Malawi - Urban Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 5200-MAI STAFF APPRAISAL REPORT REPUBLIC OF MALAWI URBAN PROJECT October 23, 1984 Eastern Africa Projects Department Water Supply and Urban Development Division 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.  CURRENCY EQUIVALENS. Currency Unit = Malawi Kwacha (MK) MKI.OO = US$0.75 US$1.00 = .iKI.33 SVRI.00 = US$1.01663 (August 31, 1984) US$1.OO = S)RO.983642 ABBREVIATIONS AND ACRONYNS BCC - Blantyre City Council CCDC - Capital City Development Corporation DLV - Department of Lands, and Valuation IDA - International Development Association IRA - Intermediate Housing Area LCC - Lilongwe City Council MhC - Malawi Housing Corporation mOWS - Ministry of Works and Supplies NBS - New Building Society ODA - Overseas Development Agency (United Kingdom) OPC - Office of the President and Cabinet SOE - Statement of Expenditures THA - Traditional Housing Area FISCAL YEARS Government of Malawi - April 1-March 31 Malawi Hoiusing Corporation - January 1-December 31 New Building Society - February I-January 31  REPBLC OF NALANI FOR OFFICIAL USE ONLY URBAN PROJECT STAWF APPRAISAL REPORT Table of Cont2nts CREDIT AND PROJADCT SU4K&RY ................................... i-iii I. SECTORAL CONTEXT .............................. 1 A. Introduction .....................1...................... B. Current Policies in the Housing Sector . . 2 C. Restoring the Momentum of Housing Development ......... . 4 D. A Phased Approach to Housing Subsidies ................. 6 E. Background and Strategy for the Association's Involvpment .......... ................................ 9 II. THE PROJECr .............. ................................. 11 A. Project Objectives and Rationale ....................... 11 B. Project Components ...... ............................... 12 C. Detailed Project Description ........................... 13 III. oDST ESTINATES AND PROJECT I ENT ION ....... .......... 17 A. Project Costs .................... ...................... 17 B. Financing Plan ................... ...................... 19 C. Flow of Funds ........... . .............................. 20 D. Implementation Schedule ................................ 21 E. Procurement .. .......................................... 21 F. Disbursements .................... ...................... 23 G. Legal Arrangements ................. .................... 24 H. Accounts and Audit ................. .................... 24 I. Project Monitoring and Coordination .................... 25 J. Project Supervision ............. ....................... 26 IV. INSTITUTIONAL AND FINANCIAL ANALYSIS ...................... 26 A. Malawi Housing Corporation ............................. 26 B. New Building Society ................................... 31 C. Office cf Housing ...................................... 35 V. PROJECT JUSTIFICATION ................. .................... 36 A. Market Demand and Affordability ........................ 36 B. Project Benefits .................. ..................... 37 C. Project Risks .......................................... 38 D. Conclusions ..................... ....................... 39 VI. RECOMMENDATIONS .......... ................................. 40 This report is based on the findings of an appraisal mission which visited Malawi in November-December 1983. The mission consisted of Mr. R. Westin (Head of Mission), Ms. F. Johnson, Messrs. R. Satin and D. Jones (IDA), and Mr. I. Wanjohi and Ms. D. Lee-Smith (Consultants). 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.  Text Tables Table 3.1: Project Cost Summary Table 3.2: Financing Plan Annexes Annex 1: Tables Table 1: Detailed Cost Estimates Table 2: Procurement Arrangements Table 3: Estimated Schedule of Disbursements Table 4: Malawi Housing Corporation: Summary of Past Financial Statements Table 5a,b,c: Malawi Housing Corporation: Projected Financial Statements for Property Development Account Table 6: Malawi Housing Corporation: Projected Income Statements for Other Activities, Net of Property Development Account Table 7a,b, New Building Society: Past and Projected Financial c,d: Statements Table 8: Affordability of Typical Housing Options Table 9: IHA Units as an Alternative to Institutional Housing Table 10: Details of Rate of Return Calculations; IHA Program Annex 2: Charts Chart 1: Implementation Schedule Chart 2: Housing Options by Income Group Chart 3: Organization of the Malawi Housing Corporcttion Chart 4: Organization of the Office of Housing (Proposed) Chart 5: Organization of the Lands Division of the Department of Lands and Valuation (Proposed) Chart 6: Organization of the Ministry of Works and Supplies Training Center Charts 7-14: House Type Plans Annex 3: Terms of Reference 1. Housing Subsidies and Wage Policy Study 2. Revisions to MRC Accounting Systems Annex 4: Selected Documents and Data Available in the Project File Photographs Maps: Malawi: First Urban Project; IBRD No. 18004 Blantyre: Location of Project Sites; IBRD No. 18078 Lilongwe: Location of Project Sites; IBRD No. 18300  REPUBLIEC OF EALANI URAN PnOJiCr CREDIT AND PROJECr SUMARY Borrower: Republic of Malawi. Beneficiaries: The Malawi Housing Corporation and the New Building Society. huouat: A development credit of SDR 14.8 mill-ion (US$15.0 million equivalent). Texas: Standard. Project Objectives and Rationale The project will help reorient future housing development in Malawi toward a market-based system by: (a) the development of housing alternatives which are affordable and attractive for purchase on a full-cost recovery basis; (b) a substantial increase in the volume of mortgage financing and greater use of domestically-generated resources; (c) restructuring of the Malawi Housing Corporation to play a more active role in housing development; (d) strengthening of ancillary support activities, including land registration; and (e) helping the Government find long-term solutions to the pervasive system of housing subsidies. The project will support Malawi's structural adjustment program by strengthening resource mobilization and management in the public sector and improving cost recovery in the social sectors. Benefits and Risks The project will help the Government achieve its objectives in the housing sector of making affordable housing available to a wider range of income groups, increasing the role of the private sector in providing housing, and reducing the burden of housing programs on the Government. The economy will benefit from substantial reductions in the cost of housing as compared to current standards, greater reliance on domestic financing and roll-over of capital funds within the housing sector, and reduced import content of housing through changes in building standards. By providing a viable alternative to the present system of subsidized rental housing, the project will assist the Government in revising its compensation policies and housing programs to a more rational basis. Project risks concern the capability of the sector's institutions to deal with the proposed restructuring, and uncertainties in determining housing demand for an untested market. These risks are considered to be reasonable because of the considerable past experience of the various institutions, the flexibility incorporated into the project design, the commitment of the Government to long-term refornm of the housing sector, and the basis provided by the project for a continuing dialogue on issues affecting the housing sector.  - ii - On-Lending Terms for the Credit Proceeds (a) Funds for mortgage finance will be passed to the New Building Society in equal parts as a 25 year annuity with interest computed on the basis of the prevailing Government interest rate for loans to parastatals and other agencies (currently set at 10 percent), and as a Government subordinated loan on which no interest will accrue for the first ten years; and (b) Funds for land development in intermediate housing areas will be passed to the Malawi Housing Corporation as an equal combination of debt and equity investment, with interest on the loan portion computed on the basis of the Government rate for lending to parastatals. Funds for the pilot building materials loan program in -traditionalV housing areas will be on-lent to MHC for ten years at the Government rate. Funds for land development in traditional housing areas will be passed to MHC as a grant. The on-lending rate to the ultimate beneficiaries (intially 12 percent) is consistent with the prevailing structure of interest rates in Malawi and is expected to be positive in real terms over the project period (i.e., inflation is expected to average approximately 10 percent). The Government has committed itself to maintaining positive real interest rates as part of the structural adjustment program, and adjustments in the on-lending rates are expected to occur as macroeconomic conditions warrant. The foreign exchange risk for the Credit will be borne by the Government.  - iii - Bstinated Project Cost Local Foreign Total - US$ mi1lon1 Component Intermediate Housing Area Program 9.6 2.1 11.7 Traditional Housing Area Program 0.5 0.3 0.8 Institutional Support and Studies Program 0.5 0.9 1.4 Base Cost 10.6 3.3 13.9 Contingencies Physical 0.5 0.2 0.7 Price 3.0 0.6 3.6 TOTAL NKOJECT COST 14.1 4.1 18.2 (Including Insignificant Taxes and Duties) - =-- - Finaning Plan: Local Foreign Total ----US$ million- Source IDA 10.9 4.1 15.0 NBS a/ 1.3 -- 1.3 MHC 0.6 - 0.6 Private individuals (as mortgage downpayments) 0.8 - 0.8 Government of Malawi 0.5 - 0.5 TOTAL 14.1 4.1 18.2 Estimated Disbursements: IDA FY 1985 1986 1987 1988 1989 1990 1991 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 Intermediate Housing Area program). Staff Appraisal Report: No. 5200-MAI of , 1984. MaPs: ISRD Nos. 180U4, 18078, and 18300. 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.  I. SECTOnL CONTEXT A. Introduction 1.01 Malawi is a small country (118,500 sq. km., of which 24,200 sq. km. covers part of Lake Malawi) lying in southeastern Africa. With a current estimated population of over six million people and a GNP per capita of only US$210, Malawi is among the poorest countries in the world. Nevertheless, Malawi has achieved an impressive record of economic growth since independence, with real GDP increasing at an average rate of 5.5 percent per annum over 1969-79 and per capita income growing at about 3 percent per annum. Malawi's growth has been based on an outward-looking, export-oriented strategy emphasizing agriculture and agro-based manufacturing. Government policy has encouraged the establishment of a market-oriented economy with the private sector as the primary engine of growth. Moderate wage expansion, coupled with growing labor productivity in most sectors of the economy, has helped to keep Malawian goods competitive in international trade. 1.02 Notwithstanding these achievements, Malawi's economy, increasingly dependent on three primary export commodities (tobacco, tea and sugar), has been highly vulnerable to international price fluctuatlons. Especially since 1978, deterioration in Malawi's terms of trade and disruption to its vital transport links through Mozambique have caused serious balance of payments problems, which the Government, assisted by IMF standby arrangements in 1979 and late 1980 and an EFF in 1983, has been successfully addressing. The economic constraints brought on by Malawi's adjustment to its balance of payments problems, however, have revealed structural weaknesses in the economy which need to be addressed to restore medium-term growth. The Government, assisted by an IBRD loan of US$45 million in 1981 and an IDA credit of SDR51.9 million (US$55 million equivalent) in 1983, has begun implementing a comprehensive structural adjustment program aimed at achieving improvements in the balance of payments, price incentives and income policies, resource management in the public sector, and key institutions in the economy. 1.03 Within the urban areas, Government policies affecting the financial viability of various sectoral programs, particularly regarding cost recovery and the provision of subsidies, are a major concern of the structural adjustment program. Urban growth has been reasonably well managed in Malawi, and basic services have been provided to the majority of urban residents through the extension of nationwide programs in health, education, water supply and housing.j/ Nevertheless, the Government has , The urban population in 1983 comprised approximately 10 percent of halawils total population. Approximately two-thirds of the urban population is centered in Blantyre, the largest city (estimated population of 250,000), and Lilongwe, the new capital (estimated population of 130,000). Gross population densities are approximately 100 persons/ha in Blantyre and 50 persons/ha in Lilongwe, the latter of which is comparable to the highest rural densities in the Southern Region of Malawi.  found it increasingly difficult to maintain service levels because of the growing constraints on both recurrent and capital budgets. 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. B. Current Policies in the Housing Sector 1.04 Housing supply in urban areas has historically been dominated by the public sector. The Government has maintained a highly successful sites and services program (locally called Traditional Housing Areas-THA's), which has enabled lower income urban residents to obtain access to basic services and 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 both the public and private sectors. The major share of such housing is owned by the Government, either as institutional housing held by individual ministries in connection with specific Government activities or as general purpose pool housing held by Malawi Housing Corporation (MHC) and rented on a sub-economic basis to the Government or to employees of statutory bodies and private firms. These various programs provide housing for roughly two-thirds of all urban residents, with half of the total residents supplied by the THA program. The remaining urban housing stock is accounted for by self-help housing constructed in unplanned housing areas (such as Ndirande in Blantyre and Old Kwale in Lilongwe) and by formal sector housing developed by private individuals, the latter of which services less than 10 percent of total urban residents. 1.05 Between 1971 and 1981, MHC and the Capital City Development Corporation (CCDC) 2/ maintained average annual growth rates of 5 percent for permanent housing and 17 percent for the TRA program. This high volume of THA production provided for a major share of the increase in the urban population, which grew at an estimated annual rate of approximately 8 percent over the period. The more modest 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 rental housing were on the waiting list. Malawi's current budgetary constraints have since reduced the volume of both new permanent housing and THA construction to minimal levels, further aggravating the growing shortage of housing. Given that urban densities and the size of the urban population are relatively low in Malawi, the stagnation in housing development has not yet been reflected in undue growth of unplanned housing settlements. Nevertheless, it is estimated that Malawi will need 2/ CCDC was formed to manage the construction of the new capital city of Lilongwe. With the completion of construction on the capital, CCDC was recently dissolved, and the main part of its housing program has been taken over by MHC.  -3- to restore an average annual production of at least 4,500 housing units (including THA plots) to accommodate the expected increase in the urban population, even allowing for multiple occupancy of plots. 1.06 The primary reasons for the decline in housing production are the deteriorating financial health of institutions in the sector, particularly MHC, and the high unit cost of permanent housing constructed to standard designs. MHC is largely dependent for its revenues on rentals charged to the Government. Because of the Governmentts own budgetary problems, rental increases have been granted reluctantly and only after MNC's financial situation weakened to a precarious level. In addition, housing construction costs have increased rapidly, so that between 1973 and 1981, the cost of a house designed for a middle-level civil servant increased by 250 percent, while MHC's average rental charge for the same grade house increased by only 50 percent. As a result of the uneconomic rental structure and its deteriorating financial position, MHC has been unable to attract long-term loans from foreign and domestic sources, which financed the major share of MHC's housing development in earlier years. In addition, the foreign grant funds which had been used for THA development are becoming more difficult to obtain, in part because of the neglect of cost recovery pricing in THA's. 1.07 The fact that housing is generally considered to be a part of the overall compensation package makes resolution of the financial issues facing the housing sector more difficult. Rental charges paid by employees receiving housing 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 10-12.5 percent of their salaries (depending on whether the house is furnished), while rental charges for employees of statutory bodies may be as low as 5-7.5 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 understandably reluctant to increase MHC's rental charges. In addition, because housing standards are determined by a schedule of entitlements rather than on the basis of the rentals charged to employees, there is considerable resistance to any changes in housing standards designed to lower the unit cost of housing, these being 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 (for example, the real wage earnings of a civil servant at the undersecretary level declined by over 20 percent between 1977 and 1983), 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. Because of the decline in real earnings paid to civil servants, the Government has been unable to implement even modest proposals to increase the share of income taken as rental charges, the most recent of which would have increased rental charges from 10 to 12 percent of income in combination with an equivalent increase in wages which took place in 1983. 1.U8 In summary, it has become clear zhat the system of housing provision which served Malawi well in the period after independence can no  -4- longer be sustained in the current economic climate. MHC has ceased all new construction for the pool of general purpose subsidized rental housing. What little construction of staff housing remains (virtually all of which is connected with specific donor-financed projects in sectors suc. as agriculture, health and education) is unduly expensive and represents a substantial drain on the Government's development budget into investments with relatively low direct productivity. Furthermore, many civil servants have recognized the inequalities of the current system and the disadvantages, including the loss of opportunities to accumulate capital in the form of housing, a major source of asset creation in many countries. Therefore, it is generally accepted that initiation of a market-based system of housing supply is essential if Malawi is going to revive its stagnated housing sector. What has constrained further action until now has been uncertainty within the Government on how best to address the joint issues of housing supply and compensation policies. Nevertheless, it is essential for Malawi to begin to address its housing problems in a phased and reasonable manner, before the growing housing shortages and induced inequalities within the system of employer-provided housing constrain many of the currently available options. C. Restoring the Momentum of Hbousing Development 1.09 While housing development and wage policies are intimately linked in the current system in Malawi, to a large extent the actions necessary to address these issues can be treated separately. The constraints on the Government's recurrent and development budget effectively rule out any significant expansion of rental housing which is offered on a sub-economic basis, so that future housing development will have to be based on principles of full cost recovery and maximum use of private investment resources. These objectives can best be achieved within a market-oriented housing sector based on individual home ownership, rather than a public sector rental system. While the task of reorienting the institutions in the housing sector toward a market system is complex, it can be achieved using principles which are wellknown and established in other countries. 1.10 The development of a market-oriented housing sector must address a number of constraints which result from the pervasive system of housing subsidies. First, the institutions which are involved in residential land development and housing construction are oriented toward housing as a service function rather than as a commercial activity. Secondly, housing finance has been primarily based on the use of long-term public funds, often from foreign sources, rather than the mobilization and use of domestic resources. The third constraint on housing development is that the standards and design of housing which has been constructed by the public sector are generally inappropriate for market sale, as the high cost of materials and the excessive building specifications are unaffordable to the majority of Malawians. Finally, ancillary support activities, particularly the land registration system, are geared for a low volume of activity and will need to be strengthened in order to service the higher volume of transactions involved in a market-based housing system.  - 5 - 1.11 The Malawi Housing Corporation will play a key role in the restructuring of the housing sector, both because it is the only agency with a substantial stock of undeveloped land suitable for residential development and because it has available a cadre of professionals experierced in land and housing development. MHC's past performance has been satisfactory compared to most housing parastatal bodies in sub-Saharan Africa, but it has begun to lose its experienced staff due to the decline in its workload and its weak financial position. Moreover, the recurring budgetary problems faced by MHC have reduced its ability to generate internal working capital, and in the longer run, these constraints would jeopardize MHC's ability to attract commercial financing or to roll-over funds gained from the market sale of houses into a continuing program of land and housing development. Finally, MHC's organizational structure and accounting system, which are oriented toward the management of a large stock of rental housing, do not permit an adequate level of cost accounting to support commercially-oriented property development. Although NHC has the technical capacity to undertake a larger program of housing development, these institutional and financial issues will have to be addressed in order to build an adequate base for sustaining the program in the longer term. 1.12 Mobilization of additional domestic resources into the housing sector will also require strenthening of the role of local housing finance institutions. The New Building Society (NBS) is currently the only financial institution in Malawi which specializes in the provision of mortgage finance. NBS has played a limited role in promoting the housing sector, financing less than 10 percent of the total stock of permanent 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 into the housing sector is promising, as it is currently holding approximately 30 percent of its reserves in liquid form and the value of deposit accounts has been increasing at an average annual rate of over 20 percent. 1.13 Because the major share of formal sector housing has not been subject to market pressures, there has been little incentive to modify building standards to promote the development of low-cost housing. The building bylaws applicable in permanent housing areas are based on UK standards adopted by the colonial government, which are obsolete in many instances and have been generally superceded in more developed countries. In contrast, a wide variety of affordable housing types is available in THA areas, ranging from traditional sun-dried mud blocks to fully-finished permanent housing. A constraint on the development of permanent housing in THA areas has been that plots are allocated on an annual rental basis, so that housing built on these plots does not have adequate title security to qualify for mortgage financing. 1.14 A basic requirement for the development of a market-based housing supply system is an efficient system for transferring title to urban land, both to encourage individuals to make the large investment that housing construction requires and also to provide security for housing  -6- finance institutions to sustain mortgage lending. Because of the low volume of private housing sales in Malawi (the current system handles an average of only 30 private transfers of urban residential land per month), the land registration system has limited capacicy and caa result in delays of up to two years for completing the transfer of title. Malawi law allows land to be registered according to a more efficient "Torrens-type of system ,3/ but until now only Lilongwe has implemented this system, with the other urban areas remaining or. a cumbersome deed system. In addition, other requirements of the current registration system, particularly the strict requirements governing land survey, could become a bottleneck to any significant expansion of the volume of housing sales. 1.15 In summary, the establishment of a market-based system of housing supply will require the reorientation and/or strengthening of a number of different activities. However, the relevant agencies are already established in Malawi and have a substantial base of experience to draw on in expanding the sector. The principal requirement now is to demonstrate that attractive and affordable housing can be produced and sold on a financially viable basis. thereby providing the Government with a credible alternative for moving away from the system of public rental housing. D. A Phased Approach to Subsidized Housing 1.16 While the process of increasir.g the supply of owner-occupied lhousing in Malawi appears feasible, the widespread availability of subsidies on the existing stock of rental housing will continue to have a pervasive influence on the development of the sector. Nevertheless, the Life President of Malawi- has mandated tnat 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, at the latest by the year 2000. The development of a private housing market is considered to be the first priority by the Government in achieving this objective, but it is recognized that this action must be matched by a gradual restructuring of the compensation system to encourage private home ownership and reduce the dominance of non-wage benefits in the total compensation package. In order to carry out this process, it is necessary to have a clear understanding of the impact of the current subsidy system in order to identify the Government's options in approaching the renaining issues. 1.17 Because housing subsidies largely consist of services in-kind, there are several ways in which the subsidy burden can be measured. If only the direct casn 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 MF.C on debt service, maintenance, and administration), the subsidv burden appears to be on the 3! The Torrens system provides for the establishment of an efficient land registry involving a Government guarantee of the particulars of ownership. it also permits the separation of the records by geographic locality, simplifying the process of reviewing the s_atus of anv particular parcel.  - 7 - order of MK3-7 million (US$2-5 million) per year.4/ The main reason for the relatively modest size of this expenditure, which represents approximately 1-2 percent of the Government's annual recurrent budget, is that much of the housing stock has been fully amortized or financed on corcessional terms through donor projects in sectors such as agriculture and education. 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), it becomes clear that housing subsidies constitute a major component of the total implicit compensation package received by civil servants.5/ In 1982, the economic value of housing subsidies for civil servants occupying rental housing ranged from an average of 160 percent of salary payments for employees at the lowest salary grade for a particular level of housing entitlement, to 75 percent of salary payments for employees who had reached the highest salary grade for a particular entitlement. As a yardstick, it is estimated that if all civil servants were housed on the basis at which the entitlement regulations specify, the economic subsidy value would exceed MK66 million (US$50 million) per year.61 This ten-fold difference between the economic value of housing subsidies and the direct cash requirements for maintaining the subsidios demonstrates that issues of employer-provided housing should be approached primarily from the standpoint of compensation policies, rather than as a problem affecting the housing sector alone. 1.18 Given the relatively modest direct cost to the Government of maintaining the current level of housing subsidies, the Government is reluctant to enact major changes in rental policies for the existing housing stock which would depress total compensation levels further. Nevertheless, a number of other actions are available to the Government to limit the growth of housing subsidies and eventually to reduce housing subsidies on the existing stock. The first requirement is to establish private home ownership as a feasible and desirable alternative for a widening income range of Malawians. Given the wide disparity between the 4/ Except for housing held by MHC, expenditures on staff housing are not broken-out in ministerial budgets. The range of estimates presented here represents alternative assumptions on debt-service and maintenance expenditures, the latter of which appears to be generally underfunded by most ministries. 5/ The principal adjustments necessary to derive the economic value of housing subsidies are: (i) housing is valued at its replacement cost rather than at historic cost; and (ii) the annual stream of rental benefits is derived by applying the current opportunity cost of capital, which in this case is taken to be the current mortgage terms for owner-occupied housing. 6, The actual economic subsidy value is lower than this amount because of the large number of civil servants, predominately at the lower end of the housing entitlement range, who do not occupy subsidi=ed housing. For these employees, no allowance is provided to compensate them for their loss of benefits, save that the 10 percent rental payments are not deducted from their salaries.  - 8 - housing standards affordable under an individual home ownership program and the standards available in subsidized housing, many potential participants in a home ownership program will choose to remain in subsidized housing if it is available. This means that the initial demand for housing oriented to individual ownership will consist mainly of individuals from either the public or private sectors who are not currently provided with subsidized rental housing, or those who wish to purchase housing as a method of accumulating capital assets, particularly to ease the economic transition of retirement. In the longer run and as the economic situation improves, the Government can introduce additional measures to encourage private home ownership, through such means as providing housing allowances or selective wage increases to individuals who do not occupy subsidized rental housing, by making lump-sum pension benefits available for use as housing down-payments,7/ and increasing rental charges and wages on an across-the-board basis. The timing of these measures must be weighed against their possible impact on the Government's recurrent budget, but a gradual policy of introducing additional incentives to encourage individual home ownership can have a substantial effect over time in lessening the dominance of public rental housing in the sector. 1.19 The second area in which the Government can control the growth in housing subsidies is by introducing various measures to improve the cost control and management of the stock of Government housing. The inmmediate concern is with the high cost of housing provided in connection with essential development projects, such as in agriculture, health and education. Malawi has been successful in decentralizing many Government services to reach the rural population, and an important factor in achieving this objective has been the willingness of the Government and many donors to finance staff housing. Nevertheless, staff housing has become an excessive drain on scarce development resources, as building costs have increased rapidly and housing standards have gradually crept upwards as a way of attracting essential staff. Clear administrative guidelines on housing entitlements and standards can help to control this cost escalation. Other measures which can be introduced in the longer run include a maintenance-sharing agreement with tenants and tighter control of the reallocation of staff housing to priority uses of the Governme_t. 1.20 The third area in which the Government must evaluate its policy options is in regard to the equity and incentive objectives of the compensation system and the manner in which reducing subsidies on the existing stock of rental housing will promote or detract from these objectives. The Government is operating under the principle that, as it phases out the program of subsidized housing, it will compensate employees for the subsidy that they would have received under the old system. however, because economic housing subsidies exceed in many instances the value of monetary wages, a simple substitution of housing subsidies for an 7/ As with most Governments, Malawi has a large unfunded pension liability which could be partially discharged through housing benefit options. The Government experimented briefly in 1981 with allowing civil servants to claim pension benefits in advance in cash, but the scheme closed quickly because of the excessive drain on the Treasury.  equivalent amount of wages is neither necessarily equitable, nor, given the constraints on the Government's recurrent budget, is it likely to be feasible. On the other hand, the Government does have the option of disposing of the existing housing stock to sitting tenants at a substantially reduced price, a policy that is equivalent to using equity in existing housing as compensation for the value of foregone rental subsidies. Although divestiture of the housing stock in this manner would allow the Government to compensate existing tenants at minimum cost to its recurrent budget, it would lock-in the equity differentials between employees who occupy subsidized housing and those who do not, and it would do relatively little to promote the long-term incentive goals of the compensation system. Clearly, there is a middle policy ground which combines selective wage changes, gradual increases in rental charges, and possible divestiture of parts of the Government's existing housing stock to arrive at a compensation system that combines the Government's equity and incentive objectives with provision for private home ownership. When the magnitude of the task remaining is fully considered, it is clear that the period specified by the Life President for completing the transition to individual home ownership is little enough time to complete the process fairly. 1.21 In summary, the task of rationalizing the existing system of subsidized rental housing in response to a move toward private liome ownership must be gradual and complex. Abrupt changes and/or poorly conceived policies could have substantial detrimental impacts on morale within the civil service and equity or budgetary concerns. The longer-term measures mentioned above should only be viewed as options within a continuing process of change, the timing and implementation of which needs to be constantly reviewed and amended. Nevertheless, a program of positive actions to initiate the process of moving to a financially viable housing sector, combined with forward discussion and studies of housing and compensation policies, will provide Malawi with a sound basis for meeting the housing needs of its citizens at a reasonable cost and without undue disruption to other sectors of the economy. E. Background and Strategy for the Association's Involvement 1.22 The Association has given priority to the housing sector in its first urban operation in Malawi because of the acute need to reorient policies and practices toward the provision of affordable and financially viable housing alternatives. The initial interest in this sector was established during the discussions for the first structural adjustment operation in 1981, when it was determined that Government rental policies for subsidized housing were a contributing factor to the financial problems of MHC and CCDC. The agreements entered into under SAL I required the Government to prepare a program by October 31, 1981, for the introduction of economic rentals on Government housing, a condition which later proved to be infeasible because it did not consider the larger context of housing subsidies in Malawi. At the same time that discussions on housing subsidies were being conducted under SAL I, the various sectoral divisions of the Association were becoming increasingly concerned about the large proportion of project costs going into the construction of staff housing in new projects. An extensive review of Malawi's National Rural Development  - 10 - Program in 1981 examined the possibilities for lowering the cost of staff housing provided through agricultural projects and concluded that only marginal savings would be possible as long as Government policy on housing entitlements remained unchanged. As a result of both the SAL and sectoral concerns about housing subsidies, the Association and the Government agreed to carry out a full review of Malawi's housing policies in February 1982. The results of this study provided the basis for the identification and preparation of the Urban Project. At the same time, the Government committed itself under SAL II, which was approved by the Bank's Board of Executive Directors on December 20, 1983, to agree on a phased program to address housing subsidies within the context of the Urban Project. 1.23 The Association's strategy in assisting the Government address the issues in the housing sector includes several complementary activities, which are supported by the Bank Group's lendiug and economic and sector work program. As stated earlier, the Government has already stopped the provision of new rental housing, with the exception of a limited number of staff houses provided in connection with specific development objectives. Therefore, the first part of the Associations's strategy, which will be supported by the Urban Project, is to assist in the establishment of a housing market based on cost recovery principles and the mobilization of domestic resources into the sector. The second part of the strategy consists of an ongoing review of staff housing costs included in projects supported by the Association and other dodors. The Government has been asked to confirm cost reductions of about 30 percent identified for an agricultural project which was recently appraised, as well as complete a longer-term study on the wider application in other sectors of the housing cost reductions identified for the agricultural project. Finally, the overall issues of housing subsidies and entitlements and their relation to the compensation system in Malawi are being addressed through a combination of project initiatives and sector work. The discussions held during the preparation of the Urban Project succeeded in defining the basic parameters and options faced by the Government in agreeing on a policy to reduce housing subsidies on the existing housing stock. These sectoral discussions form the basis for terms of reference for the Housing Subsidies and Wage Policy Study (para. 2.12) to be financed under the Urban Project, which will provide the Government with more detailed information on the cost and incidence of housing subsidies. Supervision of the Urban Project will provide a basis for maintaining these discussions as an input to the Government's structural adjustment program. 1.24 In the urban areas in general, the Bank Group has provided assistance for water supply, health, education and industrial development through projects in these sectors. The Blantyre Water Supply Project (Cr. 711-MAI) is augmenting water supply to Malawi's largest city, and the Lilongwe Water Supply Engineering Credit (Cr. 1272-MAI) is helping to identify and prepare water supply and sanitation investments in Lilongwe, with technical assistance being provided for testing and establishing low-cost sanitation programs, especially for urban dwellers. A Health Project (Cr. 1351-MAI) aims to improve the health care delivery system in Lilongwe and Blantyre, as well as a number of semi-urban and rural areas. Much of the Association's considerable lending for education has gone to construction and quality improvements of educational establishments in the  - Ii - main urban centers. With the addition of the housing sector through the Urban Project, it is judged that the Association's total program in urban areas is well-balanced and appropriate to the size of Malawi's urban sector. II. THE PROJECT A. Project Objectives and Rationale 2.U1 The primary objectives of the project are: (a) Development of Market-Based Housing Alternatives-The project is designed to introduce a wide range of housing options which are attractive and affordable for purchase on a financially viable basis. Toward this end, the project will introduce various cost saving options (such as increased use of local materials and promotion of self-managed housing construction) and assist in relaxing legal and bureaucratic constraints on housing (building standards requirements, restrictive conditions on access to credit, etc.) in order to allow a private housing market to develop in Malawi; (b) Establishment of a Financially Viable Basis for Program Replicability--The project will assist in establishing a housing program which is replicable based on the use of domestic resources and institutions, first by involving the New Building Society directly in the financing of housing which is affordable for purchase by Malawians, secondly by strengthening the institutional capacity of the Malawi Housing Corporation and establishing an adequate capital structure for MHC to sustain a continuing program of land and housing development after the completion of the project, and thirdly by introducing full cost recovery pricing of housing as the basis for continuing mobilization of funds; (c) Strengthening of Ancillary Functions in the Housing Market-The project will introduce various technical innovations and, where appropriate, provide financial support to improve the capacity and performance of housing-related services, such as land registration and title transfer procedures; and (d) Assisting the Government to Address the Remaining Issues of Housing Subsidies within a Phased Program-- The Housing Subsidies and Wage Policy Study is the next step in working toward a resolution on issues concerning the existing stock of employer-provided housing. 2.02 The rationale for IDA involvement in the project is: (i) the project supports the objectives of Malawi's structural adjustment program  - 12 - to improve resource mobilization and the management of public sector agencies and to reduce the burden of subsidies in the social sectors; and (ii) the Bank Group's substantial experience with low-cest housing projects in Africa gives it a comparative advantage in working with the Government to develop realistic policies for the housing sector. B. Project Components 2.03 The project consists of the following three programs: (a) Intermediate Housing Area Program (IHA)-The project will introduce a new standard of housing development in Malawi which is intermediate between the exist'ng high standard permanent housing and the low standard THA development. MHC will develop about 2,230 IHA plots under the project, with mortgage financing provided through NBS for the development of approximately 2,000 low-cost houses on these plots based on prototype designs developed by MHC. All land and housing development in IHA areas will be offered to purchasers on a full cost recovery basis at prevailing market interest rates; (b) Traditional Housing Area Program (THA)-The project will provide approximately 500 ThA plots in conjunction with the mixed development of IHA and TRA areas. Plots designated as THA will be allocated according to prevailing terms and conditions under the THA program. In addition, MHC will introduce principles of cost recovery pricing in THA areas through a building materials loan program designed to assist approximately 1,000 THA plotholders meet the cost of building materials, particularly for roofing sheets and poles; and (c) Institutional Support and Studies Program-The continuing development of the housing sector will be supported by several activities designed to strengthen key institutions and/or extend policy discussions already initiated during the preparation of the project. These activities and their responsible agencies include: (i) Housing Subsidies and Wage Policy Study, under the direction of the Ministry of Finance and the Office of the President and Cabinet (OPC); (ii) Small Contractors Training Program, to be carried out through the Office of Housing within OPC and the MOWS training branch in Lilongwe; (iii) Land Adjudication and Registration Program, executed by the Department of Lands and Valuation, (DLV) within OPC; (iv) Building By-laws Study, under the direction of the Office of Housing; and  - 13 - (v) Institutional Support Program, to provide technical assistance and equipment to the Office of Housing and MRC in support of project activities. 2.04 Allocation of the Credit Proceeds. Based on the initial pipeline of identif.ed projects, it is expected that the proceeds of the IDA credit (US$15.0 million equivalent) will be distributed among the various programs as follows: (a) US$12.7 million equivalent (84 percent of total credit proceeds) will be allocated to the IHA program, of which USS2.4 million will be on-lent to MHC for land development. The remaining US$10.3 million will be on-lent to NBS, which will contribute an additional US$4.4 million equivalent from its own resources to be placed as long-term mortgage financing for IHA housing development. (b) US$1.0 million equivalent (7 percent of total credit proceeds) will be allocated for THA development, of which US$0.5 million will be used for THA land development, and US$0.5 million will be used for the building materials loan program. Cc) The remaining US$1.3 million equivalent (9 percent of total credit proceeds) will be shared among the various agencies involved in the institutional support and studies program. C. Detailed Project Description 2.05 The physical components of the project are designed to establish a wide range of housing options which are affordable and bridge the gap between the current THA program and the very high standard of permanent housing which is provided to formal sector employees. Because demand has not been previously tested in many segments of this market, the project has been kept flexible to respond to changes in observed demand as implementation progresses. In addition, the project introduces a number of innovative features which could over-tax the implementing agencies if introduced too quickly. Therefore, the implementation schedule provides for a phasing-in of various features, so that the agencies will be able to introduce their staff gradually to new procedures. IHA Development Program 2.06 Land Development. During project preparation, MHC and CCDC identified a forward investment program which provided for the development of 6,720 plots in four towns over the project period. After a careful review of all the sites, it was agreed that an indicative investment plan of 2,730 plots (of which 82 percent would be IHA plots) constructed over three years in two cities (Lilongwe and Blantyre) would be a more realistic target for the first project. In order to allow MHC flexibility in revising its investment program as experience is gained with the IHA program, as well as ensuring that MHC's total investment program remains within its implementation capacity, assurances were obtained at negotiations that:  - 14 - (a) MHC will prepare a forward work plan by September 30 indicating their planned investment program for the coming fiscal year and the estimated dates of construction, anticipated cash flow and administrative requirements, for review and comment by the Association; and (b) before agreeing to undertake any additional investment project with an estimated cost in excess of US$250,000 (including projects financed from internal funds), MHC will furnish a descr'ption and an analys's of the financial viability of the proposed involvement to the Association, along with a statement of the probable impact of the proposal on the implementation of the IDA-financed project, for review and comment. 2.07 Standards of plot servicing under the IRA program will vary according to zoning requirements and consumer demand. A large portion of the IHA program will be developed in areas zoned as TRA, where plots will be provided with an on-plot water connection and an improved pit latrine.8/ In addition, some IHA plots will be developed within areas zoned by the local authorities for permanent housing construction, where provision will be made for water supply within the house, piped or septic tank sewage disposal, and an optional electricity connection. 2.08 Housing Construction. During project preparation, both MHC and CCDC built several model houses suitable for construction under the IHA program and ranging in size from a simple core housing unit (36m2) intended for construction on TEA plots to a full three-bedroom house (73m2) intended for construction in permanent housing areas. A number of technical modifications to local bylaws requirements have been agreed with the local authorities and NBS in order to reduce the cost of housing construction (e.g., thinner wall specifications, agreement for brick and stone foundations, etc.). In order to start the IRA program as quickly as possible, MNC will employ contractors to construct completed housing units on two sites to be developed during the first year of project implementation. Thereafter, MNC will reserve a portion of project sites for construction of housing by individuals (self-managed construction) or by private developers contracting for groups of individuals (such as employees of a single firm). MHC will be responsible for building inspections to ensure that houses are constructed to agreed standards and to facilitate the release of stage payments by NBS. An initial mix of housing types and cost targets for housing to be constructed under the project was agreed at appraisal and will be reviewed annually during the annual review of MHC's work program, to ensure that the project addresses a broad range of income groups. It was confirmed at negotiations that for all project sites (except for the Kanjedza site in Blantyre, Area 49/5/1 in Lilongwe, and all sites designated as specifically THA), MHC will reserve a minimum of 30 percent of the plots for construction of houses by 8/ THA areas are exempt from all building bylaws except for certain provisions of the Public Health Act pertaining to plot layout and coverage.  - 15 - individuals and/or private developers, as opposed to construction by HEC contractors. 2.09 Beneficiary Selection Criteria. WC will pre-screen applicants for IHA plots to ensure that a one-household one-plot policy is maintained under the program. For applicants accepted by MHC for the IHA program, NBS will apply standard eligibility criteria for mortgage lending; i.e., applicants to provide evidence of satisfactory earnings, and monthly mortgage payments not to ecceed 25 percent of monthly income. NBS will loan up to 75 percent of the assessed valuation of the house and land to qualified applicants. For Malawian citizens purchasing housing for owner-occupation, the Government will provide a guarantee for an additional 20 percent of the assessed valuation of the house and land, allowing NBS to increase its mortgage financing percentage to 95 percent. This guarantee arrangement has been operating satisfactorily for a number of years in Malawi and has never had to be called, although the Government may decide to levy a small placement charge under the IHA program in order to establish a guarantee fund in case of default. Mortgage payments in almost all cases will be deducted directly from salary payments by employers and remitted to NBS, which is a common practice for contractual obligations in Malawi. Agreement was reached during appraisal with the Accountant General that a circular will be prepared authorizing individual ministries to deduct NBS mortgage payments for civil servants. It was confirmed at negotiations that DLV, which controls the registration and leasehold terms for transfers of land in Malawi, will allow all plots demarcated under the IHA program to be transferred on the basis of a minimum leasehold period of 66 years, in order to provide adequate title security to support mortgage lending. NBS has also proposed some minor amendments to the Building Societies Act in order to reduce initial delays in the title transfer process and to simplify foreclosure procedures in the event of non-payment. These amendments are currently being reviewed by the Solicitor General. THA Development Program 2.10 Applicants who do not qualify for the IHA program will be allowed to apply for THA plots according to standard procedures. Most of the THA plots will be developed in conjunction with IHA plots in a mixed housing plan. A typical example of this type of development reserves all plots along the major access roads for sale as IHA plots, while THA plots are located on minor access roads and served by water kiosks only. An advantage of this type of development is that it allows for a certain degree ot cross-subsidization between IHA and THA plots, thereby improving overall cost recovery. 2.11 The building materials loan program to be introduced by the project will help MNC introduce the principles of cost recovery into THA areas. In the past, only the recurrent costs of MHC's administration of THA's have been recovered. Capital costs have typically been financed by foreign grant funds or concessional financing (particularly by the UK Overseas Development Agency (ODA) and the Federal Republic of Germany). The Government is aware of the need to introduce a greater degree of cost recovery pricing in THA areas in order to justify using loan funds to sustain the TRA program, and other donors have supported this view.  - 16 - Nevertheless, the Government feels that (i) substantial progress should be made in addressing the question of subsidies on higher income housing before full cost recovery is extended to THA areas, and (ii) provision should be made for sharing capital costs between MHC, which develops the sites, and the local authorities, which will eventually assume responsibility for administering the THA areas. Until these concerns are resolved, both the Government and I"EIC place high priority on initiating a small loans program in THA's to assist plotholders acquire the building materials (particularly iron roofing sheets and wooden roofing poles) necessary to complete self-help construction. This will help fill a gap in the housing supply system between the proposed IHA program and the existing program of THA plots. This loan program will be implemented by MHC on a pilot basis starting in the second year of the project, with a mandate to identify overhead costs and cost recovery performance for any future expansion of the program. As MHC will recover the loans from the beneficiaries over a period of five years, while the loan from the Ministry of Finance will be amortized over a period of ten years (para. 3.03), MHC will be able to carry out a second round of the loan program on a revolving fund basis using the repayments from the original loans. Institutional Support and Studies Program 2.12 Housing Subsidies and Wage Policy Study. This study will examine in detail the various policy options available to the Government for reducing housing subsidies, with particulat emphasis on quantifying the impact of the various options on overall compensation levels and the Government's budgetary requirements. The study will include a consideration of Government policies toward the existing housing stock, including the possibility for divestiture of part of the stock not required for specifically defined purposes, and also an examination of options for introducing cost recovery pricing for THA development. During negotiations, the Government confirmed its agreement with the terms of reterence for the study which had been prepared by the Association (Annex 3), and further confirmation was obtained that the Government will complete the study by March 31, 1986, and thereafter will submit to the Association by October 31, i986, an agreed action prograii and timetable with respect to the recommendations of the study. 2.13 Small Contractors Training Program. With the development of a more consumer-oriented housing market, independent local building contractors can be expected to take over an increasing share of residential building activity due to their cost advantage in responding to small contracts. Technical assistance and equipment will be provided through the project to the Office of Housing for the establishment of a training program specifically oriented at residential building construction, to be implemented through the MOWS training branch in Lilongwe. In addition, outreach support will be provided through the Office of Housing and MOWS for such activities as simplification of contract documents, assistance in the certification of local contractors, and negotiations for working capitai credit facilities from local financial institutions. 2.i4 Land Registration and Adjudication Program. The project will provide technical assistance and equipment (including the construction of a  - 17 - strong room in the Blantyre land registry office) for a four-year program of land demarcation, land survey, and claims adjudication to extend the land registration system currently used in Lilongwe to the city of Blantyre, including (but not limited to) the areas to be developed as part of the Urban Project. 2.15 Building By-Laws Study. As part of the Kenya Second Urban Project (Ln. 1550-KE/Cr. 791-KE), the Government of Kenya undertook a major study of revisions to local authority building by-laws to promote the development of low-cost housing. Technical assistance will be provided under this proiect to review the recommendations of the Kenya study for possible adoption in Malawi and to develop appropriate legislation in the area of building bylaws. In addition, close coordination will be maintained between the Urban Project and the low-cost sanitation study being financed under the Lilongwe Water Supply Engineering Credit to promote the adoption of low-cost sanitation options, ranging from improved pit latrines to low-volume flush toilets, in future housing projects in Malawi (para. 1.24). 2.16 Institutional Support. Technical assistance training and equipment will be provided to the Office of Housing in order to improve project monitoring and housing policy formulation activities, including a pilot survey of housing conditions in Malawi to be carried out by the National Statistical Office, and equipment and training to improve the mangement capability of the Office of Housing over the stock of Government-owned houses. MHC will be provided with a limited amount of technical assistance and equipment, as required, to extend its accounting system in such areas as job-costing and to improve its technical capacity to implement low-cost housing projects. III. COST ESTIMATES AND PROJECT INPLBMENTU TION A. Project Costs 3.01 Total project costs are estimated at MX24.3 million (US$18.2 million), with a foreign exchange component of US$4.1 million, representing 22 percent of total project costs (see Table 3.1, Project Cost Summary; detailed cost estimates are provided in Annex 1, Table 1). Taxes are estimated to be MKO.7 million (US$0.5 million) or approximately 3 percent of project costs. Base costs are in June 1984 prices. Estimated costs of civil works are based on final engineering designs for sites included in the first year of the implementation schedule and estimated unit costs for subsequent sites. Preliminary site investigations and layouts have been completed for all sites included in the project. Unit costs for house construction are based on detailed designs for all units and actual costs for construction of prototype units. Costs for consultancy services for the training program for small- and medium-scale contractors are based on an earlier pilot program undertaken in the Ministry of Labor. Costs for the land adjudication and registration program are based on DLV's experience with a similar program in Lilongwe. Physical contingencies, amounting to 4 percent of total base costs, are estimated at the rate of 10  Table 3.1: PRCU1l CCOT SUMMARY Fercent Fercert Percent MK'000 US$'000 Foreign Base Total Coponent lcal Foreign Total Local Foreign Total Exrhange Cost Cost IHA CUNmcrlN PROGRAM (a) Campensation 165 0 165 124 0 124 0 1 1 (b) Site Davelopmert 2,349 464 2,813 1,762 348 2,110 16 15 11 (c) Hbuse Construction 10,311 2,315 12,626 7,733 1,736 9,469 18 68 52 9ub-total 12,85 ,77 1-0 9,69 2,084 70 (a) Cmpemsation 31 0 31 23 0 23 0 - - (b) Slte De4elopnent 450 89 539 337 67 404 17 3 2 (c) BzLldiig bUtedal Loans 192 356 548 144 267 411 65 3 2 94b,total 67T 275 1,118 SW4 334 8 40 6W IN'1TIUfONAL SUW AND SDIES (a) Homirg S&bsidies & W3ge Eblicy Study 127 285 412 95 214 309 70 2 2 (b) 9nall Cbntractor Tlirirg Program 59 286 345 44 215 259 83 2 1 (c) Land AdjLdication and Registation 314 299 613 236 224 460 49 3 3 (d) Mdldi g Bylaws Study 0 122 122 0 92 92 100 1 - (e) Institutiorel upport - OPC 65 132 197 49 99 148 67 1 1