Malawi - Urban Project

Document of The World Bank FOR OmCIAL USE ONLY Reput N.. P-3894-hAI REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOP!ENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 14.8 MILLION TO THE REPUBLIC OF MALAWI FOR AN URBAN PROJECT ; November 2, 1984 I TI& dnumeutb a uikddisibdba. md may be =ad by MedpkU mliy ina th puifeue of du&sOld.E julf. ts camluis my aet .eheuwI. be dbehaud -khsu Woul Bank ah.umwkde..  -r BIYS Curreacy UnJits al aal acha (BK) and Tamibala USl.00 NK 1.33 mg 1.00 US$0.75 IVRIAIS AND AC15M BCC - Blantyre City Council CCDC - Capital City Developmet Corporation DLV - Department of Lands and Valuation IHA - Intermediate Housing Area LCC - Liongte City Council IEC - al avi Housing Corporation mwOs - Ministr7 of Works and Supplies NBS - New Building Society OPC - Office of the President and Cabinet T7H - Tfraditional Housing Area PTSZL WAS, Government of Malawi - April I-March 31 Malawi Housing Corpora.ion - January 1-December 31 New Building Society - February 1-January 31  FOR OFFICIL USE ONLY DEPUBIC OF YALAV UNBAR PROJBCr CEDIT D MMPROJE SUNmKY Borrower: Republic of Malawi. Amount: SDR 14.8 million (US$15.0 million equivalent). Terms: Standard. Beneficiaries: Malawi Housing Corporation (MHC) and New Bailding Society (NBS). Onlending Terms: To MHC - for 10 years at the prevailing Government interest rate for loans to parastatals (currently 10 percent); plus funds on equity and grant terms. To NBS - for 25 years at the prevailing Government interest rate for loans to parastatals, with one-half of the funds to be subordinated for ten years with no interest charged. The onlending rate to the ultimate beneficiaries (initially 12 percent) is consistent with the prevailing interest rate structure in Walawi and is expected to be positive in real terms during the project period. Purpose: The project would help reorient future housing development in Malawi toward a market-based system by: (a) introducing a new standard of housing development intermediate between the existing high-cost permanent housing and traditional structures; (b) expanding greatly the use of private mortgage funds to provide financing for such housing; (c) restructuring the Malawi Haousing Corporation to play a more active role hu market-oriented housing development; and {d) helping the Government find long-term solutions to the pervasive problem of housing subsidies. The project would also provide financing for Malavi's low-cost traditional housing area program, and technical assistance to assist in removing legal and technical bottlenecks to low-cost housing development. 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 Bank authorization.  - ii - Benefits: The project would help the Government achieve itr objective of making affordable housing available on a full cost-recovery basis to a wider range of income groups. The economy would benefit from substantial reductions in unit costs of housing compared with current standards, and by a diminished burden on the Government's budget through greater use of private funds for housing finance. Also, the project would demonstrate viable alternatives to subsidized housing, the phasing out of which would be addressed through the project's technical assistance. Risks: Risks concern the capability of the sector's institutions to deal with the proposed restructuring and uncertainties as regards housing demand. These risks would be obviated by the considerable experience of the sector's institutions, the flexibility of project design to respond to changes in demand , the commitment of the Government to long-term reform, and the continuing dialogue between the Government and Bank on some of the underlying issues. Estimated Cost: USS Million Local Foreign Total 1. Intermediate Housing Area Program 9.6 2.1 11.7 2. Traditional Housing Area Program 0.5 0.3 0.8 3. Institutional Support and Studies 0.5 0.9 1.4 Base Cost 10.6 3.3 13.9 4. Physical Contingencies 0.5 0.2 0.7 5. Price Contingencies 3.0 0.6 3.6 Total Project Cost (Including Insignificant Taxes and Duties) 14.1 4.1 18.2  - iii - USS Million Financing Plan: Local Foreign Total IDA 10.9 4.1 15.0 NBS al 1.3 - 1.3 -HC 0.6 - 0.6 Private Individuals b/ 0.8 - 0.8 Government 0.5 - 0.5 14.1 4.1 18.2 Estimated IDA Fiscal Year 85 86 87 88 89 90 91 Disbursements: Annual 0.8 2.0 3.0 3.2 2.6 2.6 0.8 Cumulative 0.8 2.8 5.8 9.0 11.6 14.2 15.0 Economic Rate of Return: About 15 percent (weighted average for the main component for intermediate area housing). Appraisal Report: No. 52G0-MAI, dated October 17, 1984. Map: IBRD No. 18004. a/ NBS will provide an additional amount of local funds equivalent to US$3.1 million for long-term refinancing of residential land developed by MHC. b/ In form of mortgage downpayments.  IWr MJATION&L DEvO ASSOCIaON REPORT AND RECOUMEDATIOW OF TRE PRESIDENT TO TEe EXECUTrVE DIRECTORS ON A PROPOSED CREDIT TO THE REPUBLIC OF NATAANI FOR AN URBAN PROJECT 1. I submit the following report and recomuendation on a proposed credit to the Republic of Malawi for SDR 16.8 million (US$15.0 million equivalent) for an urban project. The credit would be on standard IDA terms. PART I - TE. ECONOMY 2. A report entitled -Malawi: Growth and Structural Change, A Basic Reportx (Report No. 3082a-MAI) dated February 8, 1982, was circulated to the Executive Directors on March 9, 1982. Annexes to the report were distributed oan June 26, 1981. Annex I contains the basic country data. 3. Malawi is a small (118,500 sq km), densely-populated (about 6.6 million people in 1983) 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, Halawi has no 3'nown substantial mineral resources. S. Although Malawi has a GNP per capita of only US$210 and has been identified by the United Nations as one of the world's poorest countries, its progress since independence in 1964, measured against its natural resources, has been significant. Up until 1979 there was mostly steady growth. In 1980 and i98l major economic difficulties were encountered, but a recovery appears to have begun in 1982 and 1983. GDP at constant prices grew at an average annual rate of 6 percent between 1964 and 1979. During the same period, real growth of estate agriculture and manufacturing exceeded 10 percent per annum and export volume grew at 4.5 percent per annum. A steadily increasing investment rate (rising from 9 percent of GDP at independence to 33 percent in 1979) has been supported by heavy inflows of official and private external capita-l as well as by a significant increase in domestic savings (from virtually nil in 1964 to 14 percent of GDP in 1979). 5. Malawi's past development success has been due largely to the realistic and purposeful policies of the Government. Public investment has been intended primarily to support private initiative in the directly productive sectors by providing infrastructure, public uw'1ities and support services. The Government has emphasized smallholder agriculture, as about 90 percent of the population lives in the rural areas and depends- on agriculture for its livelihood. The Government has thus undertaken a  number of integrated rural development projects and, in the late 1970s, enbarked on the National Rural Development Program (NRDP), an ambitious 20-year program for extending services to smallholders countrywide. The Government's decision to emphasize directly productive sectors and infrastructure has resulted in.relatively slower development of social services. Over the past 10 years, 7 percent of the Government's development budget has been spent on health, education and community development, compared to 22 percent on natural resources and 39 percent on communication. 6. Malawi's economy is heavily dependent on three primary commodity exports (tobacco, tea, and sugar) and is highly vulnerable to international price fluctuations. Since 1974, there have been periodic balance of payments problems 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 cobacco, sugar and tea; and (c) significantly higher costs of transport for exports and imports owing to rising ocean freight charges, port congestion in l4ozambique, and disruptions of overland transport. 7. 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. For reasons mostly outside Malawi's control, the deficits in both the trade and non-factor services grew rapidly until 1980. Between 1977-80 Malawi's terms of trade fell by 40 percent. While export prices declined by 16 percent (due mainly to falling tea and tobacco prices), import prices rose by 39 percent, partly because of the steep increase in prices of petroleum products. The petroleum import bill more than doubled, raising its share in total imports from 8.5 percent in 1977 to more than 16 percent in 1983. In 1980 and 1981!, agricultural production suffered from recurring drought, reducing export volumes and necessitating large imports of maize, a commodity in which Malawi had been self-sufficient during most of the 1970s. Finally, disruptions of the rail transport system through Mozambique have forced Malawi to use more costly alternative routes as principal means of transport for exports and imports. As a result of these developments Malawi's current account deficit deteriorated sharply. From an annual average of about 8-9 percent of GDP in the mid-1970s, it rose to 18 percent in 1978 and 23 percent in 1979 before falling to 19 percent in 1980, 12 percent in 1981, 8.3 percent in 1982 and 11.5 percent in 1983. Capital inflows 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 1977-83. 8. Malawi's fiscal position also seriously deteriorated. From independence through 1977/78, government expenditures and revenues expanded roughly in line with the increases in GDP, and deficits rarely exceeded eight or nine percent of GDP. In the past four years, expenditure growth has outstripped the increase in revenues and the share of government deficits in GDP averaged 15.6 percent in 1978-81. The underlying cause of these deficits was the increase in government expenditure to around 35 percent of GDP compared to an average 26 percent for the previous six years. Increases in domestic borrowing, mainly from the monetary system,  -3- and in foreign borrowing, partly, on commercial terms, were required to finance the rising budget deficits. Inflationary pressures grew and prices rose at an average rate of 13 percent per annum in the first four years of the 1980s, well above the average of 9 percent from 1973-79. 9. Because of the Government's limited ability to mobilize resources, the appreciable expansion of Malawi's development program over the past decade has been financed in large part by increased public capital inflows. The net contribution from foreign official sources to the financing of public investment increased from US$17 million in FY68, to about US$105 million in FY82, of which about US$48 million were grants. However, borrowing on commercial terms accounted for about 50 percent of total borrowing from 1979-81. 10. The Government and the ITF agreed to a new standby program for SDR 22 million in August 1982. A first phase of a multi-year stabilization effort, the program aimed at reducing both the balance of payments current account deficit and the budgetary deficit. As part of the program, the Government devalued the kwacha against the SDR by 15 percent in April 1982. The other performance criteria involved phased ceilings on net domestic assets of the banking system and on net credit to the Government and a limit on government external commercial borrowing. The standby was implemented satisfactorily, and the Government and the IMF concluded a new multi-year program, and a three year Extended Fund Facility was approved in September 1983 and has been implemented successfully so far. As part of the Extended Fund Facility, the Government devalued the kwacha against the SDR by 12 percent in September 1983 and switched to a basket of currencies on January 1984. 11. These measures are complemented by a medium-tern structural adjustment program on which the Government enbarked in 1981. The program's principal objectives are to diversify Malawi's export base, encourage efficient import substitution, adjust income policies, improve the public sector's financial performance and strengthen economic planning and monitoring. The Bank's first structural adjustment loan for US$45 million was made in June 1981. After initial difficulties, good progress was made in Implementing the Government's adjustment program: additional funds were allocated to the agricultural sector, agricultural prices were adjusted, public utility tariffs increased and the budget for 1982-83 was trimmed, with sufficient resources provided for major development sectors. The second tranche was released in April 1982. However, during 1982 the country's efforts were set back by increased disruption of the traditional transport routes and continued depressed demand for Malawi's export products. Nevertheless, the country was able to hold its current account deficit to 11.3 percent of GDP in 1983, reduce the budgetary deficit for FY1983 to 9 percent of GDP, and meet its IMF standby borrowing ceilings. GDP growth recovered to 2.6 percent, and 4.4 percent, respectively in 1982 and 1983. External grants and net capital inflow continued to fall and despite a rescheduling of its external debt, net asset transfers have fallen sharply since 1980. Malawi's economic perforoance and creditworthiness are expected to continue to improve in the medium term if the structural adjustment program is implemented successfully, the external transport and terms of trade conditions do not deteriorate further, and the fall in foreign asset flows is reversed.  -4- 12. In December 1983, a second structural adjustment operation was approved by the Board. The program supported by SAL II builds on the progress made under SAL I and strengthens areas not covered in the first program or where implementation was not completely satisfactory. Implementation of SAL II has gone well in many facets such as the strengthening of agricultural marketing, setting agricultural prices, the price liberalizarion program, budgetary allocations, revenue measures and development of an estate credit project. However, there have been some delays in developing a rationalization plan for Press Holdings, projecting revenues and expenditures, and developing a three year investment program. It has also been necessary to revise the 1984/85 development budget. When these steps have been taken the second tranche will be released. 13. By the end of 1983, Halawi's external public debt outstanding and disbursed totalled US$705 million. In late 1982, Malawi rescheduled both its official and commercial debts. Otherwise its debt servicing, including repayments to the IMF, would have amounted to over US$130 million, equivalent to over 40 percent of exports of-goods and services. This compares to a level of about 10 percent in the mid-1970s. A second year of rescheduling was agreed to in October of 1983, keeping the debt service ratio to 26.7 percent in 1983. Although the Government has indicated that it will not be asking for any further rescheduling, the debt service ratio is expected to remain at 25-30 percent over the next few years. PART II - BANK GROUP OPERATIONS IN MALALI 14. Over the past 18 years. Malawi has received 31 IDA credits and one Specia-l Fund credit totalling about US$414 million and seven Bank loans totalling US$93 mlllion, of which two were on third window terms. -Of the Bank Group assistance, some US$123 million (24 percent) was for agriculture. US$108 million (21 percent) for education, US$114 million (22 percent) for roads, US$100 million (20 percent) for structural adjustment, US$39 million (8 percent) for power, US$11 million (2 percent) for water, and the balance of US$12.0 million (2 percent) for health, development finance and technical assistance. The first Bank loan to Malawi was made on third window terms in June 1976 and the first standard Bank loan in April 1977. The most recent operations were a US$13.1 million equivalent credit, a US$13.8 million equivalent Special Fund credit and a US$18.0 million loan for a fifth highways project; a US$55.0 million equivalent credit for a second structural adjustment project and a US$1.5 million equivalent credit for a related technical assistance project. IFC's -investment in Malawi consists of a loan of US$10.8 million for a textile mill, another of US$9.9 million for a sugar mill, a US$0.6 million equity investment in the Investment and Development Bank of Malawi (5nDEBANK) and a US$2.0 million loan to Malawi Motels Limited fof tourism. A US$300,000 equity investment and a loan of US$1.9 million for the production of ethanol from molasses were approved in July 1980, and a US$0.5 million equity subscription and US$1.8 million loan investment in the Viphya PlywoodS and Allied lndustries United were approved in August 1984. A Suumary Statement of Bank Group Operations is provided in Annex II.  15. During the next five years, Bank Group assistance to Malawi will continue to be designed to help Malawi restructure its economy, especially to help improve agricultural productivity and the efficiency and effectiveness of public and private enterprises. To-wards this end. the second structural adjustment and related technical assistance projects will continue to improve incentives for smallholders, increase efficiency in the productive sectors, better mobilize and manage resources and improve development administration and the capacity for policy formulation. A third structural adjustment project is planned for FY86. Further investments in agriculture, transportation, education, health/population, power and water supply are contemplated as well as a second line of credit to INDEBANK. The Bank Group's economic and sector work will build on the previous studies (e.g. basic economic report, sector work on energy, health and NRDP by focusing on five high priority areas which will, over the medium term, help Malawi improve its economic performance: (a) agricultural productivity; (b) external transport; (c) public sector management; (d) industrial productivity; and (e) development of Malawi's human resource potential by addressing the problems of population growth and the cost effectiveness of the social sectors. External Debt 16. The Bank Group's share of Malawi's external debt (disbursed and outstanding) at the end of 1982 was about 36 percent (IBRD: 11 percent, IDA: 25 percent), and its share in debt service was about nine percent. Because Malawi is one of the least developed countries, many other donors give aid on grant terms. Other major donors have been the United Kingdom, the Federal Republic of Germany, the European Economic Community and the African Development Bank. Disbursements 17. Disbursements of the Bank Group loans and credits in Halawi generally have kept close to schedule and compare favorably with other countries in the region and even on a Bank-wide basis. During the period FY80-83, the disbursement rate on loans and credits to Malawi (excluding the effect of non-project lending) averaged about 28 percent per annum, significantly higher than the Eastern Africa Regional average of 19 percent and the Bank-wide average of about 21 percent. Project Implementation 18. Overall, implementation of Bank projects continues to be good. However, the third NRDP project has recently been classified as a problem project-the first ever in Malawi--due to inadequate budget provision, fertilizer shortage and lack of marketing and input infrastructure. Implementation and disbursements are 50 percent of appraisal estimates. The Government has agreed to reassess its FY84 development budget so that it can allocate sufficient budgetary resources for the project, to commence construction of marketing and input facilities and to ensur. timely delivery of fertilizer. With these corrective actions, the project is expected to regain lost momentum. . _ .~~~~~~~~~~~~~~~~~  -6- PART III- TME OUSING S%CWO% Urban Background 19. The urban population of Malawi in 1983 comprised approximately 10 percent of the total population of about 6.6 million. About two-thirds of the urban population is concentrated in Blantyre, the largest city (estimated population of 250,000), and Lilongwe, the new capital (estimated population of 130,000). Urban growth has been reasonably well managed, and basic services have been provided to the majority of urban residents through the extension of nation-wide sectoral programs in health, education, water supply and housing. Despite this good record of providing for growth, the Government has found it increasingly difficult to maintain service levels because of the growing constraints on both recurrent and capital budgets. As a result, cost recovery policies in the social sectors and improvements in the management of statutory bodies have become important elements of the Government's structural adjustment policies. One of the most difficult areas in which the Government has tried to formulate new policies has been in housing, both because housing benefits form a major share of total implicit compensation levels in Malawi, thereby substantially affecting the level of real wages, and because housing construction under current policies constitutes a large share of Government investment costs in sectors as diverse as agriculture, health and education. Housing Development 20. Housing supply in Malawi has historically been dominated by the Government, with less than 10 percent of the urban population financing their own houses through formal market sources. The Government has maintained a highly successful sites-and-services program (based on Traditional Housing Areas - THA's), which has enabled lower income urbat residents, amounting to about half of the population, to construct self-help housing in a planned setting. However, at the upper end of the housing scale, Malawi has maintained the colonial tradition of providing subsidized housing as part of a benefit package made available to many higher-level employees in the public and private sectors. The major- share of such housing is owned by the Government, either as institutional housing held by individual ministries or as general purpose pool housing owned by Malawi Housing Corporation (MHC) (para. 22) and rented on a sub-economic basis to the Government or to employees of statutory bodies and private firms. 21. Between 1971 and 1981, an average annual growth rate of 17 percent was maintained for traditional housing'plots and 5 percent for permanent housing. This high volume of traditional housing production provided for a major share of the increase in the urban population, which grew at an estimated annual rate of approximately eight percent over the period. The more mDdest growth in the permanent housing stock was well below the increase in the number of employees eligible for rental housing, so that, by 1983, approximately half of the civil servants eligible for  -7- rental housing were on the waiting list. Halawi's current budgetary constraints have since reduced all types of housing construction to minimum levels, thus aggravating the shortages. Given that urban densities and the size of the urban population are relatively low in Malawi, the stagnation in nousing development has not yet been reflected in undue growth of unplanned housing settlements. Nevertheless, it is estimated that Nalawi will need to restore an average annual production of at least 4,500 housing units (including traditional housing plots) to accommodate the expected increase in the urban population, even allowing for multiple occupancy of plots. 22. The main institutions in the sector are: the Malawi Housing Corporation (MHC) and Lhe New Building Society (NBS). The Malawi Housing Corporation is a statutory body established in 1964 to undertake the development, construction and management of housing and housing estates throughout Malawi on a non-profit basis. MHC's charter gives it authority to engage in a number of activities in the housing sector, including the provision of serviced land and housing for resale and the extension of construction loans to individuals. In practice, MHC has been mainly involved in the construction and maintenance of rental housing estates and the development of Traditional Housing Areas. The corporation 's current housing stock consists of almost 10,000 permanent nousing units, of which over half are rented to the Government for occupation by civil servants, while the remainder are rented to employees of statutory bodies and private individuals. In addition, MRC administers over 25,000 THA plots, with 10.000 additional such plots scheduled to be transferred to MaC from the recently dissolved Capital City Development Corporation, which was formed to manage the construction of the capital city of Lilongwe. 23. MHC's organizational structure and financial accounting system have developed along the lines of a public utility, in keeping with NHC's primary emphasis as a property management company. It is organized with three uperating Departments (Administration, Technical and Finance), each of which is sub-divided into a number of operating sections. The corporation, which is almost completely Malawianized, is8 staffed by over 450 permanent employees and more than 1,000 contract workers, the latter being primarily involved in direct labor. 24. MHC is largely dependent for its revenues on rentals charged to the Government. Because of the Government's own budgetary problems, rental increases have been granted reluctantly and only after MHC' s financial situation weakened to a precarious position. In addition, housing construction costs have increased much more rapidly than average inflation, so that, between 1973 and 1981, the cost of a house designed for a middle-level civil servant increased by 250 percent, while MaC's average rental charge for the same grade house 'ncreased by only 50 percent. As a result of this uneconomic rental structure, MNC.made a net loss in 1982 and its debt-service ratio fell below 1.0. The situation worsened in 1983 and the first part of 1984, although a 20 percent increase in rental charges approved by the Government for April 1984 is expected to stabilize MHC's financial situation temporarily. However, without a fundamental change in MHC's financial outlook, a continuing cycle of periodic losses and inadequate rental increases by the Government is the only foreseeable prospect.  -8- 25. Despite HaC's recent financial problems, the corporation has performed well in fulfilling its mandate in the past, and has developed the experience and tecbnical capacity to undertake a larger and more dynamic program of land and housing de-relopment. MNC's future prospects as a property development coapanz clearly rest with the establishment of a viable financial and organizational structure for market-based housing sales. This will require a nmber of organizational and financial changes. For example, the excess demand for houses due to HEC's sub-economic rental structure has meant that marketing considerations have been min4- l in determining the corporation's investment program. Moreover, as MEC has depended primarily on long-term debt financing to develop new housing, internal cash generation and control of working capital have not been exploited as a means of maintainiag housing construction. Finally, MNC needs to strengthen its management of construction, as the use of direct labor has been identified as a source of hidden overheads and possible delays. 26. The New Building Society. The New Building Society (NBS) is the sole registered building society in Malavi. It is based in Lilongwe, with five branch offices providing coverage of the major urban areas. The Government is the principal shareholder with 51 percent of the outstanding share capital, and the remaining share capital is split equally between Lonrho (Malawi) Ltd. and Protea Assurance Co. Ltd. of South Africa. The society operates under the general direction of the Reserve Bank of Malavi, and it competes directly with the Post Office Savings Bank in attracting accounts from smaUl depositors. NBS has played a limited role in the sector up to now, financing less than 10 percent of the total stock of housing. Its current mortgage portfolio, consisting of fewer than 700 mortgages for the country as a whole, is concentrated almost exclusively in the upper-income bracket, a market which has stagnated due to depressed economic conditions in Malawi. Nevertheless, NBS's potential for mobilizing resources for the housing sector is promising. Between FY79 and Fv-84, NBS experienced growth rates of 21 percent in its deposit accounts and 14 percent in its mortgage lending. The society's ability to attract new depositors, despite more favorable tax treatment on interest paid by the Post Office Savings Bank, is due to its emphasis on customer service and its effective use of advertising. Nevertheless, the slow-down in growth of lending demand due to the stagnation of housing sales at the upper income levels has resulted in the society holding excessive liquid funds, which it has invested primarily in Reserve Bank stock. At the end of FY84, NBS held about US$3.75 million equivalent in Government bonds and current assets, while only 67 percent of its financial assets were held in the form of mortgages. This level of liquidity provides NBS with a good financial base for expanding its mortgage lending at the middle and lower income levels, provided that such bousing can be made available on an affordable basis. 27. Although NBS's net profit position has been generally satisfactory, growth in earnings since 1982 has been due primarily to the high returns on Government bonds, rather than the strength of its mortgage portfolio. In addition, in response to a recommendation by the INF in 1983, the Reserve Bank raised all deposit rates in Malawi by two percentage  -9- points but did not approve corresponding increases in lending rates. As a result, the effective spread on NBS's mortgage portfolio was reduced to the point where NBS would have sustained a loss during FY84 without its investment earnings. In response to this situation, the Board of NBS recently approved changes ikn its mortgage lending rates, including an increase in the lending rate for owner-occupied housing from 11.75 percent to 13 percent, which are expected to be adequate to maintain a position level of net income on existing operations. Subsidized Housing 28. The fact that housing is generally considered to be a part of the overall compensation package in Malawi makes it more difficult to resolve the financial problems facing the housing sector, particularly those of MHC. -Rental charges paid by employees receiving housaing are generally determined as a fixed percentage of their income, rather than on the basis of the cost of the housing. For example, civil servants are assessed rental charges at 10-12j percent of their salaries, while rental charges for employees of statutory bodies may be as low as 5-7f percent of income. As a result of this practice, employees often pay less than half of the rental charge assessed by MHC. Since the employer, which is often the Government, must cover the difference in rental payments, the Government is normally reluctant to increase MHC's rental charges. Another implication of the system of rentals is that there is considerable resistance to any changes in housing standards designed to lower the unit cost of housing, which are viewed as a loss of salary entitlement. Finally, as housing benefits have been immune to inflation during a period when the real value of monetary wages eroded significantly, the total compensation package paid to civil servants has become unbalanced with respect to non-wage benefits, aggravating the inequalities between civil servants receiving housing and those who do not. 29. If only the direct cash outlay of the Government on housing subsidies is considered (as represented by the difference between total rent collections from tenants and the expenditures by Government and MHC on debt service, maintenance and administration), the subsidy burden appears to be about USS2-5 million pet year. The main reason for the relatively modest size of this expenditure, which represents about 1-2 percent of the Government's anntal recurrent budget, is that much of the housing stock has been fully amortized or financed on concessional terms through donor projects in various sectors. However, when housing subsidies are computed in economic terms (which gives an approximate value of the income in-kind transferred to occupants of subsidized housing), housing subsidies are seen to constitute a major component of the total implicit compensation package. In 1982, the economic value of housing subsidies received by civil servants occupying rental housing ranged from an average of 75-160 percent of salary payments. As a yardstick, it is estimated that if *11 civil servants were housed on the basis of the approved entitlement, the economic subsidy value would exceed USS50 million r..;r year. 30. The Government is aware of the need to approach the subsidy problem at three Levels: (i) by establishing private home ownership as a feasible and desirable alternative for a larger share of urban residents;  - 10 - (ii) by improving cost-control and management of the existing stock of Government housing; and (iii) by addressing the role of housing benefits in the overall compensation system. Because implicit housing subsidies often exceed the value of monetary wages, a simple substitution of wage -ncreases for housing subsidies would be neither feasible nor necessarily equitable. Therefore, a course needs to be explored that would limit the growth of subsidies by providing incentives for private home ownership and by reducing the unit cost of new housing units, while at the same time addressing the subsidies on the existing housing stock through modifications of wage and rental policies and possible divestiture of part of the Government's existing bousing stock. These measures would help the Government gradually reduce the linkage between housing benefits and compensation policies in order to achieve a compensation system which combines the Government's equity and incentive objectives with provision for private home ownership. Future Sector Policies 31. The President of Malawi has mandated that the Government must begin the process of moving away from the system of subsidized rental housing and ensure that every civil servant can own his own home by the end of the century. In the framework of the ongoing structural adjustment operation, the Government has formally notified the Bank of its intent to ellliinate or minimize housing subsidies. Moreover, the Office of Housing in the Office of the President and Cabinet has recently prepared a draft policy statement that recognizes the need for Malawi to institute structural reforms in the housing sector and recommends: (a) increased emphasis on individual home ownership, particularly through sites-and-services type program_; (b) expanded credit facilities to encourage bome ownership and mobilization of private savings; and (c) phasing out of rent subsidies to civil servants and their replacement with a housing allowance system and economic rentals on the Government-owned housing stock. The development of a private housing market is considered by the Government to be the first priority in implementing this policy, in order to provide a credible alternative to the current system of rental housing. The Malawi Hous