AFRICAN DEVELOPMENT FUND

PROGRAMME: ADDITIONAL FINANCING OF THE RESTORATION

OF FISCAL STABILITY AND SOCIAL PROTECTION

(RFSSP) PROGRAMME

COUNTRY : MALAWI

PROGRAMME APPRAISAL REPORT

OSGE DEPARTMENT

April 2013

Appraisal Team

Regional Director : Mr. C. OJUKWU, Director, ORSB

Sector Director : Mr. I. LOBE NDOUMBE, Director, OSGE

Team Leader : Mr. M.P. S. MATILA, Principal

Macroeconomist, OSGE/ZMFO

TABLE OF CONTENTS

CURRENCY EQUIVALENTS ………………………………………………………… i

WEIGHTS & MEASUREMENTS ……………………………………………………... i

FISCAL YEAR ………………………………………………………………………..... i

ACRONYMS & ABBREVIATIONS ………………………………………………….. ii

GRANT INFORMATION ……………………………………………………………. iv

RESULTS-BASED LOGICAL FRAMEWORK ……………………………………. v

PROGRAMME EXECUTIVE SUMMARY ………………………………………… vii

I. THE PROPOSAL ………………………………………………………………….. 1

II. COUNTRY AND PROGRAMME CONTEXT ………………………………….. 2

2.1 Government Overall Development Strategy and Medium-Term Reform Priorities 2

2.2 Recent Development, Perspectives, and Challenges…………. …………………... 2

2.3 Bank Group Portfolio Status ……………………………………………………... 7

III. KEY DESIGN ELEMENTS AND SUSTAINABILTY …………. …………….. 7

3.1 Link with RFSSP, CSP, and Readiness Assessment ……………………………. 7

3.2 Collaboration and Coordination with other Development Partners …………... 8

3.3 Relationship to On-going Bank Group Operations ……………………………... 9

3.4 Outcomes of Past Similar Operations and Lessons……………………………… 9

IV. IMPLEMENTATION PROGESS OF THE RFSSP ……………………………… 9

4.1 Programme’s Goal and Purpose …………………………………………………. 9

4.2 Programme Components..……………………………………………………….... 9

4.3 Progress on Programme Outputs and results since July 2012 …………...…….. 10

4.4 Financing Gap and RFSSP Resource Use …………..…………………………… 13

4.5 Impact on Gender …………………………………………………………………. 14

4.6 Environmental Impact ……………………………………………………………. 15

V. IMPLEMENTATION, MONITORING AND EVALUATION…………………. 15

5.1 Implementation Arrangements ....………………………………………………... 15

5.2 Monitoring and Evaluation Arrangements ……………………………………… 16

VI. LEGAL DOCUMENTATION AND AUTHORITY.............................................. 16

6.1 Legal Documentation ……………………………………………………………… 16

6.2 Conditions Associated with the Bank’s Intervention …………………………… 17

6.3 Compliance with Bank Group Policies …………………………………………... 17

VII. RISK MANAGEMENT …………………………………………………………. 17

VIII. RECOMMENDATION ………………………………………………………… 18

APPENDICES

Appendix I : Letter of Development Policy

Appendix II : IMF Country Relations Note: Press Release

Appendix III : Malawi Selected Economic Indicators

TABLES

Table I: Progress against impact and outcome indicators

Table II: Main indicators for sub-component 1: strengthening PFM transparency and

accountability

Table: III: Main indicators for sub-component 2: enhancement of the social protection

system

Table IV: Medium-term Expenditure Framework (2009-2015) Projections

Table V: Risks and Mitigation Measures

i

Currency Equivalents

(As of February, 2013)

Currency Unit Malawi = Kwacha (MWK)

1 UA = MWK 543.490

1 UA = US$ 1.541

1 UA = Euro 1.137

1 US$ = MWK 352.609

Weights and Measures

Metric System

1 metric tonne = 2204 pounds (lbs.)

1 kilogramme (kg) = 2.200 lbs

1 metre (m) = 3.28 feet (ft.)

1 millimetre (mm) = 0.03937 inch (“)

1 kilometre (km) = 0.62 mile

1 hectare (ha) = 2.471 acres

Fiscal Year

01 July - 30 June

ii

ACRONYMS AND ABBREVIATIONS

AfDB African Development Bank

ADF African Development Fund

AGD Accountant General’s Department

AIDS Acquired Immune-Deficiency Syndrome

APM Automatic Price Adjustment Mechanism

ASYCUDA Automated System for Customs Data

CABS Common Approach to Budget Support

CIAU Central Internal Audit Unit

COMESA Common Market for Eastern and Southern Africa

CPIA Country Policy and Institutional Assessment

CPPR Country Portfolio Performance Review

CSP Country Strategy Paper

CSO Civil Society Organisation

DFID Department for International Development

DPs Development Partners

ECF Extended Credit Facility

EMIS Educational Management Information System

EPRCP Enhancing Procurement Reforms and Capacity Project

ERP Economic Recovery Plan

ETR Electronic Tax Register

EU European Union

Forex Foreign Exchange

FIMTAP Financial Management Transparency and Accountability Project

FRA Fiduciary Risk Assessment

FROIP Financial Reporting and Oversight Improvement Project

FY Fiscal Year

GAP Governance Strategic Directions and Action Plan

GBS General Budget Support

GDP Gross Domestic Product

GFEM Group on Financial and Economic Management

GoM Government of Malawi

GPRSG Governance and Poverty Reduction Support Grant

HDI Human Development Index

HIV Human Immune-Deficiency Virus

HoC Head of Cooperation

HoM Head of Mission

HRMIS Human Resources Management Information System

ICSP Interim Country Strategy Paper

IMF International Monetary Fund

IFMIS Integrated Financial Management Information System

ISP Institutional Support Project

JICA Japanese International Development Agency

KfW Kreditanstalt für Wiederaufbau

LA Local Authority

MDTF Multi Donor Trust Fund

MGDS Malawi Growth and Development Strategy

MLGRD Ministry of Local Government and Rural Development

MRA Malawi Revenue Authority

iii

MDGs Millennium Development Goals

MTEF Medium Term Expenditure Framework

MWK Malawi Kwacha

MWFO Malawi Field Office

NAO National Audit Office

NSO National Statistics Office

NSSP National Social Sector Programme

ODPP Office of the Director of Public Procurement

PAF Performance Assessment Framework

PBO Policy Based Operation

PCR Project Completion Report

PFM Public Financial Management

PEFA Public Expenditure Financial Accountability

PER Public Expenditure Review

PETS Public Expenditure Tracking Survey

PFEMRP Public Financial and Economic Management Reform Programme

PI PEFA Performance Indicator for PEFA

PPA Public Procurement Act

PRSG Poverty Reduction Support Grant

PRSL Poverty Reduction Support Loan

PRSP Poverty Reduction Strategy Paper

RBCSP Results Based Country Strategy Paper

RBM Reserve Bank of Malawi

RFSSP Restoration of Fiscal Stability and Social Protection

RMC Regional Member Country

SAL Structural Adjustment Programme

SAP System Applications and Products

SGGL Support for Good Governance Loan

SWAP Sector-Wide Approach

SWG Sector Working Group

UA Unit of Account

UK United Kingdom

UNFPA United Nations Population Fund

UNICEF United Nations Children’s Fund

USAID United States Agency for International Development

UNDP United Nations Development Programme

US$ United States Dollar

WB World Bank

WFP World Food Programme

iv

GRANT INFORMATION

Client’s Information

Grant recipient : Republic of Malawi

Executing agency : Ministry of Finance

Financing Plan (2012/13)

Source Total amount Amount disbursed Instrument

ADF RFSSP UA 26 million UA 26 million Grant

ADF Additional

Financing

UA 4 million Grant

World Bank USD 100 million* USD 50 million Grant

EU € 40 million € 40 million Grant

DFID £ 20 million £ 20 million Grant

Germany €5 million €5 million Grant

Norway NOK 65 million** Grant

* World

Bank disbursed US$ 50.0 million in 2012 as emergency support and plans to disburse another US$

50.0 million as normal budget support in June 2013

** Norway is yet to disburse its pledge amount of NOK 65 million

Other Major Financing:

IMF ECF : US$ 157 million (Zero Interest Rate Loan)

ADF Financing Information

ADF Grant : UA 30 million (RFSSP UA 26 m + SRFSSP UA4m)

Time-frame: Main Milestones (RFSSP)

Request from GoM for an ADF Grant : May 2012

RFSSP Appraisal : May/June 2012

RFSSP Board Approval : July 11 2012

RFSSP UA 26.0 million disbursements : July 31 2012

Additional Financing Appraisal Mission : January/February 2013

Board consideration of Programme : April 10 2013

Effectiveness : April 2013

Disbursement : April 2013

Programme Completion (PCR) : October 2013

v

VII. Results-Based Logical Framework

Country and project name: Malawi: Additional Financing of the Restoration of Fiscal Stability and Social Protection

Purpose of the programme: To restore public financial management and Social Protection systems.

RESULTS CHAIN

PERFORMANCE INDICATORS

MEANS OF

VERIFICATION

RISKS/MITIGATION

MEASURES Indicator (including

CSI) Baseline Target

IMP

AC

T

Impact:

Stabilised Fiscal

Situation and

Protected Social

Spending

i. GDP growth rate

ii. National reserves

iii. Human

Development Index

(HDI)

i.4.3 % (2011)

ii. National

reserves below

one month of

import cover

iii. HDI 0.400 in

2011

i. 5.5% in 2013

ii. National reserves

at one month of

import cover

iii. HDI 0.425 by

2015

IMF Reports

MDG

Reports

AfDB

Statistics

Risk: Lack of support

from Development

Partners could worsen the

foreign reserve situation

and increase inflation

following devaluation of

the Kwacha by close to

50%, and impoverish

people. ECF being off

track may lead to donor

inflow. Mitigation: DPs

have pledged support to

alleviate effects of the

devaluation. GoM

committed to reforms and

ECF on track

OU

TC

OM

ES

Outcome 1: Credible,

transparent and

accountable budget

system

i.Budget out-turn –In

year expenditure

reallocation between

primary expenditure

votes

ii.Monthly revenue

data publication

i. In 2009/10, the

variance was at

6.7%

ii. No monthly

publication of

revenue data

i. Variance

between budgeted

expenditure and outturn

for 25 votes in 2011/12

Fiscal Year amount to

10% or less of the

2009/10 approved

budget’s primary

expenditure bimonthly

ii. Monthly publication

of revenue data from

July 2012.

PEFA report

IMF Reports

AfDB Statistics

CABS Reports

(PAF)

GoM

documents/polici

es

Risk: Expenditure not

aligned to policies and

national priorities

Mitigation:

Implementation of the

Malawi Public Financial

Management Reform

Programme supported by

DPs through the Multi-

Donor Trust Fund will

continue dialogue on such

issues.

Outcome 2: Enhanced Social

Protection System

Protecting priority

expenditures

(Government meets

budget allocation

requirements of

Health and Education

SWAps in the

approved budget)

In 2010/11,

23.6% of voted

recurrent

expenditure was

spent on

education. Real

increase of 6%

in GoM

contribution to

Health sector.

Government meets

budget allocation

requirements of Health

and Education SWAPs

in the 2012/2013

approved budget.

CABS Review

Reports

Budget books

Risk: Lack of funding for

the social sectors could

increase poverty.

Mitigation: CABS

reviews and dialogue with

GoM will mitigate risks

for reduced funding to

social sectors.

vi

OU

TP

UT

S

Component 1:

Strengthened PFM

transparency &

accountability

Output 1.1

Accountability and

comprehensiveness of

the budget

Output 1.2

Strengthened

domestic revenue

Administration and

policy

Output 1.3:

Strengthened external

audit system

1.1. Budget process;

a. Functional MTEF

b. IFMIS rolled-out

to 29 Local

Authorities (LAs).

1.2. a. Electronic Tax

Register (ETR)

1.3.1 Timelines and

follow-up of audit

reports and

recommendations.

1.3.2 Timeliness and

quality of expenditure

reporting

1.1.a. MTEF not

fully functional

(2011); b. IFMIS

rolled-out to 18

LAs (2012)

1.2. a. ETR not

available ;

1.3.1 2003/04

Treasury Minutes

available,;

1.3. 2. The

2008/09 and

2009/10 Auditor

General’s Audit

Report submitted

to Parliament in

By August and

December 2010

respectively

1.1. a. Fully functional

MTEF in place (2013)

b. IFMIS rolled out to

be completed in the 8

remaining LAs (2013)

1.2.a ETR introduced and

functional(2013);

1.3 Treasury Minutes

responding to PAC audit

reports for FYs 2007/08;

2008/09

1.3.2 The 2010/11 and

2011/12 Auditor

General’s Annual Report

be submitted to and

tabled in Parliament by

December 2012 and June

2013 respectively.

PEFA report

CABS PAF

Reports

Budget Reports

GFEM Reports

Risk: Weak PFM can lead

to wastage of public

resources and unplanned

and non-responsive

expenditure. Political will

and support is necessary

for reform

implementation.

Mitigation: PFM reform

programme supported by

the DPs and dialogue with

GoM will mitigate this.

Risk: Lack of oversight

may entrench corruption

and misuse of public

resources.

Mitigation: Timely audit

reports and follow-up

with action on culprits

Component 2:

Strengthened Social

Protection System

Output 2.1:

National Social

Support Programme

approved

Output 2.2:

Efficiency of SP

interventions

improved.

2.1 Existence of the

National Social

Support Programme

(NSSP).

2.2 Existence of

National Social

Support Policy.

2.1 Preparation

and consultation

on the NSSP

2.2 Preparation of

the NSS Policy

on-going

2.1 The NSSP is finalized

and approved by the

National Steering

Committee by December

2012.

2.2 The draft Social

Support Policy is

approved by Cabinet by

June 2013.

Social sector

budgets

CABS PAF

NSSP document

Risk: Implementation

capacity constraints.

Mitigation: Capacity-

building interventions to

support PFM

implementation through

the proposed budget

support programme

KE

Y A

CT

IVIT

IES

COMPONENTS INPUTS

Component 1:

Introduction of Electronic Tax Register system &Awareness of oversight institutions

Improving transparency, accountability , preparation and execution of the budget

Strengthening capacity of external audit office

Component 2:

Increasing coverage of social protection programmes

Improving the social protection delivery and monitoring systems

Implementation of the social protection programmes.

Budget support only

ADF Grant = UA 30 million (RFSSP :

UA 26 m + Additional Financing: UA 4 m);

Other donors = UA 174.02 million

Missions: supervision, policy dialogue, and

donor coordination

Complementary capacity building and

technical assistance projects financed by

other donors not included in the budget

vii

PROGRAMME EXECUTIVE SUMMARY

Programme

Name

MALAWI: ADDITIONAL FINANCING OF THE RESTORATION OF FISCAL

STABILITY AND SOCIAL PROTECTION

Overall

Timeframe

1 July 2012 to 30 June 2013

Programme

Cost

ADF Grant UA 4.00 million (additional to UA 26 million for RFSSP)

Programme

Context

The Government of Malawi (GoM) adopted bold measures to stem the decline of the Malawian

economy and correct macroeconomic imbalances, through among others, the Malawi Kwacha’s

devaluation, exchange rate floatation, monetary policy and fiscal tightening and the adoption of an

automatic fuel price adjustment mechanism (APM). GoM continues to implement adjustment

measures adopted since May 2012, to address the macroeconomic challenges facing the country

and these measures are beginning to yield results. The availability of foreign exchange for

importation of critical inputs has since improved and fuel shortages have eased. Credit lines that

were frozen during the crisis period have been partially restored. The foreign exchange reserves

have improved but remain at a precarious level of 1.4 month import cover, as of January 31st,

2013. The impact of the devaluation of the Kwacha has been steeper than anticipated, which

coupled with the adoption of the APM on petroleum products has led to the high rise in inflation.

Programme

Overview

This is an additional financing proposal to the RFSSP, approved by the Board in July 2012 (Doc.

ADF/BD/WP/2012/64), for an amount of UA 26 million. It provides additional resources based on

progress made on the implementation of the RFSSP without additional components. The focus

areas are: strengthening Public Finance Management (PFM), with particular emphasis on

transparency and accountability; and supporting the Government’s Social Protection programme.

These areas of focus are in the Performance Assessment Framework (PAF) that has been agreed

between the GoM and the Development Partners (DPs) that are providing budgetary support (i.e.

AfDB, EU, DFID, Germany, Norway and World Bank).

Programme

Outcomes

and

Beneficiaries

The expected outcomes of the Programme are (i) macroeconomic stability; (ii) credible transparent

and accountable budget system; and (iii) enhanced social protection for the poor and vulnerable.

The operation will support ongoing efforts towards economic recovery and ease social hardships

currently being experienced, especially due to high inflationary pressures. The expected impact of

the programme is a stabilised fiscal framework and protected social spending. The beneficiaries

will be the people of Malawi.

Needs

Assessment

The Programme resources will help to close the FY 2012/2013 financing gap, alleviate shocks

resulting from economic hardships triggered by the exchange rate adjustment, and support GOM’s

momentum of the economic reforms implemented. It is therefore essential that GoM is

encouraged to maintain the momentum of reform implementation. A sound PFM environment

(notably timely reporting of expenditure, strong oversight of public resources, and efficient tax

administration) is key to successful implementation of poverty reduction measures and prudent use

of public resources. Budget deficit (overall balance), including grants is projected to fall from

8.5% of GDP in FY 2011/12 to 0.5% in FY 2012/13, supported by more than doubling of donor

grant inflows, from 4.4% to 12.7%.

Institutional

Development

and

Knowledge

Building

In using the country systems and in line with the Paris Declaration on Aid Effectiveness, the

Programme will contribute to fostering institutional capacity building. In collaboration with other

DPs, the Bank is in the process of preparing a complementary Institutional Support Project to

improve macro-fiscal management, accountability and transparency in PFM and public oversight

institutions.

Bank’s

Added Value

The Bank brings into this operation considerable experience in budget support operations, and

expertise gained from implementing similar programmes in RMCs. The Bank also adds value in

terms of dialogue, as it is a member of the Common Approach to Budget Support (CABS) DPs’

group in Malawi.

1

REPORT AND RECOMMENDATION OF THE MANAGEMENT OF THE AFRICAN

DEVELOPMENT BANK TO THE BOARD OF DIRECTORS FOR ADDITIONAL

FINANCING FOR THE RESTORATION OF FISCAL STABILITY AND SOCIAL

PROTECTION PROGRAMME TO THE REPUBLIC OF MALAWI.

I. THE PROPOSAL

1.1 This proposal presents the context, economic and technical justification for an ADF

Grant of UA 4 million as Additional Financing to the on-going Restoration of Fiscal

Stability and Social Protection (RFSSP) programme for the Republic of Malawi, approved

in July 20121. The RFSSP programme of UA 26 million was designed and processed as a Crisis

Response Budgetary Support, to promote macroeconomic stability and enhance social protection

reforms. The Additional Financing of UA 4 million will be disbursed in one tranche in the

Malawi’s current fiscal year 2012/13. In May 2012, the Government of Malawi (GoM) requested

UA 30 million for financial assistance, to address the macroeconomic instability, in particular

fiscal distortions and the social challenges resulting from the devaluation of the local currency.

Management informed the Board, during the presentation of the UA 26 million RFSSP

programme, that it would submit additional financing proposal of UA 4 million in 2013, subject

to the availability of ADF grant resources for Malawi and continued progress in the

implementation of the country’s reform agenda, so as to adequately respond to the Government’s

request.

1.2 Malawi’s Development Partners (DPs), as well as other major stakeholders, including the

business community and the public in general, have welcomed the recent reforms, including the

devaluation of the Kwacha. The devaluation was a necessary measure for GoM to take, in order

to address severe macroeconomic imbalances. It has, however, triggered social hardships

amongst the population, considering that it was followed by the introduction of an automatic

price adjustment mechanism for petroleum products and an increase in electricity tariffs. These

measures have necessitated urgent support from DPs, to maintain core public expenditures

(particularly in the social sectors), and provide scope for additional poverty safety net spending,

to mitigate the social cost of the on-going economic reforms.

1.3 The Programme’s operational policy objectives remains focused on: Strengthening

Public Finance Management (PFM) Transparency and Accountability (Component 1) and

Contributing to Social Protection for the poor and vulnerable (Component 2). The expected

outcomes of the Programme, therefore, are: (i) macroeconomic stability; (ii) transparent and

accountable budget system; and (iii) enhanced social protection for the poor and vulnerable. The

implementation period and components are the same as that of the RFSSP.

1 Ref: ADF/BD/WP/2012/64

2

II. I. COUNTRY AND PROGRAMME CONTEXT

2.1 Government Overall Development Strategy and Medium-Term Reform Priorities

2.1.1 In April 2011, the GoM adopted the second Malawi Growth and Development

Strategy (MGDS II) for the medium-term (2011-16). The strategy's overall objective is wealth

creation through sustainable economic growth and infrastructure development. The long-term

vision of MGDS II is to transform Malawi from a predominantly importing and consuming

country into a predominantly producing and exporting one through agricultural production and

industrialization. The MGDS II also acknowledges the important roles of health, education,

economic empowerment and social protection. In order to ensure rapid economic growth for

poverty eradication, the GoM further launched a short-term Economic Recovery Plan (ERP) in

September 2012, which focuses on a few key sectors, namely energy, tourism, mining,

agriculture, transport and Information Communication Technology that can support the

economic recovery.

2.1.2 In order to achieve the set objectives, the GoM has shown commitment in

undertaking reforms in economic and financial governance as well as social development.

In this regard, GoM has undertaken the following (i) An Export Strategy has since been

launched, to improve the business climate; (ii) Rehabilitation of the Kapichra II Hydro Power

Station and other reforms in the energy sector, to increase power supply; (iii) Adoption of

modern revenue collection IT systems and restructuring the institutional arrangements, with a

view to improving efficiency of the tax administration; and (iv) Introduction of one-stop border

posts between Malawi and Mozambique, Tanzania and Zambia, to enhance the cross-border

trade. In the social sector, GoM has scaled up coverage of social support programmes, to address

the risks and hardships affecting the vulnerable groups. In this regard the Social Support Policy

was approved by Cabinet in July 2012 and the National Social Support Programme has been

designed aimed at improving coordination and harmonization of the social support programme.

2.2 Recent Development, Perspectives, Constraints and Challenges

Political Context

2.2.1 Malawi enjoys political stability and is a multi-party democracy, elections are held

every five years. The last elections were held in 2009 and the Democratic Progressive Party

(DPP) led by the late Bingu Wa Mutharika won the elections. Following the death of Mutharika

in April 2012, Vice President Joyce Banda succeeded him in a smooth leadership transition in

April 2012. The Government has undertaken various democratic governance reforms aimed at

promoting civil liberties and economic rights. Media freedom has improved, especially with the

repealing of Section 46 of the Penal Code, and issuance of television and radio licences. In

November 2012, Parliament passed a Constitutional Amendment Bill paving the way for Malawi

to hold tripartite elections in 2014.

3

Economic Context

2.2.2 In 2012, real growth was projected at 4.3 % while average inflation was expected to

rise sharply to 18.4 % from 6.4 % in 2011. Real GDP growth for 2012 has since been revised

downwards to 1.9%, mainly on account of contraction in the agriculture and manufacturing

sectors, which was not anticipated. The agriculture sector performance was affected by the

drought and fall in tobacco prices, while manufacturing continued to be constrained by shortage

of foreign exchange for importation of inputs and intermittent power supply.

2.2.3 Inflationary pressures in the economy intensified during the second half of 2012, partly

due to the steeper than expected devaluation of the Kwacha. Headline Consumer Price Index

inflation in December 2012 accelerated to 34.6 %, from 9.8 % the previous period, substantially

higher than the IMF Extended Credit Facility (ECF) programme projection of 22.4%. Inflation is

being driven by rising food and non-food (fuel, transport and utility) prices. The end of period

and average annual inflation in 2013 are projected to decline to 10.1% and 18% respectively, as

the food supply situation normalizes after the harvest and growth rebounds. To curb inflation, the

Reserve Bank of Malawi (RBM) revised upwards the policy rate from 21% in May, 2012 to 25%

in December 2012. The Government also adopted a tight fiscal policy, anchored on zero net

domestic financing and aimed at consolidating macroeconomic stability and scaling-up social

safety nets.

2.2.4 The First Review of the ECF programme was completed by the IMF Board on 19th

December 2012. Malawi’s first quarter performance under the programme was assessed as

satisfactory. Only the net domestic assets target was missed on account of the RBM’s lending to

distressed banks in post reform period. The assessment of the second review undertaken in

February 2013 was that overall performance under the programme remains satisfactory. Most of

the quantitative targets for end-December 2012 were met, including those on the level of net

international reserves and net domestic assets of the RBM, and the government’s net domestic

borrowing. The indicative targets on reserve money and on government social spending were

however, missed by small margins, but social protection programmes have been successfully

scaled up. With respect to structural benchmarks, nearly all identified government domestic

arrears have been verified, and progress was made in configuring the Integrated Financial

Management Information System (IFMIS) to control government commitments (Appendix II-

IMF Press Release No. 13/55).

2.2.5 The economic reforms being implemented by the Government have started yielding

positive results. The parallel market premium for foreign exchange has narrowed sharply from

80% to 5-10%. The supply of critical inputs and petroleum and products has eased, and small

holder tobacco farmers are being paid at market determined exchange rates.

2.2.6 Overall economic outlook for the country remains positive, despite short and

medium term fiscal challenges. The economy is expected to rebound with real GDP growth

increasing to 5.5% in 2013 and 6% in 2014, driven by strong growth of the sectors that were

hardest hit by the foreign exchange shortages: transportation services, tourism, manufacturing,

4

construction and trade. The agricultural sector is also expected to rebound over the medium-term

in response to reforms to promote commercialization and modernization of farming systems. In

addition, Growth of the services sector is expected to be strong, driven by the growth of financial

services and telecommunication.

2.2.7 Government remains committed to maintain fiscal discipline and prudent monetary

policy in order to continue to improve the country’s macroeconomic environment. GoM's

2012/13 budget framework, which is anchored on a net zero domestic financing, aims at

achieving fiscal sustainability while supporting the MGDS II growth and poverty reduction

objectives. Total domestic revenues and expenditures for FY 2012/13 are projected at 33.2 %

and 34.2 % of GDP respectively, while deficit is projected to fall from 8.5% of GDP in FY

2011/12 to 0.5% in FY 2012/13, supported by more than doubling of Development

Partners’(DPs) grant inflows, from 4.4% to 12.7% (Refer to Appendix III).

2.2.8 Government’s revenue performance during the first half of FY 2012/13 surpassed

the targets by 12%, while expenditures were contained within the budget, as a result of the

tight fiscal stance. Since the approval of the RFSSP, the Government has adopted further

measures to contain recurrent expenditures by rationalizing staff travel and transport expenses.

Fiscal pressures for the rest of the fiscal year are, however, expected to increase, due to

escalating cost of goods and services (e.g. drugs and teaching materials) on account of the

depreciation of the Kwacha and increase in civil service salaries. During the mid-term review,

the budget was adjusted upwards by about 17 %, from MK 408 billion to MK 475 billion, to

ensure smooth delivery of planned programmes (excluding salary and wage increases for civil

servants) to the end of the fiscal year. The mid-year revenue projection was K130.0 billion and

by December 2012, actual revenue collections exceeded the projection and stood at K133.8

billion. Mid-year expenditure was projected to reach K249.8 billion and it was within budget in

December 2012 at K242.6 billion, thanks to reduction in recurrent expenditure by K3.8 billion

on account of reduced interest payments resulting from reduced Government borrowing. Grants

were projected at K109.6 billion and actual grants were K104.0 billion at mid-year. The

availability of DPs financing will thus be critical for the attainment of the fiscal targets for

2012/13.

Governance Update

2.2.9 Malawi is making progress in building up its anti-corruption mechanisms and its

governance indicators show an improvement. This is demonstrated, for example, by the 2012

Transparency International Corruption Index in which Malawi scored 37 out of 100 improving

its ranking since 2011. Challenges however still remain. The Government, through the Anti-

Corruption Bureau, the Financial Intelligence Unit, and the Fiscal Police is working tirelessly to

address the problem by enhancing law enforcement and implementing preventive programmes.

The PFM reform and the Public Service Capacity Development Programmes are other

interventions aimed at instilling financial discipline in the management of resources and

promoting ethical values and integrity.

5

Social Context

2.2.10 Poverty in Malawi remains high with a Human Development Index of 0.400 (in

2011), placing it below the Sub-Saharan African average of 0.463. Incomes remain very low

with GNI per capita of US$ 348 and a Gini Coefficient of 0.415 in 2010, reflecting acute income

inequalities with large sections of society marginalized. According to the 2012 Integrated

Household Survey (IHS) report, Malawi’s poverty level is estimated at 50.7% a marginal

reduction from an estimated 52.4% in 2005. The IHS indicates that there were more people in the

ultra-poor category at 25% in 2011 compared to 15% in 2005. The negative impacts of the

economic slow-down and effects of the devaluation have since pushed more people into poverty

and hence the need for social support is greater. Although the country has made some progress

towards achieving the Millennium Development Goals (MDGs), more improvements particularly

in maternal health, primary education and gender equality are required. The MDGs Report

(2011) stated that the country is likely to meet 5 of the 8 MDGs by 2015 (Technical Annex III).

2.2.11 The Consumer Association of Malawi led public demonstrations held on 17th

January

2013, protesting against the deteriorating living standards for most Malawians. This was

followed by a country-wide civil service strike in February 2013, to demand increased salaries

and wages. According to the Malawi Vulnerability Assessment Committee the number of

vulnerable people was projected to have increased by 21% to 1.9 million in October 2012

compared to 1.63 million in June 2012, mainly on account of poor rainfall which led to low cash

crop production and increased food prices. The devaluation of the Kwacha fueled prices of

essential non-food items. In an effort to address this situation, the GoM enhanced maize

distribution in many parts of the country. In addition, with support from DPs, the GoM has

increased coverage of the Social Cash Transfer Programme to 15 districts, from the initial 7

districts in July 2012. Similarly, the Farm Input Subsidy Programme has been scaled up by

144,000 farming families, thus benefiting a total of 1,544,400 people. In order to address these

challenges, GoM will require the support of DPs who are expected to fulfill their commitments

and provide additional resources.

Constraints and Challenges

2.2.12 A critical challenge in the short to medium-term is maintaining macroeconomic

stability, achieving a high growth rate and enhancing social protection. To address this

problem the authorities are committed to pursue reforms aimed at: (i) fiscal consolidation to

contain internal and external imbalances; (ii) containing expenditure while increasing the

revenue base to reduce the fiscal deficit; (iii) reducing levels of poverty; and (iv) implementing

growth-enhancing structural reforms to preserve fiscal and external stability. The RFSSP is

addressing these challenges by aiming at improving PFM systems and social protection while at

the same time GoM is protecting expenditure in targeted social sectors (such as education and

health) and constraining non priority expenditure so as to improve the fiscal situation and

macroeconomic stability.

2.2.13 The principal challenges of MGDS II and the ERP are scarce financial resources,

limited institutional and human resource capacity to co-ordinate policy implementation at

6

both central and local government levels. There is also a need to improve GoM’s internal

control systems and strengthen public finance management. Meeting the objectives of MGDS II

and the ERP requires a substantial increase in external financing to supplement Malawi’s low

domestic savings. This includes a substantial scaling-up of DPs’ support to finance public

expenditures as well as private financial inflows for investments in key sectors, such as energy,

which is important for both industrial development and domestic use. In this context, in 2013, the

US supported Millennium Challenge Corporation will provide US$ 350 million grant to

undertake reforms and revitalize the power sector. The continued support of DPs in the short to

medium term is critical as Malawi remains vulnerable to a number of exogenous shocks,

including weather conditions and a deterioration in the terms of trade.

2.1.14 Other critical, but more medium-term challenges include: (i) expanding and diversifying

agricultural exports to reduce the country’s agricultural export dependence on a single crop,

tobacco; (ii) boosting private investment by improving business climate and the country’s

competitiveness through removal of obstacles, such as access to finance, transportation, energy

shortages, and lack of skilled labour; (iii) establishing the appropriate legal and institutional

framework for the mining sector, to ensure transparency and accountability in the extractive

industries, including in allocation of exploration rights, as well as in the management of the

export earnings and revenues, and social environmental safeguard.

Impact of Recent Reforms

2.2.15 Government had, at the time of appraisal of the RFSSP programme in May 2012,

adopted bold measures to stem the decline of the Malawian economy and correct

macroeconomic imbalances, through among others the devaluation of the Malawi Kwacha,

exchange rate floatation, monetary policy and fiscal tightening, and the adoption of an

automatic fuel price adjustment mechanism (APM). The Government continues to implement

adjustment measures adopted since May 2012, to address the macroeconomic challenges facing

the country and these measures are beginning to yield results. Nonetheless, Malawi’s economy

remains fragile. Gross foreign exchange reserves have improved since last year, but remain at a

precarious level of 1.4 month import cover as of January, 2013. The impact of the devaluation of

the Kwacha has been steeper than anticipated which, coupled with the adoption of the APM on

petroleum products, has led to the high rise in inflation as earlier noted. The sharp devaluation of

the currency is attributed to the high pent up demand for foreign exchange to meet import

requirements and clearance of backlog in private sector external arrears.

2.2.16 As a result of implementing the current reforms supported by increased donor inflows,

Malawi has, among others, experienced: (i) improved availability of forex exchange making it

easier for the country, including the private sector to import essentials goods (e.g. drugs and farm

inputs) and raw materials; (ii) improved fuel supply on the market that is contributing to the

economic rebound and improvement in logistical supplies, including transport; and (iii) increased

support to vulnerable groups through the Public Works Programme, Social Cash Transfer

Scheme, School Feeding and Bursary Scheme programme, and the Farm Input Subsidy

Programme. The Farm Input Programme has provided 154,400 metric tonnes to 1,544 million

people, while the Public Works Programme has benefitted 593,750 households. Government has

also drawn down 75,000 metric tonnes from Strategic Grain Reserves for the Humanitarians

Relief Programme, aimed at supporting 1.9 million people affected by drought.

7

2.2.17 During the October 2012 CABS Review, the DPs commended GoM for its continued

implementation of economic reforms in the context of a challenging socio-economic

environment. Performance of the 2011/2012 PAF was assessed as satisfactory. Out of 42 targets

assessed, 74 % were either fully or partially achieved. PFM continued to achieve relatively

higher performance (94% of targets were either fully or partially achieved), Economic Growth

came second (83% achievement rate), Social sector third (with a 56% rate-five targets were not

assessed, due to lack of data at the time of assessment), and democratic governance fourth with a

50% rating. A summary of 2012/13 PAF review is attached in Technical Annex III. This

satisfactory performance has enhanced DP’s trust to continue supporting the reforms and the

national budget through the CABS framework, thereby creating GoM’s space for implementing

more reforms.

2.3 Bank Group Portfolio Status

2.3.1 The Bank’s portfolio in Malawi consists of 11 operations for UA 192.4 million, as at

end of February 2013. One of the projects is a regional one, namely the Nacala Road Corridor

involving Malawi, Mozambique and Zambia which supports regional integration. In terms of

sectoral distribution of the portfolio, the social sector accounts for 36%, followed by transport

sector with 20%, agriculture sector 16%, water supply and sanitation 15% and multi-sector

(budget support) at 13%. The current average age of the portfolio is 3.7 years compared to 3.5

years in 2010. During the same period, the portfolio was rated as “satisfactory” with an overall

portfolio rating of 2.2 (on a scale from 0 to 3) compared with 2.3 in 2010. It is expected that the

average age will decline when the Support to Health Sector Programme exit the portfolio by

December 2013. The cumulative disbursement rate at the end of February 2013 was 44.5%.

There are no problem or potential-problem projects.

III. KEY DESIGN ELEMENTS AND SUSTAINABILTY

3.1 Link with RFSSP, CSP and Readiness Assessment

3.1.1 The proposed Additional Financing to the RFSSP provides resources for GoM to

protect vulnerable groups from shocks, resulting from current economic hardships and to

maintain the momentum of reforms undertaken. Reform implementation under the RFSSP is

progressing satisfactorily (see paragraphs 2.1.15 and 2.1.16 and section 4.3). The RFSSP is

aligned to the Malawi 2013-2017 Country Strategy Paper (CSP), whose pillars are: (i) Support

Actions to expand private investment and trade; and (ii) Address infrastructure constraints to

competitiveness and growth. The Bank’s CSP proposes general budget support for enhancing

economic competitiveness, private sector development and for strengthening the PFM system, to

create fiscal space for social sector spending and for efficient and reliable public service

delivery. The Additional Financing to RFSSP, among others, aims to restore fiscal stability and

contribute to enhancing public finance management in Malawi. By improving the country’s

governance framework, through supporting enhancement of PFM reforms, the RFSSP is

contributing to creating an attractive fiduciary environment conducive to stimulating foreign and

local investments in infrastructure development and accelerating private sector development.

This will lead to improved service delivery, through reduced waste, thereby creating fiscal space

for social spending.

8

3.1.2 Country Readiness Assessment: Malawi meets the pre-requisites for provision of

general and crisis response budget support and also complies with the safeguard policy. A

country readiness assessment was also undertaken last year and has been updated. A fiduciary

risk assessment also carried out in May 2012 by the Bank concluded that progress continues to

be made towards improving the PFM system in Malawi. The assessment noted, however, that

challenges still exist, particularly in the areas of accounting and reporting, internal audit, external

audit and scrutiny and procurement. GoM is undertaking various reforms to address these

challenges. The RFSSP is focusing on some of these areas with a view to contributing to

reducing the fiduciary risk. The on-going PFM reforms, that include IFMIS roll-out,

consolidation and business re-engineering process will continue to mitigate the fiduciary risk

(Refer to 4.3 on progress and Technical Annex VII).

3.2 Collaboration and Coordination with other Development Partners

3.2.1 A Heads of Co-operation (HoC), Heads of Mission (HoM) and Common Approach

to Budget Support (CABS) Group provide the platform for dialogue between DPs and

GoM on economic, financial and sectoral issues. The Government has a Development

Assistance Strategy which promotes the principles of the Paris Declaration (2005), the Accra

Agenda for Action (2008) and Busan Aid Effectiveness (2011) in Malawi, and contributes to

improving the coherence of DPs’ engagement with the Government through the CABS and the

Group on Financial and Economic Management (GFEM). Besides the Bank, the other DPs

providing budget support are the World Bank, European Union, Norway, DFID and Germany.

Under the CABS, two bi-annual reviews are held to assess progress in implementing measures

agreed in the Performance Assessment Framework (PAF). The Bank participates actively

through MWFO in the review process and policy dialogue. MWFO also undertakes portfolio

supervision and participates in sector dialogue discussions between DPs and Government. This

has contributed to the improvement of portfolio management and the Bank’s visibility among

DPs and Government ministries.

3.2.2 In the social sector, many DPs provide aid to Malawi. There are 14 DPs in the health

sector, comprising AfDB, Clinton Health Access Initiative, DFID, Flanders, Germany, the

Global Fund, Japan International Cooperation Agency (JICA), Norway, UN agencies, USAID

and World Bank. In education, there are 8 DPs: the AfDB, World Bank, DfID, Germany,

USAID, UNICEF, JICA and World Food Programme. China is also financing the construction of

the University of Science and Technology. The World Bank and AfDB are collaborating in

implementing programmes in higher education and skills development in Malawi. Most of the

DPs focus their funding on basic education. In Gender, Youth Development and Social

Protection, key partners include UNFPA, DfID, WFP, UNICEF, Norway, KFW, World Bank

and EU. In all the Sector Groups, DPs provide funds and, in turn, GoM implements agreed sector

reforms which are monitored and assessed by the respective groups on the basis of the PAF

indicators.

3.2.3 The proposed Additional Financing is in line with harmonisation and aid effectiveness

principles under the Paris Declaration, the Accra Agenda for Action and the Bussan declaration,

and will use country systems for implementation and monitoring. Joint assessments will be

9

undertaken and co-ordinated with CABS partners and programme targets have been drawn from

the common PAF (Technical Annex IV).

3.3 Relationship to On-going Bank Group Operations

3.3.1 The proposed Additional Financing of RFSSP will build on the achievements of and

lessons learnt from the ongoing reform programme in Malawi. The programme will

consolidate the Bank’s support to improve the PFM systems, which is fundamental to all on-

going Bank operations, in terms of improving the quality and timeliness of financial reporting

and ensuring that procurement is done with efficiency, transparency and accountability.

Improved social protection will create opportunities for students to enroll and remain in schools

supported by the Higher Education Science and Technology project of the Bank. Improved skills

will enhance labour participation rates in agriculture and industrial development as well as

infrastructure development. Improved PFM management will enhance value for money benefits

and improve service delivery, especially, in the social sectors (education, health, water and

sanitation).

3.4 Outcomes of Past Similar Operations and Lessons

3.4.1 The Bank Group has approved five policy-based operations for Malawi, amounting

to UA 89.45 million. Results and lessons learned from these operations and other DPs’

programmes are highlighted in Technical Annex X and XI and these were taken into account in

the design of the RFSSP, hence this follow up additional financing proposal.

IV IMPLEMENTATION PROGESS OF THE RFSSP

4.1 Programme’s Goal and Purpose

4.1.1 The overall goal of the RFSSP and hence that of the Additional Financing is to restore

fiscal stability and enhancing public finance management in Malawi, as well as support social

protection measures necessary to mitigate the adverse social impact of the devaluation of the

Kwacha, and the massive increases in fuel and electricity prices. The expected outcomes of the

Programme are: (i) macroeconomic stability; (ii) improved PFM and economic governance; and

(iii) enhanced social protection for the poor and vulnerable.

4.2 Programme Components

4.2.1 The areas of focus for the additional financing remain the same as in the RFSSP and are as

follows: (i) Strengthened PFM transparency and accountability, and (ii) Strengthened Social

Protection System.

4.2.2 Component I: Strengthening PFM Transparency and Accountability- The objective

is to strengthen PFM systems by improving budget preparation and execution, improving tax

administration, as well as enhancing oversight through the National Audit Office (NAO).

4.2.3 Component II: Enhancement of the Social Protection system- This Component

supports improvement of the policy environment for social protection in Malawi. It was designed

10

to provide urgent support to bridge the financing gap, protect social expenditure and mitigate the

negative social impact of the devaluation and related reforms.

4.3 Progress on Programme outputs and results since July 2012

4.3.1 Progress in implementation of the RFSSP programme reforms is satisfactory. Most

of the logical framework targets have been achieved, except for GDP growth partly on account

of drought and the difficult macroeconomic environment facing the country. Social protection

reforms, scaling up coverage and policy approval have been achieved though more needs to be

done (see Table I below).

Table I: Progress against impact and outcome indicators

PERFORMANCE

INDICATORS BASELINE TARGET

STATUS AT END FEBRUARY 2013

Impact :Stabilized Fiscal Situation and Protected Social Spending

a. GDP growth rate

b. National reserves

c. Human

Development

Index (HDI)

a. 4.3% (2011)

b. National reserves

below one month of

import cover

c. HDI 0.400 in 2011

a. 5.7% in 2013

b. National reserves

at one month of import

cover

c. HDI 0.425 by 2015

a. GDP growth rate for

2012 revised downwards to 1.9%

from a 4.3% forecast for 2012. In

2013, GDP projected at 5.5%

b.Gross Official National reserves

stood at 1.4 months of import cover

(Jan 2013)

c.HDI was at 0.400 (2011)

Outcome 1: Credible, transparent and accountable budget system

a. Budget out-turn –In

year expenditure

b. reallocation between

primary expenditure

votes

c. Monthly revenue

data publication

a. In 2009/10, the

variance was at 6.7%

b. ii. No monthly

publication of revenue

data

a. Variance between

budgeted expenditure and

outturn for 25 votes in

2010/11 Fiscal Year

amount to 10% or less of

the 2009/10 approved

budget’s primary

expenditure

b. ii. Monthly publication of

revenue data by July 2012

a. Variance between budgeted

expenditure and outturn expenditure

for 25 votes for 2011/12 amounted to

9.2 % of the 2010/11 approved

budget’s primary expenditure.

b. Monthly publication of revenue

data started in July 2012.

Outcome 2: Enhanced Social Protection System

a. Protecting priority

expenditures

(Government meets

budget allocation

requirements of Health

and Education SWAps

in the approved

budget)

a. In 2010/11, 23.6%

of Voted Recurrent

Expenditure was

spent on Education.

Real increase of 6%

in GoM

contribution to the

Health Sector.

a. Government meets

budget allocation

requirements of Health

and Education SWAps in

the 2011/12 approved

budget

a. The education budget allocation

was met at 23.7% against a target of

20%. The health budget allocation

was also met as it increased by 14%

against the 2011/12 budget.

4.3.2 Public Finance Management (PFM): While challenges still remain, GoM is moving

towards the right direction in addressing them. In an effort to strengthen PFM transparency and

accountability (as agreed in the RFSSP), IFMIS has been rolled out to 28 LAs out of 36. Plans

are that by June 30th

2013, all the 36 LAs should be connected. This will assist in improving

timeliness in financial reporting thereby enhancing accountability. Through the FROIP, the

IFMIS business re-engineering aimed at improving the connectivity and integration of

accounting IT software such as payroll management will be supported. In order to enhance skills

of accounting personnel, the FROIP will also assist in training staff in the Accounting Common

Service.

11

4.3.3 In the area of oversight, GoM is up-to-date in submission of Annual Auditor

General’s Reports (AGRs) to Parliament. The 2010/11 Auditor Generals Annual Report was

submitted to Parliament in June 2012. However, the FY 2011/12 AGR has been delayed due to

two factors, namely absence of the Auditor General (AG), following retirement of the previous

post holder towards end of 2012, and changes in systems for submitting financial statements to

the National Audit Office (NAO). Initially, the Accountant General’s Department (AGD) was

preparing and consolidating financial statements before submitting to the NAO for audit. To

make controlling officers more accountable, and in order to reduce delays by the AGD in

consolidating the statements, a decision was made for Ministries, Departments and Agencies

(MDAs) to prepare and submit individual statements directly to NAO for audit. However,

teething problems were encountered leading to delays in finalising and submitting the 2011/12

financial statements. The statements have since been finalised. It should also be noted that, a

42% vacancy rate coupled with limited financial resources, among others, hamper the

effectiveness of the NAO to effectively execute its oversight role. GoM has since appointed a

new Auditor General, subject to confirmation by next sitting of Parliament in 2013.

4.3.4 Government is taking steps to improve tax administration, increase domestically

generated revenue and diversify the revenue base. Modernisation of the tax system is at the

centre of the reforms. The GoM has thus: (i) introduced the Self-Assessment Scheme (SAS) to

improve income tax collection; (ii) established Customs Data Processing Centres (DPCs) to

enhance the collection of trade taxes; and (iii) increased the maturity profile of domestic debt by

issuing longer term instruments. Through the Malawi Revenue Authority (MRA), GoM is in the

process of introducing Electronic Fiscal Devices (Registers) with a view to enhancing

compliance in VAT collection. GoM is also in the process of introducing an Electronic Filing

system with a view to reducing delays in submitting tax returns. All these systems will lead to

development of an Integrated Tax Administration System (ITAS). The overall goal of ITAS is to

enhance efficiency in tax administration, through improved reporting and reconciliation of

revenues.

4.3.5 Other reforms aimed at strengthening and promoting transparency include: (i) a new Bill

intended to update the current Public Procurement Act is being drafted, with a view to

decentralizing procurement functions to line ministries. The Bank together with the World Bank

has provided extensive comments on the draft Bill; (ii) GoM is implementing a Mining

Governance Growth Support Project with support from the World Bank which is aimed at

updating legislation, geophysical mapping and develop capacity as mining sector has potential to

contribute to GDP; (iii) GoM is also considering joining the Extractive Industries Transparency

Initiative (EITI) in order to promote transparency in the extractive sector; and (iv) In the same

vein, the Bank has supported through Governance Trust Fund the Construction Sector

Transparency Initiative (COST) programme in Malawi, aimed at improving transparency in the

construction sector. These initiatives will complement efforts of other oversight institutions,

namely, Anti-Corruption Bureau (ACB), the Public Accounts Committee (PAC), NAO, MRA

etc., in improving service delivery and reducing wastage.

4.3.6 To enhance capacity for implementing PFM reforms, GoM is in the process of

implementing a Public Financial and Economic Management Reform Program (PFEM RP). The

PFEM RP is a medium-term programme aimed at strengthening PFM systems and improving

their capacity. Under the Multi-Donor Trust Fund (MDTF) funding modality of the PFEM RP,

the first project, the Financial Reporting and Oversight Improvement Project (FROIP), has been

designed with a total estimated cost of US$ 19 million. The FROIP focuses on the IFMIS roll-

12

out and consolidation, payroll management, and external and internal audit. The next project,

which is currently being prepared by the Bank, as an institutional support project, will focus on

tax administration and procurement.

Table II: Main indicators for sub-component 1: strengthening PFM transparency and accountability

PERFORMANCE

INDICATORS BASELINE TARGET

STATUS AT END FEBRUARY 2013

a. IFMIS rolled-out to

Local Authorities (LAs).

b. Electronic Tax Register

(ETR)

c. 1.3 Timelines and

follow-up of audit

reports and

recommendations.

d. 1.3.2 Timeliness and

quality of expenditure

reporting

a. IFMIS rolled-out

18 LAs (2012)

b. ETR not available

c. 1.3.1 2003/04

Treasury Minutes

available;

d. 1.3. The 2008/09 &

2009/10 Auditor

General’s Reports

(AGRs) were

submitted to

Parliament by

Aug. 2010 & Dec.

2010 respectively.

a. 1.1.IFMIS rolled

out to 11 additional

LAs (2013)

b. 1.2. ETR introduced

and

functional(2013);

c. Treasury minutes

responding to audit

reports for years

2005, 2006 and

2007 submitted to

Parliament by

December 2012.

d. 1.3.2 The 2010/11

AGR be submitted

to and tabled in

Parliament by

December 2012.

a. IFMIS was rolled to 5

Las and plans

underway to roll-out

to the remaining 8

sites.

b. ETR prequalification

advertised

c. Treasury minutes

submitted to

Parliament.

d. The AGR was

submitted to

Parliament in June

2012

4.3.7 Social Protection: The Social Support Policy (SSP) provides a holistic framework for

designing, implementing, coordinating, monitoring and evaluating social support interventions in

Malawi. The National Social Support Policy (NSSP) has been developed to provide and promote

productivity-enhancing interventions and welfare support for the poor and vulnerable, as well as

interventions that reduce risks and the impact of shocks, thereby facilitating movement of people

out of poverty and reducing the vulnerability of those in danger of falling into poverty. The key

stakeholders were consulted on how the NSSP have been negatively affected by the devaluation

and floatation of the Kwacha, which partly led to increases of local prices, e.g. food, fuel, and

imported goods and services.

4.3.8 The Social Support Policy was approved by Cabinet in July 2012, and the National Social

Support Programme was approved by the National Steering Committee on April 3, 2013.

4.3.9 In order to strengthen the social protection systems, GoM and DPs further agreed on

three policy actions namely: (i) Strengthening the Social Support Policy environment by

supporting the operationalization of the NSSP through the implementation of the National Social

Support Programme; (ii) Improving the Coverage of Social Support Interventions, recognizing

that social support interventions in Malawi provided limited coverage to the target groups, with

the Social Cash Transfer Programme reaching only 35% of vulnerable groups in 8 districts out of

28, and full coverage in only 3 of the 8 districts; and (iii) Improving the efficiency in the delivery

of social support interventions in Malawi.

13

4.3.10 Government is committed to rolling out coverage of the Social Cash Transfer Programme

from 15 districts in 2013 to 28 districts by June 2014. However, lack of harmonisation across

programmes and uncoordinated social support interventions remains a concern. Through the

social support programme, social support interventions will be coordinated and harmonised.

Table: III: Main indicators for sub-component 2: enhancement of the social protection system

PERFORMANCE

INDICATORS BASELINE TARGET

STATUS AT END FEBRUARY 2013

2.1 Existence of the

National Social

Support Programme

(NSSP).

2.2 Existence of

National Social

Support Policy.

2.1 Preparation and

consultation on the

NSSP

2.2 Preparation of

the NSS Policy on-

going

2.1 The NSSP is finalized and

approved by the National

Steering Committee by

December 2012.

2.2 The draft Social Support

Policy is approved by Cabinet by

December 2012.

2.1 While social support

programs are running, the

Steering Committee is yet to

adopt the policy

2.2 The draft Social

Support Policy was adopted

by Cabinet on July 15, 2012

4.4 Financing Gap and RFSSP Resource Use

4.4.1 Malawi is experiencing a financing gap for reform implementation and additional resources

are needed to finance the budgetary requirements for the FY 2012/13. The UA 4 million

Additional Financing for the RFSSP operation, is aimed at reducing the financing gap for

Malawi for the FY 2012/13 (July 2012 to June 2013), as well as to contributing to the alleviation

of social shocks resulting from some reforms and maintaining the momentum of implementing

reforms. GoM informed the Bank that the RFSSP resources were utilised in scaling up social

protection, and supporting governance reforms, as well as importation of essential commodities

(Par 2.1.16). The Government is committed to protecting social spending and in the 2012/13

budget allocation, education received the highest allocation of 22%, followed by agriculture and

health. Table II shows an overall balance (excluding grants) estimated at -13.0% of GDP in 2012

and projected at -13.2% of GDP in 2013. Overall balance (including grants) is estimated at -8.5%

in 2012 and projected at -0.5% in 2013. This shows that grants play a key role in reducing the

budget deficit and improving the fiscal space for the country. The UA 4 million is part of the

projected grants for FY 2012/13. Section 4.3 and Technical Annex I show progress on

programme targets and the reform implementation status respectively.

Table IV: Medium-term Expenditure Framework (2009-2015) Projections

Economic Indicator

2009

Est.

2010

Act.

2011

Prel.

2012

Est.

2013

Prog.

2014

Proj

2015

Proj.

GDP at constant market prices

Percentage change 9.0 6.5 4.3 1.9 5.5 6.1 6.5

Consumer prices(end of period) 7.6 6.3 9.8 31.7 10.1 5.8 5.4

Revenue (% of GDP) 32.1 33.8 32.1 26.5 35.3 36.9 35.8

Grants (% of GDP) 11.6 10.3 7.6 4.4 12.7 12.8 11.3

Expenditure (% of GDP) 37.8 33.8 35.0 35.0 35.8 38.9 37.5

Overall balance (excluding grants) -17.3 -10.3 -10.5 -13.0 -13.2 -14.7 12.9

Overall balance (including grants) -5.7 0.1 -2.9 -8.5 -0.5 -1.9 -1.6

Foreign financing 2.0 0.9 1.3 1.6 1.0 1.9 1.6

Domestic financing 3.7 -0.9 1.7 6.6 -0.5 0.0 0.0

Reserve (months of imports) 0.7 1.5 1.0 1.1 1.9 2.4 2.8

Source: GOM authorities & IMF estimates. Note: 2009 refers to fiscal year 2008/2009 in table II.

14

4.4.2 The expenditure framework is anchored on the principle that there will be zero net

domestic financing over the period and that expenditure will be based on the resource

envelope. Overall deficit will be financed by foreign inflows as well as domestic financing up to

2012, and zero domestic financing thereafter with expected small foreign financing. Expenditure

is projected to decline over the period due to austerity measures to cut down on non-essential

expenditure. Grants will constitute a significant proportion of the resource envelope, especially

budget support resources. This projection is based on pledges already made by CABS DPs and

any failure to provide support will lead to budget deficits. It is important for all DPs to honor

their pledges, to enable Malawi, build up reserves of up to three months of imports by 2015.

4.5 Impact on Gender

4.5.1 The on-going RFFSP programme has had positive impact on gender. GoM

commitment to gender equality is expressed in MGDS II. Malawi embarked on gender reforms

in 2011, aimed at reaching the 2014 goal of 50/50 women representation in decision-making

positions in the public service. A gender audit approved in March 2012 also developed

guidelines for affirmative action on recruitment. A National Gender Equality Action Plan is

being prepared. At policy level, Parliament passed a Gender Equality Bill in February

2013, which, among others, seeks to promote gender equality and equal integration of men and

women in all functions of the society. At programme level, a € 11.7 million Gender and Women

Empowerment Programme was launched in July 2012 with a view to accelerating the

attainment of the MDG 3 (on gender equality and women empowerment) where Malawi is

lagging behind. Women and girls in the agriculture, health and education sectors have started to

benefit from the programme. Further, 58 business groups have been set up to benefit from a

MWK32.8 million credit scheme. Already, 17 groups have started receiving the support. Under

the RFSSP supported programmes, such as the Farm Input Subsidy Programme, Social Cash

Transfer Programme, and the Public Works Programme (PWP), women have been the major

beneficiaries. For example, at least 7,840 female headed households have been assisted through

the Social Cash Transfer Programme. Under Farm Input Subsidy about 70% of female headed

households have benefited from the programme. Similarly, most beneficiaries under Public

Works Programme and Food Aid Programme are women.

4.5.2 Gender Context: Malawi’s social protection programmes, especially the pilot Cash

Transfer Programme, targets the ultra-poor who constitute 25% of the population, over

half of whom are women. So far, 28,000 households are benefiting from social cash transfers

(about 28% being female headed). Evidence from the social protection programmes suggests that

direct cash transfers to women, through social cash transfers, public works or microfinance

schemes, empowers them and enhances their social standing within the household. They are also

able to invest in critical household expenditures and micro enterprises thus promoting their

empowerment and family well-being. Under the National Social Support Programme, GoM is

implementing measures to improve gender mainstreaming, targeting efficiency and collection of

sex-disaggregated data in the various social support programmes.

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4.6 Environmental Impact

4.6.1 The Programme has been classified as category 3 in the Bank’s environmental

classification. It is not expected to generate any negative impacts on the environment and

climate change, since it focuses on strengthening PFM and the social protection system.

V. IMPLEMENTATION, MONITORING AND EVALUATION

5.1 Implementation Arrangements

5.1.1 The Ministry of Finance will be the recipient of the budget support and will

continue to be responsible for the implementation of the reform agenda. The general budget

support programme in Malawi is currently assisted by six DPs (including the Bank) through a

Joint Framework for Budget Support co-operation entered into between GoM and the CABS

DPs. The policy dialogue is based on this framework and the underlying principles defined

therein which include economic governance (PFM), social sector and democratic governance.

The monitoring and review is based on a common PAF, providing a jointly approved set of

indicators for measuring progress. The National Social Support Steering Committee shall support

the implementation of the Social Protection aspects of the operation.

5.1.2 Disbursement: The proposed grant of UA 4 million will be disbursed in one tranche.

This is justified by the financing gap and the resource needs for scaling up social protection

programmes in the budget, to mitigate the impact of the devaluation on the welfare of the

population. This also reward progress made by the Government in implementing a bold

economic and social reform measures supported within the framework of the RFSSP.

Disbursement will be subject to the entry into force of the Grant Agreement and fulfillment of

the conditions precedent to the disbursement. The grant proceeds will be credited to a designated

foreign exchange account indicated by the GoM and held in the name of the Reserve Bank of

Malawi (RBM) in accordance with the Bank’s Disbursement procedures. The RBM will

promptly credit the counter value in Malawi Kwacha to the Treasury Account of Malawi’s

Ministry of Finance calculated on the basis of the ruling exchange rate on the date of transfer of

funds by the Bank. GoM will be required to acknowledge receipt of the funds and to provide

confirmation to the Bank that an amount equivalent to the grant proceeds from the Bank has been

credited to the Treasury Account with an indication of the exchange rate applied within seven

days of the credit.

5.1.3 Procurement: The procurement will be done according to Malawi’s national

procurement procedures, subject to the Negative List of Non-Eligible Items. MWFO will play an

active role in strengthening the procurement and audit processes by monitoring the

implementation of these activities through the CABS framework. However, the proceeds shall

not finance expenditures in the “Negative List” as defined in the Schedule of the Financing

Agreements. If any portion of the Grant is used to finance ineligible expenditures, the Bank

shall require GoM, upon notice from the Bank, to refund the amount involved. Amounts

refunded to the Bank shall be cancelled from the Grant.

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5.1.4 Financial Management and Auditing: In line with Bank Policy on Programme-

Based Operations, and commitments on harmonisation and alignment under the Paris

Declaration, the Programme will use the country’s systems, including audit arrangements.

Overall, the PFM system is reasonably adequate for this proposed additional financing. The use

of the country systems is justified taking into account the risk mitigation factors and the positive

trajectory towards improvement through the new PFEMRP. The PFEMRP is a multi-year

programme of reform covering the entire PFM cycle from planning and budgeting to resource

mobilization. GoM leads the implementation of this broad-based reform programme, with

financial support from DPs including the Fund. The annual audit of the GoM consolidated

financial statements will be done by the National Audit Office in accordance with its mandate

and a copy of the audit report submitted to the Fund. The Fund may require GoM to provide an

audit of financial flows verifying receipt of resources by the RBM and transfer of the equivalent

amount in Kwacha into the treasury account.

5.2 Monitoring and Evaluation Arrangements

5.2.1 The country monitoring and evaluation systems will be utilized for this operation. The

bi-annual CABS assessment will form the basis for monitoring and reviewing progress. The

relevant Sector Ministries, Agencies and Departments will have a role in the programme

implementation as well as monitoring. In addition to this, two formal supervision missions are

conducted per year, and will coincide with the annual and biannual CABS Reviews during which

overall progress in implementation and achievements of the programme objectives are assessed.

This will be complemented by the Group on Financial and Economic Management (GFEM)

quarterly reviews, annual joint analysis of the national budget, the MGDS II Annual Progress

Review, and the IMF periodic reviews. MWFO will continuously monitor the programme

performance and represent the Fund in various sectoral discussions including the CABS Group

and GFEM.

5.2.2 GoM and DPs have set up functioning Sector Working Groups (SWG) in PFM,

Transport, Education, Health, Private Sector, Youth Development and Sports,

Vulnerability, and Disaster Management. The SWGs hold regular dialogue through Technical

Working Groups meetings on quarterly basis and provide feedback to the CABS.

5.2.3 At the completion of the proposed programme, the Bank will prepare a PCR in

collaboration with GoM, focusing on evaluation of the Operation and lessons learnt.

VI. LEGAL DOCUMENTATION AND AUTHORITY

6.1 Legal Documentation

6.1.1 The Programme will be financed with a proposed ADF Grant of UA 4 million

(“Grant”) in one tranche. For the purposes of providing the tranche, the Fund will enter into a

Grant Agreement (“Agreement”) with the Republic of Malawi (“Recipient”) of ADF UA 4

million from the Recipient’s ADF 12 allocation. The Grant Agreement shall be governed by the

General Conditions Applicable to Protocols of Agreement for Grants of the African Development

Fund (“General Conditions”), as amended.

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6.2 Conditions Associated With the Bank’s Intervention

A Conditions precedent to entry into force of the Grant Agreement

6.2.2 The Agreement shall enter into force on the date of its signature by the Fund and the

Recipient.

B Conditions precedent to the disbursement of the Grant

6.2.3 The Fund’s obligation to disburse the Grant of UA 4 million shall be conditional upon the

Recipient providing evidence in form and substance acceptable to the Fund of the existence of a

foreign currency account for the receipt of the proceeds of the Grant.

6.3 Compliance with Bank Group Policies

The additional financing proposal complies with applicable Bank Group policies and guidelines

including: (i) the Policy on Programme-Based Operations (PBOs); (ii) Guidelines on

Development Budget Support Lending; (iii) Guidelines for Policy-Based Lending on

Governance; (iv) Governance Strategic Directions and Action Plan and the Long Term Strategy;

and (v) the Strategy Update for the Bank’s Private Sector Operations.

VII RISK MANAGEMENT

The risks and mitigation measures for the Programme are presented in Table V below and

are also summarized in the logical framework.

Table V: Risks and Mitigation Measures

Risk Mitigation Measure

Macroeconomic risk: Shortfalls in support

from Development Partners could worsen the

foreign reserves situation and increase

inflation, following liberalization of the

exchange rate system and devaluation of the

currency to align it to market rates. Foreign

currency bottlenecks may derail

implementation of reforms and achievement

of results. This may lead to the IMF ECF

programme going off track and further

reduction of budget support to Malawi.

The Bank will continue to engage GOM and have close dialogue

with the IMF and CABS development partners on the need to

support GoM’s reform programme. The liberalization of the

exchange rate system is expected to mitigate macroeconomic

instability. DPs have pledged and provided support to alleviate

effects of the liberalization. . GoM committed to macroeconomic

reforms and ECF remains on track.

The Bank’s additional financing proposal will help mitigate this

risk by providing resources which will contribute towards

covering import costs and building up of reserves.

External and internal shocks: The

country’s dependence on a single agricultural

export crop and frequent weather related

events, such as droughts and floods, expose

the economy to internal and external shocks.

The GoM’s economic reform program is aimed at establishing a

macroeconomic and environment and removing structural

barriers, to promote private sector investment and improve the

business climate, with a view to supporting the diversification of

the economy and alternative sources of export revenues. Climate

and disaster management to reduce Malawi’s vulnerability to

national disasters is being scaled up with the support of DPs.

DPs support to Malawi during this transition period will help

mitigate this risk.

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Political and social risks: Unstable political

climate could arise if GoM does not contain

rising inflation from depreciation of the

Kwacha and provide safety nets to the poor.

The reform agenda may be affected by the

election planned for 2014, as GoM may come

under political pressures to adopt an

expansionary fiscal stance and expand

government programmes. Lack of funding for

social sectors could increase poverty.

The current government is committed to implementing prudent

macroeconomic policies and has made significant effort to build

broad public support for the reform programme supported by the

RFSSP. The Government’s ongoing reforms efforts, which

include enhancement of social inclusion, and expanding social

protection programs, will help dampen social tension. GoM has

put in place a government of national unity for stability to drive

the reform agenda. CABS reviews and dialogue with GOM will

mitigate less funding to social sectors.

Implementation capacity constraints: Weak

institutional and human resources capacity

could hamper implementation of reforms.

Weak PFM can lead to wastage of public

resources and unplanned and non-responsive

expenditure. Lack of oversight may entrench

corruption and misuse of public resources.

There is political will to implement the PFM reforms and

enhance transparency and accountability in the management of

public resources. Through this programme, and the

complementary ISP, and other Bank and DPs intervention, GoM

is making efforts to increase spending on capacity building in key

PFM and social sector institutions. PFM reform and capacity

building programme supported by the DPs and dialogue with

GoM will mitigate this. Timely audit reports and follow-up with

action on culprits.

Fiduciary risk: Reliability of the PFM system

and ability to generate accurate financial

reports timely as well as existence of

procedures and processes to safeguard

programme resources could be a risk.

Ongoing PFM reforms undertaken by GOM and supported by

donors and continuous dialogue and monitoring of the PFEMRP

implemented through a Multi-Donor Trust Fund are expected to

mitigate the fiduciary risk. Enhanced transparency of resource

flows and service delivery, including enhance oversight, will help

mitigate this risk.

VIII RECOMMENDATION

Management recommends that the Board of Directors approve the proposed Additional

Financing Grant of an amount not exceeding UA 4 million from the ADF-XII 2013 Allocation

for the Republic of Malawi, for the purposes and subject to the conditions set out in this report.

I

Appendix I: Letter of Development Policy

Telegrams: FINANCE, LILONGWE Ministry of Finance Telephone: (265) 0178 9355 Treasury Building Telex: 44407 Capital Hill Fax: (265) 0178 8592 P.O.Box 30049 E-mail: finance@finance.gov.mw Lilongwe MALAWI

MINISTER OF FINANCE

Ref. No.: DAD /5/2/1/3 /13 4th June, 2012

Dr. Donald Kaberuka President African Development Bank BP 323 1002 Tunis Belvedere Tunisia Dear Dr. Kaberuka,

MALAWI: LETTER OF DEVELOPMENT POLICY

1. On behalf of the Government of Malawi (GoM), I write to request from the African

Development Bank an urgent ADF Grant of UA 30 million equivalent as crisis response, to support fiscal stability and social protection in Malawi at a time when the Government is undertaking macroeconomic reforms and implementing the public sector reform agenda whose framework has been provided for in the Second Malawi Growth and Development Strategy (MGDS II). These resources being requested from ADF will serve three purposes: (i) help Government bridge a financing gap in the implementation of the MGDS II; (ii) be a source of foreign exchange which is critically needed to fill the existing balance of payments gap; (iii) and assist the Government to meet social sector spending to mitigate the short-term adverse impact of the bold adjustment measures the new Government has taken in macroeconomic management and monetary and fiscal policy.

2. The overall program goal is to promote transparency and accountability in the Public Financial Management (PFM) system and restore fiscal stability and social protection. Its operational policy objective is to support restoration of fiscal stability and social protection, with the aim of regaining macroeconomic balance through exchange rate adjustment and scale-up interventions that will protect most vulnerable Malawians. This will be achieved through two main components (i) Strengthening PFM transparency and accountability; and (ii) Strengthening Social Protection systems.

3. Specifically, the proposed programme will support reforms in the following areas: (i) improving

budget preparation and execution, (ii) strengthening external audit (iii) strengthening revenue collection and tax administration, and (iv) improving the policy environment for social

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protection of the vulnerable. In budget preparation and execution, the reforms will focus on the credibility and transparency of the budget preparation process. The focus in external audit will be on follow up on the implementation of Public Accounts Committee recommendations and timely submission of the Annual Auditor General’s Reports to Parliament. While in tax reforms emphasis will be on efficiency and effectiveness in tax collection and administration.On social protection, the reforms will focus on adoption of the National Social Support Policy (SSP) and National Social Support Programme (NSSP). More details on the proposed reforms to be supported under this programme are set out in Part C of this letter.

A. Recent Macroeconomic Performance 4. Malawi experienced uninterrupted solid growth from 2006 – 2010 with real GDP growth

averaging 7.5 percent, compared to 2 % for 1999 – 2004, amid a decline to single digits inflation. This robust growth was supported by sound economic policies. In addition to positive macroeconomic environment, good weather and the fertilizer subsidy programme made significant contributions to agriculture growth. However, persistent external imbalances compounded by the reduced donor inflows, low tobacco proceeds coupled with other supply side bottlenecks contributed to the weakening of macroeconomic performance over the past year. This, in turn, contributed to a widening of balance of payments and budget gaps and slowdown in economic activity. An off-track International Monetary Fund (IMF) Extended Credit Facility (ECF) program and governance concerns adversely affected budget support.

5. There has been progress in the recent discussions with the IMF to formulate a successor program to ECF. A new ECF programme is expected to go to the Board in early July 2012. In the meantime, IMF is preparing to issue an Assessment Letter to Development Partners that will enable them to process their budget support programmes.

6. Regaining macroeconomic balance will be anchored on fiscal consolidation, restoration of external balances, and realignment of the exchange rate regime to one that is credible to all market players. To this end, the Reserve Bank of Malawi (RBM) has liberalized the exchange rate regime and removed a number of restrictions. The official exchange rate has since been devalued by 49% from MK167 to MK250 per United States Dollar. As Malawi is embarking on these reforms, it is necessary to have a reserve cushion for stabilizing the currency and clearing outstanding foreign bill arrears. Currently, our reserves are equivalent to less than one month import cover.

7. The fiscal anchor will be zero net domestic financing and government is expected to pursue a

tight fiscal policy stance while at the same time ensure prioritization of the social sectors. Due to the recent economic challenges, growth in 2011 was revised downwards from 6 % to 4.3 %. In 2012, the economy is estimated to remain at 4.3 % from a projected growth of 6.5 %. The slowdown in the expected real GDP growth in 2012 is largely attributed to reduced agriculture output arising from low tobacco production as well as dry spells experienced in some parts of the country. The overall fiscal deficit in 2012 is projected at 3 % of GDP. The average inflation for 2011 was 7.6 % but it is projected to rise to 18.4 % in 2012 reflecting the recent 49 % devaluation of the Malawi Kwacha. Increased food production, tight fiscal and monetary policies measures will assist in controlling inflation. Domestic revenues are projected to average 22 % of

III

GDP in the medium term. The share of Government expenditure to GDP is however projected to remain virtually unchanged at an average of 32 %of GDP between 2011 and 2015.

8. Domestic debt has accumulated to 17% of GDP. The overall fiscal deficit, including grants, is projected to increase from 2.9 % of GDP in 2010/11 to 7.0 % in 2011/12. The increase is primarily due to fiscal slippages and the freeze of budget support due to economic mismanagement which led to the suspension of the ECF. The deficit is expected to fall to 1.1 % of GDP in 2012. The ratio of the current account deficit to GDP worsened from -1.3 % in 2010 to -5.9 % in 2011.

9. Government’s macroeconomic management will however, face a number of challenges,

including the need for continued expenditure controls, intermittent power supply, erratic weather conditions and the need to reduce public debt arising mostly from non-performing state-owned enterprises. Government, therefore, remains committed to sound macro-economic management and will continue with the current program of structural and public sector reforms.

B. The Second Malawi Growth and Development Strategy (MGDS II) 10. The GoM finalized its third poverty reduction strategy, the MGDS II (2011-16) which was

prepared using participatory processes. The strategy's overall objective is wealth creation through sustainable economic growth and infrastructure development. The long-term vision of the MGDS is to transform Malawi from a predominantly importing and consuming country into a predominantly producing and exporting country. It is organized around six thematic areas as follows: (i) sustainable economic growth; (ii) social support and disaster risk management; (iii) social development; (iv) infrastructure development; (v) good governance and (vi) gender and capacity development. From these thematic areas, the strategy has identified the following nine key focus areas for immediate intervention: agriculture and food security; energy, industrial development, mining and tourism; transport infrastructure and Nsanje World inland port; education, science and technology; public health, sanitation, malaria and HIV and AIDS management; integrated rural development; green belt irrigation and water development; child development, youth development and empowerment; climate change, natural resources and environmental management. The MGDS emphasizes the need for Malawi to register sustained private sector and export-led growth in order to make a noticeable dent on poverty. In the long term, the Government has also identified four sectors with potential for high growth: tourism, mining, manufacturing, and agro-processing.

C. Specific Reforms to be implemented 11. In line with the MGDS, and in consultation with the GoM, the African Development Bank has

outlined its proposed support to Malawi. In this context, I would like to highlight the various reforms that the Government intends to undertake in the short to medium term.

Public Sector and Finance Management Reforms

12. In order to support the economic recovery which aims at restoring macroeconomic stability and external competitiveness, the Government plans to undertake several policy reforms in the area of business enabling environment, social protection and human development, budget process,

IV

external auditing and scrutiny, public procurement, debt management, public financial and economic management and corruption prevention. Business Enabling Environment Reforms

13. The MGDS, Malawi Country Economic Memorandum (CEM), and the Doing Business Report

by the World Bank have identified supply side constraints such as energy and lengthy business processes as some of the constraints to private sector development.

Unreliable power supply has been one single biggest challenge facing private sector development. To address this constraint, GoM is: (i) Embarking on a rehabilitation program for some of its power stations including Kapichira II and Nkula using local resources the country; (ii) Designed a program to develop new hydropower stations; (iii) Working with the private sector under a public private partnership arrangement to increase the level of investment in the subsector; (iv) Resumed discussion with the MCC on the suspended USD 350 million MCC compact program for the energy sector; and (v) Government plans to update the energy policy to take into account the new developments.

14. Following the establishment of the Commercial Division of the High Court in January 2007, the process of accessing commercial justice has improved significantly. The Government is currently strengthening the capacity of the Commercial Court through training and recruiting of additional staff. Further, Government is also involved in both national and regional efforts in trade facilitation initiatives to rationalize documentation and systems for international trade regulations and approvals. The passing of the bill on credit reference in January 2010 has also created a conducive legal framework for the introduction of credit referencing in Malawi and this should result in better risk assessment by lenders and increased access to credit by borrowers. By November 2011, two operators had been licensed by the Reserve Bank of Malawi. In a bid to strengthen the legal framework for doing business in Malawi, draft legislation on insolvency and secured transactions is in place.

Social Protection and human development

15. Social protection remains one of the priority areas of the MGDS. Government through the

2012/13 national budget and alongside development partners, civil society organisations (CSOs) and communities will implement various social support programmes to address the risks affecting the vulnerable groups and to mitigate the negative effects of the economic adjustment program. Government will continue with the Farm Input Subsidy Program (FISP) which will be targeted and scaled up to 1.5 million family farm beneficiaries in 2012/13 season. The expanded program will ensure that more people who have been affected by the economic reforms do not lose their livelihood. The expanded FISP will include more legumes which will also enhance the nutritional status and increased incomes of households.

16. The Government will expand its Public Works Support Program (PWSP) in the 2012/13 fiscal year. PWSPs are expected to increase incomes, food security of poor households who participate in the creation or rehabilitation of community assets and transfer skills through on the job training. The Government plans to reach an estimated 1.72 million people in 2012/13 through its PWSP, each working twelve days per month for a period of four months. Thus beneficiaries

V

will be able to buy agricultural inputs and have some savings following participation in the PWSP.

17. Since the introduction of free primary education in 1994, the education system has struggled to cope with the enrolment explosion that followed though there is high attrition rate especially for girls from grades 4-8. The excess number of pupils placed a strain on existing infrastructure, provision of teaching and learning materials and qualified teachers in the system. The outcome has been poor quality of primary education, with the challenge being greater in rural schools where work stations are less attractive in retaining qualified teachers compared to urban schools. Government’s short term strategy to improve the quality of primary education, particularly in rural areas, is to increase the annual deployment of qualified primary school teachers to rural areas and provide school feeding and nutrition to reduce drop-out rates. The Government is also providing bursaries to underprivileged girls in primary and secondary schools to fundschool uniforms and basic materials required in school.

18. In order to enhance skills development, Government intends to revamp technical education in its public schools. Currently, the technical vocation policy is being finalized and a review of the Act has commenced. Going forward, Government plans to construct additional technical schools, upgrade technical equipment in schools and rehabilitate its 7 public technical colleges, 13 technical secondary schools and 28 model primary schools. The Bank is assisting the GoM to bridge the skills gap through the HEST Project in order to reduce the high youth unemployment rate in the country and has funded two other projects in rehabilitating and constructing Community Development Secondary Schools. In addition, other DPs have also supported the Government in the past in rehabilitating/constructing Model Primary schools to meet the MDG target. However, more needs to be done through skills development for Government to turn its huge youth population (77% below 30) into economic growth asset thereby moving more people out of poverty.

19. The Government continues to make good progress in the fight against under-five mortality, maternal mortality, strengthening staff capacity in the health sector and in reducing the transmission of HIV and AIDS from mothers to children. For example in the previous years the national proportion of one-year olds immunized against measles reached 96%, exceeding last year’s achievement by 8%, and surpassing the set target by 14%. Good progress was recorded in the fight against maternal mortality. Compared to the previous year, more pregnant mothers in Malawi were attended to by skilled birth attendants in 2010, with the proportion rising from 58% in 2009 to 65% in 2010, exceeding the target by 5%. Good progress was registered in improving the quality of health services in Malawi through increase in the number of qualified nurses. A total of 4988 nurses were in the health system during the period July 2010 to June 2011. Government will continue with its program of training health personnel including nurses in its efforts to reduce the ratios of various cadres to patients.

Budget processes 20. With regard to the budget process, the Government has continued to put in place reforms in

order to meet the internationally recognized classification of the Government Financial Statistics (GFS). The adoption of the new classification brings our budget closer into line with international standards making it easier to compare budgets across countries. The Government has also changed its budget structure to more accurately reflect and monitor its strategic

VI

objectives as outlined in the MGDS. The revised budget structure therefore makes it easier for users of the budget documents to clearly understand what various sectors are delivering on.

21. To reflect these changes, firstly - the Government has introduced a new Chart of Accounts. The new Chart of Account has the revised functional classification and revised economic classification. Secondly, the Government will continue to pursue reforms to improve its output targeting and performance management regime, including liaising with the IMF on possible steps towards full programme budgeting in the medium term. Thirdly, there are on-going projects to review and potentially amend the legal basis of the budget through a new budget law and revised Appropriation Bill. The Medium Term Expenditure Framework (MTEF) is being reinvigorated to the extent that the 2011/12 budget used the MTEF and it is expected that the 2012/13 budget will follow the same framework.

Tax collection and administration

22. In the 2012/13 Fiscal Year, government intends to refine some tax policy measures that were recently introduced with the view to improving on their application and encouraging domestic production and investment whilst promoting investor confidence. Some of the recently introduced tax policies that will require further review and consolidation include: Minimum tax based on turnover; Value Added Tax on machinery and equipment; Domestic excise tax regime; finalization of the special taxation package on pensions and the bio-fuel industry; capital gain tax; Electronic Tax Registers (ETR’s); improving compliance and trade facilitation through the use of electronic container cargo scanners.

23. Malawi Revenue Authority (MRA) will continue with its reform initiatives by among other things implementing the automated Self-Assessment System (SAS) and further migrate to the Integrated Tax Administration System (ITAS) which is expected to reduce the costs of paying taxes by tax payers and the costs of administration of the taxes by MRA. This is aimed at improving efficiency and effectiveness in the administration and management of domestic taxes in the country.

24. Government will also continue to intensify monitoring of tax revenue collection enforcement mechanisms. In order to improve customs valuations, government is introducing Container Cargo Scanners in various border entry points in the country. Efforts are being taken to interface the IT systems of MRA for vehicle customs valuation (ASYCUDA) and the Road Traffic Directorate vehicle registration system (MALTIS) to ensure that adequate tax revenues are collected on vehicles imported into the country. The MRA will also increase its enforcement efforts and audits in order to ensure that tax payers timely honor their tax obligations.

25. In an effort to improve the efficiency and effectiveness of collecting more non tax revenue,

government will in the FY 2012/13, continue to implement various non-tax policy reforms which include the review of user fees and charges in some selected Departments to reflect their cost of administration, monitoring of non-tax revenue collecting departments, audits and extension of the payment of revenue through banks to some Departments.

VII

External audit and follow up

26. Government approved the Institutional review on the independence of the National Audit Office in 2011. The review made a number of recommendations and Government has already started to implement some of the recommendations made including drafting proposed legal amendments to the Malawi Constitution to strengthen NAO’s independence. It is pleasing to note that the audit backlogs have been cleared and now we are up to date with Central Government audits. With regards to local councils, accounts for the years 2005/06, 2006/07, and 2007/08 were audited in 2010 and tabled in parliament in 2011. The 2009/10 accounts have also been audited and awaits publication. It terms of coverage, auditing for councils is currently at 100%.

27. The Public Accounts Committee (PAC) is current in terms of scrutinizing all the reports that were submitted to Parliament. However, Government is aware of the backlog of Treasury Minutes which were mainly due to the absence of the Auditor General and irregular PAC meetings due to funding challenges. With increased funding to Parliament, PAC is able to meet more regularly to scrutinize audit reports. The Government has currently submitted a Treasury Minute for 2005 to 2007 financial years to Parliament. The Government will continue to step up its efforts to work on more recent Treasury Minutes and make necessary follow ups.

Management of public procurement systems

28. Although there has been significant progress in the area of public procurement management, through enactment of appropriate law and publication of regulations and standard bidding documents, weaknesses exist in institutional set up and compliance to the law and regulations by Procuring Entities (PEs). The major challenge has been the shortage of qualified personnel on the labour market and that is why we still have vacancies in some procuring entities (PEs). However, the GoM in collaboration with various public training institutions is continuing to run various short and long-term training courses for various cadres of procurement specialists. Some of the graduates from these institutions are already being absorbed by the Government.

29. To improve the transparency and timeliness of budget execution through procurement activities, Government started enforcing procurement planning as part of the budgeting process. The Government will continue with strengthening compliance monitoring through prior review of large value procurement, procurement audits and post procurement reviews (PPRs). To this effect, Government undertook a procurement audit between July and August 2011 in 50 procuring entities. The observations are that while some improvements have been registered by many PEs in general procurement management, there are still however a number of problems such as record management, procurement planning and evaluation processes. Debt management

30. Since reaching the historic Heavily Indebted Poor Countries (HIPC) completion point in 2006,

the Government has maintained its policy to access grants and borrow concessional loans for all its budget and project financing needs. With the support of its development partners the Government is implementing a multi-year debt management reform program which has identified areas than need strengthening in all three areas of debt management (front office, middle office and back office operations).The Government has now fully operationalized its

VIII

domestic debt unit. Since its inception in 2011, the unit has taken over the responsibility of managing domestic debt functions (determining the government domestic financing needs of the government, assessing options/costs of financing domestically and any decisions to restructure it. In this regard, Government has taken measures to lengthen the maturity profile of the domestic debt stock through issuance of treasury notes (bonds) of 2 – 5 year maturity. Corruption prevention

31. In order to strengthen the law on corruption, the Bureau is currently reviewing the Corrupt

Practices Act (CPA). Government also plans to step up efforts in the area of corruption prevention. Government is currently rolling out the National Anti-Corruption Strategy (NACS) to all sectors of the society. Using the NACS, ministries and departments have established the Institutional Integrity Committees (IIC) mandated to fight corruption from within their institutions. The institutions have taken proactive steps in the prevention of corruption by developing corruption prevention tools such as the Anti-Corruption Policies, Service Charters and have further reviewed Systems and Procedures to eradicate opportunities for corruption. Through the NACS institutions have now taken the fight against corruption as their responsibility and not the Bureau’s responsibility alone.

Public Financial and Economic Management Reform Program

32. Finally, the Government realizes the importance of having robust Public Finance and Economic

Management (PFEM) systems in place. In this regard the Ministry of Finance has in place a specialized unit which will champion and coordinate various PFEM reforms within the public sector. In addition, the Government has set up a PFEM Technical Committee to provide support to the PFEM unit. To date the Government has come up with a reform program covering 13 key PFEM issues grouped into 10 components of the entire PFM cycle which stretches from; Planning and Policy Analysis, Resource Mobilization, Budgeting, Procurement, Pararastatal Financing, Accounting and Financial Management, Cash Management and Debt Management, Monitoring and Reporting, External Auditing, and Programme Management. The Government is confident that implementation of the reform program will improve and bring our systems in line with international best practices.

33. I am confident that the outlined policies, programs and reforms will create a conducive

environment for the effective and efficient utilization of any assistance the African Development Bank may provide, towards enabling the Government to implement its poverty reduction goals as set out in the MGDS II and the Economic Recovery Program.

Yours sincerely,

Dr. Ken Lipenga, MP MINISTER OF FINANCE

IX

Appendix II: IMF Mission Reaches Staff Level Agreement with Malawi on ECF Second

Review

Press Release No.13/55

February 19, 2013

A team from the International Monetary Fund (IMF), led by Tsidi Tsikata, visited Lilongwe

during February 5-19, 2013, for discussions on the second review of Malawi’s Extended Credit

Facility (ECF) arrangement (see Press Release No.12/498) .1 The mission held discussions with

Minister of Finance Ken Lipenga, Minister of Economic Planning and Development Goodall

Gondwe, Reserve Bank of Malawi (RBM) Governor Charles Chuka (, Chief Secretary Bright

Msaka (Office of the President and Cabinet), Secretary to the Treasury Randson Mwadiwa, and

other senior government and RBM officials, representatives of civil society organizations,

financial institutions, private sector enterprises, trade unions, and Malawi’s international

development partners. The mission appreciates the constructive spirit in which discussions with

all stakeholders were held and is grateful to the authorities for their warm hospitality.

At the conclusion of the mission, Mr. Tsikata issued the following statement:

“The mission has reached staff-level understandings with the authorities on policies for

completing the second ECF review. Consideration by the IMF’s Executive Board is tentatively

scheduled for late March. Completion of this review will enable Malawi to receive a

disbursement of SDR 13 million (about US$20 million) from the IMF.

“Overall performance under the program has been satisfactory. Most of the quantitative targets

for end-December 2012 were met, including those on the level of net international reserves and

net domestic assets of the RBM, and the government’s net domestic borrowing. However, the

indicative targets on reserve money and on government social spending were missed by small

margins. The authorities indicated that after a delay, social protection programs have been

successfully scaled up. With respect to structural benchmarks, nearly all identified government

domestic arrears have been verified, and progress was made in configuring the Integrated

Financial Management Information System (IFMIS) to control government commitments.

“There are encouraging signs that economic recovery is underway, aided by increased

availability of foreign exchange, including through the re-establishment of external credit lines.

Improved price incentives for tobacco production and good rains so far this season are expected

to boost agricultural output and overall growth of the economy in 2013. The devaluation and

adoption of a market-determined exchange rate regime last May seems to be stimulating the

production of exports and import substitutes while restraining demand for imports.

“At the same time, there is growing public outcry over falling living standards and perceived

wasteful spending and fraudulent activities in the government sector. There have also been

strikes by civil servants and other workers demanding higher wages. Against that backdrop, the

mission discussed with the authorities their policy intentions with respect to addressing growing

pressures on the budget. It also discussed the scope for policy actions to stabilize the exchange

rate and lower inflation.

“Given the government’s limited resources, the mission recommended a tightening of

expenditure controls and identification of lower priority activities that can be cut or postponed to

make room for higher priorities. In that regard, it welcomed the expenditure control measures

announced in December, including a moratorium on government funded external travel (with

exceptions to be approved by the Office of the President and Cabinet) and enforcement of the

X

regulation that all procurements of goods and services require purchase orders generated

through IFMIS.

“The mission urged the RBM to maintain a tight monetary policy stance until inflation pressures

recede, and to strengthen its supervision of banks in order to safeguard the stability of the

financial system.

“The mission encouraged the authorities to continue implementing structural reforms designed

to remove regulatory hurdles and improve the investment climate, so as to enhance Malawi’s

external competitiveness and foster sustained, diversified and more inclusive growth.”

IMF EXTERNAL RELATIONS DEPARTMENT

Public Affairs Media Relations

E-mail: publicaffairs@imf.org E-mail: media@imf.org

XI

Appendix III: Malawi Selected Economic Indicators, 2009-2015

2009 2010 2011 2012 2012 2013 2013 2014 2015

Act. Act. Prel. Prog. Rev. Prog. Nov.Prog. Rev. Prog. Nov.Proj. Proj.

National accounts and prices (percent change, unless otherwise

indicated)

GDP at constant market prices 9.0 6.5 4.3 4.3 1.9 5.7 5.5 6.1 6.5

Nominal GDP (billions of kwacha) 1 710.2 812.4 879.8 1,068.1 1,062.1 1,289.0 1,298.6 1,473.8 1,659.2

GDP deflator 8.4 7.4 3.8 16.4 18.5 14.2 15.9 7.0 5.7

Consumer prices (end of period) 7.6 6.3 9.8 22.9 31.7 12.0 10.1 5.8 5.4

Consumer prices (annual average) 8.4 7.4 7.6 18.4 20.8 16.1 18.0 7.2 5.7

Investment and savings (percent of GDP)

National savings 20.7 24.7 9.4 12.0 13.8 19.0 19.9 20.4 20.1

Net factor income -1.2 -2.0 -2.1 -3.0 -3.2 -3.2 -3.9 -4.0 -3.9

Net official transfers 9.4 15.7 6.4 11.5 14.8 11.1 14.4 14.3 13.2

Net private transfers 5.1 4.7 4.6 5.6 6.2 5.8 7.3 7.1 7.0

Domestic savings 7.5 6.3 0.6 -2.2 -3.9 5.3 2.1 3.0 3.8

Government -7.1 -0.8 -7.6 -6.9 -9.8 -3.9 -7.7 -4.6 -5.1

Private 14.6 7.0 8.1 4.7 5.9 9.2 9.8 7.6 8.9

National investment 25.6 26.0 15.3 16.2 17.4 20.7 21.4 22.4 22.4

Government 6.5 9.6 6.7 7.5 8.7 7.0 8.1 8.5 7.9

Private 19.1 16.4 8.6 8.7 8.7 13.7 13.4 13.9 14.4

Saving-investment balance 2 -4.8 -1.3 -5.9 -4.3 -3.6 -1.7 -1.6 -1.9 -2.3Government -5.0 1.5 -9.6 -5.3 -6.4 -2.0 -4.1 -1.4 -2.2Private 0.1 -2.8 3.7 1.0 2.9 0.3 2.5 -0.6 0.0

Central government (percent of GDP on a fiscal year basis) 3

Revenue 32.1 33.8 32.1 27.0 26.5 33.2 35.3 36.9 35.8

Tax and nontax revenue 20.5 23.5 24.5 21.5 22.1 22.8 22.6 24.1 24.5

Grants 11.6 10.3 7.6 5.5 4.4 10.4 12.7 12.8 11.3

Expenditure and net lending 37.8 33.8 35.0 34.0 35.0 34.3 35.8 38.9 37.5

Overall balance (excluding grants) -17.3 -10.3 -10.5 -12.5 -13.0 -11.6 -13.2 -14.7 -12.9

Overall balance -5.7 0.1 -2.9 -7.0 -8.5 -1.1 -0.5 -1.9 -1.6

Foreign financing 2.0 0.9 1.3 1.6 1.6 1.1 1.0 1.9 1.6

Domestic financing 3.7 -0.9 1.7 5.6 6.6 0.0 -0.5 0.0 0.0

Privatization 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Discrepancy -0.1 -0.1 -0.1 -0.2 0.3 0.0 0.0 0.1 0.0

Money and credit (change in percent of broad money at the

beginning of the period, unless otherwise indicated)

Money and quasi money 23.9 33.9 35.7 18.2 17.1 24.5 26.5 16.9 20.5

Net foreign assets -15.5 13.3 -7.9 -1.2 -0.6 11.3 13.9 11.3 10.8

Net domestic assets 39.5 20.6 43.6 19.5 17.7 13.2 12.7 5.6 9.7

Credit to the government 19.4 -9.2 19.7 11.0 2.3 2.9 6.3 -1.0 2.0

Credit to the rest of the economy (percent change) 36.5 47.6 30.1 17.5 19.7 16.7 9.7 10.8 13.4

External sector (US$ millions, unless otherwise indicated)

Exports (goods and services) 1,050.2 1,360.4 1,408.7 1,386.1 1,357.5 1,604.1 1,603.6 1,725.5 1,861.3

Imports (goods and services) 1,961.1 2,425.4 2,236.2 2,257.6 2,259.6 2,349.2 2,329.6 2,516.7 2,689.2

Usable gross official reserves 140.5 279.6 190.2 204.5 214.7 405.7 403.3 547.1 677.7

(months of imports) 0.7 1.5 1.0 1.0 1.1 2.0 1.9 2.4 2.8

(percent of reserve money) 40.7 73.4 42.5 52.8 75.0 91.3 117.3 140.3 140.7

Current account (percent of GDP) -4.8 -1.3 -5.9 -4.3 -3.6 -1.7 -1.6 -1.9 -2.3

Current account, excl. official transfers (percent of GDP) -14.2 -17.0 -12.3 -15.7 -18.3 -12.7 -16.0 -16.2 -15.5

Real effective exchange rate (percent change) 9.5 -6.0 -3.3 ... ... ... ... ... ...

Overall balance (percent of GDP) -2.0 2.2 -1.8 -0.5 -0.1 3.2 3.7 3.3 3.2

Terms of trade (percent change) 7.7 3.0 -17.2 20.5 -3.3 1.1 1.5 3.3 2.2

Debt stock and service (percent of GDP, unless otherwise indicated)

External debt (public sector) 15.9 16.0 16.2 20.3 22.7 20.6 26.6 24.9 23.1

NPV of debt (percent of exports) 57.1 44.6 48.1 52.2 53.3 46.1 46.1 42.1 38.0

External debt service (percent of exports) 1.3 1.3 1.6 2.4 2.4 2.5 2.5 3.8 3.8

External debt service (percent of revenue excl. grants) 1.4 1.5 1.7 3.6 3.9 4.0 5.1 7.1 7.0

91-day treasury bill rate (end of period) 10.5 6.2 6.8 ... ... ... ... ... ...

Sources: Malawian authorities and IMF staff estimates.

1 Reflects substantial upward revisions to the historical national accounts data received in March 2011.

2 The government savings—investment balance is calculated adding foreign grants to government savings above.

The private savings—investment balance is calculated adding the items in the balance of payments, net of foreign grants, to private savings above. 3 For example, 2009 refers to fiscal year 2008/09, which is from July 1, 2008, to June 30, 2009.