Malawi - Technical Assistance and Structural Adjustment Loan Projects

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 6833 PROGRAM PERFORMANCE AUDIT REPORT MALAWI STRUCTURAL ADJUSTMENT I (LOAN 2026-MAI) STRUCTURAL ADJUSTMENT II (CREDIT 1427-MAI) AND TECHNICAL ASSISTANCE I (LOAN 2027-MAI) June 12, 1987 Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in the performance of their offical duties. Its contents may not otherwise be disclosed without World Bank authorization. ABBREVIATIONS ADMARC Agricultural Development and Marketing Corporation CCDC Capital City Development Corporation DSB Department of Statutory Bodies EPD Economic Planning Division ESCOM Electricity Supply Commission ICC Investment Coordinating Committee INDEBANK Industrial Development Bank MDC Malawi Development Corporation MHC Malawi Housing Corporation NRDP National Rural Development Program OPC Office of the President and Cabinet PCL Press Corporation Ltd PCR Project Completion Report PGL Press Group Ltd Press Holdings Press Holdings Company SEDOM Small Enterprise Development of Malawi GOVERNMENT OF MALAWI FISCAL YEAR April 1 to March 31 CURRENCY EQUIVALENTS (Annual Averages) Kwacha US$ per per US$1 Kwacha 1 1980 0.i121 - 1.2313 1981 0.8953 - 1.1169 1982 1.0545 - 0.9483 1983 1.1748 - 0.8512 1984 1.4230 - 0.7027 FOR OFFICIAL USE ONLY THE WORLD BANK Wastington, D.C. 20433 U.S.A. Offace aM Det0ternwral Operatiois fvalwatn June 12, 1987 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND 'IE PRESIDENT SUBJECT: Program Performance Audit Report - First/Second Structural Adjustment Loan/Credit (Loan 2026-MAX/Credit 1427-MAI) and First Technical Assistance Loan (Loan 2027-MAI) Attached, for information, is a copy of a report entitled "Program Performance Audit Report on Malavi - Structural Adjustment I (Loan 2026-hAI); Structural Adjustment II (Credit 1427-MAI); and Technical Assistance I (Loan 2027-MAI)" prepared by the Operations Evaluation Department. Attachment 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. PROGRAM PERFORMANCE AUDIT REPORT MALAWI STRUCTURAL ADJUSTMENT I (LOAN 2026-MAI) STRUCTURAL ADJUSTMENT II (CREDIT 1427-MAI) AND TECHNICAL ASSISTANCE I (LOAN 2027-MAI) TABLE OF CONTENTS Page No. Preface ************************************************* I Basic Data Sheets ...............o................................. ii Evaluation Summary .................................................. v PROGRAM PERFORMANCE AUDIT MEMORANDUM I* BACKGROUND ................................................. 1 II. DESIGN OF THE ACTION PROGRAMS ................................ 2 Strategies and Policy Instruments 2........................... 2 Improving the Balance of Payments .......................... 3 Price Incentives and Incomes o...ooo oo.eee.o ....o 3 Resource Management **********o********o********* oo**o***** 3 Institutional Improvements .........................3........ 3 Technical Assistance .o..................ooo .........** 4 Related Economic and Sector Work .......*..................... 4 Coordination and Complementarity with IMP Programs ............ 4 Complementarity with the Leading Program ...................... 5 Trenching o****************************e*e***********e***** 5 Procurement, Counterpart Funds and Disbursements .............. 6 SALs I and II .............................*...* ....... 6 Technical Assistance **************************************** 6 III. IMPLEME'iTATION OF ACTION PROGRAMS ............................. 6 Improvement In the Balance of Payments ........................ 7 Smallholder Agriculture ...... ..... ... .............. 7 Estate Production and Diversification ....................... 9 Other Agriculture Sector Measures ........................... 9 Energy: Conservation and Efficiency of Use .................. 11 Price Incentives and Incomes Policy ........................... 12 Resource fanagement *********o****************************. 12 Department of Statutory Bodies ***...........**.*****.**** 12 Public Expenditures and Revenue Enhancement .*0*.. ***...... 13 Exchange and Interest Rates ********* **** ....... 14 The Finances of Statutory Bodies and Press Holdings, Ltd .... 14 Monitoring and Management of Public Debt .................... 15 TABLE OF CONTENTS (continued) Page No. Institutional Improveuents .................................... 15 Monitoring of Investments .................,... 15 Economic Planning .................................. 15 The Reform of PHL ...................... .............. 16 Parastatal Reform: MDC and ADMARC ......................... 17 Technical Assistance ....................................... 21 IV. ISSUES ........................................................ 22 The Timing of SAL I ...... ................................... 22 Political Commitment ....................................... 24 The Scope of the SALs ........................................ 24 V. THE ECONOMIC AND SOCIAL IMPACT ............................. 26 The Impact on Economic Development ......................... 26 On Overall Gro-th ........................... 27 On the Balance of Payments .................................. 27 On the Budget and Public Investment ......................... 29 On Institutions ........................................... 30 Social Consequences .......................................... 31 VI. NAIN CONCLUSIONS AND LESSONS OF EXPERIENCE .................... 33 The Evolutionary Nature of the SAL Series ..................... 33 The Main Achievements and Failures ............................ 33 The Performance of the Borrower .............................. 35 The Contribution of the Bank ............................... 35 Sustainability ............................................. 36 Lessons of Experience ................................. 37 PROGRAM COMPLETION REPORT SUMMARY .......................e....................... 40 A. Background to the Structural Adjustment Operations ......... 40 B. The Structural Adjustment Operations ....................... 41 C. Implementation and Impact .................................. 42 D. Lessons Learned .................................. 47 E. Bank Performance ....................................... 48 l. BACKGROUND ............................................... 50 A. Onset of the Economic Crisis .............. ............ 50 B. Emerging Structural Problems and the Need for Structural Adjustment ................................ 51 TABLE OF CONTENTS (continued) Page No. II. THE STRUCTURAL ADJUSTMENT OPERATIONS ................... 55 A. The First Structural Adjustment Operation ................. 55 B. Implementation under the First Structural Adjustment Operation: Compliance with Conditionality ................ 59 C. The Second Structural Adjustment Operation ................. 62 D. Implementation under the Second Structural Adjustment Operation: Compliance with Conditionality ................ 66 E. Implementation of the Technical Assistance Project ......... 68 F. Disbursement, Procurement and Use of Counterpart Funds ..................................... ..... 69 III. IMPACT OF THE STRUCTURAL ADJUSTMENT PROGRAMS .................. 71 Expansion of the Economic Base ................................ 71 Resource Management ........................... ........... 74 Institutional Improvements . .. ................... 76 Issues to be Further Developed ................................ 77 IV. BANK ROLE AND PERFORMANCE ..................................... 78 Identification of Development Constraints ................. 78 Monitoring of Policy Reforms .................................. 79 Monitoring of Studies ....................................... 79 Design of the Lending Program ................................. 79 Coordination with the IMF ..................................... 80 V. LESSONS LEARNED ................................... 81 Lessons Related to the Adjustment Process ..................... 81 Program Related Lessons ....................................... 82 Expenditure Planning and Resource Mobilization ................ 83 Industrial Sector Development and Policy Environment .......... 84 ANNEXES Annex I - Letter of Development Policy: SAL I .................. 85 Annex II - Letter of Development Policy: SAL II ................. 90 PROGRAM PERFORMANCE AUDIT REPORT MALAWI STRUCTURAL ADJUSTMENT I (LOAN 2026-MAI) STRUCTURAL ADJUSTMENT II (CREDIT 1427-MAI) AND TECHNICAL ASSISTANCE I (LOAN 2027-MAI) PREFACE This is a performance audit of the Bank's first and second stru- tural adjustment lending operations (SALS) in Malawi and of the first Tech- nical Assistance Loan which accompanied and complemented this lending. The first SAL (Loan 2026-MAI) for US$45 million was approved in June 1981, became effective in August of that year and was fully disbursed in August of the following year. The second (Credit 1427-MAI) for US$55 million was approved in December 1983, became effective the following month and was fully disburs- ed in December 1984. The first Technical Assistance Loan (Loan 2027-MAI) for US$1 million was approved in June 1981, became effective in August 1981 and was fully disbursed in May 1985. The two structural adjustment operations were followed by a third, and a fourth is in the leading pipeline. A second technical assistance operation was also subsequently approved and is being implemented. The Program Performance Audit Report (PPAR) consists of the Program Performance Memorandum (PPAM) prepared by the Operations Evaluation Depart- ment (OED) and a Program Completion Report (PCR) prepared by the Eastern and Southern Africa Regional ffice of the Bank. The PPAM is based on the attached PCR, and on a review of the President's Reports, the Loan Agree- ments, the summaz tes of Board discussions, economic reports, special studies, related documents in the Bank's files, discussions with Bank staff associated with the lending and information supplied by the Borrower. An OED mission visited Malawi in October 1986 to review the structural adjustment and the technical assistance operations with Government officials and discussed with them the effectiveness of the Bank's assistance. Their kind cooperation and assistance is gratefully acknowledged. The PCR very ably discusses the emergerce of the structural prob- lems, the implementation of the various components of the structural adjust- ment programs and of the technical assistance, the results achieved and the administration and use of the loans and credit. The PPAM elaborates on the concept and design of the SALs, assesses the experience gained from the implementation of the v&rious action programs, comments on the several issues which emerge, reflects on the economic, sector and social impact and the sustainability of the adjustment process and draws some lessons from the experience. The report was sent to the Borrower in draft form for review and reaction; however, no comments were received. - 111 - PROGRAM PERFORMANCE AUDIT REPORT MALAWI STRUCTURAL ADJUSTMENT I (LOAN 2026-MAI) STRUCTURAL ADJUSTMENT II (CREDIT 1427-MAI) AND TECHNICAL ASSISTANCE I (LOAN 2027-MAI) BASIC DATA SHEET Original Disbursed Cancelled Repaid Outstanding ----------------------US$ Milion------------- Loan 2026-MAI 45.0 45.0 - - - Credit 1427-MAI 55.0 55.0 - - - Loan 2027-MAI 1.0 .989 .011 - - SAL I SAL II TA I Initiating Memorandum 08/15/80 04/23/83 08/15/80 End Negotiations 05/15/81 11/18/83 05/15/81 Letter of Development Policy 05/22/81 11/25/83 05/22/81 Board Approval 06/25/81 12/20/83 06/25/81 Loan/Credit Agreement 07/02/81 01/06/84 07/02/81 Effectiveness 08/03/81 01/16/84 08/18/81 Initial Disbursement 08/26/81 02/01/84 09/07/82 Scheduled Review of Progress 10/31/81 05/15/84 N.A. Second Tranche Release 04/22/82 11/21/84 N.A. Final Disbursement 08/12/82 12/26/84 05/30/85 Closing Date 08/12/82 06/30/85 12/31/84 Camulative Loan/Credit Disbursements (US# million) FY82 FY83 FY84 FY85 Loan 2026-MAI (i) Planned 45.0 45.0 - - (ii) Actual 44.4 45.0 - (iii) (ii) as Z of (i) 98.6 100.0 - - Credit 1427-MAI (i) Planned 30.0 55.0 (ii) Actual 29.2 55.0 (iii) (ii) as% of (i) 97.0 100.0 Loan 2027-MAI (i) Planned .60 .90 1.00 1.00 (ii) Actual - .55 .83 .989 (iii) (ii) as% of (i) 61.00 83.00 99.00 Mission Data No. of No. of Date of la 2026-MAI Yonth/Year Weeks Persons Mission Report Appraisal (Phase 1) 8-9/80 3 5 /a 12/08/80 Appraisal (Phase II) 1/81 2 3 02/19/81 Supervision I 10-11/81 2.5 8 11/25/81 Supervision II 2/82 2 2 03/08/82 Supervision III 3/82 3 1 05/10/82 Credit 1427-MAI Preparation 6/82 2 3 07/21/82 Preparation 2/83 2 1 02/24/83 Appraisal 6/83 2 7 07/06/83 Post Appraisal 8/83 1 1 09/26/83 Supervision I 4-5/84 3 5 06/01/84 Loan 2027-MAI Appraisal Coincided with Appraisal for SAL I Supervision I a 11/81 .6(4 days) 3 01/15/82 Supervision II 07/8i .6(4 days) 1 07/23/82 Supervision III 03/83 2 2 04/04/83 and 06/13/83 Supervision IV 1 2 07/08/83 /a Includes a separate mission by an agricultural projects division staff to review the recurrent budget allocations for agriculture. /b Coincided with the supervision mission for SAL I. STAr INPlt ( -af Uek) Fy 80 81 82 83 84 85 86 Total Loan 2026-MAI Preappraisal 8.2 1.8 - - - - - 10.1 Appraisal - 80.3 - - - - - 80.3 Negotiation - 18.1 - - - - - 18.1 Supervision - 1.5 41.4 5.5 .5 - 5.5 52.4 Other - .8 - - - - - .8 8.2 102.5 41.4 5.5 .5 - 5.5 161.7 Credit 1427-MAI Preappraisal - - 20.2 58.7 - - - 78.9 Appraisal - .4 3.6 14.8 29.0 - - 47.8 Negotiation - .0 - - 8.8 - - 8.9 Supervision - - 22.4 - 22.2 4.6 5.4 54.8 Other - a .4 5.1 - 1.1 - 6.5 - .5 46.6 78.6 60.1 5.7 5.4 196.9 Loan 2027-MAI Appraisal - .5 - - - - - .5 Negotiation - 2.4 - - - - - 2.4 Supervision - - 3.4 1.3 1.9 .7 2.6 9.8 - 3.0 3.4 1.3 1.9 .7 2.6 12.8 Totals 8.2 106.0 91.4 85.4 62.5 6.4 11.6 371.5 - V - PROGRAM PERFORMANCE AUDIT REPORT MALAI STRUCTURIL ADJUSTMENT I (LOAN 2026-MAI) STRUCTURAL ADJUSTMENT II (CREDIT 1427-MAI) AND TECHNICAL ASSISTANCE I (LOAN 2027-MAI) EVALUATION SUMMARY Introduction The steady economic growth which Malawi achieved for a decade and a half after independence was predicated on exports of tea,tobacco and, to a lesser extent, sugar, rapid expansion of the public and parastatal sectors and investment in infrastructure, much of which was in the form of construc- tion with very low ratEs of return. The external shocks of the late seven- ties caused a serious reversal to this essentially defenseless economy and budgetary and balance of payments deficits escalated to unsustainable levels. The main cause was the unprecedented decline in the terms of trade, but other serious external factors were; disruptions to the transport system caused br political instability in the region which increasingly denied Malawi access to direct routes to the sea; drought which necessitated large imports of maize; and a debt service ratio which quadrupled due largely to the appreciation of the US dollar and rising external interest rates. How- ever, important structural imbalances also became increasingly apparent under these extreme strains; the concentration of exports in a few commodities resulting in a narrow export base; the slow growth of smallholder produc- tion; the poor financial position of most public enterprises and of the private sector conglomerate, Press Holdings Ltd; price controls and the inadequate budgetary funding of key sectoral activitiec. Objectives and Strategies The main objectives of the Government's adjustment efforts support- ed by the SALs were the reduction of the balance of payments current account deficit to manageable dimensions while at the same time fostering moderate growth of per capita income. The thrust of the medium term adjustment mea- sures was to achieve a specified minimum real growth of GDP, to increase diversification of sources of foreign exchange earnings, to improve the financial performance of public enterprises and to restore sustainable budgetary equilibrium. The strategies adopted addressed four main areas of - vi - the economy; the balance of payments, price incentives and incomes, resource management and institutional improvement. The emerging problems were cor- rectly identified and the strategies adopted and the policy instruments used for their achievement were, in general, sound and appropriate for the main areas needing adjustment. The first Technical Assistance project supported these programs and provided the analytical studies on which many of the reforms were to be based. 1mplementation Experience While most of the action programs were implemented without undue delay, they were not all equally effective and performance was less than agreed in several areas, resulting in the postponement of the release of both second tranches. There were lags in commissioning studies, avoidable budgetary problems, increases in debt despite the strengthening of the debt monitoring function, and delays in revising producer prices for some small- holder crops. These performance inadequacies were remedied in due course. In most areas of reform implementation perform2nce was sound. Procurement and disbursement procedures were designed to ensure rapid draw down of the proceeds and were effective. Both the SALs were fully disbursed within a year of being made effective and the generated counterpart funds most usefully financed development projects contained in the central budget. Results The central objectives of the adjustment program, the strengthening of the balance of payments position and the restoration of economic growth, were achieved. However, the contribution of the adjustment programs, while positive, were outweighed by the impetus to growth conveyed by such external factors as improved, but globally determined, prices for Malawi's main exports and the fortuitous opportunity presented by a continuing drought in neighbouring countries to export on a once only basis large quantities sur- plus domestic miaze production. While an appropriate mechanism for determining crop price levels was installed and utilised, the impact on smallholder export crop production of the upward price adjustments was delayed and muted by disproportionate price incentives for maize production. In the first few years, smallholder export crop growth was disappointing. Little was achieved in the area of estate crop diversification, in improving the efficiency of estate management or in the growth of agro- industry. The Government continued to implement appropriate pricing policies in respect of petroleum products and, although conservation and increased efficiency of use were not pursued as energetically as they might have been, savings on the petroleum import bill were realised. But the ever increasing additional external transport costs incurred through closure of access to the sea placed - vii - continuing and excessive burdens on the economy in general and the balance of payments in particular. Whatever the cause, however, the favorable trends towards growth and a more sustainable balance of payments position were reversed in 1985, indicating that structural imbalances remained. The removal of price controls on all but a few items waf accom- plished and may have increased the availability of certain commodities, but as no systematic stud7 of the impact of this measure on production was under- taken, it is not possible to assess its contribution. Much better results were achiaved in the more efficient use and improved allocation of resources. The rationalization of the process of budget preparation and of public expenditures and investment has led to significant improvement. Revenue enhancement measures, although implemented diligently and in full, were not so successful, revenue remaining in real terms more or less constant at that time. Other domestic resource management measures, exchange rate adjustment and interest rate changes were carried out appropriately and in conformity with the agreements. Institutional improvements in economic planning and the monitoring of investments are successfully evolving as are the efforts to install external debt management, and the difficult steps which were taken to rehabi- litate and restructure major parastatals and Press Holdings Ltd. met with a good measure of success. It is difficult to attribute any social impact directly to particu- lar measures supported by the SALs since, as was typical of the first genera- tion of SALs, no attention was paid to the social implications of adjust- ment. It is probable that the SALs had considerable consequences for income distribution since rural incomes and purchasing power must have increased as a result of higher prices for smallholder production and both the rural and urban poor must have benefitted from higher budgetary allocations for the social sectors. On the other hand, restructuring of the parastatals and Press Holdings Ltd. must have increased levels of urban unemployment. In the final analysis, however, unemployment would have been worse and income levels much lower if the downward spiral of the economy had not been halted and if no steps had been taken to restore growth. The Technical Assistance Loan was well utilized and, although in some cases the resulting recommendations were of less utility than had been expected, overall it played a valuable part in establishing and refining the necessary remedial measures. Sustainability The political commitment to policy reform, although autarchic in nature, appears to be firm, and the possibility of capricious change diminishes as the internalization of the reform process continues. There is also a strong intellectual commitment to adjustment on the part of many responsible officials in Malawi whose dedication to and deep understanding of - viii - the principles of reform have played a vital part in its furtherance. The institutional capacity to sustain reform, however, remains fragile and full institutional development requires a longer timeframe than that of the SALs. Specific areas in which the sustainability of reform may be endangered are; in the Department of Statutory Bodies where more support in terms of staffing is required; in Press Holdings Ltd., and the Malawi Development Corporation where expatriate managers have made great strides in rehabilitating the companies, but where local counterparts have not been trained to take over from them in the future; and in the Agricultural Development and Marketing Corporation where the financial and managerial improvements could not be maintained, necessitating a new round of assistance provided in a Supplementary to SAL III. Malawi continues to move towards increased institutionalization of the adjustment process through integra4ed management of structural reform, the strengthening of economic planning and management capacity and the adop- tion of three year forward budgetting which reflects the policy environment for reform by adopting and extending the objectives of adjustment. Finally, the willingness of the Government to continue the adjust- ment process through further SALs and the authority with which it is now formulating its own prescriptions for reform and conducting its economic dialogue with the Bank reinforces confidence in the sustainability of the process. Overall Assessment and Lessons Although the four year period since tbi initiation of the adjust- ment programs is insufficient for their full effect to become apparent and, although external factors continue to distort aid erode gains that have been made, substantial progress has been made in many areas. Even so, the process of structural reform remains under way. Many of the shortcomings and inade- quacies that have been identified in this report have been addressed in the third SAL or provided for in other subsequent lending and the lessons of experience conceptualized for adoption later in the series. Most important- ly, the Government is now much better prepared to design its own stabiliza- tion and adjustment programs than when the series began. At all times the support of the Fund and the Bank in supervising and monitoring the process of adjustment has been an important factor in realizing the reform objectives. In addition, the combination of clearly enunciated policies and the frequent reviews of progress the Government undertook were also instrumental in obtaining better results than might otherwise have been achieved. The SALs and the programs they supported helped Malawi pursue with a substantial element of success the adjustment strategies they had adopted, in particular - ix - by assisting in focussing attention on areas where significant change was required, in defining technical and policy options and in translating adjustment strategies into actionable programs. Particular issues raised by the SAL experience, as well as the lessons drawn, which may have wider implications for future operations are presented in paragraphs 68-73 and 105 of the PPAM. - 1 - PROGRAM PERFORMANCE AUDIT MEMORANDUM MALAWI STRUCTURAL ADJUSTMENT I (LOAN 2026-MAI) STRUCTURAL ADJUSTMENT II (CREDIT 1427-MAI) AND TECHNICAL ASSISTANCE I (LOAN 2027-MAI) I. BACKGROUND 1. The behavior of the economy since independence in 1964, the 15 years of steady growth as Malawi pursued what were widely regarded as prag- matic and consistent economic policies and the onset of the economic and financial crises which affected the country from 1977 onwards are set out in some detail in the PCR. The critical issues of the late 1970's and the emerging structural imbalances are also described. In brief, for a decade and a half, Malawi was able to sustain an annual GDP growth rate in excess of 5 percent in a period when most, better endowed, developing countries consid- ered themselves fortunate if they achieved even half that level. Per capita income grew by 3 percent, inflation averaged no more than 9 percent a year and GNP per capita reached $190 in 1979. In spite of this progress, however, when deterioration set in towards the end of the 1970's and the economy was faced with worsening terms of trade, adverse climatic conditions and mounting foreign debts, Malawi remained one of the world's poorest and most vulnerable countries. By 1984, GDP per capita had fallen to US$180 due in part to nega- tive growth in several years, but also to growth generally slower than the rate of increase of the population and the devaluation of the Kwacha which further eroded the value of GNP in dollar terms. 2. Economic growth in Malawi in the years since independence has been based primarily on exports of tea, tobacco and, to a lesser extent, sugar, rapid expansion of the public and parastatal sectors and investments in in- frastructure, such of which was for construction with very low rates of re- turn. In the late seventies, the economy was without adequate defenses against the external shocks it then experie.ced, and budgetary and balance of payments deficits escalated. From 3.5 percent in 1979, GDP growth fell to a negative 1 percent in 1980 and minus 5 percent the following year. In this period, the current account deficit rose to an unsustainable 20 percent of GDP and the budgetary deficit averaged about 14 percent. The main cause of this serious reversal of Malawi's fortunes was the unprecedented decline in the country's terms of trade which by 1981 had fallen by 40 percent from 1978 levels and by 1983 had fallen by 51 percent. Other serious external factors were; disruptions to the transport system caused by political instability in the region which increasingly forced Malawi to suspend use of its direct routes to the sea through Mozambique and progressively to utilize far more costly alternative routes (a process which became complete in 1984 when the rail routes to Beira and Nacala finally closed through insurgent ectivity); drought which, although perhaps not as severe as that which affected many of its neighbours, caused Malawi to import large quantities of maize, a staple in which previously the country bad been self-sufficient, and to lose export earnings as agricultural production suffered; and the appreciation of the dollar and rising external interest rates which put even more pressure on the balance of payments as the debt service ratio quadrupled between 1977 and 1981, reaching 26 percent in that year. Despite increased foreign borrowing, partly on commercial terms, foreign exchange reserves dropped sharply from four months of imports in 1978 to less than two months. 3. This outcome was by no means solely the result of outside inflt- ences, severe as they were. In addition, important structural imbalances became increasingly apparent under these extreme fiscal and monetary strains. The structural weaknesses identified, which were to be addressed urgently under the structural adjustment program were: the narrowness of the export base and the need for export crop diversification, exports being concentrated in a few estate produced commodities such as tea, tobacco and sugar, all subject to wide international price fluctuations; the slow growth of smallholder production; the rising costs of energy and the need for alternative sources, especially for fuelwood used in tea curing and tobacco drying; the poor financial position of most public enterprises to the detriment of the central budget; the urgent need for improved management and financial restructuring of the private sector conglomerate Press Holdings Ltd.; price controls, formal and informal, which were a source of inefficiency and a constraint to domestic production; and the growing budgetary deficits and inadequate funding of key sectoral recurrent activities, in particular in agriculture, in road maintenance and in the social sectors. II. THE DESIGN OF THE ACTION PROGRAMS Strategies and Policy Instruments 4. The initiatives taken by the Government first to halt and then re- verse the precipitous decline in the economy consisted of short term demand management measures supported by a series of IMF Standby arrangements fol- lowed by an Extended Fund Facility and, in consultation with both the Fund and the Bank, the structural adjustment program outlined in paragraphs 2.02- 2.24 and 2.39-2.56 of the PCR followed by a Loan of US$45 million in 1981 and a Credit of US$55 million in 1983. This medium term program, to be imple- mented in the period 1981/82 to 1985/86, aimed at reducing the balance of payments current account deficit to manageable dimensions while at the same time ensuring moderate growth of per capita income. More explicitly, the objectives were to attain a real growth of GDP of 4.8 percent, to increase diversification of sources of foreign exchange earnings, to improve the financial performance of public enterprises and to move towards restoration of sustainable budgetary equilibrium in order to reduce reliance on external financial sources and domestic borrowing and to increase foreign exchange reserves. - 3 - 5. The strategies adopted addressed four main areas of the economy; the balance of payments, price incentives and incomes, resource management and institutional improvement. Improving the Balance of Payments 6. Improvement was to be achieved by the promotion of smallholder crop exports, the expansion and diversification of the exportable agricultural products of the estates and the conservation of energy through more efficient use and the development of alternative sources. The policy instruments to be applied were increased producer prices for agricultural export crops, a larger recurrent budgetary allocation to the Ministry of Agriculture, the elimination of remaining fertilizer subsidies to improve both efficiency of use and the finances of the parastatal marketing organization, the Agricultural Development and Marketing Organization (ADMARC), a review of the efficiency of ADMARC, which enjoys a monopoly of marketing of smallholder tobacco and cotton production, studies of the livestock and tobacco subsectors and of diversification of estate production, increased agro-industrial investment and in the energy sector, the continuation of price adjustment and objective studies (PCR paras. 2.04-2.09). Price Incentives and Incomes 7. The program was directed towards the provision of better incentives for production, and the necessary stimuli for capital formation and the ex- pansion of output. The policy instruments to be used were the removal of price controls from a wide range of consumer goods and more frequent adjust- ment of wages, periodic reviews of the exchange rate under the IMF Standby and monitoring of interest rates to ensure the maintenance of appropriate in- centives, (PCR paras. 2.10-2.12 and 2.47). Resource Management 8. With the objective of achieving growth targets and structural change by the most efficient use of public and private resources as possible, the Government undertook to; strengthen the recently established Department of Statutory Bodies (DSB); enhance Government revenues through the introduc- tion of new taxes and improved administration; strengthen the monitoring and control of public expenditures, in part through the production of a new five year public expenditure program containing a commitment to adequate levels of recurrent financing for key development Ministries; limit borrowings (as a condition of the current Standby); and improve the monitoring and management of public debt. It also undertook to increase utility and transport tariffs, to study the finances and efficiency of the Airline and the Railway, both parastatals being heavily reliant on Government subventions, and to draw up detailed plans for implementing economic rentals for subsidized housing and to consider the imposition of higher levels of cost recovery in education and health (PCR paras. 2.13-2.18 and 2.48-2.51). Institutional Laprovements 9. In order to strengthen its institutional capacity for planning, monitoring and managing its operations, the Govermint; established an In- vestment Coordinating Committee to monitor proposed investments to ensure -4- economic justification and financial feasibility; accepted technical assis- tance to strengthen economic planning and budgetting; and undertook the re- habilitation and reform of key public enterprises, in particular, the Malawi Development Corporation (MDC) and ADMARC, and of Press Holdings Ltd. (PHL) through improved management and financial restructuring. (PCR paras. 2.19- 2.23 and 2.52-2.56). 10. The specific intentions of the Government with regard to the vari- ous components of these wide ranging programs are set out in the respective Letter of Development Policy attached to the PCR as Annexes I and II. The emerging problems were correctly identified and the strategies adopted and the policy instruments used were, in general, sound and appropriate for addressing the main areas needing adjustment. Technical Assistance 11. In support of these programs, the first Technical Assistance proj- ect financed with an IBRD US$1 million loan provided the at.alytical studies on which many of the reforms were to be based. The loan financed a program consisting of the following main components; studies of development prospects and price incentives in the livestock industry; three studies of MDC on work- ing capital, budget and management, and accounting and operating strategy; strengthening MDC's export marketing capabilities by the provision of consul- tant services; and other studies associated with the SALs. The latter were identified and agreed as implementation of the SAL proceeded and as their need became apparent. They consisted of studies associated with the finan- cial restructuring and management reform of PHL and of ADMARC and of assis- tance to the Government with debt management improvement. 12. Total costs were estimated at US$1,170,000 of which US$1 million were foreign costs. The loan financed 100 per cent of foreign costs and 85 percent of local expenditures. All consultant contracts were approved by the Bank. Related Economic and Sector Work 13. Considerable staff work was expended by the Bank on assistance to the Government in the preparation of the SALs which followed earlier analyti- cal work on the economy and on specific projects. The economic reporting which pre-dated the SALs, in particular the Basic Economic Report of 1981, was largely instrumental in shaping the design of the first SAL. However, this report which was derived from field work conducted in 1979, understand- ably did not deal in sufficient depth with the emerging problems of the early 1980s as identified in the preparation of the structural adjustment program. Because, therefore, the full range of detailed prescriptive remedies required was not available, the free-standing and complementary technical assistance provided under Loan 2027 MAI to meet these needs became a necessary and inte- gral part of the adjustment process. Coordination and Complementarity with IMF Programs 14. Close collaboration was maintained with the IMF through regular sharing of information and views during the implementation of the programs of both institutions. In 1979, the initiation by Government of a number of -5- short-term demand management measures culminated in a two and a half year Standby arrangement for US$32.9 million covering the period June 1979 to December 1981. In addition, Malawi also obtained US$23.8 million from the Compensatory Fund Facility (CFF) and US$7.1 million from the Trust Fund. However, the economic dislocations caused by drought and the stoppage of all overland external transport by guerrilla activities in Mozambique in late 1979 led to the replacement of this arrangement afte: the drawing of only one tranche with a new two-year Standby covering the period April 1980 through March 1982, drawing on the second through fourth tranches of the first arrangement and the Supplementary Fund Facility for, in all, US$ 64.8 million equivalent. This second two year Standby coincided with the implementation of SAL I and aimed at constraining demand and limiting the current account deficit. Performance criteria involved phased ceilings on total domestic credit and on net bank credit to Government and a limit on Government, or Government guaranteed, borrowing. In addition, specific measures to reduce demand implemented under the first Standby but still in effect included raising the rate of surtax on imported and locally produced goods, increasing import duties and interest rates and raising the fuel import levy. A third Standby and the Extended Fund Facility (EFF) program focussing largely on redressing fiscal imbalances overlapped the implementation of SAL II. In general, the IMF provided the Government with guidance on exchange rate and interest rate policy and domestic resource mobilization efforts and the Bank advised the Government on agricultural pricing, the public investment program and the restructuring of PHL and the parastatals (PCR paras. 4.11-4.12). Complementarity with the Lending Program 15. The objectives and some conditionality of a number of projects approved during the period of implementation of the SALs directly comple- mented them. Broad as the SALs were in their scope, therefore, there was considerable room for supportive lending and, indeed, some conditionality originally contained in the SALs was subsequently left by design to project lending for implementation, since it was thought that project specific lend- ing would be a better vehicle. For example, the concern that housing sub- sidies should be reduced and that there should be some provision for staff ownership of Government housing, was left to the first Urban project for implementation. Other closely related projects were the Smallholder Fertil- izer project, which addressed the issue of fertilizer procurement and distri- bution, and the National Agricultural Research and Extension and Planning Support projects which contributed to the services available to small- holders. Tranching 16. Both SAL I and SAL II were tranched, with the release of the second tranche in each case being conditioned, not only on Bank satisfaction with the general progress achieved in carrying out the programs as defined in the Letters of Development Policy, but also progress achieved in a large num- ber of specific areas. These particular areas of focus ranged from such rel- atively general topics as the proposed measurer for the improvement of the financial and management aspects of enterprises in the public and private sectors and the adequacy of budgetary allocations to key developmental -6- departments, to such detailed and itemized issues as the provision of supple- mentary appropriation to agriculture's recurrent budget of K 2.8 million and increases to an acceptable level in a public utility's tariffs. The need for fuller development of an appropriate reform program during implementation limited the opportunities for supporting policy reforms already carried out as opposed to promised measures, and made tranching the release of funds a useful device for keeping implementation on track. The delays which occurred in releasing the second tranches (6 months in both SALs) seemed justified under the particular circumstances, which were the inconsistency of the development budget with SAL objectives and continued excessive allocations for State buildings in the first SAL and in the second SAL, among other things, a sudden deterioration in the overall economic situation and delays in the implementation of the associated technical assistance. Procurement, Counterpart Funds and Disbursement SALs I and II 17. Procurement and disbursement procedures built into the two SALs were designed to ensure rapid drawdown of the proceeds and the use of the counterpart funds generated was limited only to the extent that they were to be credited to a special &ccount and used for development purposes in the central budget. No particular problems were experienced with either procure- ment or disbursement and the counterpart funds contributed significantly to overcoming the previously endemic budgetary underfunding, both capital and recurrent, of many important development activities (PCR paras. 2.73-2.78). Technical Assistance 18. Initially, the procurement of consultants was slow and a reason for the delay in releasing the second tranche of the first SAL, partly because of the diversity of the studies and the number of agencies involved, each of which was responsible for the implementation of its particular component of the Loan. However, once appointed, the consultants received adequate guid- ance and support from steering and working committees which were established for the purpose. No real problems were encountered in the timely withdrawal of the proceeds and, in total, US$989,000 was disbursed. The balance of US$11,000 was cancelled. Because of the delays in entering into contracts with consultants, the loan was closed some six months after the originally anticipated closing date and the final disbursement took another five months. III. IMPLEMENTATION OF ACTION PROGRAMS 19. Overall, implementation per e, although mixed, was satisfactory. Performance in many areas was sufficiently good for substantial progress to be recorded. In several areas, however, procrastination, and in some cases failure to take prescribed measures, led to minimal results or failure. In agriculture, crop production response to producer price increases was posi- tive but varied and for sume crops significantly delayed. The Government in - 7 - its anxiety over food (i.e. maize) security issues failed to take prompt action on increasing producer prices for most other crops. Little in the way of crop diversification was achieved. Although the studies which were to underpin many of the prescriptive measures were eventually completed reason- ably satisfactorily, there was unnecessary delay in commissioning them. Resource management measures and institutional improvements were implemented better. As a result, public investment programming improved as did sectoral allocations and progress was made in the establishment of the debt service unit and in debt management. The finances and vanagement of Press Holdings and of some statutory bodies, especially MDC, improved--except for the recent reversals of ADMARC. The following paragraphs describe and assess implemen- tation performance in greater detail. Improvement in the Balance of Payments Smallholder Agriculture (PCR paras. 2.04-2.06 and 2.43-2.45) 20. The provision and monitoring of price incentives designed to in- crease the production of smallholder export crops was a major focus of both SALs, since prime causes of the slow growth of smallholder exports had been identified as the failure by ADMARC to pass on to farmers more than a small proportion of the relatively high export prices obtained in the 1970s and the financial disadvantage at which smallholders were placed in relation to the estates which were able to sell in an unregulated market at prices near to or at export parity. The institutional mechanism by which producer price levels by crop were to be reviewed and agreed and the formula by which they were to be determined were put into place in good time. The methodology gained gen- eral acceptance and the Government justifiably believes that it now possesses an instrument with which Malawi is able to assess with a degree of confidence appropriate levels of prices by crop and influence not only levels of produc- tion but also the crop mix. 21. Initially, the Government was slow to apply the findings of the early price reviews and the 1982/83 crop season saw a very large (66%) rise in the maize price, designed to increase production for the strategic grain reserve, and to achieve an enhanced degree of food security without corre- sponding increases in smallholder export crops, other than for cotton, the price of which was increased by 24%. It was not until the 1983/84 and 1984/85 seasons that export crop prices received significantly improved incentives. The priority given to maize production was against the advice of the Bank when it became clear that the new price would lead to excessive sur- pluses and the slow growth of export crops until the relative prices were corrected over the next few years. 22. The main objective of these measures was not attained, at least in the short run, due largely to these factors. Without corresponding increases in prices for smallholder export crops, the expansion of their production was inhibited, the trend to substitute maize accelerated and the smallholders' export crops implicitly taxed to subsidize maize production. The Bank clearly underestimated the Government's deep concern with food security following the drought years of the early 1980s, and this had a detrimental effect on the program in its initial stages. Nevertheless, in the absence of -8- good statistics on the degree of substitution (of maize for some export crops) that took place it is not possible to be categorical as to whether the response to export crop price increases in terms of increased production would have taken place earlier or have been of a greater magnitude tf the incentives to increased maize production had not been provided at such high levels. 23. As evidenced in Table 3.1, in terms of ADMARC purchases, except for maize where the response to higher prices was immediate and almost overwhelm- ing as far as ADMARC marketing facilities and capacity was concerned, the other crops stagnated and in some cases declined before the crop response became .elt in 1984 - and in the case of groundnuts in 1985. Table 3.1: SMALLHOLDER EXPORT CROPS AND MAIZE PURCHASED BY ADMARC ('000 metric tonnes) Period Tobacco Groundnuts Cotton Maize 1980 11.3 31.4 23.1 99.9 1981 12.8 19.5 21.7 136.7 1982 8.8 10.6 15.1 246.1 1983 9.3 10.2 13.4 244.9 1984 19.2 9.9 32.1 296.4 1985* 20.8 18.1 32.4 271.6 * Provisional Source: National Statistical Office (NSO) and ADMARC Only in the medium term, therefore, were increased prices paid to the small- holders for their products effective in motivating them to increase their production of export commodities sold to ADMARC. The increased volume of maize purchased by ADMARC contributed to the building up of national food reserves (recently constructed silos now contain 150 thousand tonnes of maize and ADMARC's serious financial position is exacerbated by a further 100 thousand tonnes held in excess of the required reserves) and some of the surpluses in 1983 and 1984 were, quite exceptionally, exported to neighbour- ing drought afflicted countries - a fortunate trade opportunity which is unlikely to repeat itself in normal times, given increasing levels of produc- tion in Zambia and Zimbabwe and Malawi's high transportation costs. 24. While exports of smallholder crops did increase, the increases were from a small base and in absolute terms there was little significant improve- ment in the structure of the export sector or in the composition of exports. The main estate crops of tobacco, tea and sugar continued to constitute over 80% of exports during the 1980/85 period, smallholder crops of dark-fired tobacco, cotton and groundnuts contributing only about 4% of commodity export earnings. The improvement in export earnings in 1984 arose from exceptional exports of maize and temporarily favorable prices for tea and tobacco; and the subsequent drop in export earnings in 1985 from international price fluc- tuations; and neither performance appears to have been related to the success or failure of the SAL programs. Indeed, for a significantly more positive result to have been achieved, it would probably have been necessary to supply smallholders with a conventional package of credit, extension and adaptive research and to have mounted some form of export promotion program. It was over-optimistic to have expected major production increases from producer price incentives alone and, although there was a need to safeguard the pro- gram from overloading, such a package could have been of great importance and might advantageously have been introduced at the outset. It was not until 1985 that such a package was specifically supplied under project lending, when the problems of extension, research and planning were addressed under separate projects to ensure that the price incentives were accompaniod by the provision of appropriate technologies to the farmers for their adaptation. At the outset, the Bank appears to have left the provision of credit and extension to the National Rural Development Program (NRDP), but in practice that was too diffuse a program covering at the time only a small percentage of smallholders and which, to date, whatever its other achievements, has been singularly unsuccessful in increasing smallholder production. Estate Production and Diversification (PCR paras. 1.07, 2.07, 2.46, 3.09 and 5.05) 25. The importance of the estate sector, which in the early 1980s pro- duced 80% of agricultural exports, in generating export earnings required that adjustment included measures to enhance its productivity and efficiency by improving technical and financial management, developing a credit plan and training schemes and encouraging diversification especially away from the dominant crop--tobacco. A number of studies were undertaken and SAL 1' contained some provision for extension and training and the establishment of a credit scheme, but essentially the main ingredients of the estates rehabilitation program were left to later SALs. The need for improved credit facilities and management training was clearly a major constraint to both increased production and diversification from the outset, especially since between 1975 and 1980 estate agriculture had been expanded considerably by the introduction of numerous small estates owned by Malawians who had little capital, virtually no access to credit, and who badly needed such support. Even at the risk of overloading the first two SALs, it would appear that these provisions for strengthening estate agriculture should have been included and implemented sooner. The studies of diversification were not of much help. It was relatively easy to identify a short-list of products which could cautiously be introduced, such as wheat, coffee, oilseeds, beans and nuts, but it was clearly important that for some time they should remain subsidiary crops as rapid expansion was fraught with technical and managerial difficulties. In spite of these efforts, therefore, Malawi's narrow agricultural export base remains a structural problem and one which, perhaps, is not amenable to change by way of the prescriptions which SALs are capable of offering but might be better handled through conventional project lending. As a result, agro-industrial production has also failed to expand to the extent anticipated. Other Agriculture Sector Measures (PCR paras. 1.01, 2.05, 2.06, 2.28-2.29, 2.34, 2.44-45, 2.62, 2.65 and 3.13-3.15) 26. The study of ADMARC was included in the Technical Assistance proj- ect in anticipation that it would provide recommendations leading to improved operational efficiency of obvious potential benefit to smallholder agricul- ture. It concluded that ADMARC should divest itself of investments unrelated - 10 - to marketing or processing of agricultural output and that profits from smallholder marketing operations should not in future be used for such pur- poses; that producer and consumer subsidy costs should be borne by Govern- ment; that marketing costs should be reduced; that financial management training and manpower development should be improved and that the role of the private sector in marketing should be increased; conclusions with which the Government concurred. In the event, the program which evolved was concen- trated on strengthening financial management especially by filling such key positions as that of financial controller, creating the post of General Manager and proceeding with the divestment of unrelated investments. The erfectiveness or otherwise of this program and the extent of its implementa- tion are discussed in paras. 60-63. The other recommendations were not vigorously pursued by the Bank on the grounds that the preparation of SAL II was too advanced to enable additional items to be incorporated and that, in any case, there was no urgency in the matter since at that time ADMARC remained profitable. The rationalization of ADMARC's relationship with Government in order that it might be reimbursed for non-commercial activities such as management of the strategic grain reserve on behalf of the Government were important omissions, the impact of which is also discussed in the section on the reform of the parastatals (paras. 52-63). In all fairness, however, it should be said that although more could have been achieved in the restructuring of ADMARC at that time, its relatively healthy financial posi- tion and the seriousness with which the restructuring efforts in MDC and PHL were pursued not unreasonably influenced both Government and the Bank to concentrate attention more on them than on ADMARC. 27. What was included in the SAL II program, although it did not form part of the recommendations of the study but arose from technical assistance provided under the Smallholder Fertilizer project, was an effort to improve ADMARC's fertilizer distribution and, in particular, a provision that in or- der to improve efficiency of use the remaining fertilizer subsidy should be reduced by 50 percent and eliminated within three years. The PCR dismisses performance under this subset of conditione with t1i commen'. in releasing the second tranche in November 1984, that announced fertilizer prices had been estimated on the import parity price. But this statement masks an area in which there were very serious concerns on the part of the Government. Although by 1983/84 the subsidy had been reduced by 60 percent and its com- plete removal a year later appeared to be a readily achievable target, in that year access to the Mozambique ports became an impossibility and the routing of fertilizer imports through Durban in South Africa added consider- ably to the cost. Government was already concerned that the escalating price of fertilizer was having the effect of reducing the acreage under improved maize at a time when its policy was to increase the production of bybrid maize, and concluded that the timing of subsidy removal was over-rapid. As a result, a new program was worked out giving more time up to 1989/90 to remove the subsidy and to encourage the adaptation of higher analysis fertilizer. This program is being supported by an USAID program. The Bank was right to stress the importance of the removal of the subsidy both for its effect on the budget and to encourage more efficient use of this input, and also cor- rect in reacting flexibly to this episode. 28. The study of livestock development did not produce adequate recom- mendations on the further development of the livestock industry, neither did - 11 - it provide well-conceived pricing policy recommendations. It did not, there- fore, contribute in any integral way to a planned development strategy; strategy which subsequently evolved using instruments other than the SAL. 29. The section on the Public Expenditure Program in the PCR (paras. 2.13 and 2.14) deals in more detail with the SAL conditionality relauing to enhanced recurrent funling of development activities in general. The attempt, however, to increase agricultural export efficiency and production by more funding of recurrent activities through the budget deserves a com- ment. A very specific condition contained in the first S,L asked that the recurr(:nt budget for the Ministry of Agriculture should be raised in 1982/83 by K 2.8 million. The Bank seemed to suggest that this be an additional expenditure without a careful analysis of the budget and without identifying equivalent savings, possibly in the form of waste and extravagance which could have been excised. In the eyes of Malawi officials, this condition was no more than a safeguard devised by Bank agricultural projects staff to ensure the full counterpart funding of on-going Bank financed project activity. Energy: Conservation and Efficiency of Use (PCR paras. 1.09, 2.08 and 2.09) 30. The conflict between the need to preserve national forests and the use of wood as a fuel for the production of flue cured tobacco, for tea dry- ing and as a source of domestic energy is recognized in the SAL documents. Studies, consultative services and pilot actions were incorporated in the program to curb the increasing use of fuelwocd, but implementation of a meaningful program did not start during SALs I and II. 31. An energy assessment study was completed and appropriate adjust- ments in energy prices continued to be made. Although not a condition of the SALs under review, there appeared to be little government interest in or progress towards implementing the recommendations of the assessment review. The 1982 recommendation, for example, that an energy advisor should be appointed for training local staff, was implemented in June 1986. Of parti- cular importance in the Malawian context is the need for increased efficiency of fuelwood use for tobacco curing and tea drying which, with only minimal management improvements, could reduce fuelwood consumption by an estimated 70 percent. However, given the urgent need for such changes, the delay in moving from studies and pilot schemes to the implementation stage might be deemed to be overly long. 32. Some positive actions to improve the efficiency of use and the availability of firewood and to conserve energy sources were taken. An IDA financed Wood Energy project, the approval of which preceded SAL 1, provided for the production of nursery seedlings and the establishment of fuel wood plantations and investments were launched in the production of ethanol which made useful contributions as an additive to and part substitute for some petroleum products. The Government also undertook to increase wood prices to reflect production costs. - 12 - Price Incentives and Incomes Policy (PCR paras. 2.10 - 2.12) 33. The proliferation of inefficiently administered price controls was a constraint on domestic production, especially during a period of high inflation. Even so, the Government accepted the need for decontrol with some reluctance and considerable hesitation, and decontrol took place over a two- year period with a limited number of items being decontrolled progressively at about 6 monthly intervals. Only five products (petroleum products, vehic- ular spare parts, low grade meat, fertilizer and sugar) were excluded from decontrol. But the structure of local industry and its oligopolistic nature, were such as to require increased competition in order to limit the potential for price exploitation. Although the Bank stressed to Government the need to accompany decontrol wi , efforts to encourage more local production and to use imports as effectiv. competition, this did not take place. As a result, at least for a short period, prices of previously controlled items increased at a faster rate than the general CPI. Decontrol should have been linked to an agreed wages policy, but this did not seem to be the case. The Bank wanted to see minimum delays in the adjustment of wages, which would have been an appropriate reform in these circumstances, but the Government had already agreed with the Fund to restrain wages. This anomaly remained unresolved, and wages in the public sector in fact remained unchanged from 1982/83 to 1985/86, when they were increased by 18%. The development of a more flexible wage policy is still needed. Resource Management Department of Statutory Bodies (PCR para. 2.17) 34. The undertaking to strengthen DSB was, at best, pursued without apparent enthusiasm by Government and did not receive much supervisory atten- tion from the Bank. The legislation which was to establish DSB and its responsibilities and relationships was never enacted and, although opinions differed in Government on the effect of this omidsion, it undoubtedly made the uncertainties surrounding DSB's functions worse than they need have been. The Department has proved to be useful in its initial assistance in dealing with the administrative problems which bedevilled the parastatals, in attending to and remedying where possible the abuses left behind by the exec- utive chairmen and in ensuring more uniform terms and conditions of service in the many diverse organizations it overviewed. Most of the parastatals affected by the prefectorial functions of DSB have not adopted adversarial positions and, indeed, seem to find its intermediary role helpful in their relationships with their parent Ministries and with the Treasury. The Department does not, however, have sufficient qualified staff to perform adequately its relatively sophisticated role and there is at present no counterpart to the expatriate who heads it. There is, therefore, little technological transfer and as a result the sustainability of its role is in doubt. There have also been recent indications that, perhaps by oversight, its relationship with the Office of the President and the Cabinet (OPC) is degenerating. Decisions on parastatal management and staffing changes have been taken without consultation and one new parastatal was created without reference to DSB. More support is required if the greatly improved condi- tions and the more orderly and sophisticated financial submissions of parastatals which are the result of the administrations of DSB are to be - 13 - maintained. Government representatives offered assurances that it was their intention to support and bolster DSB although, possibly, some of its func- tions and staffing levels might need revision. A recent review of the paras- tatal sector by the Bank confirms this assessment and the deficiencies are addressed in a recently issued Bank study.1/ Public Expenditures and Revenue Enhancement (PCR paras. 1.12, 2.13- 2.15, 2.18, 2.28-2.29 and 2.48-2.51). 35. The Government's commitment to the more efficient use and improved allocation of public resources was reflected in its intention to produce a five year public expenditure program covering not only recurrent and capital expenditures but also expenditures of parastatals financed through the bud- get. In the event, because of rapid changes in the economic environment and inadequate planning expertise, only a three year budget plan was produced, but this, in itself, was a great improvement. The influence of and assis- tance provided by the Bank in rationalizing the process of preparation and the size of the budget has led to significant improvement. There is now a new consciousness within the Government of the necessity for this reform and for its perpetuation. 36. Progress in SAL I embraced the reduction of low priority expendi- tures, the correction of previous imbalances between recurrent and develop- ment expenditures and increases in the funds allocated to key economic and social sectors. Government also agreed to reduce expenditures on Government buildings. SAL II continued the focus on reduction of the budgetary deficit and on the selection of public investments and reinforced the allocation of adequate recurrent funding for agriculture, road maintenance and education. 37. The proposition that budgetary allocations should be increased in these areas without recommending commensurate reductions elsewhere obviously left the Government with some difficult choices, given the general shortage of funds. Although expenditures were temporarily curbed, as far as the State House war concerned this was an extremely sensitive area and in the medium term no savings could be anticipated. Earlier efforts at increasing revenues had not been successful, smallholder export crop production had not grown significantly and debt service was becoming an increasingly heavy budgetary burden as uqw obligations, often on commercial terms, were entered into and as the U.S. dollar depreciated. 38. While the strategy of ensuring adequate budgetary allocations to key development sectors appeared to be sound, the Bank did not undertake a full scale public expenditure review. In the absence of sufficient identifi- able savings, it was necessary to consider the imposition of additional taxes. In the end, a series of essentially ad hoc tax measures were taken 1/ Malawi: Report on Psrastatal Restructuring, Report No. 6543, January 28, 1987. - 14 - without much measurable success. Although the full range of tax measures to be undertaken under the SALs were implemented promptly as agreed and revenues in nominal terms increased, in real terms they remained constant. With hind- sight, it now seems somewhat unrealistic to have expected that substantial increases could have been achieved so soon after the large tax increases of only a few years previously and at a time when the restructuring of the main parastatals and PHL was still taking place and when those institutions at that time represented a very considerable drain on Government resources instead of proiiding the return on equity and debt which Government might have expected. The quest for more revenue also led to an examination of the possibilities of greater cost recovery, especially in health and education. Whether much additional revenue could have been earned through increased charges without reducing access to the services even further for the poor is open to argument. In the event, as in the case of housing subsidies, these measures were followed up not in the context of the SALs but through sector lending. As it has turned out, the scope for cost recovery in health and education has been small and the measures taken have done little more than apply to the small proportion of the population already paying fees, who are now called upon to face nominal increases. Exchange and Interest Rates (PCR paras. 2.11, 2.12 and 2.51) 39. The exchange rate was periodically reviewed under the IMF Standby and Bank missions found no evidence of significant distortions caused by it. The Government continued to be committed to a flexible exchange rate policy in which the rate reflected the demand for and supply of foreign exchange. Between 1980 and 1984, the currency was nominally depreciated by 44 percent against the U.S. dollar. Interest rates also came under regular review by the IMF and were increased to positive levels which the Government main- tained. The Finances of Statutory Bodies and Press Holdings, Ltd. (PCR, paras. 1.01-1.11, 2.18, 2.22-2.23, 2.34-2.35, 2.44-2.45, 2.53-2.54, 2.61-2.67, 2.71, 3.13-3.17 and 4.06-4.07). 40. The financial restructuring of two of the main parastatals, MDC and ADMARC, and of the private sector conglomerate PHL, is discussed in greater detail in the section on institutional improvement (paras. 45-63). Although initially a major burden on the exchequer, with the exception of ADMARC which continues to be in serious financial straits, their rehabilitation did in the medium term provide some financial relief, in that PHL in its restructured form is beginning to make small net profits and to pay back some of its debt to Government and to pay taxes, and MDC, after the conversion of much debt into equity and the selling off of a number of subsidiaries, has been able to generate profits since 1984, whereas in the preceding six years it had con- sistently made losses. Most of the other large parastatals including Air Malawi, Malawi Railways, tha Electricity Supply Commission (ESCOM), the Water Boards and the Housing Corporation increased tariffs to offset rising opera- tional costs and to reduce deficits. 41. Although, as the PCR notes, the overall financial position of the parastatals was substantially improved, it remains precarious and losses in- curred by a number of major parastatals, which declined between 1962 and 1984, increased again in 1985. - 15 - Monitoring and Management of Public Debt (PCR, paras. 2.16, 2.24, 2.30-2.31, 2.51, 2.63 and 3.20-3.21). 42. Tne computerized public debt recording and monitoring system which the Government undertook to develop made good progress during the implementa- tion of the two SALs and is now in place. Commenting on the delays incurred, a senior Treasury official said that although it had taken a long time, the system was to a large extent Government's own. It had not been imposed from outside even though some ttchnical assistance had been accepted, and was the better for it. The register of debt which has been compiled includes not only central Government debt but also that of parastatals, although as yet private non-guaranteed and short term debt are not captured. A commitment to a target range for future public debt-service ratios was made and the debt monitoring unit in the Treasury is now an important management tool for Government, given the structure of the country's external debt, the large proportion of borrowing on non-concessional terms and the failure, after the significant reduction of commercial borrowing, of concessional and grant- based lending to keep pace with inflation. However, by the conclusion of SAL II, a coherent and useful external borrowing strategy and plan still needed to be evolved and this took longer. Institutional Improvements Monitoring of Investments (PCR paras. 2.20 and 3.19) 43. An Investment Coordinating Committee was created with the responsi- bility of monitoring all investments to ensure their economic justification and economic feasibility, to review their financing plans to ensure realism and to ascertain the extent to which the provision of public funds might be necessary. This innovation was not sustained when Government decided that the Committee was not an appropriate body for reviewing investments and the ICC met on one occasion only. Nevertheless, the need for such treatment and review, although no longer formalized in the work of a committee, has become an important part of the work of the Economic Planning Department (EPD) in OPC which has largely substituted for it and which attempts to use accepted project analysis methodologies in its screening work. The Ministry of Finance also now looks at all parastatal budgets, in so far as they are financed from the central budget, as a part of the budget cycle and endeavours to ensure that their investment plans are in conformity with national and sectoral objectives. Economic Planning (PCR paras. 2.21, 2.55, 3.18 and 3.19) 44. In addition to the institution of new procedures to improve moni- toring of investments and management of external debt, the adjustment program included the reinforcement of Government's economic planning capacity. Mea- sures were taken to train and strengthen the staff of EPD especially in rela- tion to project identification, evaluation and monitoring, the development of coordination capabilities and improvement of medium term policy formulation expertise. The necessary actions to identify and fill staffing gaps and pro- vide appropriate advisory skills were taken. The practice of preparing three year forward budgets was adopted. Although improvement in economic planning - 16 - capacity is a long term process, much was accomplished under the first two SALs and the process continues, supported by subsequent structural adjustment lending operations. The Reform of PHL (PCR, paras. 2.23, 2.35-2.36, 2.53-2.54, 2.61, 3.17 and 4.06-4.07). 45. The PCR notes that the restructuring of the private sector conglom- erate PHL was largely completed in 1984, that it has returned to financial health and that it has begun to pay its debts to Government. 46. The reform and restructuring of PHL was one of the most important and controversial actions to be taken under the first two SALs. Although legally a private company by virtue of its ownership, its only shareholder being the Life President, its importance to the economy and its close linkages to the Government and the main parastatals were such as to have a profound effect on the economy of the country and to warrant Governmental participation in its restructuring as if it were a public enterprise. Although founded by the President in 1969 with a share capital of only K 10,000, by 1981 PRL had a turnover estimated at K 400 million, employed 10 percent of the paid labor force and had a major role in the key areas of agricultural and other exports, wholesale and some areas of retail trade, energy and transportation and large interests in farming, property management, manufacturing and agro-industry. 47. Adverse economic conditions in the agriculture sector, mismanage- ment, excessive payment of dividends and over-rapid expansion led to a finan- cial crisis in 1980. Independent consultants financed from the Technical Assistance Loan estimated the assets of PHL to be worth some K 86 million and its liabilities K 126 million. The insolvency of PUL and its indebtedness to the only two commercial banks in the country totalling some K 80 million also spelled grave trouble for the banking sector, the two banks having made no provision against these debts and being in no position to incur such major losses without becoming bankrupt. PHL had also borrowed large amounts from the Reserve Bank of Malawi which had been channelled through ADMARC and on which PHL was making only minor payments, in effect forcing ADMARC to service these loans in respect of which it had been a passive intermediary. There were also direct unsecured loans to PHL from external sources totalling over K 20 million which PHL was not servicing. 48. The assessment of the consultants, even though incomplete and sub- jective in the absence of market determined evaluation of assets and of recent audited records and the lack of participation by the principals of PHL, was such as to make it clear that the structural adjustment of Malawi could not be separated from the restructuring of PHL. Even so, because of the potential cost to the Government and the sensitivity of the matter, an additional study was commissioned from the same consultants to assess the impact of restructuring on the Government's budget and an analysis of what appeared to be the only alternative option to restructuring viz. allowing PHL to become bankrupt, but insulating the banks and viable subsidiaries. The extraordinary damage to the economy forecast by this study if such a - 17 - scenario were to be permitted and the credibility of its presentation did much to persuade the more pragmatic of the policy-makers of the urgent need for and the inevitability of restructuring. 49. The restructuring was complex and not without cost. The Govern- ment assumed PHL's liabilities to the banks by issuing to them K 54 million of Special Stock, in return for which Government received preference shares and income notes from a new holding company, Press Group Ltd (PGL) which was created, and to which PHL's assets and liabilities have been transferred. In addition, shares in various agro-industrial ventures were sold to ADMARC, and assets were further rationalized by a series of share swaps with both ADMARC and MDC. There was also some divestment of interests to other parties. As a result, while the .number of PHL's subsidiaries were increased from 15 to 17, the number of companies in which PHL had share holdings was reduced from 24 to 14. 50. Under the terms of an agreement between the Government and PHL which governed the restructuring process, a number of restrictions were placed on PRL's future activities. Most importantly, and controversially, the first charge on accrued income each year is a payment of an annual fee of K 1 million to a Trust to which the President transferred his shares, and of which he is the Senior Trustee. The justification for this payment was and remains a matter for debate. It was deemed by the Bank to be a necessary cost to obtain the cooperation of the owner, and an enforceable way of con- trolling future withdrawals and ensuring that they were in no way excessive, as they had been in the past. In addition, provisions of the agreement ensure that the amortization of debt shall otherwise be a first charge on PGL. As far as the subsidiaries are concerned, under the Companies' Act they are constrained from paying any dividend until losses are erased. Within PGL at the present time there is some criticism of the inflexibility of this arrangement and of the insistence that proceeds of divestment are to be applied to meeting liabilities. It is argued that it serves as a disincen- tive to dispose of assets and reduces present and potential profitability. However, the restructuring was undertaken at considerable cost to the central budget, a cost which the taxpayers are recouping only slowly and over a long period. 51. On balance, however, and in financial terms, the restructuring and reform were a considerable success. PHL in its restructured form of PGL is now soundly based and from being insolvent and losing K 12 million as recent- ly as 1983, it made pre-tax profits of K4 million in 1984, K 16 million in 1985 and is projected to make K 20 million in 1986; and it is Bank participa- tion which has made this possible. This success, in itself, presents other issues, but these are dealt with in a later section. Parastatal Reform: MDC and ADMARC (PCR, paras. 1.10, 2.22, 2.44- 2.45, 2.71, 3.13-3.16 and 4.06-4.07). 52. MDC, a wholly Government owned holding company with interests in agriculture and agro-industry, manufacturing and commerce, suffered severe financial problems stemming from an unfavorable debt structure and losses incurred by several subsidiaries. The onset of economic crisis adversely - 18 - affected the liquidity position of many of its subsidiaries, for whose con- tinued borrowing MDC provided guarantees. It had also accumulated substan- tial amounts of medium term debt, mainly on hard terms, to finance equity investments, and large interest payments were adding to its losses. The deterioration in its performance was adversely affecting the Government's budget through increasing requirements for subsidies and deferment of debt service. 53. SAL I provided, through the Technical Assistance Loan, for studies to review MDC's present and projected financial position, management struc- ture and operating guidelines, together with technical assistance to help strengthen export marketing 4apabilities. The second SAL contained no condi- tionality relating to MDC. ,The PCR correctly claims that the studies ade- quately provide the basis for the company's improved financial and operation- al performance. Through the studies, MDC was able to design and implement an effective overall budgetting and monitoring system for its numerous companier! and to make major improvements in its overall structure, policies and proce- dures. Such changes enabled the company to move from poor liquidity and large losses to profitability. Indeed, after the conversion of much of its debt into equity and the selling off of a number of its subsidiaries, MDC was able to generate some K 16 million in accumulated profits since 1984, having incurred losses for the previous six years, The export specialist provided under the technical assistance loan to improve export marketing capabilities did not contribute much, but that was not his fault. The export potential of the subsidiaries was very limited and there were the usual inherent problems of export promotion. The real need was, and is, not for experts, but for industrial joint venture partners to help produce exportable items preferably to markets owned or penetrated by the joint venture partners themselves. To add to the expert's difficulties, the transport situation started to deteri- orate at that time and he would have been better off concentrating more on import substitution and on invisibles such as tourism. 54. The rationalization and restructuring of MDC's portfolio and debt and the implementation of new management practices recommended by the consul- tants were appropriate, especially those designed to retu.n MDC to its orig- inal development finance company function, to ensure that it should not normally have majority shareholdings and to promote its development as a mixed (i.e. public and private) bank. Existing but infrequently observed guidelines for MDC participation in equity or loans for any one project restricted its investment to no more than 10 percent of its total share capital and reserves, which in 1984 stood at about K 17 million but were subsequently raised to K 25 million. Participation was also limited to 50 percent of total cost of projects since MDC's policy was to limit. direct management responsibility by not having a controlling interest, other than in exceptional cases where control was necessary for the national interest or to protect MDC's investments. A major objective of restructuring was, there- fore, to observe these policy provisions. The conclusions derived from the study could probably have been reached by any competent management, but the pressure provided by an outside independent agency was needed to convince the Government, and was a necessary basis for the subsequent policy decisions of Government. - 19 - 55. The rationalization of MDC's portfolio and debt and the selective sale of some investments were based on an agreed separation of roles between ADMARC (agricultural and agro-industrial), PHL (commercial and manufacturing) and MDC (as a general development catalyst). It was also designed to lower MDC's participation in companies which could exist independently. To these ends, MDC swapped some of its shareholdings for those of ADMARC and PHL. Typical examples of these swap arrangements were; the transfer of such agri- culture oriented holdings as MDC's 100 percent share in Cold Storage Ltd, its 100 percent share in Freshcold Ltd. and its 30 percent share in National Oil Industries to ADMARC, and the transfer of some of its industrial interests such as its 100 percent holding of Malawi Pharmaceuticals shares, its 41 per- cent shareholding in Malawi Distillers and it 27 percent interest in Carlsberg Breweries to PHL. Some of MDC's acquisitions were PHL's 49 percent interest in Import and Export Group and Government's shares in Capital Hotel Ltd., raising its holdings to 85 percent of ordinary and 71 percent of preferred shares in that company. As a result of this rationalisation, the number of companies in which MDC retained an interest was reduced from 32 to 18, holdings were consolidated in those companies and a significant amount of cash was received in respect of the sale of holdings. Of the 18 retained companies MDC had a controlling interest in 8, even though its policy guide- lines did not permit majority holdings. But because of the lack of purchas- ing capacity and of interest in acquiring the shareholdings which MDC, (and for that matter, ADMARC and PHL), wished to divest on the part of the private sector, the restructuring and rationalization was accomplished to a great extent by share swapping betwen these three entities only, and the question of the potential purchasers for the divestment program not fully addressed in the design. 56. The profitability of MDC's portfolio following the restructuring of 1984/85 is still marginal and below its management's expectations. Al- though some joint investments with the private sector are profitable, MDC's hotel investments are either losing money (Mzuzu and Malawi Hotels) or just breaking even (Capital Hotel). The larger companies, e.g. Portland Cement and Malawi Iron and Steel are incurring losses. MDC's net profits of K 6 million in 1984 and K 8.9 million in 1985 are in sharp contrast to the losses incurred in preceding years but are exceptional in that they arise to a large extent from the sale of assets. Excluding these exceptional items, real trading profits were no more than K 317,000 in 1984 and K 1.9 million in 1985. The expected profits for 1986 and 1987 are even smaller; K 1.1 million and K 518,000 respectively. However, efforts to divest further are to con- tinue with the aim of reducing majority shareholdings. 57. For the future, MDC has ambitious investment plans with an empha- sis on tourism. Proposed investments in the manufacturing sector are limited to a tannery with an investment of K 2.4 million and a controversial fertilizer plant with a proposed investment, for which concessionary funding is sought, of K 200 million, far exceeding MDC's investment policy guide- lines, There are also plans to invest K 23 million in three agriculture based industries. What does not appear in its program is an interest in pro- moting small and medium sized manufacturing projects in association with the private sector. MDC also has plans to expand and rehabilitate some of its existing companies. Foremost is a plan to invest K 11 million in the - 20 - rehabilitation of Portland Cement, which has incurred losses for the last two years and which is wholly owned by MDC. Furthermore, although growth prospects for tourism are by no means assured, MDC plans to invest some K 30 million in the expansion of tourist facilities. The justification for so major an investment in a sector with uncertain future prospects is not elaborated upon in MDC's operational policies and action program approved by its Board for 1986/95. The objective of restoring and limiting MDC to its original function may be more difficult to realize than anticipated. 58. An important aspect of restructuring of MDC and other parastatals was the promotion of training of Malawian managers and technical personnel, but little has happened in this direction. Expatriates still dominate the management of MDC and its subsidiary companies. At least 14 out of the 18 companies partially or totally owned by MDC were managed in 1985/86 by for- eign partners, foreign management or expatriate personnel. While these managers have done an excellent job, it is not clear what will happen after they leave and this is an area to be dealt with if the SALs are to bring lasting change. 59. In spite of ite broad mandate to "develop the agricultural, com- mercial, industrial and mineral resources and the economy of Malawi using sound business principles", natural constraints faced by the economy, the small size of the domestic market, limited access to world markets, the high cost of energy and a shortage of skilled manpower weaken MDC's ability to expand its industrial activities. Apart from a significant contribution to tourism, MDC supported companies have limited exports and MDC's contribution to the balance of payments is negative. The sustainability of the reform of MDC is by no means assured and its future remains uncertain in the absence of clear directions for its future activities. 60. A tranching condition of the second SAL was that there should be satisfactory progress on the agreed program for restructuring and rehabilita- tion of ADMARC, including the filling of all senior staff positions, complet- ing the financial reorganization of the company and developing an investment strategy. This program was derived in part, but only in part, from the rec- ommendations of a consultant study financed under the Technical Assistance Loan. In these terms, satisfactory progress was made (and the second tranche released). However, there is some evidence that the program was not handled as well as it might have been and that its design contained deficiencies that led, and contributed in large part, to the subsequent rapid and unexpected deterioration of ADMARC's finances in 1985. Even so, up to 1984 as a result of the measures implemented, ADMARC's financial position strengthened consid- erably, particularly when profitable, although exceptional, maize export sales and the resumption of cotton exports led to an increase in the surplus it gained from its trading activities of K 6.5 millior in 1983/84 and K 17 million in 1984/85. The extent of and reasons for ADMARC's difficulties are set out in some detail in the PCR, and a separate policy based operation is being designed to address its most recent financial difficulties. 61. Two basic factors responsible for the deteriorating performance of ADMARC were the burden of the strategic grain reserve and the cost of con- structing the storage silos which housed it. The required ADMARC contribu- tion to the Fertilizer Fund also placed a heavy strain on the organization. - 21 - Had provision been made in the program for relieving ADMARC of these heavy costs, which were only removed in 1986 when Government bought the silos, paid for the reserve and waived the contribution to the Fertilizer Fund the deterioration might not have been so rapid or as severe as it turned out to be. Furthermore, even though the Bank repeatedly warned the Government of the inevitable outcome of the imbalance in relative crop prices, the Govern- ment's program failed to anticipate and to provide any solution, other than attempts to improve marketing efficiency, to the upsurge in the quantities of maize being marketed which placed a severe strain or. ADMARC's liquidity and facilities. 62. In addition, the focus of assistance to ADMARC in the shape of the agreed program was too narrow. Issues recommended by the study but not adequately pursued were; the rationalization of the company's relationship with the Government in order that it might be reimbursed, as it eventually was for the strategic grain reserve, for all non-commercial activities imposed by Government on it; and the opening of smallholder marketing to private sector competition, a move now being belatedly sponsored by the Bank in a policy based lending operation directed at the financial problems of ADMARC. 63. As in the case of PHL, attention f . some technical assistance was given to training and human resource deveiopment in general for both parastatals without accomplishing very much and there remains a serious shortage of required skills. It is only recently, under an Education sector project, that these issues are being seriously pursued and the ability of parastatals and other institutions to train their own specialist staff is being enhanced. As far as institutional development is concerned, it is relatively easy to put new concepts and more efficient processes in place, but much more difficult to ensure that these systems and processes which have been set in train have available the human resources to make them work properly. Technical Assistance (PCR paras. 2.66-2.72) 64. As described in the PCR, performance under the Technical Assis- tance loan was generally good. The primary objectives, which were to supple- ment and focus economic sector work in order to provide more detailed measures needed to implement a number of the main adjustments targetted under the program were mostly achieved. In particular, the studies of PHL laid a sound foundation for the subsequent restructuring and rehabilitation of the private sector conglomerate and were predominantly responsible for the urgent remedial action that was taken. 65. The MDC studies were carried out according to their terms of reference and adequately provided a basis for the company's improved perfor- mance. The main recommendations concerning the rationalization of MDC's portfolio, the need to divest itself of majority holdings and its future de- velopment as a mixed (i.e., both public and private) bank were appropriate and a necessary foundation for the policy decisions taken by the Government in respect of MDC. They also assisted the company effectively to design and - 22 - implement an overall budget and monitoring system and to improve its organi- zational structure, policies and procedures. The assistance provided to help improve export capacity, on the other hand, was not beneficial. Few of MDC's subsidiaries had any export potential and the work of the expert unfortunate- ly coincided with the closure of the Mosambique railway routes to the sea. The study on working capital also failed to have much impact. It was diffused over too many companies and, although it was claimed that it contributed to a significant reduction of working capital requirements, in fact they were reduced by not much more than several million kwacha. 66. The ADMARC study was also completed satisfactorily according to its terms of reference and contributed a most useful agenda of actions needed in respect of a range of problems. That several of the recommendations were not pursued in the rehabilitation program that was designed and agreed following the study does not detract from its merits. 67. The livestock marketing and pricing study was a disappointment, the recommendations for the development of the industry and for a pricing policy were not well thought out and, it was concluded, would not contribute to a livestock development strategy appropriate to the discerned needs of the in- dustry. As a result, there was no constructive follow up and a new study was commissioned under an agriculture project. IV. ISSUES The Timing of SAL I 68. The lack of prescriptive detail in the economic and sector work needed to underpin the first SAL has been noted. It resulted in a structural adjustment program which, because a series of studies were required in order to arrive at appropriate prescriptions, was largely preparatory in nature. As much of the reform package had, therefore, to be deferred to the second operation, the impact of SAL I was significantly less than it could have been. Some delay and more preliminary work on the part of the Bank could have resulted in more immediately positive and productive an approach. On the other hand, it can be argued that, even though the earlier economic and sector work might not have been altogether appropriately focussed and that the full prescriptions for reform were not available, there is no substitute for a SAL operation for giving direction, attention and urgency not only to economic and sector work, but also to country strategy formulation and to the lending program; and this is what happened in the case of Malawi. On balance, however, the first SAL does seem to have been somewhat prematurely timed. The main advantage to Malawi of the loan becoming available when it did was immediate balance of payments support but balance of payments support is a collateral or secondary rather than a primary objective of structural adjustment lending. 69. Two comments made by Executive Directors when the loan was pre- sented to the Board are apposite and support this view; "There are problems in the fact that a number of supply side measures could only be determined - 23 - after investigation and review only then being initiated. For example, price incentives would play a major role in increasing amal1holder production, but the scope of these was still to be determined. The same uncertainty applied to some marketing and storage operations. Project work also had to be done in agro-industry and in the identification and determination of investments in energy." "There should be a comprehensive plan of action before finaliz- ing a SAL, rather than just looking around for appropriate measures, reviews and studies in support of such a loan and in order to get such a loan approved."2/ 70. The timing of the operation was significant for another reason. It so happened that its presentation to the Board in June 1981 coincided with a temporary suspension of commitments of IDA fudds. In order to preserve the timing, what was to be an IDA credit was changed into an IBRD loan. IDA funds subsequently became available again later in the following financial year, and a relatively short postponement could have restored the intended level of concessionality. Such an option was offered to the Malawi Govern- ment but their perception at that time was that the need for the SAL was so overwhelming and the domestic pressures to pursue it were so great that they accepted the revised terms. Within the Region, the change was justified on the grounds that Malawi was a blend country, that IBRD's exposure was low, and that given the blend nature of the leading program, it made little dif- ference whether the SAL was on IDA or IBRD terms provided that, later, other lending operations restored the level of IDA in the program. This is not altogether correct, since it is clearly more advantageous for the borrower to receive IDA funds for quick disbursing operations than harder money which would have to be amortized sooner. At the Board, several Executive Directors questioned the fact that Malawi was getting a substantial loan for structural adjustment instead of an IDA credit. A loan of this nature, it was maintain- ed, could have a negative effect on debt servicing capacity. The Bank was granting a loan where the interest rate was higher and the grace and repay- ment periods shorter than the Bank was advising the Government to accept in the future. 71. In this same context it should be noted that the free standing but parallel TechniLal Assistance project which went before the Board at the same time was also on IBRD terms for the same reasons. The amount was small, but even so the financing of technical assistance on IBRD terms to a developing, lower income country is unusual. Malawi is the recipient of large amounts of technical assistance from a number of bilateral donors and from UNDP which is invariably on grant terms. It is not unreasonable to assume that equivalent assistance could have been provided by other donors on such terms, although such a prospect does not seem to have been investigated in any serious way by the Bank. 2/ It is the judgement of the Region that the Bank's knowledge of the economy and the outline program for adjustment were sufficiently advanced that the benefits of delaying structural adjustment until more detailed work could be undertaken were outweighed by the costs of further deterioration in the economy. - 24 - Political Commitment 72. It is almost axiomatic that the success or failure of a structural adjustment program in large part depends on the extent of political commit- ment to it. The absence of such a commitment has been a prime factor in the partial or complete failure of a number of SALs and it is, therefore, not unusual to find the political environment weighed carefully in the scope and design of SALs and safeguards built in against political risk. Determined efforts are made to generate a political consensus by both the responsible Government officials and the Bank on the required policies and measures. In most political systems, the building of a political consensus can be a long and painful process, and there can be no certainty that the short term costs of more difficult reforms as they emerge during implementation will not induce reversals of political support. In Malawi, however, while the rela- tively successful implementation of the first two SALs was largely due to a strong political commitment, it was a commitment of an extraordinary kind which did not require consensus building of the nature normally encountered. The control exercised by the Life President over the political life of the country and over its single party is such that it would be unusual if open opposition were to be expected or encountered., Although normally policy reforms, if they are to be sustained, have to generate active support from the body politic, it is sufficient in Malawi that they are pragmatic and are presented convincingly enough so as to appeal to and obtain the consent of the Life President. It is this feature which explains the sensitivity sur- rounding some of the conditionality which was imposed. Be that as it may, however, there is no doubting the strong intellectual commitment of many responsible officials in Malawi whose dedication to and deep understanding of the principles of reform played a vital role in its furtherance. While the risks surrounding the SALs can legitimately be ascribed primarily to the capacity of the Government of Malawi to implement the program in a timely fashion in the face of unexpected disruptions in the economy and the shortage of skilled personnel, it is almost inconceivable that implementation failure would stem from political resistance from affected parties. The real risk is the reliance on the endorsement of one individual although, of course, the postibility of capricious change would seem to diminish as the series of SALs progresses, as the internalization of the program proceeds and as its benefits are realized, as is now the case in Malawi. There is also the fundamental doubt which must assail most observers of the Malawi political scene, that the country's failure to develop politically jeopardizes sustain- ed economic development since the political institutions needed to further the development process are lacking. The Scope of the SALs 73. No SAL can, nor should it attempt to, address comprehensively the adjustment processes needed to remedy or ameliorate the entire spectrum of disequilibria associated with a country's economy. A criticism common to most SALs approved in the early 1980s is that their design contains too many features and too much conditionality, much of which is overly complex and am- bitious, especially where administrative capacity is weak. This is not a criticism which can be applied to the first two SALs in Malawi, which con- ciously refrained from addressing all the problems of adjustment and - 25 - concentrated on those more obvious deficiencies which were having a short to medium term negative impact on, and were clearly hampering the growth of, the economy. Even so, the SALe had a very full agenda. 74. Nevertheless, three critically important structural imbalances apparent at the time of preparation were excluded from coverage. They were: the high population growth rate, which at 3.2 percent was, and is, seriously eroding per capita income; the need for more efficient and equitable distri- bution of land as a prerequisite to overall improved agricultural productivi- Ly in the face of rapidly growing population pressure on arable land; and the failure of the indigenous private sector to develop. Their inclusion would have overburdened the program and their long-term objectives are probably incapable of realization within the time-frame of a SAL suries and not strictly relevant to the main purpose of alleviating a short to medium terre imbalance in the balance of payments. Such issues might legitimately and usefully be included in SAL, only if other vehicles fail, for the purposes of initiating studies, furthering a policy dialogue, or raising their profile by bringing them to the forefront of political attention and emphasizing the necessity for early remedial action. This was not necessary in the case of Malawi since the population issue is being addressed under health sector lending, and studies on the development of land policies and measures to encourage the growth of an indigenous private sector have been included in a later SAL. 75. Some attention is now being focussed or. land reform. Although ef- forts are being made by the Government to stem such transfers, there is grow- ing land alienation from the smallholder to the estate sector. The present principal agricultural objective is to increase productivity and, thus, land use intensity on customary (i.e., smallholder) land, although a program to reclaim unutilized estate land for the small sector has recently started in a minor and experimental way. Against a background of rapid population growth and increasing population pressure on limited arable land, thought will need to be given to the process by which the inevitable sub-division of the larger estates will take place in the future. Fortunately, land records are already being improved and computerized and a preliminary Bank study on land use being finalized. But more serious and timely planning is required and land reform in general should become an increasingly important aspect of country development strategy. 76. Insofar as the private sector is concerned, the rescue operation mounted to save PHL, its financial restructuring and its managerial reform, were essential to the adjustment process. Although successfully accomplish- ed, some misgivings remain. Given PHL's size, influence and access to resources and its essentially monopolistic nature, a more diverse ownership of subsidiaries might be more beneficial to the economy in the long run, ownership which could have included small and medium scale Malawian business- men in addition to the swapping of interests which took place mainly with public enterprises. Has this commercial and industrial giant been perpetuat- ed to the permanent detriment of local private enterprise and Malawian entre- preneurship? Is the domination of the private sector by PHL, as one Executive Director put it in his intervention during the Board presentation of SAL II, "a dilution of the market place philosophy which originally stood Malawi in good stead"? Since its restructuring, with minor exceptions, PHL has not - 26 - disposed of any more of its investments or brought into its numerous ventures any domestic partners. A bAsic issue, therefore, is whether a Malawian entrepreneur class can emerge which is strong enough to be able to compete with PHL for a foothold in Malawi's small market, especially when that market is also eroded further by a multiplicity of parastatals. 77. There are prospects that PHL will encourage local participation by, for example, developing franchise schemes in which it would provide techno- logical, financial and marketing support to small businessmen, and generally develop markets, for example, in bakeries and market gardening, in an orderly manner. These proposals deserve support, but it is also clear that an urgent need in the small and medium scale sector is for a financing agency to cater for those business opportunities which are not sufficiently large and which do not have the collateral to attract financing by the Industrial Development Bank of Malawi (INDEBANK). The organization set up by the Government with that purpose in mind--Small Enterprise Development of Malawi (SEDOM)--has in- sufficient resources to make a meaningful impact, although additional resources are now being provided under bilateral programs. The encouragement of small and medium local private sector business and industry should be a valuable ancillary feature of the SALs and it is proper that later SAL9 contain provisions to this end. A viable regional market is also needed and regional trade opportunities is an area which needs urgent exploration. One constraint on private sector growth is the Industrial Licensing Act. If local industrialization and Malawian entrepreneurship is to be encouraged, this particular piece of legislation should be amended or repealed to enable market forces, the banks and investors to decide on industrial resourne allocation. While a revision of this Act is being addressed under SAL III, the Bank appears to be uncertain as to other measures needed for the proper evolution of Malawian industry and the development of an industrial sector strategy should be a priority task. V. THE ECONOMIC AND SOCIAL IMPACT The Impact on Economic Development 78. It is not possible to assess with any precision the impact on the broader measurements of economic progress of the policy reforms under the SAL. directed at medium term adjustment in isolation from the short term sta- bilization measures sponsored by the IMF programs and changes in the global economic environment. All affect the main economic indicators and not always in the same direction. It is also difficult to evaluate the implementation and impact of institutional reforms because of the extended period needed for their successful completion. A very broad and, given the time-frame, tenta- tive assessment can, however be attempted. - 27 - On Overall Growth Table 5.1: GROWTH OF GDP AT 1978 FACTOR COST 1981 1982 1983 1984 1985 Agriculture -8.2 6.9 4.3 6.3 0.8 Estate -5.5 23.6 6.6 -0.6 1.2 Smallholder -8.9 2.9 3.6 8.3 0.8 Manufacturing 3.4 -0.2 7.2 3.2 1.3 GDP -5.0 3.0 3.6 3.3 2.8 Source: Malawi Government, Economic Report, 1986 Reserve Bank of Malawi, Financial and Economic Review, 1985. 79. After decreasing in 1980 and 1981, GDP growth began to improve in 1982, showed incipient promise of real recovery in 1983 and then tailed off again during 1984 and 1985, the period in which the policy reforms of SALs I and 11 should have begun to make a perceptible difference. Indeed, as the grawth of real output decelerated, the inflation rate increased and, as will be seen from the next section, the balance of payments deteriorated. The decline in output growth from 1984 to 1985 is disturbing, even though it is projected to improve. The negative growth of estate agriculture in 1984 and the very poor performance of both the estate and smallholder subsectors in 1985 illustrates the minimal and largely unsustained impact of the agricul- ture strategies in the short term, the failure to achieve any major diversi- fication or improvements in efficiency in the estate sector and the extent to which the encouragement of maize production for food security adversely com- peted with hoped for increases in smallholder export crop production. To exacerbate this poor performance, continuing difficulties in international transport hampered the movement of exports and of imports, the cost of which increased sharply, adding to the difficulties of the manufacturing sector; a sector already disrupted by the problems and restructuring of the main paras- tatals and of PHL. The absence of any significant impetus in manufacturing is also the result of the, at least initial, failure of the policies to stimulate agro-industrial output. On the Balance of Payments 80. The current account deficit in the balance of payments improved dramatically in 1984 as can be seen from Table 5.2. - 28 - Table 5.2: THE CURRENT A00UIO DEFICIT AND PUILIC IEBT SEWICB 1981 1982 1983 1984 1985 (<Ndc llons at market prices)- GP 1,103.8 1,242.4 1,434.9 1,688.3 1,858.7 Oarent Acomt -119.6 -il.9 -169.4 - 22.7 -185.8 Debt Service 93.1 77.6 82.1 157.6 191.8 Onent Acoumt (as a percenAg of GDP) 10.8 10.6 11.8 1.4 10.0 Debt Service (as a percentage of GDP) 8.4 6.2 5.7 9.3 10.3 Debt Service (as a percentage of exports) 32.7 27.6 27.5 32.9 42.3 Source: Malawi Goerment, Economic Report, 1986 Reserve Bank of Malawi, Finsmxdal and Econoadc Review, 1985. It would be gratifying to be able to attribute this marked improvement to the impact of the SALs and, to some extent, such an attribution can be support- ed. Agricultural exports by volume did increase and the rate of growth of imports slowed. However, most of the improvement was derived from fortuitous and unsustainable exports of maize following large production surpluses and severe continuing drought in neighbouring countries and more favorable prices, particularly for tobacco and tea. The improvement, however, was short-lived and, although it is not possible to offer a long-term view, recent data indicate that the structural problems of Malawi's foreign trade are still present. The marginal decline in the cost of imports was also short-lived as higher freight charges approximated to 40 percent of imports in 1984 and 1985. The current account deficit which had fallen from K 169.4 million in 1983 to only K 22.7 million in 1984 erupted to K 185.8 million in 1985. As a percentage of GDP, although better than in the late 1970s when it averaged 20 percent, the current account deficit is back to the levels of 1981 and 1982 and only marginally lower than the 11.8 percent reached in 1983. 81. After the reachedulings of the late 1970s and 1980, debt service softened considerably in 1982 and remained well below 1981 levels in 1983. It doubled in 1984 in current prices in spite of debt relief in that year of K 33 million arising from earlier rescheduling, and increased again by nearly 22 percent in 1985. This widening of the non-factor services deficit was the result of the effects of increased interest rates, the appreciation of the dollar and the ending of debt rescheduling as well an to some borrowings required to complete the low yielding investments in such infrastructure as Government buildings and State Houses. Only in the long run if at all can the SAL induced improvements in debt management be expected to be reflected in lower service payments. 82. Some initial emphasis was given to improving energy efficiency and reducing the dependence on imported oil as a part of the strategy to improve the balance of payments. As was the case in so many of the areas in which Malawi sought improvements, the effect was partially vitiated by increasing - 29 - transport costs, but even so there was a declining trend in the volume of imported petroleum products and in their value as a percentage of GDP (from 3.9 percent in 1981 to 2.5 percent in 1984). On the Budget and Public Investment Table 5.3: CENTRAL GOVERNMENT REVENUE AND EXPENDITURES (as percentages of GDP at factor cost - 1978 prices) 1981 1982 1983 1984 1985 Revenues 20.0 19.7 19.9 20.0 24.2 Recurrent Expenditures 21.0 21.0 20.1 21.6 22.6 Development Expenditures 11.2 11.2 10.0 8.2 9.0 Budget Deficit -11.6 -9.2 -7.8 -6.5 -6.2 Source: Malawi Government, Economic Report, 1986 Reserve Bank of Malawi, Financial and Economic Review, 1985. 83. This is an area on which the SALs made a beneficial impact, not only in terms of good housekeeping, but also in the rationalization of public investment. Although resource mobilization as expressed in budgetted revenue did not show any great improvement until 1985, better control of expenditures resulted in a steady decline in the budget deficit from 11.6 percent of GDP to 6.5 percent in 1984. And, as revenues climbed in 1985, the deficit was progressively reduced. The apparent sluggishness in revenue collection in the early 1980s followed major tax increases in the late 1970s when revenue grew rapidly and the effects of recession on, especially, income tax collec- tions and customs receipts. It was against such a background that the revenue enhancement expectations of the early SALs appeared somewhat unrealistic (para. 38). 84. The tight rein on recurrent expenditures and the general control imposed by the Government on, for example, staff increases for general admin- istration purposes is apparent from Table 5.3. In a situation of severe financial austerity it was to the credit of the Government that it did not allow overall recurrent expenditures to escalate. It was, however, in such a difficult financial environment that the SAL conditionality demanding an increased recurrent allocation to agriculture and the verification that allocations to developmental and social sectors were appropriate within the context of the overall budget presented difficulties to which there were no reedy and realistic solutions (paras. 37-38). 85. The process of controlling and improving public sector investment programming has been successfully evolving although further efforts are necessary to continue the improvement of the institutional support structure which remains fragile. Such efforts are in progress in subsequent SAL opera- tions. Better control of capital expenditures is now being realized, partic- ularly as expenditures on buildings which h'.ve dominated capital formation so far during the 1980s are declining as the work approaches conclusion. Some - 30 - control on parastatal capital expenditures is being realized when these expenditures are channelled through the budget but a new framework for the improved management of the parastatal sector and its 'Financial inter-rela- tionship with the Government budget remains to be developed. A review of the parastatal sector recently undertaken by the Bank at the request of the Government should contribute to this end. The demise of the ICC did not appear to detract from the fforts made and the enhanced role of EPD has effectively substituted for ft. As a result of EPD screening, investments are now more likely to be economically viable, to be financially affordable and to conform with national and sectoral priorities. On Institutions 86, The PCR notes that the financial restructuring of PHL was largely completed in 1984, i.e., during the implementation period of the first two SALs, and that the conglomerate has returned to financial health and has be- gun to pay its debts to the Government. Through the divestment of some of its subsidiaries and the consolidation and rationalization of other interests it has become more manageable and its management has become more efficient. Although the rehabilitation of PHL involved the assumption by Government of some of its debts to the detriment of the central budget, there are now hope- ful signs that the debt will eventually be repaid in full, the payment of dividends strictly curbed and a major burden on the finances of Government removed. Failure to achieve the rehabilitation and reform of PHL would have had disastrous implications for the economic performance of the country and, from that standpoint, the assistance provided under the SALs and the Techni- cal Assistance Loan was invaluable. Not only did it retrieve the situation for PHL but, also, by preventing PHL's liquidation, it saved the commercial banking sector to which PHL was heavily indebted and reduced the obligations of ADMARC which had relent to it extensive overseas loans provided by the Reserve Bank to PHL. 87. The parastatal sector in the early 1980s reflected the difficulties being experienced by the Malawi economy. Prior to the crises of the 1979-81 period, public enterprises had functioned reasonably well, were adequately managed and made consistent if modest profits. When faced with problems they could not cope, revenues stagnated and costs, especially debt, increased rapidly. Almost all the public corporations were affected, but especially the railways as a result of declining traffic and utilities which were unable to adjust tariffs quickly enough to keep pace with rising costs. Of the major statutory bodies, Malawi Railways and Air Malawi continued to have heavy losses, but MDC turned consistent losses into a healthy profit, as did ADMARC for a time, and ESCOM, the Water Boards and Malawi Housing Corporation managed to keep their heads above water. Without the SALe, the situation would have been much worse. - 31 - Tuble 5.4: PROFITS (LOSSES) OF MAJOR STATUTORY BODIES (Net. K millions) 1980 1981 1982 1983 1985 Malawi Railways (2.2) (4.4) (6.1) (5.9) (6.1) ESCOM 3.9 0.5 0.8 2.2 5.3 Blantyre Water 0.2 (0.05) 0.3 3.8 3.4 Lilongwe Water - 0.1 (0.1) 0.04 0.1 Air Malawi (0.4) (0.5) (3.0) (11.5) (3.8) MDC (0.7) 2.5 2.8 5.6 8.8 ADMARC (1.0) 3.0 7.9 4.4 (26.0) Malawi Book Services 0.9 0.6 0.9 0.9 1.4 Malawi Housing Corporation 1.1 (0.6) (0.4) 1.0 0.1 Consolidated 1.9 (3.8) (2.4) (2.9) (19.9) Source: Malawi Government, Economic Report, 1986. Reserve Bank of Malawi, Financial and Economic Review, 1985. In spite of the substantial improvement in the performance of some parasta- tals since the commencement of the structural adjustment program, others have improved only marginally and their financial position remains precarious. Outstanding in this latter category is ADMARC which was unable to sustain the gains it made between 1982 and 1984 (paras. 60-63). Social Consequences 88. The first and second Malawi SALs were typical of the first genera- tion of SALs in that no attention was paid to the social implications of adjustment and there is no evidence that the effects the proposed policy changes might have on, for example, income distribution or employment were in any way taken into account. No monitoring mechanisms were established and no attempt was made to identify particular groups which might have been in need of special assistance. What little evidence is available is inconclusive and, in the absence of any detailed relevant data, an ex pgst facto assess- ment of social impact can be made only in very general terms. However, SAL9 were not intended to address social issues directly, there being other more efficient lending instruments designed for such purposes and, in any case, it is extremely difficult, if not impossible, to differentiate between the effects of the SALs and those of other domestic or externally imposed environmental changes and thereby to be able to attribute the social conse- quences to particular measures. Three things are certain, however: that there are social costs and equity considerations in any adjustment effort; that these can be observed empirically even if they can not be quantified, and that the society as a whole stands to gain, if not in the short-term then certainly in the long-run, by the restoration of economic equilibrium and the resumption of growth. - 32 - 89. It is interesting to note that, while the PCR makes no reference to social costs or implications of the reform measures undertaken in the first two SALs, the President's Report on the third SAL for Malawi, which was ap- proved a full year after the final disbursement was made in respect of SAL II, contained a broad assessment of their socio-economic impact. This is in keeping with the increasing level of appreciation within the Bank that some analysis of effects on income distribution and employment is needed in all structural adjustment operations supported by Bank lending. There were, also, several references to the social implications of the third SAL. 90. It is probable that the first two SALs had far-reaching conse- quences for income distribution. The domestic terms of trade shifted in favor of the agriculture sector so that, for the rural segment of the population, higher prices for smallholder agricultural production meant increased incomes which were only in small part eroded by the partial removal of the fertilizer subsidy, since only a small proportion of smallholders used this expensive input. Generally, rural incomes and rural purchasing power must have increased. The reform and restructuring of ADMARC has also minimized the possibility that in the future it will again implicitly tax smallholders by withholding high percentages of sales proceeds to finance investment in non-agriculture related ventures. Both the rural and urban poor must have benefitted from the higher recurrent allocations in the budget for the social sectors, but it was the urban poor in the main who suffered from the decline in real wages resulting from the restraints on wage and salary increases. Both categories stood to lose by the resource mobilization efforts of the Government in so far as enhanced cost recovery was concerned. The restructuring of the parastatals, and particularly of PHL, must have increased levels of urban unemployment as these organizations strove to become more cost conscious, trimmed padded payrolls and divested. It is possible that PHL might have created more employment in the rural sector through its estate farming activities but, if so, these increases would need to be offset by large labor reductions in the industrial sector. On the other hand, the SALs provided resourcesior imports of machinery, equipment and intermediate goods without which prpduction and employment would have been further curtailed, and counterpart funds which helped Government avoid overly drastic cuts in domestic expenditures which would almost certainly have been at the expense of the poor in terms of services provided. In the final analysis, of course, unemployment and income losses would, inevitably, have become much more severe if the downward spiral of the economy had not been halted and if no steps to restore growth had been taken. 91. Nevertheless, consideration should be given, if at all possible, to practical %nd effective means of sharing the burdens of adjustment better, to ensuring that social disruptions are minimized and to attempting to mitigate adverse impacts on the poorest. Where the design of a SAL can be adapted without the loss of efficiency to create such an adjustment program, such modifications should be pursued and thnir incorporation encouraged. In addi- tion, it seems desirable, when it is possible to identify particular groups that will be adversely affected, to devise complementary financial and non- financial assistance, if necessary in conjunction with other donor agencies. - 33 - VI. MAIN CONCLUSIONS AND LESSONS OF EXPERIENCE The Evolutionary Nature of the SAL Series 92. While SAL I was essentially preparatory in nature, leaving a much more specific and meaningful program of adjustment to SAL II, the third SAL, which this review does not embrace, consolidated and expanded further the advances which had been achieve4, focussed more precisely and forcibly on imbalances and weaknesses which had not responded to earlier prescriptions and, in general, assisted in sustaining the growth of per capita income. In an evolutionary series of this nature, the difficulties inherent in evaluating performance become pronounced. Many of the shortcomings and inadequacies in scope, design and performance in the first two SALs, which this report has identified, have been addressed in SAL III, or their omissions provided for in other subsequent lending, and the lessons of experience conceptualized for adoption later in the series. Examples of such agenda items are; a greater concern for the socio-economic impact and the more equitable distribution of adjustment costs; schemes for medium and long-term credit for agricultural estates and estate management programs; the revision of the Industrial Development Act with a view to encouraging competition and restricting protectionist use of the industrial licensing system; the finalization of an export promotion policy scheme and the setting up of an export financing facility; the introduction of a more programatic content to the budget; and the acceleration of ADMARC's rationalization efforts. The weakness, therefore, in reviewing implementation performance at a set point in an evolving process is that the assessment is unable to do justice to the mechanics of progressive improvement by the assimilation and application of lessons learned through experience, both by the Bank and the recipient Government. The following conclusions and lessons should, therefore, be tempered by this reservation. The Main Achievements and Failures 93. The central objectives of the adjustment program, the strengthen- ing of the balance of payments position and the restoration of economic growth, were reached in that, as percentages of GDP, the current account deficit declined during the initial period of implementation, as did debt service and the budgetary deficit, and GDP growth averaged 3.3 percent immediately after the negative growth of the preceding years. However, the contribution of the adjustment program, whilst positive, was outweighed by the impetus to growth conveyed by such external factors as globally deter- mined price increases for Malawi's main exports of tea and coffee, and by the fortuitous opportunity presented by continuing drought in neighbouring count- ries to export on a once only basis large quantities of surplus domestic maize production. While an appropriate mechanism for determining crop price levels was installed and utilized with some effect, the impact of upward adjustment to smallholder export crop prices on production was delayed and muted by disproportionate price incentives for maize production and, in the first few years, smallholder crop export growth was disappointing. Little was achieved in the area of estate crop diversification, in improving the - 34 - efficiency of estate management or in the growth of agro-industry. While the Government continued to implement appropriate pricing policies in respect of petroleum products, conservation and increased efficiency of use were not pursued as energetically as they might have been; but, even so, savings on the petroleum import bill were realized. And, the ever increasing additional external transport costs incurred through the closure of access to the sea through Mozambique placed continuing and excessive burdens on the economy in general and the balance of payments in particular. Whatever the cause, however, the favorable trends towards growth and a more sustainable balance of payments position were reversed in 1985, indicating that structural imbalances remained. 94. The removal of price controls on all but a few items might have increased the availability of certain commodities but no systematic study of the impact of this measure on production was undertaken and it is not possible to assess its contribution to the efficiency of domestic produc- tion. A coherent wage policy is still needed. 95. Much better results were achieved in the more efficient use and improved allocation of resources. The rationalization of the process of budget preparation and of public expenditures and public investment in particular has led to significant improvement. Revenue enhancement measures, although implemented diligently and in full, were not so successful, revenue remaining in real terms more or less constant at that time. Other domestic resource management measures, exchange rate adjustment and interest rate changes, were carried out' appropriately and in conformity with the under- standings entered into. 96. Institutional improvements in economic planning and the monitoring of investments are successfully evolving as are the efforts to install external debt management, albeit with some delays, and the difficult and often sensitive measures which were taken to rehabilitate and financially restructure PHL and MDC met with a good measure of success. Improvements were also accomplished in the financial standing and management of ADMARC although that success was short-lived. The Technical Assistance Loan was well utilized by the Government and, although in some respects less than useful advice resulted, overall it played a valuable part in establishing and refining the necessary remedial measures, and particularly in guiding the complex restructuring of PHL and the major parastatals. 97. While the results which have been achieved during the relatively short period of implementation of the first two SALs can be described as mixed, substantial progress was made in a number of areas, laying a good foundation for the third and other possible operations in the pipeline of lending. In the particular and peculiar circumstances of Malawi, it is surprising not that optimal adjustments were not realized, but that adjustments leading to some growth were accomplished at all. The most fundamental of all the structural disequilibria affecting Malawi, which impacts with adverse consequences on every facet of economic activity, is the external transport situation imposed entirely from without and resulting in a complete lack of access to the most cost effective routes to the sea and in - 35 - crippling additional costs. It represents a gross distortion which is not amenable to any domestic policy reform. In such a context, what progress has been made is doubly commendable and if the SALs can do little more than arrest the deterioration in the economy until such time as full regional cooperation can be restored they will have served an invaluable purpose. The Performance of the Borrower 98. While most of the action programs werd implemented without undue delay, they were not all equally effective and performance was less than agreed in several areas, resulting in the postponement of the release of both second tranches. There were lags in commissioning studies, avoidable budge- tary problems, increases in debt despite the strengthening of the debt monitoring function, and delays in revising producer prices for some smallholder crops. These performance inadequacies were remedied in due course. On the other hand, in most areas of reform implementation performance was sound. 99. Factors affecting the performance of Government for the worse were unpredictable external events, in particular the worsening of the external transport problems, but also fluctuations in the international prices for the country's main export commodities; and for the better, the relative efficien- cy of the civil service and, above all, the endorsement of the reforms by the sole domestic political arbiter of Nalavi's destinies, the Life President. In addition, however, the action programs were quite specific.concerning the actions to be taken and in designating the agencies to be responsible for implementation; and the combination of clearly enunciated policies and frequent reviews of progress which the Government undertook were also instrumental in obtaining better results than might otherwise have been achieved. The Contribution of the Bank 100. It is unlikely that Malawi would initially have been able to pre- pare and design its own comprehensive stabilization and adjustment programs without the assistance of the Fund and the Bank. The Bank's support in help- ing to initiate and monitor through regular supervision the process of adjustment has been an important factor. In all, counting mission time spent in the field only, preparation, appraisal and supervision accounted for some 95 weeks of Bank staff time, over 50 of which were spent on supervision. These frequent visits helped to maintain the momentum of re!- .rm and assisted in collaborative problem solving. The Bank's careful and generally mutually reinforcing coordination with the IMF was also an essential ingredient of effective structural change. One of the most significant achievements of which this report has not so far taken cognizance since it becomes apparent only later in the series, is the extent of internalization of the process and the growing degree to which the Malawi Government is now taking the initiative in formulating current and future action programs for adjustment. 101. Although the economic and sector work underpinning the first SAL was insufficient to provide in full the prescriptions Malawi's economic situ- ation demanded, thus necessitating a complementary technical assistance - 36 - input, the Bank's earlier economic and other work did help in focusslng attention on areas where significant change was needed and in translating adjustment strategies into actionable programs. Sustainability 102, Without a lasting political commitment to policy reform and the de- velopment of institutional capacity to implement the requisite measures in an appropriate time-frame, sustainability of the adjustment process is unlike- ly. The nature of the political support to adjustment in Malawi has been discussed in para. 72). So far, there seems no reason to doubt that the commitment will continue. The institutional capacity to sustain reform, how- ever, appears to be remain fragile as is to be expected when full institu- tional development, as is invariably the case, requires a longer time-frame. Malawi still lacks sufficient trained manpower confidently to expect the new concepts and processes set in train to be operated without risk of failure. Technical risks stemming from the program's complexities require an unusual degree of coordination among ministries and public agencies, a level not yet fully realized in Malawi in spite of the obvious competence of its senior bureaucrats. 103. Specific areas where the sustainability of reform may be endangered are: in DSB, where more support in terms of staffing is needed, and the relationship with OPC, which is in danger of degenerating, requires strengthening; in PHL, where a dynamic management, impatient under the con- straints imposed by restructuring, is eager once again to exploit opportuni- ties for expansion which may not be in the national interest and where con- tinued guidance is needed if some of the mistakes of the past are not to be repeated; in MDC where the sustainability of the reforms is by no means certain without clear directions for its future activities, the management's plans for which already appear to be tending towards the transgression of the principles of reform; and in ADMARC, where the financial and managerial improvements made in the 1982-84 period could not be maintained, necessitat- ing a new round of assistance and reform provided in a Supplement to SAL III. 104. Institutionalization of the adjustment process through its entrenchment in, for example, a formal and politically endorsed development plan is a valuable device for buttressing sustainability. Malawi is moving in this direction with the adoption of three year forward budgetting, and sustainability will be strengthened to the extent that these budgets reflect the policy environment for reform by adopting and extending the programs and objectives of adjustment. A permanent framework for the integrated manage- ment of structural reform is also an important ingredient of sustainability. This, in embryo, is to be found in Malawi in OPC and the Ministry of Finance, and the strengthening of economic planning and management capacity which was started under the first two SALs is an important preliminary step in the direction of needed institutionalization, as is the sustaining of a metho- dology for crop pricing which has gained the confidence of the Government and, to some extent, the producers. And, finally, the eagerness of the Government to continue the relationship with the Bank in matters of struc- tural adjustment, its willingness to enter into new SALs and the authority - 37 - with which the Government is now formulating its own prescriptions for reform and conducting its economic dialogue with the Bank reinforces confidence in the sustainability of the process. Lessons of Experience 105. The first two SALs to Malawi have already been augmented by a third, and a fourth is in the lending operations pipeline. Since the adjust- ment process in a country such as Malawi facing serious economic problems is inevitably going to be prolonged, a series stretching over a period of five or more years is obviously appropriate. However, for this reason, it is of great importance that the lessons of early experience are quickly assimilated and applied in order to improve the effectiveness and impact of later pro- grams. An assessment of whether the third SAL benefitted from the experience of the first two is outside the ambit of this report and will have to await a later audit. At this stage in the evaluation of the series, however, there is no reason to doubt but that the architects of the third and those struc- turing the rest of the series did benefit from the early SALs. The following may, therefore, represent some repetition of lessons already derived and adopted. * The critical element in all structural adjustment operations is a strong political commitment to the process, and it makes no differ- ence whether this commitment is autarchical, as it is in the case of Malawi, or whether it is the result of a complex process of political consensus. The support of a competent and motivated bureaucracy is also a prerequisite to success, * SAL programs need careful coordination with IMF operations. In the case of Malawi, the coordination was good and the support provided by the Fund and the Bank was generally mutually reinforcing. * Focussed economic and sector work is a necessary preliminary input to the fashioning of any meaningful adjustment reform. Where it is not present in sufficient depth to provide the analytical basis for all facets of the required program, carefully defined and directed technical assistance should be supplied within a suitable time- frame. That this was done in the case of the Malawi SALe contri- buted in no small measure to the progress made, especially in the financial restructuring and managerial reform of the main parasta- tals and PHL. * As illustrated by the case of Malawi, the design of policy should be taken as an evolutionary process in which flexibility is needed as institutional, social and political issues and interactions re- sult from implementation and new areas of focus are discovered and new approaches made desirable. * The addressing of politically sensitive issues requires realism and compromise, as exemplified by the handling of the PHL reform. - 38 - Sector related policies such as crop diversification in the estate sector of Malavi can be important to support macro-economic adjust- ment and may have to be incorporated in SALs, especially in a small country such as Malawi where a large number of sector operations may not be feasible given the relatively small size of the lending program and the resources available. There is a far greater prospect of policy reform being sustained if, as in the case of Malawi, it increasingly emerges from a strengthened internal process for initiating, formulating, imple- menting and monitoring reform programs, an improved technical capa- city to undertake policy analysis, and the institutionalization of economic policy management. In institutional development, it is easier to identify problem areas and to put concepts and processes in place than it is to ensure that the processes which have been set in motion have available the trained human resources needed to make them work properly. The major adverse social impact of the SALs in Malawi was felt through increased unemployment associated with the reduction in public expenditures and divestment and consolidation of Government and PHL owned enterprises and through higher living costs arising from the depreciation of the currency. While the Bank was sensi- tive to these consequences, no efforts were made in the SALs to mitigate the possible adverse social impact of the adjustment pro- cess. For the future, consideration should be given, either in the context of the SALs or in other operations, to practical and effec- tive means of sharing the burdens of adjustment, of ensuring that social disruptions are minimized and of attempting to lessen adverse impacts on the poorest. - 39 - PROGRAM COMPLETION REPORT MALAWI STRUCTURAL ADJUSTMENT I (LI. 2026) STRUCTURAL ADJUSTMENT II (CR. 1427) TECHNICAL ASSISTANCE I (LN. 2027) Eastera and Southern Africa Region August 12, 1986 - 40 - . - MALAK STRUCTURAL ADJUSTMENT I (LN 2026) STRUCTURAL ADJUSTMENT II (CR 1427) TECHNICAL ASSISTANCE I (LN 2027) PROGRAM COMPLETION REPORT SUNMARV A. Background to the Structural Adjustment Operations 1 After 15 years of steady growth, the Malawian economy began to stagnate in 1979 and the external and government accounts began to deteriorate. While the Government had successfully steered the economy through balance of payments crtses in the past, the balance of payments crisis which started in 1978 was less manageable because of the unprecedented drop of 40 percent in Malawl's terms of trade. In addition, agricultural production suffered from drought, reducing export volumes and necessitating large Imports of atse, a commodity in w4hich Malavi had been self-sufficient for most of the 1970s. Finally, disruptions to the transport system through Mosambique forced Malawi to use more costly alternative, rail, road, and air routes. As a consequence, the current account deficit rose to 20 percent of GDP In 1978-80. Capital inflows, although Increased, did not cover current account deficits and foreign exchange reserves fell from the equivalent of over five months of imports to less than two moths between 1977 and 1981/82. Moreover, average terms of borrowing hardened in the late 1970s and the debt .service ratio climbed rapidly from 7 percent of exports of goods and services in 1977 to 26 percent In 1981. i. As a result of these deteriorating external conditions and adverse weather, GDP growth fell from 3.5 percent in 1979 to -1.0 percent In 1980 and -5.0 percent in 1981. Malawi's fiscal position also deteriorated seriously as revenue growth declined while expenditures continued to grow rapidly. The budgetary deficit averaged about 14 percent of GDP during 1978/79-1981/82, compared to the historical level of about 8 percent. To finance these deficits, the Government resorted to increased domestic borrowing, mainly from the banking system, and foreign borrowing, partly on commercial terms. III. While the primary cause of Malawi's economic difficulties was a serious deterioration in the country's terus of trade and in transport conditions, the crisis also revealed important structural weaknesses in the economy. First, the heavy concentration of exports in a few estate-produced agricultural commodities; second, the slow growth of smallholder production for export; third, the modern sector's dependence on costly Imported oil and the progressive depletion of domestic fuelwood resources; fourth, the deteriorating financial position of public enterprises; fifth, the budgetary Imbalance; sixth, Inadequate government recurrent as compared to capital expenditures; and seventh, a rigid system of administered prices and wages. - 41 - IV. Recognising these problems, the Government, in consultation with the Bank and the DI, foimulated a medium-ters program covering 1981/82-1985/86. The Government's major objectives for the five years weres (a) a real GDP growth rate of 4.8 percent; (b) Increased diversification of foreign exchange earnings and domestic savings by developing new crops for export, and expanding livestock and forestry Industries and agro-business; and (c) Improvement In the financial performance of the Government and public enterprises to reduce dependence on external resources and domestic borrowing. v. While the Goverament's program identified a broad range of issues to be addressed, it is noted that the Bank and Fund operations were designed in the context of a policy eaviroment substantially free of gross distortions. Malawi had beguan Its development at independence in 1964 by establishing sound economic policies oriented to outward-looking, export-oriented growth, and the pursuit of an open, market oriented economy. The economic crisis highlighted the need for addressing mainly Institutional Issues related to economic and parastatal sector management and the need to Improve incentives for growth and diversification, No truly serious distortions had been highlighted during sector work or during preparation of the SAL. 1. The Structural Adjustment Operations vi. Specific policy measures supported by the SAL I loan of US$45.0 million and the SAL I1 credit of 8S$55.0 million were as follows: (a) Balance of pamts - increased prices for agricultural export crope with periodic reviews; increased budgetary allocation to the Hinistry of Agriculture; review of the efficiency of the agricultural marketing organisation; studies of the livestock and tobacco sectors, including diversification of tobacco estates; a study of the energy sector and continued adjustments in energy prices; and Increased agro-Industrial investment. (b) Price incentives and incomes - 1overnment review .of the price and wage control system with a view to introducing more flexibility and more frequent adjustments; increased public utility and transport tariffs with closer monitoring and adjustment in the future; studies of the national railway and airline companies; a detailed plan to increase cost recovery for housing provided to civil servants; and periodic review of the exchange rate. (c) Resource management - establishment of the Department of Statutory Bodies to assist public enterprises In planning and financial management; periodic review of Interest rates; steps to Increase government revenue; strengthened control and montoring of domestic expenditure; improved monitoring and management of public debt; limiting Government domestic and foreign borrowing to ceilings agreed with the DWF; a new five-year investment progrea with increased shares for agricultural and for social services; and a commitment to adequate levels of recurrent financing for key development ministries. - 42 - (d) Institutional iapRovMements - establiabment of an Investment Coordinating Committee to oversee all major parastatal and public investments; technical assistance to strengthen key planning and budgeting ministries; and rehabilitation of the key public and private sector conglomerates through improved management and financial restructuring. C. Iaplementation and Impact v.. Implementation of the prescribed policy measures, given their institutional nature, was complex, and time consuaing organizational and policy changes were required, with the result that there were six-month delays in the release of the second tranches for both operations. However, significant progress was made in nearly all key areas. vii. A comparison of objectives and achievements is summarized in the Key Economic Indicators table on the following page and discussed below. 1. Ekpansion of the Economic Base Lh. Objectives Included specific targets for GDP growth rates and the current account deficit. The targets assumed achievement of increased diversification of sources of foreign exchange earnings through development of new smallholder and estate crops, faster smallholder export crop growth and development of livestock and forest industries and agribusinesses. x. Against the revised target of 3.4 percent average annual growth,1/ in real terms GDP grew at rates of 2.5 percent, 4.1 percent sad 4.1 percent in 1982, 1983 and 1984 respectively, an average of about 3.6 percent. Preliminary indications are for a 2.8 percent GDP growth in 1983. xt. The adjustment program has relied heavily on correcting prices and economic incentives to encourage increased and more diversified exports. Between 1980/81 an4 1984/85, during a period when consumer prices are estimated to have risen by 61 percent, Government administered producer prices of the five principal crops have been increased as follows: asize by 82 percent, rice by 70 percent, cotton by 100 perdent, groundnats by 112 percent and tobacco by 120 percent. The production response for.the various crops has varied; present estimates are that by 1985 the production of maize will have risen by 116 percent from its 1981 level, cotton by 75 percent, and tobacco by 55 percent. The better supply and distribution of smallholder fertilizer supported by the SAL operations have also contributed to the increases in output, and price increases appear to have been adequate to offset reductions in fertilizer subsidies. xil. In addition, significant steps have been taken to reduce the extent of price control. Controls have been eliminated for all but 5 products, as compared with 60 prior to the SAL9. A systematic study of the Impact of these measures on production has not been carried out; however, Increased availability of certain dairy products and other consumer items has been reported. ' The GDP growth target was revised at the time of appraisal of SAL I due to the continued deterioration of the economic environment. KEY ZCONOMIC INDICATORS Annual Growth Rates (2) SAL II Apprateal Estimates 1 Actuals 2/ Average 1983 1984 1985 1986 1987 1981 1982 1983 1984 National Accounts GDP 3.4 2.6 3.0 3.5 3.9 4.2 -5.0 2.6 4.1 4.1 Agriculture 3.4 2.7 3.2 3.6 3.8 3.8 -8.2 6.9 4.3 6.3 Industry 3.7 2.5 3.0 3.7 4.4 4.9 -2.6 -.4 4.1 2.9 Services 3.4 2.5 2.9 3.4 3.8 4.3 -3.6 .6 4.9 8.6 Consumption 2.3 1.4 1.0 2.2 3.2 3.5 .5 .6 1.0 9.0 Gross Investment 11.22 20.2 13.7 9.8 6.1 6.3 -61.0 5.8 1.2 5.0 External Trade Merchandise Exports 5.4 6.4 6.1 4.8 4.8 4.8 7.1 20.3 Primary 5.4 6.5 6.2 4.8 4.8 4.8 Pafactures 4.1 4.0 4.0 4.0 4.0 4.5 Merchandise Imports 6.5 14.2. 5.4 4.9 3.9 4.3 -8.7 -14.9 I Percent of GDP Actuals 2/ Publie Finance Bank Estimate 1983 1984 1985 Budgetary Deficits (FY86) Excluding granLst -7.5 -12.7 -10.8 -8.3 Including grants: -5.5 - 9.3 - 8.1 Development Expenditures 8.8-9.0 11.4 10.1 7.6 Revenue Account Expenditures (85/86) 15.4 21.2 20.4 20.7 Revenue (average throughout period) 16.6-16.9 19.9 19.6 20.0 /~ Source: SAL II Presidentes Report 2, Source: Malawis Economic Recovery Resource and Policy Needs, An Economic Memorandum -44 xii., The balance of payments improved significantly, especially in 1984, reflecting mainly positive developments in the trade account and despite disruption and subsequent increased costs of external transportation, The current account deficit (after debt relief) is estimated to have declined to MK -48.8 vlljn In 1984 compared to UK -169.4 million in 1983. This represented 2.9 percent of GDP, compared with 12.3 percent in 1983 and the IMF#' program target of 8.8 percent. This also compares to a current account deficit of 17.8 percent of GDP and 24.8 percent of GDP respectively in 1978 and 1979 at the onset of the crisis and the average 7 to 9 percent of GDP achieved in the earlier part of the 1970s. xiv. The rate of growth of Imports has also slowed considerably. This is partly attributable to the higher domestic prices of Imports following the depreciation of the Malawi kwacha and the higher costs of transportation and it also reflects the tighter allocation of foreign exchange for imports exercised by the Reserve Bank., The overall terms of trade are estimated to have improved by about 4 percent in 1984. xvO Overall, after declining in both 1982 and 1983, the US dollar value of exports increased by 34 percent in 1984, giving about a 16 percent increase during the three year period after 1981, very close to the targetted 5.4 percent annual growth rate. Exports of smallholder products rose from 28.4 percent of total exports in 1981-1983 to 35.4 percent in 1984. The volume of oil imports has declined by about one-third since 1980, in part because of the increased blending of ethanol with regular petrol, supported under the program. However, lower prices for tea and tobacco as tall as higher external debt service increased the deficit on the current account In 1985. Zvi, Further progress is expected to be made under the third phase of the adjustment program in diversifying the commodity structure of exports which has not changed much since commencement of the adjustment effort. 2. Resource Management xvii. The SAL program included the objective of ensuring the efficient use of public resources. In this respect, revenue measures were intended to reduce the overall deficit from over 15 percent of GDP in 1981/82 to 5.5 1985/86; and a capacity to monitor and manage Government borrowing as well as the finances of statutory bodies was to be established. The Fund's EFF program included specific measures and performance criteria to control expenditures and to restrict the undertaking of new short-term non-concessional external borrowing. It also included (a) separate sub-ceilings on domestic bank credit to statutory bodies and the banking system's net claims on the Government, and (b) the introduction of monitoring committees which were to review expenditures of ministries and departments against monthly allocations. Eviii. The objectives of the SAL were successfully achieved in terms of (a) Uaproving the process of public investment programming, including programming for the investment expenditures of the principal parastatals through the central budget; (b) Improving sectoral allocations including a reduction of development expenditure on government buildings from 25 - 45 - percent of the total budget in the 1970s to 12 percent by 1984; and (c) In making substantial progress in establishing a debt management unit in the Ministry of Finance. xis. The deficit, measured as a percentage of GDP, had grown rapidly from FY79 to a peak of 16.5 percent in FY81, before declining and returning to only slightly above historical levels (8.3 percent) by FY85. While revenues have been on or above target, and development expenditures have remained near or below targetted levels, recurrent spending has usually exceeded the budget. Overruns have been concentrated in recurrent expenditure in the wage bill, due to a 10 percent average salary increase for Government workers, in non-wage goods and services, and In external interest payments, largely on account of appreciation of the US dollar. Indicators of Central Government Operations (Percent of GDP Unless Otherwise Indicated) FY79 FY80 FY81 FY82 FY83 FY84 FY85 Revenue 18.4 21.8 20.6 20.4 19.9 19.6 20.0 Rscurrent Expenditures 16.6 18.3 19.0 21.4 21.2 20.4 20.7 Development Expenditures 14.0 14.9 18.1 11.5 11.4 10.1 7.6 Deficit -12.3 -13.9 -16.5 -15.9 -12.7 -10.8 -8.3 Domestic Bank Borrowing as a Percent of Total Expenditures 4.4 7.5 13.4 20.8 5.1 1.4 5.0 xx. The Finances of Statutory Bodies and Press. The overall financial position or the parastatal sector has improved substantially since commencement of the program. While the consolidated accounts for the public enterprises have shown losses almost consistently since FY80, a MIA1.0 million profit was registered in FY85. However, a number of enterprises have remained in serious financial difficulties. In 1984, the main improvement in performance came from ADMARC; its financial position had strengthened considerably, when profitEIaize export sales and the resumption of cotton exports led to an increase in the surplus earned from its main crop trading activities from MK6.5 million in 1983/84 to an estimated K17.4 million in 1984/85. =a. Subsequently, ADMARC faced major financial difficulties, which resulted in the breaking of ceilings for credit to the statutory bodies and a suspension of purchases from the Extended Facility in 1985. To a great extent, ADMARC's difficulties originated in decisions regarding maize prices taken in 1981. However, these financial difficulties highlighted weaknesses in AWLARC's management and investment policies, which are now being addressed under a separate proposed ADARC project. With regard to prices, the relative price for maize became seriously out of line with prices for export crops, and resulted in large surpluses of maize production, greatly increased storage costs, and a persisting debt overhang from overdrafts (used for crop purchases), which could not be repaid when export sales did not materialize and when receipts from tobacco exports were far below normal in 1985. In addition, ADMARC's purchases of other - 46 - domestic crops significantly exceeded the budgeted level further contributing to AMARC's need for credit being greater than the INF's program had expected in 1984/85. rZial The Malawi DevelosMent Cororation ( aDC). the COIo (MC3~ ane a ectnelity supi Comission t2a alo- Improved their performance, but heavy amortization obligations continued to create cash flow problems for ZSCOM during 1984, and are likely to do so in subsequent years* MDC's recovery has permitted it to earn profits of about HW6 million and M11 million in 1984 and 1985, compared to a loss of about MK3.0 million In 1983. Malawi Railwa continues to take cost-cutting measures and taritf Increases to actively develop new domestic sources of revenue and to seek substantial relief from its debt obligations to the Government. Serious concerns persist with the position of Air Malawi, whose losses increased to 1984 because of the increasing fuel and maintenance costs of an old and Inefficient fleet, combined with falling demand on international routes. Exii. The financial restructuring of the Press group of companies (PGL), studied and carried out during the first an second SALe, was largely completed during 1984. PGL has returned to financial health and has begun to amortize the income notes issued to the Government in exchange for the Government's assumption of )K54.2 million of the company's debts. The Goverament's annual Incremental debt service on account of this transaction is approximately K8.5 million (including amortization on a 25 year schedule). In principle, the instruments Issued by PGL should offset the cost incurred by the Government, although Press' payments would begin at a relatively low level in the early years. In 1985, the company paid approximately NO million to the Goverment on this account. 3. istitutional Improvements xxiv. The objectives of the SALs included measures to improve economic sasgement including the monitoring of investments and debt management. The control of public sector investment has two facets - (a) public sector Investment programming and (b) the control of parastatal investments. Since SAL I, second tranche release conditionality has included agreement with the Bank on the public sector Investment program. The process of improving Investment programming was to Include agreement on the overall sise of the development budget, agreement on sectoral allocations and the screening of investments In terms of their economic viability, their financial affordability and their priority within the objectives of the overall investment program. The Investment Coordinating Committee was established to screen parastatal investment proposals using standard feasibility analysis techniques. Ultimately the public sector investment programing process ws to Include the screened parestatal investment proposals and, therefore, provide a consolidated public sector investment budget. XXy. This aspect of the SAL program has been successfully evolving (para. xviii). Under SAL III further efforts are being made to introduce a more programatic content into the budgeting process and the investment and recurrent budgeting functions have been merged and are being organized under the New Economic Planning and Development Department-(PDD). While the Investment Coordinating Committee is defunct and was never -47- appropriately staffed to undertake the activities envisioned for it, the* Government has taken the initiative in requesting IDA to undertake a review of the parastatal r -etor including its financial interrelationship with the Government budget. A review of the parastatal sector is expected to lead to development of a framework for improved management of the sector, including strengthening of the Department of Statutory Bodies which, since its establishment in 1986, has successfully played a technical assistance role for the sector and whose role is expected to be expanded and strengthened. xxvi. Efforts to install a centralized debt management capacity in the NListry of Finance have been slow, but successful, especially In light of the fact that the Malavians have been developing their own systems'with limited external assistance. Currently, the unit is in the process of establishing a register of all debts, consisting of a listing of debt and debt service data including parastatal and central government debt, but not yet Including private non-guaranteed or short-term debt. IDA's assistance has played an Important role in getting the data into one place and in convincing the Reserve Bank to coordinate closely with the External Aid Division of the Treasury where the debt management unit is located. x%vii. The genesis of Malawi's debt crisis preceded the SAL, and rescheduling preceded establishment of a functioning debt analysis and debt management capacity. Therefore the impact of having such a system has not yet been felt. Nowever, Malawi has been successful in respecting the IMP program ceilings on non-concessional external borrowing in all maturity ranges. Although the program permitted up to SDR 5 million in borrowing with 12 year maturities, Nalawi has undertaken no new non-concessional external borrowing. Except for normal trade financing, the Government and public enterprises did not undertake any borrowing with maturity of less than one year. The Reserve Bank of Malawi had also completely repaid the amounts outstanding relating to lines of credit from foreign commercial banks by the end of 1984. D. Lessons Learned xxviii. Lessons learned related to the adjustment process are as follows: (a) policy design has been a process of evolution which began with implementation of solutions identified during economic and sector work, ith implementation experience - having the results of initial policy prescriptions, experience with management and implementation capacities, and deepening understanding of political and social dynamics - policy design has evolved to a more sophisticated level of activities and has gradually focussed on establishing a firmer institutional base for the adjustment process; (b) Government commitment evolves with continuity of staff, their increased understanding of the adjustment process and the establishment of credibility and trust between Bank and Government staff through solid analytical work and some demonstrated successes. Similarly the Government's role in the shaping of the various SAL operations has substantially increased over time; and (c) the SAL process can be a mechanism to address sensitive areas which cannot be dealt with independently by the civil service. Cases in point are Press related issues and the share of Government buildings in the Public Investment Program. - 48 - xix. Lessons learned during Japlementation of prescriptions in various policy areas follows. Sport Diversification. Although initial concentration on price policy as a means to achieve this objective may have been appropriate in the overall sequence of policy design, it is now recognized that diversification of the export base requires complementary specific and direct government intervention and supports. An export promotion policy and financing package is being developed under SAL III to be followed up with other direct project interventions. Agricultural Price Policy. In this policy area, lessons learned with the handling by the Government of apparently conflicting objectives regarding food security and the promotion of export crops are worth bringing out. The Bank's position was that the high relative maize prices would seriously erode incentives to produce export crops. The Government's position was that the relatively high price of maize was justified given the Importance of the food security objective. Although the Bank continued to press its point on the issue and was successful in limiting further maize increases, it was not until AUKARC's liquidity crisis in 1985, due in large part to the high costs of the company's purchase and storage of large maize surpluses, that the Government agreed to tackle ADMARC and related agricultural pricing issues in a comprehensive fashion. Expenditure planning and resource mobilization. The key lesson learned over the course of the structural adjustment process is that, while implementation of ad-hoc targets will give short term results, other problem may arise, and it is therefore best to focus .over time on improving the process and strengthening the institutions responsible for budget making and tax policy. Under SAL II, this approach is emphasised. Industrial Sector Development and Policy Environment. Initial sector work did not identify any substantial issues affecting the industrial sector. Issues related tb the Impact of price controls, a restrictive foreign exchange allocation system, and the need to give more attention to industrial sector development were identified during appraisal and Implementation of SALs II and III. Thus, continued review and analysis of sectoral issues resulted In identification of constraints to development not readily apparent at the onset of the structural adjustment process. E. Bank Performance xxx. The Bank performed the functions of (a) helping the Government to identify development constraints and (b) helping the Government to design a program to address those constraints, including the design of a complementary lending program, in an appropriate and reasonable fashion. Conditionality was based on detailed consultant studies financed by the TA I project and by sector studies and was pursued within limits which allowed for a continuous and incremental approach to policy reform. This approach has paid off well as the Bank's credibility has resulted in the Government's inviting increasing Bank involvement in politically sensitive areas. saIt. Coordination with the D. The staff of the Bank have maintained close contact with the Fund staff working on Nalawi. They have regularly shared information and views, particularly on matters related to the respective programs, and have informed each other of developments in these areas.. Some division of labor has developed between the two institutions. The Bank'has taken the lead in developing policy in the area of - 49 - agricultural prices, public Investment programming and maintenance of adequate funds for key economic sectors, while the Fund's emphasis was more on target levels of expenditure and deficits. The Fund has taken the lead In monitoring exchange rate and interest rate policy and domestic resource iobiliation efforts. uni. Collaboration between the two institutions has been particularly close with respect to (a) pricing decisions as they related to AlARC's fiances; (b) tax policy where the Bank has taken the lead, In collaboration with the Fund, In identifying and carrying out studies which will lead to a restructuring of the tax system; and (c) foreign exchange allocation procedures where Bank observations regarding restrictions has resulted In a fruitful collaboration in approaching the Government with our concerns. - 50 - MAtAVI STRUCTURAL ADJUSTMEWNT I (L 2026) STRUCTURAL ADJUSMENT I (CR 1427) TECHNICAL ASSISTANCE I (LN 2027) PROGRAM COMPLETION REPORT A. Onset of the Economic Crias 1.01 eginning In 1979, the economy of Malawi was affected by a series of external shocks which resulted In an economic downturn with average growth falling from 5 percent In the previous 10 year period to -0.1 percent for the 1979-1981 period. The price of petrolea Imports more than doubled between 1977 and 1980 while the prices for tea and tobacco dropped, resulting to a 35 percent fall in the term of trade between 1977 and 1980. In 1980 and 1981, a drought situation severely affected the agricultural sector. In addition, Malawi's traditional export routes through ossabique were disrpted by hostilities$ secessitattag the use of costly alternative routes, and a severe worsening of the non-factor services .account deficit. 1.02 Intially, the country attempted to mitigate the economic downturn of 1979-80 by Increased external borrowing$ mostly on commercial tera, to order to maintain Import levels and thus production, employment and consumption. Investment declined sharply, but consumption only slightly. 1.03 Efforts to deal with problem of increasing debt and economic stagnation began with the INF's support for the Government's adjustment program with a two and a half year Standby arrangement covering the period through December 31, 1981. However, the arrangement was replaced after six months (when it was clear that the arrangemeat's targets could not be met due to deteriorating economic circumstances) by a two-year Standby. The new arrangemt, wthich covered the period April 1, 1980 through March 31, 1982, was conditioned on limiting recurrent expenditures in the 1980/81 budget; Increases in development expenditures were to be limited to -what could be financed from additional foreign aid. Quarterly cellings were set for the expansion of net bank credit to the Government (an Increase of 13 percent In 1980/81 as compared with 31 percent to 1979/80). External borrowing on commercial terms was also limited, The Goverment raised lending and borrowing rates on two occasions between 1979 and 1980 by a cumulative total of three percentage points. Part of the IMF program provided for Increased excise taxes on cigarettes, spirits and beer, import duties (including those on capital goods) and in an Increased airport tax. These measures followed increases during the previous fiscal year in the surtax on imported and domestically produced goods (from 15 to 20 percent),. and In the levy on imported fuel to a rate equivalent to over 60 percent of its value. Together those tax measures were to have raised additional revenue equivalent to about 3.5 percent of 1980 monetary GDP. - 51 - 1.04 The fiscal position weakened considerably in 1980/81 and revenue growth was such less than expected becamie of stagnation. In addition, a number of public enterprises experienced serious financial difficulties. As a result, substantial recourse to domestic credit sources to finance extrabudgetary demands meant that the Fund's program ceilings on net bank credit to Government for 1980 and March 1981 were exceeded, the latter by a substantial amount. The IMF ceiling on total domestic credit was also exceeded in March 1981, even though private sector credit was kept well within the target implicit in the n.aancIa programe. For this reason, the Government became ineligible for the December 1980 drawing and was not made eligible for further drawings until May 1981. The second year of the Standby arrangement dovetailed both to tising and fiscal objectives with the commencement of the first structural adjustment operation which supported a medium-term program of reforms developed by the Government. B. Emerging Structural Problems and the Need for Structural Adjustment 1.05 While the primary cause of the country's economic crisis was the sharp deterioration in its international terms of trade, several underlying structural weaknesses were revealed, Specific weaknesses were analysed during a June/July 1979 economic mission: (a) the narrowness of the export base and the slow growth of smallholder exports; (b) the modern sector's dependence on imported oil and the progressive depletion of domeetic fuelwood resources; (c) the deteriorating financial position of the public enterprise sector; (d) growing budgetary deficits owing to a rapid expansion of expenditures combined with a relatively slow growth of revenue; (e) a growing Imbalance between Government recurrent and capital expenditures; and (f) increasing economic adjustment diffiulties caused by rigidities in the system of administered prices and wages. 1.06 The findings of the economic missions carried out in August-September 1980 and January 1981 were used to develop the first structural adjustment operation on the basis of the Government's medium-term program. 1.07 Lack of Diversification of Estate Exports. Around the time of appraisal of SAL I in 1980, agriculture accounted for 90 percent of total merchandise exports. Estate exports, which dominated, were heavily concentrated on tobacco, tea, and sugar, the international prices of which were subject to sharp fluctuations. In addition, future export growth was likely to be constrained by fuelwood shortages, lack of credit and shortage of managerial talent. The tobacco estates are a major consumer of fuelmood which is in increasingly serious short supply while estate reafforestation programs have been slow in catching on. Malawian tobacco curing is inefficient by international standards, It was estimated that a sustained yield of from two to four acres of timber is seeded for every acre of flue-cured tobacco. Growth of tea production would also be hampered by the lack of suitable new land and the shortage of fuelwood. Growth of sugar production would be constrained by the full cpacity use of two existing estates/mills. Shortage of credit for technology improvements, irrigation, and other productivity improving investments, and scarcity of managerial talent were expected to be a serious constraint to further rapid expansion of both burley and flue-cured tobacco. The economic mission recommended - 52 that any future agricultural growth strategy should involve Increased diversification focussed upon more rapid smallholder expansion and complemented by the movement of estates into new crops. 1.08 Slow Growth of Smaliholder Production. Despite sizeable public Investments In smallholder agriculture, smallholder exports had stagnated over the previous ten years. While this performance could partly be attributed to limited coverage of past agricultural projects, low producer prices also played an impqrtant role. An analysis of prices showed that, on balance, pricing policy had treated the smallholder sector less favorably than the estates, and within the smallholder sector, prices had subsidized the production of malie and rice while taxing production of export crops suc as cotton, groundnuts and smallholder tobacco. A price Incentive problem also applied to --eat, poultry and dairy products whibh are mostly produced by smallholders. In addition, pricing decisions were ad hoc and arbitrary with increases occurring infrequently and in quantum jmps, making adjustments difficult for both producers and consumers. 1.09 Bnergy Costs. Energy issues were becoming increasingly important In Malawi. Iustwood, then as now, accounted for some 80 percent of the total energy consumption in Malawi, being used In rural areas for cooking and for curing tobacco and tea. As a result of population growth and expansion in tobacco and tea production, the demand for fuelvood outstrips available supplies, leading to deforestation and environmental problems. With respect to petrolem, Malawi's total dependence on Imports was causing serious dislocations. While volume only increased by 8 percent between 1977 and 1980, the value of imported petroleum doubled and the share of imported petroleum in total imports, c.I.., rose from 10 to 15 percent. The Government had the difficult task of dealing with rural energy needs while reducing the modern sector's dependence on imported oil. 1.10 Public Enterprises' Finances. As a group, Malawi's statutory bodies and public enterprises had functioned well, providing essential services fairly efficiently and making a reasonable contribution to their own investment requirements. However, some enterprises' financial situation had been deteriorating, partly as a result of management's difficulty in adjusting to & more difficult economic environment. The Agrcultural Developat and Marketing CorEoration (AMARC), a marketing institution for smalihoder crops which operated as a relatively efficient marketing institution, suffered a substantial loss in 1980 as a result of higher fuel costs, losses from Improper crop handling, poor transport planning, and sharp falls in tobacco prices. Air Malawi suffered large losses on its international service which was cut back significantly at the end of 1979. Domestic tariffs were increased by 60 percent in early 1980 and international charter rates were raised later that year. To reduce losses further, additional tariff Increases of domestic and cargo service were considered necessary. Malawi Railways' finances had been adversely affected by rising fuel costs and transport problems at the ports and on lines through Mosambique. Despite a 1979 tariff increase of 17 percent, the company suffered an operating lose for the first time since 1972 and its overall cash deficit, after debt service and renewal investments, rose substantially. The previously financially sound Electricity Supply Commission (ESCOM) also began to experience large cost overruns on its Muls project, primarily as a result of transport difficulties. While - 53 - tariff Increases of 10 percent in 1979 and 5 percent in 1980 helped to alleviate the eash deficit, the company was still experiencing cash flow difficulties.. The Malawi Rousing Corporation (MBC) and Capital CIty Devejopment Cororation (CCDC) had been channeling Government fn And external loans into housing and construction of the new capital at Lilongwe, and were experiencing difficulties In meeting their mounting debt service obligations out of their low Income from rents. RC Increased rents for low cost housing by 40 percent but was not generating sufficient fund& even to provide for saintenance. The Malawi Development Corporation (NDC) is a wholly Government-owned holding company with interests in agriculture and agro-industry, manufacturing.and commerce. Its financial position had steadily deteriorated in recent years as the liquidity of its subsidiaries declined with the onset of the economic crisis, and it had had to provide more guarantees for their borrowings. It had also accumulated medium-term debt and had borrowed (mainly on hard terms) to finance equity investments. Given the large projected interest payments, MDC was expected to run substantial losses during 1980 and 1981. The deterioration in the performance of these public enterprises was having an adverse impact on the Central Government's budget by increasing the requirements for subsidies or for deferment of debt service owed to Goverment. In addition, the demand by the public enterprises for new medium-tere external credit or for additional domestic borrowing had increased. 1.11 While Press Holdings, Ltd. is a private enterprise, its operations are so large that they have a profound Impact on the country's economic life. Press is a holding company with wholly-owned subsidiaries and associated companies in most sectors of the economy, including agriculture, industry, wholesale and retail trade, building and construction, transportation, banking and insurance. Until 1979, Press and its subsidiaries had been consistently profitable, but thereafter, the group's financial position deteriorated rapidly due largely to the company's over-investment in tobacco estates. The whole tobacco subsector suffered serious losses following a drop in the market. Press' enormous cash needs had placed severe strains on Nalawi's two commercial banks and this led to restricted domestic credit expansion to the rest of the private sector. Unless Press' financial and operational problems could be resolved rapidly, they would have a serious adverse impact on the country's output, employment and exports. 1.12 Budgetary Deficits and Recurrent Expenditures. The Government had generally managed its finances prudently. Revenue had increased as rapidly as GDP, the recurrent account (since 1972/73) had consistently generated surpluses to contribute to development finance, and budget deficits had been relatively modest. Since 1978/79, however, the Government's fiscal position had deteriorated. While revenues increased slightly faster than GDP, recurrent and development account expenditures grew even more rapidly, owing to a rapid expansion of development projects. In addition, there was growing evidence of underfunding of recurrent budget requirements. Control over recurrent expenditures had become tight because of domestic revenue constraints and the need to expand government savings to finance development. On the other hand, because of the availability of concessionary foreign finance, capital projects continued to be relatively easy and inexpensive to fund and inadequate attention was paid to recurrent budget implications. As a consequence, the - 54 - expanaion of government employment and expenditures for goods and services had not kept pace with the growth of capital expenditures. The problem had become particularly saute in agriculture (and to a lesser extent in road maintenance and in health). The lack of adequate provision for recurrent operations had, moreover, reduced the benefits originally expected from project investments. 1.13 Price and Wage Polcies. A system of formal and informal price controls had evolved for most domestically manufactured goods In Nalawi during the 1970' s. Administered by the Ministry of Trade, Industry and Tourism, formal controls were exercised over a set of fairly homogeneous products such as cement, fertilisers, and sugar; they also covered comodites- that figure predominantly in the consumption of low Income groups, such as mats. meal, vegetable oils, bread, milk, matches and fish. In addition, the requirement that manufacturers notify the Mianstry to advance of price Increases Ad wait for a letter of 'no objection was in effect an informal price control on practically all goods In the formal manufacturing sector not subject to the formal controls. With increased inflation, this system began to create serious producer disincentives. Loag delays between price increase applications and approval adversely affected the financial position of many businesses. Similar delays characterised the granting of tariff increases for the country's principal statutory bodies. 1.14 The Government had also adopted a system of wage controls to restrain real Increases. Administration of the controls had been destabilising since Government would hold down wages for as long as possible- and then grant large increases to make up for several years of real decline. This had resulted in serious adjustment problems for the economy. For example, the minimum wage for urban unskilled workers, unchanged since 1973, was increased by 12.5 percent In 1980 and by an additional 56 percent In January 1981. (1ven so, the minimum wage in 1981 was only three-quarters of its real 1973 level.) The civil service wage structure had not been adjusted since 1978. - 55 - I1. THE STRUCTURAL ADJUSTENT OPERATIONS: OBJECTIVES AND POLICY REFORMS 2.01 The Government, in consultation with the Bank and DEP, formulated a mediun-term program eqvering 1981/82 to 1985/86 to reduce the balance of payments current account deficit to manageable proportions while ensuring moderate growth of per capita income. The explicit objectives of the program were as follows: * a real GDP growth rate of 4.8 percent (comprising average growth rates for smallholders of 5.0 percent per annum, estates 2.9 percent, manufacturing 7.5 percent, and 4.1 percent for the rest of the economy); - - increased diversification of sources of foreign exchange earnings or savings through the development of now sal1holder and estate crops, faster smallholder export crop growth and the development of livestock and forestry industries and agribusinesses; * measures to Improve the financial performance of public enterprises and the public budget thus reducing dependence on external resources and domestic borrowing to manageable levels and providing for an improvement In foreign exchange reserves. A, The First Structural Adjustment Operation 2.02 The Government formally requested a First Structural Adjustment Loan in April 1980 to support their undertaking the measures necessary to attain these objectives. The loan was appraised in September 1980, and a .post appraisal mission visited Nalawi in January 1981. The loan of US$45.0 million was approved by the Board in June 1981. The program was also supported by a series of IMF Standbys. The elements of the program (described in detail in the Government's Letter of Development Policies, Annex 1) fall under four main categories: (a) Improvement in balance of payments; (b) improvement in price incentive a4d income policies; (c) better resource management; and (d) institutional improvements. 2.03 The first Technical Assistance Project (US$1.0 million) supported the SAL program by financing analytical studies on which reforms were to be based. Specifically, the two-year project financed around 70 months of consultant services to: (a) study development prospects and price Incentives In the livestock industries; (b) review NDC's present and projected financial position, management structure and operating guidelines and technical assistance to help strengthen its export marketing capabilities. The project also provided for ad4itional studies to be identified during implementation of the program. These studies were related to ADNARC and Press Holdings. Improvement in Balance of Payments 2.04 Promotion of Smallholder Exports. Measures designed to promote smallholder exports included: (a) greater recurret budgetary support for agricultural services; (b) increased investment in smallholder development projects; and (c) strengthening of ADMARC. Correction of inadequate producer prices was recognized as necessary to ensure adequate incentives - 56 - for farmers to produce and market cash crops. To this end, the Government had established an interministerial Price Advisory Comittee i 1978 which completed one comprehensive price review in 1980. The Government also 4greed to carry out annual crop price reviews in advance of each growing season. The Bank assisted the Government in formalizing the methodology for these reviews, The methodology is based on setting prices consistent with export parity prices while taking account of growers' crop margins and AVIARC's financial variables. In addition, the Government agreed as part of the SAL program to review with the Bank the crop price decisions for the 1981/82 growing season. Given that the price for cotton had not changed since 1977 although input prices had risen, and given the resulting stagnation of marketed outputs the Government agreed, as part of the SAL program, to increase the producer price of cotton to a level acceptable to the Bank, before the start of the 1981/82 growing season. 2.05 The Government also agreed to begin annual price reviews for wholesale-and retail prices of livestock and livestock products based on the findings of the study financed under the TA project (Para, 2.03). 2.06 A study of ADMARC was included in the TA Project since improved efficiency of its operations in smallholder cropping, marketing and storage would be an obvious potential benefit to smallholder agriculture. 2.07 Export Expansion and Diversification. The need for diversification notwithstanding, it was recognised that Malawi's tobacco industry was and would remain crucial for generating Zoreign exchange and employment. Thus, the program concentrated on maximizing tobacco earnings by supporting the Government's tobacco sector study which had as objectives to (a) research the optimal mix of varieties; (b) examine the'long-term outlook for the various varieties; (c) identify measures to improve the efficiency of existing tobacco estates and smallholder farms; and (d) explore the possibility for future tobacco production and diversification into other crops. Greater productivity and profitability in tobacco production was considered necessary to support risks taken with crop diversification. 2.08 EnerlZ Development. The Government had been attempting to cope with the country s energy problems through price/tax policies to limit the consumption of petroleum and through investments aimed at developing new energy sources, Oil Imports had been taxed at rates equivalent to 30-60 percent and domestic prices were regularly adjusted to reflect the full CII value of fuel plus tax. These policies had already played an Important role In holding the rate of increase in domestic consumption of petroleum to 1.7 percent per annum during 1973-79, about one quarter of the growth rate of the modern sector. The Government also launched investments in wood energy and ethanol, in part to meet the increasingly critical fuelmood shortage. The IDA-financed Wood Energy Project (Cr. 992-AI, approved January 15, 1980) included (a) establishment of a national network of 88 nurseries for the production of seedlings for public sale; (b) establishment of 13,000 ha of fuelwood and pole plantations for commercial and industrial use; and (c) the establishment of an energy unit to Investigate more efficient use of wood energy and alternative sources of energy. Under this project, the Government agreed to increase wood prices gradually to reflect full production costs. An ethanol project (with IFC - 57 - loan and equity participation) involving the conversion of molasses was expected to replace 8-10 percent of Malawi's petroleum cons.umption and result in substantial foreign exchange savings. 2.09 At the Government's request* the Bank, in collaboration with USAID, carried out an energy sector study to assess available resources. The study emphasised development of fuelvood and also examined possibilities for coal, hydropower, and production of energy from biomass. Price Incentives and Income PoUl 2.10 Wmes and Prices. The Government accepted, with initial reluctancet the ueed to econtrol prices and to more frequently adjust wages. It agreed to Increase utility and transport tariffa and to the principle of maintaining appropriate tariff levels in the future. 2.11 Exchange Rate. Despite a 10 percent appreciation in the exchange rate over the previous three years, Bank missions had found, to this point, little evidence to suggest that the exchange rate had caused any significant distortions. Thus, no specific measures were recommended and, under the Iff Standby, the exchange rate was to be subject to periodic revievs. 2.12 Interest Rates. The Government had made significant increases in lending and borrowing rates (Para. 1.03). These increases had helped to ration scarce credit to more Important uses and provide better Incentives .for savings. The increases In lending rates were an important factor in reducing the demand for imports. In consultati2n with the 10F, the . . Government agreed to continue to monitor its interest rate policy to ensure that appropriate incentives were maintained, especially in light of the prevailing inflationary climate. Resource management 2.13 Public Expenditure Program. To ensure efficient use of public resources, the Government, in consultation with the Bank, produced a five-year (1981/82-1985/86) public expenditure program covering Government recurrent and capital expenditure and those public enterprise investments externally financed through the Goverment's budget. This program reflected the Government's commitment to Improved allocation of public resources. Low priority expenditures were reduced or eliminated; the past Iabalance between recurrent and capital expenditures was largely corrected; expenditures for key economic and social sectors was increased. 2.14 The sectoral allocations for the five-year program reflected the Government's emphasis on smallholder agriculture, transport and manpower to support of diversification of agricultural production and exports. The SAL program called for the share of outlays going to agriculture to increase to 22 percent (versus 18 percent of the total over the previous five years), to education, 10 percent (versus 4), and to health, 4 percent (versus 2). The share of water supply and sanitation went from 3 percent to 8. A moderate reduction was called for in the share going to transport (36 percent from 42*percent). In addition, the Government agreed to reduce expencitures on government buildings and facilities and equipment for the army and police to about one-third of previous levels. - 58 - 2.15 Resource Mobilization. In its Letter of Development Policies, the Government otated its objective of expanding revenues through more frequent adjustments of specific taxes and departmental charges to compensate for inflat4on through the introduction of new taxes and improved administration. The objectIves of revenue measures to be agreed would allow the Government to meet its commitment to provide for real growth in recurrent expenditures in the key economic and social sectors and gradually reduce the overall deficit from over 15 percent of GDP in 1981/42 to 5.5 percent in 1985/86. 2.16 Government Borrowing. Through improved budgeting control, the Government attempted to reduce its not domestic borrowing from the banking sector to zero. Moreover, under the ZW Standby, an external debt ceiling remained on the Government and on borrowing which it guaranteed. 2.17 Finances of Statutory Bodies. In the fall of 1980, a Department of Statutory Bodies (DSB) was established in the Office of the President and Cabinet to monitor the activities of all public enterprises and provide assistance as necessary, in their mediu&-term financial planning. DSB staffing was to be strengthened by experts recruited under U.K. technical assistance. 2.18 The Government planned to grant more frequent, moderate public utility tariff increases in line with increased costs. On March 1, 1981, prior to negotiations, it had increased the Electricity Supply Commission's tariff by 10 percent. During negotiations, agreement was reqched that by the program review in October 1981, the Government would Increase the Blantyre Water Board's tariff to a level acceptable to the Bank, and would review with the Bank proposed measures to Improve the financial performance and management of Air Malawi and Malawi Railways. ADIARC and MDC were to be the subject of consultancy studies and by program review the Ministry of Finance and DSB would discuss the findings of the MDC study with the Bank. Institutional Iprovements 2.19 In line wth its commitment to improve economic management, the Government instituted new procedures to improve monitoring of its investments and management of its debt. It also agreed to reinforce its planning capacity and ensure Improvements in the management and financial practices of MDC and Press Holdings. 2.20 Monitoring of Investments. The Government created an Investment Coordinating Committee (ICC) to monitor investments by all public institutions and major private corporations to ensure their economic justification and financial feasibility and that their financing arrangements were not an undue burden on themselves or the country. All large projects would also be subject to detailed technical review by independent consultants. To provide a basis for monitoring the investment program, agreement was reached that the ICC would apply specific criteria for screening major projects based on generally accepted principles of project analysis. 2.21 Economic Plannin. The Government's planning capacity was being severely srained by thincreasing demands of day-to-day economic management in a period of economic crisis. It had, therefore, requested - 59 - DUDP financing for higher-level training in economics and planning, shorter-term planning courses and consultancy services for in-house training. 2.22 Institutional Reforms to Promote Industrial Investment, Key parastatals are expected to participate in the development of new Industries which can make a substantial contribution to Malawi's structural adjustment. Because of financial difficulties, neither Press nor MDC was in a position to make substantial new investments Immediately. For this reason, the Government's medium-term program included a reform package designed to strengthen these two organizations. 2.23 During appraisal of SAL 1, Press' severe financial difficulties, indeed its Insolvency, was recognized for the first time following discussions with members of the banking community and other concerned people. Press' debts were a major part of the commercial banks portfolios. The banks were in general effected by bad loans resulting from the financial difficulties of new estates following the collapse of tobacco prices in the late 1970s and early 1980s. The seriousness of Press' finances were also affected by losses incurred by its estate investments which compounded the company's pro-existing managerial and operational weakness. The seriousness of the situation persisted even though Press had already taken a number of measures designed to improve its financial performance. It had suspended dividend payments since 19791, closed down some of its unprofitable operations and trimmed its labor force by over 20 percent. An International management consulting firm was hired to conduct studies of Press' subsidiaries and to make recommendations on changes in management and financial practices and possibly the closing down of unprofitable operations. The TA loan was used to finance consultant services to analyze the more fundamental problem of technical insolvency, the threat it imposed on the banking system and to ADWARC, and what action the Government should take. The Press issue became a central feature of the SAL progran, especially given its sensitivity within the Government and within the Bank. 2.24 Debt Management Reforms. There was a need to strengthen debt management capability and to monitor external borrowing more closely. The Government agreed that by the time of the program review it would submit to the Bank its proposals to improve its capacity to monitor and manage public and government-guaranteed private debt, as well as establish a target range for future public debt service ratios. B. Implementation Under the First Structural AdJustment Deration: Compliance with Conditionality 2.25 Conditions for release of the second tranche of SAL I (US$20 million) were: (a) overall progress in implementing studies, policy reforms, and structural reforms as part of "a comprehensive economic program for short-term stabilization, medium term adjustment and long-term development of its economy;" and more specific performance criteria including: (b) supplementary appropriations of MK2.8 million over the amount budgeted in 1981/82 to rectify underfunding of agricultural recurrent activities; (c) submission of crop pricing decisions by the Government based on the recommendations of the Price Advisory Committee and - 60 - based on the methodology agreed with the Bank; (d) submission of proposals to strengthen debt management including its capacity to monitor, record and manage public and guaranteed private debt and establishment of a target range for future public debt service ratios; (e) application by ICC of generally accepted principles of project analysis in screening major public and private investments to ensure economic justification; (f) Government submission to the Bank of updated budget, balance of payments, and national accounts projections; (g) submission by the Government of its proposals to improve the finances and management of public and private enterprises considered central to the Structural Adjustment process; and (h) increases in the Blantyre Water Board tariff to a level acceptable to the Bank. 2.26 Overall Progress. A mission which visited Malawi from October 16 to November 5, 1981, reviewed overall progress under the program and specific compliance with tranche conditionality. It found that there had been good progress made in several areas including (a) appropriations of additional funds for the Ministry of Agriculture; (b) the creation of the ICC to screen major investments; (c) increases in tariffs for the Blantyre Water Board, ESCOM, Air Malawi and Malawi Railways; (d) completion of an energy sector survey; and (e) the solution of Press' problems, including steps to ensure that no dividends would be paid until its financial problems could be rectified and top management strengthened. 2.27 However, the mission found cause for concern on a number of points and informed the Government that further action on those would be necessary for release of the second tranche. 2.28 The Budget Situation, B' iget expenditures were about 172 over the estimate. The main factors coitributing to this were: (a) unbudgeted importation of 50,000 tons of maize on Government account from Zimbabwe; (b) higher debt service payments than.estimated as a result of increased interest rates, appreciation of the dollar and under allowance for the impact of Government borrowing from the Reserve Bank in-FY80-81; (c) shortfalls in estimated receipts from foreign loans that had to be met by increased budgetary payments; and (4) spending by a nuber of ministries or projects above levels allowed for in the budget. It was agreed that the Government should inform the Bank in writing of the measures it intended to take to deal with the FY81-82 budget problem, provide confirmation of its commitment to restore revenue to at least the historic relationship of 22-23Z of monetary GDP by 1985 and include in the 1982 Economic Report (a) a set of projected revenue figures and a set of policy measures to achieve these targets and (b) within the same framework, a set of recurrent expenditure estimates that would allow for significant real growth in agriculture, education and road maintenance. 2.29 The Government complied with those agreed measures. The budget deficit was to be reduced through revenue increases from newly Implemented revenue measures. Expenditures were to be held to the previous year's level, The budget deficit was to be MK102 million, which compared to the original draft budget deficit of NK161 and the previous year's level of NK121 million. The share of recurrent expenditures going to road maintenance, agriculture, and education was to increase from an estimated level of 14.3'percent of expenditures in 1981/82 to 18.1 percent in FY83. No new projects, not financed by grants, would be financed until the - 61 - economic situation was improved. As a result, the five year development budget was cut*back by about 40 percent from the previously estimated level. 2.30 External Debt, External debt and the burden of debt payments had rapidly increased, despite Government steps to strengthen its debt monitoring function by adding two statisticians to its Economic Section. The debt service ratio had risen from 102 of exports of goods and services In 1977 to 19.7% in 1980, and would rise, it was estimated to 272 in 1981 and 29.7% in 1982. This contrasted with the peak of 252 in 1982 estimated in the SAL President's Report. 2.31 The Bank requested, as satisfaction of the tranche release condition, that the Government hire additional staff to analyze the implications of past, present and projected borrowings, and centralize all foreign debt statistics and keep them up to date. The Bank offered to supply technical assistance for the debt monitoring unit, including a senior debt analyst and the transfer to Malawi of the economic model used by the Bank for economic projections. The Bank requested that the Government confirm its commitment to a 20% debt service ratio target and recommended that the debt technical unit serve and report to a policy-making group under the Minister of Finance who approves Government or Government-guaranteed external borrowing. The Government accepted these recommendations and the indicated technical assistance was provided from the Bank. 2.32 ANARC BIM Price. The very large increase (66%) in the maize price without corresponding increases in prices for smallholder export crops was seen as a problem. The cotton price was increased by about 242 and the price of other crops (Including tobacco) was retained. The gross margins per person/day (returns to labor) rose by almost 1302 for hybrid maise, and by nearly 80% for local varieties. The returns to labor for other crops actually declined since producer prices had not been increased while costs of Inputs had. The mission found, however, that the price review had been conducted in a timely fashion and that the new prices had been computed by the suggested method of import and export parity prices. There had, however, been data problems and inadequate attention to supply elasticities. Also it was thought that price decisions had been made on other than technical bases. Specifically, the large maize price increase was attributed to the desire to achieve food security and to make maize profitable for the estates. 2.33 It was expected that these price trends would lead to significant declines in the production of crops other than maize. However it was felt that because the Malawi smallholder is highly price responsive, production of other crops would recover substantially in 1983 if appropriate prices were established for the 1982/83 growing season. 2.34 The mission recommended and the Government committed itself to strengthening the technical capacity for carrying out price reviews, emphasizing the estimation of supply elasticities and gross margins per hectare per labor unit. In addition, a set of policy considerations were Indicated including (1) the need to extend price reviews to livestock and livestock products; (1W) the need to examine justifications for ADKARC's - 62 - supplying cotton to domestic fires at prices substantially below the export price; and (III) the need to examine the fertiliser subsidy and its adverse Impact on AIARC profitability. The use Of high analysis fertiliser like urea was to be studied as a mans of reducing transport costs. 2.35 Press Group. The company had already undertaken significant reforms resMltagin substantially Improved profitability (Para. 2.23), 2.36 The mission recommended that Press formally submit to the lovernment and the Bank a set of projections for alternative assumptions about debt restructuring, together with a statement which confirmed acceptance of the principles for the restructuring of debt and of operations Including the sale of certain unprofitable subsidiaries. The mission also recommended and the Government accepted hiring a consultant to assist with the debt restructuring arrangements. This assistance was to be funded with the Technical Assistance Loan. ne required submission of letters containing Press and Government commitment to the principles Indicated above was carried out. 2.37 Lag In the 1alementation of Studies. efore release of the second tranche was recommed, t contracts for the MDC studies were awarded and tenders for the tobacco and livestock studies were to go out the following week. 2.38 Following a delay of six months, the second tranche was released in April 1982, and the loan was fully disbursed in August 1982. C. The Second Structural AdJustsent Operation 2.39 Preparation for the second phase of the structural adjustment program began in June 1982, with Nalawi still confronting a depressed economy and disruptive transport difficulties. The Government was having difficulty in asking progress In a amber of politically sensitive areas, Including the restructuring of Press (Holdings) and in reaching internal consensus on the decontrol of domestic prices. The SDI 55 million (US$55 million equivalent) SAL II credit agreement was signed in January 1984, approximately two and a half years following signature of SAL I. 2.40 In September 1983, the DIM had approved an extended arrangement (EFF) for a three-year period in the amount of SDR 100 million, to help the Government reduce inflation and the current account and budget deficits. The program called for devaluation of the kwacha by 12 percent in September 1983, and it was tied to a basket of currencies in January 1984 with a further devaluation of 3 percent. 2.41 The second phase program reflected the Implementation experience of the first phase of the SAL program and the need to build on previous efforts and reforms. To reflect continued poor economic circustances, economic growth targets were revised downward from a projected 4.8 percent annual average to a 3.4 percent annual average. The program focused on the following policy initiatives: (a) further incentives for export crop production; (b) continued Improvements in Institutions dealing with external debt and Investment screening; (c) further work to strengthen management and finances of statutory bodies; (d) Implementation of the ....."'MONOW - 63 - agreement on Presst reorganization and debt servicing; (e) further upgrading of the Government's capacity to budget, plan, Implement and monitor its programs; and (f) increased revenues and greater cost effectiveness to reduce the budget.deficit. 2.42 ' The lAtter of Development Policy (Annex II) focussed on measures tos (a) Increase performance of the productive sectors; (b) mobilize and manage resources better; and (c) strengthen key Institutions. 'The Productive Sectors 2.43 Smaltholder Agriculture. As In the first SAL operation, monitoring of rice incentives for smallholders continued to be a major focus, The Association continued to monitor the proper application of the agreed pricing methodology. Cotton self-sufficiency became an explicit Government objective. To addition to ensuring adequate prices, the Government planned to reduce processing and transport costs through further Investments in roads and ginning and processing infrastructure. The Government agreed to continue to review recurrent budget allocations to the Muistry of Agriculture annually with the Association. 2.44 ADMARC. The consultant's report (Para. 2.03) recommended that: (a) ADNARC should divest itself of Investments not related to marketing and processing, This would free up financial and management resources. Profits from smallholder marketing operations should cease to be used for non-related investments; (b) ADMAIC's financial relationship with the Government should be sUCh that producer and consumer subsidy costs wod be met by the Government rather than ADMARC, ADMARC's planning and analysis of pricing policies also needed improvement. (c) ADMARC's marketing costs should be reduced by cutting back on the number of markets; (d) A planning unit should be established to anticipate events, assess and analyze likely consequences of alternative plans of action; (e) The company's financial managment should be strengthened; (f) Crop marketing and distribution should be improved by increasing the role of the private sector; and (g) Training and manpower development should be improved. 2.45 A timetable of specific steps to be taken based on the consultant's report was drawn up by the Government and ADMARC and agreed with the Association at negotiations. They included: hiring a financial analyst and a financial controller (financed by the Second Technical Assistance Project) and reduction of the fertilizer subsidy by 50 percent in 1983 and its elimination within three years. In addition, the fertilizer supply problem was addressed by the Smallholder Fertilizer - 64 - Project designed to improve the Government's and ADmARC's ability to estimate requirements, procure, and distribute supplies to smallbolders. Reasons that other measures recommended by the consultant's report were not taken up at this point are given in para. 4.06. 2.46 Estate Diversification. The Government had compiled a tobacco sector study (para. 2.07) on hiah to base a long-term strategy for the sector. The strategy, the study concluded, should include the development of an extension service for the estates, a management training plan, and medium- and long-term credit facilities to support investments which could lead to Increased productivity. A timetable for developing a program to achieve agricultural diversification in estate agriculture was agreed to at negotiations for SAL II based on this study* 2.47 Industry, The SAL program was to provide for gradually removing price cont'ros onmost products with the exception of a few essential consumption items as determined by the Government. lefore release of the second tranche of SAL II, controls were to be removed from a substantial number of commodities. Resource Mobilisation and Management 2.48 The SAL program focussed on the selection of public nvestments and continued reduction in the budget deficit, primarily to eniture gowth. Priority was, however, placed on maintaining adequate recurrent outlays for agricultural services, road maintenance and education. 2.49 In the medium term, continued reduction of development outlays was not desirable and was likely to have a serious effect on economic growth. Revenue Growth had actually been declining as a percentage of GDP. from 22 percent in T1980 to 17.4 percent in the first part of 1982. To keep revenue growth proportionate to GDP growth, the Government agreed to: (a) Improve the buoyancy of the tax system; (b) adjust tariffs, fees and charges; and (c) reduce subsidies and increase cost recovery efforts. A package of tax and non-tax revenue measures was developed under the IMF's BZF, and the Bank was to work closely with -the 1MP on this issue to ensure that proper Investment and allocation incentives would be provided. 2.50 Measures to raise revenue paid particular attention to cost rocove.y Inadequate cost recovery had limited the Government's abiIty to expand social services and non-tax revenue as a share of total had been declining significantly, Specific measures included In the program were as follows: (a) continued removal of subsidies on fertilizer and asize; (b) 20 percent reduction in the Government's contribution to tertiary education over the upcoming five years by increasing contributions from university students; (c) review of health services charges and measures to improve collection (the IDA-financed Shalth I project was to play a key role in this area); (d) measures to reduce subsidies and Government participation in the housing sector; (e) continuation of measures taken under SAL I to improve parastatal. finances and operations. 2.51 The exchange rate was-adjusted which enabled ADMARC to pay higher producer prices without adversely affecting its finatcial position and to improve incentives for production of other agricultural exports. Deposit - 65 - rates were Increased by two percentage points In Nay 1983 to 10.75 percent andending rates ranged between 13.5 percent and 16.5 percent with most lending closer to the upper end of the range. When compared to the consumer price index, these rates were positive by approximately 7 percentage points with deposit rates positive by about 1 percentage point. The Government agreed to maintain positive rates. With respect to debt monitoriag and plavnag, a consultant had been hired to help set up a computerised recording and monitoring system and a borrowing strategy and plan was to be developed as part of the program Institutional mprovements 2.52 In the second operation, the Government was to implement recommendations of the studies of key public sector companies as well as continue to strengthen key planning and budgeting ministries. 2.53 ress JSdisl. The Government decided on a major restructuring of.Press to return it to solvency. A new agricultural subsidiary was created and would become a major focus of the company. Mnority holdings would be placed In an investment trust (PITH) and eventually sold off either locally or internationally. Some of the remaining subsidiaries would be sold off or closed down. The Government would take over comercial bank claims against Press, paying its debt to these banks and receiving Income notes and convertible preferred stock In Press. Press would also issue Income notes to AWARC. 2.54 Press Holdings' huge overhang of previous debt would be clearly separated from its ongoing commercial operations by the creation of a new holding company, Press Group, Ltd. (PML), which would Initially hold all of Press Holdings' assets and liabilities, To ensure that the operating companies would be operated on a commercial basts, corporate guidelines were drawn up and discussed with the Association. These set out pricing policy, Investment criteria, overdraft guidelines, rules for Intercompany loans, etc. Pinally, in order to reduce the debt burden of the company, detailed studies on possible asset sales would be carried outo All parties Involved in the restructuring agreed to the proposals and final legal agreements were expected in December 1983. 2.55 Development Management. Government measures under SAL II to address weaknesses in the areas of policy formulation and reconciliation of annual budgets and longer term development objectives included: (i) strengthened staffing of the Economic Planning Department (EPD) with emphasis on developing sedium term policies, project identification, evaluation, monitoring and coordination capabilities; (b) putting In place Institutional reforms to establish forward budgeting, estimating revenues and providing Improved guidelines to spending WaLstries for budget preparation; and (c) improving the institutional framework for energy policy and management. 2.56 Transportation. Despite the impressive success of the Ministry of Comanications and Transport in coordinating transportation of goods into and out of the country, there was the need for a more permanent solution, as disruption of the Mosambique routes appeared to have no short-term solution. Initial funding for the transport secretariat ended - 66 - August 319 1983, Arrangements were made for another 18 months of funding under the Fifth HIghway Project. Terms of reference for a study on the investments and arrangements needed for sn alternative route through Tansania were drawn up and agreed to by the Association as part of the overall structural adjustment effort. D. Tapementation under the Second Structural Adjustment operation: Cmliance with CoNditionality 2.57 The studies and Implementation experience under SAL I helped focus the design of tranche release conditionality under SAL I. Coditionality related to budgetary expenditures and revenues, the review process .for agricultural pricing decisions, and measures to strengthen agricultural production were essentially repeated under SAL I. In addition the need for efficient fertiliser procurement and distribution was addressed In the Smallholder Fertiliser Project. The tobacco sector, MDC, Press, AWAC and debt management studies and technical assistance carried out under the SAL I related Technical Assistance.Project provided the basis for specific conditionality related to those enterprises and to the estate subsector. 2.58 The SAL E1 review mission visited Malawi from April 28 to Way 16, 1984 and found satisfactory progress in Implementing five of the nine conditions for second tranche release, namely those related to the ANARC program, price decontrol, Increasing Government revenue and preparation of the estate credit project. 2.59 Overall Progress. The mission noted progress in reorganizing planning and budgeting but staffing had not yet been Increased. Implementation of the consultants reports on Malawi Bailways, AMARC, and MDC had progressed satisfactorily* Malawi Railways, ESCOK, Air Malawi, Malavi Housing Corporation, and the lantyre and Ulongwe Water Boards had Increased tariffs to offset rising operational costs and reduce financial deficits. The DS3 had continued to. be Instrumental In monitoring parastatal operations despite Initial diffica:tLes over its role vis-a-vis the line ministries which supervise parastatals in their respective sectors. Although Goverament remained committed to developing a program for management, training and extension In the estate sector, no donor support had been confirmed. The Government had lounched studies related to user chage recovery and subsidy reductions, Progress was being made in developing debt monitoring capacity. 2.60 An important problem was, however, discovered relating to the composition of the Development Budget which was significantly different from the one presented to the Bank prior to the credit negotiations. Ten percent of the budget and 40 percent of local funds available for the Development Budget were allocated to Government buildings (State Houses), which was inconsistent with the objectives of the public Investment and the Structural Adjustment Progra. It was also discovered that donor supported programs ware underfunded by about HK 5 million* The mission discussed these problems and was told of political difficulties in eliminating the allocation for construction of the State beuses. Although this area was not explicitly Included in tranche conditionality, the review mission - 67 - considered it to be of such importance as to Include it as a reason for delaying the tranche release and thereby to make a point of Its seriousness. 2.61 Press Restructuring. The Prese Restructuring Agreement was signed in December 1983, the new companies specified in the Recommendation plan were formed and their boards named (paras. 2.53 and 2.54). However, no audited company financial statements were available and the debt structure of the companies did not appear adequate as legislation (the New Companies Act) to permit the companies to issue preferred stock and thereby Increase equity had not yet been passed in Parliament. Similarly, the mission was disappointed with progress made In the rationalization of assets. The mission expressed dissatisfaction at the composition of the PGL Board, one of the major holding companies of Press assets established under the Reconstruction Agreement. The Reconstruction Agreement indicated that the Board should be "substantially comprised and consist of persons havitg commercial, financial and business experience." This was not the case and the mission urged that every effort be made to appoint PGL Board members from the commercial business commanity so "that expertise in large scale enterprise can be available to PCL." In the final analysis, the mission urged that the authorities take speedy action to rationalize Press' assets In order to permit release of the second tranche. 2.62 Agricultural Prices. Although the crop price proposals were found to be realistic, the proposed prices for fertilizer were below the import parity price. For fulfillment of the condition on agricultural prices, the mission asked the Government to finalize adoption of the proposed crop prices and to make the recommended adjustments to fertilizer prices. 2.63 The mission found that no major steps had been taken to prepare an external borrowing strategy and plan. 2.64 Second tranche release. Following a six month delay, the mission recommended that the second tranche of SDR25.0 million be released in November 1984. 2.65 The Government announced fertilizer prices estimated on the basis of the Import parity price. In September 1984, smallholder agricultural crop prices were announced at agreed levels. Since the May review, a strategy for the rationalization of Press assets had been approved by its Board of Directors. Substantial equity holdings were exchanged with AD4ARC and MDC to rationalize the holdings and make them more homogeneous. Corporate guidelines were discussed and adopted by the Board and Parliament passed the New Companies Act (para. 2.61). Realistic expenditure projections had been prepared and would provide the necessary analytical background to develop a mediua-term external borrowing strategy and plan. Further, the Development Budget had been revised to reduce the allocation for Government buildings by W5 million. These savings in local funds were allocated to underfunded donor supported projects. An acceptable revised three-year investment program was presented, covering fiscal years 1984/85 through 1986/87. - 68 - I. Taplementation of the Technical Assistance Project Performance of Consultants 2.66 The performance of consultants and the quality and usefulness of their reports were in general good and were produced within budget (Table 1). TABLE 1: COST OF STUDIES.UNDER THE FIRST TECHNICAL ASSISTANCE PROJECT Budgeted Cost Actal Cost/ Study at Appraisal Disbursement Livestock Sector 90,000 88,023.22 MDC 770,000 559,925.86 Press Not budgeted. 221,259.16 Other (AM(ARC, Debt Management) Not budgeted. 119,785.64 Source: Loan Department of TBRD 2.67 The consultants' report on Press Holdings was good. It described the true.severity of the existing situation of Press Holdings and urged and recommended steps for immediate action to prevent the company's collapse and ensuing bankruptcy of the commercial banks, ADARC and perhaps the Reserve lank, as well as major disruptions in agricultural production and other key sectors of the economy. The Bank requested that additional work be done to analyse (a) intercompany accounts between Press and its subsidiaries, (b) alternative recommendations and their impact ;n the governent budget. An analysis of a solution which would minimise the Government funding requirement had been specifically.requested in the terms of reference, but was not provided in the original report. As a result, the consultants were asked to do and completed an additional study on the impact of the recommendations on the Government, Including projections and additional analysis of the options of allowing Press to go bankrupt while taking steps to insulate the commercial banks and the viable subsidiaries. The credibility of the study accounted in large part for the sense of urgency with which action was taken., 2.70 Livestock Markreting and Pricing Study. Staff comments on this study were that although the descriptive work of the report was of high standard, recommendations on further development of the livestock industry were inadequate. The pricing policy recommendations were not well thought out. It was hoped that this study would form an integral part of a livestock development strategy arising from the planned NRDP IV Livestock Program Study. However, Bank staff felt that the recommendations of this study were not appropriate to the future constructive development of the industry. There was little, if any, constructive follow-through on the study recommendations, A new livestock study is being carried out under the NRDP IV Project. 2.71 MDC and ADMARC Studies and Export Marketing Technical Assistance to MDC. TSese studies were carried out according to their terms of reerence and adequately provided, in the case of MDC, thj basis for the -69- company's substantially Improved financial and operational performance. Through the stidies, MDC was able to destga and Implement an effective overall budgeting and monitoring system for its numerous companies and to make major Improvements in Its overall organizational structure, policies and procedures. These changes enabled the company to move from poor liquidity and large losses to substantial profitability and liquidity. In the case of AWAXC, the consultant' s study provided a framawork for identifying and tackling a whole array of Issues. Performance of the Borrower 2.72 Contractiag with Consultants. The process of procuring consultants tended to be slow and was one of the reasons delaying release of the second tranche of SAL 2. Rowever, appropriate procedures were followed and adequate support was provided to the consultants, including establishment of steering and working committees. However, the lack of a central unit responsible for the administrative and procedural arrangements for the technical assistance loan proved to be a problem. This was due in large part to the diversity of studies carried out and of agencies Involved.- In the future it would be useful if an assistant In the Ministry of Finance, or a department accustomed to Bank procedures, such as the Development Division, could be desiSdated to perform administrative tasks (preparing tenders, disbursement applications, etc.) for the Technical Assistance Project. P. Disbursement, Procurement and Use of Counterpart Funds 2.73 SAL . The loan was disbursed in two tranches, US$25.0 million was availa or disbursement after the loan was declared effective on August 3, 1981. US$4.5 million was provided In retroactive finance for Imports made three months prior to Board approval. The remaining US$20.0 million was made available for disbursement on April 22, 1982, after agreement by Bank management that the conditions for second tranche release had been satisfied. The loan was fully disbursed by August 12, 1982, and the loan account was closed on August 12, 1982, with no outstanding blance. 2.74 SAL II. This credit was disbursed In two tranches. SDR30 million eq-: nt was available for disbursement after the Credit was declared-effective on January 16, 1984. The remaining SD125 million was available for disbursement after satisfactory fulfillment of tranche release conditionality as agreed on November 21, 1984. Disbursements were completed on December 26, 1984. The credit was closed on June 30, 1985, with no outstanding balance. 2.75 Both operations reimbursed the foreign exchange costs of eligible Imports on the basis of evidence provided by the Reserve Bank. The Reserve Bank was responsible for the necessary documentation, the preparation and submission of withdrawals applications and the maintenance of necessary accounts for the Credit fund., The Foreign Exchange Control Department of the Reserve Bank was responsible for administering and processing foreign exchange applications for imports to be financed out of the loan. Public and private importers alike had adequate assistance in preparing tender - 70- documents from this department, which maintained adequ*te staffing and functioned efficte'tly throughout the life of the program. Ezcept for delays in tranche release, both programs experienced smooth disbursements. 2.76 Use of SAL Counterart Fuds. The Malawian Kacha equivalent generated by the foreign currency withdrawal from the loan account was credited to a special account in the Reserve Bank of Malawi and used for development purposes In the Central Government Budget. These counterpart funds were used to finance essential recurrent and capital expenditures consistent with sectoral allocations agreed with the Bank and IDA. The provision of these counterpart funds has contributed to overcoming the difficulties with obtaining adequate recurrent budget allocations for Bank and other donor funded projects. In particular, the agricultural and highways projects which had experienced significant recurrent budget problems have now overcome those constraints. 2.77 TA 1. This loan for US$1.0 million was declared effective on August 18,7=1, and following one six month extension of the closing date, was closed on December 31, 1984* Disbursements were completed on May 30, 1985 The loan was closed with an outstanding balance of approximately US$11,000. 2.78 Procurement. Bank umber countries, Switzerland and Taiwan were eligible. sources of procurement of Imports. The legal agreements provide for procurement through norqal commercial channels, except In the case of contracts costing over US$3 million for SAL I and over US$1 million for SAL II. Under SAL I, contracts exceeding US$3 million were to be subject to broad international tendering and under SAL II, contracts exceeding US$1 million were subject to international competitive bidding. For both operations, all reimbursements were made for relatively small contracts, none of which triggered the requirements for international tendering or international competitive bidding. In general, no particular problems were experienced with procurement. - 71 - III. IMPACT OF THE STRUCTURAL ADJUSTMENT PROGRAM 3.01 The four-year period since initiation of the Structural Adjustment Program is not long enough for the full effects to have become apparent. While a comparison of program targets with key economic Indicators (Table 2) reveals substantial progress in several areas, the process of structural reform - the principal objective of the program - is still underway. Expansion of the Economic Base 3.02 Objectives of the program included specific targets for GDP growth rates, and the current account deficit. The targets assumed achievement of increased diversification of sources of foreign exchange earnings through development of new smalholder and estate crops, faster smallholder export crop growth and development of livestock and forest industries and agribusinesses. 3.03 Against the SAL II target of 3.4 percent average annual GDP growth, in real terms GDP grew at rates of 2.5 percent, 4.1 percent and 4.1 percent in 1982, 1983 and 1984 respectively. Preliminary indications are for a 2.4-2.5 percent GDP growth in 1985. 3.04 To promote diversification of the economy and to encourage increased and more diversified exports, these first phases of the program relied heavily on correcting prices and economic incentives. Between 1980/81 and 1984/85, during a period when consumer prices are estimated to have risen by 61 percent, the producer prices of the five principal crops have been raised as follows: maize by 82 percent, rice by 70 percent, cotton by 100 percent, grounduts by 112 percent and tobacco by 120 percent. The production response for the various crops has varied; present estimates suggest that by 1985 the production of maise will have risen by 116 percent from its 1981 level, cotton by 75 percent, and tobacco by 55 percent, respectively (Chart 1). The better supply and distribution of smallholder fertilizer has also contributed to these increases In output, and price increases appear to have been adequate to offset the reduction in the fertilizer subsidy. 3.05 In addition, significant steps have been taken to reduce the extent of price control. from controlling about 60 items prior to commencement of the program, controls have been eliminated for all but 5 products. Liberalization measures were introduced, including clarification of the existing system which was poorly understood by manufacturers, most of whom had sought approval of price increases even when this was not explicitly required by Government regulation. A systematic study of the impact of these measures on production has not been carried out, however, informal observations indicate increased availability of certain dairy products and other consumer items, for example. Government authorities have suggested that the auch hig"Ier inflation rates in 1984 for low-income households may be due to liberalization, since controlled items account for a larger share of the expenditures of low-income households. The impact of pricing measures on development of agro-industrial and livestock activities is uncertain. Table 2: KEY ECONOMIC INDICATORS Annual Growth Rates (2) LII Appraisal Estimates 1/ Actuals 21 Average 1983 1984 1985 1986 1987 1981 1982 1983 1984 National Accounts GOP 3.4 2.6 3.0 3.5 3.9 4.2 -5.0 2.6 4.1 4.1 Agriculture 3.4 2.7 3.2 3.6 3.8 3.8 -8,2 6.9 4.3 6.3 Industry 3.7 2.5 3.0 3.7 4.4 4.9 -2.6 -.4 4.1 2.9 Services 3.4 2.5 2.9 3.4 3.8 4.3 -3.6 .6 4.9 8.6 Consumption 2.3 1.4 1.0 2.2 3.2 3.5 .5 .6 1.0 9.0 Gross Investment 11.22 20.2 13.7 9.8 6.1 6.3 -61.0 5.8 1.2 5.0 External Trade Merchandise Exports 5.4 6.4 6.1 4.8 4.8 4.8 * 7.1 20.3 Primary 5.4 6.5 6.2 4.8 4.8 4.8 Manfactures 4.1 4.0 -4.0 4.0 4.0 4.5 Merchandise Imports 6.5 14.2 5.4 4.9 3.9 4.3 -8.7 -14.9 Percent of GDP Actuals 2/ Public Finance Bank Estimate 1983 1984 1985 Budgetary Deficits (FY86) Excluding grants: -7.5 -12.7 -10.8 -8.3 Including grants: -5.5 - 9.3 - 8.1 Development Expenditures 8.8-9.0 11.4 10.1 7.6 Revenue Account Expenditures (85186) 15.4 21.2 20.4 20.7 Revenue (average throughout period) 16.6-16.9 19.9 19.6 20.0 . I Sources SAL II President's Report 2, Source: Malawi: Economic Recovery Resource and Policy Needs, An Economic Memorandu - 73 - CAT i MALAW AGRICULTURAL OUTPUT' AND REAL PRODUCER PRICES' 1974-8 TODACCO c CE 2%COrTON GROUNONUTS 250 200 200 higo 80 out W80 0 0 1974 78 78 se 83 s' is e a g 300, 0 >hgøU.OPW *t s is as sa - 74 - 3.06 The balance of payments improved significantly, especially in 1984, reflecting mainly positive developments in the trade account$ despite intensified problems with and costs of external transportation. The current account deficit (after debt relief) is estimated to have declined to MK -48.8 million in 1984 compared to MK -169.4 in 1983. This represented 2.9 percent of GDP, compared with 12.3 percent in 1983 and the FF program target of 8.8 percent. This also compares to a current account deficit of 17.8 percent of GDP and 24.8 percent of GDP respectively in 1978 and 1979 at the onset of the crisis and the average 7 to 9 percent of GDP achieved in the earlier part of the 1970s. Most of the improvement in export receipts is accounted for by the increase in both prices and volumes of tobacco and maize exports and a 76 percent increase in the value of tea exports following political problems in Sri Lanka and the restrictions on tAdian tes exports. The volume of maixe exports tripled In 1984, following increases in real producer prices in earlier years and favorable weather In Malawi but unfavorable in neighboring countries. The high volume of 1984 exports also reflected the decumulation of stocks - notably tobacco, tea and maize - built up during 1983 due to difficulties with transportation. 3.07 The rate of growth of imports slowed considerably. This to partly attributable to the higher domestic prices of imports following the depreciation of the Malawi kwacha and the higher costs of transportation and it also reflects the tighter allocation of foreign exchange for imports exercised by the Reserve Bank in 1983, The overall terms of trade are estimated to have improved by about 4 percent in 1984. 3.08 Overall, after declining In both 1982 and 1983, the US dollar value of exports increased by 34 percent in 1984, giving about a 16 percent increase during the three year period after 1981, very close -:o the 5.4 percent annual growth envisaged in the structural adjustment program. Exports of smallholder products rose from 28.4 percent of total exports in 1981-1983 to 35.4 percent in 1984. The volume of oil imports has declined by about one-third since 1980, in part because of the increased blending of ethanol with regular petrol. However, lower prices for tea and tobacco as well as higher external debt service increased the deficit on current account in 1985. 3.09 Despite recent positiva developments, there has not yet been substantial diversification of the commodity structure of exports; and exports of maize, a domestic food crop, have proved not to be sustainable following recovery of production in the previously drought-stricken neighboring countries. Resource Management 3.10 The SAL program included the objectives of ensuring the efficient use of public resources; revenue measures were intended to reduce the overall deficit from over 15 percent of GDP in 1981/82 to 5.5 percent in 1985/86; capacity to monitor and manage Government borrowing and the finances of statutory bodies was to be established. The Fund program included specific measures and performance criteria to control expenditures and to restrict the undertaking of new short-term non-concessional external borrowing. It also included (a) separate sub-ceilings on domestic bank credit to statutory bodies and the banking system's not claims o the - 75 - Government, and (b) the introduction of monitoring committees which were to review expenditures of ministries and departments against monthly allocations. 3.11 The objectives of the SAL were successfully achieved in zerms of (a) improvements in the process of public investment programming, including programming for the Investment expenditures of the principal parastatals through the central budget; (b) improved sectoral allocations including a reduction of development expenditure on government buildings from 25 percent of the total budget in the 1970s to 12 percent in the early 1980s; and-(c) making substantial progress in establishing a debt management unit In the nistry of Finance. 3.12 The deficit, measured as a percentage of GDP, had grown rapidly from FY79 to a peak of 16.5 percent in FY81, before declining and returning to only slightly above historical levels by FY85 (8.3 percent). While revenues have been on or above target, and development expenditures have remained near or below targetted levels, recurrent spending has usually exceeded the budget targets. Overruns have been concentrated in expenditure mainly for non-wage goods sad services, in the wage bill, due to a 10 percent average salary incretse for Government workers, and in external interest payments, largely tn ac.ount of appreciation of the US dollar. +99 3.13 The Finances of Statutory Bodies and Press. The overall financial position of the parastatal sector has improved since commencement of the program. However, a number of enterprises have remained in serious financial difficulties. Up to 1984, the main Improvement in performance eame from ADNARC, whose financial position had strengthened considerably particularly in 1984 when profitable maize export sales and the resumption of cotton exports led to an increase in the surplus earned from its main crop trading activities from M6.5 million in 1983/84 to an estimated NK17.4 million in 1984/85. 3.14 Largely resulting from considerably higher than expected purchases of domestic cr, s, which exceeded the budgeted level by 20 percent for aize, 28 percent for cotton, and 60 percent for tobacco, ADMARC's need for credit was much greater than the IMF's program had expected In 1984/85. Moreover, domestic sales and export shipments of crops were slower than expected. The pQrformance criteria on both cr.dit to Government and net domestic assets were met in June and September 1984. However, in the final quarter of 1984, as private sector borrowing returned more closely to its programmed path, and borrowing by ADMARC continued to increase, the indicative ceiling on net domestic assets established for December 1984 was exceeded. 3.15 AEKARC's financial difficulties, which resulted in the breaking of ceilings for credit to the statutory bodies and a suspension of purchases from the Extended Facility in 1985, are related to decisions regarding maixe prices ini1981. In particular, the relative price for asize became seriously out of line with prices for export crops, and resulted in large surpluses of maitse production, greatly increased storage costs, and a persisting debt overhang from overdrafts (used to purchase the - 76 - maize), which could not be repaid when export sales did not materialize and when receipts from tobacco exports were far below normal in 1985. However, the sequence of events and the issues affecting ADARUC are much more complex (including issues related to the financial relationship between ADMARC and the Government, Food Security, the role of the private sector in agricultural marketing, etc.). These will,be systematically addressed In a separate policy based operation. 3.16 The Malawi Development Corporation (MDC), th Malawi Bousing Corporation (MHC) and the Electricity Supply Commisaion (SCOM3 also improved their performance, but heavy amortization obligations continued to create-cash flow problems for ESCOM during 1984, and are likely to do so In subsequent years. MDC's recovery has permit;ed it to earn profits of about MK6 million and M11 million in 1984 and 1985, compared to a loss of about MK3.0 million in 1983. Malawi Railways continues to take cost-cutting measures and tariff increases to actively develop new domestic sources of revenue and to seek substantial relief from its debt obligations to the Government. Serious concerns persist with the position of Air Malawi, whose loss increased in 1984 because of the increasing fuel and maintenance costs of an old and inefficient fleet, combined with falling demand on international routes, 3.17 The financial restructuring of the Press group of companies, studied and carried out during the first and second SALs, was largely completed during 1984 in accordance with the agreements signed in December 1983. In June 1984, an issue of Special Local Registered Stock (SLRS) amounting to MK54.2 million was made by the Government to the two commercial banks to finance the Government's assumption of Press' liabilities to the banks. In return, the Government holds preference shares and income notes from the new holding company, Press Group Ltd. (PGL)* The Government's annual incremental debt service on account of t is transaction. is approxiato M08.5 million (including amortization.on a 25 year schedule). In principle, the instruments issued by PGL should offset this cost, although Press' payments would begin at a relatively low level in the early years. Press has begun to amortize its Income notes and in 1985 paid approximately MK4 million to the Government on this account. Institutional Improvements 3.18 The objectives of the SALs included-measures to improve economic management including the monitoring of investments and debt management. The control of public sector investment has two facets - (a) public sector investment programming and (b) the control of parastatal investments. Since SAL I, second tranche release conditionality has included agreement with the Bank on the public sector investment program. The process of improving investment programming was to include agreement on the overall size of the development budget, agreement on sectoral allocations and the screening of investments in terms of their economic viability, their financial affordability and their priority within the objectives of the overall investment program. The Investment Coordinating Committee was established to screen parastatal investm*nt proposals using standard feasibility analysis techniques. Ultimitely the public sector investment programming process was to include the screened parastatal investment proposals and, therefore, provide a consolidated public sector invescment budget. - 77 - 3.19 This aspect of the SAL program has been successfully evolving (para. xviii). *Under SAL III further efforts are being made to introduce a more programmatic content into the budgeting process and the investment and recurrent budgeting functions have been merged and are being organized under the New Economic Planning and Development Department (EPDD). While the Investment Coordinating Committee is defunct and was never appropriately staffed to undertake the activities envisioned for it, the Goverament has taken the Initiative In requesting IDA to undertake a review of the parastatal sector including its financial interrelationship with the Government ,budget. A review of the parastatal sector is expected to lead to development of a framework for Improved management of the sector, Including strengthening of the Department of Statutory Bodies which, since its establishment in 1986, has successfully played a technical assistance role for the sector and whose role is expected to be expanded and strengthened. 3.20 Efforts to install a centralized debt management capacity In the MLnistry of Finance have been slow, but successful, especially in light of the fact that the Malawians have been developing their own systems with limited external assistance. Currently, the unit is in the process of entering a register of all debts, consisting of a listing of debt and debt service data inaln.ding parastatal and central government debt, but not yet Including private non-guaranteed or short-term debt. IDA's assistance has played an Important role in getting the data into one place and in convincing the Reserve Bank to closely coordinate with the External Aid Division of the Treasury where the debt management unit is located. 3.21. The genesis of Malaw's debt crisis preceded the SAL and rescheduling preceded establishment of a functioning debt analysis and debt management capacity. Therefore the Impact of having such a system has not yet been felt. Howmver, Malawi has been successful in respecting the IMP program ceilings on non-concessional external borrowing in all maturity ranges. Although the program permitted up to SDR5 million in borrowing with 12 year maturities, Malawi has undertaken no new non-concessional external borrowing. Except for normal trade financing, the Government and public enterprises did not undertake any borrowing with maturity of less than one year, and there is no debt outstanding. The Reserve Bank of Nslawi had also completely repaid the amounts outstanding relating to lines of credit from foreign commercial banks by the end of 1984. Issues to be further developed. 3.22. Despite progress made during SALs I and II, and the further deepening of institutional prescriptions under SAL III, Malawi continues to need balance of payments support until certain structural reform are achieved. Specifically, further progress is needed in terms of (a) diversification of the production and export base; (b) rationalization and establishment on a sustainable basis of reforms in the areas of public sector programming, tax and budget policy-making; and (c) rationalizing the finances of parastatal bodies and their budgetary relationships with the central government. Subsequent SALs are expected to become tncreasingly specific and demanding in terms ' reforms to be undertaken with a view to achieving a sustainable impact to complete the struitural adjustment process. -78 - IV. ANK ROLE AND PEORANCE 4.01 The principal responsibilities undertaken by the Bank In Malad' s Adjustment Program have beet (a) assisting In the Identification of development constraints and working with the Government on the design of a program to address them; (b) the monitoring of progress in implemeting policy reforms; (c) carrying out and monitoring studies to provide the analytical background for policy reform recommendations; (d) the design of a lending program to support the structural adjustment process; and (e) cooperation and complementarity with the DI program Identification of Develomat Constraints 4.02 The priority which various development constraints were accorded at different points should be seen to light of the dynamic, long-term, nature of the adjustment program, the building on lessons learned from earlier experience, and the evolution of lank/Government policy dialogue. 4.03 Io general, identification of constraints to be dealt with In the program has been realistic and based on detailed analyst. This approach has paid off In terms of the credibility of the Bank In its policy A.ialogue with the Government and in terms of the Government's willingness to undertake politically sensitive restructering of its Institutional arrangemeans for budgeting, taxation policy and parastatal reform. 4.04 This step by step approach has resulted in the following timing of constraint identification and Irogras ?eforme. 4.05 Wgetag, Revenue Measures and Meettag Deficit Tanets. Initial attentlon re -sed on seeting targets'achgeved by ad im budgetary cutbacks and measures to Increase revenue, less focus was given to reforming the institutional and administrative processes involved until the third phase of the progra, although specific recommedations were made earlier. Under SAL I1, the sustatiability of reforms is being given increased attention through efforts to establish adequate processes of planning, public investment programming, budgeting and taxation policy-making. It is noted that concrete efforts to establish adequate debt planning and monitoring capacity began under SAL t. 4.06 Strengthenig of Parastatals and of Press. The report-on AIWKARC financed under the TA I project identified a broad range of Issues and made a broad set of recommedatIons, not all of which were addressed in the SAL operations. In SAL II, focus was placed on strengthening the financial manageat of the company, and proceeding with divestiture of son-agricultural related Investments. Through technical assistance provided under the seatholder fertiliser project, efforts were made to Improve AMAC's operations with respect to fertiliser distribution. Other sses not actively pursued included (a) rationalizing the company's financial relationship with the Government to permit it to be reimbursed for its non-commercial activities such as anagmnt of the strategic grain reserve (para. 2.44(b)); and (b) opening sallbolder marketing to private sector competition (para. 2.44(f)), The reasons for lack of IDA's active Involvement Io these issues were: first, the referenced report on AMARC wae produced following appraisal of SAL 11; and, secondly, since AIARC - 9 - continued to be a profitable company, the urgency of Implementing far reaching policy reforms as part of the program was met witb Veluctance by the Government. The focus of assistance actually undertaken was reasonable given these circumstances. It was not until ADMAC's tisancial crisis In 1985 (para. 3.15) that many of the issues identified earlier were brought into focus. . 4.07 The identification of problems related to Press and MDC was appropriate and resulted in the development of programs which have had impressive results in restoring the profitability of these two companies. Both companies are now making profits, are servicing their income notes, and have resumed new investments (paras. 3.16 and 3.17). Monitoring of Policy Reforms 4.08 Progress under the program was monitored in a tiely and systematic fashion. The review for SAL I was scheduled for October 31, 1981 and the mission visited the country from October 19 to November 5, 1981 and again In early February 1982. The tranche conditions were fulfilled by early April 1982 at which time the staff recommended to Senior Management that the second tranche be released, The review for SAL II was scheduled for May 15, 1984 and a mission visited the country from April 28 to May 16, 1984. On November 14, 1984, staff recommended to Senior Yanagement that the second tranche be released. The missions were appropriately staffed and maintained continuity. Throughout SALs I & II and TAI, (a) parastatal issues were dealt with by a senior financial analyst from the Industrial Development Finance Division; (b) the agricultural portions of the program were handled by senior agricultural economists as wall as by economists from the programs department; c) budget, tax, public Investment programing and macroeconomic issues were handled by economists from the programs department who received Input from staff working in the respective sectors as regards sectoral budget allocations. Monitoring of Studies 4.09 During implementation of SALa I & II, the following topics were treated in consultant studies financed under the Technical Assistance Project - AMARC, Press, MDC, Livestock Sector, and debt monitoring. The tobacco sector study was financed by the Government. The estate credit study was to be financed by the TA I Project but was In fact financed by the TA II Project. In each case, Bank input was offered in an effective and timely fashion to ensure that the studies fulfilled their terms of reference and could be expanded as important issues were identified. In addition, the Bank produced the Basic Economic Report which provided the basic analytical background for SAL I. An agricultural diversification study was carried out during Implementation of SAL II. Design of the Lading Program 4.10 During Implementation of SALs I and II, the need for several projects was identified and they were included in the leading program. The objectives and some conditionality in these projects directly complement the structural adjustment effort and have been justified on that basis. The Smallholder Fertilizer Project (Cr. 1352, approved April 1983) - 80 - addresses the issue of fertilizer procurement and distribution; the Urban I Project (Cr. 1528, approved November 1984) addresses the need for private ownership of staff housing and a reduction of housing subsidies which have placed a large burden on the Government budget; the National Agricul.tural Research (Cr.1549, approved February 1985) and the Extension and Planning Support (Ln. 1626, approved September 1985) Projeos contribute to strengthening services to smallholder producers; the Industrial and Agricultural Credit Project provides medium and long-term credit to the estate subsector to permit the financing of productivity improving Investments which eventually should free up land devoted to tobacco (while maintaining tobacco Income) for use In planting other crops. The First Wood Energy Project (para. 2.08), as well as the recently approved Second Wood Energy Project, promotes the planting of woodlots by smallholders and by tobacco and tea estates through incentives and Increased stumpage fees. The projects also promote development of fuel efficient stoves and kilns to counteract the increasing shortage of fuelwood. The recently appraised Transportation I Project will tinance rehabilitation and completion of the Northern Corridor Route through Tanzania to permit a reduction In transport costs resulting from closure of the country's most cost-effective routes through Mozambique. Coordination with the IF 4.11 The Bank and Fund staff have maintained close collaboration - during implementation of our respective programs. The Fund's second two year standby which covered 1980/81 to the 1981/82 period coincided with il Aentation of SAL 1. The fund then embarked on a third standby which covered the 1982/83 period. The Extended Fund Facility Program which commenced in September 1983 coincided almost exactly with implementation of SAL II which was approved by the Board in late November 1983 and declared effective in January 1984. 4.12 Throughout these programs, the staff have regularly shared information and views and have Informed each other of developments to areas of mutual concern. Although some ivision of labor has developed, sharing of ideas even in areas which could have been considered the domain of one or the other of the institutions has been maintained. For example, whil the Fund has maintained the lead in monitoring the exchange rate and domestic resource mobilization efforts, during SAL II and appraisal of SAL III the Bank's concerns regarding delays experienced with foreign exchange allocations and regarding the effect on incentives and revenue buoyancy of reliance on ad hoc tax measures, resulted In a fruitful collaboration in bringing these concerns to the attention of the Malaian authorities. As a result, (a) a review of the tax system has led to adoption by the Government of reforms which would restructure the tax syatem and remove distortions which were beginning to appear; and (b) concerns expressed to the authorities regarding exchange allocation problems have resulted in a more liberal and flexible management of the system. At the onset of ADNARC's liquidity crisis, the Fund began to collaborate very closely with the Bank, especially on pricing decisions (an area in which the Bank had traditionally taken the lead), since they had such a direct impact on ADARC's finances and hence on the EFF program, The two institutions continue their close collaboration on ADKARC issues or ire critically Important to continuation of both.iastitutions' programs 4nd the Fund is participating in the preparation and appraisal of the ADMAC operation. - 81 - V. LESSONS LEARNED Lessons Related to the Adjustment Process 5.01 An Important lesson learned from Implementation experience is related to the sequence of activities in the design of policy prescriptions. The design of SAL I was based largely on the economic and sector analyses carried out for the Basic Economic Report. As we embark upon a third operation, the evolution of policy prescriptions is evident. for example, SAL9 I and I focussed nearly exclusively on correcting price policy to achieve agricultural diversification and the growth of smallholder production. To some extent the institutional strengthening of Press and MDC was supported to promote agricultural iavestment. SAL III. however, is beginning to tackle the diversification objective to the form of direct Institutional supports including studies and technical assistance to establish export Incentive and promotion systems as well as financing a guarantee mechanism. As a second example, the first operations addressed the problems of Press and the statutory bodies on an individual basis and relied on the Department of Statutory Bodies to provide technical support to the sector, and on the ICC to screen Investments. SAL III will, however, help establish a comprehensive framework in which to set policy for the parastatal companies' financial and managerial relationships with the goverannt Including plaming, staffing and training, capitalisation Issues and the strengthening of DS3. These two cases illustrate the deepening of policy presorlotions which has resulted from an Initial testing of solutions and Implementation experience. Implementation of SALS I and It have yielded lessdns In terms oft (a) the efficacy and adequacy of a given prescription; (b) Institutional and administrat.ve abilities; and (c) levels of Government commitsient to policy changes. 5.02 The economic and sector work which offered the analysis on which Initial policy designs were based could not have been expected to deal In depth with the types of Institutional, social,'and political sses and Interactions which result from impleaentation. For this reason it can be said that Initial solutions tended in many cases to be oversimplifications and experience has permitted each operation to evolve to a new level In terms of the types of activities undertaken. Thus, it to perhaps not appropriate to say that in any given area that there were oversights or mistakes, but rather the whole design of policy in the Malawi SALs should be seen as an evolutionary process. The process Includes discovering new issues, new areas of focus, as well as new approaches. 5.03 Another area of lessons learned from the adjustment process is related to the evolution of;goverament's commitment. During SALs I and I, IDA played a somewhat larger role In developing policy instruments. Bowever, during preparation and Implementation of SAL III, the government has taken the initiative in several areas, including: (a) merging the Economic Planning Division and the Development Division and requesting assistance to introduce a more programmatic content Into the budget process; (b) undertaking tax reform; (c) requesting assistance to undertake parastatal reform; (d) undertaking civil service reformt and (e) requesting assistance to reform ADMAC's operations. This evolution has been due to S continuity of higher level staff involved in the SAL process, and their Increasing experience with and understanding of the adjustment process, as well as the credibility and good working relationship that IDA has established through solid analytical work and some demonstrated successes. 82- 5.04 Under1tandin of the source of commitment has also evolved. Technical staff were committed to resolving Issues related to sectOral allocations to the public investment program and the level of allocation for government buildings; however, the level of commitment fro the highest political authorities was ach lower. Similarly tackling Press related isues and food security Issues as they were addressed through pricing decisions received a certain level of commitment from the counterparts who negotiated the SAL bet there was reluctance from the highest authorities In tackling these issues. 'The lesson to be learned from these experiences is that the SAL can be a mechanism to address sensitive areas which cannot be dealt with Independently by the civil service. Addressing these sensitive issues requires realism and compromise, which IDA successfully achieved . Particular note should be given to the successful handling of Press related issues, an area to which IDA dared to tread despit the potential risk this Intervention posed to our relationship with Walawi. Progra-Related tassons 5.05 Diversification. As mentioned, the first operations relied on pricing policy to increase the growth and diversification of agricultural exports. While some progress has been achieved it has been liited and it is now recognised that to achieve a turnaround io this area there to a need to complement price policy initiatives with a more specific action plan and direct institutional Interventions including development of an export promotion policy package and financing scheme. These efforts will be undertaken In SAL III. Also, an Industrial and Agricultural Credit Project will provide medium and long-term credit to agricultural estates to support productivity Improving Investments which would (a) permit them to free up land for diversitcation crops and (b) generate Increased retained earnings to finance Investments In new crops. ODA has plans to finance an Extension and Management -Service for estates which would further support potential diversification activities, In addition, sector work devoted to developing recommendations to support the diversification objective and to identify an agricultural diversification project will be undertaken over the next year. 5.06 Price Policy. Since the 672 maize price Increase during Iaplementaion of I, IDA has continued to express concern to the Government regarding the potential effects on AVARC's operations and fiances, and the potential detriment to the develoument of smallholder export crops. The SAL I tranche release delay we due is part to this issue and subsequent price reviews have focussed heavily on restricting the price Increase for maise. This issue is an example of differences between the objectives of the SAL program and those of the political authorities, who, In this case, were committed to achieving food security and to avoiding the need to Import maiae as had been done following the 1980 drought. Although 1DA made progress in its efforts to restore balance between the relative price of maise and other crope, large maise surpluses have continued to be produced and AMKARC has continued to absorb them. While it was recognized that this profitability we due to AMARC's temporary ability to export aise to drought stricken neighbors and to meask losses on its domestic maise account with large profits from the tobacco export account, the Goverament's resolve to continue prices which easured surplus maiae production seemed to be validated by AMAC's continued profitability.- In addition, the authorities argued that the sharply Increased fertilizer prices resulting from programmed subsidy reductions needed to be offset by high maize prices. 5.07 In this policy area, there were important lessons learned In terms of the management of conflicting objectives where choices were not clearcut. The Government's interest in food security and in increasing price incentives for smallholders had merit, but this resulted in a serious deterioration of ADMARC's finances, as well as in disincentives to produce crops other than maize. It was only in 1985 when tobacco.prices fell sharply, maize could no longer be .exported, and ADARC's financial problems resulted, that the Government had to focus on making difficult choices regarding ADMARC's management as well as pricing policy. An earlier response to the problems of maize prices might have averted the difficult adjustment faced now, Expenditure Planning and Resource Mobilization 5.08 In both SAL operations public sector investment programming, the planning of public expenditure, and the level of the budget deficit received considerable attention. Despite successful efforts to 6et and meet deficit targets and sectoral budgetary allocations, it is recognized that institutional issues, related to the definition of program costs and coordination of recurrent and investment expenditures need to be directly addressed to establish on a sustainable basis an improved budgetary process. Under SAL III, the Government is employing a consultant to Introduce a mora programmatic content into the budget. While the old system will continue to be in effect with the 1986/87 budget, the ministries will prepare supplementary tables based on this new approach. As difficulties with the new system are ironed out, the new budgeting system will gradually be inst&lled. 5.09 Tax policy during the first two SALs focussed on raising revenues from 11% of GDP in 1973/74 to about 20% in 1983/84. Under the program reliance was placed on Implementing ad hoc tax measures to quickly generate increased revenue. In particular, increased taxation on imports of intermediate goods and fuel products and, to a lesser extent, on corporations, has been used. This ad hoe introduction of many taxes has led to an increasingly complex tax structure resulting in delays and inefficiencies in collection. Further, the high rates of direct taxation act as disincentives to saving and investment, while the taxation of intermediate inputs, whether domestically produced or imported, distorts production and weakens incentives for export promotion and efficient import substitution. During the course of the first two SAL's these weaknesses were recognized and under SAL III the government has commissioned a study of the tax system with a view to changing its structure, including: (a) broadening of the tax base and reduction of rates; (b) a shift of taxation from external trade to domestic transactions; (c) a shift of taxation from production to consumption; and (d) simplification and strengthening of tax administration. Such a restructuring is expected to reduce the need for new and additional tax measures each year as the bouyancy of the system would now be much improved. - 84 - Industrial Sector DeveloEment and Tolicy Environment 5.10 The initial industrial sector work carried out for the Basic Economic Report identified no Important policy issuese Specifically, (a) although the existence of price controls was recognized, they were characterised as being applied flexibly and as not causing problems or distortions; (b) no fundamental issues related to the foreign exchange allocation system were found and the exchange rate appeared to be managed flexibly; and (c) because of the apparent lack of fundamental policy Issues, future sector work on Malai's industrial sector was given a low priority In IDA's work programming. 5.11 During appraisal and taplementation of SAL II the following was .learned during discussions with private sector agents and Government officials: (a) that, in the prevailing inflationary environment, the price control system was resulting in unacceptable delays in the implementation of normal price increases; (b) that from 1982 to aid-1983, when reserves came under increasing pressure, the Reserve Bank delayed the provision of foreign exchange for initially approved imports, for periods of up to three months. However, with the improvement in the reserve position in 1984, this ceased to be a problem and the Reserve Bank is currently providing foreign exchange for imports with a lag of two to four weeks. 5.12 As a result of these observations, SAL II included measures to decontrol prices which have been successfully completed. Although no direct intervention was made by either the Bank or the Fund with respect to the foreign exchange allocation system, extensive discussions were carried out with the authorities who have agreed under SAL III to facilitate imports of products which compete with domestically produced goods. This area will continue to be reviewed under SAL III and by the Fund. Future structural adjustment efforts and sector work on the industrial sector will take place with particular emphasis on the financial sector. W%689 4*0V'1'848 - -CAPITAL CY ANNEX page 1 of 5 22nd May, 1981 Mr. Robert S. McNamara, President, International Bank for Reconstruction and Development, 1818 "H# Street, N.W., Washington, D.C. 20433, United States of America. Dear Mr. McNamara, LETTER OF DEVELOPMENT POLICIES A sharp decline in Malati's terms of trade has resulted.in a serious deterioration of our economy. The drop in the prices of principal exports, namely tobacco and tea, after 1977 was accompanied by rapidly accelerating imporb prices and greater transport costs. As a result, in 1980, GDP growth declined to only 0.6 per cent and real income fell by 1.5 per cent. 2. The crisis has highlighted a number of structural problems which call for immediate action. The most serious problems are the relatively slow growth of smallholder production, heavy reliance on a few primary commodities to earn foreign exchange, the modern sector's dependence on imported oil, financial weaknesses of the statutory corporations, deteriorating Government budgetary position, and growing imbalance between Government recurrent and capital expenditure. However, we belicve that the country's large agricultural and forestry resources would provide a basis for sustained future growth, through expanding exports and efficiently substituting local production for imports. GOVERNMENTS ACTION PROGRAMME 3. *To deal with these problems, the Government has formulated a medium-term programme of structural adjustment covering 1981/82-1985/86. The programme includes measures to- (i) improve the country's balance of payments; (ii) streamline the system of price and wage controls; (iii) improve resource management; and (iv) to strengthen public sector institutions. - 86 - ANNE I Page 2 of 5 4. Balance of Payments: Despite the sizeable public investmeNts in smallholder agriculture over the past ten years, smallholder exports have stagnated. The structure of producer prices has certainly played an important role In 1978, an interministerial price advisory committee was set up to monitor the impact of producer prices. The committee completed one comprehensive price review in. 1980. The Government will institutionalize the practi6e of annually reviewing crop prices and these will be worked out in a manner designed to maximize national income. In accordance w4,th its normal procedures, the Government will announce its price decision for each crop year before the planting season, 5. The performance of Malati's tobacco industry will remain critical to the economy from th& standpoint of generating foreign exchange and employment. The Government proposes.to carry out a major study that will define the current position of the tobacco industry, identify probable trends ond facilitate recommendations for improving the efficiency of estate operations in the country. 6. With the intention of promoting agricultural diversification, the Government plans to carry out a study to consolidate its knowledge of livestock products industries, particularly relating to supply and demand as well as cost structure for production and marketing. 7. In the area of energy, the Government has limited the consumptiqr of petroleum through price/tax policies and sought to develop new sources through investments. The Government intends to carry out a comprehensive energy sector study in order to assess available-resources, project future demand and supply and examine alternative sources of energy and the possibilities for intrasectoral subjtitution. 8. Price Controls and Wage Policy: Setting adequate prices is important for providing incentives for current production as well as providing the necessary stimulus for capital formation for maintaining and expanding output. It is the Government's intention to adjust tariffs on a regular basis and to make smaller and more frequent adjustments to prices. At the same time, it is recognized that, as with prices, wages and salaries should be reviewed on a regular basis. Whenever possible, gradual and more frequent adjustment will be made to wages to reflect the opportunity cost of labour, 87 - ANNEX I PalT"of 5 9. Resource Management: To achieve targets for growth and sTructurai change in a highly constrained financial environment# it will be necessary to use private and public resources as efficiently as possible. In the five-year development programme, Government intends to deploy its revenue and development account resources to maximize its contribqtion to national objectives. On development account,low priority items will be dropped and resources reallocated to key sectors such as agriculture, education, health and traAsport. Moreover, the Government has given priority to completing ongoing projects over undertaking of new investments. During the coming five years, the Government will continue to review the composition of the investment programme as part of its regular budgetary process and keep the Bank informed about the results of these reviews. 10. By the end of the 1970s, it had become apparent that the method used in determining recurrent account allocations needed to be reviewed. In the future, the Government will intensify its efforts to increase allocations to recurrent operations to provide adequate support for the development programme. While financial constraints may inhibit progress at first, projections suggest that revenue expansion should be adequate to compensate for inflation and provide for real expansion of recurrent services in key economic and social sectors such as agriculture and education, as implied by the Government's planned development programmes. 11. In addition, as economic recovery leads to rising economic activity and profits, the Government will take steps to ensure that revenues will rise as fast as possible. To achieve this objective, the Government will review its tax administration and introduce new taxes as opportunities. arise. It will also.make more frequent adjustments in specific rates and departmental charges to compensate for inflation. The Government has introduced the following measures in its 1981 budget: (a) an increase of 15 per cent in all specific import and excise duties; (b) an introduction of 10 per cent tax on hotel and restaurant services; and (c) an across the board tariff increase of three percentage points.. Government borrowing from the banking system will be held to sufficiently low levels to permit credit to the private sector to increase more rapidly and the country's foreign exchange reserves to build up. - 88 - ANNEX I PaSe 4 of 5 12. Since future external capital requirements will expand with economic growth, the Government intends to restrict additional borrowing on commercial terms and to manage the amounts and terms of borrowing so as to maintain Malq$i's external creditwortkiness.. Toward this objective, the Government intends to 0 strengthen its institutional capability for monitorihg, recording, and managing public and government guaranteed private debt. 13. Overall, statutory bodies have made a significant contribution to the economy and have in the aggregate generated enough profits to finance a substantial part of their own investment. However, in the past two years, the financial position of most of these public corporations has deteriorated substantially, as a cinsequence of sharp increases in costs and debt service obligations and a levelling off or d6cline in revenues. In November of 1980, a Department of Statutory Bodies (DS8) was established in the Office.of the President and Cabinet to monitor activities in all public enterprises. The DSB, in co-operation with the Treasury, has already completed a review of the recent performance and FY81-82 outlook for these enterprises. The DSB has also started to provide assistance to various enterprises in their medium-term financial planning. 14. Substantial increases in tariffs have recently been put into effect for several of the statutory bodies e.g., Air Malafi, Malafi Railways and Electricity Supply Commission of Mala*i (ESCOMJ. For all the public utilities the Government plani in the future to make moderate tariff increases more frequently in line with increased costs. It is also Government's objective that all statutory bodies prepare medium-term financial plans annually. 15. Institutional Improvements: Government intends to strengthen its instizutional capability for planning, monitoring and managing its operations. The Government has already created an Investment Co-ordinating Committee which will monitor investments by private and public iiveotments to ensure that major project undertakings meet acceptable economic and financial criteria. - 89 - ME I Page 5 of 5 Other action being undertaken toward this end includes provision of increased resources for the Ministry of Finance, the Economic Planning Division and the National Statistical Office; and a series of studies designed to improve th4roperations and finances of key institutions such as Agricultural Development aq* Marketing Corporation (ADMARC), Malafi Development Corporation (MDC) and the.Malafi Railways 16. While the Government intends to pursue the policies outlihed above, we hope that we can count on the continued support of the international community through project and additional programme loans. To help the country through a difficult period, the Government. now specifically requests a structural adjustment loan from the World Bank. Yours sincerely, L.Chakakala Chaziy MINISTER OF FINANCE MINISTER OP 1NANCE P.O. BOX .An4 - 90 - CAPITAL OTY ULONOW! 3 ANNEX II ae 1of 8 Ref. No. 32/1/62/1 25th November, 1983 Mr. A. W. Clausen, Prbsident, World Bank, 1818 H St., N.W., WASHINGTON, D.C. 20433, Dear Mr. Clausen# LETTER OF DEVELOPMENT POLICIES I wrote to the World Bank a little more than two years ago to describe the serious economic conditions that Malawi was facing and the programme we had adopted.to deal with our problems. At that time the Bank granted Malawi a Structural Adjustment Loan of US$45 milZion. Since then the economy has continued to be confronted with difficult external conditions, especially transport difficulties and depressed demand for our export commodities. Still we have been successful in implementing significant portions of our structural adjustment programme and after declining by 0.8 per cent in 1981, GDP grew by 3.0 per cent in 1982. We shall continue to address the structural problems I identified in my previous letter, namely the relatively slow growth of smallholder production, heavy reliance on a few primary commodities to earn foreign exchange, the modern sector's dependence on imported oil, financial weaknesses of the statutory corporations, weakened Government budgetary position, .and growing imbalance between Government recurrent and,capital expenditure as wall as addressing the continuing transport difficulties we face. * -91 - ANNEX II Page 2 of 8 GOVERNMENT ACTION PROGRAMME Our dontinuation of the structural adjustment programme will include measures to .() improve performance of the productive sectorsl (ii) improve resource mobilization and managements and (iii) strengthen key institutions in the country. Productive Sectors We are planning actions to increase the efficiency of smallholder agriculture, estat2 agriculture and industry. Smallholder*Agriculture. We shall continue to enqure that prices paid to smallholders keep the country self sufficient in food, encourage the production of export crops, and give them fair return for their labour. Particular attention will be paid to cotton to ensure an adequate supply for domestic needs. At the same time, we have taken steps to strengthen the agrieultural marketing agency (ADMARC) to improve its efficiency and sharpen its focus on providing service to smallholders. A detailed programme for its restructuring has been agreed with the Association, key personnel have been appointed and a jointly financed IDA-IFAD Smallholder Fertilizer Project has been approved to overcome the fertilizer shortages the country has faced recently. While our budgetary resources are quite constrained now# we shall ensure that the Ministry of Agriculture continues to receive adequate funding for maintenance of%vital services. -92 ANNEX 11 Paie 3of 8 Estate Agriculture. In recent years estates have*provided up to 80 per cent of Malawi's agricultural exports-and if the country is to correct its balance of payments deficits, the efficiency and' diversity of this subsector must be improved. This is necessary not only to keep adequate production of tobacco, tea and sugar but also to diversify into other crops without major expansion of land area. We are developing a programme for management training, extension and credit for the estates. We shall be enforcing strictly regulations to control the quality and quantity-of key crops, encourage estates to develop new crops and develop an estate credit project that we shall be bringing to the Association in 1984. We have also begun a study on size distribution of farms, yields and other productivity measures to help us formulate a policy on future land usage. Industry.. The Government has encouraged private sector development in industry by providing incentives for investment expansion with generally good results. However, over time, a system of formal and informal price controls has developed that could create a disincentive for expansion of industry, new investment and increased efficiency.. The Government is committed to the objeqtive of decontrol of industrial prices except for those items which are critical for the-well being of the lowest income groups. Howevr, because of social considerations and to minimize the risk of exploitation of monopolies in small markets, phasing out of price controls will be gradual and the Government will continue to exercise control on the prices of a few basic commodities. We have recently hired the services of a consultant to help us draw up a timetable for decontrolling the prices of most items. By early next year, we will be abolishing the need to get clearance for price increases for a significant number of items. * 93 ANNEX 1I Page 4 of 8 Resource Mobilization and Management Our recent economic difficulties have reemphasized for us the importance of using our resources as efficiently as possible. We need to increase our savings and investment rates# maintain the share of Government revenues in GDP, scrutinize carefully our public investment programme and be sure that we are allocating sufficient recurrent expenditures to maintain and utilize our capital stock efficiently. Public Investments. We have recently prepared a revised public investment programme encompassing investments of both the Government and the statutory bodies. We have discussed the programme with members of your staff and we are in agreement that the amcants and allocations are appropriate. We shall be implementing the programme over the next three fiscal years, looking for financing for projects that are not yet funded and ensuring that projects of lower priority are not implemented. An annual review of the progrAmme will be carried out. Recurrent Expenditures. In order to put our resources to their bes.t use, we shall ensure that key developmental departments such as agriculture, education and road maintenance receive adequate recurrent allotments and we shall discuss these figures annually with the Association. Government Revenues.- In the last two years' the Government has introduced.a number of new revenue measures to reverse the decline in the revenue/GOP ratio. We are committed to mike further-adjustments in the tax and non-tax systems to realize a bouyancy of at least 1.0 with respect to GDP while ensuring that proper incentives are given and economic efficiency is-encouraged. We shall ensure that departmental charges and fees are adjusted as necessary and sub- sidies such as those on fertilizer are removed in order to ensure efficient use of resources. In order to expand social services such as health, education and%housing to as large a proportion of the population as possible, user charges will be adjusted and subsidies eliminated or minimized over time. - 94 - ANNEX II Page 5 of 8 Parastatal Finances. During most of the 1970s, the statutory bodies were a source of savings and investment for the economy. The economic difficulties of recent years have affected these corporations markedly and they have become a drain upon the Government budget. "We have made tariff increases for Air Malawi, Malawi Railways, the Electricity Supply Commission of Malawi and Blantyre Water Board. We shall continue to adjust the tariffs of the major corporations -to give them fair return on their investments. We shall also strengthen the management and financial control over the corporations so that they operate more efficiently. Exchanqe Rate. In April of 1982 the kwacha was devalued by 15 per cent vis-a-vis the SDR and by. a further 12 per cent in September 1983 in order to improve export incentives. In future# the Government will pursue an active exchange rate policy. Interest Rates. Deposit rates were increased by two percentage 'points on June 1, 1983. We believe this step will help to mobilize domestic savings-and has made interest rates positive in real terms. We will continue to monitor interest rates and make adjustments in the future as they are needed. External Debt Management. Two y6ars ago we agreed that the Government needed to strengthen its debt management capability. We have set up a statistical unit in the Ministry of Finance, improved our data base, begun a more-systematic .collection of debt data and used funds under the Technical Assistance Loan to hire a consultant to help in improving our debt monitoring system.. We will continue to improve our debt management system. We have recently reached agreement on rescheduling a 'second year of an external official and commercial debts. We are developing-ou- debt policy formulation capabilities to ensure that our debt situation does not deteriorate as it did a few years ago and will produce a debt strategy and plan. - 95 - ANNEX 11 age 6 of 8 Institutional.Improvements The recent economic crisis has shown that some key institutions in the country in both the public and private sectors needed strengthening. ADMARC, MDC and Press. Under the first SAL, the TechIcalI Assistance Loan was used for studies of ADMARCt the Malawi Development Corporation (MDC) and Press (Holdings) Limited, the largest private corporation in the country. These studies have led to plans for the financial and organizational restructuring of all of these institutions. Detailed action plans have been drawn up and discussed with the Association, and their implementation has begun. In the future we shall ensure that Press is run as a commercial organization following good business practices, that ADMARC concentrates on serving the smallholder farmer and MDC returns to its primary role as a catalyst for investment in the industrial sector. Development Management. The recent economic difficulties have forced the Government to focus on immediate problems rather than the medium to long term outlook and the formulation of a development strategy. The latter are important and require additional attention. Under the first SAL we established an Investment Coordination Committee to overs&e major investments, reinforced the planning units in some ministries, took action to improve our debt management capabilities-and strengthened the planning and financial management of many of the parastatals. We will continue this process by strengthening the staffing of the Economic Planning Division, with emphasis on the sections that deal with the development of medium term policies. We will also strengthen EDP's project identification, evaluation, monitoring at.4 co-ordination capabilities. We will improve the institutional framework for energy policy and management by appointing an energy advisor to EPD to assist with the development of a medium term investment plan for the energy sector.. Government will also-carry out a tariff study for the electricity pommission and develop a pilot project for fueldood savings. We will improve our budgetary management by developing three year projections on revenues and recurrent expenditure needs. -96 ANNEX 11 Page 7 of 8 StatutorX Bodies. We will be implementing some of the recommendations of the studies that have been carried -out -on a num1ner of parastatals, such as Malawi Railways and MDC, to improve their efficiency. We are striving to fill vacancies that exist in key posts such as general manager for MDC. The Department of Statutory Bodies (DSB), which was established in 1980 to assist parastatals in financial management, planning and staffing, has done a good job. The Government will ensure that DSB does not duplicate the role of the statutory bodies' parent ministries. Clear directives on DSB1s role have been issued. Transportation As a landlocked country, Malawi has always faced transport difficulties. In recent years the problems have become more acute and we are now exploring possible additional routes to the traditional ones. We have recently completed discussions with the Tanzanian Government on improving the Northern Access Route and have agreed on terms of reference for a study for the necessary investments and most efficient modes of transport for using this route. We have decided to extend the existence of the secretariat in the'Ministry of transport and Communications to improve our ability t6 deal with the current transport difficulties. Relations with the IMF We have recently completed a successful one year stand-by agreement with the IMF and have followed it up with a three year EFF that was .approved by their board on September 19, 1983. This programme will complement the SAL programme that we have worked out with the IDA. 9 7 ANNEX 11 Pages of 8 Conclusion Malawi continues to face difficult problems* but we believe that with the policies as outlined in this letter and with the continued support of institutions such as yours, we will be able to return the economy to the robust growth that it was able to attain in the past. We ask your help for our endeavours by extending a second structural adjustment operation. Sincerely yours L. Chakakala Chaziya, M.P. Minister of Finance