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Mr. Rodrigo de Rato
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. de Rato:

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 slippages in macroeconomic policies. Because this arrangement expires in December 2004, we have decided to request a staff-monitored program in order to establish a performance track record. We would like to move into a new PRGF arrangement as soon as possible so that we can continue to restore sound financial policies and make progress with our structural reform program.

2. The government is committed to reestablishing macroeconomic stability. In the two months since the government was formed, we have stopped extrabudgetary expenditures that contributed significantly to excess spending in the past. Our policy of strict adherence to budget limits will be made easier because our new budget framework identifies all foreseeable expenditures. In addition, the Reserve Bank of Malawi has renewed its efforts to contain last year's monetary expansion.

3. The attached memorandum of economic and financial policies (MEFP) describes Malawi's economic and financial policies for 2004/05 (July-June). The program is derived from the Malawi Poverty Reduction Strategy Paper (MPRSP) and builds on the policy measures outlined in our letter of intent of September 19, 2003. We aim to establish a track record of strong performance by observing the quantitative and structural benchmarks set out in the attached memorandum. We request that the staff monitor our performance quarterly.

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 is prepared to implement additional steps 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 report available to the public, including through the IMF internet website.

Sincerely yours,

Memorandum of Economic and Financial Policies
of the Government of Malawi

I. Introduction

1. This memorandum of economic and financial policies (MEFP) outlines the government of Malawi's economic policies for the period July 2004 - June 2005, the 2004/05 financial year. It updates our policy statement of June 28, 2004.

2. Malawi's overriding goals of economic policy are high and sustainable economic growth that will spur poverty reduction and the achievement of the Millennium Development Goals. We must first, however, face the immediate problems posed by rising government domestic debt and high interest rates that threaten macroeconomic stability. Without a sound and stable financial environment, the government's domestic debt service obligations will continue to deter investment as well as crowd out expenditures for the transformation of the economy and pressing social needs such as education and health. Private sector investment has been dampened by very high interest rates. Moreover, financing government deficits by printing money will push up inflation and erode the savings and buying power of the poor. Thus, our near-term economic program emphasizes the containment of nonessential spending and efficient revenue collection. This will help stabilize government finances and pave the way for future economic successes.

3. Although much was accomplished during 2003/04, several targets under the Fund-supported economic program were not achieved. The new government has therefore decided on a fresh start and has asked IMF staff to establish a staff-monitored program (SMP). This arrangement will help us adhere to sound macroeconomic policies and restart financial support from the IMF.

II. Economic Background

4. Economic growth increased to 4½ percent in 2003, up from 2 percent in 2002, but regrettably below that needed for significant poverty reduction. The average rate of inflation continued to decline in 2003, marking the fourth year of progress in this area, and reinforcing a key element of macroeconomic stability. However, nonfood inflation picked up during the year, reflecting the depreciation of the kwacha in July-August 2003 and rapid growth in the monetary aggregates. Real interest rates remained high, adversely affecting private sector development.

5. Preliminary indicators present a mixed picture for the first half of 2004. Our maize crop was lower than a year ago due to adverse weather conditions, but tobacco production has increased, in part because of new opportunities for small scale-farmers such as contract farming. On balance, we now expect economic growth in the neighborhood of 4 percent, still well below our medium-term target. Nonfood inflation remained high, while locally produced food prices were relatively stable through June.

6. The Reserve Bank of Malawi (RBM) reduced its Bank Rate in three steps from 45 percent in late 2003 to 25 percent in June 2004. Yields on treasury bills and key commercial bank lending rates fell by similar amounts. The kwacha-U.S. dollar exchange rate remained stable over the period.

A. Review of the 2003/04 Program with the IMF

7. Since November of last year, we have complied with some, but not all, of the conditions set out in our Fund-supported program. We fell behind schedule on structural measures at the end of 2003, but by mid-March 2004 we had regained momentum with the strengthening of the Anti-Corruption Act, initiation of the domestic arrears audit, and preparations for streamlining the civil service compensation system. These efforts are paying off. In particular, we are on track to consolidate civil service wages and allowances and launch the new civil service pay scales in October 2004. The domestic arrears audit of nine ministries is nearing completion and will be extended to cover the rest of the government. The report on grain purchases in 2002 conducted by the Anti-Corruption Bureau has been forwarded to the Director of Public Prosecutions.

8. Our budget objectives were missed in December 2003, largely because of delays in donor assistance and higher domestic interest costs, but also because of some unplanned demands from the Office of the President, Foreign Affairs, security-related ministries, and special activities. As a result of these pressure points, parliament approved a supplementary budget in March 2004 that aimed to contain government borrowing and hold down the deficit. We revised our program targets with the IMF for end-March and end-June accordingly. Unfortunately, spending pressures again developed in March-May, and we exceeded targets for the government's deficit and domestic money creation. In consequence of these developments, the level of government debt rose sharply over the course of the fiscal year despite strong revenue performance.

9. Monetary developments were mostly driven by the budget deficit and its financing. By end-June 2004, government debt had reached MK 55 billion kwacha, from MK 38 billion a year before (gross debt valued at cost). RBM credit to the government had increased by more than 60 percent from June 2003, causing a very sharp rise in the monetary base. The RBM's ability to mop up this liquidity injection, however, was hampered by low levels of foreign exchange reserves and the rise in currency outside of the banking system. The RBM began to mop up excess liquidity in July 2004 by selling treasury and RBM bills.

10. During the 2004 Article IV consultations, we had the opportunity to discuss Malawi's Fund-supported economic programs over the past ten years. This is a very important exercise for both Malawi and the IMF. We draw two important lessons. First, continued engagement with the IMF will be critical for our economic success as we share the view that macroeconomic stability is the foundation of Malawi's economic future. Second, past Fund-supported programs incorporated too many structural conditions. Some of these conditions were not directly controlled by the government and, in hindsight, should not have been included in the program.

III. The Economic Program Through June 2005

11. A sound, sustainable macroeconomic framework is the cornerstone of our future economic success and, with food security, is an overriding priority. The government of President wa Mutharika is therefore committed to restoring budget discipline and reining in monetary growth. This strategy will help reduce inflationary pressures and lower interest rates. Moreover, we note that the financial targets we established for end-June 2004 were observed.

A. Fiscal Policy

12. Our fiscal policy objective over the coming year is to eliminate domestic borrowing by the government. This will be achieved in three steps. First, parliament approved a provisional warrant budget in early July that allows ministries to spend one-quarter of the authorized level for 2003/04 during the period July-September. Second, a budget for the full 2004/05 fiscal year; in line with SMP targets, will be presented to parliament in September. Third, we will revisit our performance in the January 2005 midyear budget review. We will use this opportunity to quantify the savings anticipated from recent policy initiatives. We will also look at specific measures to help us achieve the targets outlined in this paper. Some of those are outlined below.

The 2004/05 budget framework

13. As of the date of this memorandum, we are completing our budget framework for 2004/05. We are making every effort to make the budget comprehensive by including all foreseeable spending needs. This will help us avoid the underfunding that contributed to spending pressures in the past. Discussions at the ministry level proceeded during August, and we hope to begin debate in parliament in early September.

14. Our budget framework projects domestic borrowing of about 2 percent of GDP; significant borrowing will occur during the first quarter of the year. The projected borrowing in this period reflects the legacy of high interest rates and debt levels carrying over from last year and the conservative assumption that donor flows will only pick up beginning in October. In addition, we will purchase maize and fertilizer during the August-October period. We would begin to pay down our debt in 2005.

15. The proposed budgetary framework for FY2004/05 implies substantial savings relative to the last fiscal year. The funding for core recurrent expenditures, which is defined as current expenditures less debt service, maize, fertilizer, and expenses for the 2004 election, will increase by 6 percent, compared with an increase in nominal GDP of about 20 percent. We intend to focus our development budget on ongoing projects before beginning new ones. This will result in a MK 1 billion savings, compared with last year. In this year's budget there is a shift towards expenditure on medicine and food security, both priority areas. Specific savings measures include

• Travel budget. The travel budget will be reduced by 25 percent.
  
  
  • Eliminating the special activities vote. Beginning with the 2004/05 budget, any special expenditures will be met through the benefiting ministry's budget allocation.
    
    
  • Moving the presidency. The presidency has been moved to Lilongwe, producing saving on mirror ministerial offices in Blantyre and on travel.

16. We plan to implement several high priority policies. The fertilizer and maize programs reflect the importance of food security, while civil service reform, repayment of arrears, and ADMARC restructuring will contribute to fiscal sustainability in the medium term.

• A targeted seed and fertilizer program to enlarge TIP (targeted input program). We plan to issue vouchers toward the purchase of seed and fertilizer to about two million households living under the poverty line. The cost of the program will be held to MK 2.5 billion.
  
  
• Maize purchases. The strategic grain reserve (SGR) will be replenished as planned, in part funded by donors. The SGR will be distributed, if necessary, by the WFP and other organizations. In addition, the government will purchase maize for commercial distribution during the hungry season as a means of ensuring orderly maize markets and avoiding price spikes that could otherwise result from this year's low maize harvest. We will spend no more that MK 1.5 billion for the maize, and if this maize is sold for MK 17 per kilogram, the net cost to the government's budget will be limited to about MK 800 million, depending on the difference between the government's purchase and sales price.
  
  
• Civil service pay reform. We will introduce a streamlined pay structure that will help attract and retain our employees, especially in key shortage areas such as health and education. The new system will also be easier to understand and manage as it will reduce the number of pay grades and consolidate wage and personal allowances. The new structure eliminates the fuel allowance, which was one factor in above-budget spending in the past. The cost of this allowance would rise with increases in fuel prices and destabilize the budget. With the reform, personal emoluments will rise to MK 15.3 billion (including parliamentarians), but remain about 7 percent of GDP; this is in line with countries in the region.
  
  
• Repayment of domestic arrears. Each of the ministries covered by the 2004 audit will be expected to clear at least a portion of its arrears within their budget allocation. We will develop a centralized strategy to ensure that all claims are verified and prioritized to minimize cost before payments are made.
  
  
• ADMARC. The budget provides MK 800 million for ADMARC restructuring, and MK 400 million to subsidize the social functions of ADMARC.

17. We do not plan to change any tax rates prior to the mid-year review (see below). Therefore, the budget framework assumes that collections will rise owing to overall income growth, continued efficiency gains at the Malawi Revenue Authority (MRA), and the lagged effects of tax base broadening in late 2002 and rate increases in 2003. We are, however, considering tax changes in the future to make the tax system more efficient and equitable. These could include the elimination of the 40 percent personal income tax bracket, adjustments to the personal income tax brackets, and a small reduction in the surtax rate. These would only be implemented when our financial situation permits. We will request technical assistance from the IMF's Fiscal Affairs Department, to help us analyze the effects of such changes, and estimate the revenue impact. Some user fees and levies will be adjusted to account for past inflation

18. Resources available to the government will also depend on support from our development partners. Because our IMF-supported program has been replaced by a staff-monitored program, direct budget support is on hold. However, as we have made progress in restoring fiscal discipline and monetary control in June and July 2004, we anticipate this flow of resources to resume soon and increase later on as we demonstrate our commitment to sound policies. For the purposes of our budget exercise, we have made conservative estimates of budget support, in part because these flows have been very difficult to predict in the past. We will reevaluate the situation during the midyear budget review (January 2005), when we will devote any additional support to reducing our domestic debt. This will have the long-lasting benefit of lowering interest payments and releasing resources for priority services.

19. As noted above, our fiscal policy objective for this year is to limit borrowing from the domestic economy as much as possible. We are confident that this can be accomplished through a prudent budget, rigorous expenditure management, and a strong MRA. However, our projections show a significant need to borrow in the first quarter of 2004/05 (July-September) followed by three quarters of far less borrowing and some debt repayment. Therefore, this early borrowing should not be seen as an indication of weak budget performance. For this reason, we are looking at ways to keep our citizens, financial markets, and development partners better informed about our budget implementation results.

Improving expenditure management

20. A key purpose of improved expenditure management is to hold spending within the approved budget and avoid the buildup of arrears. We are making progress in this area and soon expect to see benefits. We will begin testing the expenditure information that has recently become available from the RBM's payment system for government accounts, and in August we designed and tested summary reports of reimbursements compared with the budget. These have been tailored to the needs of key management at the Ministry of Finance and RBM, and could help us to monitor budget execution. We will begin to use this system, first on a testing basis, to reject CCAs (credit ceilings) that exceed the budget. Strengthened communication between the budget monitoring and evaluation division in the Ministry of Finance and the newly established Department of Public Procurement ensures that tenders are only awarded within budget limits. In addition, we are now evaluating our new information management system (IFMIS), and we hope to correct identified deficiencies such as the absence of a cashbook in the near future.

21. We are following through with the implementation of the Public Finance Management, Public Audit, and Public Procurement Acts approved by parliament in 2003. We are currently finalizing treasury instructions to implement the new Finance Act. We have also cleared the backlog of annual final accounts. The 2002/03 accounts will soon be presented to parliament, and we are working to improve further the timeliness of the submission of our accounts as required under the new law.

22. We are also taking steps to strengthen the operations of the Ministry of Finance and the existing manual processes. We are planning to hire five to six additional qualified staff for line positions in the Ministry of Finance and the Accountant General's office (with donor support). The commitment control system and expenditure reporting forms have been redesigned to make reporting easier, and we will continue to prepare quarterly expenditure reports for senior management. An electronic reporting format has been developed which -- after testing -- will increase the reliability of transmission of information from ministries to the Ministry of Finance. The Accountant General will use inspection visits to the ministries to follow up on the implementation of the redesigned commitment control forms, as well as the results of the audit of domestic arrears.

The midyear review

23. We will use the midyear budget review to evaluate our estimates of donor assistance and the cost and savings from government restructuring. Ministries should not expect an increase in their budget allocations because we intend to devote any additional resources to debt reduction. Moreover, we will tighten spending ceilings if revenue and donor support are running below our budget estimates. In this way, we will follow through with our objective to eliminate domestic borrowing.

24. Issues that we expect to cover in the midyear review include

• Savings opportunities. Our budget saving strategy assumes that each ministry will live within its budget ceilings by finding efficient ways to deliver services. However, there are a number of areas where savings could be found across the government and we are currently looking at government-wide policies for vehicles and utilities.
  
  
• Government pension. The new civil service wage system will increase government pensions by shifting compensation from allowances to income on which benefits are based. The budget estimate for 2004/05 includes this effect and the medium-term costs and benefits of this outcome need to be studied carefully. However, we have already decided to increase the pensionable age from 55 years to 60 years.
  
  
• Tax measures. We will assess whether a small reduction of the surtax rate and modifications of the personal income tax are compatible with the SMP targets.
  
  
• Domestic arrears. We will complete the 2004 domestic arrears audit of nine ministries and extend it to cover the rest of government. These ministries will also be expected to clear their arrears with the verification and least cost to government policies discussed above.

B. Monetary and Exchange Rate Policies

25. The aim of monetary policy is to return inflation to the neighborhood of 10 percent within 12 months and reduce it to the 5 - 8 percent range in the medium term. We recognize that the recent monetary expansion and poor harvest will push inflation to the 18-20 percent range around the end of this year. This development underscores the importance of bringing the government's deficit under control and strictly limiting its borrowing from the RBM, because this amounts to the printing of money.

26. The RBM will continue to rely on the broad money stock (M2) as the nominal anchor to control inflation. We have decided to monitor deposits and broad money on a weekly basis and, if we see deviations from their paths consistent with controlling inflation, adjust our main operating instrument net domestic assets (NDA). This intensified monitoring has become necessary because of the unexplained rise in cash held by the general public that cannot be mopped up until it enters the banking system through deposits.

27. We will use open market operations, the purchase and sale of treasury and RBM bills, to control NDA. We have decided to delay planned reductions in the commercial bank liquidity reserve requirement (LRR) because this would add liquidity to the system. Since our decision to reduce the LRR last year, government borrowing increased sharply and caused a liquidity overhang that we must address before the LRR can be lowered. We remain committed to a lower LRR as this would reduce the operating costs of Malawi's commercial banks and make room for them to both reduce lending rates and increase deposit rates.

28. The RBM will also use foreign exchange sales to help mop up excess liquidity that is now in the system. This will serve to ease pressure on interest rates by lowering the amount of treasury and RBM bills sold for mop-up operations. The RBM also needs to maintain a certain level of foreign currency to meet its operating needs and to smooth the kwacha exchange rate by providing a buffer when seasonal or temporary imbalances develop between private sector supply and demand for foreign currencies.

C. Structural Policies

29. Structural measures under the SMP will be limited to those related to fiscal policy and expenditure management. We plan to focus on these areas to ensure the program's success.

30. We will nevertheless continue to work in other key areas identified in the MPRSP. A central element in reducing poverty in the medium term is to remove impediments to growth by providing an environment for the private sector to save, invest, and create jobs. Thus, our strategy, which was developed together with private sector representatives, focuses, in addition to restoring macroeconomic stability, on increasing the availability of financing, improving the tax and incentive system, enhancing basic infrastructure and utility provision, and improving the human capital. To this end, we will restructure government-owned or -controlled financial companies to better serve private sector needs. We will also simplify the tax system, provide more resources to the National Road Authority, and develop a strategy to stabilize the supply of power and water.

31. Furthermore, our recently revived Public Sector Investment Plan will strive to align all development projects to the goals spelled out in the MPRSP. In particular, we are currently putting together a database of projects that will increase the coverage of development projects in the government budget and facilitate the prioritization between projects according to the MPRSP.

IV. Program Monitoring

32. We have asked the IMF staff to monitor our economic program using the definitions, data sources, and frequency of monitoring set out in the accompanying technical memorandum of understanding (TMU). Submission of the 2004/05 budget that is in line with the budget framework presented here will be considered an important benchmark.

33. Tables 1 and 2 below set out the targets for end-September and end-December 2004 and indicative targets for end-March and end-June 2005. We will announce our monthly funding for wages and noninterest current spending at the beginning of each month and the corresponding outcome within 15 days of the end of the month. Our performance in this area will also be indicative.

Technical Memorandum of Understanding

1. This memorandum sets out the definitions for the quantitative targets under which Malawi's performance under the staff-monitored program will be assessed. Monitoring procedures and reporting requirements are also specified.

2. Coverage: 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. The accounts of the monetary authorities include those of the Reserve Bank of Malawi (RBM) and the central government's holdings of international reserves. Monetary aggregates under the program are based on the four-bank monetary survey.

I. Quantitative Targets

A. Floor on Net Foreign Assets of the Monetary Authorities

3. Definition of net foreign assets (NFA) of the monetary authorities: NFA of the monetary authorities are defined as the difference between gross international reserve assets and international reserve liabilities. NFA will be valued in U.S. dollars at the program exchange rate of MK 108.9 per US$1 and monetary gold will be valued at the fixed RBM accounting rate. The counterpart entry to the central government's international reserve assets will be classified as a negative entry under "net credit to central government". The floor is measured as the cumulative flow from July 1, 2004.

4. 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.

5. 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.

6. Adjustment clause on net foreign assets-balance of payments support: 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 support exceed the program baseline (shown in Table 1 below). The end-June 2005 target will also be adjusted downward by the amount by which the cumulative receipts from balance of payments support are less than the program baseline, up to a maximum adjustment of US$25 million.

7. Definition of balance of payments support: Balance of payments support comprises all grants and loan external financing that is not linked to additional budgetary expenditure. Excluded from this definition is external project financing to fund particular activities, including food security funding from the European Union and usage of the Tokyo-Mitsubishi account, and loan financing from the IMF. Balance of payments support is measured as the cumulative flow from July 1, 2004.

Malawi: Balance of Payments Support, FY2004/05 (In millions of US dollars)
	Q1 Proj.	Q2 Proj.	Q3 Proj.	Q4 Proj.	FY Proj.
Grants (excluding HIPC)	0	33	9	5	47
EU	0	0	9	0	9
UK	0	27	0	0	27
Norway	0	6	0	2	8
Sweden	0	0	0	3	3
Loans	0	25	18	25	68
AfDB	0	0	18	0	18
IDA	0	25	0	25	50
Total	0	58	27	30	114
Sources: UK, EU, Norway, Sweden, AfDB, and WB.

B. Ceiling on the Net Domestic Assets of the Reserve Bank of Malawi

8. Definition of net domestic assets (NDA) of the RBM: NDA of the RBM are defined as reserve money minus net foreign assets of the monetary authorities. 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. The ceiling is measured as the cumulative flow from July 1, 2004.

9. Adjustment clause on net domestic assets-balance of payments support: The ceiling on net domestic assets of the RBM will be adjusted downward by the full amount by which the cumulative flow of receipts from balance of payments support exceeds the program baseline. The end-June 2005 target will also be adjusted upward by the amount by which the cumulative receipts from balance of payments support are less than the program baseline, up to a maximum adjustment of US$25 million. Balance of payments support will be converted to Malawi kwacha using the program exchange rate (see para. 7 for the definition of balance of payments support).

C. Ceiling on Central Government's Domestic Borrowing

10. Definition of central government's domestic borrowing (CGDB): CGDB 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), (iii) net borrowing from nonbanks (including holding of local registered stocks, holdings of treasury bills, and supplier credits), and (iv) 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. The ceiling is measured as the cumulative flow from July 1, 2004.

11. Adjustment clause on CGDB-balance of payments support: The ceiling on CGDB will be adjusted downward by the full amount by which the cumulative receipts from balance of payments support exceed the program baseline. The end-June 2005 target will also be adjusted upward by the amount by which the cumulative receipts from balance of payments support are less than the program baseline, up to a maximum adjustment of US$25 million (see para. 7 for the definition of balance of payments support).

D. Ceiling on Central Government Wages and Salaries

12. Definition of central government wages and salaries: Central government wages and salaries include all payments that are classified as personnel emoluments in government budgets and accounts, including allowances and payments on arrears of personnel emoluments. The ceiling is measured as a cumulative flow from July 1, 2004.

13. Adjustment clause on central government wages and salaries—donor-funded wages and salaries in the health sector: The ceiling on central government wages and salaries will be adjusted upward by the full amount of donor-funded supplementary wages and salaries for the health sector, a facility that is currently being negotiated with donors.

E. Ceiling on Central Government Discretionary Expenditures

14. Definition of central government discretionary expenditures: These are all expenditures excluding (i) wages and salaries, (ii) interest payments, and (iii) foreign-financed development expenditures (development expenditures Part I) which are related to specific projects. Central government discretionary expenditure include statutory (i.e., nonvoted) expenditures for pensions and gratuities, and statutory compensations as well as other recurrent expenditures (ORT), domestically financed development expenditures (development expenditures Part II), and net lending (if any). Included in this definition are also recurrent expenditures and development Part II expenditures for which cash financing is or was made available by donors. Included in particular are all maize purchases for the Strategic Grain Reserve, and purchases financed from the Japan debt relief account (see paragraph 19). The ceiling is measured as a cumulative flow from July 1, 2004.

15. Adjustment clause on central government discretionary expenditures—donor-funded recurrent expenditures in the health sector. The ceiling on central government discretionary expenditures will be adjusted upward by the full amount of donor-funded recurrent health sector expenditures, a facility that is currently being negotiated with donors.

F. Ceiling on External Payment Arrears

16. Definition of external payment arrears: External payment 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, except on external debt subject to rescheduling or restructuring. A continuous performance criterion applies on the nonaccumulation of external payment arrears on external debt contracted or guaranteed by the central government, the RBM, or other agencies on behalf of the central government.

G. Ceiling on External Debt

17. Definition of nonconcessional external debt: The definition of debt, for the purpose of the limit, is set out in Executive Board Decision No. 6230-(79/140) of August 3, 1979,¹ and as amended by Decisions No. 11096-(95/100), October 25, 1995; and 12274-(00/85) August 24, 2000. For program purposes, a medium- and long-term debt is nonconcessional if it includes a grant element less than 35 percent. The ceiling on nonconcessional debt 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. 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, 2004.

18. Excluded from the limit is the use of Fund resources; adjustment lending from the World Bank, the African Development Bank, and other multilateral agencies; and any kwacha-denominated treasury bill and local registered stock holdings by nonresidents. Excluded from the limit are also (i) debts classified as international reserve liabilities of the RBM; (ii) debts to restructure, refinance, or prepay existing debts; (iii) normal import financing; and (iv) convertibility guarantees of the kwacha by the RBM. A financing arrangement for imports is considered to be "normal" when the credit is self-liquidating.

II. Treatment in the Fiscal Accounts and Balance of Payments of Certain Central Government (CG) Accounts Held Abroad

19. The account held with the Bank of Tokyo-Mitsubishi in Japan: The account was set up for the delivery and administration of Japanese debt relief. Disbursements of cash debt relief into the account are accounted as grants with corresponding amounts of foreign financing (increases in the deposit account). Withdrawals from the Bank of Tokyo-Mitsubishi account are accounted as central government expenditures with corresponding amounts of foreign financing (decreases in the deposit account). Expenditures financed from this account are either separately identified as special activities, or included in spending agencies budgets under current expenditures, or as part II development expenditures (development expenditures financed by the Government of Malawi). Flows are valued at the end-month exchange rate.

20. The European Union grants for food security purposes and the food reserve account. These grants are given to provide a cash reserve to the Government of Malawi for the purchase of food stuff (in particular maize) at times of food shortages. Access to foreign or domestic accounts that have been or are being established to administer these resources is determined by agreements between the European Union and the Government of Malawi. Deposits into the account held abroad are recorded as grants with corresponding amounts of foreign financing (increase in deposit accounts). Withdrawals from the account held abroad are recorded as increase in foreign financing. If and when the resources are transferred to Malawi, they are to be held in a bank account in the banking system until needed, and are counted as part of net credit to government. Withdrawals from the foreign or domestic accounts for payments to suppliers are recorded as an appropriate expenditure item (e.g., purchase of food stuffs), and a decrease in the respective deposit account. Should the food reserve account be operated like a revolving fund, all cash inflows are accounted as appropriately classified revenue, and an increase in the deposit account. The balance in the foreign and domestic food reserve accounts is reported separately in the monetary data.

21. The treatment of Emergency Drought Recovery Project (EDRP) funds (a World Bank grant and loan arrangement) in the fiscal accounts: The resources from this arrangement are allocated for three different purposes: import programs, in support of MASAF, and for technical assistance. The share of resources for import programs is treated as program support as the kwacha equivalent of the foreign currency resources (which are allocated for imports by the private or public sector by the RBM) received in cash by the Malawi government. The EDRP is recorded as a grant or loan, respectively, when monies are deposited in an account in the name of the RBM held abroad and as foreign financing (increases in deposits). Withdrawals from the account held abroad are recorded as an increase in foreign financing, and presumed to be transferred to an account held in Malawi and counted as part of net credit to government and thus domestic financing (increase in domestic deposits). Expenditures financed from import program resources are included in current expenditures or Part II development expenditures (development expenditures financed by the Government of Malawi), with the exception of a small amount (estimated at MK 400 million) that was already approved for the use by specific development projects. The share of resources for MASAF is treated as project support even though it is received in cash. It is recorded as a grant or loan, respectively, and as Part I development expenditures (foreign financed development expenditures), at the point in time it is received. The share of resources for technical assistance is treated as project support. It is recorded as a loan and as Part I development expenditures (foreign-financed development expenditures), at the point in time it is received. The Government of Malawi will provide detailed accounting by quarter for the EDRP funds, including the share of the different programs and subprograms; the timing of receipt of cash components and noncash components; the share of grants and loans; and the use of the cash components, and the time of that use.

III. Reporting Requirements

22. 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.

23. On a weekly basis within seven calendar days of the end of the respective week, the balance sheet of the monetary authorities will be reported by the RBM.

24. 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, the results of treasury bill and RBM bill auctions, and any direct uptake of treasury bills by the RBM will be reported by the RBM.

25. On a monthly basis within 30 calendar days of the end of the respective month, the RBM will submit the monetary survey, the monetary authorities' accounts, the commercial banks' accounts (four banks), the international reserves position, local registered stock holdings, treasury bill holdings, interest rates, exchange rates, the consumer price index, new loans contracted or guaranteed by the RBM or other agency on behalf of the central government, and a list of external arrears by creditor, with a detailed explanation.

26. 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,² central government reports on spending on pro-poor expenditure (PPE) programs, funding reports for wages, and other recurrent expenditure and development expenditure, account statements from the Tokyo-Mitsubishi account, and revenue data (reporting agency: Ministry of Finance); and the SGS import data will be reported (reporting agency: Malawi Revenue Authority).

27. On a monthly basis within 45 calendar days of the end of the respective month, the Ministry of Finance will submit a review summarizing the monthly reports by line ministries on commitment levels³ and arrears, and assessing prospects for meeting budget targets will be reported; and a consolidated table on total financing of the central government, including domestic and foreign financing, will be reported (reporting agencies: Ministry of Finance and RBM).

28. On a quarterly basis within 30 calendar days of the end of each quarter, a loan-by-loan accounting of all new external loans contracted or guaranteed by the central government, RBM, or other agencies on behalf of the central government, including detailed information on the amounts, currencies, and terms and conditions, as well as all relevant supporting materials will be reported by the Ministry of Finance.

29. On a quarterly basis within 45 calendar days of the end of the respective calendar quarter, the borrowings of the ten major parastatals⁴ (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).