Document of The World Bank FOR OFFICIAL USE ONLY Report No. 1256 PERFORMANCE AUDIT REPORT NALAWI INDUSTRIAL AND TRADE POLICY ADJUS'MAT PROGRAM (CREDIT 1920-NAI) JUNE 30, 1993 MICROGRAPHICS Report No: 12156 Type: PPAR Operations Evaluation Department This document has a resticted distibution and may be used by only In the pefounneae of their offidi duties. Its contents may not otherwise be disclosed Wod Bank authorIbalon. CURRENCY EQUIVALEN'S (annual averages) Currency Unit = Malawi Kwacha (MK) 1984 US$1.00 = MK 1.41 1989 US$1.00 = IlK 2.76 1985 US$1.00 = MK 1.72 1990 US$1.00 = MX 2.73 1986 US$1.00 = MK 1.86 1991 US$1.00 = MK 2.80 1987 US$1.00 - MK 2.21 1992 US$1.00 = MK 3.60 1988 US$1.00 = MK 2.56 1993 US$1.00 = MK 4.45 (March) ABREVIATIONS AND ACRONYMS ADMARC - Agricultural Development and Marketing Corporation CBM - Commercial Bank of Malawi DEMATT - Development of Malawian Traders Trust DFIs - Development Financial Institutions DOLV - Department of Lands and Valuation DSB - Department of Statutory Bodies ECA - UN Economic Commission for Africa EPD - Economic Planning Department EPZ - Export Processing Zone EPZA - Export Processing Zone Authority ESAP - Enhanced Structural Adjustment Facility ICB - International Competitive Bidding INDEBANK - Industrial and Development Bank of Malawi INDEFUND - Investment and Development Fund ITPAC - Industrial and Trade Policy Adjustment Credit LFC - Leasing and Finance Company of Malawi Ltd. MDC Malawi Development Corporation MEDI - Malawian Entrepreneurs Development Institute MIM - Malawi Fatitution of Management MIPA - Malawi Investment Promotion Agency MSME - Micro, Small and Medium Enterprises MTI - Ministry of Trade and Industry MUSCCO - Malawi Union of Savings and Credit Cooperatives Ltd. NBM - National Bank of Malawi NBS - Now Building Society NGOs - Non-Governmental Organizations OED - Operations Evaluation Department OGL - Open General License PAR - Performance Audit Report PCR - lroject/Program Completion Report PFP - Policy Framework Paper POSB - Post Office Savings Bank PPAR - Program Performance Audit Report PR - President's Report PSIP - Public Sector Investment Program PTA - Preferential Trade Area for Eastern and Southern African States QRs - Quatitative Import Restrictions READI - Rural Enterprises and Agribusiness Development Institutions RBM - Reserve Bank of Malawi SAL - Structural Adjustment Loan SEDOM - Small Enterprise Development Organization of Malawi SMI - Small-Medium Scale Industry SOE - Statement of Expenditure SSI - Small-scale Industry USAID - United States Agency for International Development VAT - Value Added Tax WICO - Wood Industries Corporation WWB - Women's World Banking of Malawi FISCAL YEAR April I - March 31 FOR OFFICIAL USE ONLY THE WORD SANK Washington, D.C. 204as oo of Detnomal Operadoneo Evaluadon une 30, 1993 -MEORNDU TTE=ECTN DIRECTOR AND THE PRESIENT SUBIECr: Performance Audit R-port on Malawi - Indusrial and Trad Polieo Adust mwo m (Credit 19M AD Attachr is the Performance Audit Report on Malawi - Industrial and Trade Policy Adjustment Program (CTedit 1920-MM) prepared by the Operations Evaluaton Department. The maln objectives and mac~economic targets of the reform program, -ewed as a time slice of a longer process, were largely achieved and with minimal adverse effees on standards of living. Overal performance has been satisfactory, institutional development substantial and, at this juncture, sustainability appears likely. The following lessons deserve consideration in the context of future programs: (1) In the face of slow export growth, hasty liberalization of non-essential imports offering no competition to domestic industry and caterig exclusively to the needs of high income groups may not be expedient, as It may lead to dissipation of scarce foreign exchange. (ii) The absence of along-term strategy underpinning the promotionof small-medium scale industry ~ampers efforts to achieve an appropriate balance between larger and smaler (but eficient) establihments, and foster a symbiodc relationship in which the activities of small and large firms conform to their respecuive comparative advantage. (ii) The reforms of Malawi's corporate and parastatal sectors in the 1980s took the form of ad_o measures aied primarily at the financial and anagement restructu-ing of alling holding companies, ratber. than at developng an aggressive divestiture program.. The lited progress to date In implemenhing a privatimtion program attests to an unfinished agenda within the broader scheme of industrial reorientatlon which needs to be pursued in earnest. li dam-a baa ro~ ~d ud anme beo ~e by r~-n r * puran etr e d dd, aI ou~e sWa= c~ erisbo antm w dOO~a=k~er-n FOR OFFICIAL USS ONLY XEQRE9MA ALAWIsw INDSTR AND TRAD POLIC ADJUSTMEPROGRM (CREDIT 1920-MAI) TABL OF COTNT PREFACE . £ BASICDATASHEET . Il EVALUATION SUMMARY .................................... v I. *K R* M .. . .. . . .. . . .. . . .. . . ...... 1 A. Evolutioa of Pollcy-Based Lending ......................... 1 B. The Industrial, Trade and Financial Environment .................. 3 The Industrial and Trade Regimes.......................... 3 TheFinancialSystem .......... . ..................... 5 C. Progress in Industrial Restructurng ......................... 6 Gnesls of e Cror a te and Parastatal Sector .................. 6 Attempts at Industrial Parastata; Reform .......................... 7 PressHoldings ................................... 7 MDC ............................................. 8 ADMARC ........................................ 10 WICO.......................................... 12 Outcome ......................................... 12 Small-Medium Scale Industry Development .................... .. 13 U. ORECIVS STRATEGY. AND DESIN OF ACTION PRoGRAS .... 14 Strategy .......................................... 14 Sectoral Objectives, Policy Instruments, Conditionality .............. 14 Trade Policy and Exchange Rate Management ........ 15 FiscalPolicies ........................ ............ is TaxReform ...... ................................ 15 ExportPromotion.................................. 16 Price Decontrol and Industrial Licensing .................... ... 17 Promotion of Small-Medium Scale Industries ................. .. 17 FinancialSectorPolicies ............................. 18 Expected Outcome ..................................... 18 Economic Impact .................................... 18 Social impact ...................................... 18 III .Uff*ZM........................ 19 A. TradePolicyReforms ................................... 19 Import and Foreign Excange Controls ....................... ... 19 Rationalization of Tariffs and Tax Structures ................... .... 21 This document has a restricted distribution and may be used by recipients only In the performance of their offcial duties. Its contents may not otherwise be disclosed without World Bank authodzation. TABLE OF CC9 S (cont'd.) PE No. III. IMPLEMNTUATIO AND OTME(cot'd.) B. Initiatives Fostering Private Sector Development . 22 Investment and Export Incentives .......................... 22 Promotion of Small-Medium Scale Industry (SMI) ................ 24 C. Financial Sector Reforms ............................... .26 D. Tax Reforms ....................................... 28 E. Functioning of Labor Markets ........................ . . . 30 F. Macroeconomic and Industrizl Performance .................... 31 Macroeconomic Developments .......................... 31 Industrial Performance ............................... 32 G. Social Impact of Reforms ................................ 34 IV. IND S AND ISSUS ................................. 35 Ownershp ........................................... 35 Commitment and Consensus ................................ 36 Lack of a Long-Term Strategy for SMI Development ................ ... 37 EthnicDiscrimination .................................... 39 Concentration of Economic Power ............................ 40 Fostering Competition in the Ban ng Sector ...................... 41 RegionalIntegrationofIndustry .............................. 41 Export Processing Zones .................................. 43 Privatization of Industrial Parastatals - An Unfinished Agenda ........... .. 43 V. CREDIT ADMINISRATION. COORDINATION. AND UIZAON. .. 44 VI. Q AL ASSESE O RESULT ....................... 45 VB. SUSTAINABILIT OF THE ADJUSTfM EFFORT....... 48 VIII. LOS AND RECOMMENDATIOS ....................... 50 ATTACHhMT 1: KeyEconomicIndicators,1980-92 ............................ 57 2: LetterofDevelopmentPolicy ............................... 59 3: PolicyReformMatrix ................................... 69 4: MDC: Purpose of the Corporation............................ 72 5: Press Corporation Limited: List of Subsidiaries .................... ..73 6: Press Corporation Limited: Investments in Associated Companies ........ ... 74 7: MDC: Shareboldings in Subsidiary Companies ................... 75 8: MDC: Shareholdags in Associated Companies .................... 76 9: MDC: Balance Sheets, 1983-91 ............................. 77 10* MDC: IncomeStatements,1983-91 ........................... 78 11: ADMARC: Investments in Subsidiary and Associated Companies ......... .. 79 12: Parastatal Profit and Loss Accounts, 1979/80-1991/92 ................ 80 13: Malawi Statutory Bodies: Financial Summary, 1990/91 and 1991/92 ....... 81 14: External Financing Requrements, 1988-92 . . ......... . . . . ... . 82 TABLE CONTENT (coat'd.) ATTACM S (con'd.) IS: Nomina and Effective Rate of Protection, 1989 and 1991 .............. 83 16: Impact of Partial Suspension of Surtax on Domestic Production .......... 84 17: Leasing and Finance Company - Sectoral Distribution of Loans, 1986-92 .... 85 18: Lasing and Finance Company - Fiancial Data, 1987-91 .............. 86 19: INDEBANK* Equity and Loan Investments, 1988-91 ................ 87 20: INDEBANK: Balance Sheets for the Years 1985-91 ................. 88 21: INDEBANK: Profit and Loss Accounts for the Years 1985-91 .......... ... 89 22: INDEFUND: Performance Indicators, 1982-91 .................... 90 23: INDEFUND: BalanceSheets,1989-91 ......................... 91 24: INDEFUND: Income Statements, 1989-91 ....................... .. 92 25: SEDOM: Lending Operations, 1985-92 ......................... .. 93 26: Credit Eftended by easing Companies, 1980-92 ................... ... 94 27: Profiles of Micro, Small and Medium Size Enterprises ................ 95 28: RBM: Liquidity Reserve Requirements ......................... .. 96 29: PrincipalInterestRates,1985-92 ............................. 97 30: Real Interest Rates, 1982-92 ................................ 98 31: CBM: Medium-termLending, 1987-92 ......................... 99 32: Central Government Financing, 1980/81-1992/93 ................ 100 33: Central Government Revenue, 1982/83-1991/92 .................... 101 34: Expenditure by Economic Classification, 1982/83-1991/92 ............. ... 103 35: Government Expenditure in Social Sectors, 1982/83-1991/92 ............ 105 36: Allocation of Domestic Credit, 1980-92 ......................... .. 106 37: institutional Distribution of Financial Assets, 1985-92 ................ 107 38: Distribution of Institutional Advances, 1985-92 .................... 108 39: Commercial Banks: Advances by Main Sectors, 1980-92 .............. 109 40* Sectoral Distribution of Advances by Commercial Banks, 198-92 ........ ... 110 41: Index of Industrial Production, 1980-92 ......................... . 111 42: Imports by End Use, 1980-89 ............................... 112 43: Number of Paid Employees by Industry Group, 198-90 .............. 113 44: Monthly Average Earnings by Industry, 1988-90 ................... .. 114 45: AllocationofBankFunds.................................. 115 1: Comments Received from the Economic Planning and Development Department .... ................................. 117 2: Comments Received from the Malawi Investment Promotion Agency ....... .. 121 3: Comments Received from the Auditor General ..................... 125 4: Comments Received from the Federal Ministry of Economic Cooperation (Germany) through KfW ................................. 127 5: Comments Received from the African Development Bank .............. . 129 OF C(ont'd.) PROGRAM COMPETIO REPOR . .. .. .. .. . ... .. . ... .. .. .. .. ... 131 PART I: PG REVE F m 'S ......... 133 A. Bac£rJ n . .. .. .. .. .. .. .. . ... .. .. .. . ... .. .. .. . .. 133 MacroconX:c Mwanlaff ent .. . .. ... .. .. .. .. .. .. .. .. . .. 133 Indutrial Sector ................................... 134 Financia Sector ................................... 135 B. The Role of te W k and m ...................... 135 C. Ado s e P r a eig .................. 136 Objeciv s ....................................... 136 Design ........................................ 137 ITPAC inra with other ank Operatons .................. 138 1TPAC Sequencing .... ................................. 139 D. P ms ............................... 139 E. Implem i on .................................... 142 F. Cnclsion ...................................... 142 PART R: PRGRAM RIEW FROMTHE_BORROWRS ..... 143 PART III: SAAL I .......................... 143 PERFEORMAN ALU REPOR MALAWI INDUSTRIAL AND.T&ADEMOIC AlWUSDWNTEPRORAM (CREDIT 1920-MAI) PREFACE This is a Performnce Audit Report (PAR) on the Industrial and Trade Policy Adjustment Program, involving IDA Credits 1920-MAI, 1920-1-MAI, 1920-2-MAI, and 1920-3-MAI, f-ra total of US$87 million. Credit 1920 for US$70 million was approved on June 14, 1988, and became effective on September 29, 1988. The Credit was fully disbursed and closed in December 1991, after a one-year extension. Disbursement was effected in two tranches, and the second tranche was released in September 1989. The project was co-financ.d by the Overseas Economic Cooperation Fund of Japan (US$30 million), the European Community (ECU 12.5 million), the African Development Fund (FUA 15 million), the USAID (US$25 million), the Federal Republic of Germany (DM 20 million), the Netherlands Finance Company for Developing Countries (Fl 12.8 million), and the Overseas Development Administration of the United Kingdom (f10 million), raising the total funding to US$220.5 million equivalent. The PAR was prepared by the Operations Evaluation Department (OED). It is based on the President's Report, sector and economic reports, special studies, Country Strategy and Policy Framework Papers, the credit documents, the summary of the Board discussion, study of the program files, and discussions with Bank staff. A Program Completion Report (PCR) has been prepared by the African Regional Office of the Bank and is attached. An OED mission visited Malawi in October 1992 and discussed the effectiveness of the Bank's assistance with Government officials, management of private and state industrial enterprises and holding companies, and representatives of business organizations and the financial community. Their kind cooperation and invaluable assistance in the preparation of this report is gratefully acknowledged. The PCR provides a satisfactory account of the Program experience with regard to design, implementation, the role of the Bank and IMF, achievements, and sustainability. The PAR discusses i,sefly the initial conditions in the industrial, trade and financial sectors, earlier efforts in industrial restructuring, and the pressing issues that led to the genesis of the industrial and trade policy reform effort; assesses the quality of the design of the policy package and action programs, including their consistency and appropriateness for the problems identified; considers the effective.iess of the IDA/Borrower dialogue, including IDA's role in assisting use Borrower to articulate policy options, evaluate proposals for action, or redirect priorities; examines the extent of consultations and coordination with the IMF and donors; reflects on the Borrower's ownership, consensus and commitment; and determines the purposefulness and effectiveness of conditionality and tranching. In particular, the PAR dwells on results achieved in liberalizing the trade regime, initiatives fostering private sector development, and on such issues as the concentration of economic power, regional integration, export processing zones, and privatization of industrial parastatals. Finally, the PAR evaluates the progress made in enacting and implementing agreed upon ston programs, and ascertains the key factors that determine the outcome, effectiveness and sustainability of the policy reforms. The PAR then draws lessons from the Program experience, also confirming - II - findings from audits on industrial and trade policy reforms in other countries in the region, which will feed into an upcoming comparative study. The audit and the PCR concur in their assessments of over" -erformance, institutional development and sustainability. Copies of the draft PAR were sent to the relevant Government officials, agencies concerned, and co-financiers for their review and comments. Responses from the Economic Planning ard Deve'pment Department, the Malawl Investment Promotion Agency (MIPA), the Auditor General, the Ministry of Economic Cooperation in Germany (through KfW), and the African Development Bank are reproduced as Appendices 1-5. - ii - EREOMANCE AUIREPO MALW INDUSTRIAL AND TRADE POICY ADJUSTMENT PROGRAM (CREDIT 1920-MAI) BASIC DATA SIZET CREDIT POSITION (Amounts in US$ Million) As of May 31. 1993 Credit Oriinal Dtib w La Canceled Di outandin LA 1920-MAI 70.0 65.0 - - 71.8 192-1-MAI 5.2 5.1 - -5.7 1920-2-MAI 4.7 5.0 - - 5.4 1920-3-MAI 7.2 7 - - - 7.2 CUMULAIVE ESTIMATED AND ACTUL DISBURSDEMTS,a EM EM EM EY2M Appraisal Estimate (US$M) 70.0 79.9 87.1 87.1 Actual (US$M) 37.6 75.0 81.7 81.9 Actual as % of Appraisal (%) 54% 94% 94% 94% Date of Final Disbursement: September 20, 1991 PROGRAM DATES orisial AMtua Initiating Memorandum 01/88 01/06/88 Negotiations 05/88 05/19/88 Letter of Development Policy 05/88 05/24/88 Board Approval 06/88 06/14/88 Signing 07/88 09/16/88 Effectiveness 07/88 09/29/88 Credit Closing 12/31/90 12/31/91 STAFF INPUTS (staffweeks) EM EM EMSO EM EM EY IQIAl Preappraisal 36.5 - - - - - 36.5 Appraisal 29.9 - - - - - 29.9 Negotiations 7.9 - - - - - 7.9 Supervision - 12.2 6.8 1.1 4.2 2.0 26.3 Other - i- QA * 1 . Total 74.3 12.2 6.8 1.2 4.2 2.0 100.7 L& Disbursed and outstanding amounts differ from the original amount of the credit in terns of Us$ booauseof changes in the US$/SDR exchange rates. - Iv - MISI0-N DATA No. of No. of Staff Report Wk Pj Preparation 09187 5.3 7 37 10/21187 Appraisal 01/88 7.5 4 30 04122/88 Supervision 05/89 6.7 3 20 06/26/89 Completion 10/92 6.0 1 6 12/21/92 THRPROGRAM DT Borrower/Becuting Agency: Repubi ,f Maawi Operation Institutional Development Project Credit No.: 2036-MAI Amount: US$11.3 milion Board Dato: Jue 13, 1989 Operation: Agricultral Setor Adjua~nt Program Credit No.: 2121-MAI Amount: US$70.0 million Bomrd Date: April 3, 1990 Operation: Financial Sector & Enterpris Development Project Credit No.: 2221-MAI Amount US$32.0 miion Board Dato: May 26, 1991 Opeaton Brpen0si Developmen & D~uh Ra~oer Progra Credit No.: 2396-MA Amount: $120.0 million Board Dato: June 23, 1992 RATINGS OF PROGRAM IMPLBMBENTATION PE0MANCE For di~ssion, em aa 5.01. -v- PERFORMANC AUDI REP T IAAW RIDUSTRUTMNTPRC~A (CR'DIT 1920-MAI) EVALUOU Y Introduction reorient investment toward labor-intensive and export-oriented activities. The cornerstone of 1. This is an audit of the Industrial and the adjustment program was trade liberaliza- Trade Policy Adjustment Program, approved tion. The strengthening of a market-oriented in June 1988, for US$70 million. Three system of foreign exchange allocation would supplementary credits amounting to US$17 be accompanied by the elimination of QRs on million were approved subsequently. Donor competing imports and rationalization of the cofinancing in the amount of US$133.5 mil- import tariff structure. The program also lion raised total funding to US$220.5 million included price decontrol, measures to support equivalent (Preface, p. 1). The economic the development of small-scale enterprises, circumstances and pressing issues that led to reforms to increase the efficiency of the the genesis and sanction of the reform pro- financial sector, and steps to promote exports gram are detailed in paras. 1.01-1.13, 2.01. (paras. 2.01-2.16). oWtves. Sr gy. Instruments Imoementation Expen 2. To stem the downward trend of the 3. Progress in implementing the reform economy, in 1987 the Government devised a program has been satisfactory in virtually all new development policy designed to reverse areas. Frequent exchanges were helpful in earlier policy measures, and set the stage for sustaining the reform effort and in collabora- resumed economic growth in the context of a tive problem solving, attesting to the Bank's viable balance of payments position. These effective supervision. Significantly, the objectives would be achieved through a two- momentum of industrial, trade and financial pronged strategy of economic stabilization and sector adjustments has been carried on by the structural reform. Reduction of the fiscal implementation of further reforms initiated by deficit, strict monetary and credit policies, and follow-on operations, reflecting the Govern- active exchange rate management would bring ment's strong commitment to the adjustment aggregate demand in line with available re- effort. Legislative initiatives were taken to sources. Complementary supply side establish institutional frameworks to foster measures, such as an increased flow of for- private sector development and investment, eign exchange to the private sector, trade introduce a market-oriented monetary control liberalization, redirection of credit away from system, and induce competition in the banking the public sector, tax reform, and revision of sector (para. 5.01, 6.03). incentives would stimulate private sector production and investment. Also, reduced 4. Effectiveness and tranche release protection of the domestic industry would conditions were substantially met. The - VI * closing date was extended by one year due to facilities and was concentrated in traditional slow disbursements relating to additional activities. In 1992, untoward events (drought, donor financing, and the preparation and labor unrest, shortage of foreign exchange) processing of the requisite documentation. stalled temporarily economic growth and the Import financing and auditing procedures were pace of private investment. Growth Is ex- streamlined to expedite disbursements and pected to resume in 1993 due to record agri- ensure accountability. Procurement pro- cultural performance. However, in the face cedures were satisfactory and in line with of a still modestly inviting investment climate, Bank guidelines. The bulk of the Bank's barriers to entry, and ethnic discrimination funds financed the import of industrial inputs against non-indigenous Malawians (denied by (82%) and machinery and equipment (13%). the Government), potential investors maintain The counterpart funds were made available to a wait and see attitude, and the anticipated at the Government without restriction, and were appraisal increases in manufacturing invest- used to supplement its budget (para. 5.03). ment and exports have yet to manifest them- selves. This suggests that the structure of the Outcome industrial sector remains substantially un- changed (paras. 3.02, 3.03, 3.27, 3.37, 3.38, 5. The main objectives and macro- 4.11, 4.14, 6.11). economic targets of the reform program, viewed as a time slice of a longer process, 7. Despite the wide range of policy re- were largely achieved and with minimal forms, the successful implementation of adverse effects on standards of living. Mone- specific measures, and the healthy economic tary and fiscal performance has been im- growth during the past several years, the pressive; it was marred though recently by supply response has not been sufficient to pressures for salary increases and drought- sustain balance of payments viability. Imports related expenditures. The import liberaliza- grew much faster than exports, while there tion program helped increase industrial pro- has been little diversification out cf the tradi- duction; improve efficiency by eliminating tional agricultural exports. The drought and uneconomic product lines, expanding profit- the need for unprecedented levels of food able ones, adjusting production to meet con- imports exacerbated the situation. The perfor- sumer preferences (e.g., lower quality and mance of industrial exports has not been cheaper articles), better utilization of inputs, impressive, in part impeded by foreign ex- and organizational changes; foster competition change restrictions and import licensing in and price reductions, and thereby curb infla- neighboring countries of the Preferential tion; a-d stimulate economic activity (paras. Trade Area. The current account deficit 3.01, 3.40-3.42, 6.03, 6.10). increased sharply - from 5% of GDP in 1987 to 12.2% in 1992. External outstanding debt 6. Supply response on the whole was also rose by 33% to US$1.8 billion. These satisfactory through 1991. Real GDP growth developments suggest that Malawi will con- averaged 5% annually, exceeding the targeted tinue to face balance of payments pressures in average by 1%. Capacity utilization improved the near future, and that external resources in most industries as a result of greater access remain of critical importance for sustained to imported inputs, although certain industries economic growth (paras. 3.39, 6.12). have been affected adversely by the influx of cheap imports. Private investment rose 8. During this phase of import liberaliza- appreciably (from a very low base), but It tion, emphasis was given to enhancing the aimed largely at rehabilitation of existing transparency of protection by replacing QRs - vii - on competing imports with tariffs and liberal- outcomes fulfilling Intended purposes (paras. Izing the licensing of Imports. SSecfic duties 3.30-3.33, 6.06). have been replaced with ad valorem rates, and rates have been revised to ensure comparable 10. The Government moved vigorously in treatment of similar products. The number of the financial sector, taking an array of tariff categories was reduced, initial steps measures to Instill self-discipline in borrowing were taken to lower average tariffs, and there and activate the money and capital markets. is greater reliance on tariffs as the main There has been a significant shift of credit in instrument of protection. But, while rates on favor of the private sector. Other measures non-comWeting imports have come down, implemented so far include legislative actions effective protection and tariff dispersion on to Improve the legal framework for the regu- compeing img s have increased, as a result lation of financial institutions; strengthen of the combination of statutory tariff rates, prudential supervision by the Central Bank; industrial rebates and domestic surtax suspen- Improve monetary programming and the use sion. Also, because of the high degree of of indirect monetaiy policy instruments; administrative discretion, rebates of customs liberalize Interest rates; and foster competi- duties on industrial inputs and al.hoc exemp- tion. But to date there has been no per- dons of parastatals from import duties and ceptible increase in inter-bank competition and taxes remain a vexing issue. The Government no entry of new financial institutions (paras. is committed to reducing both the level and 3.23-3.29, 3.40-3.42, 6.07). dispersion of protection, and will be intro- ducing progressively a cascaded import tariff 11. Tangible progress has been made in structure with a maximum rate of 35% by improving the institutional framework, en- FY96. The Government is also taking steps acting investment and export incentives, to strengthen customs administration and abolishing industrial licensing, virtually elim- enforce tariff compliance (paras. 3.06-3.09, mating price controls, and improving the 6.04). functioning of the labor markets. By strength- ening the system of export incentives, the 9. Significant progress was made in reform program introduced a first set of advancin& tax reforms. A surtax system actions to reduce the anti-export bias in the similar to VAT was introduced, the tax base industrial and trade policy regime. Nonethe- was expanded, excise taxes were shifted from less, there is still room for reducing "trans- jMiflc to ad valorem, a current payments action costs* In export activities. Also, the system for business income tax was adopted, Government has pursued a flexible exchange taxation was extended to fringe benefits, the rate policy and remains committed to main- corporate and personal income tax rates were taining a realistic exchange rate. Neverthe- reduced, and a capital gains tax was intro- less, in mid-1992, the Central Bank was duced. Ta- evenues increased substantially unable to provide foreign exchange for three in absolute terms over the last five years but weeks, and presently exchange allocations are as a percentage of GDP they slipped recently, "prioritized" while payments are being de- probably reflecting the combined effect of layed by one to two months. Predictably, this acceleration of inflation, which emboldens undermined the confidence of the business under-reporting and tax evasion, and lax tax community regarding the sustainability of the administration. There has also been a notice- exchange regime, and affected adversely able realignment of trade and domestic taxes, industrial investment activity (paras. 3.04, and a shift of the burden of taxation from 3.05, 3.34-3.36, 6.08). international trade to domestic transactions, - viii - 12. To alleviate some of the impediments import competition; and the Government's to small-medium scale industry development access to external funding to bridge the (para. 1.29), the Government modified zoning external resource gap in the face of the slow and land use policies, and plans to expand the export growth and faster rising imports at the available business space in housing areas and Initial stage. The latter, understandably, estates. Although credit by specialized institu- would depend on maintaining sound macro- tions has increased, further expansion is economic policies and on sustaining the ad- constrained by resource availability. More- justment effort (Wa 6.13). On the whole, over, access to credit has been very limited to the performance of the operation under review micro-enterprises, which have shown measur- has been satisfactory. Although conditional, able growth through both expansion of sustanability at this juncture appears likely. existing firms and new entry. Access to Institutional development has been substantial, credit, limited linkages to larger firms and and ongoing efforts to strengthen further the markets, technical assistance, and ethnic institutional apparatus are encouraging. discrimination remain major constraining factors to SMI's development (paras. 3.17- 3. 22). 3.22).15. The reform package was practicable 13. There has been a significant increase in and It was "owned" by the Government. The the share of social services (education, health, Bank played an important role in the design of community and social development) in total the reforms. Earlier economic and sector government expenditures - from 18.7% i work helped focus attention on areas where FY87 to 25.3% of total expenditures in FY92. significant change was needed, define tech- Employment in both the private and public nical and policy options, and translate adjust- sector increased, while there has been a sig- ment strategy into mutually consistent and nificant rise in employment in the micro- and actionable programs. Furthermore, the small enterprise sector. However, real wages Bank's involvement and support helped articu- lagged as nominal wage increases did not late the arguments for policy adjustments, match inflation rates, suggesting that labor deepen the dialogue on technical issues, and bore part of the adjustment brunt. Yet, the ease external constraints by improving access surge in imports of cheap textiles and other to concessionary financing. There has been consumer goods in recent years certainly was close consultation and coordination with the a boon to the poorest segment of the popula- imF and the donors in the course of articu- tion. Also, following the acceleration of the latins action program to ensure congruity of inflation rate in 1992 an in the wake of the purpose (varas. 4.01,501). strikes, wage levels rose substantially and are likely to have arrested declining real wage 16. The reform package represented a levels (paras. 3.19, 3.36, 3.45, 3.47-3.49). practical program for industrial and trade policy adjustment. The thrust of the strategy, 14. The effectvens and outcome of the the objectives, and the supportive policy reforms are conditioned on the Government's instruments were appropriate, and took into ability to develop and effectively use proper accountpolitical, administrative, andtechnic.d policy instruments to maintain internal and constrain. The sequencing and timing of the extbrnal balances; the investors' response to trade liberalization measures, :he incentive the incentives by undertaking new Investment structure, and initiatives involving tax and and exports; the ability of existing manufac- financial sector reforms were basically cor- turing enterprises to adjust fairly quickly to rect. However, in retrospect, relaxation of Import controls on non-essential consumer commitment to strengthening the resource goods during the second and third phase, was base and institutional arrangements pertaining hurried, in the sense that, in the face of Iag- to SMI. Yet, the outline and specifics of a sing export growth, potentially untoward long-termstrategyunderpinningthepromotion effects on industrial performance, the balance of SMI are missing (para. 4.03). Elements of of payments, and foreign exchange drain had a suggested strategy are discussed in paras. not been fully fathomed. This hinged heavily 4.04-4.10. the liberalization program on donor support (Parm 6.02). 19. Entrepreneurial talent is available in Malawi, and diverse groups within the private 17. The action programs were well-con- sector are prepared to invest. However, ceived, purposefully designed, and addressed actual investment response has been stymied priority issues. Actions to be taken were by official caution, long delays in decision- spelled out in considerable detall, thereby making, and geographical/sectoral restrictions facilitating the monitoring of time-bound on investment by non-indigenous investors. programs. Conditionality was formulated In this regard, the 1992 amendment to the through a process of constructive dialogue and Forfeiture Act that permits appeals by persons close collaboration with the Government to subject to forfeiture is not reassuring to the the end of ensuring commonality of purpose, non-indigenous community. Aside from the cooperation, and institutional commitment and fact that citizens are averse to litigation, it is support. Conditions were germane to the the person served with a notice that has to objectives and actions agreed upon, logically prove why he should not be subjected to sequenced, and performance-oriented. Time- forfeiture. Abolishing the Act altogether, tables were based on the scope and priority of removing legal barriers to entry in particular the issues at hand and, in general, were realls- activities (e.g., transport), and discontinuing tic, facilitatinggovernmentcompliance(paras. the practice of setting time limits to business 5.02, 6.02). resident permits are actions that are likely to pay off handsomely, by substantially Im- 18. An efficient SMI sector can play an proving the investment climate. It should be important role in the Malawlan economy in appreciated that these groups are a readily terms of employment gene:ation, output available source of entrepreneurship: they growth, processinglocally produced materials, have business acumen, managerial capacity and saving/earning foreign exchange. Fur- and financial resources; are well-positioned to thermore, the SMI sector can contribute move into industrial activities which necessi- considerably to the country's industrial devel- tate a long-term commitment and involve a opment, can promote structural shifts (e.g., by higher risk; and have the ability to provide enhancing the share of intermediate goods in critical links to domestic and world markets, industrial output), and can have other tangible thereby facilitating the progressive integration socioeconomicadvantages (e.g., greater scope of smaller firms into marketing and trading for initiative and the development of technical networks (par. 4.11). and managerial skills; supply of a good part of low-priced mass consumption goods; adap- 20. It has been argued that the excessive tation of production techniques to the coun- size, access to resources, and monopolis- try's particular circumstances; promotion of tic/oligopolistic positica in an array of eco- more equitable distribution of income; reduc- nomic activities of a particular industrial tion of regional imbalances; etc.). The conglomerate, coupled with the smallness of Government has repeatedly expressed its Malawi's domestic market, lmits the scope for the development of a more competitive domination and dilution of control. Limited private sector and the growth of an entre- resource availability, reinforced by inter- preneurwal class. Yet, larger and more subtle locking relationships among the fnacial questions remain unanswered and need to be Institutions and common ownership of the two probed into, while the focus of any inquiry commercial banks by a politically well-con- should not be A particular conglomerate, but nected conglomerate, is hardly conducive to the dynamics of the existing market structure, intensive competition in the bankng sector. conduct and performance; whether conduct Control of the major banks by private vested and performance reinforce market dominance; interests provides inordinate access to funds and what kind of remedial action(s) can be by particular business groups; leads to taken and enforced in the Malawian circum- excessive concentration of lending to a few stances to ensure free entry and promote clients; violates accepted principles of prden- competition. Particular issues that deserve tial lending; and can forestall new entry in the scrutiny include whether existing and new Industrial sector. To increase the available foreign investors would be interested in in- pool of loanable funds, stimulate competition, vesting in market segments with room for few and improve the operational efficiency and plants of optimum scale, and often in competi- quality of banking services, it is imperative to tion with a politically well-connected entity; foster the entry of new financial Institutions - whether indigenous entrepreneurs have the both investment and commercial banks. This managerial capacity and resources to buy into would take a determined effort by the mone- such ventures; whether restrictions in the tary authorities to attract world-class banks, activities and outright discrimination against particularly among those which are aready Asian entrepreneurs could be effectively operatig in neighboring countries and are banished to enhance their involvement in more familiar with the African cb=mstances. small and medium scale industry and agro- The referendum of June 14, 1993, which industrial businesses; whether dominant firms overwhelmingly favored the establishment of are really promoting new and otherwise fore- a multi-party system ofgovernment, hopefully gone industrial activities through joint Yen- will remove an element of uncertainty and, tures with foreign partners, thereby bringng thereby, arouse the interest of and facilitate into the country foreign capital and technical the search for potential entrants (Wra 4.14). know-how; and whether an appropriate tariff structure can be established to induce 22. To date, no regional specialization or monopolists/oligopollststo perform efficiently measurable integration has been achieved, and and, at the same time, prevent them from there is virtually no preferential trade in- exploiting their dominant market position. volving Malawi in the subregion. The lak of These issues, some of which are highly progress in intra-group trade liberaization can sensitive, would need to be addressed by the be attributed, inte ai , to the undiversified political authorities in opportune time and in economies of most members, high dependence the not too distant future (paras. 4.12, 4.13). on few commodities for export revenues, and lack of complementa*iy uneven distribution 21. The external borrowing capacity of the of prospective benefits from integration; fear two large banks has been constrained by of external domination; inability to devise foreign exchange risk and governance con- ways and means to compensate adversely siderations, while domestically the pool of affected members; opposition by organized available savings is limited. Raising new pressure groups; barriers to cross-border equity has also been inhibited by governance, investment; poor cur; presence of but probably more so by concern of foreign monopolistic niches foslted by entrenched - xi - foreign companies locating in a country under abling the country to tap their potential. agreement that they be sheltered from im- Nevertheless, the net longer-term benefits of ports; complexity of rules and regulations; EPZs are not invariably favorable. Important clash between market incentives and regula- preconditions include the presence of a very tions; resistance to dismantle trade barriers; dynamic local (ethnic) business community and reluctance by Governments to rely on the which is in a position to form effective links private sector to achieve regional cooperation with overseas investors; capability to supple- and economic integration (paras. 4.15-4.17). ment overseas equity with domestic loans, if not equity capital; an underlying local cost 23. Underlying these symptomatic impedi- structure which is internationally competitive; ments are nationalistic tendencies, lack of and ability to attract sufficient foreign interest appreciation of the long-term prospective to support the EPZ. Proliferation of EPZs benefits, and inability of member governments therefore may not always be warranted, and to build a broad-based consensus. Also, the their establishment should proceed with cir- regional members have yet to develop and cumspection (paras. 4.19, 4.20). cross a threshold of similar economic and social objectives so that the requisite partial 25. The reforms of Malawi's corporate and surrender of national sovereignty can become parastatal sectors in the 1980s took the form mutually beneficial. In the case of Malawi, of adJhoc measures aimed primarily at the this lack of progress in regional integration financial and management restructuring of and the peristent tariff and non-tariff barriers ailing holding companies, rather than at im- to trade Lave made it difficult for manufac- proving the efficiency of individual industrial turers to export to neighboring countries and parastatals and at developing an aggressive has discouraged investment in export-related divestiture program. The packages did not, activities. This, reinforced by an array of and perhaps could not, address the issue of other impediments (para. 22), tends to perpet- restructuring of Malawi's industrial and agro- uate an insular and inward-looking mentality, industrial parastatal sector due to the pressing leading industrialists to invest in capital-inten- circumstances and urgency under which they sive, sub-optimal and inefficient plants when were put together (paras. 1.16-1.28). As a more efficient facilities could cater to regional result, very limited progress has been made to markets at a much lower cost and to the date in implementing ADMARC's divestiture benefit of all countries concerned. Concerted program; in reducing the state's ownership of efforts to eliminate trade and non-tariff bar- MDC to minority shareholding; in divesting riers in the sub-region would benefit all and turning over MDC's industrial assets; and Preferential Trade Area members (paras. in transforming MDC into an industrial devel- 1.20, 3.46, 4.18). opment corporation as mandated. Also, WICO's drawn-out privatization effort may 24. In an effort to stimulate export-oriented have to be refocussed (para. 1.27). This state production, the Government has provided of affairs attests to an unfinished agenda special incentives for firms locating in Export within the broader scheme of industrial reod- Processing Zones (EPZs). The establishment entation which needs to be pursued in earnest. of EPZs could be a convenient vehicle to Empowering, and extending full political expand exports within a relatively short support to, a central coordinating entity to period, particularly if early collaboration deal with the range of activities related to the between foreign and domestic enterprises can parastatal divestiture process would be a be achieved. EPZs may also be more reas- promising starting point (para. 4.21). The swing to the Asian community, thereby en- Department of Statutory Bodies (DSB) could - xii - discharge this function if it were enabled to interest rates, raise the cost of flads and meet the aforementioned desiderata (see para. equipment and tend to discourage new invest- 1.24 in). ment, thereby negating the intended benefits of the reform program. Finally, It takes time Sustainabity to instill investor confidence in the sustain- ability of a reform program, identify more 26. The political commitment to a con- productive opportunities, shift factors of tinued industrial and trade adjustment effort production, build new capacity and develop remains strong, and tangible progress has new export markets, even assuming that been made in developing the requisite institu- market access is not restrited by non-tariff tional capacit to sustain the momentum of the barriers. The actual performance of non- enacted reforms. However, the instituted traditional exports during the late 1980s and economic policy measures have yet ia elicit early 1990s reftects the force of these abiding sustained investment and export growth. The constraints, and suggests that excessive effectiveness and sustainability of the package optimism is not warranted (paras. 7.01, of policy reforms depend critically on a posi- .02). tive response from the private sector, reflected in new industrial investments and a rapid 28. Because of the lack of growth in non- growth of non-traditional exports. Yet, the traditional exports and heavy dependence on response of the industrial sector to the new taditional cash crops, Malawi's economy has signals and incentives cannot reasonably be relied excessively on foreign resources to expected to be immediate (parm. 7.01). finance imports and the budget deficit, and continues to be vulnerable to external factors. 27. The development of non-traditional of macroeconomic stability is exports requires more time than can be crucial for the success of the reforms under- allowed by a time-bound reform program. An taken. Recurrence of uncomfortable budget- export culture needs considerable time to take ary and current account deficits and inflation- root Promotion of new export-oriented and ary pressures ar matters of concern, as the reorientation of existing industries toward new lack of supportive macroeconomic policies can markets is inherently a difficult and protracted stall, if not reverse, the implementation of the process. Binding constraints include: sunk trade lberaltion and industrial reorientation costs and capital irreversibilities, lack of program, thereby seriously undermining its competitiveness emanating from outdated effectiveness and sustainability (parm 703). technology, inefficient production and quality considerations, and absence of market con- 29. Currently, a constituency that supports tacts; narrow supply of indigenous entre- promotion of non-traditional exports, as preneurship and, perforce, reliance on foreign opposed to manufacture of import substitutes, investors; shortage of skilled manpower, poor is merely nascent and needs to be developed. condition of much plant and equipment, Policy reforms, while necessary, would not by unavailability of term financing, and poor themselves be sufficient to remove constraints infrastructure; and low labor productivity. to efficient production and exports, such as Entrenched exporters from other countries the supply of entrepreneurship and the attitude have a competitive edge over new entrants, toward developing new products for export compounding the difficulties the latter face in The gains to be derived from an export-or- penetrating highly competitive foreign markets ented strategy, compared to the costs inflicted and secure export niches. Inflationary pres- by the liberalization measures, would have to sures, leading to devaluations and increases in become visible - which takes time and propi- - xiii - tious conditions. Trade policy reform pro- able traditional exports and consequent reli- vides an enabling environment for industrial ance on continual donor support. This sug- growth and development; but it does not ges tua hat libe.aization of non-essential guarantee that entrepreneurs will take advan- o cmpgition to domesig tage of this improved environment, and that Indus and catering exclusively to the ncWs investment will be stimulated -- more so, in of a conspcos high m r m nL9 countries biased against non-indigenous entre- b PxWient, as it leads to disipi o0 preneurship (para. 7.04). scarce foign tachange. distortions in coMagsition of iMpor demand. WWd susar- 30. To make policy reforms more effective io ersal of Wolicy reform measues. and sustainable, actions are required to foster Such considerations in the case of fragile an export drive. Since the expansion of economies at a transitional stage do not neces- foreign exchange earnings from the adoption sally run counter to the thrust of an import of an export-oriented strategy will take con- liberalization program. siderable time, to sustain the import liberal- ization effort, inflows of quick-disbursing a The pace of inpo,libaizadonji external funds will continue to be required. ondignd basicAU1 on x r But access to external resources would as affected both by domestic nd externa depend, inter ali,a on sound macroeconomic ewondc develpDM=, the prospects for a management. In this regard, the willingness stable inflow of foreign resources, and the of the Government to commit itself to a new growth of non-traditional exports. Further- set of adjustment-related conditions under more, tariff restructuring ought to be od follow-on operations is encouraging, in that it in such a way as to allow domestic Industry enhances the prospects of sustaining the time to improve its competitiveness,while ad progress already achieved and consolidating hj countervailing levies Ma have to be the momentum of the adjustment process introucd to ward off unfair external com- (para. 7. 05). pedtior and establish a level plying field. Lessons and Recommendations 0 Unintrpd access to foreign ex- changg isruial In establishing and main- 31. The lessons of experience from taming business confidence in the reform Malawi's industrial and trade adjustment program, curbing speculative import demand. program are detailed in paras. 8.01-8.09. and stimulating new investment. Sustaining Many affirm similar findings in other coun- access to foreign exchange therefore deserves tries, and are critical for sustaining the the undivided attention of the monetary momentum of the adjustment effort. authorities. 32. Key recommendations that deserve the e Expansion of foreign exchange Governments and the Bank's attention include earnings from the adoption of an export- the following: oriented strategy takes considerable time to materialize because of binding constraints. * Initially, import liberalization tends to This suggests the for regWar flows widen the trade imbalance due to the in- external funds IQ sutain the iMp liberaliza- creasing disparity of growth between imports ton effort. Undersndably, Acs, to ex- (pent-up plus speculative demand) and exports ternal resources would deed on i (slow responsiveness), resulting in heavy m dependence of the external account on vulner- oti on ot ts - xiv - Only those forms of aid that have the Masurs that yoid mu an ed to effect of changing economic, social and or- ethnic discriminalo and reassure the non- ganizational structures can provide essential indigenous business ci unity are likely to benefits to the recipient. pay off handsomely by substantially Improving therefore should be circumspect and discrete the investment climate (para. 4.11). to avoid thwarting government efforts to address pressin economic and sector issues EPZs often tend to remain enclaves by providina a convenient cushion. Further- with few linkages to the surrounding more, since aid does have an opportunity cost economy. Comprehensive reforms aiming at to assure effective delivery, bilateral and the liberalization of the economy and, more multilateral agencies need to act in concert generally, creation of a favorable economic and take a firm stance to ensure congruity of environment, can perhaps be a more cost- purpose, consistency in policy reforms, coor- effective and less risky way to deepen the dination of the total effort and synchronization industrial structure and e4pand exports and of actions; prevent the transmission of con- employment. Establishment of EM, there- flicting signals; and avoid duplication and fore. should promd with cru Wetn dissipation of effort. (paras. 4.19, 4.20). * To increase the available pool of o Absence of a Igag-t= stra under- loanable funds, stimulate competition in the pining the WmWon of small-nedium s banking sector, and improve banking services, indusr hame effo to achieve an gg- it is imperative in Malawl's circumstances qopate balance btoe lrr Wd smaller foster the entry of new financial institutions (but RffcM establi m , and foster a hr attractingwod-clbab. symbiotic relationship in which the activities of small and large firms conform to their * Although automatic adjustments in respective comparative advantage. Action on minimum wages for unskilled workers to that front could contribute considerably to the compensate for inflation may be socially country'sindustrialdevelopment(was. 4.03- desirable, as the industrial sector is liberalized 4.10). and protection is reduced, automatic full compensation without taking into account 7Te reforms of Malawi's corporate and labor market conditions and the competitive parastatal sectors in the 1980s took the form situation of the various industries may not be of adho measures aimed primarily at the expedient. Wa e flexibility. along with pro- financial and management restructuring of ductivity imrovement. should be the guiding ailing holding companies, rather than at devel- Rdn*les~. oping an aggressive divestiture program. Mba limited pign s to date i m n A o The interrelated issues of concentration psatization Mor aests to an unflnise of economic power and control of the major agod within the broader scheme of industrial banks by particular business groups, though reorientation which needs to be pursued in sensitive, need to be addressed in earnest by earnest (para. 4.21). the political authorities (tiias. 4.12-4.14). PEORMANC AUDIT REPORT MALAWI INDUTRIAL AND TRADE PLCY ADUIM POM (CREDIT 1920-MAI) I. BACKOU A. Evolution of Poliy-Based Lending 1.01 Starting from a very low economic base, Malawi was able to achieve impressive growth during the first 15 years after Independence in 1964. Real GDP grew at an average rate of 5.2% per annum during 1967-79, well above the rate of population growth. This growth was sustained by the steady expansion of agricultural production, with a modest contribution from a nascent manufacturing sector based on agro-processing and simple import substitution. The economy was relatively open, and the trade regime was conducive to fairly efficient resource allocation. There were no quantitative import restrictions (QRs). Average nominal tariff rates were under 20%, albeit the level of nominal protection was augmented by the high transport costs. Effective protection, however, was much higher due to the low value added. The balance of payments and fiscal positions remained fairly stable, with the current account deficit varying between 7% and 9% of GDP and the fiscal deficit averaging less than 8% of GDP. The economy suffered a major setback in 1979 and, for the next three years, Malawi experienced a sharp decline in growth and deterioration of the balance of payments and fiscal positions. GDP fell by a total of 9.5% during 1980-82. The current account deficit rose to 21% of GDP in 1980 and the fiscal deficit to 12% in 1981 (Attachment 1). 1.02 The deterioration of the economy was due to a combination of external factors and structural weaknesses. Foremost among the external factors were a sharp rise in import prices while & For details see OED, PPAR No. 6833, Malawi: Structural Adiustment Loans I and II June 1987; OED PPAR No. 8886, Malawi: Structural Adjustment Loan I and Overview of SALI.s I. I. M and Sumalement to SAL M. June 1990; PR No. 3024a, Malawi - SAL I, June 4, 1981; PR No. 3663, Malw - SAL II November 29, 1983; PR No. 4172, Malawi - SAL I November 25, 1985; World Bank Report No. 7402, Malawi - Industrial Sector Memorandum.December 14, 1989; World Bank Report No. 6543, Malawi - Report on ParamW Restructuring January 28, 1987; World Bank Report No. 8140, Malawi- Growth Through Per Redu , March 22, 1990; World Bank Report No. 7281, Malawi - Public Exoenditure Review April 7, 1990, 2 Vols.; World Bank Report No. 9643, Malawi: Public Sector ManamementReview*- Sc-td March 31, 1993; J. Harritan, OMalawie, in Paul Mosley, Jane Harrigan and John Toye, Aid and Power The World Bank and Policy-Based Leadift London, Routledge, 1991, Vol. I, pp. 201-269; F. Desmond McCarthy (Ed.), Proms ofDvelooin Counties in the 10s. World Bank Discussion Paper 98, 1990, -Emerging Malawi", Vol. II, pp. 203-228; 1. Kydd, 'Policy Reform and Adjustment in an Economy under Siege: Malawi 1980-87,0 IDS Bulletin Vol. 19, No. 1, Institute of Development Studies, Sussex, pp. 31.41; R. Gulhati, Mlwi: mg Re a4insiBa EDI Development Policy Case Series No. 3, 1989; R. Gulhati, Tlh Malng of Economic Poliev in A EDI, 1990; J. Kydd, and A. Hewitt, *The Effectiveness of Structural Adjustment Lending: Initial Evidence from Malawi, Xggd Develoment. Vol. 14, No. 3, pp. 347-365, 1986; PR No. S189, Malawi - Amricultural Sector Adiustment Poa March 6, 1990; H. Mapondo, "Economic Adjustment Programmes: Lessons from the Malawi Experience' (draft), 1990; and Republic of Malawi, S Zomba, 1987. -2- the price of Malawi exports fell drastically, causing a major deterioration in the terms of trade; severe droughts in 1980 and 1981, resulting in a decline in agricultural production and export volumes, and compelling the country to in port large quantities of maize; and rising transport costs due to disruption of the rail route to the sea through Mozambique. However, the crisis also unmasked major structural weaknesses in the Ptnomy, including a narrow export base, stagnant smallholder agriculture, heavy import depeno .e of the industrial and energy sectors, deficient incentive framework, inefficient public enterprises, and weak institutional capacity for planning and managing public resources. 1.03 Recognizing the deep-seated problems facing the economy, the Government, with IDA and the IMF assistance, formulated a medium-term stabilization and structural adjustment program covering the period 1981/82-1985/86. The program was supported by IDA through three SALs, by the IMF through successive standby arrangements and special facilities, and by other donors through co-financing of the SALs and debt rescheduling in 1982 and 1983. The primary objectives of the program were to stabilize the economy and address the structural weaknesses referred to in para. 1.02. To stabilize the economy, the exchange rate and interest rates were adjusted frequently; public expenditures were restrained; and measures were taken to expand the tax base, improve tax buoyancy, and curtail government and parastatal deficits. To encourage efficiency in manufacturing industries, the legal framework was reformed to stimulate competition among domestic industrial enterprises, and the number of commodities subject to price control was reduced considerably.2 To improve mobilization and the management of public resources, the Government's analytical and planning capability was : 'engthened and a better budgeting process was introduced. To enhance parastatal efficiency, measures were taken to restructure and rationalize the financial and operational aspects of the Malawi Development Corporation (MDC), the Agricultural Development and Marketing Corporation (ADMARC), as well as the privately owned conglomerate Press Holdings. 1.04 The Government implemented the program satisfactorily. Although the performance of key macroeconomic variables remained uneven, the economy experienced measurable improvement up to 1985. Real GDP grew by an average rate of 4% annually during 1982-85. The fiscal deficit declined steadily to 6% of GDP and the current account deficit 4% in 1984. However, progress was short-lived and the economy deteriorated again in 1985-87. Decline of export crop prices, rising interest rates on the external debt, and another spell of drought necessitating imports of foodstuffs exacerbated balance of payments pressures; and a large influx of refugees from Mozambique increased further budgetary deficits. GDP growth fel to 1.1% in 1986 and to 2% in 1987, and the fiscal deficit rose to 10% by 1987. Inflation escalb .d irom 11% in 1985 to 25% in 1987, eroding a 29% devaluation between 1985 and 1987. With growing foreign exchange shortages, industrial licensing of new entrants (seepara. 1.06) became more restrictive, while heavy reliance on QRs and ' Price controls were implemented using a cost-plus criterion, often with extensive delays in the processing of applications. In the inflationary environment of the late 1970s and early 1980s, the inflexibility of the system created serious disincentives. Firms switched production away from rigorously controlled essential items; cost-plus pricing undermined incentives to reduce costs; delays in approvals created financial hardships for firms in the face of rising costs; and consumer and producer responses to changing demand and supply conditions weakened. Decontrol was implemented gradually, given that controls were used to protect consumers from price gouging due to oligopolistic market structures, restrain wages and contain inflation. By the late 1980s, the number of items subject to formal price control was reduced from over 80 to 4. However, a number of goods continued to be subjected to effective infomal controls (i.e., requiring firms to consult with the Ministry of Trade and Industry prior to raising prices). -3- discretionary foreign exchange allocations restricted the entry of competing imports. Also, the benel1s of price deregulation were not realized fully because of the Government's inability to liberalize imports and encourage local production, and the deregulated prices of items prominent in the retail price index rose faster than the index. Furthermore, wages remained frozen during 1982/83-1985/86, resulting in further decline in purchasing power and effective demand. However, as a result of a considerable decline in import volumes, the current account deficit fell from 11% of GDP in 1985 to 5% in 1987 (Attachment 1). B. The Industrial. Trade and Financial Environmen The Industrial and Trade Regimes 1.05 Malawi's industrial sector features simple technological processes, limited inter-industry linkages, heavy reliance on imported inputs (two-thirds of requirements), and excessive dependence on agriculture both as a source of demand for its products and as generator of foreign exchange for the importation of raw materials, and intermediate and capital goods. Industry's heavy reliance on agriculture renders it extremely vulnerable to fluctuations in agricultural production and world market prices. On the other hand, the smallness of the economy has led to high market concentration' and an unusual concentration of ownership (see para. 1.14). About half of industrial production originates in food, beverages, tobacco, textiles, clothing and leather goods. Malawi's landlocked position gives rise to a high incidence of transport costs which provides natural protection, even after allowing for the costs of the freighting in of imported material inputs and equipment. But, at the same time, the high incidence of foreign costs decreases the profitability of exports - particularly of imported input intensive industries. For instance, in 1980 the c.i.f. value of imports was 38% higher than the f.o.b. value; following the closure of the Mozambican trade routes during the 1980s, the differential rose to 67%. 1.06 Until the late 1970s, industrial sector policies have been basically market oriented and conducive to growth. The macroeconomic environment was also favorable to fast industrial growth and fairly efficient resource allocation. Low inflation, a market clearing exchange rate, free access to foreign exchange, and low and fairly uniform import duties contributed to the good financial performance of the manufacturing sector. Price controls and regulation of entry have been among the few areas of Government intervention in industry. However, except for vehicle spare parts and fertilizers, price controls on most industrial products had been eliminated by the mid-1980s (see para. 1.03, footnote 2). Up to mid-1988, the Government was empowered to grant a legal monopoly to firms on grounds of "public interest and in the interest of the efficient development of the industry concerned" for a period of up to five years, which could be extended. Also, the Government could deny a license to a new entrant or to an established firm seeking diversification. To be sure, the Government had granted monopoly rights sparingly - fertilizers, cement, and beer; but these industries are not insignificant legal monopolies. In practice, the percentage of rejected applications was small (10%-15%); nonetheless, the decision-making process and the grounds for rejection were not always transparent, and have affected measurably the degree of market ' The Governments import substituting industrializationitensified the oligopolistic industrial structure inherited from the colonial period. By the early 1980s, 86% of the firms were oligofties and accounted for 91% of total sales. -4- concentration. Malawi has also had a liberal attitude towards foreign investment, and foreign firms account for about one-third of total industrial sales. 1.07 In contrast to the industrial sector's respectable growth (5.6% annually) during the 1970s, manufacturing value added grew at only 2.7% annually in 1980-87, while its share to GDP remained stagnant at 12%. The decline in growth was particularly steep in 1986 and 1987. Industrial exports as a percent of industrial output hovered around 3% during this period, while the share of industrial to total exports at about 10%, underlining the sector's heavy domestic market orientation (Attachment 1). Labor productivity, which stagnated during the 1970s, fell during the 1980s. Also, average real wages in manufacturing in 1985 were only two-thirds of their 1974 level. Thus, industry's contribution to economic growth, employment, and exports has been negligible. 1.08 The deterioration in industrial performance was in part the result of external events - the second oil shock, disruption of traditional trade routes, drought, and the rise in international interest rates. Adverse changes in the terms of trade reduced domestic demand and the country's capacity to import, triggering a slowdown in industrial production. But, in part, performance was also affected by inappropriate policy response. When the external situation deteriorated in the late 1970s, at first the authorities did not adjust; instead they pursued a lax fiscal policy, resorted to external borrowing, and increased protection. Subsequent attempts at adjustment in 1986 through the imposition of QRs and foreign exchange rationing resulted in a progressive closing of the economy. High tariffs and QRs created excessive protection and provided no incentive to promote efficiency (see para. 3.06); fostered influence peddling and rent-seeking activities; introduced unfair differential protectionism and administrative complexities; sent the wrong signals to investors; and deterred output growth and investment by raising the cost of imported inputs and capital equipment and, eventually, by denying producers free access to such imports. At the same time, QRs on final goods left existing firms with an uncontested domestic market. 1.09 High levels of tariff protection and the confluence of reinforcing factors suggest that many industrial enterprises were not economicaliy ffi even though they may have been financially viable, and that extensive pockets of inefficiency persisted throughout the 1970s and 1980s. The natural protection afforded by the high transport costs; poorly conceived industrial and agro-industrial projects by parastatals, whose importance (estimated at 13% of industrial sales) is underrated because many de facto parastatals are classified as private firms (para. 1. 14,footnote 8); price controls based on cost-plus price-setting mechanisms; monopolistic market structure through extension of monopoly rights or concentration dictated by scale economies; discrk tionary industrial licensing forestalling new entry; and the fact that growth in the 1970s was extensive, in the sense that it stemmed from additions to factors of production and not to productivity increases, have not been conducive to fostering industrial efficiency. The rising import duties (from an average of 20% in 1976 to 39% in 1986), the widening of tariff spreads, and the QRs put in place increased further N By law, any now manufacturing firm had to obtain a license. Among other things, the applicant had to demonstrate that the enterprise will be viable and will comply with pollution laws. The location of the firm also had to be sanctioned by the authorines. To obtain the license, a notification of intention to begin operation was published in the official gazette. Existing firms could object to its establishment on virtually any grounds, including defending their market share. Although this objection was only a recommendation to the Ministry of Trade, Industry and Tourism, in practice, the decision was discretionary and effectivelycreated a barrier to entry. See also para. 1.29. -5- nominal and effective protection from the late 1970s to the late 1980s, and removed the incentive to promote efficient import substitution as well as operating efficiency. 1.10 Furthermore, as a result of higher Import duties, rising transport costs and the imposition of QRs, the domestic market for industrial goods became much more profitable than exports, accentuating the already strong domestic orientation of industry. Between the mid-1970s and mid- 1980s, the trade ratio declined from 58% to 45% of GDP, and imports from 36% to 22% of GDP. By late 1987, competing industrial imports had been effectively banned from the domestic market, and the market share of firms was being effectively determined by the Reserve Bank of Malawi (RBM) through its foreign exchange allocations. The intensification of exchange and import controls ;aused further distortions. It was not until June 1988, when it was made a condition for Board presentation of the Industrial and Trade Adjustment operation, that the Industrial Development Act of 1964 was revised in order to foster competition in domestic manufacturing and make existing regulations more transparent and less discretionary. On the other hand, the earlier Government commitment to resist discouraging the import of goods which would compete with domestic manufacturing became a moot point because of the prevailing shortage of foreign exchange. Finally, steps were taken to strengthen the Malawi Export Promotion Council, an export credit financing facility was set up in the Reserve Bank in 1987, and the Government assigned the coordination of all export promotion activities to the Economic Planning Department (EPD). However, no significant action was taken in formulating an export promotion strategy and in devising a package of export incentives, matters which were to be addressed by the operation under review. The Financial System 1.11 Partly by design and partly because of the small size of the market, Malawl's financial system is oligopolistic and fragmented on both the deposit-taking and lending sides. The two commercial banks control some 80% of financial system savings, and have close ties to one another and to the two main holding companies that dominate the industrial sector (Press Holdings and ADMARC own 80% of the National Bank of Malawi (NBM) and 70% of the Commercial Bank of Malawi (CBM)). As a result of large public sector deficits, these financial institutions have been called upon to invest in high-yield government paper or with the Reserve Bank. This system reduces foreign borrowing requirements for the Government, but it also diverts private sector savings from the potential pool of risk capital. As long as lending to Government remains attractive, the overall flow of funds for industrial activities remains limited. Also, until recently (para. 3.28), Malawi did not allow free entry into the banking sector. Rather than fostering competition, the authorities had opted for establishing specialized institutions - Industrial and Development Bank of Malawi (INDEBANK), New Building Society (NBS), Investment and Development Fund (INDEFUND), Small Enterprise Development Organization of Malawi (SEDOM) - to fill perceived gaps in financial services, or to cater to specific segments of the economy, thus intensifying market segmentation and sub rosa arrangements. 1.12 Credit ceilings on commercial banks were used frequently as an instrument of monetary control, and as a means to skew credit allocation toward the public sector at low interest rates. But because the ceilings were enforced on an institution-by-institution basis using existing market shares as a benchmark, they effectively reinforced the market's oligopolistic structure. Furthermore, credit ceilings led to a tightening of commercial banks' credit standards; raised collateral requirements; forced non-prime borrowers, especially small-scale, out of the financial system and to the informal -6- market; and fostered disintermediation. As expected, credit ceilings induced the banks to minimize their risks by lending to prime clients.-Y Liquid commercial banks opted for financing Government debt (through investments in treasury bills), or for placing their deposits with the RBM in interest- bearing accountsY Faced with excess liquidity and no lending opportunities, commercial banks had little incentive to mobilize additional resources; in fact, in mid-1988 they were turning down longer-term deposits. Private enterprises with surplus savings were circumventing the financial system and lending to deficit enterprises directly, leading to disintermedlation. 1.13 By the mid-1980s, the basic shortcomings of the financial system included: restrictive monetary policies to contain inflation, while satisfying the credit requirements of the public sector; lack of a legal framework for effective supervision of the operations of the financial institutions; low operating efficiency of the banking institutions owing to lack of competition; preferential tax treatment of interest income on deposits with the Post Office Savings Bank (POSB), and interest paid on mortgages with the building society; inadequate long-term credit; and stringent lending practices that limited industry's access to credit. The Reserve Bank's banking inspection department was short of qualified and experienced staff and needed strengthening through recruitment and training. POSB, the principal institution in small-scale savings mobilization and an important potential source of terms funds for industry, had weak management and outmoded management information and accounting systems. The DFIs (INDEBANK, INDEFUND, and SEDOM) lacked recourse to kwacha denominated funds for term lending due to legal restrictions on their activities. C. Progrss in Industrial Restructuring Genesis of the Cornorate and Parastatal Sector 1.14 In the 1960s, except for smallholders in the rural areas, economic activity was largely controlled by foreigners. Agricultural estates were owned by Europeans, multinationals dominated the manufacturing sector, Asians controlled commerce, and the commercial banks were owned by the British. After Independence (1964), while it maintained the status qu (except for the nationalization of the railways in 1966), the Government established a number of parastatals as a means to promote economic development and African control over the economy. MDC was established in 1964 to further the development of the agricultural, commercial and manufacturing sectors (Attachment 4). ADMARC was set up in 1967 to develop an efficient system for supplying agricultural inputs to smallholder farmers, and promote related commercial and industrial ventures. Press Holdings was established in 1969 as a private investment holding company, but had strong ownership ties with the political leadership. Since its inception, Press Holdings played a forceful role in an array of economic activities (tobacco, trade, transport, and manufacturing). Press had borrowed heavily from the (captive) domestic banking system, and contracted substantial external ' Whereas net domestic credit to the public sector increased from 11% of GDP in 1979 to 23% in 1986, credit to the private sector declined from 23% of ODP to 10%. & Restrictions on the expansion of domestic credit to the private sector also crowded out the commercial banking system. In the early 1970s commercial banks accounted for virtually all of the domestic credit outstanding; by 1979 their share had fallen to 75% and by 1936 to 45%, with the Reserve Bank accounting for the rest. The restrictions on commercial bank credit expansion hampered the growth of the banking system and reduced the potential impact of a larger market on the promotion of competition in the commercial banking system. ' It is noteworthy that the political leaderabip did not espouse the socialist ideology. -7 - loans with government guarantees. In 1981, its turnover was about 36% of GDP and employed 10% of the country's paid labor force. Its portfolio encompassed 22 wholly-owned companies, 23 subsidiaries in which Press had majority shareholdings and a lead management role, as well as 40% ownership of the Commercial Bank of Malawi and 44% (currently 48.4%) of the National Bank of Malawi.1 Attnmpts at Industrial Parastatal Reform 1.15 The three holding companies (Press, MDC, and ADMARC) expanded rapidly and imprudently during the late 1970s. They promoted projects which were poorly conceived, developed intricate interlocking directorates and financial relationships, and their operations were highly leveraged. Losses in a large number of subsidiaries, high interest payments, excessive dividend distributions, inadequate financial controls, and management lapses created severe financial difficulties in all three entities. The weakening of tobacco prices had a further serious negative effect on Press and ADMARC, and the growing difficulties of the Malawian economy in the early 1980s exacerbated their problems. Press suspended dividend payments, liquidated some loss-making subsidiaries, and reduced its work force by over 20%. MDC closed three loss-making subsidiaries, and consolidated operations in a fourth. But these measures did not go far enough, and the situation of the holdings remained precarious. Insolvency of this dominant triad was bound to have a major adverse impact on the banking system, the government budget, the economy, and Malawl's external creditworthiness. In the face of a serious and deteriorating situation, policymakers became concerned and sought ways to overhaul the financial and management structures of the three holding companies. 1.16 The financial performance and operating efficiency of MDC, ADMARC and Press Holdings became a major issue in the dialogue between the Bank and the Government. Press not only occupied a pivotal position in the country's economy, but was also the largest debtor of the two commercial banks. Press's insolvency posed the prospect of bankruptcy of these banks, and threatened the financial viability of ADMARC. Furthermore, Press's activities had restricted domestic credit to the remainder of the private sector, and its operational difficulties implied a major adverse impact on the country's output, employment, and exports. Thus, there were powerful reasons to avert the financial collapse of Press Holdings. In 1981, under SAL I conditionality, studies were commissioned to develop detailed plans for the restructuring of the three holding companies. Press Holins 1.17 The study ei Press Holdings revealed for the first time that it had a negative net worth amounting to K 40 million, and that it owed K 80 million to the two commercial banks. Press owed another K 54 million to ADMARC and this, in turn, made it impossible for the latter to honor its ' Hence the quip that Malawi's private sector is alive, doing well, and owned by the GovernmenL' Also, inMalawi fully or in the aority owned subsidiaries of stat-owned holding companies (e.g., ADMARC, MDC) are considered as private because they are expected to operate on commercial principles, despite the fact that their financial loses result in utransparentclaims on tho budget (e.g., reduced dividends becaus of cross-sudization). This practice undersA the importance of the parestatal sector. ' Press held joint ownership with ADMARC and MDC in over 20 companies. -8- debt of K 30 million to RBM. As a condition of SAL II, the Government agreed on a financial and legal restructuring of Press. The reorganization of Press, which was completed in 1984, turned out to be a very complex exercise. The restructuring entailed the formation of a new holding company, Press Group Ltd., a shake up of senior management, and tightening up internal operating procedures. Shares in a number of agro-industries were sold to ADMARC, and further asset rationalization occurred through a series of share swaps with ADMARC and MDC. As a result, the number of companies in which Press held shares was reduced from 24 to 14. New corporate guidelines covering price policy, investment criteria, overdraft arrangements, and rules for inter- company loans were drawn up to ensure prudent management of the new company. The restructuring involved considerable cost to the Government, as it took over Press's liabilities to the commercial banks through the issue of MK 54 million Special Stock. In return, the Government received preference shares and income notes from the new company. Following the restructuring, Press owed MK 64.5 million to the Government and MK 40 million to ADMARC. The ultimate and sole shareholder of Press Corporation Limited became the Press Trust, to which an annual fee of K 1 million was to be paid. The reorganized Press was obligated to repay the Government before investing or paying out dividends. 1.18 Following its reorganization, the financial condition of Press improved significantly, and since 1985 it has been operating profitably. To a large extent this was due to improvements in management and operating efficiency, facilitated by greater access to inputs following the import liberalization policy. The final outcome of the restructuring arrangements, however, is not without some controversial features. First, the annual fee to the trust that must be paid before servicing the debt to the Government does not sit well with particular constituencies. Second, the series of share swaps with ADMARC and MDC had the effect of passing many of Press's problems on to these parastatals, e.g., in the form of unprofitable subsidiaries (see paras. 1.19, footnote 10, 1.20). Third, the Press Group remains the locus of significant concentration of economic power. The Group has majority control over 18 subsidiaries in the distribution, manufacturing, agricultural, and financial sectors of the Malawian economy, including a number of joint ventures with foreign partners (Attachments 5, 6). Also, the Group has strategic minority positions in 12 associated companies in the same four sectors of the economy, some of which involve partnerships with foreign investors. The stipulation that proceeds of divestment be used to repay the Government reduced potential profit and created a disincentive to sell assets. This inadvertently perpetuated its dominant market position, which was further reinforced by its ability to forestall new entry through its influence on the banking system. 1.19 Progress was also made in the organizational and financial restructuring of MDC, although the objective to revert this state-owned holding company to its original role of an industrial development parastatal taking a minority interest in the projects it promotes was not achieved. The SAL-guided restructuring involved the conversion of much of MDC's debt into equity, the selling of a number of subsidiaries, and the swapping of shares with Press Holdings and ADMARC, which -9- reduced the number of companies in which MDC held interests from 32 to 18.91 However, MDC retained controlling interest in 8 companies which runs against its policy guidelines that prohibit majority shareholdings - aside from the fact that many of these companies continue to face financial lossesIL' (Attachments 7, 8). Rationalization of assets took the form mostly of swap arrangements rather than selling to private parties, in part because of the scarcity of private investors in Malawi. The management, planning, and budgeting functions of MDC and Its subsidiaries were also strengthened. The holding company and most of its subsidiaries continue to depend on expatriate management. 1.20 As a result of the restructuring process, and in contrast to the 1977-83 loss-making period, MDC has been profitable since 1984, albeit return on equity in nominal terms fell from 6% in the mid-1980s to just over 1% in 1991 (Attachments 9, 10). Moreover, much of this profit did not reflect improvement in efficiency. Rather, it resulted from the "once-off" gains derived from the sale of MK 4.8 million of assets and the conversion of MK 13 million of government debt into equity. MDC's profits are generated primarily from its real estate, finance, trading and services activities. It is still losing money in its hotel investments and on concerns such as iron and steel, construction materials, metal goods and utensils, and (until recently) cement. The poor performance of its subsidiary industrial enterprises is attributed to management problems, worn out equipment, sub-optimal plant scale, increased domestic and external competition, or poor quality of products. A few rehabilitated and well-managed industrial subsidiaries have improved their performance. But even some of its profitable enterprises are not economically efficient due to aged equipment (packaging) or uneconomical size (cement). Thus, although the reform helped restore MDC's financial health, further policy efforts are required to induce MDC to play its mandated catalytic role as a dynamic development bank.v Moreover, MDC could play a key role in promoting export- oriented ventures. Such actions would involve reducing the state's ownership in MDC to minority shareholding, thereby increasing its equity base through fresh private capital; divesting existing concerns and using the proceeds to promote new industrial projects in association with the private sector; and/or financing viable industrial projects initiated by private entrepreneurs. However, the present thinking of the Government and MDC's management is not geared to promoting these desiderata. W Such swap arrangements included the transfer of such agriculture-oriented holdings as Cold Storage Ltd. (100%), Freshcold Ltd. (100%), and National Oil Industries (30%) to ADMARC, and Its industrial interests in Malawi Pharmaceuticals(100%), Malawi Distillers (41%), and Carlsberg Breweries (27%) to Press Holdings. On the other hand, MDC acquired Press Holdings' 49% interest in the Import and Export Group and the Government's shares in Capital Hotel Ltd., raising its holdings to 85% of ordinary and 71% of preferred abares in the company. It would appear that ADMARC got a raw deal in the process, while Press the best (profit-making monopolies). U& In its Operational Policies and Action Programme 1987-91, MDC's management outlined a divestment program in which, interalia minority shareholdings in Encor Products Ltd. (23.3%) and National Insurance Co. (20%) would be sold, while mAjority shareholdings in Portland Cement (100%), Packaging Industries Ltd. (85%), and Import and Export Co. (86%) would be reduced to $1%. To date, no action has been taken to effect these divestments. IF In this sense, going ahead with the proposed construction of a new cement plant in the central region, with a rated capacity of 100,000 tons annually through its fully owned subsidiary Portland Cement Company, appears hardly advisable. Uneconomic size, poor quality of limestone, and the possibility of cheaper imports from more efficient plants located in Tanzania or Zambia militate against such a capital-intensive investment. Besides, it defeats the purpose of promoting regional specialization and integration within the Preferential Trade Area. - 10- ADMARC 1.21 ADMARC's restructuring effort, based on a 1983 study, envisaged the disposal of investments not related to agricultural marketing and strengthening of its financial management. ADMARC's portfolio contained a large number of agro-Industries, transport and industrial concerns, and sizable participations in financial institutions, farms and estates. Unable to find private buyers, ADMARC sold selected assets to Press and MDC (para. 1.19, footnote 10). Six companies (Dwangwa Sugar, Sugar Corporation, PEW Ltd., David Whitehead, Lever Brothers, United Transport) were slated for sale by August 1986; but only Lever Brothers and PEW Ltd. had been sold by 1987. The study had further recommended that the Government should compensate ADMARC for carrying out non-commercial functions, such as the consumer subsidy on maize, storage of the strategic grain reserve, and construction of silos for this reserve. However, the Government did not act on these recommendations until 1986. By then, ADMARC had suffered a severe financial crisis. 1.22 Efforts to restructure ADMARC continued under SALs II and III. A 1987 study for the rationalization and divestiture of ADMARC indicated that continuation of ADMARC's role as the manager of an array of subsidiaries and associate companies (para. 1.21) was not prudent. Divestiture of all assets unrelated to its mandate not only would improve their financial and economic performance, but would also enable ADMARC to carry out more effectively its core marketing role in agriculture, strengthen ADMARC financially and generate foreign exchange for the Government, prevent the deterioration of their physical condition, and promote participation of indigenous Malawian ownership in selected productive enterprises. Such concerns as retrenchment of labor, concentration of ownership, the regulatory environment, and the mode of divestiture (e.g., negotiated sale, competitive bids, public share distribution) would be considered on a case-by-case basis, as a matter of political decision. Concerning the management structure of the divestiture program, the recommendation was that all industrial assets be maintained within ADMARC's Development and Investment Division and be sold directly by ADMARC, except for ADMARC's interests in financial institutions, Optichem and United Transport. These latter high quality assetsly would be transferred to and divested to institutional investors and possibly individuals through a managed holding company to be established. Eventually, this holding company could be involved in the sale of other mature companies held by institutions such as INDEBANK and MDC. 1.23 The divestiture program faced a number of constraints, Including the lack of a developed capital market, the uncertain investment climate, and the financial imperatives of ADMARC and the Government. The lack of a capital market limited the possible methods of sale, ownership options, and the role of the market in determining the sale price. However, this constraint was not binding as potential sources of fu"O. to finance the divestiture program included existing shareholders, e.g., through pre-emption rights; new active members, e.g., new foreign investors, increased investment from indigenous corporations, or investment from existing foreign investors; and local passive investors, such as institutional investors (e.g., insurance companies, pension funds) and individuals. The uncertain investment climate, reflecting economic problems and instability in the region, could limit the range of possible buyers and reduce sale price, but it has been improving in recent years. The financial necessity to generate quickly additional foreign exchange for the Government and local & These assets were considered as high quality because they were managed under contract by foreign shareholders, and the dividend yield was competitive with other investment opporuities in the country. -11- currency for ADMARC would have to be balanced with the longer-term economic prospective of the enterprises Involved. 1.24 Progress to date in implementing this divestiture program has been very limited. ADMARC has completed the sale of the wholly owned subsidiary ADMARC Canning (which had a negative net worth) to domestic investors; disposed of its minority interest (22.5%) in the National Seed of Malawi to foreign investors; reduced its ownership to National Oil Industries Ltd. (100%) and Cotton Ginners Ltd. (49%) to 22.5% through sale of shares to foreign investors; and sold the loss-making fisheries to Press. ADMARC's investments in Subsidiary and Associated Companies are shown in Attachment 11. An array of attitudinal factors, socio-economic concerns, and institutional impediments account for the limited success of the divestiture program. In the first place, the divestiture process was left to ADMARC, wich had a vested interest in retaining control over profitable non-agricultural activities. ADMARC's lack of animus Is understandable, as privatization implies loss of remunerative jobs, power and prestige. Divestiture has been further constrained by divided views within the political leadership, the bureaucracy, the parastatal management, and the labor unions; economic concerns as reflected in lingering suspicion of, and fear of domination by, the non-indigenous private sector; and uneasiness about the prospective market structures and concentration of economic power. Also, there were serious institutional hurdles: the Department of Statutory Bodies' (DSB) lack of authority and support to enforce and oversee the privatization process; absence of an aggressive promotion program and concerted efforts to elicit investor interest; and lack of access to finance by local firms. 1.25 Progress has been further affected by concern about "alienation," reflected In notions of preserving state ownership in "strategic" facilities (e.g., cold storage); insistence on securing minority (30%), If not majority, ownership for indigenous shareholders in the new ventures; reluctance to transfer ownership of profitable undertakings to foreigners; inability (financial and managerial) to rehabilitate enterprises with assets in poor physical condition which, in ADMARC's thinking, was a necessary step prior to divestiture to avoid heavy capital losses; and the high cost of investible funds. The absence of clear objective(s), priorities, clear guidelines, and decision- making process for the implementation of the divestiture program, including initiatives to ease the social impact of the liquidation/divestiture process and facilitate the redeployment of the affected work force, has also contributed to the stalemate. In July 1991, ADMARC formed the ADMARC Holding Company Ltd. as a wholly owned private company, to which it proposes to transfer all assets not directly related to its marketing activities -- which has not yet been done. The holding company Is expected to draw up a divestiture program and a tentative timetable. Finally, the Bank did not pursue the matter after the completion of SAL III (1988), apparently feeling that parastatal divestiture was no longer an issue as far as ADMARC and MDC (para. 1.19) were concerned - a clear case of benign neglect at best. 1.26 ADMARC has bien nominally profitable since the late 1980s, but only because of cross- subsidization from non-industrial activities (e.g., banking, transport) in which it retains a minority position and acts as a passive investor. In 1991/92 and 1992/93 it suffered losses amounting to MK 0.5 million and MK 6.4 million, respectively (Attachments 12, 13). The poor performance of ADMARC's industrial portfolio is attributed to ADMARC's lack of control over its own investment decisions, which led to acquisition of assets motivated by political, social and poorly conceived developmental considerations; unavailability of the requisite technical and management resources to support subsidiary and associated companies; unwillingness of mgjority/minority shareholders to - 12 - allocate time and resources for corporate planning and execution of sound investment decisions; and increased competition. Also, ADMARC's assets in processing industries have for a long time underperformed because of the lack of resources to replace obsolete machinery and equipment and improve management practices. W.CO 1.27 The Wood Industries Corporation (WICO), a parastatal with several sawmill plants, was rehabilitated under a Bank loan approved in the mid-1980s. WICO has never been profitable (Attachment 13), mostly due to very low capacity utilization (0%-40% and 30% on average). Its losses for 1992/93 are estimated at MK 6.2 million. This poor performance stemmed from insufficient and irregular supply of logs to the Blantyre mill, as no inventory of the available saw log supply was taken at appraisal. The Blantyre plant, which was the focus of the Bank's rehabilitation effort, was closed down in 1990. WICO is unable to service its debt, its net worth is negative (with accumulated losses amounting to K 25 million and asset value to K 16 million), and is technically bankrupt. Privatization of WICO has been discussed during the past several years, and a study of alternative means to achieve privatization has been completed. However, guaranteed saw log supply remains a major stumbling block. Insistence on 30% state shareholding interest, concern about labor retrenchment, and heavy indebtedness have been additional impediments. Dismantling of the company and sale of the plants and machinery in segments to smaller private investors in locations with access to log supply may be an option to expedite divestiture, and stop the drain on the budget from WICO's operating losses. Outcom 1.28 On the whole, the Bank-guided reforms in the early 1980s in Malawi's corporate and parastatal sectors, with the exception of the belated attempt to restructure ADMARC, were relatively successful, particularly in the case of Press and MDC, in that the burden on the Government budget was reduced. However, the reforms larely took the form of ad hoc measures aimed at the financial and management restructurine of ailing holding companies rather than at imfroving the efficienC of the industrial parastatal sector as a whole and at reducing its role in the economyA' The Press Jy For details on this project see OED, PCR No. 8744, Malawi - Wood Industries & rWn June 13, 1990. 1F In 1980, the Government established DSB to oversee all parastatals; but for several years it remained a relatively ineffective body, with inadequate staff and unclear mandate. It tended to preoccupy itself with administrative matters rather than focus on policy issues and the parastatal divestiture process. Also, insufficient attention was paid to fostering efficiency and decentralized deciulon-making. DSB has not developed the requisite stature to oversee the larger parastatals. In 1986, the Government reorganized the parastatals into commercial entities, which are expected to operate on commercial principles, and other statutory bodies (developmental, regulatory, and promotional). The Government remains committed to strengthening the institutional capability of DSB, and it is expected that rules for reviewing investment plans and monitoring performance will be formulated, to permit commercial parastatals to function with increasing autonomy on the basis of agreed corporate plans and a performance-oriented system of oversight. Also, the respective role of DSB and the parent ministries would be clearly delineated. MDC and ADMARC are the only statutory bodies under DSB's jurisdiction which have subsidiaries and associate companies involved in industrial and agro-industrial activities. The other is the Wood Industries Corporation which operates under the Companies Act. The financial performance of commercial pastatals s sunmarized in Atachments 12, 13. - 13.- Holdings and MDC package did not, and perhaps could not, address the Issue of restructuring of Malawi's corporate and parastatal sector due to the pressing circumstances and urgency under which it was put together. Nevertheless, fundamental structural adjustments encompassing the expediency of scaling-down Press's holdings. divesting ADMARC of its non-agricultural assets, transforming MDC into a development corporation, fostering the growth of the private sector, and improving market performance and industrial efficiency through increased competition constitute an unfinished agenda within the broader scheme of industrial reorientation.W This is a tall order; yet, it presents a major challenge for the political leadership and the Bank as well. Small-Medium Scale Industry Development 1.29 For historic reasons, the indigenous (African Malawian) private sector is at a very early stage of development, and has been slow to react to new opportunities. In 1985, there were only 156 registered small-scale industry (SSI) establishments employing up to 20 workers, mostly controlled by Asian Malawians, with a total employment of 1,370 persons. While SSI accounted for 40% of all industrial establishments, it contributed 2.3% of manufacturing value added and employed 2% of the industrial labor force. SSI is domestic market oriented and dominant in food processing activities (62% of establishments). The growth of SSI has been limited primarily due to limited entrepreneurial capacity, shortage of technical skills, the regulatory environment, and the limited access to finance for investment and working capital. While there are several financial and technical assistance institutions that support small-enterprise development, they are inadequately capitalized and lack effective outreach and training programs.121 Zoning legislation, which forbids the setting up of small workshops in residential areas and/or requires existing workshops to relocate when they reach a certain size, has been a major obstacle to new entry and the growth of existing enterprises. Also, the investment licensing system has been used to curb Asian and other non- African manufacturing investment. Ethnic discrimination has undermined confidence among the Asian and expatriate communities, affected the growth of Malawian non-indigenous entrepreneurial potential, prevented its diversion from trade to manufacturing activities, and encouraged the flight of capital and skills. Inability of African Malawlans to seize investment opportunities denied to other Malawians and non-Malawians has resulted in a loss of new investment in small-medium sL enterprises and potential industrial growth. Furthermore, investment from foreign owners of existing industrial assets has been the exception rather than the rule, while foreign direct investment from corporations with no previous exposure to the country has been rare. F The notion of industrial rotientationencompasses effoirts to develop a more outward-lookldg industrial structure; create an enabling policy environment through sound macroeconomic management and trade and financial sector reforms; downsize the public sector through restructuriag/divestitureof parastatals; improve tie financial condition and management of retained parastatals; and foster the development of private industry, small-medium scale in particular. I These fimctions are performed by the Development of Malawian Traders Trust (DEMATT) and, to a lesser extent, by the Ialawian Entrepreneurs Development Institute (MEDI), the Rural Trade School, the Polytechnic and the Nasawa Technical Training School. - 14 - II. OBJCIVES.STRATEGY,ANIDLDES OF ACTION PROGRAMS 2.01 To stem the downward trend of the economy, the in 1987 Government devised a new strategy, which was set out in its Statement of Development Policies, 1987-1996. It also formulated a three-year program (1988-1991) to deepen the adjustment process and reverse its earlier economic policy measures. The thrust of the program was to align aggregate demand to available resources through strict fiscal, monetary and credit policies, and active exchange rate management; revive production and investment in industry; strengthen the role of the private sector; promote competition by eliminating QRs on competing imports; increase productivity by addressing policy and investment constraints on the performance of the major economic sectors; and enhance efficiency in the use of public resources. 2.02 The Government's new medium-termdevelopment policy was designed to reverse earlier policy measures, and set the stage for resumed economic growth in the context of a viable balance of payments position. These objectives would be achieved through a two-pronged strategy of financial stabilization and structural reform. Reduction of the fiscal deficit, strict monetary and credit policies, and exchange rate adjustments would bring aggregate demand in line witl- vailable resources. Complementary supply side measures, such as an increased flow of foreign 4xchange to the private sector, trade liberalization, redirection of credit away from the public sector, tax reform, and revision of incentives, would stimulate private sector production and investment. Also, reduced protection of the domestic industry would reorient investment toward labor-intensive and export-oriented activities. 2.03 In support of this development strategy, the Bank would follow up on earlier broad-based structural adjustment programs (SALs I-III) with a series of policy-based, sector-oriented operations designed to address remaining structural constraints in key productive sectors and deepen policy reforms (PR, paras. 11-13, 18, 19). The first such operation to address both sectoral and macroeconomic policies was the Industrial and Trade Policy Adjustment Program (1988) under review, and was supported by the IMF's Enhanced Structural Adjustment Facility (ESAF), significant donor co-financing (see Preface), and by a further external debt rescheduling in 1988. It was succeeded by the Institutional Development Project (1989), the Agricultural Sector Adjustment Program (1990), the Financial Sector And Enterprise Development Project (1991), and the Entrepreneurial Development and Drought Recovery Program (1992). Secora Objectives.-Poliev InSrment. Conditionalit 2.04 The cornerstone of the industry and trade policy adjustment program was trade liberalization, complemented by flexible exchange rate management, fiscal deficit reduction, reform of the foreign exchange allocation system, and tax reform. The strengthening of a market-oriented system of foreign exchange allocation would be accompanied by the elimination of QRs on competing imports and rationalization of the import tariff structure. The program also included price decontrol, measures to support the development of small-scale enterprises, reforms to increase the efficiency of the financial sector, and steps to promote exports (PR, para. 27). The Governments overall program is described in detail in the Governments Letter of Development - 15 - Policy (Attachment 2), and the major policy reforms, including conditionality, are summarized in matrix form in Attachment 3. The specifics of the program are presented below. Trade Poliey and ExchanWe Rate Manaement 2.05 Taeliberalizatio and the phasing out of the administered foreign exchange mechanism would be achieved by mid-1991 in three stages. The first stage, to be introduced in February 1988 as a condition of Board presentation, would remove prior foreign exchange approval for a range of items comprising about 35% of th total import bill, including 25% of raw materials and spare parts. The second stage, to be implemented before April 1989 as a condition of second tranche release, would apply to another 30%, but expanding coverage to a further 50% of raw materials and spares and a small amount of final goods. The third would cover the balance of raw materials, followed by intermediate and capital goods. The Government, as a condition of Board presentation, reduced the scope of imp licensing to items relating only to public health, safety or food security, and expanded the Open General License (OGL) system beyond the existing level of 85% of total imports bill. Also, the Government agreed to the progassiye reduction of io= tariffs Wn diseion o dytrates, the timing to be decided at the time of the release of the second tranche. Finally, the Government devalued the kwacha by 15% in January 1988, and undertook to pursue a &1l1a10 exchange rate policy, with the aim of maintaining external competitiveness and achieving balance of payments objectives. In particular, the Government would ensure that the management of the exchange rate complements trade liberalization, tariff rationalization, and external resource availability. The Bank's operation would provide the requisite foreign exchange to meet the increased demand for imports (PR, paras. 28-32, 37; Attachment 3). Fiscal Policas 2.06 Reduction of the fiscal deficit would ease inflationary pressures and excess demand for imports, facilitate credit expansion to the private sector, and avoid rapid changes in the exchange rate, thereby underpinning the trade liberalization effort. To this end, the Government undertook to reduce the fiscal deficit to a level that can be financed with minimal recourse to domestic credit. Since the tax burden on the economy was already high (the revenue to GDP ratio was above 20% and the effective tax burden on the modem sector much higher) and additional tax rate increases would likely create disincentives, the burden on fiscal adjustment would fall mainly on the expenditure side. Thus, the ratio of expenditures to GDP would decrease from 28.4% in 1987/88 to 26.5% by 1990/91, while the ratio of revenue to GDP would remain relatively stable over the program period - at about 18.8% of GDP. To maximize the benefits of budget outlays in the tight fiscal environment, institutional measures to be taken would strengthen the preparation of budgets for key development sectors and permit stricter expenditure control. Also, as a condition for the release of the second tranche, steps would be taken for the preparation of a three-year rolling public sector investment program (PSIP) (PR, para. 33; Attachment 3). Ia Reform 2.07 Malawi's tax system had developed in a haphazard manner and largely in response to urgent demands for additional revenues. As a result, it evolved a complex and inefficient structure and had major weaknesses, including inadequate investment Incentives in the corporate income tax, a cumbersome system of domestic surtax exemption, inefficient administration, and serious leakages. - 16 - By 1981, Malawi had increased its tax effort to a respectable 15.4% of GDP. But much of this tax effort came from increased reliance on international trade taxes, whose share had reached 46% of total revenue. The average tariff rate on private sector imports increased from 20% in 1976 to 39% in 1986, and high levies on intermediate goods accentuated the bias against exports and efficient import substitution. Public sector purchases, including industrial parastatals, enjoy duty-free status. To rectify the situation, trade liberalization measures would be complemented by a comprehensive reform of the tax system to improve its equity and efficiency, and rationalize trade taxes to reduce domestic protection and promote efficient production (PR, para. 35). 2.08 The Government developed a reform package to be implemented in 1988-90, based on a 1985 Bank report entitled "Tax Policy in Malawi." The reforms would shift the burden of taxation from international trade to domestic transactions, and from production to consumption. IR commodity taxation, the existing system of import duties, levies, surtaxes and excise taxes would progressively be replaced with a flat basic tax rate on all imports and domestically manufactured goods, to be collected at the point of import or efActory. Exports would be exempt under this system. The system of exempting registered firms from payment of surtax on inputs would be replaced with a surtax credit system, whereby taxes paid on inputs would be credited against payment of taxes on outputs. In addition to the basic tax, excise taxes would be imposed on selected groups of commodities consumed primarily by high-income groups. There would also be a shift from sodfic to ad.alorem rates. The Government's tax-free status would be eliminated. JA Orte income taxation, a current payment system would be instituted, replacing the existing system that allowed corporations to pay taxes with a one-year lag. Also, a single 40% expensing provision would be implemented to replace the current investment allowances. Finally, In-.a administration, a taxpayer identification system would be instituted, a tax analysis unit would be formed, and training and technical assistance would be provided. The tax reform program did not envisage rate increases, but it was expected to generate an additional revenue equivalent to 0.1% of GDP (PR, para. 36). 2.09 The Government, as a condition for Board presentation, introduced a number of tax reforms: the surtax credit system, ad valorem rates, the current payment system for corporate income tax, the single expensing provision, and the taxpayer identification system; consolidated the import duty and levy; expanded the excise tax base; and established a tax analysis unit. During the operation under review, inter Iia, the Government would move to a tax-inclusive budget and eliminate its duty-free status (condition for release of second tranche); include interest earned in taxable corporate income; and merge excise and surtax into a single tax (para. 2.08). Technical assistance to support Government's tax reform program was provided under the Institutional Development Project, approved in January 1988 (PR, para. 37; Attachment 3). EXo Promotion 2.10 The Government and the Bank appreciated that the sustainability of the trade reform program in the medium term depended on Malawi's ability to generate additional foreign exchange through export growth. Interim balance of payments financing would provide essential external resources to support initial trade liberalization efforts and increase the availability of inputs. But the fture growth of the economy rested on the expansion and diversification of Malawl's export base. Accordingly, the Government adopted a strategy to enhance the international competitiveness of Malawi's exports, and develop new areas of non-traditional exports. A flexible A n -17- WdiIg would be pursued to enhance the profitability of exports, and steps would be taken to amWls the anti-exnort bias of the incentive system. The opening of the Northern Corridor' and the Nacala route would rduce tranort cost. Government intervention in the export trade would be reduced. am new _ivabsctor initiatives would be encouraged. As a condition of Board presentation, the Government eliminat exr licensinag requirements on cement and scrap metal, and set up the legal and administrative framework for an exo revolving fund to ensure access to foreign exchange by eligible exporters. Finally, since the current import duty drawback system had proved cumbersome, difficult to operate and ineffective, as a condition for the release of the second tranche, the Government would simplify the drawback scheme by eliminating physical content requirement, expanding eligibility criteria, and providing a uniform rebate rate by sector of production. Also, as a condition for the release of the second tranche, the Government would introduce a taemptin feport rduction (PR, paras. 38-40; Attachment 3). Price Decontrol and Industrial Licensing 2.11 In early 1988, price controls extended to five politically sensitive goods: low-grade meat, fertilizer, fuel, sugar, and vehicle spare parts. To the end of expanding the role of the market mechanism, and as a condition for Board presentation, the Government decontrolled prices on low- grade meat, and undertook to adjust the price of petroleum products periodically to reflect fully import and distribution costs. The Government would undertake a comprehensive study of the social, financial and economic impact of price decontrol. The study would examine enterprise pricing behavior in the decontrolled environment, the impact of price changes on the low income groups, and the relation of price changes to changes in protection implicit in the foreign exchange allocation system. Further revisions of price controls would be undertaken once the study was completed. Also, as a condition of Board presentation, the Government eliminated the exclusive monopoly rights clause (see para. 1.06), thereby strengthening domestic competition by removing a potential barrier to entry and a deterrent to new investment (PR, paras. 43, 44; Attachment 3). Promotion of Small-Medium Scale Industries 2.12 The Government committed itself, albeit no conditions or a timetable were set, to strengthen the resource base and institutional arrangements pertaining to this segment of industry. Specifically, the Government undertook to provide additional training at SEDOM, INDEFUND, and the Malawian Entrepreneurs Development Institute (MEDI); expand the pool of funds available for debt and equity financing at SEDOM and INDEFUND; develop a credit guarantee scheme, managed and operated by SEDOM, to make institutional credit accessible to small-scale entrepreneurs; and commission studies to improve the institutional and regulatory framework. USAID and the Commission of the European Community had already extended both lines of credit and technical assistance to MEDI, SEDOM, and INDEFUND. The operation under review would reinforce their initiatives by funding technical assistance to develop the credit guarantee scheme (PR, paras. 45, 46; Attachment 3). W Supported by the Bank's Northern Transport Coridor Project, approved in 1988. - 18 - Financial Sector Policies 2.13 In the financial sector, inter alia, the reform focused on liberalizing the financial markets; introducing market-Lased instruments for monetary policy management as a means of enhancing the sector's efficiency in rsource mobilization and allocation; strengthening the financial system's legal framework and prudentrl regulation of the financial institutions; and making credit more accessible to small-medium scale iMdustry. In particular, and as a condition for the release of the second tranche, the Government %uld revise the RBM Act to empower the Central Bank to supervise and regulate more effectively the commercial banks and non-bank financial institutions, and would amend the Banking Act to update guidelines and requirements for capital adequacy, bad debt provisions, interest accruals on non-performing assets, etc. Also, the Government would conduct studies to devise ways to improve resource mobilization, including the establishment of venture capital funds, unit trusts, and equity markets (PR, paras. 47, 48; Attachment 3). Expected Outme Economic Impc 2.14 The industrial and trade policy reforms would raise the rate of real GDP growth from about 1.5% in 1987 to 4% by 1991; reduce the fiscal deficit from 10% to 6% of GDP; and decelerate the annual rate of inflation from 26% to 5%. But the current account deficit would rise from 4% to 11% of GDP, largely to allow for a higher level of imports to improve capacity utilization and support a higher level of investment. The resource gap would be financed with a higher proportion of grants and concessionary loans (Attachment 14). The resource transfer under this operation, including co-financing, will support an import volume growth of 12% per year during the program period. This increased resource availability would permit gross investment to increase from 12% in 1987 to 18% of GDP in 1991, while private sector investment would increase from 6% to 10% of GDP. Although the bulk of this increased investment would be financed by foreign savings, national savings would continue to finance approximately one-third of gross investment. Furthermore, the policy reform program would reduce protection arising from the prevailing trade restrictions and foreign exchange rate rationing, would bring domestic prices closer to world prices, and would encourage the transfer of resources to more efficient industrial activities. SocialIp 2.15 The Government's goal was to ensure growth with equity over the longer term, to be achieved through increased participation of the poor in the process of economic development, given that the adoption rate of improved farming technologies, enrollment in primary and secondary schools, and the opportunities for off-farm employment remained limited. The operation under review would support human resource development and poverty alleviation by increasing access to employment opportunities. Provision of foreign exchange for imports and liberalization of the policy environment would support an annual GDP growth of 3.3% in the 1988-1990 period. As capacity utilization increased, there would be corresponding growth in formal sector employment. Also, improvement in efficiency and productivity will permit real wages to rise in the medium-term, after a 20% decline between 1980 and 1985. Significant short-term dislocations in employment because of firm closures were not expected. Industrial sector efficiency was thought to be relatively high, and most firms were expected to adjust to renewed competition from imports with little change in -19- factors of production. Labor dislocations resulting from elimination of product lines would be alleviated by labor reallocation towards efficient and expanding product lines. In addition to expanding employment In larger industrial enterprises, the program also targeted expansion of the small-scale and informal sectors (PR, paras. 62, 63). 2.16 While the operation would improve access to employment opportunities in the medium term, it could have two adverse social effects in the short term. First, prce changes resulting from exchange rate movements may adversely affect consumer purchasing power, particularly among the low-income urban population. In the medium term, however, the upward pressure on prices would be offset by reduced costs and additional supply availability as capacity utilization increased; by increased availability of imports, initially from higher aid flows and subsequetitly from stronger export performance; and by increased competition in the market place, arising from the redaction in effective protection and greater outward orientation of the economy. Also, the fiscal and monetary restraint envisaged under the operation would check inflationary pressures (PR, para. 64). Second, it was recognized that epnditure cs required to meet the fiscal deficit targets might result in a reduction in the scope of social services. Reducing the public sector deficit to a sustainable level would necessitate difficult choices on the composition of expenditures, and the Government might be forced to make cuts in real terms in the social sectors as well. To ensure that essential social services were maintained, the Government proposed to increase the relative share of social services in the budget (PR, para. 65). m. IMPLEMNAIN AND-OUCO A. Trade Poliev Reform Imot and Foreln Exchange Controls 3.01 The i M erization roa was implemented in phases, beginning with raw materials, extending to intermediate goods and, finally, encompassing consumer goods. However, during the second phase the Government allowed a much greater volume of consumer goods imports (largely non-essential) than originally agreed (para. 205). The process was completed in January 1990, on schedule. All imports, except those included in a narrow negative list, do not require prior foreign exchange approval. Following the implementation of the final phase, some 98% of non- petroleum products are imported freely. The import liberalization program has helped increase capacity utilization; improve efficiency by eliminating uneconomic product lines, expanding profitable ones, or adjusting production to meet consumer preferences (e.g., lower quality and cheaper articles); foster competition and price reductions, and thereby curb inflation; and stimulate economic activity. -20- 3.02 Although protection levels remain high (para. 3.06), competition from imports, reinforced by evasion of import duties and surtaxes,ul unfair trade practices (e.g., subsidization of exports by trading partners, dumping,29 smuggling) and diversion of imported articles by manufacturers at rebated rates for own use to the open market, has affected adversely particular industrial subsectors and enterprises (e.g., textiles), and has prompted the Government to adjust surtax rates, or even ban imports, to shield affected enterprises whose viability was threatened. The Government appreciates that, in designing the trade reform program, pressure from competing imports to ensure efficiency of the existing industrial concerns needs to be balanced with transitional measures to prevent shutting down viable activities. However, provision of any assistance to enable affected enterprises to restructure will be explicit, temporary and transparent, and would exclude QRs. The procedure would inclule the following steps: submission of a detailed and well documented proposal to the Government by affected firm(s), thorough Government review of the claim and impact, and consultation with the Bank prior to granting any transitional relief. 3.03 The Government is reviewing the effect of massive imports of seconds and used clothing on the textile sector, and is expected to adopt a set of policies which will ensure continued access of low-income consumers to affordable clothing while stimulating small-scale tailoring activity and garment production. Significant progress has already been made in eliminating import and export licensing requirements. Apparently, licensing and a temporary ban on imports of used clothing are not enforced for small importers, and sizable quantities are available for low-income groups in both rural and urban areas. Given the complexity of the used clothing issue and its inter-relationship with small-scale tailoring and other domestic production, the Government will address the issue in the context of its broader review of the textile sector. 3.04 Currently, some 50% of Malawi's imports pass through bonded warehouses, and the increased level of activity and dispersion of operations have rendered monitoring less effective. Therefore, steps need to be taken to strengthen the monitoring of goods into and out of bonded warehouses; reduce the storage period with the option of extension; restrict the eligibility for in-bond warehousing to goods that can be easily identified (e.g., by brand names, serial numbers); and reconsider the eligibility of certain luxury items (e.g., perfume, toiletries) for in-bond storage. The basis for tariff valuation also could be adjusted to take into account intervening devaluations while in bond storage. Reportedly, goods are withdrawn from bonded warehouses before proper customs valuation. Computerization should facilitate the monitoring of bondee warehouse operations, while the suggested measures could also raise revenues and free working capital. Similarly, the da drawback systemn is not functioning efficiently, and the Government did not fulfill its commitment to improve the system (par. 2.10). Long delays in reimbursement are not uncommon. The incentive to evade payment of import duties and taxes is high because their level is high (output tariff is 45%, surtax rates escalate up to 75%); tariff classification is complex; detection of falsified customs declarations about the quantity, quality, and price of the imported goods is very difficult; and enforcement by customs officials is not always strict. LO Malawi has an anti-dumping facility in place. But, it has not been utilized, apparently because it is difficult to implement. Aside from difficulties in establishing that dumping is indeed occurring, there are problems regarding the way the affected industry should be compensated (e.g., by impounding the imported goods until a decision is reached, requiring the importer to post a bond); impounding of imports results in disruption of trade and claims of demurrage and interest; the process is time consuming and requires financial and scarce skilled human resources. Nonetheless, In instances where dumping is clearly and seriously damaging the domestic industry, the Government may have to take action. -21- Furthermore, rebates are not uniform, and are applicable only to physically identifiable Inputs incorporated into the end product. This excludes such inputs as packaging materials or fuel. The utilization of the scheme by eligible exporters could be enhanced through further streamlining of procedures and expansion of eligibility criteria. 3.05 In line with a flexible exchange rate poliev to maintain competitiveness, the authorities devalued the kwacha six times against a trade-weighted basket of currencies during 1984-88, resulting in a 42% nominal and 12% real depreciation. The currency was further devalued by 7% in March 1990, 13% in March 1992, and another 22% in June 1992. The real effective exchange rate depreciated during 1986-88, but began appreciating since then, and by 1992 had reached the 1985 level (Attachment 1). The Government remains committed to maintaining a realistic exchange rate, consistent with a level of modest protection of import competing industries. To this end, it monitors closely the exchange rate, and is making appropriate adjustments in line with trade liberalization objectives and other external developments. Nevertheless, in mid-1992, the Central Bank was unable to provide foreign exchange for three weeks, and presently exchange allocations are "prioritized" while payments are being delayed by one to two months. Predictably, this undermined the confidence of the business community in the sustainability of the exchange regime, affected adversely industrial investment activity, and fueled speculation about an impending major devaluation.211 Rationalization of Tariffs and Tax Structures 3.06 As part of a comprehensive tax reform program (paras. 3.30-3.33), the Government reduced protection by merging part of the import tax with the domestic surtax in 1988/89, and by extending the 35% surtax to domestically produced goods. The remaining import duty rates were rationalized, with a maximum rate of 45% and a minimum ate of 10% on raw materials and capital goods, and certain zero rated items. However, customs duties on industrial inputs can be rebated subject to approval by the Minister of Finance, and this increases the effective protection implied by the range of statutory tariff rates. In addition, the surtax system has been used to increase protection to industries which either had not had time to adjust to the competition provided by the relaxation of import licensing or could not otherwise compete. Even after the 5% reduction of top rates in 1992, surtax rate differentials amounting to 20-70 percentage points have been maintained between imports and domestically produced goods. The surtax rate differentials (surtax suspension) - applicable to goods representing nearly half of Malawi's manufacturing value added - is equivalent to an additional tariff rate of 20% to 70%. Thus, while the reform in 1988/89 decreased dispersion and brought down nominal protection, the combination of statutory tariff rates, industrial rebates, and domestic surtax suspension results in levels of effective protection exceeding several hundred percent in a number of economically and/or politically sensitive industries, and an average level of 190%. Moreover, industries have benefitted quite differently from the manipulation of the surtax suspension and the industrial rebates, the dispersion of protection has increased, and the amount of protection provided has become less transparent (see Attachments 15, 16).2 ILI The business community views this reversal by tbs authorities as a broken promise and as backing out of a pact. It certainly affected the credibility of the Government, the Central Bank and the country domestically and abroad. W This method of providingadditionalprotectionwas chosen (a) to avoid reversing recentpolicy decisions to eliminate import controls and rationalize the tariff structure; and (b) because changes in import duty and srtax rates (as distinct from suspension) required legislation, which was both time consuming and not easy to pas. -22- 3.07 To be consistent with the external balance objective of encouraging competitive, export- oriented, and labor-intensive activities, the Government plans to reduce both the level and dispersion of protection.2' Based on comprehensive study of trade taxation and protection, the Government is formulating a detailed phased program. The objectives, time frame and quantitative targets of the tariff and trade tax reform program were laid out in the context of the FY93 budget presentation. The target, to be reached within a period of four years to enable enterprises make the necessary adjustments, is a cascaded Import tariff structure with a maximum rate of 35% and a minimum of 10%, except for a short list of tariff-exempted goods such as medical supplies. The average tariff collection rate would not exceed 15% of non-government imports. The Government will eliminate the industrial rebate option and will significantly reduce protection by the end of FY96. In the interim, the Industrial rebate option will be granted selectively. 3.08 Specific measures are being taken in the FY93 and FY94 budgets. Measures announced for the FY93 budget include elimination of the surtax exemption for domestically produced goods; consolidation of the protective effect of the domestic surtax exemption into the existing tariff structure; and limiting the consolidated tariff rates to a maximum of 75%, down from 125% in certain instances.2' With the 1993/94 budget, the Government is expected to reduce the maximum rate to 40%, and 45% for commodities affected by the consolidation of the surtax suspension. The Government should also consider abolishing the exemption of parastatals from import duties and surtax rebates, since there is no economic basis for such a preferential treatment. 3.09 Under the ongoing tax reform program, the Government is implementing in the FY93 budget appropriate measures to strengthen customs administration, enforce tariff compliance, and increase customs revenues. A study on pre-shipment Inspection has been conducted and, based on its recommendations, the Government extended pre-shipment inspection to all imports should the study so recommend. B. Initiatives Fostering Private Sector DeloMe Investment and Expocnv 3.10 A major constraint to industrial investment has been the Indecisiveness and procrastina- tion by a string of government authorities involved in investment approvals. First, applications for the incorporation and registration of companies were submitted to the Office of the Registrar General, and referred to the Ministry of Trade and Industry (MTI) and the Inspector General of Police. MTI made further referrals. The long chain of Institutional (regulatory and procedural) responsibilities resulted in undue processing delays. Second, MTI was also given the mandate to issue Industrial Licenses and to consult with other agencies prior to approval. Considerable delays ranging from 6 months up to 4 years have been experienced in decision-making, whether involving approval or rejection - despite the fact that virtually all applications have been approved in recent years. Third, land transfer procedures for leasing of industrial and commercial land also involved delays, with the Department of Lands and Valuation (DOLV) submitting all applications for U' Incidentally, the time to reduce tariff rates and rationaize trade taxation is now propitious since exchange controls have largely been abolished. 2W Conditions for Board presenation of the Bank's Entrepreneurehip Development and Drought Recovery Program, PR No. 5461, June 1, 1992, approved on June 23, 1992. - 23 - Industrial use to MTI. In addition, there is an acute shortage of serviced Industrial and commercial plots. DOLV was required to develop estates before leasing, even though it is not equipped to do so in a timely manner. The private sector was not allowed to sublease, further inhibiting private developers. 3.11 In fostering private sector development, the adjustment operation under review initiated important first steps in the elimination of government interference in the process of investment by the private sector through a policy package supported by critical legislative, regulatory and procedural changes. Aside from such measures as removal of price controls. reduction in the scone of.iMnW (para. 3.01) and.expor (para. 2.10) Jicsing, a far-reaching reform was the elimination of the requirement for industrial licensing, with the exception of a short negative list of environmentally hazardous activities, through the Industrial Licensing Act of 1991. In addition, as contained in the Investment Promotion Act (No. 28 of 1991), the Government revised and sinlifted the incorporation and registration of companies into one step, by requiring the supply of basic information on proposed business activities to the Registrar of Companies, eliminating the approval by MTI and the Police. 3.12 Major steps were also taken to facilitate the acquisition of land for investment In new activities. First, the Government has streamlined the land lee apal prcess. The Investment Promotion Act requires DOLV to issue leases and consent to lease transfers and subleases within 90 days of the date of application. The procedure of submitting industrial and commercial applications to MTI is no longer applicable following legislative changes with regard to industrial licensing. Second, the Investment Promotion Act enables DOLV to lease without servicing, which will increase the availability of plots. Third, the Investment Promotion Act permits the private sector to lease large tracts of land for development of industrial, commercial, and residential estates. Leases to private developers will be for 105 years, which is long enough to permit development to take place within a reasonable period of time and offer subleases of the standard 99 years (see also para. 3.17). 3.13 To establish a focal point for Government-private sector dialogue, provide one-to assistance to investors, and give a clear signal of its commitment to facilitating investment, the Government established the Malawi Investment Promotion Agency (MIPA) under the Investment Promotion Act.2y Its powers are broad, including authority to investigate and solve any problems that may arise during the investment process. The General Manager of MIPA was appointed in February 1993, and a fully staffed functioning administrative unit is now in place. MIPA's active involvement in close cooperation with the private sector in supporting market analyses, opening up new markets, and developing new export products would enhance considerably Its credibility and impact. 3.14 In addition to the gradual reduction of the corporate income tax from 50% up to 1990/91 to 35% in 1992/93, the Investment Promotion Act provides a comprehensive package of inentiles for new inmnts= which includes: 40% investment allowance on qualifying expenditures for new buildings and machinery, and an additional 15% allowance for investment in designated areas of the country; up to 20% investment allon.ance on qualifying expenditures for used buildings and U/ The Bank's Financial Sector and Bnterprise Development Project (PR No. 5412, February 25, 1991, approved on March 26, 1991) provides for consultancy services to MIPA. -24 - machinery; a 50% allowance for qualifying training costs; deduction of all operating expenses incurred up to 18 months prior to start-up of operation; indefinite loss carry forward; avoidance of double taxation; reduction of withholding taxes on remittances and payments; deferred duties on ma-hinery and equipment for up to 2 years; full rebate of duties on heavy commercial vehicles; and free vocational training for company employees at national training centers. 3.15 Additional incentives are offered to enoua o. For e r sLoaeinExpr sing Zons, the Act provides for a corporate tax rate of 15%; no withholding tax on dividends; no duty on capital equipment and raw materials; no excise taxes on purchases of raw and packaging materials made in Malawi; no surtaxes (value added tax); and a transport tax allowance in the amount of 25% of international transport costs. For all other exporters. including manufacturing in bnd, the Act provides for an export tax allowance in the amount of 12% of export revenues for non-traditional exports; a transport tax allowance in the amount of 25% of international transport costs, excluding traditional exports; no duties on imports of capital equipment used mainly in the manufacture of exports for those manufacturing in bond; no surtaxes (value added tax); no excise taxes on purchases of raw materials and packaging materials made in Malawi for those manufacturing in bond; timely refund of all duties on imports of raw materials and packaging materials used in the production of exports (duty drawback); duty free importation of raw materials and packaging materials for those manufacturing in bond. Finally, investors have free access to foreign exchange for the remittance of dividends, repatriation of investment capital, interest and principal payments for approved international loans, and approved fees for management, licenses, royalties and similar obligations; work permits for expatriate labor are routinely granted where foreign expertise is needed; and two-thirds of after tax expatriate salaries are remittable. 3.16 The Bank's Entrepreneurship Development operation, approved in 1992,W proposes a set of specific policy reforms to remove remaining constraints inhibiting private sector entrepreneurship and initiative. To create an enabling environment for private sector entrepreneurs to respond and invest in physical capital, the program includes regulatory, administrative and policy measures to encourage investment by both small- and large-scale enterprises, and extend trade reform to ensure an outward orientation of the private sector response. To promote access to financial capital for new clients and activities, the program focuses on increasing financial sector competition, including introduction of market-oriented monetary control instruments and open entry of new domestic and foreign institutions into banking activities. To broaden access to human capital and expand employment opportunities, the program includes the reorientation of public expenditures in favor of human capital combined with measures to improve the functioning of labor markets. Promotion of Small-Medium Scale Industry (SMI) 3.17 Although their focus is primarily on larger undertakings, the recent regulatory and procedural changes (paras. 3.11-3.15) should help mitigate some of the constraints inhibiting the growth of the SMI sector as well. To alleviate some of the impediments to SMI development (para. 1.29), the Government modified the zoning and land use policies in the revised Town and Country Planing Act which came into force in 1991. The Government plans to expand business space within traditional housing areas and in high-density modern residential developments, and M' PR No. 5461, Majai - &=WWgft Den-lomat and RMIffM Rwmw" ftmmm June 1, 1992. -25- apply more flexible standards to allow for small commercial and industrial plots in certain estate developments.N/ 3.18 Credit to SMI by INDEBANK, INDEFUND, SEDOM, the Leasing and Finance Company of Malawi, Ltd. (LFC) and the National Mercantile Credit (NMC) has increased in real terms during 1988-91, albeit lending to manufacturing by these Institutions varies between 20% and 35% of total (Attachments 17, 19, 22, 25, 26). Of these financial institutions, INDEBANK, LFC and NMC are In the forefront. Expansion of lending by these mature and in good standing institutionsw (Attachments 18, 20, 21, 23, 24) is constrained by availability of resources, largely provided by the donor community. Most of these institutions, which finance only indigenous entrepreneurs, have had limited access to official sources of financing - domestic or foreign. Inability of the borrowers to meet credit appraisal standards and comply with equity, collateral, project viability, and project preparation requirements have been additional constraints to financing. Also, in 1987 and 1988, lending rates were negative in real terms and, as a result, they did not reflect the inherent high cost and risk of lending to this sector. Since 1989, as inflation rates abated and rates were increased, interest rates became positive in real terms. The recent move towards a more market-oriented interest rate policy that reflects the operating cost and risk of lending to the SMI sector should alleviate this constraint. The Malawi Union of Savings and Credit Cooperatives, Ltd. (MUSCCO), a cooperative lending institution, has had a very small impact heretofore. On the other hand, the two commercial banks (CBM and NBM) have not been significant credit sources for SMI, because traditionally they have catered to the needs of larger and relatively risk-free enterprises. 3.19 A 1992 survey of micro, small and medium-sized enterprises has highlighted the following: micro-enterprises comprise the bulk of the sector - 97% in number; there was measurable growth in the sector during 1988-91 both through expansion of existing firms and new entry; some 200,000 new jobs were created in the past decade, mostly in micro-enterprises, with an annual employment growth of 10.5% (16% in urban areas); of the proprietors, 94% had only primary education, 92% received no technical training, 86% started the business by drawing on personal and/or family savings, and only 1.2% (3.2% for enterprises employing 5 or more workers) received credit from a financial institution. Most frequently reported constraints included input, market and financing problems, and less so regulatory constraints, transport costs, and the high cost of tools/equipment (for details see Attachment 27). These findings, reinforcing observations by earlier studies (para. 1.29),2' suggest that access to credit, a narrow demand base, limited linkages to larger firms and markets, and technical assistance remain major constraining factors to SMI's development. ' pj., par. 89. 3' Except SEDOM, which has a high percentage of loans in arrears (38%), has run out of fbads, is not self.mustained, and needs to be strengthened. INDEFUND is also experiencing difficulties as reflected in low collection rates and high provisions for bad debts. For a description of the financial institutions serving industry, including the SMI sector, see World Bank Staff Appraisal Report No. 9096, Malawi - Financial Sector and Enterrise Development gitA,February 25, 1991; and World Bank Report No. 9009, Mawi - Financial Policie foA SthainablbOrowth. February 19, 1992. ' See also C. Prischtak, Adiustment and Constrained Response: Malawi at the Threshold of S1taind rowth. Industry Series Paper No. 41, October 1990. -26- 3.20 Facilitating investment in the SMI sector is critical to generating a broad-based and labor- intensive supply response, a more functionally integrated industrial base (paras. 4.03-4.08), and an improved income distribution. In this regard, it is noteworthy that, while the stated policy is to encourage domestic procurement, the Government uses unnecessarily stringent quality standards and cumbersome mechanisms of procurement preference for local producers. In addition, the exemption of government agencies from taxation, including trade taxes, eliminates the protection that domestic producers would otherwise enjoy. The Government has initiated a review of its procurement policies, practices and procedures, including evaluation of the option for duty-drawback and rebate of surtax on local purchases by government and international agencies. Action on this front could stimulate local production and investment by SMI. 3.21 A variety of donor-subsidized institutions provide training and technical assistance to SMIs. They include the Development of Malawian Traders Trust (DEMATT), the Malawi Entrepreneurs Development Institute (MEDI), and the Women's World Banking of Malawi (WWB). These are relatively new institutions and their performance has yet to yield tangible results. Management talent is relatively scarce, and this hinders their ability to deliver effectively technical assistance. The newly established Malawi Institution of Management (MIM) is a resource that could be utilized more fully to sharpen managerial skills. On the other hand, the SSI Unit of the MTI currently does not have the capacity to undertake a leadership role and coordinate donor support to these institutions. 3.22 Clearly, both demand and supply constraints hamper the growth of SMI, and these constraints are real. Nonetheless, putting in place a strategy for the long-term development of SMI (paras. 4.03-4.10), and taking steps to foster the growth of efficient and dynamic SMIs, would have a high payoff. In this regard, skill formation is essential in raising industrial productivity and developing a competitive labor force. Yet, the quality of primary and secondary education is poor, while skills training programs need upgrading. It is encouraging that wage differentials in private industry are quite wide and provide an adequate Incentive for productivity enhancing skill acquisition. For example, the wage differential between the bottom operative grade and top craft grade in the textile industry is about 1:7.5. Moreover, measures to strengthen the ability of smaller firms to link up with larger firms as suppliers or subcontractors, and facilitate their integration with larger market and trading networks, would reinforce the process. Such links can be forged, Jnt=r aia, by removing supply constraints and by ostracizing ethnic discrimination against Malawian Asians, as discussed in paras. 1.29 and 4.09. Finally, establishment of pre- and post-shipment financing facilities and an export credit guarantee scheme could provide a stimulus to SMI exports.w C. Financial Str Reforms 3.23 Financial sector restructuring and liberalization are often a prerequisite for effective supply and investment response and efficient operation of industry. In Malawi, major constraints to domestic resource mobilization and more efficient financial resource allocation to support structural change have been the absence of a market-oriented monetary control system and lack of competition in the banking sector. £' On the methods and mechanisms of trade financg, se World Bank, Trade Fance la Develoina Countries Policy and Research Series No. 5, 1989. -27- 3.24 The flaws of the financial system were summarized in paraL 1.11-1.13. Suffice to emphasize at this juncture that, until recently, monetary policy focused on direct control of credit and monetary aggregates and the use of private sector credit ceilings. In the early 1980s, and again in the mid-1980s, lax fiscal policies resulted In excessive domestic borrowing by the Government, including bank financing. Credit requirements of non-financial public enterprises exacerbated the situation. This resulted in the crowding-out of private sector access to credit and excess credit demand. In FY89-FY90, fiscal control was restored and resulted in negative net domestic credit financing of the Government. Nonetheless, the monetary authorities continued to maintain strict private sector credit ceilings, albeit with large increases. These credit controls have had detrimental effects. First, competition was undermined as individual bank credit ceilings were based on acquired market shares. Second, existing patterns of credit flows were maintained because commercial banks almost exclusively lent to established clients rather than new ventures. Third, ceilings entailed rationing of credit by arbitrary administrative means rather than allocation according to returns on investment. Fourth, with a lack of alternative remunerative outlets for investing excess liquidity, financial institutions were discouraged from mobilizing additional savings. 3.25 Complying with the conditionality of the operatio under review (para. 2.13), the monetary authorities have moved towards an indirect, market >riented monetary control system. The revised Reserve Bank of Malawi Act in April 1989 (Ac No. 8) expanded the operations in which the Central Bank can engage, and set limits on the total amount of outstanding advances to the Government at any moment. Reserve requirements were introduced in June 1989. They were changed several times since their inception, and the ratio currently stands at 15% (Attachment 28). Also, the Reserve Bank's rediscounting facilities were redesigned to facilitate their use in monetary control. A Capital Market Development Act was promulgated in April 1990 (Act No. 17), completing the legal framework for the introduction of market-based instruments of monetary control. In April 1992, stamp duties on the issuance and transactions of financial instruments were eliminated. A Capital Market Department was established at the Reserve Bank, and several staff have undergone training since. Auctions of Reserve Bank paper take place periodically. This, combined with reserve requirements and other monetary control instruments, made possible the elimination of direct credit controls in FY91. 3.26 Although formally liberalized in 1988, commercial bank interest rates were directed informally by the Reserve Bank until May 1990. Since that date, commercial banks adjust their interest rate structures unilaterally. Dialogue among the banks and Reserve Bank continues, but discussion of rates is indicative. Banks now have freedom to determine their Interest rate structure, in line with the cost of borrowing and risk of lending. Following the abatement of inflation, deposit and lending rates turned from negative to positive in 1990 and 1991. However, rates became substantially negative in 1992 as inflation accelerated, despite their upward adjustment (Attach- ments 29, 30). 3.27 A distinct feature of the financial system has been market segmentation and fragmenta- tion, with specialized institutions operating in market niches. The bulk of commercial banking operations is conducted by the two large domestically owned commercial banks, except for a small foreign minority share in one of the banks. High ct!centration = u has been an important factor in restraining competition. However, competition has been curbed farther by two additional factors. First, conservatism, partly in response to the financial difficulties of the early 1980s, deterred the commercial banks from moving into new areas, or broadening their clientele - it is less risky to -28- conduct business with entrenched compared to new and untested customers. Second, credit controls worked against bank competition. Without competitive pressure on profitability, the banking system had been slow in reaching out to new clients or new lines of business. 3.28 To foster competition, the Banking Act was revised in December 1989 (Act No. 19), with a view to establishing a regulatory framework conducive to greater competition and improved prudential supervision. Conditions of entry into the banking sector, and directives pertaining to solvency, liquidity and sound operating practices have been laid down. Recently, other non-bank financial intermediaries, particularly LFC, have started competing for commercial bank deposits and, to a limited extent, for lending business. This has prompted the commercial banks to diversify their banking activities, which is suggestive of the potential for financial deepening that can result from increased competition. 3.29 Historically, commercial banks have been minimally involved in term financing. NBM's involvement in term lending has been nominal, as its management feels that traditionally commercial banks are not expected to lend long term. However, CBM began lending medium term since 1987 and, by 1992, 30% of its portfolio included term financing (Attachment 31). In 1991, CBM launched CBM Commercial Services Ltd., a joint venture which is engaged in leasing activities. In essence, inter-bank competition is reflected mainly in the quality of bank services and the terms of lending. Also, in 1991, INDEBANK established a banking division which, understandably, at this juncture offers relatively limited services. Expectations are that eventually the division will become either a wholly owned subsidiary of INDEBANK, or an independent entity. But it will take some time for this division to offer effective competition to the existing banks. POSB, which has an extensive branch network and a large volume of deposits, is currently undergoing organizational restructuring, inter ali., involving legal separation from the Fst Office and improvement of information systems and procedures. It is expected that it will be in a position to operate as a full- fledged bank, and be empowered to expand the use of its funds to include financial instruments other than locally registered stock. To promote access to financial capital, the Bank's Entrepreneurship Development operation is supporting further measures to increase competition in the financial sector, including the introduction of market-oriented monetary control instruments into banking activities. D. Tax Reforms 3.30 The comprehensive tax reform program, designed under SAL WH and supported by the operation under review (par. 2.08), has made significant progress in expanding the tax base. A surtax credit system which is similar to a VAT was introduced in FY90, with a base surtax rate of 35% and additional luxury surtax rates of 55%, 85% and 100%. Also, excise taxes were shifted from a gdiflc to an ad valorem basis in FY88-FY89. Other major steps were the introduction of a current payments system for business income tax in FY89, the extension of taxation to fringe Baned on analytical work done under the Industrial and Trade Policy Adjustment Program. For details see C. Chamley, R. Conrad, Z. Shalizi, J. Skinner, L Squire, Tax Policy fo Mwi. 1985, 2 vols.; Z. Shalizi and W. Thirsk, *Tax Reform in Malawi, in J. KhalWivdeh-Shirazi and A. Shah (Eds.); Ia Polieyi eloing Countries. A World Bank Symposium, 1991, pp. 23-37; Z. Shalin and L Squire, "Tax Policy in Sub- Saharan Africa, Poliev & Research Series 2 1988; Z. Shalizi and W. Thirsk, Tax Reform In Malawi PRE Working Paper No. 493, August 1990. -29- benefits in FY91, and the lowering of the corporate income tax rate in FY90 from 50% to 35% in FY93 without jeopardizing the revenue base. Also, in FY91, the marginal personal income tax rate was reduced from 45% to 40%, and the mortgage interest deductibility for personal income tax purposes, which favors those in high-income brackets, was eliminated. In FY92 the Government combined a reduction in the base surtax rate from 35% to 30% with a widening of the base, expanding the coverage to electricity, telephone and certain other services. In the FY94 budget, the Government will increase the surtax rate on those services to at least 10% and consider the expansion of the surtax to additional services. Furthermore, a capital gains tax was introduced, the dividend income imputation system was replaced by a dividend tax account system to eliminate taxation of inter-firm dividends, and capital losses became deductible subject to certain limitations (Act No. 7 of April 24, 1992). 3.31 Tax revenues as a percent of GDP increased from 21.2% in FY87 to 22.7% in FY90, but slipped to 18.7% in FY92, largely due to a decline in non-tax revenues from 4.4% to 2.5% of GDP. The share of the constituent elements of the tax revenue, i.e. corporate and personal income taxes and taxes on commodities and trade, remained fairly stable during FY87-FY92 (Attach- ments 32, 33). There has been a noticeable realignment of trade and domestic taxes, and a shift of the burden of taxation from international trade to domestic transactions. This should eliminate existing biases in investment decision-making on whether to produce for the local market or for exports. The expectation is that economic agents will opt for a more outward-oriented posture. The share of trade taxes fell from an average 20.5% of total revenue in FY83-FY86 to 15.8% in FY87- FY92; similarly, the share of commodity taxes rose from 30% to 33.2% during the same time span, suggesting a shift of the burden of taxation from production to consumption (Attachment 33). Both outcomes fulfill intended purposes (para. 2.08). 3.32 Corporate and personal income tax revenues doubled in FY89-FY92 compared to FY86-FY88. However, both taxes experienced virtually no growth as a percentage of total revenue in FY90-FY92, and their respective shares in GDP declined from 19.2% to 16.2% and 4.7% and 3.6% in FY90-FY92, despite the fact that real GDP has been rising steadily (Attachment 33). Their decline as a percent of total revenue may reflect under-reporting and lax tax administration. This tendency may have been reinforced by the acceleration of inflation, which causes the effective company tax rate to rise because the real value of depreciation allowances is being eroded, and because nominal capital gains from inventories are being included in the assessment of taxable company income. To some extent, this tendency may have been offset by the provision for asset revaluation following the devaluation of the kwacha. In the case of personal income taxes, inflation contributes to bracket creep under the pay as you earn (PAYE) system and emboldens tax evasion. 3.33 Elimination of the Government's tax-free status and the introduction of a tax-Inclusive budget, both conditions for the release of the second tranche, have been put off following numerous objections from several government departments. Apparently, the Government is not convinced about the benefits to be derived from the introduction of a tax-inclusive budget, or entertains the view that there are other ways to achieve the same results. Further changes in the tax system deserving Government consideration include: taxing small businesses on a presumptive basis to curb evasion, establishment of more realistic depreciation rates, abolition of the tax-exempt status of the POSB deposit interest which has attracted a significant number of corporate savers, and repeal of the tax-free status of deposits with NBS for owner-occupied housing. -30- E. Enaciofning Lr Marktis 3.34 To elicit investment response in labor-intensive activities and foster employment generation, stable and competitive labor market conditions are essential. In general, Government intervention in private sector employment conditions has been avoided. One important regulatory device in force for some time has been the statutory minimum wage, put in place to counteract the imperfectly functioning of labor markets, raise the efficiency of workers, address imbalances in bargaining power, and mitigate the skewed income distribution. The intention has been to set wages at levels where labor demand and, hence employment, was not adversely affected. However, adjustments of the minimum wage have been sporadic, and the last adjustment had occurred in May 1989. Following the unprecedented unrest in April and May 1992, the minimum wage was increased by 20% - well below the intervening increase in the consumer price index. 3.35 To rectify the situation, the Government revised the minimum wage legislation in April 24, 1992 (Act No. 1). The Act mandates a regular review process for setting the minimum wage, triggered by a cumulative change of 20% in the national price index since the last minimum wage adjustment and, at a minimum, every two years. The review would outline recommendations based on economic analysis of shifts in the appropriate real wage due to labor market conditions and relevant macroeconomic factors. During such reviews, the Government will ensure that consultations between employer and worker organizations have taken place, and will take action on any minimum wage adjustment called for by the review. The Government will also take steps to improve the functioning of the labor markets. Thus, during the review process, the Government will analyze the appropriateness of minimum wage policy in the face of labor market imperfections, distiaguishing between rural and urban areas since these two markets function quite differently. Also, the Government will evaluate options to improve the underlying functioning of labor markets, including measures to strengthen the bargaining and consultation process between employers and workers, improve information flows, and develop a competitive labor force. Based on the recommendations of this review, the Government will formulate an action plan for improving labor market policies. Given that the last revision was in 1989, steps to initiate the next review were taken with a view to adjusting minimum wage levels early in FY93. Implementation of the minimum wage adjustment called for by the review is a condition of second tranche release under the Entrepreneurship Development Program. 3.36 In 1992, increases in governing salaries (the first in some years) were limited initially to about 25% on average, although they were considerably higher for some workers. In the absence of established mechanisms for discussion and settlement, demonstrations and wildcat strikes ensued, leading to negotiations that resulted in further major wage hikes in the private and public sectors. In the end, the average rise in wages and salaries amounted to 68% in the civil service, to 50% or more in the rest of the public sector and in some key private sector enterprises, and to less than 50% elsewhere in the economy. The incident also signaled the emergence of labor-management bargaining as opposed to the traditional unilateral decisions by employers. Nevertheless, increases of this magnitude without a commensurate rise in productivity rekindled inflationary pressures, posed a threat to international competitiveness, and reduced employment in some industries. -31- F. Macroeconomic and Indutrial erfo anc Macroconomic Development 3.37 Real GDP growth resumed and expanded significantly between 1987 and 1991. From a low 2% in 1987 it increased to a remarkable 7.8% in 1991, exceeding the targeted average of 4% per annum by about 1%. Real per capita GDP growth followed a similar trend, reaching 4% in 1991 compared to a negative growth in 1987 and 1988. Per capita private consumption also showed small real gains during this period (Attachment 1). The high growth rate in agriculture, partly due to favorable weather conditions and partly due to the positive impact of structural changes in smallholder agriculture; the import liberalization program; and more stable financial conditions contributed to the recovery of the manufacturing, construction, services, and distribution sectors. Inflation decelerated sharply from the peak 34% in 1988 to an average of 12% in 1989-91 as a result of tight aggregate demand management. The improved performance in output, relative price stability, and access to imports led to a significant rise in gross domestic investment - from 15.4% to 19% of GDP. Stimulated by a growing demand and access to foreign exchange, real private sector investment more than doubled, and increased its share in GDP from 5.4% in 1987 to 9.2% in 1991, while the ratio of private to public investment rose from 42% to 50%. Gross domestic saving, however, hovered around 9% of GDP, suggesting substantial reliance on external resource transfers. Real manufacturing output grew at 5.8% annually, but its share In GDP increased marginally to 14%. 3.38 In 1992, the severe drought, labor unrest, and the shattering of business confidence due to the extreme shortage of foreign exchange and the ensued prioritization of exchange allocations (para. 3.05), combined to stall economic growth and dampen the rather euphoric investment climate. Real GDP fell by 8% in 1992, while real per capita GDP and consumption by 11% and 15%, respectively. Real fixed capital formation and private investment remained virtually unchanged, but domestic savings fell precipitously to 4% of GDP. Real manufacturing output virtually stagnated (Attachment 1). The outlook for 1993 though appears very good, with projected real growth of 11% due to record agricultural performance. 3.39 Despite the wide range of policy reforms, the successful implementation of specific measures, and the healthy economic growth during the past several years, the supply response has not been adequate to sustain balance of payments viability. In 1987-91 export growth (70%) has been much slower than import growth (118%), with little diversification out of the traditional agricultural exports, and limited development of the potential for manufactured exports. Exports of manufactures rose from US$20 million to US$30 million, while their share in total exports fell from 7% to 6%. The drought and the need for unprecedented levels of food imports exacerbated the situation. The cumulative result of these developments was that the current account deficit increased sharply - from 5% of GDP in 1987 to 11% in 1991, or from 2.5% to 7.5% if official transfers are included; it rose further to 12.2% in 1992. External outstanding debt rose from US$1.4 billion in 1987 to US$1.7 billion in 1991, and over US$1.8 billion in 1992 (Attachment 1). External debt service, even after reschedulings and debt relief, accounts for some 20% of exports of goods and services. This suggests that Malawi will continue to face balance of payments pressures in the next several years, and that foreign savings remain of critical importance for sustained economic growth. -32 - 3.40 The growth of money supply fell precipitously - from the peak 37% in 1987 to 11% in 1990; but it accelerated to 22% in 1992. This was achieved largely by the substantial reduction of the budget deficit from 10% in 1987 to 5% of GDP in 1991 (7% in 1992), and the consequent dramatic decline in net domestic borrowing from K 136 million in FY87 to K 2 million in FY93 (Attachments 1, 32, 34). Government revenues increased by 87% in absolute amount between FY87 and FY92, but their share in GDP fell from 21% to 18%, because of the ebbing economic activity and delays in the implementation of revenue measures. During the same period, expenditures increased by 128%, but their share in GDP dropped from 30% to 24%, resulting in a decline of the deficit from 13% to 5% of GDP (Attachments 33, 34). These developments suggest that the originally set targets were attained (para 2.06). However, in FY93, while government revenues are estimated to increase to 20% of GDP, expenditures would increase to 30% of GDP because of substantial increases in salaries, drought-related expenditures, and lax control over recurrent spending. As a result, the fiscal deficit would exceed 10% (6% including rants). Furthermore, a three-year rolling PSIP has been developed, and Is regularly submitted to the Bank for review. To facilitate the reorientation of the external aid programs in line with the Government's priorities, drafts of the PSIP are shared and discussed with individual donors in the course of their preparation, and final versions are taken up in Consultative Group meetings. 3.41 Net domestic credit increased nominally at 12% annually but declined in real terms during 1987-92. However, there have been significant shifts in the composition of credit in favor of the private sector. Net claims on the Central Government fell precipitously between 1987 and 1991, by 48%, albeit the trend reversed itself in 1992 when claims climbed back again almost to the peak of 1987. The pattern has been similar in terms of the source of funding, i.e., the monetary authorities and the commercial banks. Net claims on statutory bodies (parastatals) by monetary authorities remained at about the same level during this period, but there has been a significant decline in the claims of commercial banks. At the same time, there was a dramatic increase in private sector gross claims by commercial banks - from K 205 to K 810 million, or 32% per annum (Attachment 36). This implies a measurable increase in real terms, and a clear shift of short-term financial resources to the private sector - albeit about half of the credit has been loaned out to a handful of large borrowers. The institutional distribution of financial assets and advances is shown in Attachments 37 and 38. 3.42 Credit to manufacturing increased from K 25 million in 1987 to K 136 million in 1992, while its share in total lending from 12% to 16%, after a peak of 23% in 1990. More dramatic, however, was the increase in credit to wholesale and retail trade - from K 35 million to K 345 million, raising its share from 17% to 41% of total. On the other hand, the share of agriculture fell from 54% to 29% (Attachments 39, 40). This pattern, coupled with the high concentration of industrial short-term credit and the limited expansion of W=n facilities, underscores the need for additional financial resources and intermediaries to cater to the needs of the industrial sector, particularly of smaller enterprises. Industrial Erformnc 3.43 Private investment recovered during 1986-1991, rising from US$17 million to US$97 million. There has been no foreign direct investment during this period. Private investment aimed largely at rehabilitation of existing facilities, and was concentrated in traditional activities. Investment in non-traditional sectors responded positively to macroeconomic stability and increased - 33 - profitability, but the response was short of the levels required to usher In structural change (Attachment 1). The performance of Industrial exports has been erratic and unimpressive (para. 3.39). Malawi exporters of manufactured goods are experiencing difficulties in selling to neighboring countries because of import licensing in these countries, and this has not encouraged investment in export-related activities (para. 3.46). Also, the slow pace of tariff rationalization has not been helpful in reducing the anti-export bias. 3.44 Capacity utilization improved in most industries as a result of greater access to imported inputs, as evidenced from the substantial increase in imports of machinery and equipment, raw materials and intermediate goods, and the rise in production (Attachments 3 41, 42). The competition that ensued import liberalization has forced manufacturing firms to take actions to improve factor productivity, overall efficiency of operations, and profitability. Such actions include discontinuation of uneconomic production lines, addition of modern machinery and equipment, balancing and streamlining of operations, better utilization of inputs, organizational changes, upgrading of management and technical skills, improvement in management-labor relations, better worker compensation, and injecticn of new capital. Furthermore, there is evidence of erosion in market shares and well below inflation sales prices increases as a result of increased domestic and external competition (e.g., plastics, iron and steel, textiles, personal care products). 3.45 The influx of a wide variety of cheap textiles..' coupled with the recently reduced consumer spending power as a result of the drought, resulted in a decline of sales volume and market share for large producers and financial losses in 1992. Capacity utilization fell from 67% in 1989 to 49% in 1992, and a substantial number of workers were laid off. Increases in surtax, the ban on commercial imports of second-hand clothing, and other informal measures have proved ineffective in discouraging imports and in protecting the domestic textile industry. However, this competitive pressure forced firms to take actions aiming at strengthening production control (e.g., improved efficiency in spinning, weaving and printing processes; experimentation with cheaper dyes and chemicals; reduced inventories of cotton, dyes, chemicals and spares); improving inventory control and management information systems; tightening of controls over costs of imported inputs and overheads; reduction in the number of expensive expatriates; adaptation of marketing and distribution practices (e.g., improvement ofproduct quality, introductionof new products to compete with imports, establishment of a Market Research Department, placement of stocks on consignment, entering into contracts with major wholesalers for manufacture of their exclusive designs, opening of additional retail outlets, improvement in customer relations); and greater scrutiny by top management of all aspects of business operations (e.g., manufacture, sales, finance). Furthermore, efforts have been intensified to export to regional and world markets. 3.46 The regional market has been difficult to penetrate due to the tight foreign exchange restrictions and import licensing in the Preferential Trade Area (PTA) member countries, and the fact that South Africa has also been inundated with textile imports form the Far East. Nevertheless, textile firms are making efforts to find niches in the South African market. Sizeable quantities of at There appears to have been extensive evasion of custom duties and surtaxes through miadescription and undervaluation of imported goods, importation of subsidied items by exporting countries, and ulawM diversion of imported cloth for garment manufacture into the market for resale. Also, large quantities of second-hand clothing found their way to the market, either smuggled or through resale of charity imports. Foreign exchange allocations without any time limit within which imports would have to be effeoted exacerbated the situation. -34- grey cloth are being exported to Europe and the USA, but these sales are not profitable because of competition from cheap and often subsidized Asian producers, and because of high transport costs due to Malawi's landlocked situation. They cover variable costs and, depending on price movements, they may contribute to overhead.A In the face of such developments, the textile industry is faced with the decision to downsize, focusing on a narrower range of high volume products and leaving short-run production items to imports, and confining exports to profitable items (instead of selling spare capacity in the form of grey cloth). This would be coupled with financial restructuring and injection of additional capital. The new investment and export incentives to promote non-traditional exports (paras. 3.14, 3.15) should help modernize and make up for some of the disadvantages facing the textile industry. G. Socal I =mpac of R rmsW 3.47 There has been a significant increase in the share of social services (education, health, community and social development) in total government expenditures - from 18.7% in FY87 to 25.3% of total expenditures in FY92. Recurren and development expenditures in education rose from 10% to 13% of total expenditure, in health services from 6.6% to 9.7%, and in community development from 2% to 2.5% (Attachment 35). This reversed the declining trend of the early 1980s. In addition, in 1991, the Government began implementation of the Social Program Support Fund. The Fund supports pilot efforts to assess the effectiveness of targeted poverty reduction programs, and includes NGOs as a vehicle to widen participation in the provision of social services and complement the financially and staff constrained public sector. Furthermore, IDA's health and nutrition operation, approved in March 1991, would improve the quality, access, efficiency and effectiveness of the sector by strengthening basic programs, support services, and operating efficiency.0- 3.48 Employment in the private sector increased by 17% between 1987 and 1990, while employment in the public sector rose by 12.5% (Attachment 43). Also, there has been a significant rise in employment in the micro- and small enterprise sector (para. 3.19). Unemployment rates remain relatively low - estimated at 4.5% in the urban sector and 1% in the rural areas. This is significant as the labor force is overwhelmingly rural (92%) and only 8% urban. However, real wages continued to fall, as nominal wage increases remained below inflation rates in 1987-90 - more so in manufacturing (Attachments 1, 44). This suggests that labor bore part of the adjustment burden. However, a Government study of employment and minimum wages concluded that the 1989 adjustment, by and large, corrected the shortfall. Specifically, it indicated that, for the rural sector, the wage level in that year probably approximated a market equilibrium, and was not detrimental to employment; for casual labor in the urban sectors, the adjustment resulted in some loss of employment for casual labor and may have been slightly above the market solution; and for formal labor in the urban sectors, the increases have had little impact on the wage bill and employment because of its low absolute and relative level, and because workers were paid well above the During the 1980s, textile exports have accounted for about two-thirds of manufactured exports. For details see Staff Appraisal Report No. 9036, Mun - Pmul Healh an ition m& February 1991. -35- minimum wage.' The surge In imports of cheap textiles and other consumer goods in recent years (para. 3.45) certainly was a boon to the poorest segments of the population, given that about half the population is estimated to be living below the poverty line and have limited opportunities to expand their incomes. Until very recently, relative price stability most likely has had a similar effect. 3.49 Following the acceleration of the inflation rate in 1992 and in the wake of the strikes, wage levels rose to 68% for civil servants, 50% or more for the rest of the public sector and the larger private enterprises, and close to 50% elsewhere in the economy (para. 3.36). These recent wage developments are likely to have arrested declining real wage levels, and have narrowed significantly wage differentials, which is important in the context of Malawi's skewed Income distribution. This, combined with a squeeze in profits in particular industries following the trade liberalization, may have also improved the share of wages relative to profits.9' Although automatic adjustments in minimum wages for unskilled workers to compensate for inflation may be socially desirable, as the industrial sector is liberalized and protection is reduced, automatic full compensation without taking into account labor market conditions and the competitive situation of the various industries may not be expedient. Wage flexibility, along with productivity Improvement, should be the guiding principles. IV. FINDIN S AND ISSU Ownershig 1 01 During the preparatory stage of the reform program, the Government and the Bank reached agreement on the diagnosis of the main inpediments to restoring internal and external equilibria, the needed macroeconomic and microeconomic policies and institutional changes to restore economic growth, the development objectives for the manufacturing sector, and the most appropriate strategy to achieve them. These understandings were reflected in the Government's Statement of Industrial and Trade Policy (Attachment 3). The specific policy changes supported by the program were the subject of extensive discussions between the Bank, the Government and, where appropriate, the IMF and the donors. There have also been consultations with the business I' The nominal minimum wage remained fixed from August of 1986 to May 1989, when it was raised by 126% in the rural areas, 98% in the large cities, and 107% in municipalities, restoring the real wage to roughly the level of 1980-84 after an erosion of some 88% slace 1986. Large employers in the urban and estate sectors have traditionally adhered rather closely to the prescribed minimum wage, which in principle is intended to provide a floor for unskilled workers. Large urban employers pay higher wages to all but casual and entry-level workers. Also, some urban and rural employers provide their workers with a cooked meal every workday, in recognition of the link between caloric intake and physical effort. There is, however, evidence that non-compliance with statutory minimum wages is fairly extensive among urban small scale and micro-enterprises, and among rural small estates, as the enforcement by regular inspection is beyond the resource availability of the Ministry of Labor. IV There has been a shift in the share of income from wages toward income recipients from property, entrepreneurial and capital, as price margins widened during the period of price decontrol (1983-88) and Import constraints (1985-88) while real wages were aling. From 1980 to 1987, wages as a percent of value added decreased from 49.9% to 33.6% in the estate sector, and from 24.4% to 20.6% in the remaining non-governmental formal sector. World Bank Report No. 8140, Md - March 22,1990, pars. 2.20,4.06. o' The appraisal mission also included staff from the USAID, ODA and the EC. - 36 - community. The central ministries and Institutions, as well as the sectoral ministries and agencies to be involved in the implementation of the program, worked closely and formulated a negotiating strategy. This not only facilitated concerted action and strengthened the negotiating team's position, but also helped sensitize all participants to the issues at hand, enabled them to appreciate the significance of sectoral linkages, and helped reconcile differences and build consensus at the decision-making and implementation levels of the government hierarchy. The dialogue was based on the findings of earlier economic and sector work, which had pinpointed weaknesses in economic management, dwelt on strategic issues for the longer-term development of the industrial sector, and proposed concrete policy actions that could be undertaken in the short-to-medium term. These extensive exchanges, the concurrence on strategy and measures and, more importantly, the fact that the top political leadership made the final decisions, reflected a political wil and V* luh ul f , although not necessarily broad-based consensus, and betoken that, in effect, the Government "ownedo the program, in the sense that it satisfied itself that the policy reforms and actions represented an appropriate, realistic, and feasible course of action, considered the political trade-offs, understood fully its requirements and implications, and accepted it in its totality.2' On the other hand, making available a pool of resources conditioned on carrying out a set of policy reform measures reassures the Borrower that the Bank and donors are supportive of an inherently difficult adjustment effort, and that the exercise will not stall in the face of imponderables or difficult to predetermine constraints. The fact that the Government essentially owned the program contributed to the overall satisfactory results of the operation under review. Commitment and Consensus 4.02 Judging from the progress that had already been made in the implementation of the SALs, IDA felt reassured about the Government's commitment and determination to carry out the measures supported by the operation under reviow. Nevertheless, a firm political commitment, though necessary, is not a sufficient condition for ensuring the unimpeded implementation of the reform package and the sustainability of the adjustment effort. Unanimity is a virtual impossibility, and even a broad consensus Is very difficult to achieve, as pressure groups adversely affected by the reforms may succeed in slowing down the pace if not derail the reform process, particularly if they have political clout, the supply response is not sufficiendy quick, and the social costs of the reform a' This formulation sets forth an operational definition of ownership. For an elaboration of the constituent elements of ownership within an overall interactive conceptual framework, see OED Report No. 10870, World Bank Structurl and Sectora Aditmt O : T Second OED OJune 30, 1992, pp. 173-183. -37 - are not equitably shared.P Nevertheless, the Bank's assessment turned out to be correct in virtually all initiatives. Lack of a Lng-Term Strategy for SMI Development 4.03 An efficient SMI sector can play an important role in the Malawian economy in terms of employment generation, output growth, processing locally produced materials, and savinglearning foreign exchange. Furthermore, the SMI sector can contribute considerably to the country's industrial development, can promote structural shifts (e.g., by enhancing the share of intermediate goods in Industrial output), and can have other tangible socioeconomic advantages (e.g., greater scope for initiative and the development of technical and managerial skills; supply of a good part of low-priced mass consumption goods; adaptation of production techniques to the country's particular circumstances; promotion of more equitable distribution of income; reduction of regional Imbalances; etc.). The Government has repeatedly expressed its commitment to strengthening the resource base and institutional arrangements pertaining to SMI. Yet, the outline and specifics of a long-term strategy underpinning the promotion of SMI and an action program are missing. Elements of a suggested strategy are presented below. 4.04 In the first place, subsectors which appear most promising in terms of potential SMI growth comprise the food processing, ready-made garments, footwear and leather products, wood- based products and furniture, plastics, construction materials, and engineering. Aside from growing domestic demand and export potential, factors reinforcing the potential growth and viability of the SMI in these industries include: relatively low scale economies in a wide range of activities in each industry; locational factors, such as local processing of bulky raw materials (saw mills) or local production of bulky products (construction materials); complementarity with larger industry, involving manufacturing operations in which the processes are readily separable (e.g., producing specialized machine products, components and tools), craft or precision handwork, simple operations of assembly, mixing, or finishing, provision of services and repairs to other industries; production 'It is inherently difficult to define the contours of a . A practicable approach to take would be to establish whether the reform program proposed by theI2liand wmmigzms2ift as custodians of the public interest, satisfies certain fNndamentalpreconditions. Specifically,whether(a) the design and implementationof the proposed reform program in its mqjor facets (timing, capacity, scope, content, sequence, pace) appears sustainable, in the sense that it provides a carefhl balance between demand-side measures to achieve macroeconomic stability, supply- side measures to induce economic growth, and suffcient financial resources to ensure the viability of the program; (b) the longer-term effects of the reform can be reasonably expected to benefit the general public and the economic agents at large; (c) the ftg in launching the reform program is minimized because the program is realistic, in the sense that it is restrictive, reflecting the financial and foreign exchange constraints, yet it is socially and politically tolerable as the costs will be shared equitably- (d) the policy package has been approved by the parliament (in democratic regimes) or the Party (in one-part systems); (e) provision is made to alleviate the social costs of the reform for a transitional period; (f) the action programs embody some flexibility to permit fine-tuning of policy measures and adjustments during implementationthat could accommodateimponderablesor difficult to predetermine constraints, and thereby prevent a stall or reversal; and (g) a credible effort has been made to debate the Ises, raise awareness, arouse interest, and rally to the cause key groups who share common interests and have the power to influence the outcome, by explaining to the public at large and the economic agents concerned in no uncertain terms the origin of the crisis, the rationale for a reform program, what is involved, the benefits to be derived, the price to be paid, and what the consequences will be if action is not taken. Given that unanimity is a virtual impossibility, a 2otve assessm of these desiderata should provide a fairly reliable basis to rnAm the existence ofa broad coanensum sufficient to justify the launching of the proposed reform program fOrmt consensus>. -38- of differentiated products for specialized markets, or low-priced mass consumption goods; and relatively low capital intensity. Engineering is perhaps the most inviting of all subsectors. 4.05 In view of SMI's multi-faceted potential, support of SMI in a judicious and eclectic manner is an efficient way to use scarce resources. In devising a strategy and the requisite policy framework for SMI development, two major and complementary objectives stand out: (a) employ- ment generation, an arduous task whose accomplishment is heavily conditioned on economizing capital in the process of industrial investment; and (b) alleviation of the problems constraining the growth and development of SMI, the latter amounting essentially to concerted efforts at modernization of tools and equipment;i improving efficiency through technical assistance schemes fostering management and skill development; and promoting a conducive business environment free of undue regulatory constraints and ethnic discrimination. 4.06 The strategy should be to achieve an appropriate balance between larger and smaller (but efficient) establishments, a mix of more and less capital-intensive techniques in accordance with the country's factor endowment, thereby ensuring a symbiotic relationship in which the activities of small and large firms conform to their respective comparative advantage. The Issue is gI promotion of small xrm large establishments, or indiscriminate support of SMI for the exclusive purpose of creating employment opportunities at any cost. The historic lesson is that a bi-modal industrial structure composed of mutually supportive large and small firms has worked, has become highly productive, and Is economically and socially desirable. 4.07 An equally important imperative is the need to improve operating efficiency, ensure consistently high quality of Intermediate and final products, and foster the diversification and growth of SMI. This can be achieved primarily through modernization of tools and equipment; improvement of the performance of small-medium manufacturing establishments through well- conceived and properly tailored financial and technical assistance programs, including skill upgrading and accelerated training; and by inducing structural changes (e.g., trading and/or cooperative arrangements, consolidation of smaller enterprises, linking up with larger industrial firms as suppliers or subcontractors, integration into larger marketing and trade networks), export orientation, and adaptation to new circumstances, rather than protecting inefficient firms and out-of-date methods of production from the competition of modern techniques. 4.08 In light of the above, the introduction of sophisticated and specialized tools and equipment at this stage of Malawi's development should not be discouraged. However, this does not mean to imply an indiscriminate choice of capital-intensive techniques and equipment. Given the scarcity of capital and foreign exchange and the comparatively lower wages in Malawi, a conscious effort should be made to adopt, to the extent possible, appropriate technologies suitable to the local circumstances. This would imply for the Government: (a) to allow factor (i.e., capital and labor) prices to reflect their true opportunity costs; and (b) to take upon itself the task of ascertaining, promoting, demonstrating and disseminating appropriate technologies. An appropriate authority, properly strengthened and assisted, could be assigned the tasks of advising on matters of technology. Financial Intermediaries could also play a useful role in guiding prospective borrowers, and providing the requisite financing. ' It is nowarthy that replacemnt of obsolete equipment helps preserve existing jobs, which otherwise might have been eliminated. -39- 4.09 Transformation and growth of the small workshop into a modern factory is equally important for the dynamic development of the industrial sector. Support to SMI would enable the most efficient and dynamic enterprises to grow in size and graduate to higher size brackets which are now thinly populated. Much of the increase of SMI establishments in size derives from Jutmal gmvd, attained in phases of successive expansions and less from mergers. Also, much small firm growth is likely to result from second generation owner-managers as they succeed the family firm, and this is a continuing process. The latter, contrary to owner-managers with an "artisan* identity and mentality, are more likely to have a conventional middle-class background and education and, therefore, a more modern "managerial" view of economic activity and acceptance of the dominant business ideology which stresses growth and efficiency. Imbued with such principles, they are likely to be more receptive to such ideas as expansion of the firm, technological developments, professionally managed business, external borrowing; would probably display less strong element of paternalism which minimizes dependence on others inside or outside the firm; and would be more appreciative of the administrative necessity to use more consultative leadership style, to delegate, and to negotiate with professionally trained people brought in from outside. 4.10 In essence, the strategy should be to direct private investment and to expand support primarily to SMIs with relatively high probability of survival and success and conducive to promoting the gradual integration of the SMIs with the rest of the industrial sector. Viability and self-sustained growth of SMI are most likely to be attained, it would seem, by focusing on industrial activities with promising growth potential and characterized by rather low economies of scale, catering to specialized or low-priced market niches, or displaying complementarity with activities undertaken by larger firms in the form of ancillary or sub-contracting arrangements, or provision of services.R At the enterprise level, the establishment with a realizable potential for growth, and consequently for continuing viability, is likely to be the one in which there is some degree of specialization of management functions. Such a conscious approach, effected through the appraisal and lending procedures of financial intermediaries, would ensure acceptable economic and financial rates of return on investment, and that SMIs fill interstices, command an interlocking position within the industrial structure, and constitute vital parts of a functionally integrated whole. Ethnic Discrimination* 4.11 Entrepreneurial talent is available in Malawi, and diverse groups within the private sector are prepared to invest. However, actual investment response has been stymied by official caution, long delays in decision-making, and geographical/sectoral restrictions on investment by non- indigenous investors. In this regard, the 1992 amendment to the Forfeiture Act that permits appeals g In turn, strategies could be formulated for the development of the most promising subsectors, including programs to encourage ancillary and subcontracting arrangements, industrial estates and export processing zones (see paras. 4.19, 4.20). For the elements of such an approach, see World Bank Report No. 2913, Trv- Prspects for Small4caloutryUM DeveLmentand EmoloymnentGnmaion mSepmber 10, 1980,3 vols. A tworonged strategy to assist the development of micro-onterprises has been suggested: (a) toidwn involving improvement of the business environment by influencing macroeconomic variables such as prices, government reglations and policies, and by building up the physical infrastructure; and (b) bottom-up. entailing mobilization of indigenous resources with the active participation of beneficiaries to foster horizontal and vertical linkages. For details see World Bank Technical Paper No. 122, Africa Department Series, Suoort for M og! "Mo for Sub- Saaa Afa 1990. The existence of ethnic discrimination is denied by the Government (Appendix 1, pp. 2, 3). -40- by persons subject to forfeiture is not reassuring to the non-indigenous community. Aside from the fact that citizens are averse to litigation, it is the person served with a notice that has to prove why he should not be subjected to forfeiture. Abolishing the Act altogether, removing legal barriers to entry in particular activities (e.g., transport), and discontinuing the practice of setting time limits to business residence permits are actions that are likely to pay off handsomely, by substantially improving the investment climate. It should be appreciated that these groups are a readily available source of entrepreneurship: they have business acumen, managerial capacity and financial resources; are well-positioned to move into industrial activities which necessitate a long-term commitment and involve a higher risk; and have the ability to provide critical links to domestic and world markets, thereby facilitating the progressive integration of smaller firms into marketing and trading networks. Cocentration of Ecnomic Power 4.12 It has been argued that, Press's failure to divest and involve domestic partners in its ventures has prevented the development of Malawi's entrepreneurial class. According to this line of thinking, Press's size, access to resources, and monopolistic/oligopolistic position in an array of economic activities, coupled with the smallness of Malawi's domestic market, limit the scope for the development of a more competitive private sector and the growth of an entrepreneurial class. What adds plausibility to this assertion is that Press continues to expand. For instance, in 1990-91 it entered into three new joint ventures with a majority interest in the manufacturing and distribution sectors, and is intent on pursuing this course of action: "We have ample financial resources at our disposal and shall be actively seeking additional opportunities for investments which meet our strategic objectives. "IV 4.13 Nevertheless, larger and more subtle questions remain unanswered and need to be probed into, while the focus of any inquiry should not be the Press Group but the dynamics of the existing market structure, conduct and performance; whether conduct and performance reinforce market dominance;W and what kind of remedial action(s) can be taken and enforced in the Malawian circumstances to ensure free entry and promote competition. Particular issues that deserve scrutiny include whether existing and new foreign investors would be interested in investing in market segments with room for few plants of optimum scale, and often in competition with a politically well-connected entity; whether indigenous entrepreneurs have the managerial capacity and resources to buy into such ventures; whether restrictions in the activities and outright discrimination against Asian entrepreneurs could be effectively banished to enhance their involvement in small and medium scale industry and agro-industrial businesses; whether Press as well as other dominant firms are really promoting new and otherwise foregone industrial activities through joint ventures with foreign partners, thereby bringing into the country foreign capital and technical know-how; and whether an appropriate tariff structure can be established to induce monopolists/oligopolists to perform efficiently and, at the same time, prevent them from exploiting their dominant market position. In a sense, policymakers may be facing a dilemma. On the one hand, steps to reduce the role of dominant firms may not be warranted until sufficiently strong challengers have emerged to fill the gap to be left by scaling down the activities of the larger players, and until they have developed the Press Group, Annual Review 1991, p. 9. For instance, are the benefits of vertical integration (cotton ginning, cotton seeds, cotton-seed oil) attained by a foreign firm operating identical facilities in neighboring countries compromised by securing a virtual monopoly position in the domestic market? -41- requisite dynamism to advance firmly the country's industrialization effort; on the other hand, the very presence of dominant enterprises and their expansive predisposition may well thwart the emergence and growth of such potential challengers. These issues, some of which are highly sensitive, would need to be addressed by the political authorities in opportune time and in the not too distant future. Fostering Competition in the Banking Sector 4.14 The external borrowing capacity of the two large banks has been constrained by foreign exchange risk and governance considerations, while domestically the pool of available savings is limited. Raising new equity has also been inhibited by governance, but probably more so by concern of foreign domination and dilution of control. Limited resource availability, reinforced by interlocking relationships among the financial institutions and common ownership of the two commercial banks by Press, is hardly conducive to intensive competition in the banking sector. Control of the banking system by private vested interests provides Inordinate access to funds by particular business groups; leads to excessive concentration of lending to a few clients; violates accepted principles of prudential lending; and can forestall new entry in the industrial sector. To increase the available pool of loanable funds, stimulate competition, and improve the operational efficiency and quality of bank services, it is imperative to foster the entry of new financial institutions - both investment and commercial banks. This would take a determined effort by the monetary authorities to attract world-class banks, particularly among those which are already operating in neighboring countries and are more familiar with the African circumstances. The referendum of June 14, 1993, which overwhelmingly favored the establishment of a multi-party system of government, hopefully will remove an element of uncertainty and, thereby, arouse the interest of and facilitate the search for potential entrants. Resgional Interation of Industry 4.15 Malawi is a member of the PTA, which was formally founded in 1981 under the auspices of the UN Economic Commission for Africa (ECA) and comprises 18 countries. ECA's approach has been that regional grouping in Africa should comprise a large number of countries to create sufficiently large markets for the establishment of viable industries that would gradually substitute for imports and promote Africa's self-sufficiency. The creation of a preferential trade area was the first step towards the ultimate goal of establishing an economic community. Initially, a Common List of 212 goods was selected for preferential treatment within the sub-region. The intention was to expand the list to comprise all goods of PTA origin. Customs duties on the goods in the list were to be reduced by 25% every two years and be completely eliminated by 1992. Negotiations, however, got bogged down on such matters as what goods to include in the list, how to define the rules of origin, or how to create compensatory mechanisms for those members that would suffer revenue losses. As a result, the target date for effective liberalization was put off to the year 2000, and even that appears optimistic. Thus, while, the Policy Organs of PTA have been taking a number of decisions aimed at liberalizing and facilitating latra-PTA trade, important decisions have yet to be implemented by most members. To date, no specialization or measurable integration has been achieved, and there is virtually no preferential trade involving Malawi in the subregion. 4.16 The main focus of internal liberalizations among PTA members has been tariff preferences and the removal of non-tariff barriers for a limited list of products. Yet, PTA has found -42- it hard to convince Its members to act decisively in dealing with the intra-regional barriers to trade and factor flows, particularly non-tariff barriers - except for granting tariff preferences on a limited range of products on a bilateral basis. These preferences were in turn nullified by the maintenance of non-tariff barriers. A three-year program for phasing out import licensing for goods on the Common List starting on January 1, 1992, has not been implemented by all members. In part, this is because PTA decisions and measures have to reflect the lowest common denominator. This not only limits the pace of progress but also fosters state interventionist tendencies (e.g., setting up multinational public enterprises while national governments are trying to privatize; reluctance to let multinational industrial enterprises operate without government controls). 4.17 The lack of progress in intra-group trade liberalization can be attributed, Intralia. to the undiversified economies of most members, high dependence on few commodities for export revenues, and lack of complementarity; uneven distribution of prospective benefits from integration; fear of external domination; inability to devise ways and means to compensate adversely affected members; opposition by organized pressure groups; barriers to cross-border investment; poor infrastructure; presence of monopolistic niches fostered by entrenched foreign companies locating in a country under agreement that they be sheltered from imports; complexity of rules and regulations; clash between market incentives and regulations; resistance to dismantle trade barriers; nd reluctance by Governments to rely on the private sector to achieve regional cooperation and economic integration.1v 4.18 Underlying these symptomatic impediments are nationalistic tendencies, lack of appreciation of the long-term prospective benefits, and inability of member governments to build a broad-based consensus. Also, the regional members have yet to develop and cross a threshold of similar economic and social objectives so that the requisite partial surrender of national sovereignty can become mutually beneficial. In the case of Malawi, this lack of progress in regional integration and the persistent tariff and non-tariff barriers to trade have made it difficult for manufacturers to export to neighboring countries and has discouraged investment in export-related activities (pam. 3.46). This, reinforced by the array of impediments just outlined (para. 4.17), tends to perpetuate an insular and inward-looking mentality, leading industrialists to invest in capital- intensive, sub-optimal and inefficient plants when more efficient facilities could cater to regional markets at a much lower cost and to the benefit of all countries concerned. For an example of such a poorly proposed investment see para. 1.20, footnote 12. Concerted efforts to eliminate trade and non-tariff barriers in the sub-region would benefit all PTA membersA 0 For details see World Bank Report No. 7685, Intra-Reaional Trade in Sub-Saharan Afria May 23, 1991, paras. 3.23,3.24,3.28,5.01-5.98; World Bank, Reioal JaWmai a mi Industry Series Paper No. 14, November 1989; World Bank Policy Research Working Paper No. 992, Reoa In-teration in Sub- October 1992; P. Streeten, 'Tho Special Problems of Small Countries," World DVol. 21, No. 2, 1993, pp. 197-202. 0 Incidentally, it is not quite clear that opening up an economy to regional trade through a preferential trade area agreement has tangible advantages before the economy has reached a certain threshold of openness. Premature regional arrangements may impede progress in achieving ll trade liberalization. However, there appear to be advantages in improving the infrastructure and tariff harmonization between adjoining countries so that trade can flow more easily. -43 - Exor Procssing Zone 4.19 In an effort to stimulate export-orientedproduction, the Government has provided special Incentives for firms locating in Export Processing Zones (EPZs) (para. 3.15). It is not clear whether the task will be left entirely to the private sector, or whether an Export Processing Zone Authority (EPZA) will be established to create and operate EPZs or oversee private EPZ developers. If the latter route is decided, the business community and MIPA ought to be represented, and the respective jurisdictions of EPZA and MIPA (para. 3.13) would have to be clearly delineated to avoid overlapping (e.g., who is to act as a one-stop center for processing applications for permits and facilities for firms locating in the EPZs). EPZA's main functions would, inter a be to identify and map areas to be designated as EPZs; plan the construction, maintenance and finance of EPZ infrastructure; examine, process, and approve applications for licenses by EPZ developers; formulate rules for the operations of EPZs (e.g., siting of enterprises, activities, movement of goods); issue certificates of origin to EPZ enterprises; regulate and administer approved activities within EPZs; and enforce within the zone customs procedures, administrative functions normally performed by local authorities, and foreign exchange control procedures. 4.20 The establishment of EPZs could be a convenient vehicle to expand exports within a relatively short period, particularly if early collaboration between foreign and domestic enterprises can be achieved.0 EPZs may also be more reassuring to the Asian community, thereby enabling the country to tap their potential (para. 4.09). Nevertheless, the net longer-term benefits of EPZs are not invariably favorable. At the beginning of a country's move from import-substitution to export-oriented policies, EPZs, assuming they are organized and managed efficiently, can play a useful role through their strong demonstration effect, particularly in the absence of an export- oriented constituency. But major challenges remain: thwarting their tendency to remain enclaves with few linkages to the surrounding economy; ensuring the development of regional centers of economic activity; and deepening the industrial structure through backward linkages, integrated production activities, and technology/skill transfer to local firms outside the EPZ. Furthermore, it may be difficult to repeat the success of Mauritius in developing EPZs. Important preconditions include the presence of a very dynamic local (ethnic) business community which Is In a position to form effective links with overseas investors; capability to supplement overseas equity with domestic loans, if not equity capital; an underlying local cost structure which is internationally competitive; and ability to attract sufficient foreign interest to support the EPZA Thus, creating an economy- wide favorable environment may be a more cost-effective way to expand exports and employment compared to creating costly enclaves. Proliferation of EPZs therefore may not always be warranted, and their establishment should proceed with circumspection. Privatization of Industrial Parastatals - An Unfinished Aenda 4.21 The reforms of Malawi's corporate and parastatal sectors in the 1980s took the form of adthm measures aimed primarily at the financial and management restructuring of ailing holding & For a perspective on the role of EPZ, see World Bank, Free Trad Zones in Exporateues Industry Series Working Paper No. 36, December 1990. For factors conditioning EPZ mucess or filure we* also World Bank, Exoord Processin Z Policy and Research Series No. 20, pp. 21-23. B' World Bank, International Economics Department, Working Paper No. 619, March 1991, pp. 40-43. -44- companies, rather than at improving the efficiency of individual industrial parastatals and at developing an aggressive divestiture program. The packages did not, and perhaps could not, address the issue of restructuring of Malawi's industrial and agro-industrial parastatal sector due to the pressing circumstances and urgency under which they were put together (paras. 1.16-1.28). As a result, very limited progress has been made to date in implementing ADMARC's divestiture program; in reducing the state's ownership of MDC to minority shareholding; in divesting and turning over MDC's industrial assets; and in transforming MDC into an industrial development corporation as mandated. Also, WICO's drawn-out privatization effort may have to be refocussed, as suggested in para. 1.27, infiIX. This state of affairs attests to an unfinished agenda within the broader scheme of industrial reorientation which needs to be pursued in earnest.4' Empowering, and extending full political support to, a central coordinating entity with a finite life to deal with the range of activities related to the parastatal divestiture process would be a promising starting point. DSB could discharge this function if it were enabled to meet the aforementioned desiderata (see para. 1.24 in fine). V. CREDIT ADNISTRATION. COORDINATION. AND UTIIATI 5.01 The Bank played an important role in tto design and implementation of the reforms undertaken by the Government. In particular, earlier economic and sector work focused attention on areas where significant change was needed, defined technical and policy options, and translated sectoral adjustment strategy into mutually consistent and actionable programs. The Bank's involvement and support helped articulate the arguments for policy adjustments, deepen the dialogue on technical issues, and ease external constraints by improving access to concessionary financing. Frequent exchanges were helpful in maintaining the momentum of reform and in collaborative problem solving. Although the frequency of supervision has been low, judging from the results achieved, the Bank's 6 'pervision effort was effective. This should be attributed to the fact that progress was being track-d through the continuing PFP process, public investment program reviews, and follow-on adjustment operationsP' There has been close consultation and coordination with the IMF in the course of articulating particular action programs to ensure congruity of purpose. On the whole, the reform package was practicable and was *owned" by the Government. 5.02 Conditionality was formulated through a process of constructive dialogue and close collaboration with the Government to the end of ensuring commonality of purpose, cooperation, and institutional commitment and support, and aimed at facilitating the Implementation of prerequisite steps and at supporting forthcoming initiatives. The conditions were germane to the objectives and actions agreed upon, logically sequenced, and performance-oriented, in the sense that tranche disbursements were conditioned on completion of specific tasks within agreed timetables. The ' Divestiture of industrial parastatal assets would also help foster the development of the private sector (see parm. 4.11). U The 590 Form produced by the supervision mission conducted prior to releasing the second tranche (June 1989) contains no ratings. The accompanying Back-to-Office Report, however, states that "the adjustment program is proceeding very well, albeit with some problems" for each year during 1989-92. The Region's ratings for both overal2g[&EMw ivelogmtotivin the Annual Report on Portfolio Performance were "satisfatoory with moderate problems.- .45 - timetables in turn were based on the scope and priority of the issues at hand and, in general, were realistic, facilitating government compliance. Tranche release conditions referred to distinct and complementary areas, involved several ministries and agencies, and generally were Implementable. The second tranche was released based on the fact that progress in implementing the overall program was satisfactory, since the specific conditions for trade liberalization, tariff and sales tax reform, export Incentives, financial sector reforms, and measures to lower the fiscal deficit were fufilled, and there were positive developments in macroeconomic and Industrial performance. 5.03 The reforms initiated under this operation followed on, and were an integral part of, the stabilization and structural adjustment package financed by the IMP, and were also supported by several bilateral and multilateral donors (see Preface). Procurement procedures were satisfactory and in line with Bank guidelines. The closing date was extended once due to slow disbursements relating to additional donor financing, and the preparation and processing of the requisite documentation. Import financing and auditing procedures were streamlined to expedite disbursements and ensure accountability. The Credit was disbursed with a delay of one year. All imports financed under the credit were below the ICB procurement threshold of US$2 million. The bulk of the Bank's funds financed the import of industrial inputs (82%) and machinery and equipment (13%) (Attachment 45). lTe counterpart fAuds were made available to the Government without restriction, and were used to supplement its budget. They were used in part to repay outstanding debt to the banking system. Actual external financing requirements for the three-year (1988-1990) disbursement period were higher than projected by about 10%, largely due to underestimation of imports. The resultant resource gap was financed by increased donor contributions (Attachment 14). VI. OVERAI ASSESSMENT OF RESULT& 6.01 At appraisal the macroeconomic situation was unsatisfactory, reflecting the vulnerability of the economy to external factors (e.g., declining terms of trade, rising interest rates) and the vicissitudes of nature (e.g., spells of drought). Notwithstanding the magnitude and complexity of the task at hand, the initial conditions appeared fairly propitious and called for the launching of a focused and sustainable adjustment program. Macroeconomic stability was to be pursued in tandem with trade reform and industrial reorientation efforts. 6.02 The reform package represented a practical program for industrial and trade policy adjustment. The thrust of the strategy, the objectives, and the supportive policy instruments were appropriate, and took into account political, administrative, and technical constraints. The sequencing and timing of the trade liberalization measures, the incentive structure, and initiatives involving tax and financial sector reforms were basically correct. However, in retrospect, relaxation of import controls on unessential consumer goods during the second and third phase, was hurried, In the sense that, in the face of lagging export growth, potentially untoward effects on Industrial Since the policy reform package has not been in place very long, certain Initiatives are uniblding, and the scope of some measures is being deepened, extended or complemented by follow-on initiatives, the full impact of the reform undertaken under the preseatoperation cannot be assessed at this juntate (see para. 8.09 fr more details). -46- performance, the balance of payments, and foreign exchange drain had not been fully fathomed. This hinged heavily the liberalization program on donor support. On I - whole, the action programs were well-conceived, purposefully designed, and addressed priority is.des. Actions to be taken were spelled out in considerable detail, thereby facilitating the monitoring of time-bound programs. 6.03 Progress in implementing the reform program, viewed as a time slice of a longer process, has been satisfactory in virtually all areas. The main objectives and macroeconomic targets were largely achieved, with minimal adverse effects on standards of living. Significantly, the momentum of industrial, trade and financial sector adjustments has been carried on by the implementation of further reforms initiated by follow-on operations, reflecting the Government's strong commitment to the adjustment effort. Legislative initiatives were taken to establish institutional frameworks to foster private sector development and investment, introduce a market- oriented monetary control system, and induce competition in the banking sector. 6.04 During this phase of import liberalization, emphasis was given to enhancing the transparency of protection by replacing -QRs on competing imports with tariffs and liberalizing the licensing of imports. SMecflc duties have been replaced with advalrem rates, and rates have been revised to ensure comparable treatment of similar products. The number of tariff categories was reduced, iitial steps were taken to lower average tariffs, and there is greater reliance on tariffs as the main instrument of protection. But, while rates on no-coqtng imports have come down, effective protection and tariff dispersion on mgting imrt have increased, as a result of the combination of statutory tariff rates, industrial rebates and domestic surtax suspension. Also, because of the high degree of administrative discretion, rebates of customs duties on industrial inputs and ad.lo exemptions of parastatals from import duties and taxes remain a vexing issue, encouraging favoritism and increasing variability in protection. The Government is committed to reducing both the level and dispersion of protection, and will be introducing progressively a cascaded import tariff structure with a maximum rate of 35% by FY96. This timetable should enable firms to make the necessary adjustments. 6.05 Although claims of anomalies in the tariff structure (para. 3.08) and unfair competition by threatened local manufacturers (e.g., under-declaration of landed value of imported items, complex tariff classification, falsified customs declarations, illegal imports, dumping) need to be considered, strnahnin custoMs administration is also a matter of priority. Notwithstanding the transparency issue, the matter deserves attention as one objective of the conversion of QRs into tariffs is the expectation to raise revenue - which is defeated if collection is problematic. Moreover, tariff reform (lowering of rates and reducing dispersion) intended to red.ce the anti-export bias and promote an outward-oriented development strategy may not be sustained if revenue cannot be collected to offset revenue losses. The trade-offbetween liberalization and fiscal imperatives cannot be ignored in a tariff reform effort. Furthermore, steps need to be taken to eliminate ad.hoe duty exemptions and rebates because of their distortive effects. 6.06 Significant progress was made in advancing tax reforms. A surtax system similar to VAT was introduced, the tax base was expanded, excise taxes were shifted from WiG& to a ,alrim, a current payments system for business income tax was adopted, taxation was extended to fringe benefits, the corporate and personal income tax rates were reduced, and a capital gains tax was introduced. Tax revenue increased substantially in absolute terms over the last five years but as a percentage of GDP slipped recently, probably reflecting the combined effect of acceleration of -47- inflation which emboldens under-reporting and tax evasion, and lax tax administration. There has also been a noticeable realignment of trade and domestic taxes, and a shift of the burden of taxation from international trade to domestic transactions, outcomes fulfilling intended purposes. 6.07 The Government also moved vigorously in the financial sector, taking an array of measures to instill self-discipline in borrowing and activate the money and capital markets. Other measures implemented so far include legislative actions to improve the legal framework for the regulation of financial institutions; strengthen prudential supervision by the Central Bank; Improve monetary programming and the use of indirect monetary policy instruments; liberalize interest rates; and foster competition. But to date, there has been no perceptible increase in inter-bank competition and no entry of new financial institutions. 6.08 Tangible progress has been made in improving the institutional framework, enacting investment and export incentives, abolishing industrial licensing, and virtually eliminating price controls. Also, the Government has pursued a flexible exchange rate policy and remains committed to maintaining a realistic exchange rate, consistent with a modest level of protection of import competing industries. By strengthening the system of export incentives, the reform prograri introduced a first set of actions to reduce the anti-export bias ir, the industrial and trade policy regime. Nonetheless, there is still room for reducing "transaction costs" in export activities. 6.09 The Government recently has begun a review of the existing regulatory, administrative and policy measures; industrial zoning policies; and minimum wage legislation, to the end of reducing regulations to a minimum, simplifying their administration, and improving their effectiveness. In this respect, administrative hurdles in setting up and running smaller private enterprises persist. Coupled with the limited access to institutional credit and the shortage of management and technical skills, these impediments forestall new entry and stifle the growth of the private sector. 6.10 The competition which followed the import liberalization has forced manufacturing firms to take actions to improve factor productivity, overall efficiency of operations, and profitability. Such actions include discontinuation of uneconow'ic production lines, addition of modern machinery and equipment, balancing and streamlining of operations, better utilization of inputs, organizational changes, upgrading of management and technical skills, improvement in management-labor relations, better worker compensation, and injection of new capital. Furthermore, there is evidence of erosion in market shares and well below inflation sales prices increases as a result of increased domestic and external competition (e.g., plastics, iron and steel, textiles, personal care products). 6.11 Supply response on the whole has been satisfactory through 1991. Capacity utilization improv0 in most industries as a result of greater access to imported inputs, although certain indu '. have been affected adversely by the influx of cheap imports. Private investment rose appr.ciably (from a very low base), but it was concentrated in traditional activities. In 1992, untoward events (drought, labor unrest, shortage of foreign exchange) stalled temporarily economic growth and the pace of private investment. Growth is expected to resume in 1993 due to record agricultural performance. In the face of a still modestly inviting investment climate, barriers to entry and ethnic discrimination, potential investors maintain a wait and see attitude, and the anticipated at appraisal increases in manufacturing investment and exports have yet to manifest themselves. This suggests that the structure of the industrial sector remains substantially unchanged. -48- 6.12 Despite the wide range of policy reforms, the successful implementation of specific measures, and the healthy economic growth during the past several years, the supply response has not been sufficient to sustain balance of payments viability. Imports grew much faster than exports, while there has been little diversification out of the traditional agricultural exports. The drought and the need for unprecedented levels of food imports exacerbated the siLuation. The performance of industrial exports has not been impressive, in part impeded by foreign exchange restrictions and import licensing in the Preferential Trade Area. The current account deficit increased sharply - from 5% of GDP in 1987 to over 12% in 1992. External outstanding debt also rose to US$1.8 billion. These developments suggest that Malawi will continue to face balance of payments pressures in the near future, and that external resources remain of critical importance for sustained economic growth. 6.13 The effiYens and outcom of the reforms are conditioned on the Government's ability to develop and effectively use proper policy instruments to maintain internal and external balances; the investors' response to the incentives by undertaking new investments and export initiatives; the ability of existing manufacturing enterprises to adjust fairly quickly to import competition; and the Government's access to external funding to bridge the external resource gap in the face of the slow export growth and faster rising imports at the initial stage. The latter, understandably, would depend on maintaining sound macroeconomic policies and on sustaining the adjustment effort. VII. S TAINABIITY OF THE ADJUSTMENT E 7.01 The political commitment to a continued industrial and trade adjustment effort remains strong, and tangible progress has been made toward developing the requisite institutional capacity to sustain the momentum of the enacted reforms. However, the instituted economic policy measures have yet to elicit sustained investment and export growth. The effectiveness and sustainability of the package of policy reforms depend critically on a positive response from the private sector, reflected in new industrial investments and a rapid growdb of non-traditional exports. Yet, the response of the industrial sector to the new signals and incentives cannot reasonably be expected to be immediate. The development of non-traditional exports requires more time than can be allowed by a time-bound reform program. An export culture requires considerable time to take root. Entrenched exporters from other countries have a edge over new entrants, compounding the difficulties the latter face in securing export niches. Inflationary pressures, leading to devaluations and increases in interest rates, raise the cost of funds and equipment and tend to discourage new investment, thereby negating the intended benefits of the reform program. The investment and export effort is further constrained by the narrow supply of Indigenous entrepreneurship and, perforce, the reliance on foreign investors.-V Needless to say, ethnic discrimination exacerbates the situation. AV During the 1970s, the share of the multinationals in the exports of the newly industrialized countries ranged from 31% (Korea) to 84% (Singaport). S. Lal, "Exports of Manufctures by Newly Industrializing Countries - A Surveyof RcentTreds, Eponomicand iek, Vol. XV, No. 49, December 13,1980, pp. 2103-2112. -49- 7.02 The promotion of non-traditional exports and the opening up of new markets Is an inherently difficult and protracted process. Response from import-competing Industries can be expected to be sluggish because of sunk costs and capital Irreversibilities. The existence of excess capacity in particular subsectors does not necessarily ensure that it could be used to produce for foreign markets because of lack of competitiveness emanating from outdated technology, inefficient production and quality considerations, and lack of market contactsAy The absence of a well- functioning financial market inhibits structural change, i.e. the intended reorientation of resources and firms away from less and into more productive activities. Restrictive land use regulations hamper new investment for expansion of processed agricultural exports. Traditionally, many firms are inclined to start exporting only after they are well established in the domestic market and have low costs by world market standards, initially viewing exports as a residual in their production plans. Supply constraints stemming from the inadequate production and irregular flow of agricultural inputs, shortages of skilled manpower, poor condition of much plant and equipment, limited access to term financing, and poor infrastructure impedes efforts to improve competitiveness. Labor costs are not necessarily low by the standards of other developing countries, especially in the face of low labor productivity. Malawi's landlocked situation adds considerably to transport costs. Finally, it takes time to instill investor confidence in the sustainability of a reform program, identify more productive opportunities, shift factors of production, build new industrial capacity, and develop new export markets, particularly in the difficult to penetrate industrially advanced countriesAl' The limited growth of non-traditional exports during the late 1980slearly 1990s reflects the force of these abiding constraints, and suggests that excessive optimism is not warranted. 7.03 Because of the lack of growth in non-traditional exports and heavy dependence on traditional cash crops, Malawi's economy has relied excessively on foreign resources to finance imports and the budget deficit, and continues to be vulnerable to external factors. Maintenance of macroeconomic stability is crucial for the success of the reforms undertaken. Recurrence of uncomfortable budgetary and current account deficits and inflationary pressures are matters of concern, as the lack of supportive macroeconomic policies can stall, if not reverse, the implementa- tion of the trade liberalization and industrial reorientation program, thereby seriously undermining its effectiveness and sustainability. & On thk determinants of international competitiveness both at the firm level and the supporting environment see IL Alani, 110madmal ndicim World Bank, Policy Planning and External Affairs, Industry Department, Industry Series Working Paper No. 29, March 1990. AV On the importance of foreign collaboration for promoting manufactured exports, as well as types of collaboration, see World Bank, Buildina a Comoetitive Edae in Sub-Saharan African Countries - The Catalytic Role of Foreln and Domestic Enterrise Collabration in Export Activities. Industry and Energy Department Working Paper No. 57, April 1992; World Bank, Buye-Seller's LigM for Export Industry and Energy Department Working Paper No. 23, March 1990. On the array of marketing problems export manfacturers face, conditions for initiating and accelerating the expansion of exports, learning sequences in marketing manufactured exports, and the need for buildbg up export supply capability, see D.B. Keesing and S. Lall, "Marketing Manufactured Exports from Developing Countries: Learning Sequences and Public Support,* in G.K Helleiner, Trade PoHv. Industrialization, and Develomnent: New Persoative. 1992, pp. 176-193. Finally, on the Institutional arrangements, policies, and kind of external assistance likely to be helpfil in developing the requisite support services for exports, see P. Hotan, D.B. Keesing, A. Singer, The Role of Sunnort Services in Expandina haN rd fts in-Dveloning Connties EDI Samia Series 191. -50- 7.04 Currently, a constituency that supports promotion of non-traditional exports, as opposed to manufacture of import substitutes, is merely nascent and needs to be developed. Policy reforms, while necessary, would not by themselves be sufficient to remove constraints to efficient production and exports, such as the supply of entrepreneurship and the attitude toward developing new products for export. The gains to be derived from an export-oriented strategy, compared to the costs inflicted by the liberalization measures, would have to become visible - which takes time and propitious conditions. Trade policy reform provides an enabling environment for industrial growth and development; but it does not guarantee that entrepreneurs will take advantage of this improved environment, and that investment will be stimulated - more so, in countries biased against non- indigenous entrepreneurship. Therefore, to make policy reforms more effective and sustainable, actions are required to draw small and medium firms into the export drive, few of which are owned by Malawian-Africans. 7.05 Since the expansion of foreign exchange earnings from the adoption of an export-oriented strategy will take considerable time, to sustain the import liberalization effort, inflows of quick- disbursing external funds will continue to be required. But access to external resources would depend, igralia, on sound macroeconomic management. In this regard, the willingness of the Government to commit itself to a new set of adjustment-related conditions under follow-on operations is encouraging, in that it enhances the prospects of sustaining the progress already achieved and consolidating the momentum of the adjustment process. VII. LESON AND RECOMMENDATIONS 8.01 The experience with Malawi's industrial and trade adjustment program offers instructive lessons and suggestions for defining a more workable Bank posture and approach to country macroeconomic and sectoral reforms. Certain conclusions affirm the experience with industrial and trade reforms in other countries. 8.02 The experience with the timing and conceptualization of policv reforms leads to the following conclusions. (i) Poliy-oriented economic and sector work has been of critical importance in appreciating the modus opendi of key economic and institutional parameters, in identifying deficiencies in performance, institutional structures and policies, and in enhancing the Bank's (and the Borrower's) capability to craft workable policy reforms and purposeful and action-specific programs. (ii) Well thought out proposals and convincing arguments grounded on correc diagnosis of the initial conditions. consistency in approach. and a firm Bank (and donor) suport for poiev rfm reassured decision-makers, and ensured more effective implemenAto and sustainability of the adjustment effort (iii) Action programs backed by strong gglitical will, broad consensus, and stUIng Z= gf incumbent proponents of the reforms were successfully implemented. - 51 - (v) There is greater likelihood that noliev reforms will be successful and sustained if the Drqess of Ugigy formulaton is intrnanlrd, in the sense that industrial sector and trade reforms are basically initiated, formulated and implemented through Institutional processes and mechanisms originating within the country, than if reforms emerge from the exercise of external leverage. The Bank can facilitate the process by helping focus attention on areas where significant change Is needed; identifying technical and policy options; and translating the adjustment strategy into mutually consistent actionable programs. (v) A orogram can be said to be "owned" by the Government when there has been extensive exchange of views, concurrence on strategy and measures and, more importantly, when the top political leadership made the final decisions. This reflective process implies political will and commitment. albelt no necesarily a crehensivel broa consenss. and betokens "ownershi" in the sense that the Government satisfied itself that the policy reforms and actions represented an appropriate, realistic, and feasible course of action; considered the political trade-offs; understood fully its requirements and implications; and accepted it in its totality. (vi) There are inherent difficulties in defining the contours of a co*sens. A practicable approach would be to establish whether the reform program proposed by tegpoI and economic leadership, satisfies certain fundamental preconditions. A positiv asens of these desiderata, as detailed in para. 4.02, foonote 40, should provide a fairly reliable basis to premeM the existence of a brad cness sufficient to just the launching of the proposed reform program (ps t consensus) 8.03 The experience with the design of action promrams yields some interesting insights. () The credibility of industrial and trade reform programs instills confidence, shapes business expectations, and generates support. It is greatly enhanced when the design and pace of implementation take fully into account the country's legacy of deep-rooted structural and institutional weaknesses; prevailing economic conditions; the interde- pendence and interaction with reforms In other sectors (e.g., agriculture, infrastructure, human resource development); social and political constraints; and actual economic opportunities. (ii) Conditionality is operative when it strikes and reinforces a practicable balance between industrial and trade oliev reforms. regulatory changes. and macroeconomic stabillza- JIo. (iii) As attested by the contrasting approaches during the mid-1980s, earlier efforts to reduce budget deficits placed undu emhass on uting mxodbum, while 1W s paid to instituting and imlementin a credible tax reform program to raise revenues - by broadening the tax base, promoting a more fair and rational tax structure, and improving tax administration. Fiscal discipline is more likely to be sustainable If expenditure cuts and increase in tax effort are pursued in tandem. -52- (iv) V M in g=, e.g., by eliminating progressively interest subsidies, raising deposit and lending rates to modestly positive levels, moving toward market financing of government debt. Complete deregulation awaited until macroeconomic conditions were reasonably stable, and prudential supervision capacity improved to the point that collusive behavior among banks in the determination of interest rates could be monitored. (v) Credit availability is a prerequisite for eliciting supply and Investment response, and ensuring efficient operation of industry. To increase the available pool of loanable funds, stimulate competition in the banking sector, and improve banking services, ia imperative in Malawi's circumstances to foster the entry of new financial intermediaries by attracting world-class banks. narticularly among those familiar with African condtons. (vi) To alleviate the socio-economic repercussions of certain measures enforced under restructuring programs, it would be expdient to ientify ely on in the design rcess Uartar " lation gouns/industries in need for snecial assistanc, and to ensure that such assistance would be forthcoming for a t Rod. 8.04 The experience with taxrform offers some general guidelines. (i) Reforms may be introduced more easily at a time of a anasi-crisis situation, as structural weaknesses tend to be more evident, and the existing tax system does not provide the requisite foundation for raising more revenue. (11) Tax structures can be rationalized even when data are limited. Making different tax instruments serve distinct functions can help clarify the intention of the reform process in a way that makes it easier to redesign the instruments in current use and to defend proposed changes. Also, tax reforms may be easier to implement if they build on existing instruments rather than introduce entirely new ones. (iii) It is possible to link trade and domestic tax reform successfully. The overall approach adopted in Malawi realigned the non-protective components of existing trade and production taxes so they could function as a rudimentary consumption tax. (iv) Exemption of low-income earners from personal income taxes contributes to the proagressivity of the overall tax system. Nonetheless, it may still be necesnr to ensure additional aro&ressivity in the design of indirect tax rates because these taxes affect the poor, and help compensate for income tax evasion by well-to-do individuals. (v) Exansion of th tax ba and Wmve administrto m be mo mora than rate g. As both processes take time, in the short run, tax reform is not a panacea for deficit reduction without substantial cutting and restructuring of expenditures. 8.05 Attention to particular concerns when designing reform programs can contribute significantly to the sustainabiliy of the adjustment effort (see also para. 8.02 (i), (iv)). -53 - (i) Given the complementarity and mutually reinforcing nature between stabilization and adjustment policies, the pror or conur satisatr ImlMetIde of a sablizati proaram throurh Judicious demand management provides the requisite economic environment and confidence for a more effective implementation and sustainability of industia and trade adiusten maures. (00 Ecoomc stbilit facilittes the prcess of privat invetmen and industrial orientato by providing the right business climate to attract investors. Yet, the magnitude and pace of the required stabilization effort depends, lateala. on access to external fundina to support the reform. In this regard, close collaboration between the Bank, the IMF and the donor community can ensure consistency of advice, enhance the chances of purposeful design and effective implementation of policy reforms, and provide the requisite resources to sustain the adjustment effort. (ili) Persistent fiscal imbalances and a heavy external debt service burden increase the chances of recourse to inflationary means of financing, and add to the pressure to devalue the currency. In countries with heavy indebtedness such as Malawi it may therefore be advisable to conside Som form of debt eiew by GUM= Md& private creditors concerned pdrior to or concurrently with the Implementation of an adiustment program to facilitate debt serviceability and, by extension, enhac te susainbt of the reform progra. (iv) First-best policies may not always be sustainable because of strong opposition. Arguably, more differentiated and nuanced second-best policies responding better to unforeseen shocks and economic. political. and social realities may prove more successful in the longer pull. (v) The Mainabilb of the industrial and trade adjustment effort Is enhanced when the negative effects of the reform effort on growth, employment and living standards are mitigated and short-lived; supply response is fairly quick and visible; the proposed reforms foster both gmth (increase capacity and productivity through new investment) and aquity (by increasing opportunities to engage in industrial production and reap the benefits from productivity gains); actions are credible and sustainable and, more importantly, that they are perceived to be sustainable; there is access to a regular flow of external resources; and there is faith in the determination, courage and capacity of the political leadership to carry out the reforms. (vi) Uninterrupted access to foreign exchan=e is crucial in establishing and maintaining business confidence in the reform program, curbing speculative import demand, and stimulating new investment. (vii) Factors critical to supply response seem to be: getting price relationships correct through adequate exchange rate adjustments, and price decontrol of productive goods and services; maintaining price relationships through effective stabilization programs and periodic exchange rate adjustments; permitting free trade; making foreign exchange available on a non-discriminatory basis for productive inputs and capital goods; removing government restrictions on investment for production, trade and exporting; .54 - reducing the fiscal burden imposed by inefficient parastatals; creating a favorable environment for a functional private banking system; and developing an Infrastructure which can function at a sufficient level of effectiveness. 8.06 The experience with the effectiveness of external financial assistance leads to the following observations. (1) Ral asan can be helpful in promoting reform when It is conceived and presented as a reinforciny agent and as a means of reducin the cost of reforms to which the poliy-makers in the reciient country are already committed. Aid is likely to be self-defeating if it is proffered as a ai a au for the reform commitment itself. (li) Only those forms of aid that have the effect of changing economic, social and organizational structures can provide essential benefits to the recipient. External ASsac therefore should be cicmspec and discrem to avoid thartnovrmn efforts to address pressing economic and sector Issues by providing a convenient cushion. Furthermore, since aid does have an onportunity cost, to assure effective delivery, bilateral and multilateral agencies need to act in concert and take a firm stance to ensure congruity of purpose, consistency in policy reforms, coordination of the total effort and synchronization of actions; prevent the transmission of conflicting signals; and avoid duplication and dissipation of effort. 8.07 The experience with actions that address specific issues on pR a restruc n and qritatn provides some useful insights. (1) It is extremely difficult to dismantle and divest enterorises In the public domain because of the resistance of entrenched bureaucracies and a concerned labor force. The situation is exacerbated when the political leadership is unable to reach a consensus on the divestiture issue; there is distrust of the private sector; undue emphasis is placed on ensuring inordinate indigenous participation in the new ventures; and there is unwarranted preoccupation with the transparency of asset valuation and the social repercussions of worker displacement. (i) The restructurinalprivatisation effort may be Impeded by ineffective arrangements devised to carry out the divestiture program. Such institutional impediments include inadequacy of organizational structures, procedures, and decision-making mechanisms; shortage of technical expertise to devise and carry out realistic financial restructuring programs; and lack of a developed capital market. (1) Development of an Wopropriate oranizational structure and institutional framework. including guidelines, procedures, and a centralized decision-making process isLudal for ensuring smooth implementation of a divestiture program. In particular, it is not epedient to entrust Partial narastatals with the task of prmoting divestiture - for obvious reasons. Therefore, the establishm of a cntral coordinat orai o empowered to deal with the whole range of activities related to parastatal restruc- turing/privatizatlon process Is most ap ro -55 - 8.08 Attempts to streamline the im=or c im and to devise arrangements to pm manufacurng e yield some interesting insights. (1) The na of Import liberalization is conditioned basically on exoort performance. as both by do ic and M rnal economniedannmM the prospects for a stable inflow of foreign resources, and the growth of exports. Furthermore, tariff restructuring ought to be phased in such a way as to allow domestic industry time to improve its competitiveness, while ad.hgc countervailing levies may have to be introduced to ward off unfair external competition and establish a level playing field. (l) Initially, import liberalization tends to widen the trade imbalance due to the increasing disparity of growth between imports (pent-up plus speculative demand) and exports (slow responsiveness), resulting in heavy dependence of the external account on vulnerable traditional exports and consequent reliance on continual donor support. This suggests that hasty liberalization of non-essential imports offering no competition to domestic industry and catering exclusively to the needs of a conspicuous high income garou may not be expedient. as it leads to dissipation of hard-earned and donor supplied foreIln exchange. distortions in the composition of import demand. and suspension or reversal oplie reform mea . Such considerations in the case of fragile economies at a transitional stage do not necessarily run counter to the thrust of an import liberalization program. (iii) Crucial facor constraining the roh ofvat= Mnustr invWten and Srn=r suach as unsound macroeconomic management, debt overhang, emphasis on etinicity in the face of limited supply of indigenous entrepreneurship, difficulties in penetrating foreign markets, geographic location, restrictive regulatory policies, quality of infrastructure, level of real interest rates, limited access to institutional term credit and equity financing, should be duly appreciated and factored in on proiected outcomes of industrial ion and trade refom pgms. Civ) Although automatic adjustments in minimum wages for unskilled workers to compensate for inflation may be socially desirable, as the industrial sector is liberalized and protection is reduced, automatic full compensation without taking into account labor market conditions and the competitive situation of the various industries may not be expedient. Wage flexibility, along with productivity improvement, should be the guiding principles. (v) The stron link between an efficient productlon substructure and export_potential. In view of the constraining effects of smply inelasticities in the short. and even the medium term. should be duly appreciated in efforts to stimulate export garowth. This in turn suggests the importance of macroeconomic stability to maintain investor confidence; the institution of an appropriate policy of foreign exchange rate management; and the creation of an institutional and incentive framework conducive to industrial investment that would broaden the country's export base, including a system of circumspect and time-bound export incentives that encourage backward integration and the opening of export niches. - 56- (v) In a findamental sense, export incentives should be compensatory in nature, counterbalancing discriminatory domestic levies and/or equalizing advantages of competitors due to subsidies; they should not aim at making up for production Inefficiencies. (vii) Promotion of non-traditional exports is a difficult and protracted process. (viii) The net. longer-term benefits of the export promotion zones (EPZs) are not necessarily or alws fuAle. At the beginning of a country's move from import substitution to export-oriented policies EPZs, assuming they are managed efficiently, can play a useful role through their strong demonstration effect. However, EPZs often tend to remain enclaves with few linkages to the surrounding economy. Comprehensive reforms aiming at the liberalization of the economy and, more generally, creation of a favorable economic environment, can perhaps be a more cost-effective and less risky way to deepen the industrial structure and expand exports and employment. Establishment of EPZs, therefore, should proceed with circumspection. (lx) Expansion of foreign exchange earnings from the adoption of an export-oriented strategy can take considerable time to materialize because of binding constraints. This suggests the need for remIlar flows of external funds to sustain the import liberalization effort. Understandably, access to external resources would depend on sound macroeconomic mangeen ad prores in.carryia out policy reform cmmijtmnts. 8.09 In as it outcom of an indusral and ta ausmn p rm. certain limitations in determinin the fill Impact of the poliev packae would have to be appreciated. Sectoral adjustment programs constitute a time slice of a longer process, and their full impact can be ascertained with some certainty only in the longer pull. Normally, it takes time for the measures to take effect and, as a result, at this Juncture only a broad assessment of the effects of the policy reform package and actions taken under a particular program can be made. Moreover, such an assessment may have to be tentative. Because of the synergy of many concurrently impacting factors, some of which may be external, the final outcome is the resultant of a confluence of interacting and interdependent forces, and it is not always possible to establish a clear cause and effect relationship between a particular measurm and its effect on outcome. Furthermore, in practice, a policy package suces and builds on earlier initiatives, and in the course of its Implementation, Is complemented or expanded, by further initiatives. E.g., SALs are usually followed by trade, industrial, or financisl sector reforms, while most reform packages contain a m1ang of sectoral elements all impacting simultaneously, thereby making it difficult to establish unequivocally causal links and quantify their impact. Finally, time lags In the compilation or virtual absence of vital economic indicators at a sufficiently disaggregated level (e.g., on industrial capacity utilization, private manufacturing investment, production costs, non-traditional exports, income distribution, (un)employment) compound the difficulties. A more informative judgment could be made by evaluating the cumulative effect of the composite of Inter-related cluster operations taking a cunt f=cs, and after a reasonable time has elapsed since their completion. ーーーー――ーーーーーーーー一ーー歯一ーーh曲加～由加白関畜国踊レ山自四臨 ..－・‘--\ //\―「\- 舞 _59- AgOdEM2 ftp I ofg LK= OF DEVELOPMNI EQL= NUMM OF PC4A?= VA R= sm CAPWAL CRY LUMOM J Mt. No. C32/1/62/5 24th Mayo 1980 Mr. Barber a. Conable, President, The world Bank, 1818 8 Streets N.W. MINGM, D.C. ag§33 UOS.A. Dear Mr. Conable, The Government of Malawi requests a credit from the International Development Association to support a broad programme of industrial and trade policy reforms. This programme would reinforce macroeconomic adjustment efforts initiated under earlier Structural Adjustment Programmes and allow sufficient mobilization of external resources to recover from the external shocks of 1905-86. As discussed in the Statement of Development Policies issued in 1988 And the Policy Framework Paper of 1988, Government views the reform programme as central to its medium-term development strategy. We review below our medium-term policy framework, the specific actions we plan to cart out* and measures for monitoring programme implementation and impact. !W_kqrgugd Malawi experienced fast growth during the fifteen years following Independence, but economic performance weakened after 1978 as a result of external shocks and Intensification afatructural Imbalances. Falling international prices for export commodities, soaring oil prices# and a gradual disruption of external transport routes through Mozambique led to a deterioration in terms of trade of some 28% between 1978 and 1981 and to a 5.2% drop in GDP in 1981. These external shocks were perceived as transitory and the Goverment tried to maintain *999099te demand and the country I a income level through anpansionary fiscal policies fAanced to a large extent with foraign loans contracted an commercial terms. Za 1981, the Government launched a broad-based structural adjustment programme geared to restoring macroeconomic atability and removing structural constraints. As a results Malawi managed to reduce domestic and external. Imbalances while resuming GOP growth in 1982-85. 2/9 * o -60- Page 2 of 9 A series of new external shocks in 1985-64 derailed the AdJustment process. The closure of direct rail links to Mozambican ports Increased transport costs. In 1986, unbudgeted expenditures for security and displaced persons from Mozambique and budgetary transfers to the Agricultural Development and Marketing Corporation contributed to a central Government deficit equivalent to 13% of GDP. Deterioration of export crop prices exacerbated balance of payments difficulties. As a result of these factors, real GOP grew by only 3% in 1986 and fell slightly in 1987. The deterioration of the macroeconomic environment has had deleterious effects on the performance of industry. The sector's real growth rate has slowed to about 14 per year since 1980, from 10% between 1964 and 1980. Likewise, the annual rate of employment growth in the industrial sector fell from about 70 in the 1970s to It between 1980 and 1986. Macro-Rconomic and Sectoral Adjustment Programme Government began preparing the current adjustment programme in 1987 in response to the deterioration in Malavi's domestic and external financial position. The ovorall reform programme, described in detail in the Statement of Development Policies and the Policy Framework Paper# is designed to stabilize the economy and lay the foundation for a resumption of economic growth. The programe focuses on reduction of the public sector and balance of payments deficits through structural reform and financial stabilization. The government's medium- term strategy for economic growth and development continues to be based on a policy of encouraging private sector activity, managing public sector resources more efficiently, Increasing the role of decentralized decision making in resource allocation, reducing administrative impediments to economic activity, maintaining an attractive environment for foreign investment, while improving the provision of social services. Specific measures include budgetary policies that ensure adequate resource availability to the private sectorl complete liberalization of foreign exchange allocationt and policies to address structural problems in agriculture, transport, industry and human resources. The basic macro-economic objectives for the overall adjustment programme include (1) attaining a rate of real GOP growth of 1.5% for 1988, 4% in 1989, 4.3% in 1990, and 4.94 by 19921 (i) moving steadily toward a sustainable external financial position# and (iii) reducing the annual rate of inflation to about 5 by 1991. 3/... -61- P3of9 Government initiated the current adjustment programe in January 1986 and has aready implemented a number of reforms In fiscal management, exchange rate management, and trade policy. Specific measures implemented to date include devaluation of the Xwacha by 15%, on January 16, 1988; removal of prior Reserve Bank foreign exchange approval on 25% of imports of raw materials and &pare parts in February 19881 a package of current expenditure caute and revenue increases designed to reduce the 1980/89 fiscal deficitl and elimination of external trade payments arrears. Complementary measures Include limits on net domestic assets of the banking system, limits on Government and Statutory Bodies borrowing from the banking system, and limits on new non-concessional external loans contracted or guaranteed by Government. To expand and deepen initial adjustment efforts, Government plans to implement a comprehensive reform package, as described below. in view of the financing requirements of this reform programme, we will continue to seek financial spport from other major multilateral and bilateral creditors and donors and would welcome Bank assistance in arranging co-financing. We would also welcome assistance components. In addition, we have reached agreement on rescheduling of external obligations with the London and Paris Clubs, which will provide additional financial relief for the reform programme. Fiscal Policies The most critical component of the adjustment programme is the reduction of the fiscal deficit. This step will reduce balance of payments pressure, improve private sector's access to credit and reduce Inflation. Accordingly, fiscal policy will be based on lowering the deficit from an estimated 10.7% of GDP for 1987/88 to 8.1% in 1988/89. After grants the deficit would be reduced from 7.2% of GDP in 1987/88 to 3.4% of GDP in 1908/09, a level which can be financed entirely by foreign concessional inflows the 1980/89 budget envisages negative domestic financing of HX 20 million. Government will take special care to ensure that the composition of expenditure is consistent with the overall adjustment programme, the fiscal deficit targets and national develop- ment priorities. Government will review closely the priorities in sectoral budgets and the balance between recurrent and capital expenditures.with a view to ensuring that outlays are sufficient to preserve the Government's effectiveness in promoting development. Government is taking steps to improve information flows from the sectoral ministries in order to monitor and control expenditures 4/0. -62- Page 4 of 9 more closely, keep them in line with budget priorities, and respond more quickl! to changes in revenues. Government will also gi a priority to the social sectors in allocating additional resources, should they become available. Government will continue to exchange views with the Bank on relative priorities of zational expenditures and will seek to ensure that expenditures on social sectors are maintained at adequate levels. Likewise, Government has reviewed the revenue increase measures and ensured their consistency with development objectives and other components of the adjustment programme. We also plan to continue annual preparation of a rolling three-year Public Sector Znvestment Programme. Tax Reform The Government is also committed to improving the equity and efficiency of the tax system and initiated a comprehensive reform programme which began with the 1987/88 budget. The programme aims to improve the structure of incentives facing producers and investors and to ensure that the tax system as a whole is reasonably progressive. Compared with the existing system, the proposed structure reflects a shift from the taxation of international trade to the taxation of domestic transactions, a ahift from the taxation of production to the taxation of consumption, and a shift in the burden of taxation from low to high income groups. The changes that the Government introduced during the 1988/89 fiscal year include the followings on domestic transactions, a first step towards the introduction of a value added tax and changes in the structure of domestic excise taxes from ad rem to ad valorems on income tax, the initial steps for a transition for corporate taxpayers to pay income taxes on a current tax basiss on international trade, an expansion of the duty drawback system to enable exporters to obtain rebates for import duties on inputs used to produce exports more expeditiously. For the 1989/90 fiscal year, Government intends to introduce a tax inclusive budget$ begin rationalising the corporate and individual Income taxy unify the treatment of interest income and expense; and move towards a lower and more uniform import tariff to reduce dispersion and lower protective barriers, 5/... -63- page$ of 9 Trade Policy and Exchang ga.e Management Government is committed to removing the administered foreign exchange allocation system and to reinstating a market-determined system that would allow importers to obtain foreign exchange con request without prior approval. To this end, Government liberalized existing quantitative restrictions on the approval of foreign exchange applications for imports of certain raw materlals and spare parts in February 1988, an amount equivalent to 25% of total 1984 imports of raw materials (other than petroleum) and spare parts* the last year of large foreign exchange inflows and relatively few quantitative restrictions. Subsequent liberalization will focus on remaining raw materials and spare parts followed by most intermediate and capital goods, with a final shift to a negative list. Subject to availability of resources, the next step will cover a further 50% of spare parts and raw materials imports as well as some intermediate finished goods. In support of the elimination of prior Reserve Bank foreign exchange approval for imports, Government will expand its Open General Licence (OGL) system for imports. While more than 85% of all imports are currently subject to OGL# thirty-four specific-categories of goods, and all goods from certain conntries, are subject to import licensing reqirements at the Ministry of Trade, Industry and Tourism. As part of the reform programme to liberalize existing quantitative restrictions on imports and enhance competition in the domestic market, Government will eliminate the licensing requirmeents for 7 goods and for 22 countries prior to June 1988 (the list of goods and countries to be exempted from import licensing are contained in Arrachment 1). The few remaining licensing requirmensts remain primarily in the Interests of either public health, safety, or food security reasons. Government will continue to pursue a flexible exchange rate policy to encourage exports, maintain an adequate level of competitiveness, achieve balance of payments objectives, and support the liberalization of the foreign exchange allocation system and the rationalization of the import duty schedule. As a first step prior to the implementation of the first stage in the liberalization programme, the Kwacha was devalued by 15% in Janaury 1988 to restrain the demand for imporota while reinforcing export Incentives. 6/... -64- Export Promotion The sustainability of the trade reform programme in the medium-term will depend largely on Malawi's ability to generate additional levels of foreign exchange through increased exports. Exceptional balance of payments financing will provide essential external resource flows in the short-term to support the initial liv-Alization, but the future growth of the economy rests on the expansion and diversification of Malavi's export base. Accordingly, Government is committed to enhancing the competitiveness of Malawl exports in world markets and to developing new areas of non-traditional exports. In addition to pursuing a flexible exchange rate policy, Government will continue investing in the Northern Corridor and in the Nacala route to reduce the structural constraints to export growth arising from the high external transport costs. Finally, Government will endeavour to expand the role of private sector initiatives in export development, as explained below. Government will undertake a number of specific policy reforms and project components in support of this export promotion strategy. First, the scope of export regulation will be reduced to streamline administrative procedures and allow producers to meet export orders in a more timely fashion. To this end, Government will eliminate the export licensing requirement for cement and scrap metal prior to June 1988. The few remaining licensing requirements are primarily in the interest of food security, export quality control, and environmental protection. Second, as part of the overall tax reform programme, Government is reviewing a variety of proposals to strengthen incentives to exporters. Exporters are currently legally eligible for import duty drawbacks on imported inputs in export production, but the system has proved cumbersome and difficult to implement in practice. Therefore, Government reviewed the existing drawback scheme and designed a system that provides a flat rebate rate by sector of production according to import contento These changes in export fiscal incentives are consistent with overall revenue and expenditure targets under the adjustment programme. Government will have the revised drawback scheme fully operational by October 1988. Finally, to ensure that exporters have sufficient access to foreign exchange for the imported inputs in their export production, Government will establish an export revolving fund of up to US$35 million in the Reserve Bank, The fund will provide foreign exchange to both traditional and non-traditional exporters and will finance Imports of raw materials, intermediate goods, and packaging materials. 7/.,. -65- Page 7 Of 9 tadustrial Policies The Industrial Development Act was enacted in 1966 to encourage industrial development. Since then the country has experienced marked changes in industrial activities, rendering some of the Act's provisions Inappropriate to present circumstances. The Act provides for the granting of exclusive protection in cases where the Government considers that it would be in the best interest of efficient development of the manufacturing ladustry. These provisions proved useful at one stage soon after Independence when import substitution industry was brought into Malawi. Although this right has been rarely granted, it is still on the books and acts as a deterrent to investors. Government wishes to give clear signals that competition in the industrial sector will be maintained by eliminating this provision. Government revised the Industrial Development Act to eliminate these provisions in April 1988. Price Decontrol Under the Second and Third Structural Adjustment Programmes, Government decontrolled prices on all but five commodities to strengthen the efficiency of resource allocation and improve the structure of incentives. In support of our goal to encourage private sector pricing decisions, Government decontrolled prices on low grade meat in March 1988. Having decontrolled prices on more than 50 goods during the past five years, Government plans to undertake a comprehensive study of the social, fianncial and economic impact of the price decontrolled environment, the impact of price changes on the low income population, and the relation of price changes to the changes in protection implicit in the foreign exchange allocation system. Small*Scale Indautries The growth of small-scale industry in Malavi has been slow, owing to, among other things, limited entrepreneurial experience and shortage of working capital. The Small Bnterprise Development Organization of Malawi (SEDOM) is one of the principal sources of credit to small-scale industries and of important technical assistance to small entrepreneurs. To expand this coverage SEDOM and other such organizations need to provide more technical assistance, increase lending and graduate some of the small entrepreneurs into the commercial banking system. Government aims at increasing the effectiveness of these organizations by improving the quality of their staft through intensive training# by expanding the pool of funds available for leading# anS by strengthenihg and increasing the funding for 8/... -66- ARrMMnt2 pag 8 of 9 a credit guarantee scheme managed and operated by SEDON to make commercial bank credit accessible to small entrepreneurs. Financial Policies The full impact of the macroeconomic adjustment programme is unlikely to be realized as long as these are constraints to financial sector efficiency and growth. Thus# as discussed in the Statement of Development Policies, financial sector policy will be designed to improve efficiency in resource mobilisation and credit allocation, ensure the provision ofadequate levels of credit to the economy, and develop the financial markets. Government will revisethe Reserve Bank of Malawi Act to strengthen the Bank's supervisory authority by April 1989. In addition, Government will strengthen the supervisory capabilities of the Reserve Bank of Malawi and revise the legal and regulatory framework of the financial system. We believe we have laid out in this letter an ambitious and comprehensive adjustment programme that will lead to a significant resumption of economic growth. in view of the measures being taken, the Government of Malawi looks forward to the support fo the World Bank in this endeavour and to your continuing assistance in the economic development.of Malavi, Yours sincerely, L.J. Chim O, M.P. AINItc mIMeWC G ORRMr OF UMWI Attachment -67- page 9 Of 9 Attachment 1 1. Countries to be removed from the list for which an import licence is required for importation of all goodel Afghanistan, Bhutan, Bolivia, Columbia, Costa Rica, X1 Salvador# Guatemala, Honduras, Hungary, Iran, Iraq# Lao People's Democratic Republic, Lebanon, Neal, Panama, Paraguay, People's Republic of China, Poland, Romania Venezuela, Viet Nam, Yugoslavia. 2. Goods for which an import licence will no longer be requireds wheat flour, cement, ghee, vegetable oil$ stationary (except academic exercise books), corrugated iron, soap. 1NUSRYAND TRADE POL1C ADEUSMENTf PROGRA POICY REFORM MTI rtAc ORIECTIVS BACKGRO ND IMF AND oAF PROGRAM ITPAC PROGRAM CONDITIONAUT A.FialPics RAdm.. sWa di~ es to h m~ to igh Red~ dclt in e of~inaof isal dekacitto a Reuon of defi to level occeptabl to dm Bor Praanadan and inaan and crovding om of end-1970 and ndy 190, gAl. 1-H1 levet that an be nanced abmc~ Ba. Second Ttanche Reaa.. cedit and foareign eine to focused a lnpuwed public mct~r e~th~ly by concesionut fogn privat. sector. nunagun and inaone fokowing uond grant. Te specifi Pepurad n of roll~g thue.-year Peblic Sector Second T~anch Reeas. rfors: PSIP review, p eael wfi be reviewed dud~g the Inveamen Program ach year. b0dget, fon~gn boaowing pho, tadff programped in light of increase and - rea~taag. avaleble foreign oonc-e~n De~eit red~ from 15% of GDP in inflowa. Fiscal program in baed 1981 to 9% in 1984. Bt I inreased on new mv~enue~myea yelding to 12% in 1986 du to bgh debt- MK35 mi~s per year, raal ca. service and ea~amahocka, inding in rcuent budget aulag fr drougt, sefig..s and esudt. fra.. on civil ervice employaunt ' and wagu, and no eal growth in B. TrPol and EX*hn~ am Reduce dnua~ic protedo. and Trade regie was eladiely open in Dva~aan of kwacha by 15% in wantanof utafa~toq exa~ny rte. B pard P»ntadln and qua~nh reidions on tde 1960s ond 1970., with few enita January 1988 and ffain of Second Tranche Raka. and iwease compedve~s, selio~Mon mpots. Emeaal flexible n=~ang~ rat policy outward ornadon, and d~e and lfucal pr ifn in 1980 thereafer. *fflci~ yof prodctive sctrs. peacipinmed inida of program. Firat auge coverng 25% of Elnd~et. admfnfia e aeonan adminl«s~v conoa on foreign MTn of phiaed i,po~t Impost. hmplena February 1988. of foreign acang and in~roduce exhange anocado, hghr taif0, and mad program. Firt slage ma~set determined sysem, to nw trade neguldom. Despite acive coverg 25% of Impot. Pwogressively eaand 8 a=aan of fei8n second Tranc ~eka-- ~ ~galn eermfl ulance and exarge ate g in 1980s, Imptamena February 1988. aDunn kpproval aysem to al heposs, Improve eftienacy of d~res. thet. han been a hog. of feign Progesely et leraian ahhig at coptele ibseu~=tn by udd- urna. exchange siem 1986. Dete~rinn of fomign 0etqana appovat 1991. Tin ia to be aged pe befdr tmrm of trade imply Auther real system to a Import, elming at December 1988, scond sage to be deprmciation~s eeded %hr equlibdin. com~plet lbera iatlnn by end of M~ ~ bfo A I99 pregrain nd-1991. Redutlon In acope of lurport lieune and Board Pter-asttnrn Enad~ of al connmea expmn~Donof opngmneraloan system. Ind. a~m~ by JaIa y 1988. -70- m 'i111111 11Iii1 1 i 1 1 1 il Iijaa 們 C戶C叩颼 抓灑叫鬨神·IL。 .72- AUWhm= 4 HALAW I== AND TROLEOM ADJUSTMENT UMAM WX: EVIME OE 3ZE CORWEAnO U* MalawDe"Vmeft COrPOrWOn (MDQ wu established by an Act of Parliament in 1964 as a sft=ty body wholly owned by the Malawi Government- 'Me Purpose, Of MDC is to play a catalytic role in the development of the agricultural, commercial, and industrial sectors, and the mineral resources of Malawi, employing sound business principles. 7bis purpose is to be, achieved through direct investment or in partnership with domestic of foreign private investors. 2. Ite corporate objectives of' MDC we: (9) TO iRveWV" and formulaft projects for the promotion or expansion of new or existing entetprlses, and to implement such projects. This includes identification, promotion, evaluatim and structuring of economically and financially viable projects. (b) To attract technical and commercial know-how, managerial expertise, and investment capital from local and foreign investors. (c) To participate with equity or loans or both in the financing of viable projects initiated by h= or by third parties. 3. MDC will seek to support projects having a positive developmental impact on the country in term of foreign exchange earnings or savings, employment, tecimological development, value added and fiscal revenue. -73- RNDSTR AND TRADE POLICY ADJUSTMENT PROGRAm PRmS CORPORTIO iM~TE: LIST OF SUBSIIR~ (At September 30, 1991) Psrcentage Company of Contrl Natur of Operations Bergers Trading Limited 51.0 R~tailer of lades and gets wer Cartsberg Malawi Brewery Limited 51.0 Brewery Enterprise Containers Limited 62.5 Contaner manuacturer Hardware and General Dealer ited 100.0 Deuler in hardwre and manufacmurer of fritumr Malawi Distilleries Limited 60.8 Di~diler Malawi Pharmacics Limited 100.0 Pharmaoy cha n Maldeco Piheies Limited 100.0 Pishing company National Insuran~e Company Limited 65.0 Insurer Oil Company of Malawi (1978) i Amitm 80.0 Puel and oil distributor PIople's Trafinig Centre LImae 60.0 ,upermarkt chain Press Agriculture Limed and its subsidiaries 100.0 Intermediate holding company Bandanga Limited 100.0 Parming company General Parming Company Limited 100.0 Parming company Press (Faring) Limid 100.0 Parming company Kasikidzi Ra Limited 100.0 Parig company Buwa Tobacco Estates Limited 100.0 Farming company Press Foods Limited 100.0 Food distributor and manufacturer Press (Properties) Lm~e 100.0 Pmoper m an devlop company Press and Shire Clothing Limuted 100.0 Garment manufa~turer Prea Trading (Pty) Limited 51.0 Procurement aenoy (registered in d Repubie of South Afrca) Press Transport (1975) Limhu 100.0 Transpoter Press (Bakeries) i mlud 100.0 Propery holding company Press (Produce) Limited 100.0 Property holding company Sales Servies Limited 100.0 Property holding company Tyre Retreaders Limited 60.0 Tyre retreading company Non-taig subsidiaries R s Prod L~ 100.0 Dormant Malawi Press (1966) Lmkd 100.0 Dormant Press Agencies Limited 100.0 Dormant Press (Engineering) Limie 100.0 Dormant Press Furniture and Joinery Limited 100.0 Dormant Press General Dealers Limited 100.0 Dorant Press Investment Trust Holding Limited 100.0 Dormant Press Ranching Limied 100.0 Dormant Press (Trading) Limited 100.0 Dormmnt Press (Transport) Limited 100.0 Dormat The Oil Company of Malawi im"e 100.0 Dormant Thondwe Bakery Limited 100.0 Dormant g : Press Group, Annual Review 1991. -74- INDJUSTRYANDnTADEP~Y6ADOUSTMPORM PRES CORPORATMON LIMMTD: INVESMENT IN ASSOCIATE COMPANIES (At September 30, 1991) Prss Pas.enge of at Cot gr Corp. Id.'. Shares &~r rtary Valuj 0 Effetive by Group Accouts 1991 1990 Interest Companes Year End Central Poultry Ltd. (poultry farmers) 49.0 49.0 Sep. 30 129 129 Chibuku Products Ltd. (brewing of local beer) 30.0 30.0 Sep.30 614 614 Commer~lal Bank of Malawi Ltd. (bankers) 40.0 40.0 Dec. 30 3,918 3,918 D. Pinto Coelho (Malawi) Ltd. (int~rior doorator) 50.0 50.0 Aug. 31 36 36 Ethanol Company Ltd. (ethanol manufaeturers) 24.4 30.5 Mar. 31 975 975 Limbe LIf Tebacco Company Ltd. (tob~.:o processors) 42.0 42.0 Feb. 28 11,107 11,107 Mandala Ltd. (general traders) 32.1 32.1 Sep. 30 2,008 2,008 National Bank of Malawi (banker) 48.4 48.4 Dec. 31 10,633 10,633 Nw Building Society (buiding society) 15.9 24.5 lan. 31 650 650 Oilmc Ltd (transporter) 36.0 45.0 Sep. 30 45 45 Press Hal St d (Holdings) Ltd. (steul processors) 50.0 50.0 Dec. 31 2,043 2,043 Southern Dottlers Ltd. (sot drink manufaeturera) 25.4 49.8 Sep. 30 1L.20 ..8.96 At Cost or Valuation g At Not Asst Value Net Asset Value at October 1, 1990 97,546 Share of Prota after Tax and Minority Intere t 16,516 Sharo of Revalation Surpes18.178 Not Asset Value at September 30, 1991 Soo: Press Group, Annual Review 1991. -75- Aachme 7 INDSTR AND TRAD EQLIC AD&USMEPRgRAM MD:SHAKRHLDNG IN SUBIDAR COMIE (As of December 31, 1991) 1991 1990 Can Makers (MDC) Limited (In voluntary liquidation) 100 100 Definco Investment Trust Limited (In voluntary liquidation) 100 100 Development Finance Company of Malawi Limited 99 99 Freshcold Fisheries Limited (In voluntary liquidation) 100 100 Gem Company of Malawi Limited 100 100 Mpico Holdings Limited 51 S1 Merolga Knitwear (MDC) Limited (In voluntary liquidation) 100 100 Packaging Industries (Malawi) Limited 85 85 The Import and Export Company of Malawi (1984) Limited 86 86 The Portland Cement Company (1974) Limited 100 90 Tourism Development and Investment Company of Malawi Limited 72 98 g : Malawi Development Corporation. -76 - Atcuen8 INDUSTR AND TRADB POLICY ADZAUSTM PROGRAM MDC: SHAREHOLDINGS IN ASSOCIATED COMPANIES (As of December 31, 1991) Faflty CoRoHod (%) Reporting Date 1991 1990 Chillington Agrimal (Malawi) Limited 12/31/91 40 40 Bata Shoe Company (Malawi) Limited 12/31/91 49 49 Brick and TIle Company Limited 12/31/91 40 40 Capital Developments Limited 12/31/91 42 (11) 42(11) Capital Investments Limited 12/31/91 50 (13) 50 (13) Encor Prducts Limited 03/31/91 23 23 INDEFUND Limited 1231/91 29 29 Malawi Iron and Steel Corporation Limited 12/31/91 44 44 Pipe Extruders Limited 06/30/91 36 36 Leopard Match Company (Malawi) Limited 12/31/91 30 30 The National Insurance Company Limited 09/30/91 20 20 Commercial Bank of Malawi Limited 12/31/91 30 30 Note: The group's interest is shown in brackets where this differs from that of the sub-holding company. * Malawi Development Corporation. C4 0 I g i m i 3. ýn 1 4 ug, i i -e g Ji -78- Attaghmt1 DUSTR ANDZU TRDMPLC ADITM PROGRAM MDC: NCOME STATEMENTS. 1983-91 (At End Dembwr Mx ') 1983 1984 1985 1986 1987 1988 1989 1990 1991 income 2,284 2,534 4,628 3,928 4,744 5,712 6,299 6,995 8,339 Expenditures 3,239 2,851 2,797 2,609 3,107 3,390 4,057 4,171 5,084 Operating Prot (955) (317) 1,831 1,319 1,637 2,322 2,242 2,824 3,255 Plus Net Exceptional Itm (1,868) 5,939 8,782 (574) 793 446 731 (412) (39) Net Profit Befor Tex (2,823) 5,622 10,613 745 2,430 2,768 2,973 2,412 3,216 Tax - - - - - 10 10 Net Profit Ater Tex (2,823) 5,6?2 10,613 745 2,430 2,768 2,973 2,402 3,206 Tranfer from Non-Distributabl Reseves- - - - 53 53 24 24 24 Net Profit (2,823) 5,622 10,613 745 2,483 2,821 2,997 2,426 3,230 Dividend (Prefmnce) - - - 1,059 115 115 115 115 Retained Earnings -2,823 5,622 10,613 745 1,424 2,706 2,882 2,311 3,115 Sourc: MDC Anmal Reports. -79 - MALAWI INDUSTRY AND TRADE POLICY ADJUSTMENT PR M AMARD: INVESTMENTS IN SUBSIDIARY AND ASSOCIATED COMPANIES (As of 19' 2) Value of Company Percentage ADMARC Renarks Held Shares at Cost Subsidiaries 1. ADMARC Canning 100 40,000 Sold to private sector (local) 2. Auction Holdings Ltd. 58 882,615 3. Central Tobacco Prperties Ltd. 68 500,000 4. Coldstorage Co. Ltd. 100 1,079,000 5. Orain & Milling Co. Ltd. 100 5,440,000 J.V. - sale of 51% underway 6. National Oil Industries Ltd. 100 4,086,850 J.V. - completed (ADMARC's shae 22.5%) A=sociAte Comwaies 7. Cotton Ginners Ltd. 99 251,934 J.V. - completed (ADMARC's share 22.5%) 8. David Whitehead & Sons Textiles 49 8,847,020 9. Dwangwa Sugar Corp. 36 14,468,998 10. Finance Corp. Of Malawi Ltd. 100 220,000 11. Investment & Devt. Bank of Malawi Ltd. 22 1,500,000 12. Malawi Tea Factory Co. 40 4,000 13. Manica Freight Services Ltd. so 500,000 14. National Bank of Malawi 31.25 2,013,796 15. National Seed Co. of Malawi 22.50 580,000 Sold to private sector (foreig ) 16. Optichem Ltd. 33.50 564,210 17. Sugar Corp. of Malawi 49 9,300,000 18. Stagecoach Malawi 35 1,391,960 Soyg ADMARC. -80 - Atå#~nn 12 I 55i i I in -81 - MALAWa nUSTY fADiTADEpoLICYADnUSMENMEPRORA LMAIW fTATUTMR MMIE: FINANCIAL.&UMARY 1990/91 AND 1991/9 (As At Marh 31; K Million) Copitm Tota Sautory Body Rmen Net P ~. Assi= L 199091 1991/92 199091 1991/92 1990191 1991/92 199091 1991/92 1990191 1991/92 ADMARC 249.4 324.2 14.6 -0.5 17.2 10.5 39.0 44.6 87.4 88.4 Malaw Ra~lways 27.7 25.8 -8.5 -7.8 38.8 11.4 139.0 149.4 80.0 88.3 ESCOM 75.5 89.6 36.6 38.7 51.0 119.6 289.7 406.9 152.9 254.6 Malawi Developn tCorp. 6.9 8.3 2.4 3.2 2.2 0.4 2.1 2.3 33.0 30.5 Malaw Housing Corp. 21.8 27.9 3.8 4.9 2.1 5.1 24.0 22.7 29.6 42.5 AirMalaw 48.9 6f.4 1.2 2.9 2.1 78.1 13.7 106.7 28.4 99.2 Blatyr Watr Board 16.8 21.4 -0.1 2.0 4.8 9.1 204.6 211.7 27.4 29.0 Llogw Water Board 8.9 11.9 0.7 2.6 23.9 12.4 156.1 180.7 74.7 84.3 Malawi Book Sevice 11.7 11.1 0.1 -2.4 0.4 -2.4 2.' 2.7 0.0 0.0 Wood lad~urie Corp. 7.7 9.7 -0.5 -4.2 0.1 -4.2 5.1 5.1 16.4 21.9 MIDCOR 3.0 4.2 -1.2 -2.2 0.7 -2.2 2.8 3.5 0.0 0.0 Malaw Dairy Indus~res 20.0 0.5 2.9 2.0 1.1 2.0 8.0 22.8 0.8 0.8 KFCTA 8.4 9.7 1.8 3.2 1.2 1.5 11.0 13.3 5.9 5.9 Smaholder Toa 6.1 6.2 0.3 0.3 0.4 2.8 1.0 3.4 5.6 5.6 Smallbolder Coffe 2.1 1.2 -0.9 -1.0 0.9 1.8 3.3 4.7 3.3 3.3 Smallholder Sugar .M .jj . . j _QU _Q.0 .M .U .4 _U TOTAL 1i L ha Ea i"24 am5 JLMil iM ZwLZ assis: Dep%taent of S~utory Bodies. - 82 - Atah n 14 wm (US Mions) 1988 1989 1990 1991 1992 1984-92 A. C ArrentmAcountDeoit 101.1 1625 183.4 198.9 198.9 844.8 8. Debt Repayatts ta 62.5 54.4 40.9 42.2 50.4 250.3 C. R~selve Chansa 99.8 75.0 57.9 42.9 32.7 308.2 1. R~rv Bsuild-p 23.5 32.3 28.7 22.4 14.4 121.3 2. IMP Reputohasea 26.9 25.6 18.6 20.5 18.4 109.9 3. SalmnAt of Artar 46.0 0.0 . 0.0 0.0 0.0 46.0 4. Other ReuM Bank LibJities M -U TOTAL r ANCING REQUIREMBNTS 263.4 291.9 282.2 284.0 281.9 1,4033 A. DibbursemUts from Exiting Connitmmnt å 1. Publio Borrowing 133.5 108.6 108.3 86.4 46.8 483.7 a. Net 0~Oal Transfers 37.9 36.6 41.8 36.5 19.4 172.3 o/_ A4umstn Lmnding 13.6 2.3 0.0 0.0 0.0 15.9 b. Bilat~rul Loans 25.1 23.2 20.9 19.6 11.7 100.5 */w: Adusnt Lnding 11.7 0.0 0.0 0.0 0.0 11.7 o. Ma tnbl~ La P'.9 48.8 45.6 30.4 15.7 198.3 o/w: Adjusmen Leadn 1.4 0.0 0.0 0.0 0.0 1.4 d. IMP Purcase 12.6 0.0 0.0 0.0 0.0 12.6 2. Private Bonowing -U .4 0 -JU -U -JA Total Biing Disbursemets 134.3 109.0 108.6 86.4 46,8 485.2 o/w A**~nant L~ading 26.7 2.3 0.0 0.0 0.0 29.0 8. Diburam~ent from e~ nm n~ 1. Publi Borroing 68.6 143.3 117 98.3 102.0 529.6 a. Net Oial Transfrs 16.5 36.2 14.0 6.8 13.5 87.0 o/w: A4juatnt Lnding 16.1 34.2 10.0 0.0 0.0 60.2 b. Bilater Las. 1,4 22.7 15.3 6.8 10.8 56.8 ow. A4ust et Ladng 0.0 20.0 10.0 0.0 0.0 30.0 o. Mu~lal Loans 25.7 59.3 63.1 84.8 77.7 310.4 ow: Adjustmen~Lnding 22.4 52.5 48.1 60.1 30.0 213.0 d. IMF Purchases 25.1 25.1 25.1 0.0 0.0 75.3 2. Privat Boowing -U . -lå _tu J4u Total E~pcted Disbursemes 75.5 147.7 123.1 111.2 118.6 576.0 o/w A.djus~t Lending 38.5 106.7 68.1 60.1 30.0 303.2 C. Debt Rofid& 53.6 10.9 0.0 0.0 0.0 64.5 TOTAL PINANCING SOURCES 263.4 267.6 231.6 197.6 165.4 1,125.7 ow: Aduatment Lending 65.2 109.0 68.1 60.1 30.0 332.3 t& Caloulated beore debt reUl. & Cømnfat s of Deember 31, 1987. ta Debt Relif ba~d on agfefmentøsgotiated wih London and Paris Clubs in April 1988. : PR No. 4778, Kak-M - bd u d ~P Adlad~ Pm, May 25, 1988, Amex i, p. 3. - 83 - MAIAMI IDUSTR AND TRADE POLIC ADJSME ROLgRAM NOMINAL AND EFFECTIVE RATE OF PROTECTION. 1989 AND 1991 19891 13 1991 & ]I& IM L W S &NPOl NPIIf ENF& NPO R PIZf WW Food processing 13 4 78 39 11 243 47 7 337 Beverages & tobacco 27 17 35 39 27 53 66 27 110 Textiles & clothing 33 8 159 49 33 134 75 33 290 Lather & footwear 74 11 296 50 29 126 80 12 322 Wood & paper prolucts 32 8 109 25 27 19 30 27 40 PlasticelpharmaceutWas 37 12 106 35 23 68 42 23 93 Chemicals & fertilizers 49 11 524 44 23 304 64 23 573 Cement & glass 70 7 575 10 11 0 10 1 0 Steel products 61 13 299 25 24 30 25 24 30 Miscellaneous products 11 12 0 50 25 295 50 25 295 Average& 36 10 140 40 24 101 57 23 190 /a Estimates of nominal and effective protection rates in 1989 are based on actual price observations, i.e. upon direct price comparisons of free trade and domestic prices which held in the market place at that time. As such, they measure the net impact upon domestic as compared with free trade prices of the policy environment - of the array of indirect taxes and of quantitative restrictions and of competitive market conditions. & Estimates of nominal and effective protection rates in 1991 indicate what would have occurred in 1989 if the difference between free trade and domestic prices were accounted for only by the policies prevailing in 1991, i.e. by actual tariffs, surtaxes, domestic surtax suspensions, and industrial rebates applicable in 1991. /g Coefficients reflect the impact of the tariff ol on domestic prices. /d Coefficients reflect the hypothetical effect of the tariff, sales tax, import surtax, and industrial rebateson the domestic prices of inputs and outputs. /, NPO: Nominal Protection Rate on Output. /f NPI: Nominal Protection Rate on Inputs. L& ERP: Effective Rate of Protection. & Average values of effective protection rates have been obtained by weighting the respective subsector estimates by their share of free trade value added. Average values of nominal protection rates are obtained by weighting by the respective shares in outputs or inputs. Su Extracted from T.W. Allen and Associates, Ltd., MalaW Ptecton Study May 1991, Table 2, p. 9. - 84 - MALW INUSRYAND TRADE m POLICY ARTMNRoGRA BEMPOFPARTIAlSPNSOMURTXMNDOMESTCPOUTO Surtax Tariff NRP (4) Seoleted Commodities (1) (2) (3) Prior Current Butter, chee, margarin. 55 55 35 45 45 74 Edible oils(various) 35 35 20 45 45 66 Sugar 35 35 10 45 45 81 Preserves (various) 55 55 35 45 45 74 Beverages, iMrits, vinegar 55 55 35 45 45 74 sentia oils, peroumes,etc. 55 55 35 45 45 74 Cigarettes, eto. 85 55 35 45 45 117 Sops, polis~es and creamo 55 55 35 45 45 74 Mathes 55 55 35 45 45 74 Woven fabrics of cotton (various) 55 85 35 35 35 75 Sy~thetic filament yarn (various) 55 85 35 35 35 75 Synthetic stable fibres (various) 35 85 35 35 35 102 Cans (forclosing) 35 35 10 35 35 68 Electronic god (variou) 55 55 35 45 45 74 (1) Surtax prior to partial suspension. (2) Surtax at the time of suspenuon. (3) Suspended surtax rate levied on domestic production in 1988/89. (4) NRP: Nominal tariff coefficient on the respeotive outputs prior to and after the introduction of the suspended surtax (1991). Somi: T.W. Allen and Associates, Ltd., Proe t May 1991, Table 1, p. 7. -85- I I I I g i, I I I - - 〕需鷹’儸 &,&‘身 應口口口州細口開話．屬•鏽•需繡＿一〝 .87- b9~ Rmi= AND Mi= ~ Mann= Mq~ R~m. m= am LOM enmslh~. i~ (W lom M M 4."3.491 19.18 6,553,~ 13.19 917»1= 4832 20XS.6ý4 28.190~ 39.15 28,607.855 1.46 25.4»,M -0.62 a 3~ 4~1580 SW7,9U 27.79 ?,M~ 2SJ4 9,472,= 20.66 R~ a TO~ 2.523.W3 2.523A33 0.00 2,MýW3 0.00 slýmdm M.01 lad~ 9,428,416 11,M,541 27.M 20.3n,405 41.15 19,414~ -4.73 PM~ lånå13 3.163318 " 4-WLM TOTAL us 2~ loa~ ~ Ri TWAL Rn2EMMM am m am * Im, M M M M 4,773,491 11.11 S~ 9.95 16,553,= 9«W 91~ 2 12.36 A8ro-laduMy 20ýZ%AU 47.14 28,190,3W 49JI 28,W7,US 40«% 2$A29,"3 X16 Fin~ Co^ a 5~ 4~~ 10.21 SW7,M 9.81 ?,M~ 11.14 9,412,383 12.05 m~ a To~ 2.523~ 5.87 2ý523ffl3 4.41' 2,523.033 3 -q sýMM3 6.64 9.428,416 21.94 11,~ 1 20.98 20^ 405 28.91 19,414~ 24.9 ~ 3 2.163.718 Tort, INDESAM - 88 - MALAW INDEANK: BALANCE SHEETS FOR THE YEARS 1985-91 (At Snd-Doember MX '000) 1985 1986 1987 1988 1989 1990 1991 vul Into(nt) 22,992 25,480 26,524 29,136 37,989 39,195 47,445 Fixed asets (Det) 521 497 462 379 372 307 955 Other Assts . .574 6. u.3 4.01 1 3 2 Total As~s 22412 am1 2 å21g &2l3 75f iablite Borrowings 23,133 24,670 26,363 28,451 29,303 33,493 50,733 Other Liabilitis ..L212 .J42 ..L2E .2å(12 _4I20 ..L422 _J,fg Total Liabilities 31.0 2.R 2LZl L11 33J706 39.120 52JZ ar Cpita 5,000 5,000 5,000 6,833 6,833 10,833 10,833 Rsv. .24m .,2 ,Qi Lmf i m lMi Total 5.16 24& a.2 12 Iå2§ 13,71& 16.QZ Total Liabilities and SharholdE Funds 2 31.5l . 52,13 lf ggi: INDEBANK. -89- Attchma 21 INEAZ PROFIT AND LOSS ACCOUNTS FOR THE YEARS 1985-91 (At End December, MK '000) 1985 1986 1987 1988 1989 1990 1991 Interest & Dividends 3,483 4,443 4,478 6,035 7,238 8,653 11,816 Other Income 982 681 631 1,006 1,583 884 1,416 Total income 4,465 5,124 5,109 7,041 8,821 9,537 13,232 Finance Charges 1,865 1,975 2,093 2,311 2,341 2,819 3,658 Other 2,213 2,360 1,902 1,974 1,817 2,724 3,538 Total Expenses 4,078 4,335 3,995 4,285 4,158 5,543 7,196 Profit before Tax 387 789 1,114 2,756 4,663 3,994 6,036 TAUxes 195 414 594 1,387 3,040 1,994 2,369 P.,t Afer Tax &ag: INDEBANK. 1982 19 D : 1984 1R R N 1N 1987 9 im 10 1991 No. of Ru~ 324 200 288 234 120 113 279 192 184 220 No. Ap~nvd 16 7 22 26 13 20 28 33 38 26 Value of L~ans Apoved (K) 801.000 325.000 853.000 1,113.356 940,800 1,608,84 2.348,000 3,183,200 8.619,844 3,047,000 ~ ~lams APinoved 801,000 1,126,000 1.979,000 3,092,356 4,033.156 5,642,050 7,990,050 11,173,250 19,793,094 22,840,994 Avap~lgSLaa (K) 50,0= 46,429 38.773 42,821 72,369 80,445 83,857 96,461 226838 117.192 Appsoval Ra 5% 4% 8% 11% 11% 18% 10% 17% 21% 12% Lm A e in the Yr ( 175,154 423,173 551,250 636.779 729,092 1,461,910 1,222,772 2,297,821 6,781,775 7,272,529 D"""i gImDffi)175,754 598,927 1,150,177 1,786,956 2,516,048 3,977,958 5,200,730 7,498,551 14,280,326 21,552,855 in &h Yr ( 0 11,866 134,886 138,07 239,147 528.771 496,163 359,547 750,469 2,474,425 (K) 0 11,866 146,752 285,459 524,606 1.053,377 1.549.540 1,909,087 2,659,556 5,133.981 m bwc~~ 175,754 587,061 1,003,425 1,501.497 1,991.442 2,924,581 3,651,190 5,589.464 11.6M,70 16,418,874 S CDmna~ D*AplM ovals 22% 53% 58% 58% 6% 71% 65% 67% 72% 94% New Jobs C~ed 467 133 395 310 145 302 486 320 1.720 609 Jobs Cä~ged 467 600 995 1,305 1,450 1,752 2,238 2,558 4,278 4,887 Co~Bob - (CM. loMa~bs) () 1,715 1,877 1,989 2,370 2,781 3,220 3,570 4,368 4,67 4,674 Sector Sectoral D ~rbuionof Lmas (%) Agriut,Ag.IduyB Pishig 41.0 33.1 48.9 39.6 29.8 28.7 33.4 36.1 38.0 34.1 40.0 21.4 15.6 24.0 27.9 33.1 36.3 2S.6 28.6 22.4 5.0 3.7 2.3 1.5 0.0 0.0 1.3 0.6 0.0 0.8 MiningAMaaials 8.0 5.7 3.5 2.2 3.6 0.0 1.1 2.4 0.0 0.0 Hes& To~rimn 6.0 4.1 10.3 15.1 15.9 20.7 15.4 19.7 17.6 18.0 Te~ilee 0.0 17.7 9.3 6.0 5.2 4.1 2.0 2.5 1.6 1.3 Survca Transpot 0.0 12.5 6.3 7.4 13.1 11.0 6.8 7.5 10.8 19.5 Trudig _Q ~U 44 ~U 24 .7 . ~j4 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.4 §8g DMEFUND. -91 - MALAM1 IN IR NDFTPN.DR POLICY ADHUTMEN P9 OGRAM (KEwachao) 1989 1990 1991 CAPITAL EPOE FIXED ASSETS Land & Buildings U12590 Sit,229 Motor Vehicles 133,359 265,861 390.984 Furniture & Fitngs 175.752 146. 392.1 Total At Cost 309,111 445,230 1,141,363 Depreciation 196i 220-04 321i2n Net Book Value 112,127 225,185 819,628 INVESTMOTS General 5,005,916 9,799,083 14,154,342 Lss: Bad Debt Provisions M.M1 (4 1 -M.M Net Invesanests 4,737,153 9,379.541 13,430,454 CURRENT ASSE1S Debtors 1,691,152 1,660,953 2,158,921 Staff Loans & Other Debtors 950,333 1,527,989 Short-Term Deposits 1,043,934 650,000 Term Deposits 999,970 999,970 4,017,565 Bank & Cash Balances ,2L!S 4J2,539 0M21i TOTAL CURRENT ASSETS M.d. CURRENT LIABILTES Creditrs & Accruals 110.711 ..3IIAl .10.408 NET CURRENT ASSBTS ,4P OWNERS EQUITY FMO 776,729 1,187,110 1,187,110 INDEBANK 1,218,885 1,218,885 1,218,885 rMC . 1,000,000 1,000,000 Accumulated Profi(Loss) GA.128 2.2d 1 Total Owner's Fund 1,254,802 3,106,149 3,648,170 OTHER LOANS REQUIRElk LOANS EXPECTED: Readi Project Fund * 145,470 Project Grants (UNDP/READI) 556,556 Technical Service POnd RMO 70,73S 38,686 76,029 Capital Grant 238,500 800,728 117,944 TERM LOANS: READI I 2,555,620 4,233,613 5.454526 FMO 2,410,380 2,000,000 4,919,600 KFWAthe 2.4U 347512 =.27 $80:INDEFUND. - 92 - 92-Attacment 24 MALAW INDUSTRY AND TRADE POLICY ADJUSTMENT PROGRAM INDEFUND: INCOME STATEMENTS. 1989-91 (Kwachas) 1989 1990 1991 INCOME Loan Interest: General 694,758 1,189,181 2,247,283 Term Deposits 195,250 187,000 182,885 Other Income 163,574 181,546 506,447 Appraisal Fee. 112.421 329,279 126,142 TOTAL INCOME L1W600 OPERATING EXPENSES Personnel Costs - Core Operations 493,608 367,012 736,037 - Client Services 225,628 513,392 210,349 Travel Costs 94,163 91,923 221,012 Premises - Office Costs 67,968 74,680 138,833 Gen. Expenses & Training 129,554 162,504 Depreciation 53.,139 55.2g . 1038 TOTAL OPERATING EXPENSES OPERATING PROFIT 231,497 654,903 1,40,8IT4 GRANT INCOME USAID Grants 225,628 285,829 193,656 PMO Grants 69,112 TOTAL GRANTS 225,628 285,829 262,768 FINANCE COSTS 274,067 276,063 421,736 BAD DEBT PROVISIONS 126,095 223,703 710,449 PRfEAX PROFIT/(LOSS) 56,963 440,966 620,767 Income Tax Provision 0 0 78,206 After Tax Profit 56,963 440,966 542,561 Dividend 0 0 0 Acoum. Profit/(Loss) B/P (797,775) (740,812) (299,846) Acoum. Profilt(Loss) C/P (740,812) (299,846) 242,715 EAa INDEFUND. i sii isi tp I 5 -94- C~ LP.MALMAL 0 1980 2.0 - 2.0 - 1981 2.3 - 2.3 14.1 2.3 1982 2.2 - 2.2 -4.1 -13.9 1983 2.3 - 2.3 6.9 -6.6 1984 2.7 - 2.7 18.4 -1.6 195 3.8 - 3.8 38.3 27.8 1986 3.7 - 3.7 -2.4 -16.4 1987 4.7 15.9 20.6 456.1 430.9 198 3.7 31.6 35.3 71.4 37.5 1989 5.9 63.3 9.1 953 80.5 1990 5.9 59.1 6.0 -5.9 -17.7 1991 14.8 82.4 100.2 54.2 42.3 19 22.0 92.5 1143 14.3 -3.5 " R vb*k of m~ und Afla s of d1a LP.C. -95 - Attachmen 27 MALAWI PROFIE OF MICRO SMALL AND MEDIM SIZE ENTERRISP 1. A recent survey estimates that the micro, small and medium (MSME) sectorV comprises some 570,000 enterprises, employing over one million people. Based on a sample of some 10,800 enterprises, close to 90% of the MSMEs are located in rural areas and 10% in urban areas. Approximately two-thirds of MSMEs contribute 50% to household income in both urban and rural areas. Women represented 46% of all MSME proprietors. In terms of sectoral distribution, accounts for 43%, with food, beverages, tobacco, textiles, leather, wood and wood processing, and fabricated metal production being the major activities; trade for 52%; and services for 5%. In terms of size distribution, micro-enterprises comprise 96.4% of the MSME sector, small enterprises 3.3%, and medium enterprises 0.3%. Over 60% of MSMEs are operated by one person, and 97% have one to three workers. The average size of all MSMEs is 1.8 workers; of urban MSMEs, 2.2; and of manufactuing MSMEs, 2.6. The average age of MSME is 7.4 years, but over half are less than three years old. This suggests that the sector is growing not only through expansion of existing firms, but also through new entry; that during 1988-91 there was significant growth, and that mortality rates probably were also high. 2. The majority of MSMEs are first generation enterprises. Some 91% of the proprietors started the business themselves, with 86% drawing on personal andlor family savings. Some 200,000 new jobs were created in the past decade, mostly in micro-enterprises. The average annual employment growth rate of MSMEs was 10.5%. Urban MSMEs grew at a faster rate, 15.9% (m17.8%), than the rural MSMEs which grew at 9.6%. Close to three-quarters of all MSMEs experienced no change in employment since start-up, 3% contracted and only 23% expanded. Of the proprietors, 94% had only primary eduction; 92% had never received technical training; and only 6% had received technical assistance during operation from a government or donor organization (49% women). 3. About50% of manufacturing firms are affected by seasonal variations. Most frequently reported constraints were input, market and financing problems, and less so regulatory, transport costs, and high cost of tools/machinery. Over 80% of all MSMEs had never received any credit, while only 1.2% received loans from a formal credit institution. The percentage increases to 3.2% for MSMEs employing 5 or more workers. t L Daniels and A. Ngwir WeMslts of a Nation-Wide Survey of Micro. Small. and M9t1e Baterarles in Mulawi . October 1992 (Draft), supported by USAID. Mo-eaftrries are defined as thoe enploylag 1.4 workers; umall, those unploylg 5-20 workers; and medium enterprs, those eaploying 21-100 workers. -96- AtUcNt_ 28 MALAWM RWDSTR AND TRADE POLICY ADRUSTMEN PROGRAM RBM: LIOLUDIY RES Ra 06/01/89 10 01/02/90 25 05/15/90 15 06/01/90 10 09/30/90 20 04/12/91 10 08/01/91 15 ia The LRR is caculated a proportion of deposit liabilities of commercial banks (demad, time and savings). Tlie ctual amou~t held in the LRR account at RBM is les the amount of vault cash. gg: RBM. -97- Alani~iest22 (zD emet) 1985 1986 1987 1988 1989a 1990 1991 1992 11.00 11.00 14.00 11.00 11.00 14.00 13.00 20.00 Treasury Bill (91 days) 12.75 12.75 15.75 15.75 15.75 11.50 11.50 11.50 Local Røgistered Stock 16.75 16.75 19.75 19.75 19.75 19.75 15.50 15.50 a. Deps~ Rdme Savings D~posits 10.75 10.75 13.75 10.75 10.75 14.00 13.00 20.00 30 days caU 11.50 11.50 14.50 8.75 8.75 6.00 6.00 13.00 .s mantlm xed 12.75 12.75 15.75 12.75 12.75 13.25 12.25 19.25 6 anis 6xed 13.25 13.25 16.25 13.00 13.00 13.25 12.50 19.50 12 mionthe ~ed 14.25 14.25 17.25 13.25 13.25 13.50 12.75 19.75 b. La~ding Rata Minianu Ldag Rate 16.00 16.00 17.00 16.00 18.00 15.00 14.00 21.00 Maximm ading Rat. 19.00 19.00 23.00 23.00 23.00 20.00 20.00 - a. Depo~ Rdue Si 10.75 10.75 13.75 10.75 10.75 12.25 12.25 17.00 Ivanen 12.25 12.75 15.75 12.25 12.75 13.00 13.20 17.50 6-12nwoits ~ xed 12.25 13.25 16.25 13.25 13.25 13.25 13.25 19.50 13-24 ant fixed 12.75 14.25 17.25 13.75 13.75 13.75 13.75 19.75 b. Motgage Rat owne Ocwupied (< 20000) 13.75 13.75 13.75 13.75 13.75 12.50 14.00 19.00 Ownør Occupid (> 20000) - 13.75 13.75 13.75 13.25 12.75 - - Ruted - 16.25 19.00 19.00 19.00 16.00 21.00 23.00 Conmercial 17.75 17.75 20.00 20.00 20.00 17.75 19.00 26.00 ai 10.75 10.75 13.75 10.75 10.75 10.75 10.75 16.00 IM June. figgig Resrve Bank of Malawi. -98 - (Pnags, End of ~rdod) 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 coa~~s LUd~g (ænuin ' 2.3 0.3 4.6 5.6 1.4 -2.4 0.1 10.8 7.1 -6.6 Savinga -0.5 -0.7 -2.5 -2.7 -1.7 -6.2 -12.1 -9.9 2.7 0.9 -6.6 TI~neD~poubn(12-13^uos.) 1.3 1.1 -0.8 0.4 1.4 -3.3 -10.1 -7.9 23 6.7 -6.8 PoO b8usBank 40.5 -0.7 -2.5 -2.7 -1.7 -6.2 -12.1 -9.8 -0.2 -1.1 -13.8 MLamn Morgage -5.9 5.6 3.6 3. 4.5 -6.2 -9.7 -8.3 1.6 0.7 -12.2 Ph~edDeposb (6-11 uwe.) 0.9 0.7 -1.2 .0.5 0.5 -4.2 -10.1 -7.9 2.0 1.1 -7.0 hnna Dpoa 1.3 1.1 -0.8 -0.9 0.1 -4.6 -10.9 -8.6 1.9 1.1 -8.5 Lmadae~ ~daook 3.4 3.2 1.2 1.1 3.6 - -1.3 -5.0 -6.0 4.1 -10.1 Chag in apokODPDdaot 9.3 11.5 13.6 13.8 12.7 21.3 26.0 22.9 11.0 12.0 283 ggg: Reserve Bank of Malawi, innaladBomiRvie.vadan as iss. .99. Cfm: &M LJM.HM L§bdflnG 1~79 (K M~nos) nti nwManiun-Tan Nauet of Yar Pm~ Total 1987 '0.7 17.6 24.9 1988 107.3 26.3 24.5 1980 132.4 35.3 26.7 1990 1733 41.7 24.0 1991 220.7 66.3 30.0 Sept. 1992 315.2 94.6 30.0 comm ank of Malaw. DuTR AND TRD POIC ADiUnT~ PROGRA (Fiscal Year, Miian Kueebas) 198081 1981/82 1982/83 1983/84 1984/85 1985/86 1986/87 1987/88 1988/89 1989/90 1990/91 1991/2 1992~3B RECEIPrs Reve 199.2 221.0 244.3 286.0 353.2 442.0 476.5 583.4 752.9 991.0 1,034.9 1,164.2 1,291.2 ~ a a 43.3 42.2 41.7 33.7 40.5 29.3 54.5 69.0 209.2 171.6 112.7 2053 208.0 Tol 242.5 263.2 286.0 319.7 393.7 471.3 531.0 652.4 962.1 1,162.6 1,156.6 1,369.5 1,499.2 TOTAL EXPENDM7URE Rmeure Renmr~tu 183.7 231.9 260.7 29.1 364.8 425.6 555.9 616.5 695.2 962.8 1,0603 1,104.2 1,2~.1 Dridlopmen ERp a~ 174.9 124.2 139.6 142.9 138.4 160.2 176.9 207.4 341.3 295.3 311.6 404.9 427.2 E r~budgete: 0.0 36.7 0.0 0.0 0.0 26.0 46.7 - 34.8 34.8 100.0 Ta 358.6 392.8 400.3 432.0 503.2 611.8 779.5 823.9 1,0713 1,292.9 1,371.9 1,509.1 1,796.3 BAANCE 9" Er-d> r -116.1 -92.9 -114.3 -112.3 -109.5 -114.5 -201.8 -240.5 -318.4 -301.9 -328.0 -344.8 -50.1 O~ D~ -116.1 -129.6 -1143 -112.3 -1095 -140.5 -248.5 -171.5 -109.2 -92.7 -2153 -1395 -297.1 FNANCING OF BAANCE Pouig LOMau (ad 40.0 31.3 75.2 95.0 53.0 67.3 112.8 80.0 162.0 190.6 265.4 202.4 295.0 Baowint 62.3 63.1 87.4 112.1 102.7 153.2 210.7 198.2 258.3 284.6 403.2 319.9 412.4 Re9a7waent 22.3 31.8 12.2 17.1 49.7 85.9 97.9 118.2 95.3 94.0 137.8 117.5 117.4 D uu (m> 7.1 98.3 39.1 17.3 56.5 73.2 135.7 91.5 -53,8 -97.9 50.1 -62.9 2.1 Tktal 116.1 129.6 114.3 112.3 109.5 140.5 248.5 1715 109.2 92.7 215.3 139.5 297.1 TAXES ON DIERNATMONAL TRADE Tola Dus 42.1 50.2 52.5 58.5 66.6 92.6 75.1 87.2 112.4 153.1 164.0 216.5 281.6 Cm~tm D~llas 41.6 49.7 51.5 58.1 66.3 73.9 70.3 86.6 113.8 152.2 163.4 215.4 280.8 E mport I.y 0.0 0.0 0.0 0.0 0.0 18.3 4.5 0.2 -3.3 - - O 0.5 0.5 1.0 0.4 0.3 0.4 0.3 0.4 1.9 0.9 0.6 1.1 0.8 aI :Ma Eo R o s - 101 - anDUTR AND TRAD PZLXC ADuaTMERWRA . ~ 2 CNRLGOVERNMN RE9EN~ 198/31991/9 1982/83 1983/84 1984/85 1985/86 1986/87 1987/88 1988/89 1989/90 19991 1991/92 A. IA¥ ~LU5.M U LIAN REVENE 244.3 286.0 353.2 442.0 49.5 583.4 752.9 994.3 1,021.3 1,119.9 Ta~veune 207.7 238.8 296.1 373.5 390.7 451.4 653.7 844 873.2 *7.8 - Cmp~uut Tax 45.2 53.3 72.2 102.3 103.8 96.8 1684 206.1 212.0 215.0 - P*~^omeTax 34.3 40.4 45.0 52 64.9 83.1 109.5 143.5 138.0 142.0 -Tome a~ Gooda 73.8 86.1 110.7 124.1 139.6 181.2 258.5 336.2 353.4 412.1 -Taxe~caTude 52.5 58. 66.6 92.6 80.2 86.7 113.8 152.2 164.8 193.8 - Odm 1.9 0.5 1.6 2.3 2.2 2.3 2.7 5.4 4.6 4.6 Non-TUxRvenn 364 47.2 57.1 68.5 101.8 133.2 99.2 149.7 148.1 152.1 s. m R AGEOFTA.REENU rVENU 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Tax Rve~ 85.0 83.5 83.8 84.5 793 77.4 86.8 85.0 85.5 86.4 . Copa~at Tax 18.5 18.6 20.4 23.1 21.1 164 22.4 20.7 20.8 19.2 - P*roal Iom Tax 14.0 14.1 12.7 11.8 13.2 14.2 14.5 14.4 13.5 12.6 -Tamson ooda 30.2 30.1 31.3 28.1 28.3 31.1 34.3 33.8 34.6 36.8 -TaxmosTmd 21.5 20.5 18.9 21.0 16.3 14.7 15.1 15.3 16.1 17.3 -O i 0.8 0.2 0.5 0.5 0.4 0.4 0.4 0.5 04 0.4 No~-Tex Rvenu 15.0 16.5 16.2 15.5 20.7 22.8 13.2 15.1 14.3 13.4 C. OF REV NU 18.9 19.0 20.0 22.0 21.2 22.3 22.0 22.7 20.1 18.7 Tax Rovenne 16.1 15.9 16.7 18.6 16.8 17.3 19.1 19.2 17.2 16.2 C*p~s Tax 3.5 3.5 4.1 5.1 4.5 3.7 4.9 4.7 4.2 3.6 -Pkbal ~nouTax 2.7 2.7 2.5 2.6 2.8 3.2 3.2 3.3 2.7 2.4 -Tas an Good 5.7 5.7 6.3 6.2 6.0 6.9 7.6 7.7 7.0 6.9 -TamsoT.de 4.1 3.9 3.8 4.6 3.5 3.3 3.3 3.3 3.3 3.2 -Odmr 0.1 0.0 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Non-TaxRvn 2.8 3.1 3.2 3.4 4.4 5.1 2.9 3.4 2.1 2.5 CDPQniBoaKwach) 1,293.5 1504.7 1,768.2 2,010.2 2,322.2 2,614.0 3,417.9 4,388.2 5,069.9 5,975 -103- (On MK M~lon 1982/83 1983/84 1984/85 1985/86 1986/87 1987/88 1988/89 1989/90 1990/91 1991/92 A. AeLmAmN EXPmNDIR 400.3 432.1 503.2 611.9 797.0 823.9 1,036.5 1,202.7 1,426£ 1,487.6 Roun» udgut 260.7 289.2 364.8 425.7 560.5 616.5 65.2 907.4 1,064.5 1.181.3 - bn~es 59.8 55.9 105.6 93.3 152.2 1804 161.3 221.8 181.7 192.3 - Non-Intes=t 200.9 233.3 259.2 332.4 408.3 436.1 533.9 685.6 882.8 989.0 - Was & 41a8s 60.0 76.7 85.4 104.6 132.0 163.1 175.5 198.6 770.6 278.2 -~ as&ubidis 25.0 43.5 33.7 43.6 53.2 54.8 95.5 206.2 213.3 245.0 - Other Goods & S~vies 102.8 107.2 129.1 155.1 207.9 202.6 238.9 245.3 354.8 410.5 -~rosPixedCopifalPormainn 5.1 5.4 8.0 26.6 13.2 13.6 19.5 32.1 39.1 46.5 -Loas&Ca~ 1 ~o . 0.0 0.5 3.0 2.5 2.0 2.0 4.7 3.4 5.0 8.8 Dv~opant udgut 139.6 142.9 138.4 160.2 189.8 207.4 341.3 295.3 362.0 306.3 xma-Budgery& 0.0 0.0 0.0 26.0 46.7 0.0 0.0 0.0 0.0 0.0 DEFICIT -156.0 -146.1 -150.0 -169.9 -304.5 -240.5 -334.5 -359.2 -2803 -2543 PINANCING 156.0 146.0 149.9 149.9 304.4 240.5 334.5 399.2 280J 2543 Gra 41.7 33.7 40.5 47.6 51.7 69.0 82.1 91.5 2043 82.0 Posei8 Lomns (nm 75.2 95.0 52.9 73.6 99.8 80.0 i15.4 185.9 70.6 114.4 - Borwsg 87.4 112.1 102.7 143.2 219.8 198.2 356.3 289.5 150.2 209.6 - RlpUnmn 12.2 17.1 49.8 0.6 120.0 118.2 140.9 103.6 79.6 95.2 Do~nse Bowi~n (nO 39.1 173 56.5 48.7 152.9 91.5 37.0 81.8 5.6 57.5 B. AS Pe OF TOA gXRN u EXPENDITURM 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 R=rntBudge 65.1 66.9 72.5 69.6 70.3 74.8 67.1 75.4 74.6 79.4 - In~efst 14.9 12.9 21.0 15.2 19.1 21.9 15.6 18.4 12.7 12.9 - Non-bft~ 50.2 54.0 51.5 543 51.2 52.9 51.5 57.0 61.9 66.4 - Wages & Saaie 17.0 17.8 17.0 17.1 16.6 19.8 16.9 16.5 18.9 18.7 - G ans& Subnidu 6.2 10.1 6.7 7.1 6.7 6.7 9.0 17.0 14.9 16.5 -OdherGoodd&wS vis 25.7 24.8 25.7 253 26.1 24.6 23.1 20.4 24.9 27.6 - GOm id Cape~n Fom 1.3 1.2 1.6 4.3 1.7 1.7 1.9 2.7 2.7 3.1 - Las &Capia Tmmtm~ 0.0 0.1 0.6 0.4 0.3 0.2 0.4 0.3 0.3 0.6 Develognaent9dge 34.9 33.1 27.5 26.2 23.8 25.2 32.9 24.6 25.4 20.6 Exra-Budgeay& 0.0 0.0 0.0 4.2 5.9 0.0 0.0 0.0 0.0 0.0 DEPICIT .39.0 -33.8 -29.8 -27.8 -38.2 -29.2 -32.2 -29.9 -20.0 -17.1 FINANCING 39.0 33.8 29.8 27.8 38.2 29.2 32.2 29.9 20.0 17.1 Grnts 10.4 7.8 8.0 7.8 6.5 8.4 7.9 7.6 14.3 5.5 Pos~ign Lone (an) 18.8 22.0 10.5 12.0 12.5 9.7 20.8 15.5 4.9 7.7 - Bous~ng 21.8 25.9 20.4 23.4 27.6 24.1 34.4 24.1 10.5 14.1 - RpayMan 3.0 4.0 . 9.9 11.4 15.1 14.3 13.6 8.6 5.6 6.4 Domesto Dowing (MOl 9.8 4.0 11.2 8.0 19.2 11.1 3.6 6.8 0.4 3.4 - 104-- ~g2 of2 198283 1983/84 1984m5 1985/86 19887 1987188 1988189 1989/90 1990/91 1991/92 C. As.JCNTG OF GD EXPENDITUR 30.9 28.7 28.5 30.4 34.3 27.8 30.5 27.4 28.1 25.0 R~u9ml Bud 20.2 19.2 20.6 21.2 24.1 .0.8 20.3 20.7 21.0 20.0 -Intrst 4.6 3.7 6.0 4.6 6.6 6.1 4.7 5.1 3.6 3.2 - No-kst 15.5 15.5 14.7 16.5 17.6 14.7 15.6 15.6 17.4 16.6 -Wags&Saliss 5.3 5.1 4.8 5.2 5.7 5.5 5.1 4.5 5.3 4.7 - CGnt &S~in 1.9 2.9 1.9 2.2 2.3 1.9 2.7 4,7 4.2 4.1 -OmtGoods&Servius 7.9 7.1 7.3 7.7 9.0 6.8 7.0 5.6 6.9 6.9 . Gro Pled Capal Form~åon 0.4 0.4 0.5 . 1.3 0.6 0.5 0.5 0.7 0.7 0.7 -~Loans&Capnu1Tanstei 0.0 0.0 0.2 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Development Dud8~ 10.8 9.5 7.8 8.0 8.2 7.0 9.9 6.7 7.1 5.1 Bot-Budtay/ 0.0 0.0 0.0 1.3 2.0 0.0 0.0 0.0 0.0 0.0 DEPICrT -12.1 -9.7 -.5 S.5 -13.1 -4.1 -9.8 4.2 -5.5 .4.2 FINANCING 12.1 9.7 8.5 8.5 13.1 8.1 9.8 8.2 5.5 4.2 Ganis 3.2 2.2 2.3 2.4 2.2 2.3 2.4 2.1 4.0 1.2 Poruign Loan (ud) 5.8 6.3 3.0 3.7 4.3 2.7 6.3 4.2 1.4 1.9 - Bonowhig 6.8 7.4 5.8 7.1 9.5 6.7 10.4 6.6 3.0 3.5 - Relament 0.9 1.1 2.8 3.5 5.2 4.0 4.1 2.4 1.6 1.6 Dom~ &m~ (MowiO() 3.0 1.1 3.2 2.4 6.6 3.1 1.1 1.1 0.1 1.0 §gig Mlw cooi Rnr.Varos~sus A.ls -9 15 - m 1~ INRU8H1mAl AlUffRA olml sevice 76.46 89.15 10.28 111.49 149.04 151.78 211.99 256.70 310.38 381.84 Ruet 53.02 62.34 74.41 87.95 124.54 126.37 156.19 208.72 239.95 245.13 Developmen 23.44 26.81 27.87 23.54 24.50 25.4 55.80 47.98 7043 136.71 £du~asl 51.25 55.60 58.36 67.11 80.11 84.54 114.44 136.10 167.29 198.41 24re et 31.58 35.46 40.08 46AS 61A0 69.95 83.23 111.29 127.07 134.55 Deueopmnt 19.67 20.14 18.28 20.66 18.71 14.59 31.21 25.81 40.22 63.86 maRh 21.19 28.12 37.49 41.79 52.72 49.68 73.09 92.86 11.79 146.03 R«~ 17.42 21.60 28.03 39.04 47.06 40.75 50.30 71.49 76.93 80.20 Dveopnt 3.77 6.52 9.46 2.75 5.66 8.93 22.79 21.37 25.86 6.83 Com^. & SoM. Deve l 4.02 5.43 6.43 2.59 16.21 17.56 24.46 26.74 40.30 37A0 Rea~ent 4.02 5.28 6.30 2A6 16.08 15.66 22.66 25.94 35.95 30.38 Devffpnu 0.00 0.15 0.13 0.13 0.13 1.90 1.80 0.80 4.35 7.02 B. As ERfica~GE F T r DTUR Soial Srvice 19.10 20.64 20.33 18.22 18.70 18.42 19.79 19.85 22.62 25.30 ROMn~t 13.25 14.43 14.79 14.37 15.63 15.34 14.60 16.14 1749 16.24 Develpment 5.86 6.21 5.54 3.85 3.07 3.09 5.21 3.71 5.13 9.06 Ed~ulan 12.80 12.87 11.60 10.97 10.0 10.26 10.68 10.53 10.19 13.15 Romffi t 7.89 8.21 7.97 7.59 7.70 8.49 7.77 8.61 9.26 8.92 Dvdopmn 4.91 4.66 3.63 3.38 2.35 1.77 2.91 2.00 2.93 4.23 H1IÉ 5.29 6.51 745 6.83 6.61 6.03 6.82 7.18 7A9 9.68 Ruanent 4.35 5.00 5.57 6.38 5.90 4.95 4.70 5.53 5.61 5.31 0.94 1.51 1.88 045 0.71 1.08 2.13 1.65 1.88 4.36 Comm. & So. Devdopn 1.00 1.26 1.28 0.42 2.03 2.13 2.28 2.07 2.94 2.48 Reu~n 1.00 122 1.25 0.40 2.02 1.90 2.12 2.01 2.62 2.01 Deveopmnd t 0.00 0.03 0.03 0.02 0.02 0.23 0.16 0.06 0.32 0.47 C Al PERCENTAG OPGD so9~l Sevices 5.91 5.92 5.78 5.55 64 5.13 6.20 5.85 6.12 6.39 Reou~n 4.10 4,14 4.21 4.38 5.36 4.27 4.56 4.76 4.73 4.10 Duvclpmnt 1.81 1.78 1.58 1.17 1.06 0.86 1.63 1.09 1.39 2.28 Bd~amatt 3.96 3.70 3.30 3.34 3.45 2.85 3.34 3.10 3.30 3.32 Reomnt 2.44 2.36 2.27 2.31 2.64 2.36 2.44 2.54 2.50 2.25 D«d 1.52 1.34 1.03 1.03 0.81 049 0.91 0.59 0.79 1.06 u~ 1.64 1.87 2.12 2.08 2.27 1.68 2.34 2.12 2.03 2.44 Recu~ent 1.35 1.4 1.59 1.94 2.03 1.38 1.47 1.63 1.52 134 Dvdopmnst 0.29 0.43 0.54 0.14 0.24 0.30 0.70 0.47 0.51 1.10 C m n. a. DdrApmnt 0.31 0.36 0.36 0.13 0.70 0.59 0.72 0.61 0.79 0.63 Rocune~t 0.31 0.35 0.36 0.12 0.69 0.53 06 0.59 0.70 0.50 Dvdopmnt 0.00 0.01 0.01 0.01 0.01 0.06 0.05 0.02 0.08 0.12 1 ij liaa i 1 a sina i 5 1 i i es 41 i *a s 11 -107- 1985 1996 1967 1980 1989 1990 1991 1992 R ak Of Ma~sel 34.1 33.7 36.8 40.5 43.8 40.9 40.7 38.6 C4mEu~ci S~an 42.5 42.9 41.0 36.5 40.0 42.1 43.6 45.6 NafinanlfBonk of Mm l 30.2 31.5 28.4 24.2 25.8 27.9 28.0 30.1 c"w ank Mahl 12. 11.4 12. 12.3 14.2 14.2 15.6 15.5 i "M . g.4 0.7 1.3 1.8 2.9 2.4 2.9 3.0 NOw Building oiy 2.4 2.3 2.4 2.9 2.7 3.2 4.1 4.8 Del n fr== h*~ 7.4 6.8 6.1 5.6 - - - P« ~Ofe in8 auk 5.4 5.2 5.5 6.1 - - 1mm~. ..u . .1 u .0 -19u j 180 -Au -A_ TOTAL10. 10. 10. 10. 10. 10. 10. 10. Sme W R ~eeBn of k~tue - 108 - (Prenhaes,a lEnd of YGar) Institud~n 1985 1986 1987 1988 1989 1990 1991 1992 RBM 39.4 32.2 38.0 34.9 32.9 25.4 23.4 23.9 CommecalBanksa 40.5 27.3 23.6 26.9 28.2 31.3 32.2 32.6 (N0M) (23.3) 19.2 16.0 17.0 18.0 20.6 21.4 20.9 (CBM) (17.2) 8.0 7.6 9.8 10.2 10.8 10.8 11.7 DFIs 3.1 - - - - PosBe 7.0 5.5 7.0 - - Inurace Compane 7.1 5.7 5.2 7.2 6.7 8.1 6.9 5.7 Ote 2.0 2.1 2.6 4.2 4.0 3.8 5.3 5.2 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Total in million MK 881.3 1,357.6 1,494.6 1,412.7 1,758.5 2,053.3 2,525.3 3,191.7 Total in miDion US$ 522.7 738.3 676.0 550.7 637.7 752.1 900.8 934.5 ä Figures ar not cowaoi~datad & Commerial bank a~sta cxlud customs' labiltis on PM P0~B ats and advaces are a of Septeber 30,1985. hi9: Rewe Bank of Malawi, Fi and Emmdcooi . varous issu. -109- A8iulu£m ei-y, TranmpoAt Foestr Ter. and and Pialdag Mining Manufacturing and Gas Coanuon Trade oom..nl.aes." Pnano Caueatly Bana Toel 1980 92.7 0.4 6.7 0.0 1.5 16.5 4.0 35.5 9.7 5.2 172.2 1981 94.3 0.3 6.1 0.0 1.3 20.4 6.8 39.7 13.9 7.0 189.8 1982 115.1 0.2 7.8 0.1 1.3 19.7 3.4 45.8 22.4 6.3 222.1 1983 138.5 0.3 10.8 0.1 0.9 30.7 8.5 55.2 15.8 3.3 264.1 1984 113.5 - 19.8 0.5 0.4 29.8 1.1 18.4 7.5 13.3 204.3 1985 117.9 0.3 9.2 0.0 1.0 69.0 1.7 2.3 12.8 6.6 220.8 1986 133.5 0.0 15.3 0.0 1.4 41.5 0.7 6.5 25.2 8.1 232.4 1967 109.9 0.0 24.7 0.0 1.7 34.7 0.6 2.3 23.6 6.6 205.4 1988 92.3 0.6 48.6 0.2 1.4 71.8 0.9 20.3 9.3 9.3 270.3 1989 125.7 0.8 83.4 0.0 2.5 105.5 6.8 24.9 15.0 11.4 376.1 1990 136.2 0.7 119.2 0.5 4.6 173.6 13.2 43.4 12.2 9.4 513.0 1991 143.3 0.4 114.2 0.0 8.8 212.6 21.5 69.4 8.7 25.9 40.8 1992 241.6 0.3 136.4 0.0 6.6 345.5 243 39.3 9.7 34.8 838.7 a Zune, 1992. ggigg8 Reserv Bank of Malani. - 110- XAttachment 40 k~me 1980 1981 1982 19m 19m 1985 1986 1987 1988 1989 1990 1991 1992 Agd~utu. 53.8 49.7 51.8 52.5 55.5 65.1 57.4 53. 34.1 33.4 26.5 23.7 28.8 Mi&a Quayn 0.2 0.2 0.1 0.1 - 0.2 .2 0.2 0.1 0.2 - Mån 3.9 3.2 3.5 4.1 9.7 5.2 6.5 12.1 18.0 22.1 23.2 18.9 16.3 E ~eoidiy, WatGas - 0.1 - 0.3 0.1 - 0.2 - - 0.1 - - Co0n~sion 0.9 0.7 04 03 0.2 0.5 0.6 0.8 oj 04 0.9 1.5 0.8 What-AnafR~lkIede 94 10.7 8.9 11.6 14.6 15.9 17.9 17.1 26.5 28.1 33.8 35.7 41.2 Tm~&rmm..~ 2.3 3.6 1.5 34 0.5 1.0 0.3 03 0.3 1.8 24 3.6 3.1 &a.n. veu 206 203 20.7 20.9 9.0 1.3 2.8 1.1 7.5 6.6 8.5 11.5 5.2 c..ay&So~ia8srvices 5å 7.3 10.1 6.0 3.7 7.1 10.8 11.6 9.1 4.0 2.4 13 1.4 8~ Afo~wi 3.0 3.7 2.8 1.2 63 3.6 3.5 3.2 3.4 3.0 1.8 4.3 3.2 TOrAL 100.0 100.0 100.0 100. 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Tad In a M K 172.2 189.8 222.1 264.1 204.3 181.2 2324 200A 270.3 376.1 513.0657.0 782.8 r: n tm*'- r e.. uLseenmk ~, ~: iuuw ak o Mal,1, - - 111 - Attchmnt41 MA1AWM eiD =R N TAEPLC ADU§ ~EN PRZ RA DX OF DuiALPOUCg~a 909 (1984 =100) Godm Maufactured Maly for the Domesde M0d~c Good Manlyfor PiaeCnupe Fo, Fowr,Products for General B~rag hing & Othero au idingand Export Total E~tricity adul PWrWo & Tobs=c Te~e God Tota Consruedl Tota Good Maneni g &ater Pwod~si W~lsbts 13.0 9.0 23.0 45.0 18.0 63.0 23.0 86.0 14.0 100.0 1980 105.5 107.6 91.0 98.5 141.9 110.9 80.0 102.6 83.3 99.9 1981 131.7 113.5 93.9 108.7 116.8 111.0 74.5 101.3 84.1 98.9 1982 116.2 122.0 71.2 94.4 103.3 96.9 85.3 93.8 88.7 93.1 1983 131.8 132.3 98.3 114.8 102.7 111.3 86. 104.7 95.7 103.4 1984 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 195 111.8 75.4 115.3 106.3 99.9 104.5 100.4 103.4 102.3 103.2 1986 111.3 91.5 117.0 110.3 109.3 110.0 89.8 104.6 109.7 105.3 1987 115.2 89.9 114.0 109.5 80.8 101.3 87.7 87.6 119.9 100.8 1988 127.6 64.2 120.5 111.3 98.0 107.5 95.2 104.2 121.7 106.6 1989 151.7 66.4 128.4 122.8 113.3 120.1 95.1 113.4 130.8 115.8 1990 162.5 76.8 146.0 137.0 126.0 133.8 117.8 129.5 145.5 131.8 1991 148.3 114.7 157.5 146.7 125.4 140.7 123.4 136.0 154.0 138.6 1992 g 169.1 104.2 128.0 135.1 127.2 132.9 109.4 126.6 164.3 131.9 a Exluding= ng and quaryng and coverng ostffailutsmployng 100 and more peple. &M Soap, nawbee, urnitr, printing and publishing. j8 Sepeberm 1992, preldminary. aigg:Näd~a &e.la Offkco, Mont~ tdtca ultn - 112 - IMPOR'3 BlY END USB..1980-89 (Million Kwachs) nd Use 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 cosumer Good.: 40.9 41.7 44.5 47.5 45.5 61.6 64.8 68.6 100.3 155.2 Non.duableSods 34.4 34.5 37.5 41.4 38.9 53.0 54.5 57.4 84.0 129.0 Durable goods 6.5 7.2 7.0 6.1 6.6 8.6 10.3 11.2 16.3 26.2 Plant, Ma~y&Equipment: 50.3 37.6 35.8 44.1 41.3 72.1 66.4 123.6 167.1 207.9 Op~rtng mamins 27.3 21.9 20.5 29.1 22.5 42.7 37.5 68.4 112.9 140.5 Auuiliary .quipment 23.0 15.7 15.3 15.0 18.8 29.4 28.9 55.2 54.2 67.4 TnaPo Me~n: 61.2 29.3 28.8 38.8 42.4 64.0 71.1 60.4 132.9 199.5 Motora & bi~ys 6.5 4.2 4.0 7.1 6.3 11.3 9.8 7.3 11.9 29.2 Othor 54.7 25.1 24.8 31.7 36.1 52.7 61.3 53.1 121.0 170.3 Products for building & conutruction 30.9 19.3 22.8 18.7 18.3 29.7 26.1 31.1 66.7 79.2 for n 106.1 116.3 120.7 133.2 157.2 189.6 158.8 247.1 425.0 524.1 Purb, ols&mboeä~nan p n 10.6 10.0 10.9 10.8 10.1 16.3 17.9 20.9 34.0 43.5 c4mnwiti~ for intum~dat & finao n : 56.4 57.2 58.7 68.7 65.7 70.9 69.8 98.2 145.5 178.9 5.7 8.2 8.4 9.4 8.1 11.1 10.4 8.3 21.1 29.9 Oil, fus & lubrint 50.3 48.9 49.6 59.2 55.9 58.5 58.7 89.2 124.1 144.0 Othr 0.4 0.1 0.7 0.1 1.7 1.3 0.7 0.7 0.3 5.0 Impots under K20 0.2 0.1 0.2 0.2 0.1 0.1 0.1 0.0 0.0 0.0 Mkdh~nou _trasation .i .u 9 . .l _. u . . T-TAL 2Z E?ad E fL2 EkZ I2 å%2 MLI J2Lf Igggg Nation S~iel Offie. ~IU~~ij~~ I I ~ I I - ii i I i I - 114 - (Kwa~lhe) ndustry Group ad Sctor 1987 1988 % 1989 % 1990 % AB Induri Total 80.67 87.17 8.0 99.97 14.7 112.25 12. 1iate 78.08 85.08 9.0 97.69 14.8 109.66 12.3 Governmet 89.42 95.42 6.7 107.45 12.6 121.25 12.8 Agrå~ultur. Forsy & PlÄhig Total 29.08 30.50 4.9 33.17 8.7 39.16 18.1 PdvMe - 26.67 - 33.25 24.7 35.33 6.3 Govnammnt - 58.83 - 66.08 12.3 67.33 1.9 Min&Quarry~ng Total 42.92 43.17 0.6 46.67 8.1 125.301683 1p~ub - 43.17 - 46.67 8.1 125.30168.5 Government - - - - - -- mo m Total 125.75 135.67 7.9 147.00 8.4 176.75 20.2 Pata - 136.92 - 148.50 8.5 180.08 21.3 Govemet - 98.08 - 98.00 0.0 104.00 6.1 Ee & Wa Total 116.50 135.17 16.0 152.7 12.9 174.91 14.6 pae - 148.50 - 167.27 12.6 196.16 17.3 Govurm- 80.33 - 82.08 2.2 86.00 4.8 nna & Constuction Total 64.58 73.08 13.2 80.25 9.8 84.66 5.5 plat- 79.83 - 86.58 8.5 88.91 2.7 Governmmnt - 37.00 - 49.08 32.6 59.25 20.7 Wh~aia Rtd Tad, ous T& Ram Total 90.42 140.58 55.5 183.26 30.4 225.32 23.0 Ivat - 142.17 - 185.30 30.3 228.02 23.1 Gvrment - 46.58 - 46.97 0.8 47.91 2.0 Tapot,Stoe eam Total 103.80 126.08 21.5 171.83 36.3 175.50 2.1 pata - 124.00 - 178.92 44.3 181.41 1.4 Govnment - 133.92 - 127.75 -4.6 138.75 8.6 Pn~ign m&Þamsr~ Total 327.25 364.75 11.5 412.92 13.2 433.58 5.0 piate - 391.08 - 439.67 12.4 460.58 4.8 Govermant - 69.00 - 89.08 29.1 92.33 3.6 Com~uniy, Social& Personal servis Total 117.58 124.83 6.2 147.92 18.5 158.66 7.3 Piat. - 152.42 - 178.08 16.8 179.16 0.6 Goverment - 115.17 - 137.00 19.0 151.42 10.5 gg: M~nity of Idusty. - 115- PYl9 PY9@ PY9I PY92 to daie 1. Agiculinal lapi. 978.5 - - . 9g8g5 2. Arnalracs.y a seg.-- 121.1 - - - 121.1 m. 3,018.9 6,311.7 1,168.9 . 10,4095 4 knW m m" 18,=. 42,301.6 5,30.2 s6.,7o. 5. hbm em..m.2= 'I. LOal Depulmait Wd But ECONOMIC PLANNING. - 117 - 21-06-93 16:47 (321 #1 * n PQ p a w qe t No. ................................. Page 1 of 4 OFFICB OF THE APESIDENr AND CADDET amanes ZcONOMIC PLANNINo AND DEVLOPMENT the au awt shness aDeee P.O. BOX 30134 CAPMAL CITY LLONOWE 3 MdALAWI Ref. No. MP/1 7/4 Comt Receive &rom t EconMIc Plannin ad DeOomen Demadmn 16th June. 1903 Mark Baird, Division Chief. Country. Policy, Industry and Finance. 0 erations Evaluation Department. World Bank. 1818 H Street. N.W.. Washington D.C. 20433, U.S.A. Dear Sir. O*AWENTS ON MALAWI-INDUSTRIAL AND TRADE POLICY ADJUSTHINT PROURAMME (ITPAP DRAFT PERORMANCE AU T MYOW1 GHtoMAL aOXMMENTS The audit report is very comprehensive and covered even areas that are not relevant to ITPAP. It has infact gone beyond ITPAP to current past programs that followed ITPAP and in the process lay some preliminary ground for tiny further adjustment program the current can envisage. Regardless of whether that is part of report's terms reference the effort is commendable. The report style. unfortunately. necessitated too many repetitions. May be the style is PAR standard but the following observations arc. nonetheless, impcrative:- () ('hapter IV "'windings and Issues" could be combined with part of Chapter VIII "Lessons and Recomondations". Recommendations scould have their own chapter leaving the lessons to be part of the chapter dealing with .n findings and Issues. The recommendations should follow pam $2 not only from the lessons but also the findings and issues. Further. the recommendations ought to be clear and is easy to translate into action. Lessons would flow very well if specifically related to the findings and issues. So far the lessons appear academic and sumetimes unclear. ECONOMIC PLANNING. 21-06- 3 16:47 1323 #2 118 Page 2 of 4 (Ii) If the proposal In (1) is acceptable the sequencing of the chapters starting from IV could bc as follows:- Chapter IV Credit Administration. Coordination and utilization Chapter V Overall Assessment of Results Chapter VI Sustainability of the Adjustment Effort Chapter VII Findings, issues and Lessons Chapter Vill Recommendations SPECITFIC COMMENTS Paragraphs 5. 3.34 - 3.36. The improvement in management-lubour relations is not necessarily as a result of the import liberalisation. In fact with the Import IIherulisation there was some squeeme on profit margins and Pam.s that Is not conducive to management-labour relations. Tf anything, the *improved" management-labour relations were as a result of the dWhour unrests of May 1992. Moreover, pasagraph 3.36 seems to correct the assertion. Paragraph 6 and related paragraphs While it is acceptable that there are still structural tigidities In the econmy. it is rather unfair to conclude that there are barriers to entry and ethnic discrimination against non-indigenous ft Malawians. Structural problems. which arc endogenous. are not An. barriers to entry, which are exoucnous. As for the ethnic discrimination, it is unfortunate that investment in industry is taken as commerce in rural areas. The conclusion would be true if investment in industry is dependent on or tivd to establishing commercial outlets in the rural areas by the Asains. Paragraphs 16 and 6.02 The pace of liberallsation was fast but the key phrase is, in retrospect. It would be ignoring a fact if we say that the whole t uestion of liberalisation was not discussed thoroughly including the Pwa. tv- emerits. In fact. the last sentence in paragraph 16 may hold the . key to the pace of the import liberalisation program. Without dwelling too much on spilt water, the comment here is that the Antended results of the Ulberalisation did not materialise. However, eXpecting export growth to have marched the import growth would be too optimistic bearing in ind the deep-rooted supply rigidities. ECONOMIC PLANNING. 21-0-93 16:48 (32] 4 -119 APei 3 of4 Paragraph 2V and related paragraphs This paragraph gives a very gleam picture of the 1alaw; economy. It seems to imply that the existing companies have covered all areas of the economy leaving no room for new entrants. aier qas That is not necessarily true especially when considering small and "* b medium enterprises. in fact, since the liberulisation new companies " a have sprung up. There are areas where new investors can go into without bothering into areas where the report alleges that are inaccessible. Once again, it rather strange for the report to imply that Asian entrepreneurs are discriminated against in industry. Paragraph 24 One gets the impression that LPZ's can only be useful if utilised by domestic enterprises. However, the current thinking is that EPZs will be used by both domestic and foreign enterprises. So far, we have no evidence to suggest that if EPZs are predominantly used by foreign enterprises the facilities will not be best utilised. On the hand, the evidence available shows that even domestic enterprises are keen to use the facilitics. Paragraphs 25 and 4.21 The paragraph underestimates the achievcments made under the AI)MARC*s divesture program. What is remaining in ADMARC's portfolio is due to lock of buyers. As for MIX', one does .not find 50P* L20, 1.24 in the program or anywhere at all where the Government was L23.. supposed to have a minority stake in the corporation. MWX' restructuring was intended to transform it into an industrial development corporation and the other clements followed under this objective. Regardingly a central coordinating agency for parastatal divesture. one fails to understand the proposal in the face of the Department of Statutory Bodies. Why not use it? Creating another s"s".J.2 body to oversee divesture of one or two cooperations is not viable, O " to put it mildly. It should also be recognised that the slow pace of Pam&5OV the parastutaf divesture is a product of the absence of a developed A capital markut in the country. i Paragraph 36 T am sure it is the wish of donor-funds recipients to see donors have congruity of purpose and act in concert. What is clear is that donor agendas and priorities are not always common to all. It Is recognised that C(!.% assist but to a limited extent. Paragraph 3.3. The last sentence of this paragraph has ignored the statement in paragraph 3.36 which metitions the last revision in wages of May 1992. ECONOMIK M.I4NNoimU. 21-06-93 16:49 E321 #4 -120- Page 4 of 4 Paragraph 3.38 Res 3DP growth for 1992 was -7.9% and not -7.5%. See amm report's AttUchmat 1. Paragraph 3.3 Once again, it is too optimistic to expect export growth to mstch or even surpass import growth in order to close or indeed narrow the current account deficit. Paragraph 4.13 The paragraph tails to outline a workable solution to the problem of concentration of economic power, as it has done on other problem areas. Paragraph 4.19 Creation of an PE Authority seems rather too early. As at now, the thinking is that MIPA should handle this. If Its not MIPA then it should be same existing institution. it is sincerely hoped that these comments will assist you in your finalistion of the report. Your extension of the deadline to June 18th, 1993 was greatly appreciated. Yours falthfuly, Maston G. TOU For: I "R MA -UN-94 .AA 9P4 M.PA '*3 -121- Annodix2, PP I of 4 MALA I INVESTMENT PROMOTION AGENCY Aquarius House. - 0 .Capital City, a Private Bag 302. - Lilongwe 3 Phoie: 780 800 F Fax: 781 781, Telex: 44944 Our Ref; MIP/0/1/2/2 Your Ref: COMM Recie fom th Mw vn Paomt Anc 8th June, 1993 The Division Chief, Country Policy, Industry and Finance, Operations Evaluation Department, The World Bank, 1818H street, N.W., Washington D.C 20433 UNITED STATES OF AMERICA. (Attention: Mr. Mark 8tird) Dear Sir, RE: MALAWI - INDUSTRIAL AND TRADE POLICY ADJUTMENT PROGRAM (CREDI 1W20- MAM) DRAFT PERFORMANCE AUDIT REPORT I refer to your lette4 dated April 26, 1993 under cover of which you forwarded to the Agency, for review and comments, a copy of the draft Perfoc,rance Audit Report on the above - captioned subject. I have the following comments to make from the view point of the Agency:- EXECUTIVE SUMMARY 413. The effects of the two devaluations on inflation and the real wage rate should be explicitly stated. s,* 3.4. 18. There is a need for a coherent and well defined strategy building upon the ITPAC and ECMAC which should be executed by the Ministry of Trade and Industry. 19. I feel that the Issue of restrictions on investment should be addressed In respect of resource availability implications. So...= 12, S.20 414 - .UN-9 WaD 9:49 MIPA - -122- Page 2 of 4 37. 1) Over and above countervailing levies more measures should be put in place to protect domestic Industry from unfair compettion bearing in mind the particular disadvantages faced by the country, like distance and land lookedness. II) I would like to see concrete measures aimed at prioritising Import ilberalleation of goods and deliberate interventions intended to re-direct resources intoexport-orlented productive activities. I feel that domestic producers have suffered due to lack of mechanisms to check the negative effects of Import liberalisation on'the local Industry. 8. Initiatives Festering Private S or Dvelopment Investmennt p1nd Exort-Fncentivy 3.13. Investment Promotion component of the Financial Sector and EnterpriseDevelopment Project provides for consultancy services to MIPA. The Services Group (TSG) have been engaged as Technical Advisors who are going to work with the General Manager to establish a fully fledged investment Promotion Agency. FIAS Is also involved In the consultancy. The Issue of the sustainability of MIPA is critical realising that the Agency is fully subvented with World Bank financial support for the first five years of operation; it Is the feeling, therefore, that the Agency should be commerciallsed In order to sustain its operations In the long-run. In the development of Its corporate plan and strategy the Agency Is considering several ways and means of achieving this objective. 4.19 A discussion paper on the Introduction of EPZs and an accompanying draft EPZ legislation have since been prepared and circulated to both the private and public sectors before consideration by Government. I have noted the Bank's position in respect of the development, operation and administration of. EPZe. These will be taken into consideration when the Government will be considering the operational and administrative framework of EPZs as proposed in the discussion paper. p-seeir u e asee r -123- Pag 3 of 4 LeLS AND flEMMKENATI. Z8.03 (iv) I am convinced that-there Is no competition in the banking S* * sector as to set the stage for competitively determined interest rates. There Is a pressing need to enhance the participation ofA" a local and foreign banks. Also, there is a need to address the , an attitude of existing banks towards investment and export trade financing, more especially that of the small to medium-scale type. There is need for investment and merchant banks. 8.06 (vi) Uninterruptd Access t Porelga Exhange I feel the suspension of development aid to Malawi has not only reduced Government resources but the Government capacity to maintain the level of subvention to MIPA is likely to be affected. The consequences are a Jeterioration of the country's investment climate and loss of business confidence including a curtailment of MIPA's ability to provide Investment promotion services4. 8.07 (II) I feel the Bank should supervise closely the development of capital markets as provided for under the Capital Market Development Act, 1990. An assessment should be carried out to Identify constraints and map out a programme for the development of capital and securities markets as one of the ways of moblilling investment resources. 8.08 vii) Promotion of non-traitional exports The export incentives package Is generally perceived by lovestore as discriminatory against traditional exports and yet the contribution of traditional exports is very significant as compared with the export value of non-traditional exports. I have noted the dismal Industrial performance In terms of the following:- a. Some recovery of private Investment; b. Private Investment in the form of industrial rehabilitation of traditional sectors; P-JUN-9 WED 9:Se MIPA -124- Page 4 of 4 C. No foreign direct Investment; and d. difficulty of access of Malawi's exports Into the markets of neighbouring countries which in turn has operated to discourage investment in export related activities; which have, in part, led to investment and export growth to fall short of the desirable level that would bring about structural change. I am of the view that this will significantly affect the scope and effectiveness of succeeding projects. One would want to see, for example, how this carry over effect will be taken into account. Over and above external f unZing, the levels of investment and export have not generated the resources required to sustain structural adjustment efforts. These results have a bearing on current economic transformation and future structural adjustment efforts. I have found the assessment of the audit report reflective of the complexities of Issues to be addressed In the Industry and trade sectors. I trust that the foregoing will assist you to finalise the audit report. Yours faithfully, -1& hl M.J.M. Phirl gNERAL MANAMER *125- 780700 .O I of 2 P. BOX Pan 00MCAPL CITY FAX NO: 788071 THE AUDIrOR GRRAL JUN 18 1993 Comment Realel frm th* nhr eea Ref'. No. DEV/223/1 10th June 1993 Mr. Mark Baird Division Chief Country Policy, Industry and Finance Operations Evaulation Department THE WORLD BANK 1818 H STREET, N.W. WASHINGTON, D.C. 20433 UNITED STATES OF AMERICA Dear Mr. Baird, Ns MALAWI IDUSTRIAL AW aD ICr AsDes2"M ROcGAM (CREDo 1626-Hr) DRAFT PERORMXCE-AUDIT REPOR I have the honour to refer to your letter of 26th April 1993 through which the draft Performance Audit Report was forwarded to me for review and comments. 2. I wish to confirm that the audit report actually embraces many observations and includes Important features which are pertinent to the activities of the Project. 3. t have examined the main parts of the report. The figure of USD 220.5 Million which represents the equivalent value of the various currencies which the World Bank and other donors contributed towards the Uiplementation of structural reforms under the highly successful ITPAC Programme needs to be presented in tabular form, showing both the actual currencies, and in contra, the equivalent in United States dollars. 4. With regard to paragraph 8 on Page (vii) on, inter alia, administrative discretion, you may be aware that 2/. -126- AmodIxL Page 2 of 2 such rebates are administered under Schedules 6, 7 and 8 of CAP 42:01 of the Laws of Malawi. 5. As for the Findings and Issues as well as lessons and recommendations, one is aware that ITPAC was reform-oriented/driven programme. The parameters within which to assess in realistic terms the impact of cause and effect relationships tend to defy strict definition, as there is always a lag effect, more particularly the fact that the socio-economic framework is dynamic and most necessarily reflect pragmatism. One is however able to assert that these lessons, important as they werer did play a significant part in the follow-on reform programmes such as ASAC. I hasten to add also that the availability on a timely basis of finance is crucial, whether one is talking about successful project or programme implementation, encompassed within a spirit of willingness to "ownl the programme and the desire to ensure that the rdforms/programmes initiated are set on a sustainable and sort of self-perpetuating path. 6. At this juncture I would like to congratulate you on a good audit report which wi believe to be a means to an end - the need to learn from previous experiences of impleventation of reforms and ensuring that future programmes build on such important considerations. Yours Sincerely, G. B. Chivaula ADiOa CC s The Resident Representative The World Bank P.O. Box 30557 LILONGE 3. - 127 - Pagp l of 2 Com ~et Reeve firmm the Ed~a M ~nsr for M= EQonom~ Coflra o ~ g~ray)trne (English tranlation of ino=ng letter) Federal Ministry for Economo Cooperadon May 28, 1993 and Development 5300Bba . Attention: Mr. Gast Re: Financial Assistance for Malawi hda and Trade Poicy Adjes~mont Pogram DM 20 million Gentdemen: We acknowiedge your letter of Aprl 28, 1993, and wis to maka the folowing connam s on t draft Performance Audit Report on the Industrial and Trade Policy Adjoatmmnt Program (MTPAC). The Operations Evaluadon Department (OED) of the World Bank ops its rpout with a positv. asses n of ITPAC. It finds that progress in impl~mnting the reform program bas be.. madsfatory In virtuay al areas (pa. 3). Consequently, the macroeconomio targets were largely achieved, at lest temporadly [sk - 7ansaor (para. 5). This findngis in contrast t erecent ud n developments in the areas of balance of paymeuts and economio grow, the abatn of whlch was to program's main objectve (para. 2). The obvous reference to te severe drought of 1992 as an expanation for the poor economo situation (par. 3.38)is in our opinion too bri. We would point out that e reform program was sp e to lssen Malawi's heavy dependence on a smal group of agdcultural eports. Howw#er, no =wo~ progress was made during the enr a progm peod toward div s u 3.39). The events of 1992 Olearly OED's finding that eco mi devo and heue industdal reoudetaton, will remäln utrouuly jw~pardized sm long as t Malawian economy Is dp on the flow of ex~trnal savings and the sale of traditonal crops (para. 7.03). It Is e that thmrm has not been enough time since the beginning of tho reform prograum for the d of intMrnationally seren.25- competitive industdal enterpdses (para. 7.01). However, if the program recelves a positve am n such a situation, thn plauuible reasons must at the same time be given as to why, de~pht the continuing structural we of the Malawien economy, subh as con~ntrated daras, strong pubue-sector influenc, and moager capital resourcos, it Is sti possible to expect dåverxfcation of Its export strueture In the long man. -4 In this ares, te OED report see~s to f11 short on several couts. We should theå~ fora lika to ask OED to expound in greater detail on the following pois: - What has been the breakdown of grass fixed ~ mpital fnaen in the diffbren inansrial n&t~wn ~ W w since 1987? - What has been the sha o since 1987 of exporting and import-bs in capital fonRaton? - 128- Page 2 of 2 4.1I9. 4. 20, - When does OED expect a noticeable diversification of Malawi's export sector to take place? 7.0-.O* 8.0S(, WI). - Which of the measures of the ongoing reform programs are expected to assure the long-term &0JI4 p .9 success of ITPAC? For the rest, and as fir as we are presently able to judge, the Report represents an essentially complete and accurate picture of the reform program and the concurrent development of Malawi's industrial and financial sectors. Since we received no copy of the draft Report directly from the Bank, we are retaining the copy you sent us. Very truly yours, Kreditanstalt fOr Wledeauban - 129 - BAQEAVRICAlM DE DEVELOPPE~ME 129 AflICAN DEUEOP~El'BSEAnni 1 s+nl k~ 0SF. 14.1. -At4Au1 WELJD 88a717 DAn!Jm>,18 FAX NO: (code 225) CSy Prorm~ Depe SouhR~go 21 6645 'IELECOPR RNMISSIN R : FAX No: (202 676-0560 :tOMP:M.FALL * Operaions Evaain Dp. 7ie World Bank C Proa D Wahington D.C. 20433 Son* Rg Ann. Mr. Mark ard, Divison Chie Abidja No. of Pgs (lncdldng cvr): l PLEASE TELEPHONE (+225) 20 40 54 IF YOU HAVE AND TROUBLE RECEVING TIS TRANSMISSION OR DID NOT RECEIVE TIE NUMBER OF PAGES SHOWN ABOVE. SUMECT :MLAW- dusra ad TraEledi tM ~tPrMramm:Dran rfoman= IiIs to inform you at wc have bad dm oppormnity to ~oroughly revew e drthe Peformanc Audit~ Rpo on te Indutrlal and Trade Ajusemc* Programme in Malawi prepared by the Operaons Evaluadon Dqpartment. We agree with couclusons, findings and sons of expuuienc, dedved from d operation In quesdon. In order to sustain the reform effors, whcb have ylelded posiuive rum~s to dat, Øm Governmea of Maawi ne~ds to be auistd whb more quickdisbursing extemal support. The avuilableprojecdons suggest that dhe extenal financing requiremn of MaIawi is eu* amlal, $o also is the ~ed to cond~e strengthenng co-f~nancing aragemen In the context ofbalanceof-pay~ems support to the country. The African Developmen Bank is willing to collaborat with the World Bank and other donors in u~re policy-basd opeados 1n the cdumty. for «to envisag d dor' assh~ance ) bo effecive, bowever, there is ~ud for dloser aid coordinaion as in the past, In the context of clearly defined programmu wbose focus wIll be targed at the unfinished as Identified in dm report. cc: AREP, Washington D.C. (Atta. Mr. R. Murg ) - 131 - PROGRAM COMPLETION REPORT MALAWI INDUSTRIAL AND TRADE POUCY ALJUSTMENT PROGRAM (CREDIT 1920-MAI) June 25, 1993 Industry and Energy Division Southern Africa De t Africa Regional Ofice -133- PROGRAMIgCOfMPLTON RPR MALAW1 INDUSTRIAL AND TRADE POLICY AD.ASTMENT PROGRAM (CREDIT 1920-MAI) PART I: PRORAM REI FROM THE BANKS PERSPCI A. Background Macroeconomic Management 1. During the first fifteen years after independence ' 1964, Malawi's economy grew rapidly and its structure was transformed. Total GDP more than doubled and per capita GDP increased by almost two-thirds. Economic growth was sustained by the steady expansion of agricultural production and a modest contribution from a nascent manufacturing sector based on agro-processing and simple import substitution. Gross fixed capital formation rose from 16% of GDP in 1965 to 26% in 1980 and savings rates increased from 4% to 18% during the same period. Inflation rates averaged about 8% per annum during the 1970s, about the same as developed countries. Unlike other Sub-Saharan African countries, whose currencies appreciated in real terms, Malawi's real effective exchange rate depreciated almost 5% between 1970 and 1980. The economy was relatively open, with an average import to GDP ratio of about 35% in the 1970s, and trade policy was conducive to efficient resource allocation, with average import duties of about 12%. Good macroeconomic management and sector policies and high investment rates resulted in rapid growth. 2. Malawi's economic performance began to weaken in the mid-1970s, sliding into severe problems at the beginning of the 1980s. Through the early 1970s, the government's budget deficit had been maintained at about 6% of GDP. Fiscal policy became highly expansionary in the late 1970s and early 1980s as the government responded to a series of external shocks. Falling international prices for Malawi's export commodities, soaring oil prices and a gradual disruption of external transport routes through Mozambique led to a deterioration in the terms of trade of about 28% between 1978 and 1981. In addition, the government had to import maize in 1980/81 as drought in Malawi reduced production. The government tried to maintain income levels through deficit spending. The central government's deficit, financed to a considerable extent by external commercial debt, rose to 11% of GDP. Despite the stimulus to domestic demand, GDP fell by 5.2% in 1981. The balance of payments also came under pressure, with current account deficits increasing from an average of 9.5% of GDP in 1973-77 to an average of 22% in 1979-8 1. The government increased import duties, among other measures, to deal with fiscal and external imbalances. Import duty receipts increased from 12% of imports in the mid-1970s to about 32% in 1981. The spread between the highest and lowest duty rates also increased, from 30% in 1975 to 90% in 1981. 3. Starting in 1981, the government launched a broad-based structural adjustment program to restore macroeconomic stability and remove constraints on economic growth. This effort was supported by three SALs from the Bank, successive Stand-by arrangements with the IMF and external debt rescheduling in 1982 and 1983. The adjustment package included price rationalization and liberalization, improved public sector resource mobilization and management, active exchange rate -134- management and rationalization of external sector policies and restructuring of the parastatal sector. Malawi managed to reduce domestic and external imbalances while resuming GDP growth in 1982-85. GDP grew at 4% per annum, the fiscal deficit (excluding grants) dropped from 15.1% of GDP in 1981/82 to 8.4% in 1985 and the current account deficit declined from 21% of GDP in 1980 to 8.2% in 1985. Progress was short-lived, however. In 1985/86, the public sector deficit increased due to expenditure on refugees from Mozambique and export crop prices dropped, putting pressure on the balance of payments. By the end of 1986, Malawi's external reserves were virtually depleted and the government had to tighten the rationing of foreign exchange to the private sector. To deal with the balance of payments and fiscal problems, the government raised import duties further, gradually dosing the economy and worsening the policy environment for industry. The average tariff rose from 26% in 1980 to 38% in 1986 and the standard deviation increased, raising the extent and variability of protection. Investment rates, which had been declining since 1980, reached their nadir in 1986, at 12.2% of GDP. As a result of these events, real GDP growth was only 2.8% in 1986. 4. In 1987 and 1988, after two years of severe fiscal and balance of payments pressures, the government initiated a number of reforms to restore domestic and external balance. Under a SAL M Supplemental Credit and a Shadow IMF program, the government reduced the fiscal deficit from 12.5% of GDP in 1986/87 to 10.2% in 1987/88 and the Kwacha was devalued by 20% in February 1987 and again by 15% in January 1988. The current account deficit was reduced from 6.1% of GDP in 1986 to 4.1% in 1987 and international reserves increased somewhat, to the equivalent of eight weeks of imports at the end of 1987. Despite the difficult situation, the government continued to implement structural reform in 1987. Smallholder agricultural marketing was liberalized, agricultural producer prices were adjusted and actions were taken to improve parastatal performance. Economic performance, however, continued to deteriorate. The inflation rate rose to 25% and real output fell by 0.2%. Industrial Sector 5. Industrialization in Malawi began after independence. Between 1964 and 1980, manufacturing value added increased at an annual real rate of 10% and the sector's share in GDP expanded from virtually nil to 12% in 1988. The sector is still at an early stage of development. The food, beverage and textile subsectors account for about two-thirds of total output. Malawi's landlocked position, with high transport costs, provides natural protection for the domestic market and decreases the profitability of exports. Consequently, manufacturing is heavily oriented towards the domestic market. In 1988, Industrial exports were about 3% of industrial goods sales and the share of industrial exports in total exports was 4%. Industry Imports about two-thirds of its raw materials and, with the exception of agro- processing, has few linkages within itself and with other sectors of the economy. 6. Despite its inward orientation, Malawi's manufacturing sector has a number of strengths: (i) the sector's efficiency, measured by the domestic resource cost ratio, is relatively good. In 1988, the average long-run domestic resource cost ratio for the manufacturing sector was about 1.2, compared with 1.3 for Kenya and Zimbabwe and 3.0 for Tanzania; (1l) the sector is well managed, although mostly by foreigners; (lil) the product quality is adequate; and (lv) most firms were in sound financial condition. The sector also has some negative aspects. The small domestic market cannot support more than one or two firms in a product group, resulting in a considerable degree of concentration. In the absence of strong competition from imports, this structure can lead to inefficiency or monopoly rents. Moreover, there is an unusual concentration of ownership. Three holding companies own a sizeable proportion of the sector's total equity and two of them also have a majority share of the only two commercial banks in Malawi. - 135 - 7. The sector's early growth and high efficiency are the result of relatively good macroeconomic and sector policies. The sector enjoyed stable prices, good exchange rate management, high rates of savings and investment, relatively free entry, liberal policies towards foreign and private investment, very low protective tariffs and no distorting privileges for "Infant industries". Expansionary fiscal policies throughout the 1970s and a mild form of price control were the most salient negative features of the policy environment. Manufacturing sector performance deteriorated in the 1980s. The macroeconomic response to external environment deterioration had a deleterious effect on sectoral policies. From 1980 to 1986, manufacturing output growth slowed to an average annual rate of 1%, Initially because of slack domestic demand, and since 1986, because of a foreign exchange shortage. The system of discretionary allocation of foreign exchange, which began in 1982 and became stringent after mid-1986, increased protection and undermined efficient resource allocation. Imports of goods fell from 24% of GDP in 1980 to 14% in 1986. Competing imports were effectively banned and the market share of firms was determined by their foreign exchange allocation. Private investment hit its low point in 1986, at 4.4% of GDP. Low investment rates and slow output growth resulted in negligible employment creation and a decline in labor productivity. iuancial Sector 8. Malawi's financial system is small and at an early stage of development. The main financial institutions are the Reserve Bank of Malawi, two commercial banks, three development banks, two finance houses, the Post Office Savings Bank and a building society. Although the financial system has played an Important Intermediation role, several constraints have limited its growth and supply of financial services to the economy. Among the constraints were: lack of an up-to-date legal framework for effective supervision of financial institutions; low operational efficiency due to lack of competition; inadequate long-term credit; and stringent lending practices that limited access to credit for industry. The fiscal deficit has had an impact on the distribution of domestic credit and the performance of the banking sector. Net domestic credit to the public sector increased from 11% of GDP in 1979 to 23% in 1986, while credit to the private sector decreased from 23% of GDP to 10% during the same period. Restrictions on expansion of credit to the private sector decreased commercial banks' share of domestic credit outstanding from 75% in 1979 to 45% in 1986 (the Reserve Bank accounting for the balance), hampering growth of the banking system. B. The Role of the World Bank and IMF 9. In 1981, the government launched a broad-based structural adjustment effort to restore macroeconomic stability and remove structural constraints. This program was supported by three Structural Adjustment Loans (SAL) by the Bank (in 1981, 1983 and 1985 and a supplemental in 1987) and an Extended Fund Facility and successive Stand-by operations by the IMP. The SALs were designed to address institutional issues related to economic and parastatal management and for improving price incentives for growth and diversification. A project completion report prepared in 1986 reviewed the experience of the first two SALs, and concluded that significant progress had been made in all key areas. Nevertheless, implementation was more complex and time consuming than anticipated and there were delays in the second tranche release of both operations. Malawi was in full compliance with the conditions of SAL M. After terminating a three-year extended arrangement in September 1986, which had been suspended in June 1986, Malawi was unable to reach agreement with the IMF on a successive facility in 1986 and 1987. With the collaboration of Fund staff, however, the government introduced a "shadow program" in August 1987, designed to reduce the fiscal deficit through expenditure and revenue measures. After reviewing progress under the shadow program, the IMF approved a 15 month Stand-by arrangement in March 1988. Under the arrangement, the - 136 - government undertook to reduce the fiscal deficit, maintain a flexible exchange rate policy, introduce a phased Import liberalization program, maintain market based interest rates and limit money and credit expansion. 10. The unexpected deterioration in Malawi's external environment necessitated a more profound and protracted adjustment of the economy. Malawi needed balance of payments support for a longer period than expected. The Bank's strategy for Malawi was to continue to provide support for broad- based structural adjustment leading to sustained real growth by imprvving the efficiency of the productive sectors and building institutional capability for improved macroeconomic management. The Bank planned to complement broad adjustment programs with ! series of policy-based sectoral operations designed to remove remaining structural constraints in the key productive sectors and deepen policy implementation. This support was Initiated by the Industrial and Trade Policy Adjustment Credit (ITPAC) in FY88 and the Agriculture Sector Program in FY90. The institutional capability required to implement these programs was advanced by the Institutional Development Project in FY89, which was designed to Improve the capabilities of the Ministry of Finance and establish a management institute. 11. Bank and Fund staff have worked closely with the government in reviewing macroeconomic and sectoral developments and in formulating the new medium-term strategy for the economy. They also collaborated in designing the IMF's Extended Structural Adjustment Facility and ITPAC. The Policy Framework Paper (PFP), discussed by the Bank's Executive Directors and the IMF Board in June 1988, provided the macroeconomic framework as well as the general policy direction for ITPAC. To avoid overlapping performance criteria between the IMF and Bank programs, the two institutions pursued separate but complementary actions. The Fund led on aggregate fiscal deficit targets, monetary policy and credit targets and exchange rate management. The Bank focussed on trade and industrial policy, export promotion and tax reform. Since the import liberalization program bridged both macroeconomic and sector policy issues, the Bank and Fund worked together in reviewing progress. The Bank, Fund and government collaboration in the PFP process has continued from 1988 until 1991. 12. Extensive economic and sector work under preparation during loan processing, provided the basis for the Bank's policy dialogue with the government. Macroeconomic discussions were based on a Country Economic Memorandum (Report No. 8140-MAI, March 1990) and a Public Expenditure Review (Report No. 7281-MAI, April 1990), and ITPAC discussions used an Industrial Sector Memorandum (Report No. 7402-MAI, December 1989). These studies were the basis for the gradual deepening of the Bank's dialogue on management of the economy and the design of ITPAC. In addition, several components of ITPAC, such as the tax reform program, were based on studies financed under the technical assistance program of SAL III. C. Adjustment Proram Objectives and Desin Objectives 13. The overall objective of ITPAC was to assist in stabilizing the economy and restore the basis for sustained per capita income and consumption growth. Specific objectives included: () real GDP growth of 1.5% in 1988, 3.3% in 1989 and 4% per annum during the 1990s; (ii) reduction in the budget deficit from 10.2% of GDP in 1987/88 to 8.1% of GDP in 1988/89, down to about 6% of GDP by 1990/91; (11) reduction in the rate of inflation from 20% in 1988 to about 5% by 1991-92; (lv) decrease in the current account deficit from 7.3% of GDP to about 4% by 1993, after an Initial widening; (v) increase in the official International reserves to 11 weeks of imports by the end of 1988, -137- and up to 14 weeks by the end of 1990; and (vi) increase in gross investment from 12.3% of GDP in 1987 to 15.3% by the end of 1991. ITPAC supported trade, industry and finance policy reforms to achieve these objectives and, after nearly a decade of continuous Import compression, provided much needed foreign exchange. The backbone of the operation was the liberalization of the foreign exchange ailocation system, which was needed to ease the most binding constraint on industrial growth and improved resource allocation. In support of import liberalization, the operation sought to reduce the level of excess demand by lowering the fiscal deficit and pursuing an appropriate exchange rate policy. ITPAC also sought to lower effective protection for industry, facilitate expr :6 of manufactures by establishing an effective duty drawback system and spur domestic competition by removing legal provisions that inhibited entry of firms and permitted the creation of monopolies. Finally, the program included measures to support the development of small-scale enterprises and improve efficiency in the financial sector. Design (a) Exchange Rate Management and Trade Policy. To restrain relative demand for imports while reinforcing export incentives, the Kwacha was devalued by 15% in January 1988. The government agreed to pursue a flexible exchange rate policy to maintain external competitiveness, achieve balance of payments objectives and complement trade liberalization and tariff rationalization. The centerpiece of ITPAC was the liberalization of the trade regime. The government committed to a phased liberalization of the foreign exchange allocation system to be completed by mid-1991 and implemented the first stage in February 1988. In parallel with the elimination of prior Reserve Bank foreign exchange approval for imports, the government expanded the Open General License system to cover all items except those controlled by license for reasons of public health, safety or food security. The sustainability of the trade reform program and the future growth of the ecoromy rests on the expansion and diversification of Malawi's export base. The government agreed to streamline the administrative procedures for exporters by eliminating export licensing requirements, except for food security and environmental protection, and Improving the duty drawback system. The government also agreed to create an export revolving fund to ensure access to foreign exchange for exporters to import inputs during the initial stages of liberalization. (b) itscal Policy. The government committed to reducing the fiscal deficit to a level that could be financed with minimal recourse to domestic credit. As the tax burden on the economy was already quite high, the adjustment was expected to fall mainly on expenditures. The government agreed to prepare an annual rolling three-year public Investment program. (c) Tax Reform. Trade liberalization was complemented by a comprehensive reform of the tax system designed to improve its equity and efficiency. The government had already implemented a number of reforms including the introduction of a surtax credit system, imposition of ad valorem rates for excise taxes, combining the import duty and levy into one tax, Introduction of a current payment system for business income tax and initiating the phase-in of the expensing provision to replace investment allowances. Over the next two years, the government committed to reducing the spread of import duty rates, merging excise and surtax Into a single tax, modifying the allowances under the current company tax code, moving to a tax-inclusive budget and introducing modifications to the personal income tax code. - 138 - (d) Industrial Licensing. The government agreed to revise the Industrial Development Act to eliminate a clause that could be used to grant monopoly rights to producers for five years. This revision was expected to strengthen domestic competition. (e) Small-Scale Industries. While there were a number of financial and technical assistance institutions that support small enterprises, they were inadequately capitalized and lacked effective outreach and training programs. The government committed to providing additional training staff, augmenting the pool of funds available for debt and equity financing, developing a credit guarantee scheme for small-scale borrowers and reviewing the institutional and regulatory framework for the small-scale sector. (f) Financial Sector Policies. The government agreed to pursue tight money and credit policies to reduce inflation and provide sufficient resources to finance the expected expansion of the private sector. The government also undertook to update and strengthen the financial system's legal framework and the supervision of financial Institutions and improve the mobilization of long-term funds. (g) Price Decontrol. After substantial price decontrol under SALs II and III, only five items remained under price control, including fuel and low-grade meat. The government agreed to decontrol meat prices and adjust fuel prices periodically to reflect a full pass-through of import and domestic distribution costs. ITPAC Linkage with other Bank Operations 14. ITPAC was designed to build upon the three policybased operations that the Bank had already done in Malawi. The earlier operations were concerned mainly with price rationalization and liberalization, improvement of public sector management and restructuring parastatals. ITPAC tackled trade and industrial policy distortions and helped to alleviate the current macroeconomic deterioration and restore previous sound policies. The tax reform package was a continuation of a technical assistance component of SAL I. Previous SALs sought to increase exports through modifications of agricultural price policies. ITPAC attempted to improve Malawi's International competitiveness by: supporting a more competitive exchange rate; lowering protection for industry; and facilitating the flow of credit to the economy by strengthening the financial system. These steps were expected to improve the incentives for exports of manufactures and lower the cost of domestic industrial inputs for agriculture and enhance the impact of the FY89 Agricultural Marketing credit. Implementation of ITPAC and other operations was facilitated by the FY89 Institutional Development project. The improvements envisioned In the financial sector were expected to set the stage for the Bank to provide long-term funds for the industrial sector. A sector adjustment operation for agriculture was expected build on the reforms of ITPAC, particularly for exports. Taken together, these operations were intended to provide adequate balance of payments support for successful structural adjustment. The Bank expected improvement of sectoral policies would elicit sufficient investment and export response to ensure sustainable structural adjustment during the implem,tation period. This expectation may have been unrealistic as other, better situated countries have taken a longer period for successful structural adjustment. For example, Chile took about seven to ten years, after appropriate policies were in place, to achieve sustainable growth; and Indonesia, a star performer, took three to five years. - 139 - ITPAC Sequencing 15. Lessons from internal Bank reviews of trade and industrial policy adjustment loans suggest that economic sector work is critical in the early stages of designing a sequence of structural adjustment and sectoral reform programs. Successful reforms have implemented macroeconomic stabilization policies, such as reductions In the budget deficit and dampening high Inflation, and trade reform at the same time. Trade reform is most effective when sequenced as follows: (I) a depreciation of the exchange rate in real terms; (ii) introduction of export policy reform shortly before or at the same time as import reform to an early export supply response; (II) initiating import reform by reducing the coverage of quantitative restrictions; and (iv) reducing protection through tariff reform. In Sub-Saharan African countries, where there are market rigidities and institutional capabilities and infrastructure are weak, attention should be paid to competition policies, management capability, entrepreneurship development (small-scale industry), financial sector issues and infrastructure. ITPAC design has considered and incorporated virtually all the lessons learned from similar reform programs in other countries. D. Progrm Achieme 16. ITPAC and the 1988/89 PFP macroeconomic targets were substantially achieved: (I) GDP growth was 3.3% in 1988, 4.1% in 1989 and 4.8% in 1990, exceeding targets in all three years; (i) the budget deficit was 5.6% of GDP in 1990, below the 6% target for that year; (Ill) Inflation came down from 20% in 1988 to 11.5% in 1990, a little over the 9% target; (iv) the current account deficit, after exceeding the target in 1988 and 1989, was on target at 8.6% of GDP In 1990; (v) external reserves at 3.3 months of imports in 1990 were close to the target of 14 weeks; (vi) the gross investment growth target for 1990 was exceeded in 1989 due to stockbuilding, but the rate came down a little In 1990 because stocking requirements were low. The private investment/OD? ratio increased from 4.4% in 1986 to an estimated 15.1% in 1989, partly reflecting stockbuilding mentioned above. Economde Performance Dat (oreentaes 1988 1989 1990 GDP Growth 3.3 4.1 4.8 Budget Defcit/ODP -7.4 -6.8 -5.6 Ination (CPI) 31.4 15.7 11.5 Gross Investment/DP 18.7 21.2 18.2 Current Account Defcit/GDP -9.1 -12.9 -8.6 Real Effective Exchange Rate 1985 = 100 88.6 94.3 94.6 Imports Volume (merchandise) Growth (%) 25.0 7.7 8.2 Imports/GDP 30.3 27.8 28.4 Exports Volume (merchandise) Growth (%) -2.7 -14.2 50.4 Exports/GDP 24.1 18.8 24.3 External Reserves (months of imports) 4.8 2.9 3.3 20Bi: Policy Framework Paper 1991/92 to 1993/94. -140- 17. The index of the real effective exchange rate at the end of 1989 was well above the level prevailing after the January 1988 devaluation. In order to reverse this loss of external competitiveness, the Kwacha was devalued by 7% in March, 1990. However, relatively high inflation eroded the devaluation's gains by the end of 1990. There have since been two devaluations to maintain the Kwacha's competitiveness. After an initial misunderstanding between the business community and the Reserve Bank about the operational aspects of import liberalization, it was implemented smoothly and completed at the end of 1990. Foreign exchange payments through 1991 appear to have been made promptly by the Reserve Bank. Due to a foreign exchange shortage, however, delays in payment ranging from one to three months for goods and longer for dividends, were noted towards the end of 1992. An informal foreign exchange rationing system seems to have been reinstated. Unless the foreign exchange shortage is considered a temporary cash flow shortfall, exchange rate action is the appropriate policy action instead of a return to rationing. 18. Import volume growth surged to 25% in 1988 with initial liberalization and then steadied to about an 8% per annum growth in 1989 and 1990. Easier access to raw materials and other inputs allowed firms to increase capacity utilization. While data for the manufacturing sector as a whole are not available, major companies such as Press Holdings and Lever Brothers reported substantial increases in capacity utilization, and later capacity expansion. Firms took advantage of access to capital goods imports to expand capacity and modernize plant and equipment. New investments occurred in plastics, steel shaping, beer, TV assembly, bus body building, etc., but nothing major. Access to imports was especially helpful to small-scale industrialists who had felt crowded out by large firms in the rationing system. Small Enterprise Development Organization of Malawi's (SEDOM) client list grew at twice the rate after import liberalization. Manufacturers enjoyed higher profits initially, before imports of final goods were liberalized. Imports of final goods increased competition for domestic producers and among traders, bringing prices down. Except for textiles, manufacturers were able to withstand the competition, in spite of smaller margins and a loss in market share, by improving efficiency and business strategy. A major textile firm was forced to retrench and has been given temporary adjustment assistance by the government. Competition also increased among traders and margins and prices were forced down. 19. Implementation of an improved duty drawback system for exporters was delayed until 1991 and the export revolving fund was never implemented because general import liberalization was accelerated. An income tax allowance for exporters has been introduced and an in-bond manufacturing scheme has been implemented, with a few garment factories taking advantage of it. One firm switched production from supplying clothes to the domestic market to garment assembly for a South African company because of import competition. Another firm assembles garments for a Taiwanese firm. Export volume growth was negative from 1987 to 1989 and then grew by 50% in 1990, but exports/GDP were nevertheless 1% less than in 1987. Other than the few, relatively small in-bond garment assemblers and a bus body manufacturer that exports regionally, there has been no significant change in exports of manufactures. The government has created an Export Promotion Council recently with the expectation that its activities will assist export development in the future. 20. Program budget deficit reduction targets were met through cuts in expenditure which did not depress domestic demand sufficiently to prevent achievement of program growth targets. Bank staff reviewed the three-year public investment program (PIP) for 1988/89 to 1991/92 and found it satisfactory. This rolling three-year PIP has been reviewed annually in the PFP process. The government embarked on a tax reform program in 1987 which was intended to be revenue neutral. The reform program has proceeded but revenue/GDP fell slightly in 1990/91, putting pressure on expenditure cuts to achieve the budget deficit target. Reforms of indirect taxation have resulted in the - 141 - implementation of a value added tax on the manufacturing sector and progress has been made in rationalizing tariffs and excise taxes. Reform of direct taxation included implementing a current payments system for company tax in 1988/89 and lowering the company tax rate from 50% in that year to 40% in 1991/92. Rates of personal income tax have also been reduced, with the top marginal rate at 40%. The small technical assistance component of ITPAC, intended to finance studies to develop a credit guarantee scheme and regulations for small-scale industry, was diverted to fund technical assistance urgently needed to continue tax reform. The small-scale industry component was somewhat delayed and the credit guarantee scheme and regulations were implemented in 1988/89. 21. In spite of increased competition from import and some new entries, manufacturing and banking in Malawi is still dominated by the same few firms as a few years ago. The domestic market is too small to support many firms in any product line. Moreover, high transport costs make production for export very difficult. In addition, there is considerable bureaucratic inertia in issuing industrial licenses, which take about six months and have been known to take three years. The government has recently established an investment promotion agency which may expedite the process. In contrast, the small- scale industrial sector has benefitted by the program in spite of increased competition from imports. Regulations have been changed to facilitate entry, financing is provided by SEDOM and a credit guarantee scheme operated by commercial banks is in place and SEDOM also provides training. 22. A revised Reserve Bank Act and Banking Act were approved by Parliament in 1989. The Reserve Bank can now operate fully all traditional central banking functions including open market operations and enhanced supervision of the financial system. The new Banking Act includes a wider definition of banking activities to encourage entry, increase competition and avoid distortions in the banking system. Interest rates were deregulated in 1988 to encourage resource mobilization and improve resource allocation. The government's expenditure restraint resulted in a decline in its share of domestic credit in 1989 and private sector credit grew by 45% in that year. In 1990, the passing of the Capital Market Development Act and the issue of bonds by INDEBANK were a significant first step in developing a capital market in Malawi. 23. In summary, improvements in macro-management stabilized the economy and the program removed many policy distortions to improve resource allocation in Malawi. It also provided foreign exchange for imports needed to spur manufacturing sector growth. Manufacturers liked import liberalization of inputs, raw materials and capital goods. They were able to increase capacity utilization, improve profitability, modernize plant and expand capacity. Manufacturers faced increased competition when imports of final goods were liberalized but, in most cases, were able to withstand the competition by improving efficiency and reducing margins. Traders' volume increased substantially with liberalization of final goods and, despitf narrower margins due to competition, profitability improved. On the whole, the business community, especially small-scale industries, are pleased with ITPAC and would like the program to continue. Manufacturers would have preferred more time te make efficiency adjustments between liberalization of inputs and raw materials and liberalization of final goods. The structure of the manufacturing sector, however, remains substantially unchanged, with no significant new entry or reallocation of resources, in spite of improved profitability for manufacturers and traders and a decline in wages. Import growth dwarfed export growth and exports of manufactures remain minuscule, bringing into question the sustainability of the program. It is possible that the four years since the program began are too short to overcome many of the rigidities in the economy, and for the business community to be sufficiently convinced of the program's continuity to make substantial new investments. Several traders seemed poised to enter industry and manufacturers were considering new investments. A reversal of the program at this stage, as Indicated by the delays in foreign exchange payments, could nip a supply response in the bud. - 142 - E. Implementation 24. Conditionality and Tranching. The credit was disbursed in two tranches. The first was available upon credit effectiveness in September 1988 and the second in September 1989, when IDA judged second tranche conditions to have been met. Virtually all ITPAC conditionality was implemented on or ahead of schedule except: (i) the export revolving fund, which was not needed and therefore not implemented; (ii) the delay in implementing the duty drawback scheme for exporters; (iii) the delay in funding studies for a credit guarantee scheme and regulations for small-scale industry. Most ITPAC conditions were met prior to presenting the credit to the Board. There were six conditions for second tranche release to track performance on fiscal deficit targets, foreign exchange liberalization targets and enactment of tax and financial system laws. These conditions were well prepared, easily implementable and monitorable. 25. Supervision and Coordination with the IMF. There was one supervision mission prior to second tranche release in June 1989. While this mission was adequate for the second tranche release decision, missions should have been fielded subsequently to track the impact of ITPAC, continue the dialogue with the Government and feed into the design of following operations. Performance of the program outlined in ITPAC's Letter of Development Policy was also tracked through public investment program reviews and, together with the IMF, the continuing PPP process. 26. Procurement and Disbursement. Procurement procedures were designed to ensure rapid disbursement of the credit while preserving efficiency and accountability. The credit financed foreign exchange costs of general imports not specified in a negative list. All contracts above US$2 million were to follow International Competitive Bidding (ICB) procedures and contracts below that amount were to follow commercial practice or government procedures. Since all contracts were below US$2 million no ICB procedures were used but commercial practice using competitive bids appears to have been followed. A Special Account and statements of expenditure (SOE) were used to u.aburse the credit. 27. Accounts and Audit. After some initial problems, records were kept in good order as were the statements of expenditure. Bank missions reviewed these records in September 1989 and September 1991. SOEs and the Special Account were audited regularly. The last audit was done at the end of March, 1991 and there has not been sufficient activity to warrant another audit since. F. Conclusions 28. The ITPAC reform program was well designed. It took into account Malawi's economic situation and applied the lessons learned from Bank reviews of earlier trade and industrial policy adjustment loans. The reforms were fully implemented in a timely manner and none of the risks outlined in the President's Report affected the reform process in any way. No data are available yet on subsector output, capacity utilization, investment, imports, exports, etc., to assess the impact of the program accurately. Anecdotal evidence and some data suggest that some increase In capacity utilization and investment in modernization and expansion has occurred. Competition increased substantially and prices came down. Many firms adjusted successfully by improving efficiency and shaving margins. One large firm was forced to retrench and another firm shifted from domestic to export production. Thus, there was a distinct improvement in resource utilization and some reallocation of resources took place. There was little evidence, however, of substantial new investment or increase in exports of manufactures. With growth in imports still exceeding growth in exports, import liberalization is not sustainable without continued balance of payments support. The recent delays in - 143 - foreign exchange payments are an indication of unsustainability and the possibility of a reversal to foreign exchange rationing. 29. A well designed, fully Implemented program like ITPAC, which was supported by the government and the business community, has not yet elicited sufficient investment and export response to ensure sustainability. This is partly due to some market rigidities and other problems in Malawi. The country has a small market dominated by a few manufacturing firms that also control the only two banks. This market concentration impedes entry. Malawi also suffers from very high transport costs which make it unattractive as an export platform. Weak investment response is partly due to a lack of interested domestic entrepreneurs and foreign investors. The government has not been responsive to investors or aggressive in soliciting them. Indeed, its tardy and passive response may have turned away some domestic and foreign investment. Until very recently, the Asian community has felt restricted by the government in expanding its business activities. New investors have to feel welcome and secure in the government's commitment to continue with non-discriminatory market oriented policies. Malawi is not unique among Sub-Saharan African countries in its weak investment response and slow structural change of industry. Apparently, it takes several years to make the business community feel secure about investing and to develop new entrepreneurs in a country. The Bank and Malawi may have had unrealistic expectations. As mentioned earlier, other better situated countries have taken almost ten years to achieve structural adjustment and sustainable growth. Malawi is at the stage where several local traders are interested in entering manufacturing and foreign investors have made inquiries about investments in tourism. It should continue with policy reforms to decrease market concentration in industry and finance and emphasize production for exports and aggressively pursue new investment. The Bank should consider a follow-up balance of payments operation to support these reforms. 30. The main lesson for future industrial sector adjustment programs in Malawi is that, in the presence of market rigidities, undeveloped entrepreneurship and restrictions on many potential entrepreneurs, few links with external markets for exports or foreign investment and high transport costs, sustainable sectoral adjustment is a very long process. Export growth is essential for sustainable development and exports will mostly be generated from new investment rather than a reallocation of resources. New investment for export production will take time as domestic entrepreneurs have to establish links with markets abroad and foreign investors have to become acquainted with Malawi. Attracting new investment will require Malawi to make a concerted marketing effort and improve its policies and infrastructure. The Bank can provide support through a series of well designed programs stretching over a decade or more, probably every two years to maintain reform momentum and dialogue with the Government. ITPAC should be viewed as the first of such a series of programs and it should already have been followed by two other programs. The lapse in momentum will delay adjustment. Future programs should continue to address policy constraints and have considerably larger capability building components for entrepreneurs and institutions. PART II: PROGRAM REVIEW FROM THE BORROWER'S PERSPECTIVE The Borrower was invited to prepare Part I, but to date none has been received. PART III: STATISTCAL.INFORMATION Please see the Basic Data Sheet at the front of the Performance Audit Report.
Groupe de la Banque mondiale · Project Performance Assessment Report
Malawi - Industrial and Trade Policy Adjustment Program Project
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Groupe de la Banque mondiale
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Project Performance Assessment Report
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Malawi
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Banque mondiale