Malawi - Transport Engineering and Services Project

FILE COPY DOCUMENT OF INTERNATIONAL DEVELOPMENT ASSOCIATION Not For Public Use Report No. P-1451-MAI REPORT AND RECOMMENDAT-ION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT TO MALAWI FOR A TRANSPORT ENGINEERING AND SERVICES PROJECT May 22, 1974  Currency Unit Malawi Kwacha (MK) ITS $1 MK 0.84 1/ MK 1 US $1.19 1/ 1/ The exchange rate of the Malawi Kwacha is determined daily by the central bank to equal a weighted average of the value of the Pound Sterling and the US dollar. Above rates reflect the situation as of March 31, 1974. Fiscal Year: April 1 - March 31  INTERNATIONAL DEVELOPMENT ASSOCIATON REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT TO MALAWI FOR A TRANSPORT ENGINEERING AND SERVICES PROJECT 1. I submit the following report and recommendation on a proposed credit to the Republic of Malawi, for the equivalent of $2.0 million, to finance part of the foreign exchange cost of engineering and other technical services required to prepare and develop a wood processing project in Malawi. Part of the program is being financed by UNDP and assistance is also expected from the United Kingdom. The credit would have a term of 10 years, including 5 years of grace, and would subsequently be refinanced under any loan or credit which the Bank Group may make to help finance the wood processing project itself. PART I - THE ECONOMY 2. A report, "Recent Economic Developments and Prospects of Malawi" (67a-MAI), was distributed to the Executive Directors on April 17, 1973 (R73-77). Country data are provided in Annex I. An updating economic mission visited Malawi recently. Its report is under preparation. 3. Since independence, in 1964, Malawi's economy has grown by an annual average of just over 7 percent. However, with a per capita income of only about $90, Malawi remains one of the poorest countries in the world, and is included in the United Nations list of 25 least developed countries. Natural resources are limited to moderately fertile soils, substantial water resources and a climate favorable to crop production. Although bauxite and coal deposits have been discovered, their exploitation has not yet been found commercially viable. Forests, which cover about 23 percent of Malawi, constitute the main essentially unused resource which could be exploited on a significant scale in the near future. 4. The economy is heavily dependent on agriculture and is, therefore, subject to annual fluctuations in output. Thus, while real GDP dropped in 1968, it rose by 13 percent in 1971 and by 7.7 percent in 1972. Only 10 percent of the economically active population is in modern sector wage employment, but their average earnings are about five times those of traditional farmers. Government policy is oriented towards rapid growth of agricultural production and, indeed, real per capita farm income has risen faster during the last two years than income in the non- agricultural sector. 5. A substantial savings and investment effort and generally efficient management of the economy have contributed to economic growth. At Independence, domestic savings were negligible and gross domestic invest- ment was only 8.7 percent of GDP. By 1972, domestic savings had increased to 9 percent of GDP and gross domestic investment to 20 percent, leaving a re- source gap of US$48 million. A significant improvement in the financial  - 2 - position of the Governmaent bas contributed to this impressive rise in savings. At Independence, the Government was alle to finance only about half of re- current expenditure from local resources, the deficit being met by grants and loans from the U.K. Between 1964 and 1972, however, improvements in tax administration and some changes in the tax system caused domestic revenue to rise annually by 16 percent, in comparison with an average increa3e in recurrent expenditure of only 8 percent. Consequently, the deficit on the recurrent budget has diminished steadily - a trend which is expected to continue. 6. The Government has increased development expenditures at an annual average rate of 25 percent over the last five years, and has laid heavy em- phasis on infrastructure and agriculture. Infrastructure investments have in- cluded the construction and improvement of roads, particularly those opening up the central and northern regions, and the construction of a rail link to Nacala, in Mozambique, completed in 1970, which has provided a second outlet to the sea, supplementing the existing railway to Beira. Since 1969, the construction of a new capital at Lilongwe has taken up about 10 percent of the Government's annual development budget. After 1968, several large-scale agricultural schemes, including the provision of credit to small scale farmers and the supply of inputs, marketing facilities and some basic infrastructure, have also been started near Salima (with German aid) and near Lilongwe, Chik- wawa and Karonga (with IDA credits). Approximately one-fifth of total Govern- ment investment has been in agriculture. However, greater emphasis is now being placed on this sector, and one-third of the US$76 million public invest- ment program over the next two years will be devoted to agricultural develop- ment. One of the Government's major objectives is to raise the productivity of small farmers. 7. Total investment was US$92 million in 1972 and is expected to grow by over 7 percent per annum through 1980. Private investments are ex- pected to equal those of the public sector, with approximately one-tenth of private investment in the non-monetary sector. The projected level of private capital formation shows that private sources are expected to continue to play an important role in Malawi's economic development. Out- side agriculture, domestic private capital tends to be concentrated in small enterprises, mainly in rural trade and transport. Large scale business is still dominated by foreign-owned companies which have found a favorable investment climate in Malawi. 8. In view of both of the Government's present economic policy and the maturing of past investments, an annual economic growth rate of about 6 per- cent seems likely in the 1970s. Much of this will occur in the agricultural sector, as a result of increased production of export crops such as tobacco, tea and cotton. Small but growing surpluses of maize, pulses, groundnuts, cassava and sugar are also anticipated. Malawi's agricultural exports, which increased, in constant 1973 prices, at an average rate of nearly 14 percent during the last three years, and which stood at about $70 million in 1973, are projected to rise by an average of over 6 percent annually until 1980.  - 3 - However, despite the anticipated growth of: exports, it is likely that the country's import requirements will, as in recent years, grow even more rapidly. In 1972, for example, the deficiL on goods and services was US$45 million, slightly higher than in 197i. Capital inflow has been adequate, however, to finance this deficit. 9. The sustained improvement in the mobilization of domestic resources for economic development is likely to continue during the rest of the decade. Public savings, which have been negative in the past, should in the future make a positive contribution to investment. In 1972, Malawi financed 47 percent of its investment from domestic resources; this proportion should grow to about 60 percent by the end of the decade. The external capital require- ments will, however, continue to be in excess of the foreign exchange com- ponent of projects and external aid should, therefore, also cover a substan- tial portion of local costs. 10. At the end of 1972, Malawi's external public debt totalled $231 million, of which $173 million had been disbursed. Debt service in that year amounted to $6.5 million, or about 8 percent of export earnings. As Malawi's need for external capital is expected to increase in the next few years, the Government is determined to minimize borrowing on hard terms. Even if future debt is obtained at rates as favorable as those of the past, the debt service burden is likely to increase and the debt service ratio may reach about 15 percent by the end of the decade. In view of its low per capita income and the possibility of fluctuating future export earnings, Malawi should continue to receive substantial amounts of external assistance on concessionary terms. 11. The full impact of recent petroleum price increases on the economy has not yet been fully assessed. Malawi imports only refined petroleum pro- ducts, and relies on hydro power for electricity generation, using oil principally for transport purposes. Overall, it seems unlikely that the country will suffer heavily and the increase in import values resulting from the increased price of petroleuim products should raise the resource gap by no more than $3.5 million, or about 6 percent, in 1974. PART II - BANK GROUP OPERATIONS 12. Malawi has to date received ten IDA credits 1/ totalling US$64.6 million. Five of these, representing $34 million or almost 53 percent, have been for agriculture. The other credits have been for highways ($11.5 mil- lion), education ($6.3 million) and power ($12.8 million). There have been no Bank loans or IFC investments. Annex II contains a summary statement of IDA credits as of April 30, 1974 and notes on the execution of on-going projects. Project execution is generally satisfactory. 1/ Credit No. S-2-MAI of US$0.49 million, for highway engineering, which was made in 1967, has since been refinanced.  13. In 1972, IDA!s share in Ealawi's total external debt was about 20 percent, while servicing of the IDA credits accounted for only 2.8 percent of total debt service. For 1977, these figures are projected at 21 and 4 percent, respectively, assuming a moderate growth in IDA lending. 14. Prospective Bank Group operations in Malawi will continue to focus primarily on rural development. An agricultural sector mission visited Malawi in April, 1973 to review with the Government its strategy for agricultural development. The report, "Agricultural Sector Review, Malawi" (235a-MAI) was distributed to the Executive Directors on January 14, 1974 (R74-9). In accordance with recommendations in the report, several projects are being prepared, including the next stage of the Lilongwe Rural Development project, which is currently under appraisal. The tovernment has also requested assistance in the preparation of a national rural development program. In the transportation sector, tthe Bank has been acting as executing agency for a UNDP-financed detailed engineering study of two main roads, from Lilongwe westwards to Mchinji and from Lilongwe north to Mzimba. The first road will be constructed with assistance from USAID. Financing for construction of the second road has been requested from IDA, and this project has been appraised recently. A water supply project for the city of Blantyre, for which the Government intends to request IDA financing, Is also being prepared, with assistance from the United Kingdom. Finally, discussions have taken place with the Government recently on their future plans for the education sector. This may well lead to the identification of a second education project for IDA consideration. PART III - THE INDUSTRIAL SECTOR 15. Malawi's economy is predominantly agricultural. In 1972, agri- culture contributed 51 percent to GDP and manufacturing only about 15 per- cent. However, the manufacturing sector has grown rapidly since 1964 when it contributed only 8 percent to GDP. At the time of Independence in 1964, manufacturing in Malawi was limited to the processing of agricultural products, such as tea, tobacco, maize and fish. After 1964, import substitution indus- tries producing consumer goods for the local market were quickly established. At the same time existing processing industries were expanded and new ones were added, most: notably for cotton and sugar. 16. By now, most of the obvious possibilities for import substitution have been exploited. Further industrial growth will depend mostly on the performance of the agricultural sector. In this respect, there is scope for developing export-oriented processing industries since many agricultural products are currently being exported in raw or semi- processed form. The Government's agricultural policies aim at further in- creases in the cultivation of export crops, such as sugar and tobacco, which would provide an expanded supply of raw materials for processing industries. Manufacturing is expected to continue to grow at 10 percent annually.  - 5 - 17. Large-scale industrial development has so far been hindered by the lack of economically exploitable natural resources. There are some coal deposits in the north but the distance from potential markets has so far made it impossible to envisage their coihmercial exploitation. Relatively large bauxite deposits have also been ditcovered at Mulanje, but export of bauxite would face transport disadvantages and production of aluminum would only be warranted if power could be obtained at a cost which would permit competi- tive pricing of the end-product. This is currently under investigation. Forestry is, therefore, the only practicable source of raw material which might be utilized in the near future for large scale export-oriented industrial development. As of 1972, forest plantations, which are virtually all government-owned, amounted to 38,000 ha, of which 15,000 had been earmarked for timber production and 23,000 for pulpwood production. Although production of sawn timber has grown rapidly in recent years, Malawi is still a net importer of wood and wood products; it is hoped that self-sufficiency will be reached by 1980, at least for construction timber. PART IV - THE PROJECT Background 18. The idea of creating a forest resource on the Viphya Plateau, in the Northern Region of Malawi, for an eventual pulp and/or timber industry took shape in the 1960s. Tests carrie] out at that time showed that this area presents ideal ecological conditions for