Malawi - Entrepreneurship Development and Drought Recovery Program

Docnsntof The VWorld Bank FOR OMfCLAL USE ONLY MICROFICHE Copy Report NO, P- 5461-MAI Type: (pR) qu P56MA SCHAFER, H/ X34421 / J11O46/ AF6co Repo!N P-5461-MAI REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 85.4 MILLION (US$120 MILLION EQUIVALENT) TO THE REPUBLIC OF MALAWI FOR AN ENTREPRENEURSHIP DEVELOPMENT AND DROUGHT RECOVERY PROGRAM JUNE 1, 1992 lThis document has a restricted distribufion and may be used by recpients only in the performance of dtir offici duties. Its contents may not otherwise be dbcosed widtu Wodd Dank authorizadon.  OVRREM] ,AND M= EQUIVALERNTS Amua A,xu Excch=neRt Kwacha get US Dollars 1985: 1.719 1986: 1.861 1987: 2.209 1988: 2.561 1989: 2.730 1990: 2.729 WEIGHTS AND MEASURIES 1 cubic foot (cu ft) = 0.0283 cubic meters 1 cubic met (mn) = 35.3 cubic feet = 264 US gal 1 kilometer (kim) - 1,000 meter = 0.621 miles I hectare (ba) = 10,000 square meters - 2.47 acres GLOSSARY OF ABBREIATIONS ADMARC - Agricultura Development and Marketng Corporation ASAC - Agricultural Sector Adjustment Credit DevPol - S of Development Policies DOLV - Department of Lands and Valuation EDDRP - Entrepreneurship Development and Drought Recvery Program ESAP - Enaced Structura Adjustment Facility ESW - Economic and Social Work FlAS - Foreign Investment Advisory Service FSEDP - Financial Sector and Eteprise Development Project INDEFUND - Investment and Development Fund of Malawi ITPAC - Industial and Trade Policy Adjustmnt_ Credit MDC - Malawi Development Corporation MT1 Miistry of Trade and Indusy MOH - Ministry of Healtih OECF - The Overseas Economic Corporation Fund of Japan POSB - Post Office Savings Bank PSIP - Public Sector Investm Program RBM - Reserve Bank of Malawi UNDP - United Nations Development Ptogram USAID - United States Agency for Internaional Development SEDOM - Small-scale Enterprise Development of Maawi WID - Women in Development Government of Malawi FsWa Year April 1 - March 31  FOR OMCJAL USE ONLY MfALAW libbotCOnbeSM IC= RORA Table of Contumat PROGRAM SUfMMAY ............................................... 1-iii PART L COUNTRY POUCIES AND BANK GROUP ASSISTANCE STRATEGY ... 1 A. Ba .rnd .......................................... I B. The Adjustment Process To Date and Economic Perfor m nene ........... 3 C. Cenra Imues and Govenmens Adjutmt Strategy ............... S D. Izrpacofl9 lDrought .................................. 8 E. BankCowitryAssistanceStrategy ........................... 10 1. Lending Strt .......................................... 11 2. Economic and Setor Work ...................... 12 3. SectorSpecificBankOperatons ........................ 13 4. PrivateSectorandCollaboraonnwlh IFC ................... 15 5. AidCoordiation .................................. 16 6. ReatiomnswiththeMF ............................... 16 F. Bank Group Opeaos ........ ......................... 17 G. Projectmpleetationssues ............................. 18 B. Perfbonance hIdicators . . . 18 L Exte Financing r.. ......................... 19 L. Summary Assessment ........ .......................... 20 PART . THE GOVERNMENrS ENTREPRENERSHIP DEVELOPMENT AND ADJUSTME1 PROGRAM .............................. 20 A. OverallCObjeciv .................................... 20 B. Macreconmic Framework and Fnancing Requirements ............ 21 C. Investment men ................................. 24 1. InvestmentPolicy ................................. 24 2. SmallandMcero-EnterprseSector ....................... 25 3. TradeRebozn .................................... 26 Ths report is based on the findinp of an appraisal mison which viidb M in June 1990. The mission conised of Ms. Kathie Knunm (Mion Leader and Senior Economist); Mr. Simon Bell (iancial Economist); Messrs. Claudo Frisdcak, Friedrich Kabnert, Jom Kniht and Chades MdLe (Consltants). Thi mission was followed by post-apprais mions in Agu 1991 by Ms. K. Krumm, and in November 1991 by Mr. Hartw*i Sdafer (Country E mist). Mr. Djordje Jovanovic (Senior Country Officer) also contibuted to the report. Mr. Prafid Pat b the mnaging Division Chief and Mr. Stephen D g the Department Director for the his document has a restricedbdbution ad may be usd by recipients only in the perforzance f their ofcd duties. s contents may not otheise be dislosed witho World Bankhorion  D. Accs to Finncial Capitd ............................... 28 1. MonetaryControl and btrRst Roe MaMaemont .............. 28 2. BankingCompton ............................... 29 3. Capl Market Dveyopment ........................... 30 E. Access to Human Capid ................................ 31 1. PublicEad km Reorientation ........................ 31 2. T Ban ........................................ 33 3. FUncouing of Labor Markets. ......................... 33 PARTDL. THE DROUGHTRECOVERY PROCRAM ..................... 3S PART IV. THE PROPOSED CREDIT ................................ 39 A. Objecve andRationalefbr IDA Fincnig ..39 B. FiangPlan .................... 40 C. Procurement, Dibsm t AccountsandAudit . ............. 40 D. MonitoringandTrandieR eilea ............................ 41 E. ImpactonGrowth ..................................... 44 F. Impacton Poverty Reduction .............................. 44 G. Rism .................................... 45 PARTV. RECOMMENDATION . ................................. 46 ANNEXI Social and Economic Indicator A. Soial ncator Data Shee B. Key Macaoecomic dcators 1987-95 C. Externl Fiacing Requiremens 1987-1995 D. Detailed Balancef-Payments Projections 1987-97 E. ForeignExchag Requireme and Debt Service Assumptions, 1987-9S lANNXI Staus of Bank Group eatios A. Staeus of Bak Group Opeati B. Statement of IFC Investments ANNEX m Performance Under Past Adjustment Opratis ANNEXI Supplementary Crdit Data Sheet AlN V Letter of Development Policy ANMM Vl Agenda of Policy Actions  MALAWI Republic of Malawi Republic of awi I:DA: SDR 85.4 million (US$120 million equivent) The opera is supported under the Specal Program of Assistce to Low-come Debt-Dbtessed Counties in Sub-Sabara Afirica Cofinancing of this program has bee araged by the African Development Bank in the amount of FUA 11.2 mi}lion (US$13.4 Standard IDA terms; 40-year mauty with a 10-year grace period. Endo MOREn " RDegm=ni. The Govnment's adjusotm program aims at removig constaint thst have inhibited privae sector en nd initative. Ihe structural reform program andimpovm n short-tem maroeconomic manag_ment in the 1980s have created a stable macroeconomic and more liberalized product markets. Nonetheless, movement ho new producte acvities in reponse to the taditonal adjustment measures bas been consuained by polcies that confine privat en t both large and small-se, throgh investment controls, limted access to fianci capial, and inadequate human resource development. The core of the adjustment progm supported by the proposed Credit is a set of specific policy reforms which wll remove these constrains. To create an enabling envronmet for private sector entrpeneu trespond and Invest in physical capital, the program includesregulatory, administrf amt and poliqc measures to encourage investment by both small- and large-scale enterprises and extend trade reform to ensure an outward orienton of the private sector response. To promote access to financial captal for new cliens and activitie, the program focs on increasing financial sector c itn, including htoduction of market-oriented monetary contol intuments and open entry of new domestic and foreig inttun into banking actvities. To broaden access tO human capital and expand employment oppotunies, the program Inchudes the reorienton of puelc d in favor of human capital combied with measures to improve funcong of lbor markets.  -11- Drougbl Re2oq. A serious drought has affcted the entre Southerm African region. Malawi has exprienced a nearly 60 percnt reduction in the output of its ma staple-maize-in 1992. Mm Government has approaced the donor community to meet addiional maize impott requrmn of 656,000 MT to avoid widespe huwr and food insecurity among significant segmen of the Malawi populatio As immediate and ffective, the Credit would provide balace of payments suWort of US$50 milliofor the purchm of maz equivet to 21 peent of the total foeign cost of maize imports. The entire drought-related compont of the Credit will be disbursed with the first trahe. Benefits and Riss: ne proposed Credt is epected to broaden economic patirdc and enable a sustainable supply response consistt with medium- term balanceofpayments viability, growth, and poverty reduction. he proposed rorm measur will have a potive and immediate Impact on economic growth by remvig obsac'cs to pivae sector investment from large to mi pr and expanding the flow of fnacial resoures into new productive actvities. Ihe iceased emphasis on human capital and labor market tUf a will ensu sustainability by making use of Malawi's abundant labor resources. Simuasly, these growth masures wfill contbute greatly to povrty reduction. Labor-intensive growth beneft the poor who oen have insufficient land resources and require other employment opportLLities. The program would directy increase employment opportunities tugh expanded invesmet, and the outward orientation would ensure a focus on labor-intensive acdvities where Malawi Is cmpetitive. Financial reorms wil result in incteased resource flows into sectors with increased partcipadon of the poor, i.e., in sectors other ta the narrow foma sector. Improved social services will ensuret the poor can take advantage of these new employment and finan deelopmets as well as other in key produedve sectors such as agricutre. The Cret woud provide for a significant proporti of the drought-eatd ficng reqre s, thus hlping to reduce widespred starvion and food insecurity. The main beneficiaries of the drougt-related Credit component are the rural and urban poor, including landless labor and food deficit smhoIders. A potent risk is the political resistance to loosening contol and widenimg economic participation that i itcal for any frther progress under the adjustm progrm. However, the Govenment is convinced of the importce of easing constrit on entrpeeuria actvity in order to create a positive investment climate. The Govenme has comrmed Its by taking a number of politically difficut meaes prior to Board  -Ill- presentatin with certain othe as condit of the second tranche. Anodha major risk is the possible failure of the Government to meet the concerns of bieral donors, expressed at the rece Constive Group (CO) meeting, regartg the need to impove govance, especialy basic freedoms and human rig. Bleral dons are sking tangible and irreverible evideo of a basic transformation in the way Malaw aproaches these matters, so dth there s a fundamena shift in the way human rgs In Malawi are viewed. The proposed Credit will provide condtnu in etwe support and to keep the adjustment program on track over the next six montis. The gene bancef-payme suport under the firt8 tranche of the Credi wil sustain the Goverments adjustent program for the rmnder of 1992. Additional blaterad balanoc-fwayments support from 1993 onward will depend on reahig agr with biatera donors. Govement's faiure to resolve the woernance, Issues with bilateral donors by end-1992 would result in postponing the second tramche release until additonal xerl financing is secured to sustain the Government's adjustment program from 1993 onward. An additonal-though smaller-risk is the GovmeW s failure to seue exr fnancing in order to flly meet the drought-reated impo rqiements, mainly maize. Ibis risk shoud d be mimized following the recent CO meetig where all donors ehzed that humantarian and drought-related aid would not be affected bv the ntroversy over goverace. Several donors indicated hat pledges on drougt relief were forthcoming as they were finizing their respectve regional drought relief strategies. Except for an amount of SDR 0.4 million earma for consultancy services, the prceeds of the Credt will be disrse in two tranches: SDR 57 million upon oan effedtivees, which is expected in July 1992, and the remaing SDR 28 million after the implementtion of key actions and resolving the govenace issues with blater donors on whIc& the sustainability of the adjustment program depen. Release of the second tranche is aepected in the second quarter of calenda 1993. The Credit proceeds for consltacy services would be disbursed over a peiod of 18 months. Thi Is a combined Presdent's and Staff Appraisa Reprt  INTRNATIONAL DEVELPNT ASSOCIATION REPORT AND REOMMENDATION OF THE TO TE EXECUTIVE DIRECTORS ON A PROED CREDIT TO TIlE REPUBLIC OF MALAWI FOR AN ENRERENEURSHIP DEVELOPMT AND DROUGHT RECOVERY PROGRAM 1. I submi the lowing report and reconion on a proposed IDA Credit of SDR 85.4 million (US$120.0 million equivalent) to Malawi for an Enrepreneurship Development and Drught Recovery Program (EDDUP). * Ei= dhe Credit supports rdorms aimed at removing conaS that have inhibited private secr e and initative and limited access to financial and human capita. This will broaden economic paricipation and enable a sustainable spply response consstent with medium-term balancef-payments viability, growth, and poverty reducdon. * Seomdv the Credit provides IWnediue and efectve baleof-payments support for food and othr impors t alleviate theimpact of a severe drought and to prevent widesped food insecuriy. The Credit wfll be on standad IDA tem, with a 40-year matui. The African Development Bank cofnancing this program and is planig to increase the allocated amount (US$13.4 million) by VIS$10 million emaked for drought relief imports. 2. A deaied aalysis of the Main economy can be found in the Country Economic MXemrandum etited 'Malawi: Growth Through Poverty Reducdton (Report No. 8140-MM), whch was circlaed to the Executive Directors in March 1990. A fourth-year Policy Frameork Paper (P) was reviewed by the Comminee of the Whole in September, 1991. Basic oounty socil and economic data are given in Annex I. PART L COIRY ROLL= AND BANK 6MTEGY A. 1 3. Despite a series of adjustment programs, Malawi remains one of the poorest counies in te world. Maai already ranks low with regard to human resource development and social indicaors, and its popation growth rate and population density are among the highest in African counoies. he major pillar of Malawi's economy is agriculture, comprised of the estate and smaliholder sub-sector. Malawi is extremely vulnerable co extra shocks because of its geographicaly land-locked position and narrow resource base. Despite considerable progress on he m fron over the past four years, the medium-term economic outlook is higly uncertain because of. * the advese impact of an drougbt in 19 throughout Soutern Africa; and * ddterioratn reons wih bflatera donors due to unresolved issues rlated to governan.  -2- 4. Eady d.gvel y . Malawi's developmene str fllowi in 1964 by and large emphsized inhfstucu and agriculture as vehicles for increased produedom While the estate sub-secor was deemed the driving force for export growth, producer prices to the saflholder sub-sector we kept below world market levels to transfer resources from the smallbolder sector into the ate and aprocessing sub-sectors. Ihe country successUlly exploited its endowmeut during the 1960s and 1970s when real GDP morm than doubled and rea per capita Incom gew by 3 percet per yer. Sp. Maawi s period of strNg growth came to a halt in the early 1980s with the onse; of a series of economic problems and exteal shocks, inuding a maked dedoration in the teams of trade, high international intr rates, and weather-related shodc. Ihe fist series of adjustment operaons was a response to this set of shock. However, while the Governmnt was responing to these, the country was hit in the mid-1980s by a worsenig of the war and civil strife in neigboring Mozambique, which not only led to a debilitaftng increase in internaonal trsportaon costs but also to increased security-related expenditu and a large influx of refgees. This led to sharp deterioration in the maroeconomic balance and policy setbacks, cuminat in an economic crisi in 1986-87. Despite the recent partial reopening of the Nacala rail route and peace overtures, the Mozambique situation has not yet eased and remais highly unmceta. Certain policy responses to this second and more drmaic set of socs, including expanded fiscal deficits and implementaton of import controls, compounded the difficulties and discouraged private sector investment and output. Widesprd poveny and food Inecrt emerged as importat social dimensions to the economic difficulties. 6. IM Drught. A severe drought is the latest In the series of extal shock which have affected Malawi. The sharp reduction (nearly 60%) in the 1992 maize crop will reult in dditional foreign eage requirements of US$236 million for maize imports in order to avoid widespread food shortages, malmution and starvation. In addition, drought-rela expenditures for ital distibution of emergency food aid, water supply rehabilitation and health programs will further exacera the Government's fiscal constain. 7. Govemanc. At the CG meeting hed In P on May 11-13, 1992, there was a discussion of issues related to governance. At the meeting, the Goverment and the donors agreed on the objective of good goverment. The meeting helped specify the areas in which the blatera doos saw problems, incudig freedom of speech, freedom of association, freedom of the press, and basic human rights such as the release or trial of detainees, and mai pror conditions in the prions. The meeting helped confirm that the bilatw donors were not seeking to impose multi-party democray or any other system of goverunent on Malawi. Bilater donors indicated that fiuther non-Irn co I would depend, as the CG press release indicated, on 'tangible and iversible evience of a basic trformaion in the way Malawi approaches thw matters, so that there was a fidamental shi in the way human right Iues In Malawi are viewed.' A pridpan agreed that there should be further consultations among tie Consutatve Group as soon as substative progress has been made in the area of govenan, preferably with six monffis, as a basis for reassessment for fure external assistce to MaawL 8. Despite the outcome of the CO meeting-where bilatral donors declined to pledge addtion assistanco and in some ases redWced exisng commitments, the Goverment has confrmed its commiment to proceed with the adjustment program as plamned. The Goverments generally good economic maragement was unanimousy endorsed by donors at the May 1992 Consultative Group meedng.  -3- B. mmD s c fQ TO Do aqd Econig PerEnmc 9. As eay as 1981, the Governmt embarbed on a broad-based stctural adjusn_t effort to ress the economic impact of eera shocd s and regain m c stabity and econmic viablity. Supported by three SALs frm the Bak and arrangemns wit e Fund, this pvra encompassed sundard well-dend measures required for adjustmet The major element of the program during ths perod wer: resuucturing of public &ector esqwim; reformng smallholder agricultura picing and marketing; and estblsh fiscal discipline. An expanded adjustment effort emerged fram the second set of eral difficies and econmic crsis of the mid-1980s. Four Polcy Framework Pps (FP) have been agrd with the Bank and Fund since 1988/89. Supportd by an Industry and Trade Policy Adjustment Credit (QTPAC) and Agriculur Sector Adjustme Credi (ASAC) from the Bgnk and other bier donors, as wdl as by su cessive arrangeme with the Fund, the adjustent program cluded firther adju ts in fisc and agricutural policy and, in aWdion, the restoration of a relativey open excuhane and trade regime. However, by the end of the 1980M, it bm clear tat the well-defined adjustme measures already being taken were insfficet to overcome the structuWal problems of Malawi, given s frile resource base and limited breadth of economic patcipation. The scope of the progm began to exand to more subtde dimensions aimed at xpandi economic pattion and addring the problems of food Iscrt and povaty which were diagnsed as ceal to Maawi's economic growth prospects. The proposed Crdit raflects the expndd scope of the adjusment progm tat is aimed at addresing the serious stutal pediment to susned growdt and poverty reduction in Malawi. 10. Public secto nite . Restructuring of the parast$ sector included reorgnizat of the Agticulual Development and Marketing Corporain (ADMARC) and MalawiDevelopment Coqrotio (MC, as well as the divesure and restucBt of the larp quasi-public conglomerate, Press Group. ADMARC's financial position has improved y with a ret to profitabiity, and a program to divest assets In non-core ar is ongaing. MDC has shed a number of operto and became profitale. Financi performa of the parasatal sector as a wbolo has been fvorable, and financial targets under the PFP have been met. Profiabilit was restred t the Press Group sa in 1984. 11. Ekl nLlicies. Fiscal policy under the adjustment program established fiscal discipline, includig development of a tax reform program and tegthened budget produres. A substnt reduction in the central governnent budget deficit enabled a transfer of fincial resouces from the Goverment to te pivate sector. The deficit declined itiay from 16 percent of GDP in 1980181 to 8 peren in 1984/85, and, in reponse to the fisc imbalances emmigfrotm the second series of sboes, the deficit again was reduced from 13 percet In 1986187 to slightly above 5 percent in 1991192. Ihe private sector shar of domestic credit was increased from about 30 percet in the mid-1980s to about 70 pct by 1990191. Sctral reforms in budgetary planning included intoduction of a rolling Public Sector Inestment Program and progr c budgeting. The Govenment als initiated a comprehensive tax refom aimed at impowved tax . ah on and allocative efficiency, with a major restructuing of Idirect taxes. Revenue generaticn has remained strog at around 20 percent of GDP. 12. E alicies. In the early adjustme period, MalawPs trade and xchange regie was rela y open. However, this trend was rversed by gradual increases in trd taxes and  -4- apreaton of the curmcy, compounded by the introduction of exchange controls on imports in reonsoe to the crisis In the mid-1980s. Beginnig In 1988, the Government phased out these import controls; the fnl stage of the import libealization program was completed in January 1991. Over the past decade, the kwaca was devalued sver times against its basket in order to rverse the loss in etal comp vess and to uppott the import liberization. The last kwacha devaluation by IS percent in Mach f992 has restored enal compitveness to levels equWivalent to 1987188, the period with the most depreciated real exchange rate. Ihe Govermeot is committed to fiuther excage rate action if exteral objectives so require. 13. Smallholder aggz IrL wlkiea. Smaholder agricultural policy rorm ialy focused on strenening price incenives and expanding mketing participation to the private sector. Rmallholder producer prices were increased significantly, wifth pricing for tradeables based on export-import price parity. In the cue of maize, which generally is not traded, domestic prices were set betwen export and import prices in line with domestic demand and supply condidons. ADMARC's monopoly marketng role was eliminated. This rested in improved performance among ager smallholders. Under ASAC, approved by the Board in March 1990, the scope of agsicula refrm was exended to remove more subtle barriers to broader patcia0on of smaller smalholders and to provide Incenives for more efficient estfte production in light of land constraints. The licensing system which prevented smaliholder production of high -ale cash crops, including burley tobacco, was revised and a program to ensure a steady increase in smallholder participation was put in place; focus on research and other public expenditumes was shifted to smaller farmers; privae sector pardcipation in marketing of coops and inp was widely promoted rather than merely being condoned. To promote efficient land use and sound envint practes, pardcularly in the estae sub-sector, land res were iceased, most recnty in 1992 to the real level prevaling in 1985, and enforcement of environmena covenans was stengthened. 14. Toonoic nhe strucu reforms and improvements in short-term macroeconomic management have created a stable macroeconomic enviroment, as Indicated by the tables presented in Annex L After negative growth in 1986 and flat performance in 1987, GDP (factor cost) grew by 4 percent per annum during 1988-91, restoring per capita GDP growth to a positive level. TAe omprehensive import liberalization program and more stable financial conditons contiud to recovery in the ma, constuction, d distiuton setofrs. Real GDP grwth for 1991 was e at lightly below 8 percent, with real growth in the smallbolder agricultural sub-secr in the double digits. The high growth rate In the agriculte sector was party due to overall favorable weather conditions in 1991, but also indicates the positive impact of suctur change In smallholder agriculture. Inflation decelerated shuply from an average of about 30 peren in 1987-88 to 16 percn in 1989 and 12 percent in 1990-91 as a result of tight aggregate demand managemet Real wages have dedlined; in fact, labor bore a sigfica part of the adjutmt burden. The Improved performance in output and relative price stability supported a large increase in gross investmt, from 12 percent of GDP in 1986 to 19 percet In 1991. 15. Despite the wide rae of policy refims, successfl implementation of measures during difficult perios, and sound economic growth during the past few years, the supply response has not been adequawe for susined growth and balanceof-payments viability. Over the past five years, export growth has been slower than import growth, with litte diversification out of the tadional exports of tobacco, tea and sugar, and limited development of the potenial for 'naufactured exports. As a result, the current account deficit was only marginally reduced from  & 0 'SOS I,.I d . t!8 .2 0 .  o5 'Ii tjii ijil I.US ijt Id zI Ii 2 "a t.8 lilipiti 6 lit .oIijJ 4141 1:1. . ill 8 fl h ifF 34111 fi 411 1111- II I' 1111