Document of The World Bank FOR OFFICIAL USE ONLY Report No.: 21419 THE REPUBLIC OF MALAWI Country Assistance Strategy Progress Report November 28, 2000 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. The last Country Assistance Strategy was dated August 4, 1998 CURRENCY EQUIVALENTS MK I = US$0.0125 US$1 = MK 80 ABBREVIATIONS AND ACRONYMS ACB Anti-Corruption Bureau ADMARC Agricultural Development and Marketing Corporation Aford Alliance for Democracy AIDS Acquired Immunodeficiency Syndrome CAS Country Assistance Strategy CEM Country Economic Memorandum CBM Commercial Bank of Malawi CG Consultative Group CPAR Country Procurement Assessment Review CPPR Country Portfolio Performance Review CFAA Country Financial Accountability Assessment DflD Department for International Development, U.K. ESAF Enhanced Structural Adjustment Facility ESCOM Electricity Supply Corporation of Malawi EU European Union FRDP Fiscal Restructuring and Deregulation Program HIPC Highly Indebted Poor Country IIV Human Immunodeficiency Virus IBRD Intemational Bank for Reconstruction and Development IDA International Development Agency IMF International Monetary Fund IFMIS Integrated Financial Management Information System JSA Joint Staff Assessment LIL Learning and Innovation Loan MCP Malawi Congress Party MDC Malawi Development Corporation MTEF Medium-Term Expenditure Framework MTL Malawi Telecommunications Limited NBM National Bank of Malawi NFRA National Food Reserve Agency NRA National Roads Authority PCC Petroleum Control Commission PER Public Expenditure Review PRGF Poverty Reduction and Growth Facility PRSP Poverty Reduction Strategy Paper RBM Reserve Bank of Malawi UDF United Democratic Front USAID United States Agency for International Development VAT Value Added Tax WBI World Bank Institute Vice President: Callisto Madavo Country Director: Darius Mans Task Team Leader: Johannes Zutt FOR OFFICIAL USE ONLY The Republic Of Malawi Country Assistance Strategy Progress Report Table of Contents Executive Summary ......................................... iii Introduction ...........................................1 Social, Political and Economic Context........................................... Performance under the CAS .......................................... S What Went Well ...........................................6 What Went Less Well ...........................................8 Development Partnerships .........................................9 Lessons Learnedfor the Bank ......................................... 10 Current Status of the Bank Program .......................................... 11 Preparation of the New CAS .......................................... I4 Strategic Issues for the Next Full CAS ......................................... 14 Lending Program and Non-Lending Services . .......................................... I5 Alternative Scenarios ......................................... 17 Risks and Risk Mitigation ......................................... 17 Conclusion ......................................... 18 Annexes ......................................... 19 Table of Figures Box 1: Poverty and Inequality ..........................................I Box 2: The Reform Program and its Successes ..........................................3 Box 3: Malawi's Growth Prospects ...........................................4 Box 4: HIVWAIDS in Malawi ..........................................7 Box 5: The External Partnership .......................................... 11 Box 6: Performance against the Base Case Indicators ......................................... 13 Box 7: Five Key Interconnected Challenges for Malawi ......................................... 15 Table 1: Malawi at a Glance ..........................................2 Table 2: Economic Trends ..........................................3 Table 3: Gender Profile in Malawi ..........................................9 Table 4: Bank Group Portfolio (FYOI) ......................................... 12 Table 5: Key Economic and Sector Work .........................................1 6 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization. THE REPUBLIC OF MALAWI COUNTRY ASSISTANCE STRATEGY PROGRESS REPORT EXECUTIVE SUMMARY 1. Malawi's CAS was discussed by the Board in August 1998. This Progress Report reviews developments since then, analyses the Bank's experience in implementing its assistance strategy, and presents the Bank Group's program for the next 12 months. 2. Since the 1998 CAS, Malawi has made progress in consolidating its young democracy, improving macroeconomic performance, and implementing structural reforms. However, growth has been moderate (3% to 4% per annum) and annual inflation has remained high (30% in September 2000), partly as a result of slippages in fiscal and monetary policies and partly as a result of unanticipated external factors leading to sharp depreciations in the exchange rate in 1998 and 2000. In this context, the Government since March 2000 has pursued a Ten-Point Economic Plan designed to meet spending priorities while maintaining fiscal discipline. The IMF is now concluding discussions with the Government on an economic program to be supported by a new PRGF arrangement. This program is expected to be presented to the Fund Board on December 21, when the Bank Board will meet to discuss this Progress Report, the HIPC Decision Point document, the Interim PRSP, the Joint Staff Assessment of the Interim PRSP, and the Third Fiscal Restructuring and Deregulation Program credit (FRDP). 3. Malawi remains a very poor country with difficult development challenges: limited natural resources, landlocked position, weak human capital base, poor social indicators, high incidence of HIV, environmental degradation, and heavy reliance on tobacco and maize. To promote growth and reduce poverty, the country has to move systematically on a broad front. The 1998 CAS aimed to assist the Government in creating conditions for broad-based labor-intensive growth, fostering environmental sustainability and human development, improving public sector management and capacity, and strengthening the policy dialogue. This strategy remains appropriate, but performance against it has been mixed. 4. On the macroeconomic side, there has been progress in reducing trade tariffs, prioritizing expenditures, improving financial management, and establishing a revenue authority, but expenditure controls remain weak. On the structural side, key cross-cutting sectors (transport and telecommunications) have been liberalized, but the electricity and water utilities continue to experience financial difficulties and many enterprises remain under public control. In addition, although the Commercial Bank of Malawi has been brought to the point of sale, it has not yet attracted a buyer. Within the social sectors, community-led development initiatives remain strong and primary school enrolment rates are high with near parity between boys and girls, but the quality of education remains a problem. The Government of Malawi now has a strategic plan for controlling HIV/AIDS, but the health sector is in crisis. Progress towards sector-wide programs in the social sectors has also been slower than expected. In June 1999 President Muluzi was returned to power in elections deemed free and fair. Preparation is underway to devolve service delivery to local authorities, who were elected for the first time on November 21, 2000. In addition, in light of a 1999 Auditor General's report on public service activities, the Government has started to deal decisively with several high-profile corruption cases. 5. Progress against the base case indicators of the 1998 CAS has been slower than expected. However, the Government remains committed to the reform agenda and has recently taken action to improve its performance; hence the IDA program remains in the base case. Bank support has been substantial. The portfolio currently includes 12 projects in seven sectors, for a total commitment of $450 million ($201 million undisbursed). Its performance has improved since the last CAS, when 27% of the commitments were in problem projects and 49% were at risk; today 12% are in problem projects and 12% at risk. Some projects, including Malawi Railways and the Social Action Funds, have performed very well; others, including the recently closed Agricultural Services and Rural Finance Services projects, have performed less well. Joint Bank-Government portfolio reviews, occurring most recently in July and November, have helped to focus on improving performance. 6. This Progress Report is being presented at the same time as the Joint Staff Assessment of the Interim PRSP. The next full CAS will be elaborated on the basis of priorities set in the full PRSP, which is expected to be available in draft form in March 2001 and finalized in June. Over the next 12 months, and until the new CAS is completed, Bank activities in Malawi will involve completing the program set out in the previous CAS. Since the 1998 CAS was discussed, the Board has approved one adjustment operation and four projects against a proposed program of two or three adjustment operations and nine proj ects. Proj ects planned for FY0O-0 1 and not yet delivered are now being reprogrammed for delivery in FY01 -02; these include a new adjustment credit (FRDP 3, being presented with this Progress Report) and four other operations supporting private sector development (including another adjustment credit). The thrust of the non-lending program will be to support preparation of a full and prioritized PRSP and to bring all key economic and sector work up-to-date. 7. In elaborating the next CAS, the Bank intends to be more strategic and selective in determining the level, type and sectoral composition of Bank support to the Government's poverty reduction strategy. This is likely to involve placing higher levels of resources into fewer sectors to achieve real sectoral transformation. Discussions concerning sectoral composition will involve close coordination with the Government and the partners, both to determine the Bank's comparative advantage and to ensure that important activities continue to receive support. The Bank Group will also examine the possibilities for shifting from discrete project-based lending to a more programmatic approach, financing credits which support reforms meeting performance benchmarks in key sectors. 8. In reviewing this Progress Report, the Board may wish to consider the following: * The Bank Group's strategy pending completion of the full PRSP and the next CAS is to proceed with selected lending preparation already discussed in the 1998 CAS and to shift the focus of non-lending services to assisting the Government in completing the full PRSP. Is this interim strategy appropriate? * The Bank Group proposes a higher degree of selectivity in the new CAS as well as an examination of the prospects for a shift away from project-based lending and towards programmatic lending. Are these the right issues to consider? Country Assistance Strategy Progress Report I. INTRODUCTION 1. The last full Country Assistance Strategy (CAS) for Malawi (IDA/R98-127) was discussed by the Board on August 27, 1998. The Government completed an Interim Poverty Reduction Strategy Paper (PRSP) in August 2000, and it is now developing a full PRSP, with a view to presenting a first draft in March 2001 and a final draft in June. The next CAS will be elaborated on the basis of priorities set in the full PRSP, and will be completed in mid-FY02. In the meantime, Malawi is being considered for reaching the decision point under the HIPC initiative, and IDA financing for Malawi's adjustment program, in keeping with the Interim PRSP, is proposed to continue with the Third Fiscal Restructuring and Deregulation Program (FRDP 3). This Progress Report, which is being presented to the Board together with the proposed credit, the HIPC Decision Point document, the Interim PRSP and the Joint Staff Assessment, reviews developments since the last CAS, analyses the Bank's experience in implementing its assistance strategy, and presents the Bank Group's lending and non-lending program for the next 12 months. The thrust of the non-lending program will be to support preparation of a prioritized and costed PRSP that a resource-constrained Malawi can realistically implement and monitor. Box 1: Poverty and Inequality * Malawi is one of the world's poorest countries: per capita income is just $180 per year; 46% of Malawians have too little income to meet their basic needs; and income distribution is extremely unequal (a Gini ratio of 0.62) * Infant mortality rates are high (134 per 1,000 births) and maternal mortality rates are also high (560 per 100,000 births) * In a context of widespread food insecurity, child malnutrition rates continue to exceed 30% * HIV prevalence, at 16%, is alarming, and AIDS-related deaths have already created an estimated 250,000 orphans and caused some key social indicators to deteriorate (e.g. life expectancy) * Female-headed households, which comprise one in four rural households, are especially hard hit Because poverty is deep and access to land, education, and other assets sharply unequal, large changes in average incomes result in only small improvements in Malawi's poverty measures. To reduce poverty, growth rates need to exceed about 5.3% and to be broad-based. Concerted efforts need to continue to improve social outcomes and to protect the poorest and most vulnerable groups (e.g. through targeted employment schemes, food subsidies, and seed and fertilizer distributions). In addition, the work burden of girls and women (who continue to do the bulk of farm and house work, including rearing children and fetching water and firewood) needs to be reduced, and they need to be enabled to enjoy access to assets and levels of well-being on an equal basis with boys and men. An Integrated Household Survey was comnpleted in 1998, providing much-needed poverty data. The Government is now completing a detailed disaggregated poverty analysis which will update the poverty profile and inform elaboration of the full PRSP. II. SOCIAL, POLITICAL AND ECONOMIC CONTEXT 2. Social context: Malawi remains a very poQr country with difficult development challenges and long-term prospects due to its limited natural resources, landlocked position, weak human capital base, and heavy reliance on tobacco and maize. Low productivity of labor in subsistence agriculture, combined with limited off-farm employment opportunities, results in extreme poverty, with per capita income averaging about $180 per annum (see Box 1). High population growth (2.6%) has been a concern, 2 as 78% of Malawians are subsistence farmers and almost all arable land is already under cultivation. As of the 1992/93 agricultural season, almost four in five households held less than one hectare of land (compared to one in two in 1985/86). As a corollary, environmental degradation, including soil erosion and deforestation, is accelerating. Also of serious concern is negative change in the ecosystem of Lake Malawi, the country's most important single asset, providing water and fish, attracting tourists, and facilitating transportation and power generation. These long-run problems are exacerbated by the high incidence of HIV/AIDS (about 16% among adults and 31 % among pregnant women attending urban antenatal clinics), which is eroding social gains made in the past 20 years. 3. Social indicators are extremely poor (see Table 1). Because Malawi has only a single growing season and is vulnerable to drought, there is widespread food insecurity and consequently malnutrition (30% in children under five). Combined with poor health services and inadequate water and sanitation, this results in an infant mortality rate of Table 1: Malawi at a Glance 134 (among the highest in the world) and Economic indicators Malawi SSA life expectancy at birth of about 42 years GNP per capita (the lowest in southern Africa and likely (Atlas method, US$) 180 500 to sink lower as a result of HIV/AIDS). Population (rnillions) 10.8 642 Illiteracy remains high, with only 74% of Of which urban (%) 22 34 men and 44% of women literate. Free Agriculture as % of GDP 19 29 primary education, introduced in 1994, has increased primary enrolment from Social indicators about 1.9 million to 2.9 million, but the Life expectancy (years) 42 50 number of facilities, school materials, and Adult illiteracy (%) 41 39 trained teachers has not kept pace. As a Infant mortality (per 1,000) 134 92 result, quality has deteriorated sharply, Child malnutrition (%) 30 32 jeopardzn has outomes and Access to safe water (%) 45 54 Jeopardizing education outcomes and Gross primary enrolment (%) 134 78 student-parent commitment. At the same Male 140 85 time, secondary and tertiary schools have Female 127 71 limited capacity, capping the intake at HIV prevalence (%) b Adults 16 8 levels below those needed to support Women in antenatal care 31 12 sustained growth. 4. Economic context: Given a highly unequal income distribution and continuing population growth, it is estimated that Malawi needs to grow at 5.3% per annum just to keep the number of the poor from increasing. Although Malawi has achieved some important successes in its reform program since 1995 (see next page, Box 2), progress since the last CAS, in August 1998, has been mixed. Overall growth has been moderate, at 3.0% to 4.0%, while small-holder agriculture performed well, growing by 9% in 1998 and almost 15% in 1999 in favorable climatic conditions. Free distribution of a maize seed and fertilizer "starter pack" resulted in a record maize harvest in 1998/99 (2.5 million tons, compared to a drought low of 1.3 million in 1996/97)-but this program is unsustainable, and the Government has recently decided to target it on poorer households (a measure to be supported by the Bank's proposed new credit, FRDP 3). Interest rates (50%) and annual inflation (about 30% in September) are high, and can be traced back to 40% depreciations in the exchange rate in 1998 and 2000 due to unanticipated external factors (see paragraph 25) as well as periodic slippages in control of the overall fiscal deficit, with the latter resulting from heavy government and parastatal 3 borrowing from the banking system in 1997 and 1999 and periodic delays in the disbursement of external aid. A 19% fall in exports and 8% rise in imports in 1999 increased the current account deficit from 11.5% of GDP in 1998 to 17.0%. 5. A medium-term expenditure framework (MTEF) has been introduced in stages since 1995/96, but spending is still spread thinly over too many activities, with continuing pressure to over-spend. In November 1997, following a collapse in budgetary discipline, the IMF suspended its program in Malawi. From April 1998 the Government successfully implemented a staff-monitored program, leading to IMF approval of a third ESAF arrangement in December 1998. In 1999, heavy borrowing by two parastatals, the National Food Reserve Agency (NFRA) and the Agricultural Development and Marketing Corporation (ADMARC), increased the broad money supply by 34%, fueling inflation and keeping interest rates high. In early 2000 the Government introduced a Ten-Point Economic Plan which Table 2: Economic Trends includes measures to establish greater spending prioritization, contain 1990-93 1994-97 1998 1999 spending of government departments (Avg.) (Avg.) Population (million): 8.9 10.1 10.5 10.8 within predefined monthly limits, Population growth (%): 3.0 2.7 2.6 2.6 tighten controls on parastatal and GDP ($billion): 2.0 2.0 1.7 1.8 government borrowing, improve GNP per capita fiscal transparency, and recover costs (Atlas method, $): 227.0 198.0 180.0 180.0 foritems of exclusive consumption. GDP growth (%): 4.2 4.9 2.0 4.0 for ~~~~~~~~~~~~Fiscal deficit (%/): 8.4 17.1 10.7 11.6 These measures were at the core of Inflation (CPI avg., %): 16.7 32.7 26.2 44.8 the June 2000 budget and are being Export growth (%): 5.6 10.8 21.8 -18.6 implemented. 6. Agricultural commodities still constitute 80% of Malawi's exports, and so its trade balance remains vulnerable to climate and global market conditions. Export composition has remained fairly constant, with tobacco accounting for about 60% of Box 2: The Reform Program and its Successes since 1995 Until 1994, the Government of Malawi pursued a highly elitist development model which left a legacy of high inequality in income and access to services. Private sector investment was limited and the business environment unfriendly, due to excessive red tape, poor macroeconomic management, an ineffective public service, and low penetration rates for essential utilities such as electricity and telecommunications. After the 1994 elections brought Malawi's first democratically-elected administration to power, a four-part reform program was introduced to address these constraints. Elements of the program, recently reiterated in the Interim PRSP, include (1) establishing a supportive macroeconomic framework, (2) prioritizing public expenditure and improving service delivery to the poor; (3) creating an enabling environment for private sector development; and (4) developing a cost-effective social safety net. As a consequence of the reform program, there has been a deliberate shift in expenditures away from non-essential services towards the social sectors and specific anti-poverty programs such as the Malawi Social Action Fund (a Bank-supported initiative) and public employment schemes. The economy today is also much more open and competitive. Since 1995, subsidies have been eliminated; the weighted average tariff rate has fallen from 19% to 14%; the export tax rate has been eliminated; and the exchange rate has been allowed to float freely. Forty firms, employing over 9,000, have been privatized; two new commercial banks have entered the market, raising the total to four; the number of cellular telephone connections increased from 5,000 to 24,000 lines following entry of a private operator; and a stock exchange has been established (eight companies, including the Commercial Bank of Malawi, the National Bank of Malawi, Blantyre Hotels, and the South African insurer Old Mutual, are currently listed). Controls over agricultural prices, inputs and marketing were dismantled and restrictions on smallholder participation in cash crops were lifted, leading to some remarkable pro-poor transformations. 4 earnings in 1999, followed by tea (12%), cotton (7%) and sugar (4%), but nascent non- traditional exports grew by 17% per annum over 1994-99 to reach 18% of all exports. Smallholder participation in burley tobacco production has grown tremendously since the Government ban was lifted as part of the adjustment program in the early 1 990s-from 21 million kilograms in 1995 to almost 90 million in 1999-but this represents mostly a shift away from estate production rather than a net gain. While this shift has positive distributional effects, the total value of tobacco exports has actually dropped from a peak of $352 million in 1997 to $275 million in 1999, mainly as a result of price weakness. Currently, declining tobacco prices are exacerbating pressure on the terms of trade and encouraging farmers to seek alternative cash crops. At the same time, the production of root crops (notably cassava and sweet potatoes) has increased dramatically, reducing dependence on maize. Manufacturing, which accounts for about 14% of GDP and 13% of exports, remains highly concentrated in the Press Corporation (a private entity controlled by a quasi-public trust) and a few other sizeable companies. A small ready- made garments export industry emerged in recent years, but is now facing difficulty satisfying rules of origin in South Africa, its main market. Malawi's landlocked status, leading to high transport costs, continues to result in a marked services deficit. The country's growth prospects are described in Box 3. Box 3: Malawi's Growth Prospects To achieve poverty-reducing growth, Malawi needs good policies and a supportive external environment. Good macroeconomic policy, including funding of core activities, is key; non-essential spending must be curbed; and inflation and real interest rates must be sharply reduced. At the same time, smallholder agriculture needs to reach its full potential. In the short term, this implies removing transport constraints as well as extending support services, especially for women (who perform 87% of labor on smallholdings). In the medium term, it implies diversifying away from tobacco and resolving land issues to ensure that estates contribute to growth or release underutilized land. To sustain growth in the long term, industry will need to make a contribution. This will require a stable business-friendly policy environment that is competitive with Malawi's neighbors, as well as further improvements in infrastructure, including lower costs and higher numbers of connections in the key utilities (water, electricity, and telecommunications). The labor productivity of women also needs to be increased, by improving their access to key assets such as land, credit and education, and by investing in labor-saving technologies in the household economy. But Malawi also depends on external conditions, including favorable tobacco and oil prices, key determinants of the terms of trade; generally positive regional economic performance, particularly in South Africa (Malawi's major trade partner) and Mozambique (its main transport corridor to the outside world); and continued assistance from the international community. This long-termn program is doable, but it will require luck as well as perseverance. 7. Political context: In the June 1999 elections, deemed substantially free and fair by international observers, President Bakili Muluzi was re-elected and his party, the United Democratic Front (UDF), obtained a parliamentary plurality, taking 93 seats in the 194-seat National Assembly. By October 1999, following UDF victories in three by- elections and pledges of support from four independent MPs, the UDF had regained a majority. The Malawi Congress Party (MCP, the former ruling party) holds 65 seats in the current parliament and the Alliance for Democracy (Aford), with which MCP formed an alliance to fight the 1999 elections, has 29. Party strength reflects regional ties, with UDF strong in the populous south, MCP in the center, and Aford in the north. Policy differences are small, with all parties committed in varying degrees to pro-poor free- market policies. Alliance-led legal challenges to the 1999 election result in the courts are continuing but have so far been unsuccessful. Local elections, the first in Malawi, were held on November 21. 5 III. PERFORMANCE UNDER THE CAS 8. The overall objective of the 1998 CAS was far-reaching and sustained poverty reduction. The CAS included four pillars: * Creating the conditions for broad-based, labor-intensive growth: This growth was to be achieved by promoting smallholder agriculture and associated demand linkages to off-farm activities, in particular through IDA's Agricultural Services, Rural Financial Services, and Social Action Fund projects, as well as IDF-funded assistance to land reform. Support would also be provided through adjustment lending and analytical work to facilitate private sector development, in particular by privatizing selected state-owned enterprises (including the commercial banks), increasing competition in the financial sector, and promoting sound macroeconomic management. The Bank would also enhance private participation in infrastructure through the Power, Roads, Railways, and National Water projects. * Fostering environmental sustainability and human development: Bank assistance would focus on empowering communities to manage their natural resources through an ongoing Environmental Management project; developing sector-wide approaches in the key social sectors through the Primary Education, Secondary Education, and Population Health and Nutrition projects; and helping to articulate and implement a responsive and affordable social safety net strategy emphasizing labor-intensive works programs. - Improving public sector management and capacity: Key Bank action in this area was to include improving the MTEF, introducing a centralized revenue authority, strengthening civil service reform, and building capacity; Bank support would consist of adjustment lending, the Local Government and Second Institutional Development projects, and assistance from WBI. The Bank would also provide an IDF grant in support of the Anti-Corruption Bureau (ACB). - Strengtheningpolicy dialogue, implementation and donor coordination: Bank assistance in this area would involve helping to articulate comprehensive sector strategies in health, education and agriculture; focusing on implementation; and strengthening collaboration among the external partners. 9. Performance under the 1998 CAS has been mixed, with most benchmarks being met, albeit with some delay (see Annex B9). Progress has been hampered by weak implementation capacity, recurring macroeconomic disruptions, lack of unanimity within Malawi on some elements of the reform program (especially those related to withdrawal of the state from sensitive areas such as food and agricultural marketing and core utility and infrastructure services), and concerns about the slow output and employment response from previous reforms. Although these factors have not changed the overall direction of reform, they have affected its pace. The main priorities identified in the Interim PRSP reflect this mixed performance by focusing on further measures needed to enhance macroeconomic stability and to promote economic diversification through private sector development while ensuring adequate investment in human development and protecting the most vulnerable. 6 What Went Well 10. With IDA support, a significant number of key economic reforms have been completed. Trade tariffs have been reduced from a maximum rate of 35% to 25% (among the lowest in the region) and a market-based exchange rate has been adopted. Expenditures have been prioritized in broad terms, with allocations to health, education, and community-based programs doubling from 16% to 33% of the budget between 1993/94 and 1999/2000, and selected sub-items within sectors (e.g. drugs, teaching materials) are now being protected. Further work has been done to integrate the medium- term expenditure framework (MTEF}-introduced in 1996 with support from FRDP 1- into the budget and to incorporate the findings of a joint Governnent-Bank Public Expenditure Review (PER) now nearing completion. To improve financial management, an Integrated Financial Management Information System (IFMIS) is being introduced in four pilot ministries (with support from IDA's Second Institutional Development project); procurement and accounting reform has been initiated; and new units have been established in the Ministry of Finance to manage the aid budget and to monitor parastatals and implement tighter financial controls. A more independent and professional Malawi Revenue Authority has also been established and is expected to result in higher revenue collection. 11. Structural reforms have been implemented in several areas, improving the business environment. To date, 40 of 100 enterprises scheduled for privatization have been privatized. In telecommunications, a regulatory body has been established; an independent cellular telephone operator, Celtel Malawi, has entered the principal urban markets; and Malawi Telecommunications Ltd (MTL) now is seeking a strategic private- sector partner (a measure to be supported under the proposed FRDP 3). In the power sector, an electricity regulatory body has been established; preparations are underway for restructuring the Electrical Supply Company (ESCOM); and the state-owned Petroleum Control Commission (PCC), which in 1999 shed half of its staff, has relinquished control of fuel importation to the private sector. In the water sector, the Government is reviewing options for private sector participation in water supply, removing Government from its traditional role as a service provider. Substantial progress has also been achieved in policy and institutional reform in the transport sector, with support from two IDA operations, Malawi Railways and Roads Maintenance and Rehabilitation. After restructuring and downsizing Malawi Railways, the Government recognized a need to concession railway operations in order fully to exploit external trade along the Nacala corridor; this concession was subsequently awarded to Central and East African Railways (CEAR)-a joint venture held by the Mozambican railway company, Caminhos de Ferro de Moqambique, and a United States partner-and it has been operational since late 1999. Malawi Lake Services is also being prepared for privatization. In the road sector, road management services have been conferred on a commercially-oriented National Roads Authority (NRA), and a Road Fund (financed by a fuel levy) has been established to fund a comprehensive road maintenance program. In the agriculture sector, the Government recently abandoned the maize price band and agreed to shift the role of the National Food Reserve Agency away from direct market intervention to a purely relief function (a measure to be supported by the proposed FRDP 3); it also reformed the Starter Pack program, which provided small amounts of free farm inputs to all 2.9 million farming families, into a Targeted Input Program catering to the 1.5 million poorest households. In addition, the issuance of Temporary Employment Permits has been liberalized; a National 7 Safety Net Strategy has been articulated through a collaborative effort involving the Government, the Bank and other donors; and a Presidential Commission has made recommendations for changes in land policy. 12. Within the social sectors, the Government continues to accord high priority to education, with specific commitment to providing equitable access to good quality basic education. These initiatives are receiving support under IDA's education projects. Since the introduction of free primary education, gross enrolment has reached 134%, with near parity between boys and girls (52:48). The Cabinet has also approved a Policy Investment Framework which outlines education development strategies and sets the basis for all sectoral expenditures and donor assistance. The strategy includes improving access, equity, quality, relevance, management, and finance. Support to community-led development initiatives, including the IDA-financed Social Action Funds, continues to be strong, with over 1,300 community-designed and -supported projects completed or underway. Contraceptive prevalence has increased markedly, and activities have been initiated under a Population and Family Planning LIL to pilot community-based family planning services. The strategic plan to fight HIV/AIDS was launched with strong Government support, and a donor roundtable held this year to mobilize financing resulted in commitments of over $100 million (see Box 4). Box 4: HIV/AIDS in Malawi Malawi is among the countries in the world worst affected by HIV/AIDS. The adult HIV prevalence rate is now estimated at almost 16%, with women usually infected at younger ages than men. The toll in human suffering has already been immense, and the emergence of a generation which may include hundreds of thousands of AIDS orphans threatens the country's economic base and social fabric. In 1998, a World Bank study estimated that between a third and a half of productive urban workers such as police, teachers, and health care workers will be lost to AIDS within the next decade. Other sources have estimated that at current prevalence rates the cost of AIDS in termns of lost growth could amount to between 0.7% to 2.0% of GDP per year. After a slow start, the Government has recently begun to show strong political leadership on the issue, with the high-profile launch of a national AIDS strategy by the President in October 1999, and repeated public pronouncements by senior politicians since then. A round-table was held in March 2000 to mobilize donor funding for the national AIDS program, and over $100 million was pledged. But progress remains slower than desired. Implementation and organizational capacity, including in a health care system that was underfunded and overtasked even before HIV/AIDS appeared, remains weak relative to the scale needed to reverse the pandemic. In addition, real solutions require behavioral change, which will take considerable time to be realized. 13. There has also been progress in governance. In 1998, the parliament passed a Local Government Act which provides for responsibility and accountability for service delivery and several public functions to be transfen-ed to semi-autonomous elected local governments; the first elections for District Assemblies were held on November 21, 2000. Since the 1999 legislative elections, parliament has become more vocal, encouraging greater accountability in the executive. In October, the all-party Public Accounts Committee reported on corruption in the Ministry of Education and put unprecedented pressure on the Government to act; in November 2000, the Anti-Corruption Bureau (ACB) prepared a report on these cases, after which President Muluzi dismissed three implicated Cabinet ministers. The ACB has also been working with police to investigate high-profile cases involving contracts for police vehicles, identity cards, customs evasion, and irregularities at the PCC. Limited capacity in the courts has slowed progress, but aid 8 from DfID for hiring prosecutors may help. Malawi is also an active participant in the seven-nation WBI anti-corruption program. In addition, the Government is moving forward on procurement reform as well as on reform of the flnance and audit functions (to be supported by the proposed FRDP 3). It has also established an Ombudsman, a Law Commission, and a Human Rights Commission. What Went Less Well 14. Economic indicators remain disappointing. Annual inflation averaged 45% in 1999, is near 30% today, and is projected to fall to 26% at year-end. Lending rates still exceed 50%, making most investments unprofitable. Even so, throughout 2000, monetary policy has not been restrictive enough to offset inflationary pressures resulting from high oil prices and feed-through effects of the kwacha devaluation-which has fallen a further 40% since July 2000. Public expenditure control, though improving, needs further tightening. Despite use of a cash budget, arrears to the private sector continue; in late 1999, the Government belatedly reported substantial arrears accumulated during the 1995-99 ESAF program, highlighting the need for an improved monitoring and control system (now in place). 15. There have also been delays in structural reform. Despite significant progress on privatization, many productive and trading enterprises remain under defacto public control-often at arms length through the Malawi Development Corporation (MDC) or the Agricultural Development and Marketing Corporation (ADMARC). The Commercial Bank of Malawi (CBM) has been brought to the point of sale, but has not attracted a buyer; the National Bank of Malawi (NBM) remains in Government hands; and cross- ownership of financial institutions by conglomerates such as ADMARC and the Press Corporation (which dominates many sectors of the economy) continues. The major utilities are still experiencing financial difficulties-ESCOM, the electrical utility, because of management problems, politicization, and below-cost tariffs, and the water boards because they cannot collect dues from government entities-undermining their ability to maintain or expand their physical assets and provide essential services, as well as adding to the quasi-fiscal deficit; IDA projects supporting these reforms (Power 5 and National Water Development) have had mixed results (see paragraph 22). 16. Policy reforms in the agriculture sector have also been uneven, involving sporadic interventions that distort incentive structures and discourage private sector investment, thus preventing the market from showing what it can deliver on its own; IDA projects supporting this sector have also been less than satisfactory (see paragraph 22). Although women provide 87% of labor on smallholdings, they continue to have substantially less access to land and credit than men; only 9% of extension agents and 13% of agriculture club members are female, contributing to sub-optimal results. Agri- business is also struggling. In the tobacco sector, the country has not determined what marketing niche it can best exploit to increase export earnings and farm incomes and consequently its marketing strategy and research and extension efforts remain muddled. The NFRA, which has acquired maize stocks in excess of the country's requirements, is now unlikely to recover its purchase and storage costs and consequently may be unable to service its commercial debt (0.8% of GDP). At the same time, the privatization of ADMARC continues to be delayed, though progress is expected in commercializing it 9 and divesting its holding in NBM. The Government recognizes that solving many of these problems requires liberalization, privatization, and regulatory reform. 17. The health sector is experiencing serious difficulties, worsened by the HIV/AIDS crisis. Staffing is deficient at all grades; morale and productivity have declined to crisis levels; and essential drugs and equipment are lacking, in part because of mismanagement of the Central Medical Stores (CMS). In addition, essential health spending, while protected in the aggregate, is not adequately prioritized and remains well below recommended per capita minima. The education sector suffers from poor quality, resulting from insufficient trained teachers, an acute lack of learning materials, and weak sector management; and gender disparity in enrolment continues in secondary education (82% male, 18% female) and beyond. While the 1998 CAS anticipated as a major thrust throughout the CAS period the development of sector strategies leading to sector programs, progress in this direction has been slower than anticipated. 18. While considerable progress has been made in governance, further efforts are needed in some areas. Civil service reform has been slow. Although the number of ministries. has been reduced and some services have been contracted out, the government apparatus remains stretched over too many activities, agencies, and operations; as a result, many are under-funded, inadequately staffed, and ineffective. The problems of staff rationalization and salary compression have not yet been resolved, but recent efforts to put senior civil servants on performance-based contracts may help (so far about 20% of eligible senior officials-Deputy Secretary and above-have accepted contracts). As a consequence of these problems as well as the effects of HIV/AIDS, the working conditions of most doctors, nurses, teachers and other key civil servants have not improved and service delivery remains below targeted levels. Legal and judicial reform has also been slow and fragmented. The EU and DfID have provided some support to the criminal justice system, but the judicial system as a whole remains Table 3: Gender Profile in Malawi underfunded and understaffed, with Female Male consequent delays in the disposal of Age at first marriage 18 23 cases. A comprehensive assessment of Adult literacy (15+, %) 44 74 the judicial system and a program of Primary enrolment (share) 48 52 reform are required. Further work also Secondary enrolment (share) 18 82 Tertiary enrolment (share) 30 70 can and should be done to include women HIV prevalence (15-24, %) 14.5 6.1 more fully in political decision-making; Adult labor force (%) 49 51 to increase their access to health care and Agriculture labor force (%) 70 30 education; and to safeguard their legal Admin. labor force (%) 8 92 rights and protections, including from Share of ealed income gender-related violence (see Table 3). Extension agents (%) 9 91 Development Partnerships 19. The Bank's partnership with the Govermnent has broadened and deepened over the CAS period, through structured consultations on the CAS, the Interim PRSP, and portfolio reviews; collaborative analytical work (including the ongoing PER and the recent safety net strategy study); and selected institution-building exercises, including with WBI. Civil society and the private sector have also become more frequent and valued interlocutors, particularly in discussion of the PRSP and the CAS. Even so, early 10 results from the ongoing Client Survey indicate that the Bank needs to communicate its poverty reduction mission better. Some client ministries and agencies find the Bank to be slow and unresponsive, and some believe that Bank staff apply preconceived solutions without due attention to local conditions. The survey also pointed to a need for the Bank better to assess the likely consequences of recommended reforms. 20. The Bank works closely with the principal external partners in Malawi (see Box 5). There is now a dedicated Aid Coordination Group, chaired jointly by the Bank and UNDP, along with active sectoral groups in all of the main areas. Efforts continue to be made to move towards common sector programs in education, health, agriculture, and local government/decentralization, although discussions on sector strategies and expenditure programs are still ongoing. Since the 1998 CAS was prepared, two Consultative Group (CG) meetings have been held, in December 1998 and May 2000, both in Lilongwe. At the more recent meeting, CG members pledged $1.1 billion of support to Malawi for 2000-01. Lessons Learnedfor the Bank "A country that tries to do everything is a country without an agenda; a country without an agenda is a country without a vision; and where there is no vision the people perish. We need to rationalize our expenditure, choose afew items of importance that fit within our budget constraint, and then do those few things well. " --Matthews Chikaonda, Minister of Finance and Economic Development 21. In retrospect, the program articulated in the 1998 CAS was too ambitious-in terms of the scope of reforms proposed, the Government's capacity to deliver them, and the degree of dialogue needed within Malawi to ensure ownership. The reform process has been slower than planned and needed to have a strong impact on performance and the supply response. In addition, the CAS, seen in retrospect, was too optimistic in its macroeconomic projections: exports and growth proved to be much lower, imports and inflation much higher, and the terms of trade less favorable. There were also larger than expected changes in the nominal exchange rate. A number of specific lessons emerge for the Bank in formulating the next phase of its assistance strategy: * The Bank (and the donor community) needs to be more strategic and selective: Efforts to date remain spread over a large range of sectors and issues, tying up scarce Government capacity, and resulting in modest tangible benefits. In some cases, lack of demonstrable success, including a slow supply response from the private sector, is exhausting tolerance for further reform. * Within areas of concentration, the Bank's aims need to be more modest, supporting reforms which are owned by the Government and within its capacity to implement. * The Bank needs to do more to ensure ownership of reforms before proceeding. This in turn requires a better understanding of what is involved in ownership and of how to judge when it is present. * The Bank needs to support further investment in building capacity to fornulate and implement reforms. 11 Box 5: The External Partnership Malawi is heavily aid dependent. External aid was equivalent to about 16.6% of GDP in 1998/99 (net foreign borrowing was 10.3% and grants 6.3% of GDP); aid financed about one-half of the overall budget that year and four-fifths of the development budget. Delays in donor disbursements can have, and have had, strong negative repercussions on the country's ability to meet its macroeconomic targets and implement its reform program. In addition to the Bank Group, a number of partners are currently developing new country assistance strategies which aim to focus on two or three sectors. At present, the partnership has the following composition: * The European Union is currently preparing a new country assistance strategy for 2001-05; support is expected to be concentrated in the two focal sectors of health care and transportation (roads). * The United Kingdom has focused on basic health and education; good governance (including economic and financial management, public service reform, decentralization, and human rights), and the environment (soil fertility and forestry); the current strategy covers 1998/99 to 2000/01. * The United States recently prepared a five-year assistance strategy (2001-05) outlining project support for health, HIV/AIDS, basic education, good governance, the environment, agriculture and food security, and private sector development. * Japan has provided both loan- and grant-based assistance to Malawi, with grant aid expected to continue in the areas of agriculture, water supply, communications, and the environment. * Denmark provides budget support and project support in education, agriculture (including animal husbandry), and governance (including for parliament, the ACB, and the Law Commission). * Germany provides support to agriculture (horticulture promotion and post-harvest loss prevention), education, rural development, and good governance. * Canada is active in the areas of health (including HIV/AIDS), education, small town water supply, and Lake Malawi biodiversity, with a general emphasis on gender equality. * Norway provides support to health care, HIV/AIDS, primary education, and the environment, as well as debt relief through the Bank's HIPC Trust Fund. * Sweden focuses project support on Blantyre electricity and HIV/AIDS; future support may include health care and governance. * The Netherlands has historically provided debt relief under the Fifth Dimension initiative. * The African Development Bank has a loan portfolio focused on agriculture, education, water and sanitation. * The United Nations is completing a Conunon Country Assessment, which will form the basis for a new Development Assistance Framework for 2002-06. All the major UN agencies are represented in Malawi. UNDP focuses on sustainable livelihoods, governance, and development management; UNICEF on children's and women's welfare rights; FAO, IFAD and WFP on smallholder food security, soil and water conservation, and food-for-work programs. Current Status of the Bank Program 22. As of November 2000, the Bank's portfolio covered seven sectors and consisted in 12 projects totaling $450 million in commitments ($201 million undisbursed) (see Table 4 and Annex B8). There have been some notable successes in the portfolio, including the Malawi Social Action Fund (MASAF), followed last year with MASAF 2, as well as the Malawi Railways project, which revitalized the Nacala rail route and restructured and privatized the railways and lake services. Portfolio performance has improved since the last CAS (today 12% of the commitments are in problem projects or projects at risk, while in 1998 27% were in problem projects and 49% in projects at risk), yet capacity constraints and implementation bottlenecks remain. Following a concerted effort in 1999, during which the National Water Development project was upgraded and the Local Government project was restructured and upgraded, performance indicators improved substantially. Indicators fell off again in late FY00 with the downgrading of 12 the Primary Education, Road Maintenance, and Environmental Management projects, but action is underway to bring these projects back on track. In addition, three projects closed within the past 12 months with less than satisfactory outcomes: Power 5 saw completion of the new Kapichira hydroelectric scheme, but was not able to improve ESCOM's financial and management situation; Rural Finance Services helped restore the smallholder farmer credit scheme and boost smallholder burley tobacco production, but the Malawi Rural Finance Corporation is not yet a sustainable entity; and Agricultural Services, though it introduced some new technology, did not result in sustainable agricultural service provision. Joint Bank-Government reviews of the portfolio were instituted several years ago, and in July and November 2000, at review meetings chaired by the Minister of Finance and the Country Director, the Bank and the Government agreed to implement an improvement plan as quickly as possible. 23. IFC's portfolio in Malawi is small, totaling $3.5 million in seven projects which are concentrated in the financial sector and in small and medium enterprises in tourism, agribusiness and health care. Projects approved in the CAS period include support for Table 4: Bank Group Portfolio (FY01) the privatization of Malawi's largest insurer (through a management buyout) and IDA cofmpitments ($m): 450 financing for a small business hotel. Two Sectoral composition $ 2 % additional projects in the financial sector are Health: 61 11 pending commitment. IFC is targeting Education: 71 13 additional opportunities in the financial Water: 79 14 sector, tourism and agribusiness; and Social action: 122 22 ultimately in the various infrastructure Public sector reform: 76 13 Transport: 30 5 sectors as they are lberalized and prvatized. Environment: 12 2 IFC also expects to support additional IDA undisbursed ($m): 201 privatization transactions, such as may IFC exposure ($m): 3.5 emerge with ADMARC and other groups. Number of projects: 7 At present, there are no MIGA guarantees in MIGA guarantees ($m): 0 Malawi. 24. Although Malawi's progress against the base case indicators of the 1998 CAS has been slower than expected (see page 13, Box 6), the Government remains committed to the reform agenda and has recently taken action to improve outcomes, including by implementing the Ten-Point Economic Plan, introducing (with IMF assistance) a commitment control system, moving top civil servants onto performance contracts, eliminating the maize price bands, reducing the cost and coverage of the starter pack by one-half, and developing a National Safety Net Strategy. The IDA program is currently in the base case. Malawi has made consistent progress since 1994, when state regulation of the economy was still pervasive and democratic governance institutions were non- existent. But it has been difficult to transform the economy. Its small size and long history of monopolistic practices and limited competition has made large privatizations difficult, with few new buyers willing to invest in the country. 25. Under the 1998 CAS, the low case would be triggered by inflation above 20%. While inflation has exceeded this target, it is important to recognize that the inflation target was intended to be a proxy measure for slippages in the Government's monetary policy. While some slippages have occurred, mainly as a result of parastatal borrowing taking place before the Government introduced its Ten-Point Economic Plan in March, 13 the country is now back on track with an IMF PRGF program. In addition, high inflation in the past six to eight months has been chiefly the consequence of unanticipated external factors resulting in a sharp exchange rate depreciation of about 40% between July and October. This depreciation was a response to falling tobacco prices, rising oil prices, and devaluations of the South African rand and the Zimbabwean dollar. All of these factors were outside the Government's control. Progress in the reform program and Government efforts since the introduction of the Ten-Point Economic Plan indicate that Malawi continues to be in the base case. Box 6: Malawi's Performance against the Base Case Indicators Malawi's progress against the base case indicators of the August 1998 CAS has been mixed. While the Government remains committed to the reform agenda included in the base case and has recently taken action to accelerate implementation, more time will be needed to complete the agenda than originally anticipated. Progress against the key indicators has been as follows: * Progress on improving the fiscal and monetary framework has been mixed. Tariff and surtax reforms have been implemented, but further work is being done to improve financial discipline and attain deficit and inflation targets. * The MTEF has been implemented and more than 20 spending items are protected, including in the social sectors. * Civil service reforms are incomplete. The number of ministries has been reduced, some Government services have been contracted out, and senior civil servants are being placed on performance contracts, but staff rationalization and salary compression remain issues. * CBM has been brought to the point of sale. The Government has stated an intention to commercialize ADMARC and to divest its holdings in NBM, but plans to sell NBM and the mature holdings of MDC are delayed. . Malawi Telecoms is being prepared for tender to a strategic partner, and regulatory reforms have laid the base for more conunercial and competitive power and water sectors, but further work is needed to put ESCOM and the water boards on a viable footing. . Agricultural reforms have been modest. Recently, the maize price band was eliniinated. In addition, the starter pack is being scaled back and targeted on poorer households; this is expected to reduce its coverage from 2.9 million to 1.5 million households and its costs from about $25 million to about $12 million. * Portfolio performance improved significantly over the CAS period. 26. The 1998 CAS overestimated capacity to implement the reform program, and so it is not surprising that the program is only partially completed. To date, the Board has approved one adjustment operation and four projects against a proposed program of two or three adjustment operations and nine projects. The last adjustment operation, the Second Fiscal Restructuring and Deregulation Program (FRDP 2), was approved in December 1998 ($92 million) and is fully disbursed. The four approved projects include Population and Family Planning ($5 million), Road Maintenance ($30 million), and Social Action Fund 2 ($66 million) in FY99; and Privatization and Utility Reform ($28.9 million) in FY00. All of these projects currently have a satisfactory rating, except Road Maintenance, where recent improvement in implementation progress should result in upgrading to a satisfactory rating in the next few months. Each of the four approved projects was front-loaded in the lending program (i.e. planned for FY98 or FY99); back- loaded projects (planned for FY00 or FY01) are now being reprogrammed for delivery in FYO1-02 (see paragraph 31 and Annex B3). The exception is the AIDS operation ($4 million, planned for FY99), which the Government has not yet requested in light of strong interest in the sector from donors providing grant funds. (For a discussion of the future lending program, see paragraph 31.) 14 27. With continuing progress in the reform program, and satisfactory ratings for FRDP 1 and 2, Malawi continues to deserve critically needed support. FRDP 2 supported reducing tariffs, prioritizing Government expenditures, improving expenditure monitoring, initiating rationalization of Government functions, and introducing regulatory reforms in the electricity and telecommunications sectors. On this basis, a new adjustment operation, FRDP 3 ($55 million), is being presented to the Board together with this Progress Report. FRDP 3 is closely linked to the priorities identified in the Interim PRSP, including improving public sector management; implementing the National Safety Net Strategy; and supporting private sector development through liberalizing telecommunications, the financial sector, and petroleum imports and retail marketing. It is likely to be the only operation presented for Malawi in FY01. IV. PREPARATION OF THE NEW CAS 28. In August 2000, the Government completed its Interim PRSP. The existing poverty strategy has four pillars: (i) creating a supportive macroeconomic framework by ensuring fiscal discipline and so lowering inflation; (ii) restructuring public expenditures and improving public sector management to improve service delivery to the poor (with particular attention to the HIV/AIDS strategy); (iii) creating an enabling environment for private sector development (concentrating on commercial agriculture and off-farm employment); and (iv) investing adequately in education and implementing a comprehensive and cost-effective safety net. The 1998 CAS, which supports this strategy, remains appropriate, but the underlying constraints facing Malawi are more severe than was previously recognized. Moreover, while the program to date has had some success-for example, in increasing small business and rural economic activity- there have been costs to the poor, especially in the form of price rises. The Joint Staff Assessment of the Interim PRSP points out some of the challenges that the authorities face in preparing and implementing a poverty reduction strategy, including expanding public-sector capacity, improving the implementation record, better prioritizing public spending, and strengthening financial management and accountability. 29. These challenges are being addressed in the preparation of the full PRSP, which is proceeding well. By October 2000, the Government had finalized an issues paper, determined the modalities of public consultation, and created structures at the ministerial and technical levels to guide development of the full PRSP. At present, it is planned that all analytical work, consultations, and political debate underpinning the full PRSP will be completed by March 2001, when a first draft will be available to inform discussions regarding the 2001/02 budget. The final version of the PRSP should be issued in June. The new CAS will be developed on the basis of the completed PRSP as well as on broad consultations with stakeholders (including consultations with the donors), and it should be presented to the Board in mid-FY02. Strategic Issues for the Next Full CAS 30. Malawi faces a number of formidable challenges (see page 15, Box 7). For the Bank, the central strategic issues concern the level, type and sectoral composition of support. With more than a dozen major partners active in Malawi, each historically pursuing individual programs that impose a significant burden on Malawi's limited capacity, a concerted effort is now underway among the principal partners to coordinate 15 more effectively not only in program implementation but also in the division of labor. The Bank is working particularly closely with the United Kingdom, the European Union, the United States, the Nordic donors, and the UN family. All of these donors are participating reciprocally in the ongoing formulation of each others' country assistance strategies (see page 11, Box 5, for information on program cycles). In framing its next CAS, the Bank will need to determine its specific role and contribution in any particular activity, taking into account: the importance of the activity to Malawi's development; Government ownership, capacity and commitment to act; as well as the Bank's own track record and comparative advantage vis-a-vis the other partners. A number of interconnected issues will require discussion, including: (i) whether the Bank's program should place greater quantities of resources into fewer sectors to ensure that assistance in any particular sector has a transformational effect; (ii) whether it should focus on interventions such as safety nets which have short-term, but possibly unsustainable, poverty-reducing effects, or on interventions such as private sector development which will lead to poverty reduction in the medium- and long-term; (iii) whether Bank lending is appropriate in the critical social sectors, where absorptive capacity is weak, grant resources are generally available, and other grant- Box 7: Five Key Interconnected Challenges for Malawi giving partners appear to be * Attaining high levels of export-led growth: Malawi needs to willing and able to take the grow at 5.3% per annum to keep the absolute numbers of the lead; and finally (iv) whether poor from increasing. Over the long term, this will involve lending should shift away diversifying away from tobacco and promoting non-traditional from project-based lending to manufactured exports. Improving the distribution of wealth: High growth alone is not a more programmatic enough; the distribution of assets such as land, credit and approach, financing annual or education-now highly inequitable, especially to girls and multi-year credits which women-needs to improve. support reforms meeting * Increasing human capabilities: Improving health and performance benchmarks in education outcomes has a direct imnpact both on quality of life and on labor market productivity. key sectors. Resolving these * Controlling HIVIAIDS: Besides causing untold human issues will require hard suffering and overwhelrming the health care system, it is choices between sectors and believed that HIV/AIDS is reducing Malawi's growth by 0.7% between activities as well as to 2.0% per annum. close coordination with the * Protecting the environment: Overintensive use of land and lake, though profitable in the short term, is doing irreparable Government and the external damage to Malawi's patrimony and long-term potential. partners. Lending Program and Non-Lending Services 31. As the program set out in the 1998 CAS remains relevant and unfinished, Bank activities in the next twelve months will involve completing it. To this end, lending will continue to follow the program agreed in the CAS, including FRDP 3, an adjustment operation supporting budgetary reform, liberalization of the petroleum, telecommunications and financial sectors, and creation of an affordable social safety net (FRDP 3 is being presented to the Board together with this Progress Report). Continuing efforts will be made to bring projects out of problem status, to ensure continued satisfactory progress in the remainder of the portfolio, and to remain above the targeted 20% disbursement ratio. Project preparation will also continue, albeit with some change in sequencing vis-a-vis the 1998 CAS (see Annex B3). At present, the Private Sector Development project ($20 million), the Lake Malawi Fisheries project ($20 million), and 16 the Regional Trade Facilitation project ($10 million) are all on track for Board presentation in late FY02; these projects are consistent with the Interim PRSP and clearly within areas where the Bank has a comparative advantage. In light of the imminent closure of the Primary Education project and the Population, Health and Nutrition project (on December 31, 2000), IDA is also willing to prepare successor projects in the health and education sectors, if the Government and the external partnership agree that Bank expertise and lending in these sectors remains desirable. Provided that the Government continues to implement its reform program, that there is a continuing need for balance of payments support, and that FRDP 3 disburses fully and carries a satisfactory rating, a new adjustment operation may also be prepared for late FY02. 32. For the next 12 months, most non-lending services will be concentrated on helping the Government to complete the PER and the PRSP. Looking further ahead, the country team will focus on ensuring that key economic and sector work is brought up-to- date (see Table 5). To address criticisms raised in the Client Survey, the Bank will also ensure that communication with all stakeholders is improved, that proposed reforms are explained more fully, and that these reforms are adequately tailored to local conditions. Assistance to the PRSP process will respond to emerging requirements and involve close collaboration with Malawi's other external partners. Bank analysis will focus on the macroeconomic reform agenda, the structural reform agenda (particularly as it relates to private-sector-led growth, including in the important agriculture sector), the role of the state (including decentralization), and public financial management arrangements. Bank support may help to identify which sectoral and structural reforms will have the greatest impact on poverty. It may also assist in prioritizing interventions, both between and within sectors; articulating them in specific implementation plans; costing them within the limited medium-term resource envelope; and developing an appropriate system for monitoring implementation. In addition, the Bank is prepared to assist in implementing a Table 5: Key Economic and Sector Work consultative process that captures and integrates the interests and concerns of Product Last Done Planned all key stakeholders into the PRSP as PER Ongoing 2001 well as in completing a disaggregated CFAA .. 2002 poverty analysis based on the 1998 CPPR 2001 2002 Integrated Household Survey; this Poverty Assessment 1996 2002 poverty analysis is expected to update CEM (Accelerating 2003 the poverty profile, inform elaboration CPAR 1996 2003 of the full PRSP, and issue ultimately in a new Poverty Assessment (in FY02). 33. The triggers for the base case lending program will be monitored on an ongoing basis and will remain the same as in the 1998 CAS (see page 13, Box 6), with two modifications. First, in line with the IMF's PRGF projections, the year-end inflation target is being revised to 26% for 2000 and to 10% for 2001. Second, in light of low foreign interest in buying Malawi' s public enterprises (including CBM, which has been brought to the point of sale but has not yet attracted a strategic partner), plans to sell NBM and the mature holdings of MDC and ADMARC are being reprogrammed; ADMARC will be expected to take further stages of commercialization in the interim. 17 Alternative Scenarios 34. In one possible scenario for Malawi, economic growth would quicken as a result of decisive action to control public spending, further liberalize agricultural marketing and production, and reduce cartelization within the business community. Key short-term measures would include firm steps towards full (as opposed to partial) privatization of CBM and NBM, together with improved financial sector regulation, as well as improved transparency in the operations of the Press Corporation. With good rains and timely supply of inputs, agricultural performance would be strong. New investments in mining, tourism, and non-traditional exports would also begin to materialize. In addition, the ACB, the Department of Public Prosecutions, the Ombudsman and the parliamentary oversight committees would work effectively to investigate allegations of corruption, prosecute offenders, and recover misappropriated funds. Under this scenario, portfolio performance would be good and development of the PRSP and the new CAS and preparation of new projects could be accelerated in recognition of the exceptional efforts and performance of the Government. In another possible scenario for Malawi, the macroeconomic situation could deteriorate sharply as a consequence of fiscal indiscipline. Expenditure prioritization and management could become weaker, with the result that priority items (e.g. teaching materials, essential drugs and medical equipment, or road maintenance) received substantially less than their expected allocations. Important reforms could be slowed or reversed (for example if some growers were given less access to the tobacco sales network, or the intermediate buyer mechanism were abandoned, or maize or petroleum subsidies were reinstated). Whatever the cause, under this scenario, reaching the completion point for HIPC debt relief would be significantly delayed and adjustment lending would stop. Provided that Malawi continued to meet its debt service obligations to the Bank, disbursements for ongoing operations would continue, but new lending would be scaled back to emergency operations only. Selected non-lending services would also continue. Risks and Risk Mitigation 35. Malawi continues to be a high-risk medium-reward country. The program faces six major risks that extend well beyond the period covered by this Progress Report. First, there is a risk of macroeconomic instability if the Government fails to apply fiscal discipline, maintain a tight monetary policy, and reduce the overall fiscal deficit. Measures contained in the IMF's PRGF and the proposed adjustment operation, FRDP 3, as well as the implementation of a new expenditure control system will help to mitigate this risk. Second, sentiment that current growth-inducing policies are not sufficiently benefiting the poor, or Malawian businesses and workers, could lead to backsliding on reform, particularly in the key agriculture and financial sectors. To mitigate this risk, IDA is improving dissemination of its analytical work and joining with the Government to ensure that development processes are more inclusive, for example, through PRSP- and CAS-related consultations. Third, needed improvements in public administration, capacity, and governance may not materialize quickly enough to improve program implementation, particularly where this concerns assisting private sector initiative. To contain this risk, the Bank is providing continued support to public sector reform and also working with the Government to improve economic governance and combat corruption. Fourth, HIV/AIDS, if unchecked, could substantially increase poverty and compromise or reverse Malawi's development. Implementing the national HIV/AIDS plan is a critical 18 step to mitigating this risk, and the Bank will play an important role in supporting it, by providing technical assistance, galvanizing additional resources, and providing new lending as needed. Fifth, Malawi's economic prospects are increasingly linked to those of the sub-region, such that adverse economic developments in neighboring countries, particularly Mozambique (its principal transportation corridor) and South Africa (its principal market) will dampen prospects for Malawi. To address this risk, the Bank is supporting efforts to contain regional crises and their spill-over effects, including by promoting trade diversification away from the region and active participation in regional and global organizations. Sixth, Malawi is vulnerable to climatic variations that can adversely affect health, water supply, agricultural growth and productivity, and economic development. The Bank is working with other donors and the Government to identify, reduce and manage such risks to the extent possible, with particular emphasis on the agriculture and water sectors. CONCLUSION 36. Malawi is an extremely poor country. To achieve its poverty reduction objectives in the medium- to long-term, it is important for the Government to remain committed to a sound reform program and a doable and well-prioritized PRSP. With commitment and perseverance, Malawi can overcome the daunting challenges and risks that confront it to realize its full potential. The Bank has played an important role in supporting Malawi's progress in the past and this CAS Progress Report continues the strong support under the 1998 CAS, particularly in the preparation of the Government's poverty reduction strategy, to consolidate past gains and realize future ones for the people of Malawi. James D. Wolfensohn President by Shengman Zhang Washington D.C. November 28, 2000 19 The Republic Of Malawi Country Assistance Strategy Progress Report ANNEXES Annex Al Key Economic and Program Indicators-Change from Last CAS Annex A2 Malawi at a Glance Annex B2 Selected Indicators of Bank Portfolio Performance and Management Annex B3 Bank Group Program Summary Annex B3 Bank Group Fact Sheet-IFC and MIGA Program Annex B4 Summary of Non-lending Services Annex B6 Key Economic Indicators Annex B7 Key Exposure Indicators Annex B8 Status of Bank Group Operations (Operations Portfolio) Annex B8 Statement of EFC's Held and Disbursed Portfolio Annex B9 Outcomes under the Last CAS Annex Al- Malawi Annex Al Key Economic & Program Indicators - Change from Last CAS As of 11121/2000 Forecast in Last CAS Actual Current CAS Forecast Economy (CY) 1997a 1998b 1999b 2000b 1997c 1998c 1999a 2000b 2001b 2002b Growth rates (%) GDP 5.0 4.4 4.5 4.5 3.8 2.0 4.0 3.2 3.0 4.0 Exports (GNFS, LCU) 9.9 3.7 6.0 5.2 10.2 3.7 -0.2 -1.5 0.7 6.1 Imports (GNFS, LCU) 11.0 -11.3 4.9 6.9 33.2 -5.5 -2.7 -8.9 -4.1 -1.9 Inflation (%, average) 9.1 22.8 14.3 7.8 9.1 26.2 44.8 27.1 18.0 7.2 National accounts (% GDP) Current account balance ( -9.5 -10.6 -9.1 -7.6 -13.9 -11.5 -17.0 -15.2 -15.4 -12.2 Gross investment 12.5 11.6 14.1 15.8 12.2 13.5 14.8 16.1 17.2 17.6 Public finance (% GDP) Fiscal balance (excl grant -7.6 -10.7 -7.7 -7.3 -14.2 -14.3 -11.6 -10.0 -8.4 -6.9 Foreign financing 6.1 13.9 9.7 6.7 6.9 14.9 12.9 10.9 11.3 11.5 International reserves (as months of imports) .. .. . 2.6 4.0 4.2 3.9 4.7 4.8 Program (Bank's FY) FY97a FY98b FY99b FY00b FY97c FY98c FY99c FYOOc FYO1b FY02b Lending ($ million) .. 48.2 178.9 115.0 12.4 48.2 101.0 28.9 55.0 100.0 Gross disbursements .. .. 54.4 110.8 142.5 112.5 80.0 50.0 ($ million) a. Estimated year b. Projected year c. Actual outcome 21 Annex A2, page 1 Malawi at a glance 11/29/00 Sub- POVEFRTY and SOCIAL Saharan Low- Malawi Africa lncorne Development diamond' 1999 Population, mid-year (millions) 10.8 642 2,417 Life expectancy GNP per capita (Atlas method. US$) 180 500 410 GNP (Atlas method US$ bl/fions) 2.0 321 988 Average annual growth, 1993-99 Population (%) 2.6 2.6 1.9 Labor force(%) 2.6 2.6 2.3 GNP Gross per primary Most recent esmate ilatest year available, 1993-99) capita enrollment Poverty (% ofpopulation below national poverty line) 46 Urban popuiation (% oftotalpopolat/or) 22 34 31 Life expectancy at birth (yeas) 42 50 60 Infant mortality (per 1 000 live births) 134 92 77 Child malnutrition (% of children under 5) 30 32 43 Access to safe water Access to improved water source (% of population) 45 54 64 Illiteracy (%of population age 15+) 41 39 39 Gross primary enrollment (% ofschool-age population) 134 78 9B - Malawi Male 140 85 102 Low-income group Female 127 71 88 1 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1979 1989 1998 1999 Economic ratios* GDP (USS billons) 1.1 1.6 1.7 1 8 Gross domestic investmentIGOP 32.5 24.6 13.5 14,8 Trade Exports of goods and services/GOP 22.4 18.8 33.3 27.1 Gross domesticsavings/GDP 15.5 8.8 6,1 -0.6 T Gross national savings/GDP 4.0 4.8 1.9 -2.2 Current account balance/GDP .. -13.4 -11.5 -17.0 Domestic Interest payments/GDP 2.2 1.8 1,6 1.5 Investment Total debt/GOP 61.2 88.7 142.8 143,0 Savings Total debt service/exports 17.9 39.5 17.2 20.4 Present value of debt/GDP .. 84.8 81.8 Present value of debt/exports .. .. 249.7 295.5 Indebtedness 197949 1989-99 1998 1999 1999403 (average annual growth) GDP 2.1 3.6 2.0 4.0 3.6 -Malawl Low-income group GNP per capita -07 1t.0 -1.3 1.6 1.3 Exports of goods and services 2.6 5.3 21.8 -18.6 2.3 ----- STRUCTURE of the ECONOMY 1979 1989 1998 1999 Growth of investmnent and GDP (
Groupe de la Banque mondiale · CAS Progress Report
Malawi - Country assistance strategy progress report
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CAS Progress Report
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Malawi
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Banque mondiale