reported (reporting agency: RBM).

34. On a monthly basis within 30 working days of the end of the respective month, the monetary survey, the monetary authorities' accounts, the commercial banks' accounts, the international reserves position, local registered stock holdings, treasury bill holdings, interest rates, exchange rates, the consumer price index, guarantees extended by the RBM or central government on foreign operations of Malawian residents (reporting agency: RBM); and a consolidated table on total financing of the central government, including domestic and foreign financing will be reported (reporting agencies: RBM and Ministry of Finance).

35. On a monthly basis within 30 calendar days of the end of the respective month, the fiscal accounts of the central government, tables summarizing by line ministries achievement of commitment levels and arrears in the CCS3 and CCS4 returns, CCA, supplementary CCA, and reimbursement to commercial banks, central government reports on spending on pro-poor expenditure (PPE) programs, funding reports for wages, and other recurrent expenditure, and development expenditure, and account statements from the Tokyo-Mitsubishi account (reporting agency: Ministry of Finance); and, the revenue data and SGS import data will be reported (reporting agency: Malawi Revenue Authority (MRA)).

36. On a monthly basis within 45 calendar days of the end of the respective month, a review summarizing the monthly reports by line ministries on commitment levels and arrears and assessing prospects for meeting budget targets will be reported (reporting agency: Ministry of Finance).

37. On a quarterly basis within 45 calendar days of the end of the respective calendar quarter, the borrowings of the ten major parastatals (reporting agency: Ministry of Finance); a report on performance under the program (reporting agencies: RBM and Ministry of Finance); and a report on the verified expenditure arrears will be transmitted (reporting agency: Auditor General).