Malawi - Population, Health and Nutrition Sector Credit Project

Document of The World Bank FOR OFFICIAL USE ONIA' '.} . C . - / i I Report No. P-5401-MAI MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 38.6 MILLION (US$55.5 MILLION EQUIVALENT) TO THE REPUBLIC OF MALAWI FOR A * POPULATION, HEALTH AND NUTRITION SECTOR CREDIT FEBRUARY 19, 1991 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 EQ'IVALENTS (February 1991) Currency Unit = Malawi Kwacha US$1.00 = MK 2.56 MK1.00 = US$0.39 SDR 1.00 = US$ i.43 MEASURES Metric Sysiem ABBREVIATIONS AND ACRONYMS ADMARC Agriculture Development and Marketing Corporation AIDS Acquired Immune Deficiency Syndrome ASAC Agricultural Sector Adjustment Credit DEVPOL Statement of Development Policies, 1987-1996 ECMAC Entrepreneurship and Capital Market Adjustment Credit FIAS Foreign Investment Advisory Service FSEDP Financial Sector and Enterprise Development Project IEC Information, Education and Communication ITPAC Industry and Trade Policy Adjustment Credit MDC Malawi Development Corporation MOH Ministry of Health PFP Policy Framework Paper PHN Population, Health and Nutrition UNICEF United Nations Children's Fund WHO World Health Organization FISCAL YEAR Government Fiscal Year: April 1 - March 31  FOR OFFICIAL USE ONLY MALAWI POPULATION HEALTH AND NUTRITION SECTOR CREDIT CREDIT AND PROJECT SUMMARY Borrower Republic of Malawi Beneficiaries: Ministry of Health and Ministry of Community Services and Social Welfare Amount: SDR 38.6 million (US$ 55.5 million equivalent) Terms: Standard, with 40 years maturity Financing Plan a/ Government US$ 6.3 million IDA US$ 55.5 million EC US$ 11.1 million Netherlands/WHO USS 1.4 million TOTAL US$ 74.3 million Economic Rate of Return: Not applicable Staff Appraisal Report: Report No. 9036-MAI Map: IBRD No. 22688 Note: a/ Excludes taxes and duties of US$2.3 million This document has a restricted distribution and may be used bh recipienlts only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE REPUBLIC OF MALAWI FOR A POPULATION HEALTH AND NUTRITION SECTOR CREDIT 1. The following memorandum and recommendation on a proposed development credit to the Republic of Malawi for the sum of SDR 38.6 million (US$55.5 million equivalent) Is submitted for approval. Part I of the document discusses Malawi's development prospects and economic performance, and the Bank Group's assistance strategy. Part II of the document describes the proposed credit. I. Country Policies and Bank Group Assistance Strategy A. Background 2. Malawi is characterized by pragmatic economic management, with emphasis on a market-based policy framework and private sector production. The economy, however, has a fragile and narrow resource base and faces several structural weaknesses: smallholder agricultural productivity is low, leading to seasonal food deficits and low nutrition levels; human resources are largely undeveloped, with exceedingly poor education, literacy, health and mortality levels; the population growth rate of 3.5 percent per annum is one of the highest in Africa; poverty is worsening; and a small and narrow export base has undermined balance of payments stability. As a result of these factors, Malawi has been extremely susceptible to external shocks, which has undermined strong and sustainable economic performance. 3. The country successfully exploited its endowment during the 1960s and 1970s, when GDP more than doubled and real per capita income grew by 3 percent per year. The economic development strategy at this time emphasized infrastructure and agriculture as vehicles for growth. While prices paid to smallholders by the monopsonistic marketing board (the Agricultural Development and Marketing Corporation -- ADMARC) were below world levels, a considerable share of the profits was reinvested in the sector, albeit in estate or agro-industrial investments. The estate sub- sector was deemed critical to export performance. Explicitly recognizing its constrained resources, the Government limited public expenditures, particularly in the social sectors, and maintained tight macroeconomic management, with low inflation levels and an appropriate real effective exchange rate. 4. Malawi's period of strong growth came to a halt in the early 1980s as a result of external shocks, delayed policy responses, and intensification of structural imbalances. On the external front, declining export prices, soaring oil prices, and disruption of external transport routes through Mozambique led to a dramatic decline in the terms of trade. While the Government was responding to these shocks, the country was hit in the mid-  - 2 - 1980s by a worsening of the war in Mozambiquxe, which not only led to a debilitating increase in international transportation costs but also to increased security-related expenditures and a large influx of refugees. This led to a sharp deterioration in macroeconomic balance and to policy setbacks, culminating in an economic crisis in 1986 from which Malawi is just recovering. B. The Adjustment Process 5. In response to the external shocks, the Government andertook a broad- based structural adjustment effort beginning in 1981. This program was supported by three SALs and two sector adjustment operations, the Industry and Trade Policy Adjustment Credit (ITPAC) and the Agricultural Sector Adjustment Credit (ASAC), from the Bank and other bilateral donors as well as by successive arrangements with the Fund. A set of three Policy Framework Papers (PFP) have been agreed with the Bank and Fund since 1988/89. The major elements of the adjustment package comprised: (a) restructuring of the parastatal sector; (b) reforming smallholder agricultural pricing and marketing; (c) establishing fiscal discipline; and (d, restoring a relatively open exchange and trade regime. 6. Restructuring of the parastatal sector included reorganization of ADMARC and Malawi Development Corporation (MDC) as well as divestiture and restructuring of the Press Group. ADMARC's financial position has improved substantially with an estimated net profit (before tax) of MK 29.9 million in 1989/90. The restructuring continues, including asset divestiture. MDC has shed a number of operations and has become profitable. Financial performance of the parastatal sector as a whole has been favorable and financial targets under the PFP have been met. Profitability was restored to the Press Group starting in 1984. 7. Smallholder agricultural reform focused on strengthening price incentives and expanding participation in marketing to the private sector. Smallholder producer prices were increased significantly, with pricing based on export-import price parity, or domestic conditions in the case of maize. This resulted in improved performance among larger smallholders. Private sector trading was encouraged, with the exception of tobacco and cotton, and differentiated ADMARC producer and consumer maize prices were implemented to facilitate this participation. The ongoing ASAC operation, approved by the Board in March 1990, targeted policy reform to the smaller farmers, including elimination of restrictions on smallholder production of high value cash crops such as burley tobacco and liberalization of fertilizer distribution, and estates, including increases in land rents. 8. Fiscal policy under the adjustment program aimed at establishing fiscal discipline, including development of a tax reform program and strengthened budgeting procedures. A substantial reduction in the central government budget deficit enabled a transfer of financial resources from the Government to the private sector. The deficit declined initially from 15.5 percent of GDP in 1980/81 to 8.5 percent in 1984/85, and, in response to the fiscal imbalances stemming from the second series of shocks, the deficit again was reduced from 13 percent in 1986/87 to an estimated 6 percent in 1990/91. This fiscal discipline supported a 41 percent  average increase In private sector credit per year between 1988/89 and 1990/91. Structural reforms in budgetary planning included introduction of a rolling Public Sector Investment Program and programmatic budgeting. The Government also initiated a comprehensive tax reform program aimed at improved tax administration and allocative efficiency, with a major restructuring of indirect taxes. Revenue generation has remained strong at 20-21 percent of GDP. 9. In the early adjustment period, Malawi's trade and exchange regime was relatively open. However, this trend was reversed by gradual increases in trade taxes compounded by the introduction of import exchange controls in response to the 1985-86 crisis. Beginning in 1988, the Government removed these import controls in a phased manner; the final stage of the import liberalization program was completed in January 1991. Throughout the adjustment period, the Government has made appropriate adjustments of the exchange rate, resulting in a 15 percent depreciation of the real effective exchange rate between 1985 and 1990. These adjustment measures have resulted in increased efficiency of import use and increased manufacturing capacity utilization. 10. The structural reforms and improvements in short-term macroeconomic management have stabilized the macroec.'nomic environment, as indicated by the figures presented in Schedule A. After static growth in 1986 and 1987, GDP grew by 3.0 percent in 1988 and 5.3 percent in 1989, restoring per capita GDP growth to a positive level. Despite drought conditions, GDP grew 4.8 percent in 1990 as a result of expansion in the manufacturing and distribution sectors following the import liberalization program. Inflation decelerated sharply from an average of about 30 percent in 1987- 88 to 16 percent in 1989 and 12 percent in 1990 as a result of tight aggregate demand management. The improved performance in output and relative price stability supported a large increase in gross investment, from 12.3 percent of GDP in 1986 to an estimated 19.0 percent in 1990, and national savings, from 6.3 percent of GDP in 1986 to 10.2 percent in 1990. Despite the resumption of strong economic growth during the past few years, structural weakness remain that impede the development of a sustainable supply response in Malawi, as discussed below. C. Central Development Issues 11. As reviewed in the recent Country Economic Memorandum, Malawi's central problem is poverty. It is estimated that 55 percent of the population lives below the poverty line, almost entirely in rural areas. The principal factors behind the pervasive problem of low income include limited employment opportunities, low physical productivity of labor and land, low levels of human capital, limited access to land and economic rents, minimal income transfers, and rapid population growth. Consequently, as noted below, these issues form the core of the development agenda for the 1990s. 12. Low aRricultural productivity. As population pressure leads to smaller farm sizes and continuous mono-cropping depletes soil fertility, more than one-half of the rural population risks facing seasonal food deficits and low nutrition levels. Adoption rates of higher-yielding maize  - 4 - varieties and labor-saving technologies have been low in Malawi, due to limited access to production credit packages, weaknesses in extension services, and smallholder resistance to available varieties. 13. Inadequate human resource development. Malawi's human capital is poorly developed. In education, primary and secondary enrollment rates are low, the quality of the education system is uneven, and there is limited vocational and technical skills training. Health conditions are among the worst in the world, with high infant and maternal mortality rates, chronic malnutrition, and shortages of key medical personnel. 14. Rapid population growth. Malawi is already one of the most densely populateA -ountries in Sub-Saharan Africa, and, with a population growth rate est.m.ted at 3.5 percent in the 1987 census, the problem is worsening. Rapid populacion growth is inevitable over the next few decades. If fertility remains constant, the rate of population growth is expected to climb to four percent by 2015, implying a doubling of the population within 17 years. Growth of this magnitude threatens to exhaust the country's land resources and create a massive demand for food, energy, and social services. 15. Employment. Malawi's rapid population growth rate has created a young age structure and fast-growing labor force, which is putting pressure on labor market absorption. Given land corx.traints in agriculture, most of the increase in employment opportunities will have to come from expansion of off-farm rural employment and formal and informal urban employment. However, the former is constrained by inadequate farm surpluses and limited rural credit mechanisms, and the latter by the small size of the domestic market and Malawi's limited comparative advantage in export manufacturing. 16. Environmeatal degradation. Malawi's natural resource base is experiencing significant stress as a result of population pressures and the influx of Mozambican refugees. In addition to the problem of increasing soil degradation, natural forests are being rapidly depleted by firewood and pole extraction, land clearing for cultivation, and excessive felling of indigenous high-grade timber species. Under current trends, it is estimated that the indigenous forest on customary land will be totally eliminated over the next ten years. 17. Narrow export base. Malawi has a small and undiversified export base, with tobacco accounting for 63 percent and tea and sugar for 10 percent each of total ex?ort proceeds. This dependency on a few primary agricultural commodities, which have been vulnerable to poor weather conditions and declining prices in recent years, has contributed to highly variable export earnings and widely fluctuating current account deficits. 18. Economic management. Despite the stated commitment to the private sector, economic and political policy makers continue to demonstrate a "control reflex" over private sector entrepreneurship and initiative. In particular, the policy framework for industrial investment, small-scale business activity, and financial sector intermediation has been overly restrictive in several areas, which has constrained a broad-based supply response and impeded the development of entrepreneurial talent.  D. Government Development Strategy 19. The Government prepared a comprehensive new medium term development strategy in 1987, the Statement of Development Policies. 1987-1996 (DEVPOL), in response to these development problems. As outlined in DEVPOL and the three successive PFPs, the Government's principal development objective is to increase the rate of economic growth to sustainable positive per capita levels in the context of macroeconomic stability and poverty reduction. Key issues are reviewed below. Economic Growth 20. Agriculture remains the key sector for growth in the Government*s development strategy. Given land scarcity and the narrow cropping base of the smallholder sub-sector, Government plans to increase food production through increased fertilizer use and the adoption of higher-yielding maize varieties. Emphasis is placed on the development of new research, credit and extension programs to support the dissemination of improved crop packages. Given the low land utilization rates in the estate sub-sector, Government is introducing measures to increase productivity and labor absorption in estate land. Growth in this sub-sector will be important in raising export earnings, as much of the increase in smallholder production is expected to be consumed domestically. Specific measures include the establishment of an estate extension service, increased land rents, and expanded access to medium-term investment funds. Given the central role of natural resources in the economy, the Government is committed to further strengthening of the incentive framework for sustainable natural resource management. 21. While agriculture is expected to remain the primary source of growth, Government also expects significant output increases in the industrial sector. Recent reforms, including import liberalization, reduction in the scope of industrial licensing, and development of a new investment policy statement, are expected to foster a more favorable environment for new investment in export growth and efficient import substitution. Development of small and medium-sized industries by Malawian entrepreneurs is a key element in positioning the sector for future growth and expansion, and will be necessary to help absorb the rapidly growing labor force and help the development of rural areas. 22. Finally, while the service sectors are highly dependent on economic activity in the rest of the economy, further strengthening is envisioned to ensure they do not to become a bottleneck in future growth. Reduction in external transport costs is a high priority for Government and the completion of the Northern Transport Corridor Project in 1993 is expected to provide a significant impetus for growth. The expected reduction in the cif margin from 40 percent in 1988 to 35 percent in 1993 under this project will lower the price of imported inputs in domestic production and improve the competitiveness of export production in world markets. Government also continues to explore ways to reopen the traditional rou._es to Beira and Nacala. The financial sector remains extremely underdeveloped and Government is planning to improve resource mobilization and financial  - 6 - intermedtacion. Specific measures include development of bond and equities markets, improved monetary management, and expansion of rural credit mechanisms. Poverty Reduction 23. The Government is increasingly emphasizing equity and distribution issues in light of the pervasive poverty problem. Its development strategy addresses the five key factors behind the poverty nexus that were reviewed in para. 11. To address -he previously inadequate attention to human resource development, the Government is increasing public expenditures for health and education. The first priority in education is expansion and quality enhancement of primary schooling, with emphasis also on science and technical skills training, improved teacher training, and curriculum reform. Special attention will be paid to increased access and retention rates for girls. The main priorities in health are improved staffing of primary health care, increased allocation of resources for maternal and child care facilities, and strengthening of hospital and health service management. Nutrition will receive special emphasis through increased food security efforts and targeted supplemental food programs. To address the problem of population growth, the Government is committed to expansion of family planning activities, including increased population education in school curriculum, expansion of child-spacing services, and support for a new Family Welfare Association. 24. To increase employment opportunities and labor productivity, the Government is introducing new policy reforms and investments to support the expansion of the urban and rural informal sector. Key measures include liberalization of small-scale and micro-enterprise regulations, introduction of labor-saving and income-generating programs for women, and continued implementation of trade, finance, and industrial policies that promote labor-intensive production. To improve land productivity, the Government agriculture development strategy gives emphasis to the smaller farmers who face the greatest food insecurity. Key measures include expansion of burley tobacco production to smallholders, introduction of food for work schemes and targeted credit schemes to farmers with less than one hectare of land, and expansion of fertilizer marketing in small packets. Finally, to raise the cash income of the poor, the Government continues to review the scope for targeted transfer payments, including the introduction of a new Social Program Support Fund to test pilot interventions that reduce poverty among the most vulnerable groups. Macroeconomic Management 25. The Government places great emphasis on maintaining the macroeconomic stability that has been achieved during the recent adjustment period. In public finances, the Government will continue to maintain strict fiscal discipline to reduce inflationary pressures and excess demand for imports and to ensure adequate credit expansion to the private sector. Since the tax burden on the economy is relatively high, the burden of fiscal adjustment will continue to fall on expenditures, which will entail difficult but critical choices among competing allocation priorities. These efforts will be complemented by a comprehensive reform of the tax  - 7 - system designed to improve the structure of incentives facing producers and investors. 26. The stance of monetary policy will continue to be geared towards achieving and sustaining a low inflation rate and protecting the balance of payments, while structural reforms in the financial sector will be implemented with a view to strengthening monetary control, enhancing domestic financial saving, and improving the allocative efficiency of investment. Key policy measures include constrained monetary expansion, maintenance of liberalized interest rates, and the introduction of more market-based monetary control instruments. Growth Prospects 27. The Government development strate4,y is expected to lay the groundwork for a resumption of strong economic growth. The projected economic indicators are included in Scheduled A and summarized below in Table 1. Real GDP is expected to increase by about 4.5 percent annually in 1991-93 reflecting increased capacity in manufacturing, construction, and distribution, associated with higher levels of investment following the import liberalization program; major productivity gains in the smallholder and estate sectors generated by recent policy reform and investment activity; and strong growth in the service sectors in response to financial sector reform and liberalization of business regulations. These growth levels will permit real increases in per capita consumption. Fixed capital formation is projected to increase from 16.4 percent of GDP in 1990 to 18.5 percent in 1993 to support the higher output levels. The increase in investment activity will be backed by improved domestic resource mobilization, with domestic savings expected to increase from 8.1 percent of GDP in 1990 to 14.7 percent in 1993 in response to financial sector reform. However, foreign savings will continue to play an important role in financing the development program. The current account deficit is expected to decline gradually from 8.8 percent of GDP in 1990 to 6.0 percent in 1993, as export performance improves over the medium-term following the increases in agriculture and industrial productivity. TABLE 1: MALAWI - MACROECONOMIC INDICATORS, 1990-1993 1990 1991 1992 1993 GDP Growth Rate 4.8 5.0 4.5 4.5 Consumption/Capita Growth Rate -0.8 1.1 0.7 0.7 Fixed Investment/GDP 16.4 18.0 18.5 18.5 Domestic Savings/GDP 8.1 12.8 13.9 14.7 Current AccountlGDP -8.8 -8.5 -7.2 -6.0  -8- E. Bank Group Operations 28. Over the past 25 years, the Board has approved 56 projects financed by 53 IDA credits (totalling US$897 million excluding cancellations) and 10 Bank loans (totalling US$106 million excluding cancellations), of which two were on third window terms. About a third of the total US$1003 million has been provided through structural and sectoral adjustment operations, in line with the critical need for adjustment in the last decade. Other important areas were infrastructure and water (19 percent) to overcome the constraints from limited rural infrastructure, agriculture (16 percent) in line with the smallholder focus of the Government's development strategy, and education (16 percent) to address the problem of inadequate access to primary and secondary education. The balance has been used for energy, health, development finance, technical assistance, industry, urban housing, and institutional development. In recent years, the distribution of Bank lending has shifted slightly, with more emphasis on adjustment lending following the macroeconomic disequilibria of the mid-1980s and less emphasis on infrastructure development with the completion of many key investment projects, as shown in Table 2. 29. Implementation of past lending operations has been relatively strong. Adjustment operations have not experienced significant delays in tranche releases. Nonetheless, the management capacity of the Government frequently became over-stretched in trying to implement a comprehensive adjustment package, particularly as new exogenous shocks continued to undermine stabilization and adjustment efforts. In recognition of these implementation constraints, the future adjustment lending program will be focused sharply on a smaller, more manageable set of priority policy issues, as reviewed below. Investment operations in general have been implemented in a timely and effective manner. TABLE 2: MALAWI - DISTRIBUTION OF BANK LENDING, FY86-90 (US$ Million) Sector Amount % of Total Adjustment Lending 189.9 43 Agriculture and Forestry 52.5 12 Industry and Finance 7.8 2 Health and Population 11.0 2 Education 63.9 14 Urban and Water 20.0 5 Transportation and Infrastructure 42.2 9 Energy 46.7 10 Institutional Development 11.3 3 Total 445.3 100  9 F. Bank Country Assistance Strategy 30. The Bank will continue to play an important role In the design and implementation of Malawi's development program as well as in the mobilization and coordination of financial resources required to support economic development. The primary goal of the country assistance strategy is to support the four critical areas of economic growth, poverty reduction, natural resource conservation, and macroeconomic management in the Goverrnment's development agenda. This support will be provided through a mix of economic and sector work, project and non-project lending, and aid coordination. Economic and Sector Work 31. The Malawi ESW work program is designed to strengthen the analytic underpinnings of our policy dialogue with Government, identify investment priorities for our proposed lending program, and facilitate aid coordination by providing a framework for other donors. In the area of economic growth, the Bank has recently completed several sector studies on agriculture, industry, and finance that formed the basis of the FY89 Industrial and Trade Policy Adjustment Credit, the FY90 Agriculture Sector Adjustment Credit, and the proposed Financial Sector and Enterprise Development Project scheduled for Board review in FY91. A comprehensive review of transport sector issues is currently underway, which is expected to identify a broad range of policy, investment, and technical assistance measures to improve the efficiency of resource use in road, rail and air services. Future work is planned in the areas of energy pricing, which will strengthen the incentive framework for the energy sector, and domestic trade and distribution, which will address the remaining constraints to private sector development associated with the high degree of concentration in the formal economy. 32. In the area vf povert S reduction, the Bank prepared a Country Economic Memorandum in FY91 that laid out a comprehensive program to tackle Malawi's poverty problem. This work, which was supported by several sector studies in population, food security, and women in development, provided the focus for the recent Consultative Group Meeting and laid the groundwork for a concerted government and donor strategy to reduce poverty. The review of social sector expenditure priorities in the report provided the analytical underpinnings for the proposed operation, the Population, Health, and Nutrition Project. In the area of natural resource conservation, an economic report on environmental policy issues is being prepared that will map out a medium-term policy reform and investment program to ensure efficient and sustainable use of the resource base, with emphasis on the pressing issues of deforestation, soil erosion, and water pollution. This work is expected to form the basis for the Government's Environmental Action Plan and future Bank lending. 33. Finally, in the area of macroeconomic management, the FY90 Public Expenditure Review, as well as future economic work on budget rationalization, is expected to assist the Government in maximizing the benefits of budget outlays in a tight fiscal environment. Close monitoring of the size and composition of the annual Public Sector Investment Program  - 10 - will continue to be a key issue in the work program and the policy dialogue with Government. A review of public sector management issues is underway to identify policy and technical assistance measures to improve the incentive framework for effective economic management. Lending Program 34. The planned volume of lending for the FY91-95 period represents a slight increase from the level of the FY86-90 period, with about three lending operations programmed per year. This strong IDA support to Malawi is appropriate in light of the extent of poverty in the country and the effective implementation of economic reform. The evolution of the lending program will be based on progress on policy performance, as reviewed in para. 49, particularly in creating a more open environment for private sector initiative and implementing the poverty reduction strategy. In response to policy slippage, the lending program would be cut back significantly, with suspension of adjustment operations and focus on investments in sectors where implementation was proceeding smoothly and where policy shortfalls would not jeopardize effective implementation. In response to more rapid implementation of an appropriate policy framework combined with evidence of sufficient institutional capacity, the lending program could expand by about 20 percent. 35. The lending program is gradually shifting towards a greater reliance on investment operations. Planned non-project lending would decline from the 40 percent level during the last five years. However, since significant policy reform is still required to ensure a sustainable impact of specific investment activities and since Malawi is expected to face balance of payments pressures over the next few years as a result of continuing external shocks, adjustment lending remains an important component of the medium-term lending strategy. The need for future adjustment assistance will continue to be reassessed in light of the following uncertainties. First, Malawi continues to face a difficult external situation related to the Mozambique civil strife as well as the Gulf crisis. Second, the speed of the supply response as reflected in export and import growth is uncertain. As adjustment lending tapers off in the 1990s, sectoral investment projects will increasingly combine policy elements and time-slices of the Government's sectoral investment program to ensure adequate resource flows to the private sector, continued policy improvement, and support for the Government's core expenditure program. The specific components of the lending program are reviewed below. 36. Reflecting recently completed economic and sector work, the Bank has revised its agriculture strategy to address the pressing issue of low productivity. More emphasis is being given to raise smallholder production through development of appropriate technology, credit and extension packages and improve the efficiency of resource use among estates. The focal point of sectoral policy reform is the ongoing Agriculture Sector Adjustment Credit. Future Bank investments will focus largely on the expansion of smallholder access to agricultural services, particularly for the smaller farmers, and improved conservation of the natural resource base.  - 11 - 37. The restructuring of the industry and trade policy environment has been a major emphasis of Bank assistance during the past three years. With a favorable policy framework in place, the Bank is now focusing on another key constraint to industrial development: the thin, undeveloped financial market. A recent review of financial sector issues identified a number measures to deepen financial markets and improve the efficiency of resource mobilization, which are contained in the proposed Financial Sector and Enterprise Development Project (FSEDP), scheduled for Board review in FY91. This investment operation will be complemented by the proposed Entrepreneurship and Capital Market Adjustment Credit (ECMAC), scheduled for Board review in FY92, which is designed to remove the policy constraints to private sector entrepreneurship and initiative, particularly in the areas of investment controls, small-scale business regulations, and limited access to financial capital. 38. The Bank will continue to support development of the physical infrastructure required for growth. Given the constrained public expenditure program, emphasis will be on integrated, sector-wide investment operations that target high priority investments and provide sufficient resources for the maintenance of the existing capital stock. Reflecting the central role of transport shocks in Malawi's macroeconomic disequilibrium during the past ten years, the strategy emphasizes rationalization of transport sector investments and policies, through such ongoing projects as the Northern Transport Corridor Project of FY88 and the Infrastructure I Project of FY90 and current sector work on transport policies. The restructuring of the parastatal transport agencies, particularly Malawi Railways, will be a focus of Bank lending in this sector. The strategy also emphasizes the appropriate expansion and increased maintenance of infrastructure development functions, as well as the implementation of the least-cost power development program. 39. As part of the increased emphasis on poverty reduction, social sector lending will be increased. The proposed operation, the Population, Health, and Nutrition Project, is a key vehicle for this objective. Building on several existing programs of bilateral donors, this proposed operation provides critical support to strengthen primary health care programs, increase family planning activities, and improve medical support services. Ongoing education credits, including the Education Sector II Credit approved in FY90, are focused towards expansion and quality enhancement of primary schooling and increased efficiency in resource use. Finally, additional investment in the development of rural water supplies is expected to improve access to clean water and reduce the incidence of water borne disease. 40. Increased social sector investment will be matched by an expansion of employment opportunities and labor productivity, directly benefiting the poor who do not have many assets other than labor. The proposed credit as well as future investment operations will address women in development issues, particularly the need for labor-saving technologies that relieve the constraints on women's time and enable them to seek other income earning opportunities. Likewise, the proposed FSEDP and ECMAC operations emphasize the expansion of credit to the small-scale sector. As reviewed above, future investments in agriculture will directly support poverty  - 12 - reduction objectives by targeting productivity increases for the smaller farmers. Finally, continued macroeconomic policy reform under adjustment operations will promote increased employment through greater labor- intensity of production and higher investment levels. 41. In response to growing need for natural resource conservation, future Bank investments are expected to expand on-going projects in rural afforestation and soil conservation and introduce new initiatives in fisheries development, customary forestry management, rural water pollution, and agroforestry systems. These investment efforts will be complemented by further strengthening of the incentive framework for efficient resource use, particularly adjustments in fuelwood and water pricing and stricter enforcement of estate conservation and afforestation covenants. 42. Finally, in the area of macroeconomic management, the Bank will continue to support policy measures to sustain macroeconomic stabilization and technical assistance requirements to strengthen public sector implementation capability. In public finance, future projects will emphasize continued fiscal constraint, improved budgeting systems, and expansion of the tax reform program. In monetary policy, the proposed FSEDP operation will assist the Government in moving away from direct regulation of commercial bank credit to a more market-based monetary program. Given implementation constraints in several key ministries involved in planning and implementing macroeconomic policy reform, the Bank will continue to provide technical assistance to strengthen public sector management, including the FY89 Institutional Development Project that supported the restructuring of the Ministry of Finance and the establishment of the Malawi Institute of Management. 43. To ensure a successful winding down of the adjustment process in the 1990s, Bank lending will increasingly emphasizing the need to liberalize macroeconomic management, particularly the government's "control reflex" that has constrained a broad-based supply response in the critical areas of agriculture, capital markets, and domestic trade and distribution. The proposed ECMAC operation is expected to play a key role in addressing policy obstacles to entrepreneurship that constrain physical capital investment and limit access to financial and human capital. Private Sector and Collaboration with IFC 44. The Government's strategy gives the private sector a central role in the development of the economy. As noted above, the Bank assistance strategy includes support for policy reforms critical to removing constraints to private sector entrepreneurship, increased emphasis in the investment lending program on the financial sector as a vehicle for extending resources to the private sector, and further economic and sector work oriented toward private sector development including the issues of concentration of ownership, private transport services, and micro- enterprise development. 45. The Bank will continue to work closely with other arms of the Bank Group in expanding the opportunities for the private sector. The Bank is  - 13 - working closely with the Foreign Investment Advisory Service (FIAS) in developing the appropriate policy framework for investment. The IFC currently has seven operations in Malawi, totalling US$32.6 million in gross commitments and is actively seeking new investments. Recently, IFC has launched a number of initiatives to supplement its regular investment activities in Africa, including the African Project Development Facility, which has completed six projects and has three active projects in Malawi, and the African Enterprise Fund, which is currently appraising a project in Malawi. The Bank strategy is to work closely with the IFC in identifying options for strengthening the flow of resources to the private sector in Malawi. Aid Coordination and Collaboration with IMF 46. Reflecting the centrality of a stable macroeconomic environment to the adjustment process in Malawi, Bank and Fund staff work in close collaboration on the macroeconomic program. The third-year PFP was presented to the Bank and Fund Boards in August 1990. Malawi is now in the third year of a three-year ESAF program with the Fund; the final tranche release was approved by the IMF Board in February 1990. 47. A Resident Mission was established in Malawi about five years ago and has been quite successful in improving our policy dialogue, supporting supervision, and strengthening aid coordination. The Resident Representative provides leadership to an active local donors' aid coordination effort. In addition, bi-annual CG meetings have been an effective mechanism for donor coordination and consultation. The third CG meeting, which took place in May 1990, was successful in mobilizing needed external resources, directing Government towards high priority investment areas, and addressing key issues related to poverty alleviation and budgetary processes. 48. Bank lending operations have attracted a large volume of co- financing, particularly of adjustment credits in line with the Special Program of Assistance. Sector operations, such as the Northern Transport Corridor and Infrastructure I Projects, have been effective in coordinating the efforts of various donors. Various sector studies on population, food security, transport, and the environment, together with the Public Expenditure Review and Country Economic Memorandum, have provided a policy framework and sector strategy which can be drawn on by other donors. Continued active coordination will ensure ongoing support from the donor community in achieving the objectives of balance of payments sustainability, growth, and poverty reduction for Malawi. G. Performance Indicators 49. The Bank will continue to monitor closely Malawi's economic performance and revise the country strategy and operational program accordingly. The principal indicators for judging progress on the implementation of Malawi's adjustment program are reviewed below. In economic growth, key measures include: development and dissemination of appropriate high-yielding maize varieties; phased increases in estate land rents; liberalization of investment regulations, zoning laws, and business  - 14 - procedures related to industrial and small-scale enterprise development; and restructuring of transport sector parastatals. In poverty reduction, principal actions are: increased credit to the small-scale enterprise sector; increased expenditures for primary health and education and for family planning; and introduction of productivity enhancing measures targeted to the smaller farmers. In natural resource conservation, preparation of an Environmental Action Plan is the critical step. Finally, in macroeconomic management, key measures include: maintenance of a real effective exchange rate consistent with external competitiveness and import demand; maintenance of strict fiscal discipline to ensure adequate availability of resources to the private sector; implementation of new tax reform measures in rate reduction and base expansion; preparation and implementation of a prioritized Public Sector Investment program; and introduction of market-based monetary control instruments. H. Summary Assessment 50. Despite Malawi's successful implementation of a comprehensive adjustment program over the last decade, there is a consensus that much remains to be done to ensure higher growth for a wider range of beneficiaries in the economy. The poverty reduction and growth strategies outlined above will be complementary and mutually reinforcing over time. The effectiveness of the program, however, will be greatly influenced by external events and the maintenance of policy commitment. On the external front, the economy will be greatly influe.iced by events, positive as well as negative, in neighboring Mozambique as well as by developments in the terms of trade. On the policy front, progress will be judged by continued responsible macroeconomic management and by continued implementation of policies to open up the economy to private sector entrepreneurship and to expand the participation of lower income groups, particularly in the smallholder sector. 51. However, one or more problems may emerge over the next few years and undermine the structural adjustment process and Malawi's growth prospects. In the event of an adverse exogenous shock, the strategy would remain robust, but there would be a casc for a combination of stronger macroeconomic adjustment and higher levels of concessional external assistance from both IDA and other donors. There is an additional risk that the political system will not be suited to absorbing the policy changes required for growth combined with poverty reduction. In the event of policy slippage, IDA will reassess its assistance strategy and focus on core investment projects. II. The Proposed Credit 52. The proposed credit would be on standard IDA terms with 40 years maturity. It would help finance a population, health, and nutrition (PHN) project. The project would be parallel financed by the European Community and World Health Organization (WHO). 53. Sector Background and Strategy. Within the context of the issues and priorities described above, Government has initiated policy and program reforms and improvements in population, health and nutrition to strengthen  - 15 - services and address the extensive needs of the country, in line with the DEVPOL strategy. The first phase of this reform and improvement effort has involved preparation of new sectoral strategies and expenditure plans, both for the near-term and for a ten-year horizon. This work has been backed by extensive assessment of the problems, options, and implementation issues, building on two IDA-aided projects (the First and Second Family Health Projects, the former of which has been completed) and other donor activities, and facilitated by three sector reviews and other studies. Progress thus far on the reform program (and on the Second Family Health Project) has been encouraging, but much more remains to be done. 54. The next phase will focus on two main concerns. First, many basic PHN programs are still seriously inadequate. Primary health care, although fully endorsed by all concerned, remains weak on the ground. Population programs, supported by Government through its "child spacing" initiative, are still inchoate compared to the need. Disease control, especially for the highest priorities (malaria and acquired immune deficiency syndrome (AIDS)), and nutrition interventions, are unable to keep pace with the growing requirements. Vital opportunities to build on promising experiments in women-in-development efforts that could improve PHN status are being missed due to lack of resources. Second, many crucial support services, including especially those relating to staffing issues, pharmaceuticals provision, and information, education and communications (IEC), continue to have major shortcomings, resulting in substantial deficiencies in management and institutional capacity. Staffing shortfalls, acute in several health cadres and at numerous facilities, are not being adequately resolved. The pharmaceuticals supply system and IEC programs are struggling. The nation's hospitals, instead of effectively backstopping primary care facilities and meeting referral needs, are over- congested, inefficient, and costly -- thus draining away resources required elsewhere. The Government's budget for PHN services, and budget management, are out of line with the DEVPOL goals. 55. Project Objectives. The project's objectives are to improve quality, access, efficiency, and effectiveness in the sector through: (a) strengthening of basic programs, focussing on primary health care, maternal and child health care, child spacing (family planning), malaria control, AIDS program, nutrition interventions, and women in development activities; (b) strengthening of supPort services, focussing on staffing issues, pharmaceuticals, and IEC; (c) efficiency improvements, focussing on management strengthening, hospital decongestion, cost sharing, and budget reform; and (d) support to the Government's social dimensions of adjustment initiative. 56. Project Description. In line with these objectives, the project's component on strengthening of basic programs will include: (a) for primary health care and maternal and child health care, development and expansion of the Health Surveillance Assistants into outreach-oriented and village- based PHN promoters and service providers; rehabilitation and/or construction of rural health centers; provision of rural housing where needed to attract essential personnel; and provision of some vehicles to improve the effectiveness of district level services; (b) for malaria,  - 16 - improvements in logistical support, in the supply of anti-malarial drugs, and in support for drug resistance monitoring; (c) for AIDS, acceleration of efforts in education and prevention campaigns and in acquisition of blood screening equipment; (d) for child spacing, launching of a Family Welfare Council to promote family planning and expansion of the Ministry of Health's (MOH) program; (e) for women in development, institutional strengthening, upgrading of training activities, and testing of small scale demonstration projccts on appropriate technology dissemination and credit ptovision; and (f) for nutrition, extension of a community-level food security approach developed and tested by the United Nations Children's Fund (UNICEF), and a micronutrient deficiency program. The component on strengthening of support services will include: (a) for staffing issues, upgrading of training programs and facilities for health cadres currently in critically short supply, and enhancement of personnel management information and planning capabilities; (b) for the IEC program, expanded activities for training health workers, and provision of resources for conveying population, health, and nutrition messages to communities; and (c) for pharmaceuticals, technical assistance and training on drug procurement, distribution and production, and improvement of facilities and equipment. The component on efficiency improvements will include (a) rehabilitation of three urban health centers and construction of two others to shift more outpatient care away from the more costly and overcrowded hospitals, (b) rehabilitation of one district hospital, construction of another, and replacement of worn-out equipment in selected other hospitals; (c) introduction of reforms in patient fees; and (d) budget reforms involving increases in the MOH budget and the share of it devoted to outreach and peripheral health services. The component on the social dimensions of adjustment initiative will include support for a "social support program fund" to assist small scale pilot interventions derived from felt needs of communities and expressed through government or non- government channels. 57. Rationale for IDA Involvement. The project is consistent with the IDA lending strategy for Malawi and the latest Policy Framework Paper, which emphasize human resource development. IDA involvement is needed because (a) the new initiatives to be launched under this project involve complex issues on which the Government has limited experience and capacity, and thus requires technical and other assistance; and (b) IDA has a comparative advantage in addressing the financial and institutional issues in the health sector and in mobilizing donor support within a common framework of sectoral objectives. 58. The proposed project complements and reinforces the activities of other donors, including: the African Development Bank (which has supported improvement of curative services); United States Agency for International Development (extensive assistance in multiple areas, involving, inter alia, health education, rural water supply, and training of peripheral workers); Overseas Development Administration of the United Kingdom (fellowships and technical assistance); the Dutch, Egyptian and other governments (technical assistance); European Community (expansion of peripheral and curative services); the West Germany aid agency, Kreditanstalt fur Wiederaufbau, (construction of Machinga Hospital as well as building and rehabilitation of health centers); United Nations Development Program  - 17 - (health manpower development and technical assistance); WHO (primary healtth care); UNICEF (immunization program, diarrhoeal disease control, and maternal and child health, with support from the Italian Government); United Nations Fund for Population Activities (family life education); the Japanese International Cooperation Agency (volunteers, vehlicles and drugs); Canadian International Development Agency (bore holes for Health Centers); and several non-governmental organizations involved in direct provision of services. IDA has maintained close cooperation with donors during the development of the project. 59. Agreements and Recommendations. Prior to negotiation, the Government sent to IDA (a) the Statement of Health Policy and related policy action program; (b) a five-year plan for each major hospital to improve efficiency and reduce recurrent expenditures; (c) a detailed plan for rationalization and management of the health services of Local Authorities and MOH at the district level; (d) a plan for the decentralization of management authority to the district, including the establishment of the District Health Management Teams and the District Health Planning and Coordinating Committees; (e) terms of reference and composition of the District Health Management Teams and the District Health Planning and Coordinating Committees; (f) evidence that the proposed Health Manpower Planning and Development Unit will be established in the MOH; (g) an approved list from Department of Personnel Management and Training showing all the approved posts for each of the individual health facilities at the district level (Local Authority, Private Hospital Association of Malawi and MOH); (h) a plan for deployment of all 91192 graduates to individual health facilities showing an increase in number of peripheral staff equal to the number of graduates; (i) evidence that Government has introduced a revised fee schedule for the "paying patients" service, has an implementation plan to cover the full cost of this service by April 1992, and will assure that the fees will be reviewed and increased every year subsequently; and (j) a plan for the introduction of cost sharing measures. 60. At negotiations, IDA and Government agreed on the issues and documents noted above, including: the year the borrower will implement the cost sharing measures; the requirement that for each of the fiscal years 1991/92 through 1994/95 the revenue and development budgets for peripheral health services will be at least 2 percent higher than the appropriations for the preceding fiscal year; and the inclusion of a line item in the budget of MOH to cover non-salary items of Local Authorities' health facilities. 61. By credit effectiveness, the Government will send to the Bank: (a) the proposed MOH revenue and development budgets for 1991/92; (b) a detailed work program for FY 1991/92 to improve efficiency at each central hospital; and (c) the first phase of a plan to raticnalize and manage Local Authorities health services at the district level. Disbursement for the women in development component will be conditioned on receipt and agreement by IDA of a plan for administration of funds for income generating activities in the 24 villages and receipt of a plan for the restructuring of Magomero Training Program. Disbursement for Lilongwe District Hospital will be conditioned on introduction of the new cost sharing measures at the two central hospitals (which Government intends to do once the urban health  - 18 - centers are completed and operational) and adoption of a revenue and development budget satisfactory to the Association. The date for credit effectiveness is expected to be June 1991. 62. Justification and Risks: The proposed credit is designed to support the Government's population, health and nutrition programs and the key adjustment measures stressed in the Policy Framework Paper, including especially improved internal efficiency and increased cost recovery. The credit would fund a major strengthening of district health services, provide support for priority programs, reduce the incidence of malaria and malnutrition, finance an accelerated program ef manpower development and continue the institution building activities initiated under the Second Family Health Project. There are three main risks. First, the fiscal difficulties and constrained Government expenditures pose the risk that the health budget may not increase fast enough to permit timely realization of the investment plan and adequate funding of the system. This risk is being minimized by the Government's commitment as stated in the DEVPOL to allocate more resources to MOH and by the requirement that MOH submit its forward budget estimates after approval by the Ministry of Finance for IDA review. A second risk concerns the introduction of cost sharing measures and their effect on demand for health services in the rural areas. This risk is being minimized by the gradual pace proposed. A final risk is that the staffing requirements for the consolidation of peripheral services might prove difficult for Government to meet. This risk is being minimized by the provision in the credit for the training of district health administrators. Furthermore, the credit provides for the system to be evaluated two years after its inception and adjusted if necessary. 63. The project finances inputs primarily and has no impact on the environment. 64. Recommendation. I am satisfied that the proposed Credit would comply with the Articles of Agreement of the Association and recommend that the Executive Directors approve the proposed Credit. Barber B. Conable President Attachments Washington, D.C. February 19, 1991  SCHEDULE A - 19 - Page I of I MALAWI KEY MACROECONOMIC INDICATORS, 1986-1993 --Ac-----Actual