Malawi - Industrial sector memorandum

4 I Report No. 7402-MAI Malawi Industrial Sector Memorandum December 14, 1989 Industry and Energy Operations Division Southern Africa Department FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Units Malawian Kwacha (MK) Exchange Rates Calendar 1988 August 1989 US$1.00 MK 2.56 US$1.00 MK 2.X8 MK 1.00 = US$0.40 MK 1.00 US$0.36 Fiscal Year April 1 - March 31 GLOSSARY OF ABBREVIATIONS ADMARC Agricultural Development and Marketing Corporation AES Annual Economic Survey AREE Annual Report on Employment and Earnings CBM Commercial Bank of Malawi DEMATT Development of Malawian Traders Trust DFI Dcvelopment Finance Institution DRC Domestic Resource cost INDEBANK Industrial and Development Bank of Malawi INDEFUND Investment and Development Fund ISIC International Standard Industrial Classiflcation MDC Malawian Development Corporation MEDI Malawian Entrepreneurs Development Institute MEPC Malawian Export Promotion Council MTIT Ministry of Trade, Industry and Tourism MUSCCO Malawian Union of Savings and Credit Coopcralivc MVA Manufacturing Value Added NA Not Available NBM National Bank of Malawi NSO National Statistical Office OGL Open General License POSB Post ')ffice Savings Bank RBM Reserve Bank of Malawi RTS Rural Trade School SEDOM Small Enterprise Development Organization of Malaaiwi SITC Standard Industrial Trade Classification TFPG Total Factor Productivity Growth  FOR OMCIL USE ONLY SYNOPSIS The contribution of Malawi's industrial sector to economic growth, employment, and exports was negligible during the eighties. This performance stands in stark contrast to the sector's record during the sixties and seventies, when manufacturing output and employment outpaced GDP growth and the sector attained its present 12 percent of GDP. This report examines the causes for the dramatic slowdown in the growth of industrial output and employment and offers policy recommendations to spur efficient manufacturing growth. The report has two main findings. First, Malawi's industrial sector is among the most efficient in sub-Saharan Africa, despite the facts that it is small, characterized by simple technological processes, heavily dependent on raw materials, and mainly geared to satisfy domestic demand. Second, the sector's efficiency and relatively high rates of growth during the sixties and seventies were the result of good sectoral and macroeconomic policies. In general, sectoral policies have been market-oriented and relatively neutral. Thus, the authorities have never used tax holidays to favor industrial investment, and have used subsidies only occasionally. Until the late seventies, protection was low and fairly uniform. Finally, the Government has not pursued industrialization through large investments in industrial concerns either. The weak performance during the eighties was the result of exogenous factors and inappropriate policy response. Adverse changes in the terms of trade reduced domestic demand and the country's capacity to import, triggering a slowdown in industrial output. The authorities' response--in particular, higher import duties and discretional allocation of foreign exchange--increased protection, led to a misallocation of resources, and aggravated the economic slowdown. To spur growth, the report recommends returning to the macroeconomic policies that spawned Malawi's industrial sector. In particular, it advocates eliminating the foreign exchange allocation system and supports the authorities' flexible management of the exchange rate. The reports argues for reducing tariff-based protection by lowering the overall tariff level and reducing tariff spreads, but only after access to foreign exchange has been fully liberalized. The report also recommends adopting policies to place manufacturers in a free-trade-equivalent situation to spur industrial exports, listing duty drawback schemes, and export processing zones as two possibilities. With respect to financial policies, the report concluded that the institutions now operating in Malawi cater mostly to prime customers and do very little, if any, term intermediation: their liabilities are mostly short-term and so is their asset base. This conservative bias falls particularly heavily on the small and emerging entrepreneur. The report argues that the instruments of monetary policy used by the authorities are in large part responsible for this bias. In particular, the use of credit ceilings (enforced on an institution-by-institution basis) to control the money multiplier reinforces the market's oligopolistic structure, raises collateral requirements, and displaces non-prime borrowers. When credit ceilings are binding banks prefer to lend to their established client base and to prime clients with the best collateral; they also actively discourage savers by directing them to instruments with the lowest interest rates, making time deposits less attractive than other assets. The report recommends using open market operations instead of credit ceilings to control the money supply, and revising the legal framework accordingly. This document has a restricted distribution and may be used by recipients only in the performance | of their official duties. It3 contents may not otherwise be disclosed without World Bank authorization.  MALAWI INDUSTRIAL SECTOR MEMORANDUM TABLE OF CONTENTS Pae No. EXECUTIVE SUMMARY.. ..................... . ... . . I Introduction .. Industrial Structure ...i Industrial Efficiency ... ii The Policy Environment and its Impact on Industrial Performance. iii Growth Prospects.v Recommendations.v Financial Sector.vi Institutional Setting.vi Performance.vii Small Scale Industry.viii Institutional Arrangements.viii Credit.ix Gr wt Pr EOOMANTEspects ........................... . . " _...... "................................................... The Malawian Economy .1 Recent Industrial Performance .. 2 Industrial Structure .3 Concentration .4 Export Orientation and Import Dependence.S Financial Characteristics.6 Rates cf Return and Pay-out Ratios.6 I1. PROTECTION AND INDUSTRIL EFFICIENCY.. .. .... ........... 7 Introduction.7 Nominal Protection.8 Effective Protection.9 Industrial Efformany .11 Sources of Inefficiency.12 Capacity Utilization and Foreign Exchange Allocatin .13 Firm Ownership.14 Import Content.15 Capital Intensity.16 This report is based on the findings of an industrial sector mission that visited Malawi during October 1987. The mission was composed of Pedro Belli (Chief and principal author), Vincent Rague (financial sector analyst), Richard Scobey (economist), Caroline Doggart (consultant, economist), Jorge Garcia- Garcia (consultant, economist), and Gradimir Radisic (consultant, economist). A draft report was discussed with the Government of Malawi in May 1989.  -2- Firm Size .............................................. 17 Market Concentration .............................................. 17 Profitability and Economic Efficiency .............................................. 18 Conclusions .............................................. 18 Ill. THE POLICY ENVIRONMENT AND) INDUSTRIAL PERFORMANCE.-..-. . . . . . ......... . .... 20 Introduction ..................................................... 20 Key Stages in the Trade Regime ...................................................... 22 Tariff Policy ..................................................... 22 Adjustment ..................................................... 24 Foreign Exchange Allocation and Protection ..................................................... 25 Nominal Protection ..................................................... 25 Increasing Protection and its Impact on Trade Ratios ..................................................... 26 Relative Prices ..................................................... 27 Exchange Rate .................................... 27 Nominal Minimum Wage and Real Wages .................................... 29 Sources of Growth in Manufacturing 1974-79 .................................... 31 Employment, Labor and Total Factor Productivity .................................... 35 Employment ............................................. 35 Labor Productivity .................................... 35 Investment and Capital Stock Estimates .................................... 37 Total Factor Productivity .................................... 37 Sub-sectoral Total Factor Productivity Growth .................................... 39 IV. FINANCIAL INSTITUTIONS AND POLICIES ... .... .... . . .. ... ......... . 40 Introduction ..................................... 40 Institutional Framework ..................................... 40 The Reserve Bank of Malawi ..................................... 40 Commercial Banks ..................................... 40 Other Financial Institutions ..................................... 42 The Post Office Savings Bank ..................................... 42 Finance Houses ..................................... 43 The New Building Society (NBS) .43 Development Finance Institutions (DFIs) .43 Pension Funds and Insurance Companies .43 Performance ......... 44 Portfolio Quality ......... 46 Ownership ......... 46 Monetary Policy ......... 46 Interest Rate Determination ............................. 47 Credit Ceilings ............................. 48 Liquidity Management ............................. 48 The Regulatory and Supervisory Framework ............................. 49 V. SMALLSCALE INDUSTRY IN MAlAVI ......... . .. . .................... .0.... s Structure and Development .............................. 50 Financing Small-Scale Industries .............................. 51 Industrial Licensing .............................. 52 Barriers to Entry and Growth .............................. 52 Government Policy and Institutional Framework for SSIs ...................................... 52  Lox . .. . . ....... . .. .... .......................... .................................. IT----------------lp3JD BS............................................................................................ ~~~~~~~~~.....................................................................u w i l LS ............... ............................................s i uoTIPP . 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