Malawi - Second Structural Adjustment Project

Document of The World Bank FOR OFFICIAL USE ONLY C //t /Y>- Report No. P-3663-HAI REPORT.AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION ON A PROPOSED CREDIT OF SDR 51.9 MILLION TO THE REPUBLIC OF MALAWI FOR A SECOND STRUCTURAL ADJUSTMENT PROJECT NOVEMBER 29, 1983 | alhis documnent has a restricted distribution and maY be used by recipients only in the performance Or their official duties. Its eontents may not otherwise be disclosed without World Bank 2uthorization.i  CURRENCY EQUIVALENT Currency Units Malawi Kwacha (MK) and Tambala SDR 1.00 - MK 1.3577 US$1.00 MK 1.25 MK 1.00 US$.80 WEIGHTS AND MEASURES 1 foot (ft) 0.305 meters (m) 1 mile (mi) 1.609 kilometers (km) 1 square mile (mi2) = 2.590 square kilometers (km2) 1 ton (t) 0.907 metric tons (m ton) (As the Malawian Kwacha is officially valued in relation to a basket of the currencies of Malawi's trading partners, the USdollar/Malawian Kwacha exchange rate is subject to change. Conversions in this report were made at US$1.00 = 1K 1.25.) GLOSSARY OF ABBREVIATIONS ADMARC Agricultural Development and Marketing Corporation AfDB = African Development Bank CCDC = Capital City Development Corporation DRIMP = District Roads Improvement and Maintenance Program EDF = European Development Fund EPD = Economic Planning Division (Office of the President and Cabinet) ERR = Economic Rate of Return ESCOM Electricity Supply Commission INDEBANR = Investment Development Bank MDC Malawi Development Corporation MHW = Malawi Housing Corporation MTC = Min.stry of Transport and Communications mWS = Ministry of Works and Supplies NRDP = National Rural Development Program PAL = Press Agriculture Limited GOVERNMENT OF MALAWI FISCAL YEAR April 1 - March 31  FOR OFFICIAL USE ONLY MALAWI STRUCTURAL ADJUSTMENT CREDIT II CREDIT SUMMARY a Borrower: : Republic of Malawi Credit Amount : SDR 51.9 million (US$55 million equivalent) Terms : Standard IDA terms Credit Description : The proposed credit would provide support for the Government's program of economic recovery outlined in a Letter of Development Policies from the Government to the Bank. It is a follow-up to a loan made in June 1981. This program is designed to diversify the export base, encourage efficient import substitution, adjust incentives, improve the public sector's financial performance, and strengthen policy-making capability. Foreign exchange would be used for essential imports. Counterpart funds would be used for development purposes in the Government budget. Estimated : The credit would be disbursed in two tranches. Disbursements US$30 million would be available for disbursement after effectiveness. The remaining US$25 million would be disbursed after a review of progress in April 1984. Risk : The principal risk relates to the capacity of the Government to implement the program in a timely fashion and overcome external difficulties such as transport disruptions. a There is no Staff Appraisal Report. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Dank authonzation.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED SECOND STRUCTURAL ADJUSTMENT CREDIT TO THE REPUBLIC OF MALAWI 1. I submit the following report and recommendation on a proposed structural adjustment credit to the Republic of Malawi for SDR 51.9 million (US$55 million equivalent) on standard IDA terms. PART I. THE ECONOMY 2. A report entitled -Malawi: Growth and Structural Change, A Basic Report' (Report No. 3082a-MAI) dated February 8, 1982, was circulated to the Executive Directors on March 9, 1982. Annexes to the report were distributed on June 26, 1981. Annex I contains the basic country data. 3. Malawi is a small (118,500 sq. km), densely-populated (about 6.2 million people in 1981) landlocked country in southeastern Africa. Its main assets are moderately fertile soils, good water resources and a climate favorable to crop production. Unlike its neighbors, Malawi has no known substantial mineral resources. Background and Development Strategy 4. When Malawi gained independence in 1964, its economy was charaterized by surplus labor and few natural resources other than a favorable climate and moderately fertile agricultural land. It lacked capital, technology, entrepreneurship, skilled labor and managerial talent. Being landlocked, it has to depend on other countries for access to the sea. 5. Despite these constraints, the Government was determined to achieve rapid, sustained economic development. It has opted for an outward-looking, export-oriented growth based on agriculture and agro-based manufacturing. This strategy has been reflected in the Government's policies toward the agricultural and manufacturing sectors, and toward the roles of domestic and foreign investment. In order to attract foreign capital and managerial skills, government policy has encouraged the establishment of an open, market-oriented economy with the private sector as the primary engine of economic growth. The role of public enterprises  - 2 - has been limited to a few key sectors and to that of investment partners with the private sector. Relatively low tariffs and limited use of quantitative restrictions on imports have prevented the emergence of inefficient local import substitution industries so characteristic of many other developing countries. The Government has deliberately restrained those forces which would raise wages above market-determined levels (e.g., trade unions, excessive, decreed wage increases), thus encouraging the establishment of labor-intensive manufacturing firms and agricultural estates. Moderate wage expansion, coupled with growing labor productivity in most sectors of the economy, has helped to keep Malawian goods competitive in international trade. Wage moderation has also kept the demand for labor high and the resultant rapid expansion of employment opportunities has helped control the rural-urban income gap and hence the rate of internal migration. 6. Public investment has been intended primarily to support private efforts in the directly productive sectors through provision of essential infrastructure, public utilities and supporting services. The Government has opted for a two-pronged approach to agriculture, involving the traditional smallholder and estate sectors. The smallholder sector has produced the food crops and a limited amount of export crops while the estate sector has concentrated on the major exports of tobacco, tea and sugar (see para. 48 for details). Attaching high priority to public investment in the traditional sector, the Government undertook a number of regional integrated rural development projects involving provision of infrastructure and agricultural inputs and services. More recently, it embarked on the National Rural Development Program (NRDP), an ambitious 20-year program designed to extend agricultural services to smallholders country wide. The estate sector has been left largely in private hands (except for public enterprise participation in sugar and in some tobacco estates) and the Government has limited its role to that of providing a favorable investment climate. The Government's decision to emphasize directly productive sectors and related economic infrastructure has resulted in relatively slower Aevelopment of the social services such as lhealth and education until recent years. Evaluation of Past Performance 7. In terms of its stated objectives, Malawi has an impressive record of accomplishments. Aggregate aLid per capita real incomes have grown rapidly. Real GDP grew at an average rate of 5.5 percent per annum over 1967-79 and per capita income at about 3.0 percent per annum. Growth in all sectors (except in subsistence production) exceeded 5.0 percent per annum. By 1979, GNP per capita in current prices reached US$190. Over the same period, inflation averaged 9.0 percent per annum.  - 3 - 8. At independence, Investment constituted only 8.6 percent of GDP and domestic savings were virtually nil (0.5 percent of GDP). The little capital formation that took place had to be financed from foreign sources. But since then, the picture has changed dramatically. Between 1967 and 1979, gross domestic investment grew at an average annual rate of 12.5 percent per annum, raising Investment's share of GDP from 16 to 29 percent. The domestic resource mobilization effort has been even more impressive. Domestic savings rose from 4 percent of GDP in 1967 to 17 percent in 1979. increasing the share of investment financed from domestic sources to about 60 percent. Owing mainly to government mobilization of foreign assistance but with increasing contributions for private and public enterprise ventures, net foreign long-term capital flows increased from a total of US$66 million over 1967-69 to US$328 million over 1977-79. 9. Over the 1967-79 period. export volume grew at an annual average rate of 4.5 percent while import volume grew at 3.5 percent. Agriculture accounts for some 90 percent of export earnings. Since 1967, agricultural estate production grew much faster than smallholder output and during 1967-79. agricultural exports from estates expanded at 15.0 percent per annum while smallholder exports recorded no growth. Thus the estates' share of agricultural exports increased from 32 percent in 1967 to 65 percent in 1979 and 80 percent by 1981-82. Since estate exports are tobacco, tea and sugar, the concentration of Malawi's exports has increased significantly. 10. The country's favorable export performance can be partly attributed to the policy of moderate wage increases and to growing labor productivity which has kept Malawi's products competitive in the international market. Over the same period, wage employment exranded almost as rapidly as the modern sector as a whole (over 8 percent per annum) suggesting a labor-intensive pattern of growth. Recent Economic Developments 11. Notwithstanding these impressive achievements, the Malawian economy, increasingly dependent on three primary commodity exports, tobacco, tea and sugar. remained highly vulnerable to international price fluctuations. (Production of previously important export crops, particularly cotton. groundnuts and tung oil, declined and worker's remittances, which were an important source of foreign exchange, were greatly reduced.) Since 1974 the country experienced periodic balance of payments disequilibria of increasing severity due primarily to (a) rapid escalation in import prices. particularly of fuel and intermediate and capital goods: (b) cyclical swings in export prices of tobacco, tea and sugar: and (c) signiticantly higher costs of transport for both exports and imports owing to rising ocean freight charges, port congestion in Mozambique, and disruptions of the overland route.  - 4 - 12. While the Government successfully steered the economy through balance of payments crises in the past, the deterioration in the balance of payments since 1978 has been less manageable. Between 1977-80 Malawi's terms of trade fell by 40 percent. The petroleum Import bill more than doubled, raising its share in total imports from 10.2 percent in 1977 to 12.5 percent in 1980. In 1980 and 1981, agricultural production suffered from drought, reducing export volumes and necessitating large Imports of maize, a commodity in which Malawi had been self-sufficient during most of the 19709. Finally, disruptions of the transport system through Mozambique forced Malawi to use more costly air, or alternative rail and road routes. As a consequence, Malawi's current account deficit rose sharply from an average of 8-9 percent of GDP in the mid 1970s to an average of 20 percent in 1978-80 before falling to 12 percent in 1981 and 9 percent In 1982. Capital inflows, although increased, did not cover current account deficits and foreign exchange reserves fell from the equivalent of over five months of imports to less than two months between 1977-82. Moreover, in contrast to past capital inflows which were mainly grants and soft loans, over 50 percent of the 1978-81 borrowings of US$570 million were on non-concessional terms. As a result, the debt service ratio climbed rapidly from 7 percent in 1977 to 26.3 percent in 1981 and would have been over 40 percent in 1982 were it not for a rescheduling of Malawi's debt. 13. Economir; growth, savings and investment have declined sharply. GDP growth fell from 5.5 percent in 1979 to only 0.4 percent in 1980 and -0.8 percent in 1981 as virtually every sector contracted during the two year period. Growth was back up to 3.0 percent in 1982 and should be at a similar level in 1983. While domestic savings declined somewhat, investment dropped sharply from 34.3 percent of GDP in 1979 to 21.2 percent in 1981 and 20.3 percent in 1982. 14. Malawi's fiscal position also seriously deteriorated. From independence through 1977/78, government expenditures expanded roughly in line with GDP, and deficits rarely exceeded 7-8 percent of GDP. Subsequently, however, rapidly rising expenditures outstripped revenues and pushed government deficits up to an average of 13.6 percent during 1978/79-1981/82, before falling to 9.4 percent in 1982/83. Government expenditures in these four years averaged around 33 percent of GDP compared to 25 percent in the previous six years. To finance these deficits, the Government resorted to increased domestic borrowing, mainly from the monetary system, and foreign borrowing, partly on commercial terms. Inflationary pressures grew and prices rose at an average rate of almost 13 percent per annum between 1979 and 1982.  -5- Emerging Structural Problems 15. While the primary cause of Malawi's economic difficulties was a serious deterioration in the country's terms of trade and transport conditions, the crisis also revealed important structural weaknesses in the economy. First, the heavy concentration of exports in a few estate-produced agricultural commodities; second, the slow growth of smallholder production for export; third, the modern sector's dependence on costly imported oil, and the progressive depletion of domestic fuelwood resources; fourth, the deteriorating financial position of public enterprises; fifth, the budget deficits described earlier (para. 14); sixth, a growing imbalance between government recurrent and capital expenditures; seventh, rigidities in the system of administered prices and wages. 16. Concentration of Exports. Malawi's exports are heavily concentrated on tobacco, tea and sugar produced on estates. Each, unfortunately faces uncertain growth prospects, both in terms of supply and demand. In the first place, the shortage of suitable land will severely limit any increase in output from extending cultivation. Any expansion will have to come largely from higher yields. Moreover, a growing shortage of fuelvood threatens the production of flue-cured tobacco and tea (which requires wood for drying). In addition, shortage of credit and scarcity of managerial talent in the country are expected to become a serious constraint to any rapid expansion of both burley and flue-cured tobacco. The recent snarp drop in sugar prices and the imposition of quotas by the United States has shown the vulnerability of this crop. For the estate sector to recover and expand its foreign exchange earnings, diversifying into other crops is essential. 17. Slow Growth of Smallholder Production. Following a decade of rapid growth investments, smallholder produced exports of tobacco, cotton and groundnuts have stagnated over the past ten years despite sizeable public investments in smallholder agriculture. While such performance can partly be attributed to limited coverage of past rural development projects, low producer prices have almost certainly played an important role. A Government and Bank analysis has shown that, on balance, prices paid to smallholders by the Agricultural Development and Marketing Corporation (ADMARC), which handles smallholder crops, have been less favorable than those paid for estate produced crops sold on the world market. Within the smallholder sector, maize and rice production have been subsidized while production of export crops (cotton, groundnuts, and tobacco) have been taxed. Incentives for expanding meat, poultry and dairy output, mostly produced by smallholders, also are weak. In addition, the Government's pricing decisions have been ad hoc and frequently arbitrary; since prices were changed infrequently, the resultant quantum jumps, made adjustments difficult for both consumers and producers.  - 6 - 18. Cost of Energy. Malawi is totally dependent on Imports for petroleum. While imports increased only 8 percent in volume between 1977 and 1980, their cost doubled and as a share of total imports rose from 10 to 12.5 percent. Fuelwood accounts for some 80 percent of the total energy consumed in Malawi. In the rural areas, wood is used for cooking and for curing tobacco and tea. As a result of population growth and expansion in tobacco and tea production, the demand for fuelwood Is outstripping available supplies, leading to deforestation and environmental degradation. Thus, the Government faces the task of developing indigenous energy sources in the rural areas and reducing the modern sector's dependence on imported oil. 19. Deteriorating Finances of the Public Enterprises. As a group, Malawi's statutory boards and public enterprises have functioned well both by providing essential services with reasonable efficiency and by making a contribution to their own investment requirements. However, the financial condition of several has deteriorated since 1978. ADMARC, a government marketing institution for smallholder crops, which has operated relatively efficiently, suffered substantial losses in 1980 and 1981 as a result of higher fuel costs, improper crop handling and poor transport planning. In 1982 a small profit was achieved. Air Malawi suffered large losses on Its intercontinental service which had to be terminated at the end of 1979. Domestic tariffs were increased by 60 percent in early 1980 and international charter rates were raised later that year and moderate increases were enacted in 1981, 1982 and 1983. Malawi Railways finances have been adversely affected by rising fuel costs and transport problems at the ports and on lines through Mozambique. Despite a 1979 tariff increase of 17 percent, the company suffered an operating loss for the first time since 1972 and its overall cash deficit, after debt service and renewal investments, rose substantially. Further increases were affected in 1981 and 1983 but continued external difficulties have exacerbated the railway's financial problems. Hitherto financially sound Electricity Supply Commission (ESCOM) also began to experience large cost overruns on its Nkula project, primarily as a result of transport difficulties. While annual tariff increases averaging 10 percent from 1979 to 1983, have helped to alleviate the cash deficit, the company was still experiencing cash flow difficulties and has had to defer some payments on Government debt. The Malawi Housing Corporation (MHC) and Capital City Development Corporation (CCDC) have been channeling Government funds and external loans into housing and construction of the new capital at Lilongwe, and are now experiencing difficulties meeting their mounting debt service obligations out of their low income from rents. MHC recently increased rents for low cost housing by 40 percent but it is not generating sufficient funds even to provide for maintenance. The Malawi Development Corporation (MDC) is a  - 7 - wholly government-owned holding company with Interests in agrlculture and agro-industry, manufacturing and commerce. Its financial position has steadily deterlorated in recent years, am the liquidity position of Its subsidiaries declined with the onset of recent economic crises, and MDC has had to provide more guarantees for its subsidiaries' borrowing. It has also accumulated medium-term debt, borrowed mainly on hard terms to finance equity investments. Given Its large interest payments, MDC suffered slzable losses during 1980, 1981, 1982 and 1983. The deterioration in the performance of these public enterprises is having an adverse impact on the Central Government's budget by increasing the requlrements for subsidies or for deferment of debt service owed to Government. In addition, the demand by the public enterprises for new medium-term external credit and for additional domestic borrowing has increased. 20. Although nominally a private enterprise, Press (Holdins) Llmited's operations are so large that they have a profound impact on the country's economic life. Press is a holding company with wholly-owned subsidiaries and associate companies in most sectors of the economy, including agriculture, industry, wholesale and retail trade, building and construction, transportation, banking and insurance. Until 1979, Press and its subsidiaries had been consistently profitable, but thereafter, the group's financial position deteriorated rapidly. Press' enormous cash needs have placed severe strains on Malawi's two commercial banks and this led to restricted domestic credit expansion to the rest of the private sector. A good start has been made on resolving Press' financial and operational problems. Given the impact on the country's output, employment and exports, early resolution is imperative. 21. Budgetary Deficits and Underfunding of Recurrent Activities. The Government has generally managed its finances prudently. During the first 15 years after independence, revenue increased as rapidly as GDP, the revenue account consistently generated surpluses (since 1972/73) to contribute to development expenditures, and budget deficits have been relatively modest. Since 1978/79, however, the Government's fiscal position has deteriorated. While revenues have increased slightly faster than GDP, recurrent and development account expenditures have grown even more rapidly owing to a rapid expansion of development projects. In addition, there is growing evidence of underfunding of recurrent budget requirements. Control over recurrent expenditures has been tight because of domestic revenue constraints. On the other hand, because of the availability of foreign finance on concessionary terms, capital projects have been relatively easy to finance. Thus, the expansion of government employment and expenditures for goods and services has not kept pace with the growth of capital expenditures. The problem is particularly acute in agriculture (and to a lesser extent in road maintenance and in health). The lack of adequate provision for recurrent operations reduces the benefits originally expected from project investments.  - 8 - 22. Rigidity of Price Control. and Wage Policy. A system of formal and informal price controls has ovolvad for moat domentically manufacturod goods in Malawi over the past decade. The Ministry of Trado, Industry and Tourism exercises formal controls over products such as cement, fortilizers and sugar; and itemo important to low income consumers --vegetable olls, bread, milk, matches and fish. In addition, manufacturers arc requird to notify and receive comments from the Ministry before raising prices for practically all other manufactured gods. Disincentives created by the system have grown with increaead inflationary pressura. Long delays botween price increase applications and approval have adversely affected the financial position of many businesses. Similar delays have characterized granting of tariff increases for the country's principal statutory bodies. 23. The Government has also adopted a system of controls designed to restrain real wage Increases. However, the Government's practice of holding down wages for long periods and then granting large wage increases has been destabilizing for the economy. For example, the minimum wage for urban unskilled workers, which had remained unchanged since 1973, was increased by 12.5 percent in 1980 and by additional 56 percent In January 1981. (Even with these quantum jumps the minimum wage in 1981 is only three-quarters of Its 1973 level In real terms.) PART II. THE GOVERNMENT'S MEDIUM-TERM PROGRAM 24. Recognizing these problems, the Government, in consultation with the Bank and the IMF, formulated a medium-term program covering 1981/82-1985/86. The Government's major objectives for the five years were: (i) a real GDP growth rate of 4.8 percent; (ii) increased diversification of foreign exchange earnings or savings by developing new smallholder and estate crops, accelerating smallholder export crop growth, livestock and forestry industries and expanding agro-business; and (iii) improvement in the financial performance of the Government and public enterprises to reduce dependence on external resources and domestic borrowing and increase foreign exchange reserves. 25. The policies for achieving these objectives were incorporated in a comprehensive structural adjustment program which aimed at improving (i) the balance of payments, (ii) price incentives and income policies, (iii) resource management, and (iv) the institutional structure. Specific policy measures were:  (i) Balance of PAmesnt. Increased prices for agricutural export crops with periodic roviews; incrouead rocurrent budgetary allocation to the Ministry of Agriculture; revlew of tho officiency of tho Agricultural marketing organization; studios of the livestock and tobacco sector., Including diversification of tobacco estates; a study of the energy sector and continued adjustments In onergy prices; and increased agro-industrial investment. (il) Price incentive, and incomes. Government review of the price and wage control system with a view to introducing more flexibility and more frequent adjustments; increased public utility and transport tariffs with closer monitoring and adjustment in the future; studies of the railway and the airline; a detailed plan for implementing economic rental of housing; and periodic review of the exchange rate. (iii) Resource Management. Establishment of the Department of Statutory Bodies to assist public enterprises in planning and financial management; periodic review of Interest rates; steps to increase Government revenue to its historic levels in relation to GDP; strengthened control and monitoring of domestic expenditure; improved monitoring and management of public debt; limiting government domestic and foreign borrowing to ceilings agreed with the IMF; a new five-year development program with increased shares for directly productive sectors and social services; a commitment to adequate levels of recurrent financing for key development ministries. (iv) Institutional Improvement. Establishment of an Investment Coordinating Committee to oversee all major investments; technical assistance to strengthen key planning and budgeting ministries; and rehabilitation of the key public and private sector conglomerates (notably Press Holdings, Ltd.) through studies, improved management and financial restructuring.  - 10 - Implementation 26. Initially, implementation of the program was uneven. On the positive side, additional funds were allocated to the agricultural sector, agricultural prices were adjusted, public utility tariffs were increased, the Investments Coordinating Committee was established to screen all major investments, a joint energy assessment study was carried out and steps were taken to strengthen the management and the policies of Press. 27. At the same time, however, there were areas where execution was less satisfactory: inadequate expenditure control, delays in adjusting government charges and prices. continued poor performance of many public corporations and lack of public debt management. These combined with continued adverse international developments (rising interest rates and fuel prices, cyclical swings in export prices of tobacco, tea and sugar) and poor weather, led to a serious deterioration in the Government's budgetary position and the balance of payments. As a result, the Government was not able to make its last two drawings in its two-year IMF stand-by. There were also delays in starting the various studies stipulated in the SAL, formal agreement between the Government and Press on principles of restructuring was slow in coming and the set of agricultural prices chosen emphasized maize to the detriment of export crops. As a result, the Bank delayed releasing the second tranche of the SAL, while continuing discussions with the Government on steps that could be taken to get the adjustment program back on track. After these discussions, the Government agreed to modifications in the methodology of setting agricultural prices, strengthened its ability to monitor and control external debt and agreed on a debt servicing target. The studies stipulated in the SAL began to progress well, the budget for 1982/83 was a realistic one with sufficient resources provided for the major development sectors, and agreement with the Fund on a new stand-by was reached. The second tranche was therefore released in April 1982. The Revised Program 28. The growth targets set out in the Government's program two years ago, will not be realized soon. Since then problems with external transport have continued to play havoc with the country's external trade, the world economy remains more depressed than had been projected and the Governmental system of Malawi has been slow to make decisions and meet the increased demands placed on it. As the letter of Development Policy (Annex IV) makes clear, the Government will continue to address the structural problems outlined in paragraphs 15-23. In continuing this program, however, some modifications and shifts in emphasis are necessary. Specifically these include:  - 11 - (i) further incentives for expert crop production; (ii) continued improvements in institutions dealing with external debt and investment screening; (iii) further work with statutory bodies to strengthen them managerially and financially; (iv) implementation of the agreement on Press' reorganization and debt servicing; (v) further upgrading of the Government's capacity to budget, plan, implement and monitor its programs; and (vi) increased revenues and cost effectiveness which are needed to bring the budget in line. 29. The Letter of Development Policy takes cognizance of these problems and outlines an action program for dealing with them. In this program the Government will build upon the foundation laid during the last two years, shoring up weak points and branching into other areas that have emerged as crucial to a successful adjustment. The program will focus on measures to: (i) increas. performance of the productive sectors; (ii) mobilize and manage resources better; and (iii) strengthen key institutions. 30. To increase performance of the productive sectors, more attractive prices, better marketing operations and improved procurement and distribution of fertilizers will provide incentive for smallholders to raise their output, especially for export. For the estates, steps will be taken to help them upgrade their management, have greater access to credit and diversify their production. In the industrial sector, emphasis will be on relaxing the present system of price controls. 31. To improve resource mobilization and management, the Government is committed to increasing revenues proportionate to GDP, emphasising non-tax sources, to raising the efficiency of capital use through a solid public investment program, and to expap4ing the parastatals' profits through improved policies (including pricing) as well as better management. The work begun under the first SAL in strengthening the Government's expenditure control, foreign debt management, and planning and budgeting capabilities will be continued, as will monitoring of recurrent allocations to key developmental agencies. The Government also will take steps to reduce the current high costs of its social services in housing, health and education, raise user charges and eliminate or minimize subsidies. Agricultural subsidies have been examined too, and a phased program of eliminating them developed. 32. Strengthening Key Institutions continues to be an important part of the Government's action program. Toward this end, implementation of detailed action plans - produced from studies for restructuring ADMARC, MDC and Press Holdings will continue.  - 12 - In addition, the program calls for improving the management capacities of other key parastatals and the Government, particularly the Economic Planning Division of the Office of the President and Cabinet (EPD). 33. Economic Framework. The revised program has been set in a geT-ral macro-economic framework for the 1983-87 period, which projects an annaal average growth in GDP of 3.4 percent versus 4.8 percent envisaged two years ago. As discussed above, given continuing unfavorable conditions externally and the Government's inability to move as quickly as originally anticipated, the revised figure probably is a realistic target for GDP growth. Sectorally, the framework projects agriculture growing at a yearly average of 3.4 percent, industry at 3.7 percent and the rest of the economy at 3.4 percent. Table 1 below sets out our estimates of the key macroeconomic variables with the structural adjustment program and what they would be without the program. Without improvements in transport, proper incentives for agriculture and improved resource use and mobilization, both exports and overall growth would be lower and the balance of payments gap larger. 34. One key to attaining these growth rates is improvement in the export performance, particularly that of agricultural products. After examining the potential for every major export category, a 5.5 percent annual growth for total exports in real terms over the next five years appears to be feasible. Overall export volumes fell by 10 percent in 1981 and another 9 percent in 1982; thus, most of the targeted increase represents a recovery from the current low levels to those that were attained in the past. Table 1: Development of the Malawian Economy with and without Structural Adjustment Policies With without Structural Structural Indicator Adjustment Adjustment Growth of GDP(%) 1983-87 3.4 2.5 Agriculture 3.4 2.4 Industry 3.7 2.6 Export Growth 1983-87 5.5 4.0 Primary 5.5 4.0 Other 5.0 4.0 Resource Gap 1987 $105.0 million $120.0 million Current Account Deficit 1987 $152.0 million $175.0 million  - 13 - 35. A second key requirement is to further reduce the current account deficit. Having risen to 24 percent of GDP in 1979, the current account deficit was reduced to 13 percent in 1981 and 1982 largely due to a sharp fall in imports. The IMF's EFF program calls for the deficit to decline gradually to 5.0 percent of GDP by 1987. 36. Malawi's foreign financing needs and expected resources are shown in Table 2 below. Total available foreign financing for the 1983-87 period has been based on past trends, as well as expected levels of grants, and medium and long term loans from Individual sources. Even allowing for two SALs totalling US$115 million and possible IMF programs throughout the five years,1 a gap of US$75 million remains to be filled. 37. -it should be noted that Malawi had very heavy debt repayments due in the period of 1982-1984, but has recently completed a rescheduling of both its commercial and official debts. The commercial debt repayments, due in 1982 and 1983, will be stretched out over the next 6 1/2 years and official repayments over the next 8 years. Table 2: MALAWI-Foreign Financing, 1983-1987 CUSS million) Current Account Deficit 725 Capital Account Amortization 285 Reserve Build-up 50 Total Requirement 1060 Official Grants 270 M&LT Loans 505 Net IMF 85 SALs 115 Other Capital 65 Debt Rescheduling 35 Total Available 985 1 The IMF has recently agreed to a three year EFF with Malawi, but has no commitment for any program beyond mid-1986.  - 14 - With this rescheduling, Malawi's debt service ratio, which would have reached over 40 percent in 1982 will be very flat over the period at about 25-30 percent per annum. The debt rescheduling will provide about US$35 million in resources. 38. Another key to attaining sustained growth with a manageable balance of payments current account deficit will be substantially reducing the Government's budgetary deficits, which reached an average of almost 16 percent of GDP during FY80-FY82. Under the EFF, the deficit is targeted to decline gradually each year to reach 7.5 percent of GDP by FY86 by keeping development expenditures to 8.8-9.0 percent of GDP; reducing the revenue account expenditures from 17.6 percent of GDP in FY83 to 15.4 percent by 1985/86, and keeping revenue between 16.6 and 16.9 percent of GDP throughout the period. 39. To achieve the growth targets set out, both the saving and investment rates will need to recover from the depressed levels of recent years. At the same time, the efficiency of investment will need to improve. Domestic savings will have to increase from the 1982 figure of 13.5 percent of gross domestic product to 17.8 percent by 1987, and the decline in investments by both private and public enterprises must be reversed. 40. Given the program proposed by the Government and the political commitment to it, the targets above should be achievable. Malawi already is pursuing an agriculturally based, export-oriented policy which has been implemented well in the past. Therefore, the present program does not aim to introduce radial changes, but has as its major goals enhancing the efficiency of implementation and strengthening the relevant institutions. The Productive Sectors 41. Agriculture. As in the first SAL operation, monitoring the price incentives for smallholders, will continue to be a major focus of the adjustment program. Over the last two years, a methodology for setting prices for smallholder crops has been developed, which sets the price levels which will provide the incentive to expand both overall and export crop production. With recent increases in smallbolder crop prices, the terms of trade are shifting in favor of agriculture and the returns per labor-day for all major crops in most locations are greater than the opportunity cost of labor. Table 3 below sets out recent price trends in real terms and shows that for most crops prices are well above the 1980 levels in constant prices. This increase has been achieved despite the low rates of growth in border prices, the basis for setting export crop prices, due to small price increases in international markets and large increases in transport costs to and from Malawi. A better indicator of the incentives offered to farmers is the trend in real returns per man-day of labor which are set out in Table 4. This shows the reversal of the downward trend beginning for many crops in 1982 and other crops in 1983. The Association will continue to be involved in ensuring proper application  - 15 - Table 3: Real Smallholder Crop Prices (1974 tambala/kilogram) 1980 1981 1982 1983 1984 Maize (local) 3.7 3.3 5.0 4.2 4.3 Tobacco (NDDF) 33.3 30.0 31.8 39.2 39.2 Groundnuts (Chalim- 18.6 18.6 25.0 21.1 21.0 bana) Cotton 13.0 14.4 14.8 14.6 14.7 Rice (Faya) 5.6 5.0 5.2 4.4 5.2 Table 4: Real Gross Margins per Labor Day for Smallholder Crops (1974 tambala) 1984 1980 1981 1982 1983 (est.) Maize (local) 45.4 39.0 60.9 54.0 51.2 Tobacco (Northern Div. dark-fired) 28.1 24.3 20.6a/ 26.8 26.8 (25.6) Groundnuts (chalimbana) 32.6 24.9 25.7 30.9 36.3 Cotton 31.3 24.3 28.7 36.3 38.0 Rice (faya) 48.6 40.1 33.7 38.6 47.5 a A 15 percent second payment was made in 1981/82 resulting in total receipts of 25.6 tambala in 1974 prices. of the agreed pricing methodology and help as needed to improve the system further. Specifically the question of the comparative advantage of various crops will be looked at and the effect of pricing policies on the budget, the balance of payments and other macroeconomic variables will be examined. In recent years, production of groundnuts, cotton and a number of minor crops have fallen significantly as the relative returns to maize have been much more attractive. Incentives provided under recently increased prices and available technical packages should restore the production of most of these back to previous levels. Despite a buoyant international price, the export parity price for cotton is low due to  - 16 - relatively inefficient and costly cotton ginning and processing and the high cost of external transport particularly in view of recent disruption in the shortest and cheapest routes through Mozambique. The Government has deemed cotton self-sufficiency necessary and will set prices sufficient to achieve this. In the meantime, it plans to reduce processing and transport co:;ts through further investments in roads and ginning capacity. 42. The Government will continue to review annually with the Association the recurrent budget allocations to the Ministry of Agriculture to be sure they are adequate, as was done under the first SAL. 43. ADMARC is the major source of inputs and marketing for smallholders. It was established in 1971 to increase exports, provide supplies to those farming on customary land (smallholders), and to maintain a system for export marketing. While it provides an outlet for all produce grown on customary land, its monopoly extends only to certain types of tobacco and cotton. Besides these functions, ADMARC was also given the task of assisting by credit or investment any "works, undertakings, projects, schemes or enterprises relating to the development or improvement of the economy of Malawi". ADKARC was to be run as a commercial enterprise and its selling price for produce sold within Malawi was to be no less than the purchase price plus ADMARC costs or, if sold below this price, the Government was to make good any losses from public funds. Unfortunately, misapplication of these two provisions has led to some of ADMARC's present difficulties. 44. While ADMARC was conceived primarily as a marketing agency, during the 1970s it gave much more attention to the development aspects of its mandate. In effect, it used its pricing decisions to tax the smallholder sector and invest the revenue in the rapidly expanding estate sector. Until 1978, ADMARC showed large profits and was able to carry out its investment plans and still provide most of the services needed by smallholders, including the procurement and distribution of subsidized fertilizer. By the end of the 1970s, however, ADMARC began to lose money on its operations due mainly to increased marketing costs (despite a slight decrease in the volume purchased), due to excessive staffing and buying points, failure to adapt to more difficult and costly transport, and a shift to distribution of maize and subsidized fertilizer within the country relative to more profitable export activities. 45. Contrary to statutory requirements, ADMARC has not been compensated by the Government for losses incurred in maize and fertilizer distribution. In addition, export markets have been eroded or lost due to poor crop forecasting, irregularity of supply and shipment, and for groundnuts, poor grading standards and declining quality. By 1980 ADMARC's trading profits had disappeared and overall operations showed a loss of almost MK 9 million. As a result, it was unable to order sufficient fertilizer to meet farmer demand that year. The same happened the following year when it lost more than MK 10 million. The Finance Ministry,  - 17 - forced to procure rid