Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-6799-MAI REPORT AND RECOKENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION : THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT IN THE AMOUNT OF SDR 73.2 MILLION OF WHICH SDR 2.9 MILLION HAVE BEEN ALLOCATED FROM IDA REFLOWS TO THE REPUBLIC OF MALAWI FOR A FISCAL RESTRUCTURING AND DEREGULATION PROGRAM APRIL 3, 1996 This document has a restricted distribution and may be sed by recipients only in the performance of their official duties. Its contents may not otherwise be discosed without World Bank authorization. CURRENCY EQUIVALENTS Currency Unit = Malawi Kwacha (MK) USSI = MK 15.3 (March 1996) FISCAL YEAR (FY96/97) April 1, 1996 to March 31, 1997 FOR OFFICIAL USE ONLY ABBREVIATIONS AND ACRONYMS ADMARC Agricultural Development and Marketing Corporation ASAC Agricultural Sector Adjustment Credit BMR Budget Management Review BOP Balance of Payments CAS Country Assistance Strategy CBI Cross Border Initiative for Eastern and Southern Africa CCFF Compensatory Contingency Financing Facility COMESA Common Market for Eastern and Southern Africa CPPR Country Portfolio Performance Review EDDRP Entrepreneurship Development and Drought Recovery Program EDI Economic Development Institute EPZ Export Processing Zones ESAF Enhanced Structural Adjustment Facility FMIS Financial Management Information System FRDP Fiscal Restructuring and Deregulation Program GOM Government of Malawi IBRD International Bank for Reconstruction and Development IDA International Development Association IMF International Monetary Fund ITPAC Industrial and Trade Policy Adjustment Credit LDP Letter of Development Policy MASAF Malawi Social Action Fund MDC Malawi Development Corporation MIPA Malawi Investment Promotion Agency MK Malawi Kwacha MT Metric Tons MTEF Medium-Term Expenditure Framework PAR Project Audit Report PCR Project Completion Report PFP Policy Framework Paper PHL Press Holdings Ltd. PSI Pre-Shipment Inspection PSIP Public Sector Investment Program RBM Reserve Bank of Malawi SAR Staff Appraisal Report SGR Strategic Grain Reserve SPA Special Program of Assistance to Low-Income Debt- Distressed Countries in Sub-Saharan Africa SOE State Owned Enterprise TCC Tobacco Control Commission TEP Temporary Employment Permit TOR Terms of Reference VAT Value Added Tax This docutment 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 wiihout World Bank authorization. Contents SUURY ..............................................................i 1. INTRODUCTION ............................................................I 2. BACKGROUND AND RATIONALE ............................................................2 Overview ...........................................................2 Experience Under Previous Adjustment Operations ............................................................3 Environment Conducive to Higher Impact Adjustment ........................................................5 Commitment to Poverty Alleviation ........................ ....................................6 Commitment to Broad-Based Private Sector Development ..........................................7 Govemment-driven Preparation Process and Broad Consultation ................................8 3. WORLD BANK GROUP ASSISTANCE STRATEGY ........................................................8 Links Between the Proposed Program and the CAS ............................................................8 Stakeholder Involvement During Preparation of the Program ........................... ...................9 Internal Consultation Process in the World Bank ........................................................... 10 Collaboration with IMF ........................................................... 10 4. MACROECONOMIC FRAMEWORK ........................................................... 11 Recent Turn-around in Macroeconomic Situation ........................................................... II Objectives and Policies ........................................................... 12 Extemal Financing Requirements ........................................................... 14 5. THE FISCAL RESTRUCTURING AND DEREGULATION PROGRAM ..................... 15 Objectives ........................................................... 15 Actions Supported by the Operation ................. .......................................... 16 Fiscal Restructuring ........................................................... 16 Deregulation of Agricultural Policies ........................................................... 25 Deregulation of Private Sector Development Policies ................................................ 30 6. THE PROPOSED CREDIT ........................................................... 34 Conditionalities: Borrower-IDA Contract ........................................................... 34 Supervision Plan ........................................................... 35 Supervision Focus ........................................................... 35 Organization and Timing of Supervision Activities ............................................. ...... 36 Performance Indicators ........................................................... 37 Borrower's Contribution to Supervision ........................................................... 37 Credit Administration ........................................................... 37 Coordinating Agency ........................................................... 37 Financing Plan ........................................................... 38 Disbursement and Audit ........................................................... 39 Procurement Procedures ........................................................... 40 Benefits ........................................................... 40 Risks ........................................................... 40 Implementation Risks ........................................................... 40 Outcome Risks ........................................................... 42 7. RECOMMENDATION ........................................................... 43 Annexes Annex A: Previous Adjustment Operatios ............................................................. 44 Annex B: Environment for Higher Impact Adjustment Lending in Malawi ..................... 52 Annex C: Supplementary Information ............................................................. 53 Annex D: Privatization Program ............................................................. 54 Annex E: Matrix of Policy Actions ............................................................. 57 Annex F: Supervision Chart ............................................................. 60 Annex G: Disbursement Performance ............................................................. 64 Annex H: Letter Of Development Policy ............................................................. 67 Annex 1: Statistical Data ............................................................. 91 Tables TABLE 2.1: MALAWI - PREVIOUS ADJUSTMENT OPERATIONS ......................................3 TABLE 2.2: MALAWI - POVERTY INDICATORS ..................................................................5 TABLE 2.3: MALAWI - MAJOR POLICIES IMPLEMENTED SINCE MAY 1994 .................6 TABLE 4.1: MALAWI - SELECTED MACROECONOMIC INDICATORS .......................... 12 TABLE 4.2: MALAWI - EXTERNAL FINANCING REQUIREMENTS ................................ 14 TABLE 5.1: MALAWI - TARGET SHARES IN RECURRENT EXPENDITURES (%) ......... I 8 TABLE 5.2: MALAWI MTEF - SECTORAL EXPENDITURE SHARES ............................... 19 TABLE 6.1: FRDP - SUMMARY OF COMPLETED ACTIONS ............................................. 35 TABLE 6.2: FRDP - FOCUS OF SUPERVISION ................................................................. 36 TABLE 6.3: FRDP - SELECTED PERFORMANCE INDICATORS ....................................... 38 TABLE 6.4: SENSITIVITY ANALYSIS - MACROECONOMIC SCENARIOS ..................... 43 Figures FIGURE 2.1: MALAWI - REAL GDP GROWTH ..................................................................4 Boxes BOX 2.1: LESSONS LEARNED FROM PREVIOUS ADJUSTMENT OPERATIONS ...........7 BOX 5.1: QUOTES FROM SECTORAL MTEF REPORTS .................................................... 20 This operation was prepared by a team comprising of Hartwig Schafer (Senior Country Economist and Task Manager, AFIMI); Alexine Frank-Cooper (Task Assistant, AFIMI); Gene Tidrick (Lead Economist, AF1DR); Peter Harrold (Economic Advisor, AFTPS); Ladipo Adamolekun (Principal Public Sector Management Specialist); Lloyd McKay (Senior Economist, AFIMI); Jim Smith (Senior Economist, AFIML); Shem Migot-Adholla (Senior Rural Sociologist, AGRPW); Paul Siegel (Rural Poverty Specialist, AFIAE); Ahmad Ahsan (Country Economist, AFIMI); Andrew Stone (Private Sector Development Specialist, PSD); Hakan Wilson (Private Sector Development Specialist, PSD); Stanley Hiwa (Agricultural Economist, AFIMW); Noel Kulemeka (Program Officer, AFIML); and Teja Raparla (AFIMI). Aberra Zerabruk is the Senior Counsel (LEGAF) and Steve Gaginis is the Disbursement Officer (LOAAF). Peter Miovic (Lead Economist, EDI) is the Peer Reviewer. Barbara Kafka (AFIC3) is the Country Operations Manager, Ataman Aksoy (AFIMI) is Chief of the Macro, Industry and Finance Division, and Katherine Marshall (AFIDR) is Director of the Southern Africa Department. MALAWI FISCAL RESTRUCTURING AND DEREGULATION PROGRAM SUMMARY Beneficiary: Republic of Malawi Project Task ID: 3MAL-PA-1648 Implementing Agency: Government of Malawi IDA Amount: SDR 73.2 million (US$106.4 million equivalent) of which SDR2.9 million (US$4.4 million) have been allocated from IDA Reflows. Terms: Standard IDA Terms: 40 years maturity with a 10-year grace period. Co-financing: Co-financing and parallel financing is expected from the Government of Germany (US$7 million equivalent) and the Government of Japan. The Governments of Denmark and Sweden have expressed interest in supporting the operation through quick-disbursing grants. Disbursement: The proposed Credit will be disbursed through the Reserve Bank of Malawi. The initial tranche of SDR 50.9 million (US$74.4 million equivalent) including the allocation from IDA Reflows, will be available upon Credit effectiveness and the Second Tranche of SDR 21 million (US$30 million equivalent) will be disbursed when the conditions relating to civil service reform are met. SDR 1.3 million (US$2 million equivalent) is available for consultant services. Background: The Fiscal Restructuring and Deregulation Program (FRDP) will be the first economic reform program Summary designed and implemented by the new Government of Malawi (GOM). The operation (a) is anchored in the GOM's medium-term strategy as reflected in the 6th Policy Framework Paper (PFP, issued on October 10, 1995) and the attached Letter of Development Policy (LDP); and (b) is a core component of the World Bank Group's Country Assistance Strategy (CAS), which is being presented to the Board in conjunction with the proposed operation. The FRDP is supported under the Special Program of Assistance to Low-Income Debt- Distressed Countries in Sub-Saharan Africa (SPA) and the Cross Border Initiative for Eastern and Southern Africa (CBI). Description: The FRDP is designed to support a critical new phase in Malawi's emerging macroeconomic reform program, aimed at the dual strategy of ensuring the macroeconomic essentials to allow growth, and a fundamental restructuring of programs that address the country's pervasive poverty. The cornerstone of this phase of the program is a far-ranging overhaul of public expenditure planning and management, with a view to raising allocations in pro-poor expenditure categories within agreed macroeconomic targets. Specifically, the operation supports development of a Medium-Term Expenditure Framework (MTEF), comprehensive civil service reform, and tax and tariff reform. In addition, the FRDP focuses on policy measures that will allow the poor to participate in the full range of economic activities. This includes complete removal of remaining pricing and marketing constraints on smallholder agriculture, and removal of the binding constraints to broad-based private sector entry and development. Rationale for IDA Involvement: The proposed Credit represents the logical continuation of IDA involvement in Malawi's adjustment to a difficult external environment. Despite a series of earlier adjustment operations, there remains a backlog of policy constraints which the new Government--with technical and financial support from IDA and other donors--is committed to removing rapidly. The proposed FRDP supports a time-slice of Malawi's economic reform program starting with a wide range of credible policy measures that have been implemented over the past Summary iii 12 months (including education sector policy, expenditure reform, and agricultural liberalization). In other areas the GOM has expressed its commitment to reform and launched medium term initiatives--but further analytical work needs to be carried out before specific measures are identified. In those areas, IDA will remain engaged in providing guidance and advice during supervision and expects to narrow down the scope and timing of specific measures within the next 12 to 18 months (including land policy reform, drought proofing, and privatization). Government Commitment: Critical components of the FRDP--such as the civil service census, the privatization strategy, the measures under the CBI, and the MTEF--were prepared by Government. The GOM has firmly demonstrated its commitment to policy reforms, economic growth, and poverty alleviation and has unequivocally stated its commitment to involving broad segments of civil society in the planning and implementation of its development programs. The proposed Credit will provide funds for consultants' services to carry out stakeholder meetings to gauge the impact of policy measures on vulnerable groups and support a communications strategy for the proposed measures. Benefits: The policy package will directly benefit the poor through redirection of public resources towards their needs (such as primary services in education and health) and through reduced inflation resulting from macroeconomic stabilization. Improved access to cash crops and alternative marketing channels should increase smallholder household incomes. Exporters will gain through increased incentives for agricultural diversification, helping the economy to reduce its dependency on tobacco (from currently 66% of export revenues to about 50% by 2005) and creating additional employment opportunities. Risks: The FRDP faces implementation and outcome risks. The risk of failing in macroeconomic stabilization because of, for instance, excessive civil service wage increases, will be managed through continuation of bilateral negotiations between the GOM and the Civil Servants Union. The resolution of the August 1995 civil service strike is iv Summary indicative of the GOM's determination to offset higher civil service salaries only with parallel reduction and restructuring of the size of the civil service in the context of civil service reform. It is probable that civil service reform and privatization will encounter political pressures by civil servants and parastatal employees who will object to retrenchment plans. Although extensive stakeholder involvement will help reduce resistance from special interest groups (and the GOM's communication strategy will help build broad- based consensus), residual risks remain. These will be managed by reaching agreement on end-of-service and severance benefits packages. The recently completed staff retrenchment of Malawi Railways has set a precedent by which future retrenchment packages in the public and parastatal sector might be measured. Accelerated agricultural liberalization could result in further increases in maize prices (main staple). This would adversely affect food deficit households and receive significant attention from civil society and critics of adjustment programs--and could eventually lead to reversal of the GOM's liberalization policy under popular pressure. This risk will be managed through a mix of stakeholder consultations, targeted pro-poor activities (such as public works under the Malawi Social Action Fund (MASAF), targeted input distribution programs, and supplemental food programs) and sales from the Strategic Grain Reserve (SGR). Although the GOM's political willpower will continue to be tested, actions taken so far clearly signal the GOM's commitment to poverty reduction and macroeconomic stabilization. In all policy areas, preparatory work was carried out by the GOM and implementation of critical measures is on track, thus reducing the risk of back- pedalling on key issues. The aforementioned residual implementation risks can be reduced to a level similar to those associated with many of IDA's successful programs. But even if Malawi does all the right things, vulnerability to external shocks--outcome risks--will persist. The risk of drought is by far the highest and least controllable of such risks. In the short term, the impact of a major Summary v drought cannot be offset alone by shifting resources or by relying on substantial donor grants; additional aggregate demand management would be necessary to stay within the agreed fiscal framework. In that case, some measures are necessary to reduce the burden on the poor; the MTEF will help to protect expenditure allocations in the social sectors and will identify low-priority areas from which to reallocate expenditures to drought-related operations. Over the medium term--and for a limited number of households--the agreed expansion of smallholder tobacco production is a measure to improve drought vulnerability. Over the longer term, the GOM and IDA intend to address drought vulnerability through a more systematic and integrated effort to promote alternative crops, disseminate alternative technologies and foster increased non-farm activities. I INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO SUPPORT A FISCAL RESTRUCTURING AND DEREGULATION PROGRAM TO THE REPUBLIC OF MALAWI 1. INTRODUCTION 1.1 I submit the following report and recommendation on a proposed International Development Association (IDA) Credit of SDR 73.2 million (US$106.4 million equivalent) of which SDR 2.9 million have been allocated from IDA Reflows to the Republic of Malawi in support of its economic reform and structural adjustment program. The Credit would be on standard IDA terns with 40 years maturity and a 10-year grace period. Co-financing is expected from the Governments of Germany and Japan. The Governments of Denmark and Sweden have expressed their interest to support the prograrn through quick- disbursing grants. 1.2 This will be the first economic reform program designed and implemented by Malawi's democratically-elected government, following 30 years of one-party rule. The operation is (a) anchored in the GOM's medium-term strategy as reflected in the 6th Policy Framework Paper (PFP, issued on October 10, 1995); and (b) a core component of the World Bank Group's Country Assistance Strategy (CAS), that is being presented to the Board in conjunction with the proposed operation. The GOM's program is also supported by a three-year arrangement under the IMF's Enhanced Structural Adjustment Facility (ESAF approved by the IMF's Board on October 18, 1995). 2 Chapter 2 2. BACKGROUND AND RATIONALE OVERVIEW 2.1 The Fiscal Restructuring and Deregulation Program (FRDP) is designed to support a critical new phase in Malawi's continuing macroeconomic reform program, aimed at the dual strategy of ensuring the macroeconomic essentials to allow growth, and a fundamental restructuring of programs to ensure that these better address the country's pervasive poverty. The Poverty Profile (prepared by the GOM and the Bank) shows that Malawi's per capita spending in the social sectors compares favorably with other low-income countries. However, social sector spending is highly biased against primary level services and therefore fails to reach broad segments of the poor. The GOM has launched a far-reaching process to reorient public spending to pro-poor areas in line with its commitment to expand the provision of social services to the majority of the population. Further, the GOM has embarked on the accelerated liberalization of the economy to achieve broader-based development and sharing in the country's wealth by those segments of the population that were largely excluded in the past. Consequently the proposed operation focuses on the following two policy areas in the GOM's medium-term program: (a) Fiscal restructuring in favor of social sectors. (b) Deregulation to integrate smallholder farmers (who account for 85% of the poor) and a nascent private sector in the mainstream of development. 2.2 Proceeds from the proposed Credit will (a) help fill Malawi's projected external financing gap through FY96/97; (b) provide budgetary support for critical expenditures in the social sectors and a substantial net repayment to the domestic banking system; and (c) smooth consumption to lessen the costs of stabilization and help prevent undue hardship to the poor. 2.3 Initially we planned to present a larger Credit with two tranches plus a floating tranche linked to implementation of specific actions under an agreed civil service reform program. However, in view of the breadth and complexity of the overall reform agenda, we decided that the operation should be geared to a shorter timeframe. An initial tranche (US$74.4 million equivalent) will support a wide range of far-reaching policy measures which the GOM has already taken during the past months. A smaller Second Tranche (Civil Background and Rationale 3 Service Reform Tranche equivalent to US$30 million) will be linked to specific actions under civil service reform (to follow about 6 months after the initial tranche). We expect continued strong commitment by the GOM and plan to pursue specifics under the medium-term policy agenda in conjunction with supervision of the proposed program and during preparation of a follow-on operation which we plan to present for Board approval in FY98. EXPERIENCE UNDER PREVIOUS ADJUSTMENT OPERATIONS 2.4 Since 1981 Malawi has undertaken six adjustment operations, including two supplemental Credits (Table 2.1: Malawi - Previous Adjustment Operations), reflecting a pattern of recurrent periods of short-lived economic recovery and growth (as in 1983-85 and 1988-91), which were halted or reversed by external shocks followed by economic recessions. Details on previous Adjustment Operations are presented in Annex A. Although these repeated periods of economic recovery earned Malawi the reputation as a "strong adjuster", sustainable and broad-based growth has remained elusive (Figure 2.1: Malawi - Real GDP Growth). During the early 1980s structural reforms were pursued and designed primarily for their impact on fiscal stability, for instance, restructuring loss-making parastatals and removing fertilizer subsidies. While Malawi succeeded in the short run, the costs of successive stabilizations were significant. Much of the burden of fiscal tightening was borne by the poorest segments of the population because expenditure cuts perpetuated the imbalance between spending on primary social services (which can benefit the poor) and tertiary level social expenditures (which benefited a small elite). Malawi's poverty indicators fell behind other countries that started from similar low levels at Independence. Table 2.1: Malawi - Previous Adjustment Operations Name of Operation Board Approval IDA Credit (USS M) SAL-I FY81 45 SAL-Il FY84 55 SAL-Ill FY86 30 SAL-IlI Supplement FY87 10 Industrial and Trade Policy Adjustment Credit (ITPAC) FY88 79 Agricultural Sector Adjustment Credit (ASAC) FY90 79 Entrepreneurship Development and Drought Recovery Program (EDDRP) FY92 120 Entrepreneurship Development and Drought Recovery Program - Supplement FY95 40 2.5 The pre-1994 Government's lack of commitment to poverty alleviation-- combined with Malawi's vulnerability to recurrent external shocks--forestalled any sustained and comprehensive transformation of the economy. Until a few years ago, Malawi's economy--in particular the smaliholder agricultural sector-- 4 Chapter 2 was among the most regulated private sectors in Africa. Marketing and production restrictions excluded smallholders from growing profitable cash crops (especially burley tobacco), from getting prices that corresponded to world market prices, and from competing with the privileged estate sector. Until 1987 the marketing monopsony of ADMARC (Agricultural Development and Marketing Corporation) effectively taxed the smallholder sub-sector and prevented entry by private traders. Expanding tobacco exports provided a thin veneer of growth (almost exclusively in the estate sector) that concealed a fragile and narrow macroeconomic base, highly skewed income distribution, and lack of economic diversification. SALI SALII SALIII ITPAC ASAC EDDRP 1100 . ..... . .. . . .. . .. j . . . ..- .. , 9.7 8.3 600 5.4 4.4 4.6 3.7 . -.00 I.4 -4.00 -10.2 -14.00 - - - - - - ---- - 1975 1991 193 1985 1987 19S 1991 1993 1il Figure 2.1: Malawi - Real GDP Growth 2.6 The formal sector became increasingly dominated by a few public and private conglomerates (such as Press Corporation, ADMARC, and Malawi Development Corporation (MDC)). Concentration of property ownership in the economy reinforced the increasingly domineering political regime. President Banda personally owned Press Corporation, a "private" company controlling over half of Malawi's small formal sector, including banks, manufacturing and agricultural estates. A small number of Malawians benefitted, while the lives of the majority became worse. Malawi's Gini coefficient for household expenditures (.62) may be the highest recorded in the World (Table 2.2: Malawi - Poverty Indicators). Background and Rationale 5 Table 2.2: Malawi - Poverty Indicators Malawi SSA Income per Capita (US$) 140 520 Life Expectancy (years) 45 52 Adult Illiteracy (%) Total 59 50 Female 69 62 Income Inequality (Gini coefficient) .62 Population per Physician (1984) 11,340 24,180 Access to Safe Water (%) 48 ... Infant Mortality Rate 142 93 Child Mortality Rate 223 172 2.7 By 1987 it was clear that business as usual was not going to lead to sustained recovery. The Bank launched analytical work which pointed to the magnitude of rural poverty, the deeply engrained economic inequalities, and the Government's weak commitment to poverty alleviation. The first explicitly pro- poor operation in Malawi (the 1989 Agricultural Sector Adjustment Credit - ASAC) led--after significant resistance by the past Government--to the gradual removal of several restrictions on smallholder agriculture (including barriers to participation by private traders, and limited smallholder access to burley). Preparation of the 1992 adjustment operation--the Entrepreneurship Development and Drought Recovery Program (EDDRP)--coincided with the onset of political transition and mounting internal opposition to the previous government. The operation deepened a number of structural reforms (such as tariff reform, further liberalization in the agricultural sector, and investment deregulation) but became effectively a holding operation to keep the economy on track during the severe drought of 1992 and through the process of political transition. ENVIRONMENT CONDUCIVE TO HIGHER IMPACT ADJUSTMENT 2.8 Since the 1994 political transition in Malawi, the odds for successful structural reforms have substantially improved, especially in those areas where Malawi compares unfavorably with other countries in the region (such as fiscal management and pro-poor policies). In contrast to the previous regime, the new GOM has firmly demonstrated its commitment to policy reformn and has radically improved the approach to dealing with the country's pervasive poverty. Major policies implemented by the new GOM are listed in Table 2.3. The design of the proposed program takes into account the lessons learned from 6 Chapter 2 previous operations (Box 2.1: Malawi - Lessons Learned from Previous Adjustment Operations). The variables that contribute to an environment conducive to Higher Impact Adjustment Lending in Malawi are summarized in Annex B: Environment for Higher Impact Adjustment Lending in Malawi. Table 2.3: Malawi - Major Policies Implemented Since May 1994 Policy Measure Impact * Removal of all primary I lncrease in primary school enrollment from 1.9 million school fees students to 3 million students; increase in girls' gross enrollment rate from 75% to 96% (overall enrollment rate from 81% to 108%) * Increase in smaliholder > Annual cash injection of between US$50 million and USS75 burley tobacco quota from million into smallholder sector 15,000 tons to over 50,000 tons * Removal of ADMARC = Smaliholder farmers get producer prices paid by private monopsony on all traders that are higher than ADMARC's announced price smallholder crops > Increasing share of smallholder tobacco marketed directly or through intermediate buyers who pay higher prices than ADMARC * Retrenchment of about => Budgetary savings in FY95/96 20,000 temporary workers in the civil service * Enforcement of Customs => For FY95/96 cumulative tax revenues are running about 9% and Tax Laws above projections * Implementation of cash > Fiscal stabilization has resulted in decline of quarterly budget inflation rate from 34% to about 20% between January and December 1995 * Strengthening of foreign > Stabilization of exchange rate at MK 15.3 per I US$; exchange interbank market accumulation of total foreign reserves equivalent to 4 months of imports by end-1995 of which 2.0 months equivalent are gross official reserves; seasonal smoothing of divergent foreign exchange demand and supply flows Commitment to Poverty Alleviation 2.9 The new GOM had run on a poverty-focused platform, and since taking office has followed through in both word and deed. Within weeks of the 1994 elections, the new GOM acted on a campaign promise and announced the removal of all primary school fees. This resulted in a dramatic, and largely unexpected, increase in the number of primary students from 1.9 million to over 3 million, with more equitable enrollment across gender, regions, and household Background and Rationale 7 income levels. Girls gross enrollment increased from 75% to 96%, gross enrollment of the poorest quintile increased from 58% to 74%. The GOM's seriousness about putting poverty alleviation at the center of its development agenda was translated into a Poverty Alleviation Program. A Poverty Monitoring Unit was set up to track Malawi's social indicators and coordinate periodic household surveys. The GOM has embarked on a comprehensive revision of the budgeting process (Medium-Term Expenditure Framework, MTEF) and intends to direct more expenditures into pro-poor areas. Box 2.1: Malawi - Lessons Learned from Previous Adjustment Operations The following six lessons--drawn from Performance Audit Reports prepared by OED--point to the reasons why Malawi still ranks among the poorest countries in Sub-Saharan Africa despite significant efforts and large resource flows under previous programs: * The most important obstacle to sustainable growth and reforms has been the lack of clear and unequivocal political commitment to poverty alleviation, liberalization in the smallholder sector, and broad-based private sector development. * Delays in acting on agreed measures underscore the weak administrative and institutional base which constrained many policy reforns. * Recurrent and serious external shocks--including terms-of-trade shocks, high interest rates, oil crises, and closure of Malawi's shortest external transport links through war-tom Mozambique--repeatedly diverted policymakers' attention from medium-term and long- term issues. * The domineering leadership style of the former Head of State combined with pragmatic economic policies had some success--particularly in areas where vested interests of the political elite were not compromised--but failed to achieve broad-based transformation of the economy. * Tangible results with regard to poverty alleviation which have only started to emerge over the past two years, attest to an unfinished agenda within the broader scheme of macroeconomic stabilization and broad-based private sector development. * Greater rigor in economic and sector analyses might have pointed to actions that could have enhanced the impact of adjustment operations, particularly in poverty alleviation. Commitment to Broad-Based Private Sector Development 2.10 Through the preparation of a Privatization Policy Framework, the GOM has launched a privatization program to help attract foreign and domestic investment and facilitate broad-based private sector development. In addition, new agricultural strategy comnmits Malawi to far-reaching deregulation and the promotion of smallholder development. In early 1995 marketing restrictions on smallholder tobacco growers were lifted, and smallholder tobacco quotas were de facto removed to benefit the poor. Fixed producer and consumer prices for maize were replaced by a market-oriented price band; this should improve 8 Chapter 2 efficiency in production and marketing of maize and other food crops and help promote crop diversification and food security. Government-driven Preparation Process and Broad Consultation 2.11 In addition to initiating the policies that are supported by the proposed operation. the GOM has moved effectively in preparing critical program components. such as the civil service census, the privatization framework, and the MTEF (ref. attached GOM's Letter of Development Policy - LDP). The GOM is building political commitment to the reforms, for instance, through Cabinet-level discussions of both the PFP and the pre-appraisal mission's Aide Memoire. Furthermore, the GOM has vowed to involve civil society in the planning and implementation of development programs. Meetings between policymakers, private sector representatives and the churches have helped to increase and widen understanding of and appreciation for the tight fiscal and macroeconomic measures which are often perceived as anti-poor. Two Economic Development Institute (EDI) missions visited Malawi since November 1995 to assist the GOM in working out a systematic communications strategy, held meetings with a cross section of civil society, and provided training to Information Officers and the press. 3. WORLD BANK GROUP ASSISTANCE STRATEGY LINKS BETWEEN THE PROPOSED PROGRAM AND THE CAS 3.1 The World Bank Group's work in Malawi--policy dialogue, economic and sector work, and lending--is all intended to bring about sustainable poverty reduction (details are presented in the CAS) by supporting macroeconomic stabilization, investing in physical infrastructure and human capital formnation. assisting broad-based private sector development, and implementing targeted programs to protect the poorest segments of the population from undue hardship. 3.2 The FRDP represents the logical continuation of IDA involvement in Malawi's adjustment to a difficult external environment. It removes a large backlog of policy distortions and supports several planks of a comprehensive and medium to long-term reform program that is anchored in the 6th PFP. Many policy measures from this agenda have been implemented (including education sector policy, agricultural pricing, fiscal stabilization). In other areas credible Bank Group Assistance Strategy 9 processes have been launched and specific performance benchmarks have been agreed (including expenditure reform, civil service reform, and privatization). Lastly, there is a range of policy issues where GOM has expressed its commitment to reform, but where further analytical work needs to be carried out before specific measures are identified. In those areas we are actively engaged in providing guidance and advice to the GOM and expect to narrow down the scope and timing of specific measures within the next 12 to 18 months (including land policy reform and drought-proofing). 3.3 The proposed program draws on the successful components of previous adjustment programs and is linked to several ongoing IDA projects. First, policies initiated under the two previous adjustment operations (such as tariff reform and agricultural liberalization) will be accelerated and completed under the proposed program. Second, policies supported under the proposed operation complement the technical assistance provided under the Second Institutional Development Project; in particular civil service reform, privatization, and budget management. Third, the proposed program aims at increasing recurrent expenditures to the social sectors and, above all, enhancing their effectiveness. This will be critical for sustaining ongoing and forthcoming IDA projects; for instance, the Integrated Education Sector Project, the community-based Malawi Social Action Fund (MASAF), and the Population, Health and Nutrition Credit. Finally, a wide range of activities (including tax and tariff reform) is being promoted in Malawi under the Cross Border Initiative for Eastern and Southern Africa (CBI); the proposed Credit will support these measures. STAKEHOLDER INVOLVEMENT DURING PREPARATION OF THE PROGRAM 3.4 The FRDP has been prepared with an explicit consensus regarding the need to broaden the understanding of (and commitment to) reform within and outside government. This continues the close collaboration established at the operational level during preparation of the program and launching of the CAS with stakeholder meetings in the field. Important areas for policy actions identified by various stakeholder groups overlap with the measures to be supported by the adjustment operation (for example, agricultural marketing and restrictions on private sector entry). The findings of the 1993 manufacturing sector survey were discussed in a joint workshop with GOM and the private sector. The ensuing policy recommendations for increasing access to industrial land and streamlining the investment process will be supported by the proposed operation. Joint GOM/Bank meetings with the private sector and NGOs were held during appraisal to solicit feedback on the envisaged policy measures; there was broad support and understanding of the FRDP policies. The proposed operation takes into account the findings from the 1995 Borrower Feedback Survey and focuses directly on poverty alleviation; for instance, policies that will give smallholders access to the full range of economic activities, and the targeting of expenditure allocations in primary social services. The Credit will 10 Chapter 3 provide funds to carry out stakeholder meetings to gauge the impact of policy measures on vulnerable groups and support the GOM's communications strategy. INTERNAL CONSULTATION PROCESS IN THE WORLD BANK 3.5 The proposed operation is based on extensive empirical and analytical work carried out by IDA with the GOM. Staff from the Southern Africa Department, the Technical Department, the Agricultural Research Department, and the Private Sector Development Department were full team members throughout the preparation of the operation. The 1994 Agricultural Sector Memorandum (and GOM's Agricultural Strategy Paper) identified strategy options to help trigger broad-based agricultural growth. Background papers on the transport sector and a manufacturing sector survey (both in 1993) provide insights into policy and institutional constraints to private sector development. Quantitative analyses--carried out jointly by IDA and the GOM over the past 9 months--provide the basis for recommendations on tax and tariff policy reforrns. The 1995 Budget Management Review (BMR) provides a basis for expenditure control measures and modifications of the budget-making process. Civil service pay issues are discussed in the 1994 Pay and Employment Study. The 1995 Malawi Poverty Profile identifies the dimensions and main variables of poverty in Malawi and lays the groundwork for promoting reforms in land policy and deregulation of agricultural markets and domestic transport. The operation will be complemented by ongoing work on strategies to mitigate the impact of drought-related shocks. Key processing steps and a list of supporting documents for the operation are presented in Annex C: Supplementary Information. COLLABORATION WITH IMF 3.6 The programs of the Bank and IMF in Malawi are coordinated closely and there are no outstanding differences of opinion. Balance of payment needs are jointly agreed among the Bank, the IMF, and the GOM as part of the PFP and the Consultative Group processes. Bank proposals on trade and taxation policy, privatization, civil service reforms, investment incentives, expenditure targets are kept consistent with the fiscal targets under IMF supported programs, and the IMF's structural policy benchmarks are developed in close consultation with the Bank. Joint Bank/IMF missions prepared the 6th PFP in July 1995 and reviewed macroeconomic developments in early March 1996 when the IMF reached understanding with the authorities on a program for 1996/97. Macroeconomic Framework /l 4. MACROECONOMIC FRAMEWORK RECENT TURN-AROUND IN MACROECONOMIC SITUATION 4.1 Over the past 12 months, the GOM has made good progress in achieving macroeconomic stabilization; it assumed power in May 1994 when the economy was rapidly deteriorating. In 1991-94 Malawi suffered from a series of external shocks (equivalent to a 25% loss in GDP) including three droughts, a substantial decline in the terms-of-trade and suspension of bilateral non-humanitarian aid for 18 months before the elections. Immediately after taking office, the new GOM's macroeconomic management was challenged by (a) a series of civil service strikes; (b) the deterioration of fiscal management during the months leading up to the elections; and (c) the financing requirements to hire more than 20,000 additional teachers and provide textbooks to accommodate the "overnight" increase in enrollment after removal of primary school fees. The new GOM acted quickly and--despite initial difficulties in effectively controlling expenditures--is gradually achieving fiscal stabilization. Since April 1995 public expenditures are controlled under a cash budgeting system. The GOM has let market forces determine the exchange rate and has resisted popular pressures to reverse the floatation of the kwacha (February 1994)--even when the kwacha depreciated by 100 % in October 1994. The exchange rate has been stable in the last 15 months. The Reserve Bank has been successful in smoothing seasonal fluctuations in foreign exchange demand and supply and, aided by tobacco earnings, accumulated official reserves equivalent to 2 months of imports by end-1995. Quarterly inflation rates decreased from 34% to 7% between January and August 1995; since then rates have picked up (to around 20%) because of sharp price increases in food stuffs as a result of the 1994/95 shortfall in maize production. These improvements in economic performance led to agreement on (i) a three-year program under the IMF's Enhanced Structural Adjustment Facility (ESAF, presented to the IMF's Board on October 18, 1995); (ii) the 6th PFP (issued on October 10, 1995); and (iii) recent agreement with Bank and IMF missions on a program for 1996/97. The proposed operation would complement the IMF-supported stabilization program by adding the medium and long-term elements needed for sustained stability and growth. 12 Chapter 4 OBJECTIVES AND POLICIES 4.2 The macroeconomic situation remains precarious, and economic management in the near term will focus on stabilization to further reduce fiscal imbalances and lower the inflation rate. The medium-term strategy places greater emphasis on policies and structural measures to promote domestic savings and investment and improve external competitiveness. Agriculture will continue to be a major source of growth--providing employment and subsistence for some 80 % of the population. Growth in the manufacturing sector is expected to be supported by a liberalized exchange system, the rationalization of external tariffs, and the reduction in external transport costs as direct routes to Mozambican ports will become fully operational. 4.3 Against this background, the overall medium-term macroeconomic objectives (Table 4.1: Malawi - Selected Macroeconomic Indicators) are: (a) recovery in real GDP in 1995 and medium-term real growth of 1.5% per capita; (b) a sharp, early deceleration in the rate of inflation, with a decline to an average annual rate of less than 10%; (c) a gradual decline in external imbalances over the medium term; and (d) the accommodation of pressing social needs within the constraint of fiscal sustainability by prioritizing government expenditures in the context of a MTEF. Table 4.1: Malawi - Selected Macroeconomic Indicators 1994 1995 1996 1997 1998 1999 2000 Real GDP Growth -10.2 9.9 10.5 4.0 4.0 4.0 4.0 Real GDP Growth per capda (%) -12.9 7.0 7.7 1.4 1.4 1.4 1.4 Annual Inflation Rate 34.7 82.9 48.0 15.0 8.0 8.0 8.0 As Share (%) in GOP Gross Investment 13.2 15.8 16.0 16.4 17.1 17.8 18.0 Private Investment 7.0 9.4 9.6 9.5 10.1 10.5 11.0 Gross Domestic Savings -0.5 4.1 9.0 10.8 12.2 12.8 14.9 Fiscal Deficit (before Grants) 25.8 15.9 9.9 6.6 5.9 6.0 6.0 Current Account Balance -18.0 -15.0 -10.1 -8.4 -7.7 -6.6 -5.8 Exports GNFS 30.3 32.6 26.2 26.0 25.5 25.1 25.0 4.4 The attainment of the growth objectives requires an increase in the rate of investment, particularly of private investment, as well as a substantial improvement in investment quality. The revised medium-term projections indicate that the investment/GDP ratio would rise from 13% in 1994 to about 17% in 1998. Over the medium term, domestic savings are expected to finance an increasing share of total investment as a result of the improvement in the public financial position and higher private savings. Most of the projected increase in domestic savings will come from fiscal savings (in the order of 5% GDP), leaving a 3% increase to be created by private savings. The Macroeconomic Framework 13 assumption is that Malawi will recover from three droughts in the past four years, and income levels--and hence savings ratios--will be slightly above pre- drought levels (of around 12%). Additional savings will be realized from (a) reduction in external transport costs after the shortest routes to the sea through Mozambique become fully operational; (b) higher rural incomes in line with liberalization in the smallholder sector; and (c) improved investment climate. 4.5 The fiscal policy strategy will emphasize discipline and the consolidation and extension of structural policy reforms. On this basis, after rising from 8.4% of GDP in 1993 to 25.8% of GDP in 1994, the overall deficit (before grants) is targeted to decline to 9.9% by 1996 (about 4% after grants). Current expenditure is targetted to decline from 29% of GDP in 1994 to 18% of GDP in 1996; mainly through reduced interest payments and a smaller wage bill, but also through eliminating the costs related to the political transition in 1994 (equivalent to 2% of GDP) and drought (6% of GDP in 1994). This will restore recurrent expenditure levels for goods and services to historical levels (10% of GDP) and implies an increase in real terms of 5% against 1995. Prioritization of current expenditure will ensure adequate provision for basic education and health services, extension services in agriculture, and operation and maintenance of the road system. Development spending is projected to remain at between 6% to 7% of GDP. Reduction in the fiscal deficit will also be supported through revenue enhancing measures, improved administrative capacity of Customs and broadening the tax base, to sustain a revenue/GDP ratio of 18%. 4.6 The medium-term projections indicate that the prospects for Malawi's major exports will improve moderately because of the protracted stagnation of world market prices for tobacco, and the generally weak demand outlook for sugar, tea, and other agricultural exports. Nevertheless, exports are expected to be boosted by continued trade liberalization, including the removal of export licensing. Given this, the volume of exports is projected to increase at an average annual rate of 7.6% over 1995-98, reflecting increases in the volume of nontraditional agricultural exports and manufactured goods in response to the accelerated removal of the remaining barriers to competition in production and marketing. Import volume is projected to grow broadly in line with the increase in real GDP, with the impact of further import liberalization and tariff reform being roughly offset by tightened demand management and depreciation of the kwacha. The external current account deficit (excluding grants) is expected to decline from 18% of GDP in 1994 to 7.7% in 1998. Malawi's debt service ratio is projected to decline modestly from 23% in 1995 to an average of about 20% of exports of goods and non-factor services over the medium term, reflecting the continuation of current policies, which largely limit external borrowing to concessional long-term loans. With the assumed levels of external assistance, gross official reserves would increase from the equivalent of 0.8 months of imports at the end of 1994 to 5 months equivalent by end-1998. 14 Chapter 4 EXTERNAL FINANCING REQUIREMENTS 4.7 Malawi's continued progress in structural reforrns significantly enhances long-run growth prospects. However continued donor support in the form of external concessional resources is needed in the short and medium term to support the adjustment agenda. For 1996 expected aid flows are sufficient to close Malawi's external financing gap (Table 4.2: Malawi - Extemal Financing Requirements); comprising of US$131 million in project support, US$128 million in balance of payment support (including US$74.4 million under the initial tranche of the proposed operation, anticipated support under the FRDP from the Governments of Japan, Germany, Denmark, and Sweden and US$24 million expected under the IMF's ESAF), and US$9 million for drought- related support. For 1997-98, external financing requirements to be met by aid flows are estimated at US$539 million of which approximately US$480 million has tentatively been identified. A financing gap of US$60 million remains for 1997-98 which could be filled in part from resources under a follow-on IDA operation. On average over the next three years, IDA's contribution of approximately one-third of total import support would be in line with average IDA contributions over the past years. Table 4.2: Malawi - External Financing Requirements (IN MILLION US$) 1996 1997 1998 1997-98 IMPORTS OF GOODS AND SERVICES 625 653 690 1343 PRIVATE SECTOR TRANSFER PAYMENTS 13 13 13 26 DEBT SERVICE 96 99 100 199 RESERVES ACCUMULATION 56 57 38 94 TOTAL FOREX NEEDS 790 821 840 1661 EXPORTS OF GOODS AND SERVICES 490 536 576 1112 PRIVATE SECTOR TRANSFER RECEIPTS 8 8 8 16 PRIVATE CAPITAL OUTFLOWS (NET) -2 -2 -3 -6 TOTAL FOREX EARNINGS 496 542 580 1122 IDENTIFIED PLANNED AID FLOWS 294 250 230 480 -as .* S S I, -s ,_ The Fiscal Restructuring and Deregulation Program 15 5. THE FISCAL RESTRUCTURING AND DEREGULATION PROGRAM OBJECTIVES 5.1 Two constraints have consistently been identified in stakeholder meetings, our dialogue with the GOM, and our analytical work, as most binding to poverty alleviation and to achieving Malawi's economic objectives of significant medium-ternn real growth per capita, single-digit inflation, and a viable external balance: * Anti-poor bias and low quality of social sector expenditures The Poverty Profile shows that public expenditures on social services such as education and health have been consistently higher in Malawi (US$58 per capita in 1993) than in countries with similarly low GDP per capita (US$41 per capita). These aggregate numbers, however, are misleading because they conceal a highly unequal subsectoral composition of social spending. Proportional allocations to primary level services, which is the level most likely to be needed by the poor, are among the lowest in Malawi. In 1990/91 the poorest income quintile received only 10% of all public education spending, while the share going to the richest income quintile was 38%. Although the removal of all primary school fees in 1994/95 has substantially reduced this inequality (to 16% and 25%, respectively), additional restructuring is needed to reach a larger share of the population. * Restrictions and regulations that prevent the poor from participating in the full range of economic activities Both the Agricultural Sector Memorandum and the Poverty Profile concluded that deregulation of smallholder marketing, pricing, and production (especially profitable cash crops like burley tobacco) will be critical for unleashing the economic potential of rural areas. Through forward and backward linkages, incremental smallholder income has an income multiplier effect of approximately 1.5 which makes the agricultural sector-- specifically smallholder production--a potential engine of broad- based growth. 16 Chapter 5 5.2 To assist Malawi to attain its economic objectives and succeed in alleviating the country's pervasive poverty problem, the proposed operation focuses on two broad policy areas: * Fiscal restructuring aims to prioritize, protect, and, where necessary, expand inter-sectoral and intra-sectoral allocations to the social sectors on a sustainable basis while staying within the overall fiscal framework now being monitored under the IMF's ESAF program. The operation supports development of a MTEF, comprehensive civil service reform, and tax and tariff reform. * Deregulation will accelerate the consolidation of structural measures already initiated by the GOM under previous adjustment operations. This includes complete removal of remaining pricing and marketing constraints on smallholder agriculture, and removal of the binding constraints to broad-based private sector entry and development. 5.3 In both areas, Government has implemented significant policy measures and has launched several initiatives that put the program on track toward yielding results on the ground. In fact, before Board presentation, (Government implemented 41 out of 42 actions and policy measures that are supported under the FRDP and were identified in the Initiating Memorandum. As envisaged in the Initiating Memorandum the remaining civil service reform measures will trigger release of the Second Tranche. ACTIONS SUPPORTED BY THE OPERATION Fiscal Restructuring 5.4 Fiscal restructuring has four dimensions: (a) The main challenge is to reorient public spending to pro-poor areas in line with the GOM's commitment to expand the provision of social services to the majority of the population. (b) To this challenge must be added the task of restoring fiscal discipline and reversing the collapse in expenditure control and lack of accountability in the wake of unbudgeted expenditures during the political transition and the precipitous and unanticipated depreciation of the kwacha (250 %) in the 10 months following floatation in February 1994. The Fiscal Restructuring and Deregulation Program 17 (c) Civil service reform will be crucial for reversing the increasing imbalance between wage and non-wage recurrent expenditures. (d) Tax and tariff reforms are essential for improving fiscal revenue performance. Expenditure Reorientation 5.5 The BMR shows that Malawi typifies the pattern of development financing based on numerous and fragmented donor-funded projects, slow implementation because of insufficient counterpart funding, and chronic tension between the recurrent and development budgets with recurrent expenditures inadequate to sustain investment projects beyond the donor-supported implementation phase. The required expenditure restructuring cannot be accomplished within the traditional public expenditure planning process; the project-driven planning and budgeting process needs to be changed to link the recurrent and development budgets. 5.6 Under the FRDP, a MTEF is being developed to help ministries prioritize inter-sectoral and intra-sectoral expenditures within the agreed overall macroeconomic expenditure envelope. Instead of setting a priori global expenditure shares for education or health--which are ineffective indicators because of a high wage component in sectoral budgets--the proposed program will support a bottom-up process whereby sectoral program priorities (such as allocations for district level health services, goods and services for primary schools, medical supplies for rural health clinics) be reconciled with varying funding levels in a MTEF. The program will help to ensure that both the targeted fiscal deficit reduction and the concurrent expansion of social services are achieved rationally without compromising the GOM's pro-poor policy focus. Since the MTEF was launched in May, during Preappraisal, we have been monitoring progress closely and are providing technical assistance to supplement GOM's capacity in this area under the Second Institutional Development Project. At this time, the MTEF pilot includes four sectoral working groups: Ministry of Health, Ministry of Education, Ministry of Agriculture and Livestock Development, and Ministry of Works and Supplies. The MTEF progressed well in preparation for the FY96/97 budget. Political commitment at the Cabinet level for a more rationale expenditure allocation was secured, and the benchmarks for the FY96/97 budget were agreed with IDA during Appraisal in December 1995 (Table 5.1). 18 Chapter 5 Table 5.1: Malawi - Target Shares in Recurrent Expenditures (%) SECTOR FY95/96 FY96/97 FY97/98 FY98/99 EDUCATION 22 25 24 24 HEALTH 12 16 14 15 AGRICULTURE 4 5 5 5 WORKS 2 3 4 4 TOTAL 40 49 47 49 5.7 The FY96/97 budget conforms to the macroeconomic targets agreed to under the ESAF for total expenditures and domestic borrowing. To provide adequate funds for priority areas and essential items, the Government reviewed expenditures in non-priority sectors and cut/reduced these expenditure categories (such as fuel and lubricants, travel, and replacement of motor vehicles). Detailed sectoral expenditure plans for the four MTEF pilot ministries were completed in February 1996, agreed with IDA, and are reflected in the FY96/97 budget (Table 5.2: Malawi MTEF - Sectoral Expenditure Shares). In nominal terms, allocation of recurrent spending to the four primary sectors will increase by 33% while the increase in recurrent spending to the remaining ministries will be limited to 5% in nominal terms. Further, the Government reviewed and rationalized the PSIP in the context of the MTEF to ensure that the selection of investment projects is consistent with pro-poor development priorities and recurrent expenditure capacities. For FY96/97 60% of the PSIP has been allocated to social sectors, this compares favorably with 55% in FY95/96. The bulk of resources has been allocated to those projects which are rural in nature and have a more positive impact in alleviating poverty. For instance, new primary road projects were canceled in favor of village access roads and maintenance of district roads. 5.8 More specifically, with the FY96/97 budget, the GOM is aiming to protect the recent increase in the Ministry of Education's share (22% in FY95/96) in total recurrent expenditures and even increased it to the medium- term target level of 25%. The share of primary education within recurrent expenditures of the Ministry of Education was increased from 47% in FY95/96 to about 66% in FY96/97. Similarly, the expenditure share on primary health care was increased from 8% in FY94/95 to about 14% in FY96/97 of recurrent health care spending. The GOM aims to reach an allocation for medical supplies and medicines equivalent to US$1.25 per capita by FY97/98. Within total recurrent expenditures for health care services 7% has been allocated to Family Planning Services in FY96/97. The share of the Ministry of Agriculture and Livestock Development in total recurrent expenditures has been maintained at around 5% of total recurrent expenditures with about 40% of this being allocated to extension services to ensure that an increasing share of smallholder farmers is being reached. Within the recurrent expenditures allocation to the Ministry of Works (about 5% of total recurrent expenditures) emphasis is given to road maintenance and rural roads (50% of the Ministry's recurrent budget). The Fiscal Restructuring and Deregulation Program 19 Table 5.2: Malawi MTEF - Sectoral Expenditure Shares ES 1 Pla n1S Ean 16s/3 I Plan'190697 Shwe.h TowM Shwe. In Sedtora Expenditure Category Rcxrnt Eiqd:es R.curmrt Expmrthtures Total Expenditures (excluding statutory expenditures) 100.0% 100.0% Recurent 100.0% 100.0% 817% e8 0% SalIs 27 9% 31 3% Ow 33 8% 34 7% D 28 7% 29 1% Drought RStd 98% 4 8% Total Recurrent Education Expenditures 21.8% 25.1% 100.0% 100.0% P/mary 47 9% 88 3% Salanes 36 8% 58 5% Goods ad Service. 11 1% 98% Seconry 10 0% 15 5% othe 42.1% 18 2% Total Recurrent Health Car Expenditures 12.3% 1 6.8% 100.0% 100.0% Ca-nat Hosls 23 D% 17 7% District Hoapdse 5e.8% 42 6% Ote 20 5% 39 7% ohv Mod Suppea & Mdonrs ra 23 3% Tota Recurrent SpNng on P//mary Healt Cae nrl 14 5% Salaries rWs 10 4% Goods and Swvic W 4 1% Tot Recunsn Espendure on Fanill4 Phannh SgrLeMon r 7 5% Total Recurrent Budget for Mn. of Agriculture 4.3% 4.7% 100.0% 100.0% Exttwon 401% 39.2% Rseach 38 3% 23 9% oate 21 8% 38.9% Total Recurrent Budget for Min. of Works and Supplies 3.0% 5.3% 100.0% 100.0% Road /tennce 3 7% 34 9% AfIn Roads 13 3% 106% Seconary Roads 11 2% 93% Rural and Obuer Roads 112% 15.1% Other 28 7% 30 1% 5.9 The MTEF will be rolled out over the next six months to all ministries in preparation for the FY97/98 budget. In this context, lessons learned from the pilot phase of the MTEF will be applied (Box 5. 1): (a) First, the Audit and Finance Committee of Permanent Secretaries will provide guidance to the MTEF Task Force. Tentative sectoral expenditure envelopes for the next three years will be discussed by the Cabinet Committee on the Economy in June 1996. (b) Second, increased focus will be put on the medium-term aspects whereby tentative expenditure needs and shares will be developed for a three-year rolling period. In this regard, by October 1996, ministries will carry out a line-by-line review of functions and identify those programs that will be phased out, functions that will be outsourced to the private sector, and those priority functions for which funding levels would be increased. (c) Third, line ministries will take into account changes in civil service staffing levels that will allow a reallocation of (i) civil 20 Chapter 5 servants from low priority areas to high priority areas and (ii) resources from the wages and salaries category to goods and services. (d) Fourth, the links between the PSIP and the MTEF will be strengthened to ensure that the selection of investment projects is consistent with pro-poor development priorities and recurrent expenditure capacities. (e) Fifth, the GOM intends to integrate the recurrent and capital budgets. For the FY97/98 budget, this integration is envisaged to be completed for the four MTEF pilot ministries. (f) Sixth, the program costing exercise will be improved , inter alia, through preparation of a MTEF manual. Box 5.1: Malawi - Quotes from Sectoral MTEF Reports "one of the main achievements of the process was the wide participation of officials in the costing of programs and activities." "Each of the sectors had developed well-articulated sector policies and strategies, and used these to develop sectoral programs." "... the costing exercise was one of the weaker elements in the process.... Improving the programme costing exercise will be the main focus of refining the MTEF methodology to line ministries in 1996." "The four pilot ministries have concentrated their efforts on the 1996/97 estimates and made little progress in refining the details of forward estimates for 1997/98 and 1998/89." "...most ministries have high proportions of the budget allocated to personal emoluments which leaves little room for reductions in other recurrent expenditures. ...significant reductions in personal emoluments will only come about through medium-term restructuring of ministries' functions and establishments." "Two of the key activities for the second round of the MTEF preparation will be a review of the functions and activities of ministries, so as to determine those activities to be contracted out or stopped altogether." "The MTEF exercise has enabled the Ministry to identify and cost in detail its activities and this information will be used to determine which specific activities need to be given higher priority than those that will be scaled back." 'The required expenditure cuts imply that certain activities will have to be foregone by the Ministry and the implications of these cuts were identified and described "Secondary school utilization is inefficient as many schools are not used in the afternoons." Expenditure StabUization 5.10 The essential short-term measure to effectively control expenditures--a cash budget system--has been put in place. It is being supported by additional medium-term measures, including: (a) a monitoring system to ensure that cash The Fiscal Restructuring and Deregulation Program 21 books are kept up-to-date and reconciled with bank statements; (b) development of a Financial Management Information System (FMIS) to permit continuous monitoring of commitments; and (c) periodic reconciliation of GOM's accounts with parastatals (electricity, water, telecommunications) to prevent accumulation of arrears. These measures are working satisfactorily and will help ensure a reduction in the fiscal deficit. Until comprehensive expenditure prioritization is achieved through the expansion of the MTEF, the cash budget system will remain in place. Civil Service Reform 5.11 Civil service reform is critical for containing the overall wage bill to achieve fiscal stabilization and restructure expenditures to increase the efficiency of public service delivery. Over the past eight months, several short-term measures to contain the civil service wage bill and reverse the explosion in the size of the civil service have been taken. Funded vacancies that had remained unfilled for more than five years were frozen. In August 1995 the GOM removed a number of vacancies for which line ministries had drawn funding ("ghost workers") from the establishment. Between February and September 1995, under the FRDP, the GOM retrenched approximately 20,000 civil servants in non-established and temporary positions in non-priority areas (for instance, unskilled laborers, cooks, gardeners, bricklayers, plumbers, drivers, messengers and janitors). 5.12 With a medium-term perspective, the GOM has embarked on a civil service reform process to increase the efficiency and effectiveness of public service delivery. A Civil Service Census was carried out during October 1995 to help generate reliable benchmark data for an effective personnel management and control system. Technical assistance for the Civil Service Census exercise was provided under the ongoing Second Institutional Development Project. The FRDP would support the policy measures under civil service reform and provide budgetary support--through the Second Tranche (Civil Service Reform Tranche)--on a "just-in-time basis" to reduce the fiscal implications of separation packages and civil service retrenchment plans that might otherwise squeeze recurrent expenditures in priority social sectors. 5.13 To this end the GOM has also embarked on analytical work that will broaden and deepen the scope of civil service reform; including a systematic review of government functions and a review of civil service pay and remuneration. The latter study has been completed and is currently being discussed by Government. The functional review is at an interim stage and is expected to be finalized by end April 1996. It is apparent that some ministries and departments are overstaffed, with considerable duplication of functions, while critical personnel categories such as health--i.e. doctors--remain understaffed. An Interministerial Commission has been appointed to oversee the 22 Chapter 5 implementation of the results of the Civil Service Census and prepare an action plan for the next steps in civil service reform. 5.14 Completion of the Civil Service Reform Action plan--acceptable to the Bank--is expected by September 30, 1996 and will draw on the findings and conclusions of the civil service census, the functional review, the remuneration study and the ongoing MTEF exercise. Civil service reform will go beyond downsizing of the civil service; it is expected that part of the savings resulting from reducing the size of the civil service would be plowed back to raise civil service remuneration levels and reduce wage compression. It is the GOM's objective to achieve a civil service size and remuneration structure that is consistent with a sustainable civil service wage bill of not more than 6.5% of GDP. The Action Plan will include, inter alia, timing and scope of: (a) A retrenchment program including transparent retrenchment criteria, appropriate safety net measures, and quantitative targets for the size of the civil service as well as cost and financing estimates thereof. (b) The restructuring of civil service salaries with improved incentives and levels of remuneration for a smaller civil service within a sustainable overall wage bill. (c) The arrangements for implementing decentralization, including intergovernmental fiscal relations. (d) The completion of job evaluation exercise with a view to improving the present recruitment, posting, and promotion practices. (e) The realignment of civil service staffing levels in line with government's pro-poor focus and a reduction in both low priority government programs and functions, including (i) focus on training of qualified teachers to achieve a student: teacher ratio of 60:1 for primary education and (ii) adequate staffing of all health clinics with at least one general nurse and one maternity nurse. 5.15 In addition, implementation of the following measures from the aforementioned Action Plan would trigger release of the Second Tranche: (a) The GOM will have stopped paying salaries or wages to civil servants who are not listed on the civil service census file. (b) The GOM will start to eliminate or merge duplicating and overlapping government functions that are currently being carried out by different agencies. The Fiscal Restructuring and Deregulation Program 23 (c) Within the context of the functional review, the GOM will have started to outsource, privatize, or eliminate functions such as security guard services, management of rest houses and inns, office cleaning services, etc. (d) The number of industrial workers will be reduced and the category absorbed into the civil service. (e) To improve the efficiency and effectiveness of common services cadres, Government will have started to put in place provisions for adequate authority of line managers in deploying, retaining, and evaluating performance of common services staff. Tax and Tariff Policies 5.16 Malawi has established a good record in tax and tariff reform. In many ways, Malawi's tariff system is more efficient than in neighboring countries: (a) the surtax rates (effectively a value-added tax collected at the production stage) on domestic production and imports were harmonized in 1993; and (b) ad valorem excise taxes on luxury goods (imports and domestic goods) were introduced in 1994. The current tariff structure comprises seven rates ranging from 0% to 45%. In FY95/96, the GOM introduced a temporary 10% export tax on tobacco, tea, and sugar and special drought levies (3%) on personal and corporate taxes to redress revenue shortages. These taxes will be phased out as revenue collection is strengthened; with the FY96/97 budget, the GOM reduced the export tax to 8%. 5.17 Tariff Reform: However additional tax policy reforms are needed to encourage the growth and diversification of non-traditional exports which have been virtually stagnant during the last five years. Under the FRDP, priority is given to reducing anti-export bias, increasing external competitiveness, and gradually shifting the revenue function from tariffs to surtax. To attain these vital objectives, Malawi is undertaking tariff reduction in line with the agreements under the CBI and the Uruguay Round with the ultimate goal of achieving a 4-tier tariff structure with maximum and average rates of 25% and 15%, respectively, by FY98/99. We have agreed with the GOM on a phased plan to achieve these targets; with the FY96/97 budget, the maximum tariffs were reduced from 45% to 40% and average statutory rates were lowered from 18% to about 15%. Further, average statutory tariff rates for capital goods and intermediate goods were reduced from 17% to 12%. This will provide effective border tax relief for Malawian exporters and producers who were competing against consumer goods imported from neighboring countries at preferential tariff rates agreed under bilateral treaties and the Common Market for Eastern and Southern Africa (COMESA). 24 Chapter S 5.18 Surtax Reform. Lowering tariff rates could have adverse revenue consequences for Malawi in the middle of fiscal stabilization efforts. To protect revenues, tariff reductions are accompanied by surtax reform; making the surtax rate uniforn across goods and increasing surtax rates on items which are taxed below the standard rate of 20%. With the FY96/97 budget, the GOM simplified the surtax structure on goods and services to a four tier system: 20%, 10%, 0%, and exempt. This involves increases in the surtax rate from 10% to 20% for (i) hotel and restaurant services, and (ii) a number of intermediate and final goods (thus bringing imports and domestic production to an equal footing). The zero and exempt surtax rates for the agricultural, food processing, and pharmaceutical sectors where maintained in the interest of equity and poverty alleviation. Finally, during FY96/97, the GOM will review discretionary exemptions and phase-out those that are not based on or linked to diplomatic status or treaties with international organizations. 5.19 Administrative Strengthening. Good progress has been made over the past six months in strengthening customs administration and tax collection; at end FY95/96, cumulative tax revenues were running about 9% above agreed targets. With regard to strengthening tax and customs administration, the GOM has expanded the Pre-Shipment Inspection System (PSI) to cover all import shipments in excess of US$3,000 in conjunction with improvements in customs clearance and valuation. The GOM is receiving substantial technical assistance in support of these policy measures from the IMF and the British Government. 5.20 Additional steps to boost tax and tariff collection efficiency are desirable. The GOM intends to establish a performance-related remuneration system for revenue agencies in FY97/98 and is currently evaluating the feasibility and cost effectiveness of establishing an autonomous revenue authority outside the civil service by FY98/99. Over the medium term, the GOM plans to expand the surtax credit mechanism for inputs to the retail level with a view to converting the present system to a full-fledged VAT. 5.21 Export Promotion: Concurrently with the preceding reforms, additional specific tax incentives are needed to promote non-traditional exports and reduce the inherent anti-export bias of border taxes. Bonded manufacturing provisions have existed in Malawi for several years, but have mainly been utilized by the ready-made garment industry. In practice, the procedures for obtaining in-bond manufacturing status have been cumbersome and have excluded important industries, for example horticulture and agroprocesssing, both areas where Malawi has shown good growth potential and significant investor interest over the past three years. To address these shortcomings, in December 1995, the GOM implemented new legislation for Export Processing Zones (EPZ). The Act is comprehensive in its coverage of all sectors and portable, in that specific factory sites and horticulture farms can be established as EPZs. Furthermore, to simplify and streamline export duty drawback regulations, in February 1996, the The Fiscal Restructuring and Deregulation Program 25 Ministry of Finance has expanded the initial refund to bona fide exporters from 75% to 100% of duty paid, and a revolving fund has been set up with the Customs and Excise Department to effect refund payments within 5 working days. Over the medium term, Malawi plans to replace the administratively intensive case-by-case drawback program with simple rate coefficients or average duty drawback rates for a limited number of commonly-exported products. Deregulation of Agricultural Policies 5.22 Agriculture accounts for 40% of GDP and 90% of the export earnings of Malawi, and will remain the mainstay of growth for the foreseeable future. Given that 85% of the population lives in the rural areas, the performance of this sector directly affects the welfare of most Malawians, including the most vulnerable. In December 1994 the GOM adopted a comprehensive sectoral strategy to help transform the agricultural sector from a subsistence/dualistic structure (over-dependent on maize and tobacco) to a more diversified and viable one that also functions as a catalyst for growth in the non-farm sector. The main objective of the GOM's strategy is to attain broad-based sustainable agricultural growth of at least 3% p.a. (which is the four-year average of three normal years with 4.5% growth each followed by a moderate drought year with - 1% agricultural growth). This can be achieved by removing the most binding constraints (access to land, cash crops, inputs, and markets) to the integration of smallholders into the mainstream of development. Access to Land 5.23 Since Independence, agricultural land-use policy has remained strongly divided between freehold or leasehold and customary tenure, that is, between mostly export crop production by estates and mostly subsistence farming by smallholders. Privileges to grow burley tobacco (allocated exclusively to estates through a license and quota system) fueled large-scale reclassification of land from customary tenure (smallholder land) to leasehold; the number of leasehold estates soared from 1,200 in 1979, to 30,000 in 1994, and average size dropped from 250 ha to less than 20 ha. Much of the tenure conversion has taken place in an uncoordinated way and many plots are claimed by more than one leaseholder. In addition, there is a large backlog of unregistered lease applications. 5.24 Recent economic and political liberalization has resulted in increased assertiveness among the land-poor, who challenge the integrity of leasehold titles and call for a comprehensive reform of land policies. The increasing incidence of encroachments by smallholders on estates and public lands is evidence of mounting problems of land availability (about 40% of all 26 Chapter 5 smallholder households cultivate less than 0.5 ha) which is compounded by weak capacity in land administration. With high population growth and conflicting interests between estates and smallholders, more serious upheavals can be expected, with high social, political, economic, and environmental costs. Thus, there is an urgent need for a thorough examination of land titles and lease registration and for the formulation of new policies. This task requires widespread national consultation and consensus building to find acceptable solutions in a democratic environment. Forced land redistribution is neither politically viable nor economically desirable. 5.25 In line with the overall political liberalization, the new GOM is open to discussions and actions on land policy issues which were virtually taboo in the past. However, in view of the GOM's limited administrative capacities in this area the dialogue is at an early stage. We expect detailed measures of a new land policy to be agreed upon by 1997 after substantial analytical work is completed. In preparation of the proposed program the GOM has undertaken actions that demonstrate its commitment to land policy reform at the highest political levels. In March 1996 the GOM appointed a Presidential Commission of Inquiry to undertake a broad review of land problems throughout the country and to recommend the main principles of a new land policy which would foster a more efficient, environmentally sustainable and socially equitable land tenure system. The Presidential Commission (representing a wide cross-section of Malawi society and economic interests, such as smallholders, traditional authorities, estate owners, tenants and workers, urban business owners, NGOs, and representatives of major parties) will adopt transparent and participatory methods in reviewing land problems and considering their solutions. The Commission's recommendations--combined with the analytical work that is being carried out by the newly-created Policy Planning Unit of the Ministry of Land and Valuation--will define the new land policy principles and institutional structures aimed at secure land tenure arrangements and sound land lease procedures, along with market clearing land rents, and an active land market. 5.26 While the Presidential Commission is carrying out its work, the Ministry of Lands and Valuation has suspended all conversions from customary to leasehold tenure--country-wide--to allow government agencies to review the validity of existing leaseholds, resolve pending lease disputes, update land registries, and prevent environmentally harmful encroachment along the lake shore. To immediately raise incentives for more efficient use of existing estate land and facilitate the development of a more active land market, the GOM has increased land rents, effective April 1996, from MK35 per hectare to MK50 per hectare. Significant areas (estimated to be as much as 20%) under leasehold are idle and higher opportunity costs (higher land rents) will create incentives for estate owners to sublease and subdivide land. In line with this objective, the GOM plans to increase land rents in real terms--if necessary--and has revised the The Fiscal Restructuring and Deregulation Program 27 Lands Act to allow for annual land rent updates (previously, land rent updates could take place only every three years). Access to Cash Crops 5.27 Over the past four years important progress has been made with regard to granting smallholders gradual access to profitable cash crop production and marketing (growing burley tobacco and eliminating the monopsony power of ADMARC). The Agricultural Sector Memorandum illustrates how smallholder access to burley tobacco production has (a) improved household income levels for about 66,000 smallholder households which had burley quotas (average of 250kg) in 1994; (b) enabled diversification in other agricultural and non- agricultural activities through forward and backward linkages (multiplier of 1.5 for smallholder income from burley tobacco); and (c) reduced household vulnerability to the effects of drought. 5.28 Convinced by the success of the smallholder burley program, the GOM has announced plans to remove the quota system within a year. * For the 1995/96 season the GOM expanded the smallholder burley tobacco quota system and the intermediate buyers program. About 100,000 smallholders registered to produce about 50 million kg, which is twice the planned ceiling of 25 million kg. The GOM continued to accept all applications for intermediate buyers licenses (introduced in 1994/95)--to purchase about 8 million kg of non- quota tobacco from smallholders--which has evolved as another attractive marketing outlet for smallholder burley. * For the 1996/97 season the Tobacco Control Commission (TCC) will take over responsibility for administering and allocating national burley tobacco quotas and the registration of smallholders. The GOM has announced that the TCC will allocate sufficient new or unused national quota to meet all smallholder production registrations. There will be no planned ceiling on burley quota for smallholders. Smallholders belonging to producer clubs will register their production with TCC to gain direct access to auction floors. Smallholders not registering with TCC can sell through one of 750 intermediate buyers. * For the 1997/98 season the GOM has announced replacement of the national production quota system with a production registration system with TCC. The registration system is for statistical purposes and will allow TCC to schedule delivery to the auction floors and will provide all estates and smallholders with equal opportunities to produce and market tobacco. 28 Chapter 5 5.29 The number of burley-producing smallholder households could increase to 200,000--300,000 by the year 2000. Over the next two years this action is expected to inject US$100 million p.a. into the smallholder sector. Nevertheless, the burley policy will not reach all smallholders--especially those with less than 0.5 ha land and no cash to purchase inputs--and will need to be augmented by other pro-poor policies and programs, for instance: (a) public works under the coming IDA-supported MASAF; or the IFAD-financed smallholder food security project (implemented by IDA) that is providing a package of hybrid maize (for 0.2 ha) and minute tobacco quotas (100 kg for 0.1 ha) to resource-poor farmers with land holdings below 0.5 ha. Access to Inputs 5.30 A key part of the GOM's strategy to enhance agricultural productivity and diversification is to increase the access of farmers to improved and suitable technologies and inputs (such as seeds, fertilizers and feeds). Since 1994 private traders have been allowed to participate in the import and distribution of smallholder inputs. However cumbersome licensing and compulsory approval procedures continued to inhibit smallholders' access to fertilizer, agrochemicals and improved seeds. This kept transaction costs high, discouraged private trader participation, and limited crop and livestock options for smallholders. In contrast, estates have had unrestricted access to inputs. 5.31 In line with the Agricultural Strategy the GOM has approved (January 1996) amendments to both the Fertilizer, Farm Feeds, and Remedies Act and the Seeds Act to streamline the licensing, registration and reporting procedures for the importing, selling and distribution of fertilizers and seeds. The amendments, among other things, (a) remove the requirements that fertilizers be registered and importers and sellers be licensed; and (b) remove government control over introduction of new seed varieties. Entrepreneurs will be free to multiply and trade in all seeds, including hybrid maize and tobacco. In both markets, the GOM will now only set and monitor truthful labeling and phytosanitary standards. Private sector entry regulations have been harmonized with general business practices and are covered under the Business Licensing Act which is functioning well. The approved changes will improve dissemination of technology and enhance farmers' access to the best seed varieties and fertilizers at competitive prices while protecting farmers from unscrupulous traders. Access to Markets 5.32 Important progress was made during the early 1990s with the liberalization of virtually all agricultural producer prices and export controls, leaving maize as the only regulated market. Even in the maize market, private traders are now allowed to participate and ADMARC has moved from sole The Fiscal Restructuring and Deregulation Program 29 buyer and seller to buyer/seller of last resort. In April 1995 the system of fixed producer and consumer prices (linked to production costs) was replaced by a price band in which the actual price can fluctuate and ADMARC defends the announced floor and ceiling prices. However, the current system could prove unsustainable and in excess of GOM's financial capabilities if ADMARC were asked to defend floor and ceiling prices set too far from import or export parity prices. 5.33 The FRDP will support operationalization of the new maize pricing and marketing policies in a phased manner with the aim of gradually separating ADMARC's commercial and developmental functions to become more commercially-oriented and ready for privatization within the next five years. The proposed policy measures are supported through technical assistance under the Agricultural Services Project. Terms of Reference for studies on "The Future of ADMARC" and "Expanding Private Sector Participation in Maize Marketing" were agreed with IDA and the studies will be commissioned by end- May 1996. Specific policy measures would be agreed upon over the next 12 months and implementation could be supported under a follow-on operation. 5.34 The GOM's intention to liberalize agricultural marketing, promote private sector participation, and enhance smallholder access to competitive prices was reaffirmed with (a) the repeal (January 1996) of the Agricultural and Livestock Marketing Act which eliminates ADMARC's monopsony to purchase smallholder cotton and other crops; and (b) the revision of those provisions of the Special Crops Act that designated several crops as "special" because of a perceived need to control production and marketing of these crops. The Act was also used to exclude smallholders from producing and marketing certain high- value cash crops, including burley and flue-cured tobacco. Access to Economic Transport 5.35 In addition to Malawi's high costs of external transport, manufacturers and consumers alike suffer from inefficient and costly domestic road transport. Under the protective mantle of government regulations and statutory minimum freight rates, Malawi's domestic road transport industry has grown over the last seven years from nearly nothing to almost 500 companies varying in size from one truck to over 200 trucks. However, while the objective of developing a substantial domestic trucking industry has been achieved, the objective of developing efficient domestic road transport service has not; many operations are poorly managed and inefficient. In early 1995 the statutory rates for domestic freight exceeded average costs-plus-normal profits by 50% to 70% resulting in an economic transfer from users of road freight to the trucking sector equivalent to US$10 million p.a. At times, domestic trucking costs in Malawi were twice those in neighboring countries and transport for hire (for instance, to haul smallholder produce from farms to markets) was three times as much as 30 Chapter 5 owner-provided transport. High transport costs make cash crop production unprofitable for many smallholders, exacerbating poverty levels, preventing higher land and labour productivity, and constraining agricultural diversification. 5.36 The GOM realizes that Malawi's trucking sector is no longer an infant industry and that it is necessary to increase efficiency and lower costs in the transport sector. In line with this objective, in 1995, the GOM lifted all restrictions on importing second-hand vehicles and spare parts to make Malawian truckers competitive with foreign-owned trucking companies who have long benefited from access to lower-cost second-hand equipment. In January 1996 the GOM revised the Road Traffic Act including the removal of the statutory domestic freight rates. Liberalized domestic road transport will reduce transport costs, and thus, bring a direct benefit to the rural poor and facilitate higher agricultural productivity and agricultural diversification. Deregulation of Private Sector Development Policies 5.37 The GOM supports the development of a broad-based private sector. An intensive investment promotion campaign to attract investors is underway and a privatization campaign is gaining momentum. Investment Promotion 5.38 IDA supported a manufacturing sector survey in 1993 which identified-- in addition to high inflation and (at the time) lack of foreign exchange--the following main constraints to broad-based private sector development: (a) the access to industrial land is narrowly constrained, both by an unnecessarily complicated bureaucratic process and by limited public resources for servicing potential industrial land; (b) the process of planning and implementing new investment in Malawi could easily take three years, two of which could be spent gaining or awaiting various government approvals; and (c) the high level of economic concentration and considerable market power of large conglomerates and parastatals discourages entry by potentially more efficient small-scale private firms. The findings of the survey were discussed in a joint workshop with the GOM and the private sector and the following policy measures were identified as priorities to assist the private sector: * Accelerated Processing of Temporary Employment Permits: Starting in 1994, the approval and renewal of Temporary Employment Permits (TEPs) slowed because of public concerns over observed abuses of TEPs for remitting foreign exchange and perceived inadequate skill transfers from expatriates to local staff. The long delays and rejections in processing TEPs left many skilled expatriate workers and managers in limbo. The resulting partial exodus of expatriates was impeding the normal operation of many The Fiscal Restructuring and Deregulation Program 31 firms and clouding future investment decisions. In October 1995, following the first meeting of a consultative forum between the GOM, the Malawi Investment Promotion Agency (MIPA) and private sector representatives, clear guidelines were agreed for processing TEPs, including: routine approval within 30 days, automatic approval for new investments, transparent requirements for training and skills transfers to Malawian nationals, and granting of permanent resident status for long-term expatriates. As a result, the months-long backlog of applications has been removed. * Enhanced Access to Industrial Land: For years the lack of serviced and unserviced industrial sites was a significant obstacle to private investment. A combination of recent public and private activities should remove the shortage of industrial land. In Lilongwe, the Ministry of Lands and Valuations is making available to investors an area of some 80 hectares (200 serviced plots) on public lands. The plots can be grouped for larger developments, and will be available under an accelerated lease procedure that should take only a week from application to preliminary approval. In addition, the GOM is making available to investors over 300 unserviced plots in two areas near Lilongwe. In Blantyre, two industrial sites (90 ha and 150 ha) have been rezoned and surveyed for serviced and unserviced industrial sites. A private industrial estate (110 serviced plots on 100 ha) has recently opened in Blantyre. - Removal of Discriminatory Laws and Practices against Asians: The GOM realizes that a number of practices and laws that discriminate against race, gender, and religion, conflict with Malawi's new Constitution and are significant barriers to investments. The GOM has reviewed existing laws and removed discriminatory references; most notably the GOM approved the repeal of Article 3a of the Business Licensing Act, which limited Malawian citizens of Asian origin to trading only within designated business districts in the four major towns. The relevant Amendment Bill to the Act has been forwarded to Parliament for approval. Deconcentration 5.39 Following the May 1994 elections, the issue of control over the Press Trust (de facto owned by the former President) assumed great political significance. For the first time, the question of whether the Press Trust should be seen as essentially a parastatal or a private institution became a real issue since the private control of the Press Trust had formerly been indistinguishable from the State itself. The challenge is to change this distorted and opaque 32 Chapter 5 arrangement without undermining the real economic strength which Press represents. On balance, subject to rigorous divestiture in specific sectors (such as the financial sector) and to changes which broaden the membership of the Board of Directors, the GOM has concluded (and we agree) that it is in the interest of Malawi to leave Press largely intact to focus on its core operating businesses. It is generally recognized that Press's economic success represents a valuable source of momentum for the development of the Malawi economy and that, once refocussed on its core activities, it can become an engine powering Malawi's economic development. 5.40 Progress between January and October 1995 was encouraging with a mediator trying to move the two sides (the new GOM and the former President) close to an agreement which would have depoliticized the parent Trust. However, negotiations stalled over a final issue: the former President sought a higher compensation than the GOM was willing to consider. Subsequently, the GOM obtained Parliament's approval of the Press Trust Reconstruction Bill under an emergency procedure (presentation of the Bill and approval on the same day) to put in place the arrangements that had tentatively been agreed before negotiations stalled. Because approval was obtained without allowing the customary time (21 days) for a bill to be tabled, the now opposition and former President's party walked out of Parliament. The GOM justified the emergency procedure as necessary to avoid siphoning of funds by the former President's party, but has been criticized widely, including by donors, for not having followed democratic procedures. This is an area we will keep monitoring closely while--jointly with other donors--we try to convince the GOM as well as the opposition to return to the negotiating table. 5.41 Notwithstanding the deadlock in negotiations, Press and the GOM have already started to reduce Press's interlinking ownership with the financial sector. Over the past year Press has reduced its ownership in the two commercial banks from over 40% each to less than 25% each and 6% of Press' shares were sold to a foreign-owned insurance company. This will pave the way for restructuring Press, offering of Press stock on the newly created stockmarket, and focusing the business on its core strengths and towards a pattern of substantial external growth in the sub-regional economy. A new--more balanced--Board of Directors and a new Board of Trustees have been appointed. Privatization 5.42 Compared to many other developing countries the parastatal sector in Malawi--comprising 12 major commercial parastatals and over 200 small and very small developmental statutory entities, state-owned investments, farms, guesthouses, etc. accounting for 20% of GDP--has been well managed and for the most part profitable. However large losses have been incurred by Malawi Railways, and to a lesser extent by Air Malawi and Viphya Timber Plantations. The Fiscal Restructuring and Deregulation Program 33 Some privatization of both ownership and management has taken place over the past few years. Examples of this are the divestiture of some of ADMARC's investments, and of some of MDC's portfolio, and, most recently, the restructuring and future privatization of Malawi Railways which is supported by an IDA project. 5.43 The new GOM started a rigorous privatization effort in late 1994, when the newly-elected President appointed a Privatization Commission chaired by the First Vice President (cum Minister of Statutory Corporations). The Commission, which has 19 members representing all political parties in Parliament, the private sector, and relevant government departments, was charged with developing the strategy for privatization in Malawi. Supported by the GOM and IDA, the Commission has made considerable progress along three main directions: (a) a legal framework for privatization; (b) an institutional set up to deliver privatization; (c) and an inventory of State Owned Enterprises (SOEs) and a preliminary action plan for privatization. 5.44 The legal framework consists of the GOM's policy paper, a Privatization Bill to be submitted to Parliament in Spring of 1996, and detailed operational procedures for privatization currently being prepared. The framework provides a fair, transparent, competitive and yet efficient fundament for privatization in Malawi, and has drawn on best practice examples from the region, the entire continent, Latin America and Asia. 5.45 The institutional setup draws upon maximum use of the private sector. Implementation of privatization will be delegated from Cabinet to the Commission, which will delegate implementation to a Privatization Transaction Unit, consisting of about 4 high quality professionals on 2-3 year contracts and with performance-related compensation. The Unit's Executive Director has been recruited locally and has been appointed. The Unit will orchestrate individual transactions by using consultants for preparation, for studies of regulatory concentration or monopoly issues (where necessary), and for implementing the actual transaction. This Unit can manage privatization in Malawi such that the program progresses quickly without compromising quality or the interest of Malawi. 5.46 The potential benefits from privatization are considerable. Of approximately 230 SOEs in Malawi, about 40 are non-commercial and will be integrated in the appropriate line ministry for reporting and financing or will be liquidated. The remaining assets include many small inns, farms, Telecom, Air Malawi and the portfolios of ADMARC and MDC. The preliminary plan is to prepare for privatization virtually all of MDC's and ADMARC's investments over 3-5 years, and to divest (to farmers and smallholders) the crop authorities, farms and ranches over 2-3 years. In parallel, it is envisaged to study the competitive and regulatory situation for utilities and the largest corporations 34 Chapter 5 such that privatization (or concessions and management contracts) can begin in 1997/98 and be concluded within 5 years. 6. THE PROPOSED CREDIT CONDITIONALITIES: BORROWER-IDA CONTRACT 6.1 There have been no significant changes in the design of the FRDP since approval of the Initiating Memorandum by the Loan Committee on November 13, 1995. The GOM has met all actions required for Board Presentation. The main actions taken in preparation of the FRDP are presented in the following Table (details on policy measures are presented in Annex E: Matrix of Policy Actions). The macroeconomic developments in FY95/96 were broadly on target and consistent with the framework agreed under the 6th PFP. In addition, the GOM has reached agreement with the Bank and IMF on a macroeconomic framework for FY96/97. 6.2 Disbursement against the Second Tranche (Civil Service Reform Tranche) would be triggered by: (a) satisfactory implementation and deepening of the overall adjustment program; (b) continuation of macroeconomic policies conducive to adjustment and in line with fiscal and monetary targets agreed under the 6th PFP; (c) implementation of an Action Plan agreed with IDA for comprehensive civil service reform as presented in the Letter of Development Policy. The Proposed Credit 35 Table 6.1: FRDP - Summary of Completed Actions Fiscal Restructuring Expenditure * introduced cash budget Rationalization . completed MTEF for four pilot sectors . approved substantial increase in social sector expenditure allocations Civil Service Reform * completed civil service census . retrenched about 20,000 temporary workers a started analytical work to feed into civil service reform Tariff and Tax Policies . strengthened Pre-Shipment Inspection * improved duty drawback system . implemented Export Processing Zones Act * rationalized tariff structures and reduced average tariff rates . expanded surtax base and rationalized surtax structure Agricultural Policies Access to Land * increased land rents * amended Land Act * appointed Presidential Commission of Inquiry on Land Policy Access to Cash Crops * lifted all constraints on smallholder access to burley Access to Markets * replaced fixed producer/consumer price system for maize with a price band Access to Inputs . approved removal of licensing and registration procedures for private traders in seed and fertilizer marketing Access to Transport . removed all restrictions on imports of second-hand trucks and spare parts * removed minimum freight tariff Privatization * approved Privatization Bill . adopted transparent Privatization Policy Investment Promotion * made available suitable industrial land * approved repeal of laws that discriminate against race SUPERVISION PLAN Supervision Focus 6.3 IDA will review implementation of the overall program as well as specific actions outlined in the GOM's LDP. Because most policy actions supported by the FRDP have already been implemented, the focus of supervision will be on deepening the impact of adjustment and identification of policy measures that could possibly be supported under a follow-on quick-disbursing operation (Table 6.2: FRDP - Focus of Supervision). The envisaged timetable for medium-term policy implementation in the areas of expenditure reform, civil service reform, land policy, maize pricing policy, and privatization is presented in Annex F: Supervision Chart. 36 Chapter 6 Table 6.2: FRDP - Focus of Supervision Policy Area Monitoring of... Macroeconomic * Achievement of fiscal and monetary targets agreed Performance under PFP Expenditure * Roll-out of MTEF Rationalization Civil Service Reform * Implementation of agreed Action Plan Land Policy Reform * Translation of recommendations made by the Presidential Commission of Inquiry on Land Policy Maize Pricing Policies * Translation of recommendations from maize marketing studies into policy measures Private Sector * Private sector response to streamlined investment Development procedures * Implementation of export promotion measures Privatization * Transparency of divestiture process * Number, type, and size of SOE's divested Social Impact of * Perforrnance of safety net measures Adjustment * Performance of smallholder agriculture Organization and Timing of Supervision Activities 6.4 Supervision of the FRDP will involve 40 staff weeks (30 staff weeks in FY97, and 10 staff weeks in FY98). The responsibility for supervising the FRDP will be coordinated by the Task Manager (from the Macro, Industry and Finance Division in the Southern Africa Department) in close collaboration with (a) the coordinator of the Malawi Agricultural Program in AFl's Agriculture and Environment Division, and (b) the Economist in the Resident Mission, who has been involved in the preparation of the FRDP. Regarding the macroeconomic framework, restoring fiscal balance while improving the effectiveness of government spending will be critical for the success of the overall stabilization effort. As the MTEF will be extended to other ministries, monitoring of expenditure allocations will be possible. Close collaboration will be maintained with IMF staff on monitoring macroeconomic developments and sequencing of structural measures in the PFP. Contact with the private sector, other stakeholder groups, and donors will be the responsibility of the Task Manager. The first supervision mission is planned for May 1996 to launch the program. The next supervision mission will be approximately six months later. It is likely that that mission will be combined with a performance review, before release of the Second Tranche. The Proposed Credit 37 Performance Indicators 6.5 Performance indicators have been identified during Appraisal, and will be monitored during supervision to assess whether the program's potential development impact is being achieved or whether policy corrections are indicated. This is in line with the GOM's commitment to monitor the impact of policies on economic performance, poverty reduction and social conditions. Trends in the selected indicators would also feed into the preparation of possible follow-on operations. The GOM, in collaboration with supervision missions, will collect periodic information on the indicators and track developments over time. The performance indicators in Table 6.3 will serve as proxies to gauge the impact of the FRDP. Policy indicators monitor the policy and institutional actions required to implement the adjustment program. Intermediate indicators track the impact on stabilization, structural change and the provision of social services. Outcome indicators monitor progress towards the ultimate objectives of growth, poverty reduction and better social conditions. Borrower's Contribution to Supervision 6.6 The Ministry of Finance will have overall responsibility for managing the program, and for monitoring and reporting responsibilities as described in this report. Administrative arrangements for IDA supervision missions, as well as discussion of the results of supervision will be managed by the Ministry. The social impact of the adjustment program will be monitored in conjunction with the Ministry of Economic Planning and Development, specifically with the Poverty Monitoring Unit. As part of supervision and implementation, the GOM will meet frequently with beneficiary groups, including exporters, private sectors, and smallholder farmers. CREDIT ADMINISTRATION Coordinating Agency 6.7 The coordinating agency is the Reserve Bank of Malawi (RBM) which would administer the Credit on behalf of the GOM and disburse funds through the interbank market. The RBM has extensive previous experience in coordinating import programs and will assure compliance with the agreed disbursement arrangements. RBM is adequately staffed to undertake these duties which it has discharged effectively under previous adjustment operations. 38 Chapter 6 Table 6.3: FRDP - Selected Performance Indicators Policy Indicators | Intermediate Indicators Outcome Indicators Expenditure Rationalization Fiscal Deficit Domestic Inflation Share of public sector in GDP Expenditure share of Primary Number of classrooms built Literacy levels Education in Total Education Expenditures Student/teacher ratio Infant mortality rate Maternal mortality rate Expenditure share of Primary Netepimamoenrolmenrrat Health in Total Health Net prmary enrollment rate Expenditures. Immunization rate Civil Service Reform Civil service wage bill as share of Number of civil servants Vacancy ratio in civil service recurrent spending establishment Wage compression ratio Comparator ratios Tariff and Trade Policies Average and maximum tariff Revenues as share in GDP Growth of non-traditional exports rates Ratio of tariff revenues/surtax Share of non-traditional exports revenues Agricultural Policies Smallholder burley production Number of registered private traders in Poverty rates agricultural produce and input markets Floor and ceiling maize price in Consumption per capita relation to border prices Gini coefficient Level of land rent Private Sector Development Policies Number of serviced and Tum-around time for industrial lease Industrial sector share in GDP unserviced sites available in application Blantyre and Lilongwe Private sector investment as share in Tum-around time for foreign GDP Number and (asset) size of SOEs investment applications prepared and offered for Level of direct foreign investment. privatization GOM subsidy to parastatal sector Employment growth in industrial Number and (asset) size of SOEs sector divested Financing Plan 6.8 A total of SDR 73.2 million (US$106.4 million equivalent) is expected to be provided under the proposed IDA Credit of which SDR 2.9 million have been allocated from IDA Reflows. Substantial co-financing and parallel financing is expected under the Special Program of Assistance from the Governments of Germany, Japan, and possibly, Denmark and Sweden. 6.9 Except for consultancy services, the proposed IDA Credit would be disbursed as follows: an initial tranche of SDR 50.9 million (US$74.4 million equivalent) including the allocation from IDA Reflows would be made available upon Credit effectiveness and the remaining amount of SDR 21 million The Proposed Credit 39 (US$30 million equivalent) would be disbursed upon meeting the conditions related to civil service reforms (Second Tranche Conditions). SDR 1.3 million (US$2 million equivalent) would be available for consultancy services in connection with implementation of agricultural pricing and marketing, tax and tariff reform, introduction of a VAT and National Revenue Authority, and facilitation of beneficiaries consultations to discuss the impact of policy measures and increase understanding of the GOM's economic program. The amount allocated from IDA Reflows would be used within 12 months of the date of signing the legal documents of the Credit. Disbursement and Audit 6.10 Simplified Disbursement Procedures under Adjustment Credits will apply. The Borrower will open an account in the Central Bank. Upon IDA notification of tranche release for each tranche, proceeds of the credit will be deposited by IDA in this account at the request of the Borrower. If after deposit in this account, the proceeds of the credit are used for ineligible purposes (to finance items imported from non-member countries, or goods or services in the standard negative list) IDA will require the Borrower to either (a) return that amount to the account for use for eligible purposes; or (b) refund the amount directly to IDA, in which case IDA will cancel an equivalent undisbursed amount of the credit. Although routine audit of the account will not be required, IDA reserves the right to require it. A summary on the disbursement status of the IDA portfolio is attached (Annex G: Disbursement Performance). 6.11 The Borrower shall open a Special Account with a commercial bank of its choice under terms and conditions satisfactory to IDA, in which US$500,000 for consultant services will be deposited. All applications to withdraw proceeds for consultants services will be fully documented, except for expenditures of contracts with an estimated value of US$100,000 or less for consulting firms, and US$50,000 or less for individual consultants which may be claimed on the basis of certified Statements of Expenditures. Documentation supporting expenditures claimed against Statements of Expenditures would be retained by the Reserve Bank and will be available for review as requested by IDA supervision missions. Upon IDA's request, the Borrower shall have the deposit account and the Special Account audited, in accordance with appropriate auditing principles consistently applied, by independent auditors acceptable to IDA. The Borrower shall furnish to IDA as soon as available, but in any case not later than nine months after the date of IDA's request for such audit, a certified copy of the report of such audit of such scope and in such detail as IDA shall reasonably request. 40 Chapter 6 Procurement Procedures 6.12 Selection of consultants shall be carried out in accordance with "Guidelines for the use of Consultants by World Bank Borrowers and by the World Bank as Executing Agency" (dated August 1981). Selection of consultants shall be subject to IDA prior review as follows: (a) contracts with consulting firms or individuals to be awarded on the basis of competitive selection respectively valued at $100,000 and $50,000 or higher; (b) all sole- sourced contracts; (c) all TOR; and (d) amendments to contracts resulting in final values higher than $100,000 with consulting firms, and $50,000 with individuals. BENEFITS 6.13 The poor will benefit from the redirection of public resources towards their needs and from reduced inflation. With regard to gender-specific benefits. the removal of all primary school fees has had a favorable impact on girls' enrollment rate (increasing gross enrollment from 75% to 96%), laying the foundation for higher literacy rates among women and having long-run implications such as increased female-business ownership or lower fertility rates. Improved access to cash crops and alternative marketing channels should increase smallholder household income. Small businesses and the informal sector will gain through incremental cash injected in the rural economy as a result of expanded smallholder cash crop production. Exporters will gain through increased incentives for agricultural diversification, helping the economy to reduce its dependency on tobacco (from currently 66% of export revenues to about 50% by the year 2005) and creating additional employment opportunities. Credible action in investment promotion and privatization will attract foreign investment beyond the actual program period, thus creating employment, helping diversify the economy, and improving fiscal revenues. A restructured and smaller civil service will allow GOM to increase civil service salaries in line with private sector comparators, thus retaining qualified staff and increasing motivation and public sector efficiency. RISKS Implementation Risks 6.14 The GOM faces a weighty agenda and its political willpower will be continuously tested. Actions taken so far clearly signal the GOM's commitment to poverty reduction and macroeconomic stabilization. In all policy areas, preparatory work was carried out by the GOM and implementation of critical measures is on track, thus reducing the risk of back-pedalling on key issues. The The Proposed Credit 41 following residual implementation risks can be reduced to levels similar to those associated with many of IDA's successful programs. Failure to Contain the Civil Service Wage Bill 6.15 In a country where three civil service strikes were called within one year, continued pressure by civil servants for higher wages is likely. If the nominal increase in the aggregate wage bill was 30% instead of the projected 19% between 1996 and 1997 (Low Case Scenario I) the budgetary financing gap would increase by the equivalent of US$20 million. The fiscal deficit would increase by approximately 2% of GDP in 1996, though real growth would be slightly higher in 1997 compared to the base case (Table 6.4: Sensitivity Analysis - Macroeconomic Scenarios). The risk will be managed through bilateral negotiations between the GOM and the Civil Servants Union. The resolution of the August 1995 civil service strike is indicative of GOM's determination to offset higher civil service salaries only with parallel reduction and restructuring of the civil service size. This risk is further mitigated by the agreement between the GOM and the Civil Servant Union to postpone wage negotiations and implementation of the recommendations of the report on civil service pay (Chatsika Report) until the results of the Civil Service Census are available. Political Resistance and Vested Interests 6.16 Notwithstanding the GOM's commitment across the full spectrum of structural reforms, there is always the risk of political pressure by special interest groups. Civil servants and parastatal employees are likely to object to retrenchment programs under civil service reform or privatization. Although extensive stakeholder involvement will help reduce resistance from special interest groups (and the GOM's communication strategy will help build broad- based consensus), residual risks remain. These will be managed by reaching agreement on end-of-service and severance benefits packages. The recently completed staff retrenchment program of Malawi Railways has set a precedent by which future retrenchment packages in the public and parastatal sector might be measured. For civil service retrenchment, the proposed Credit will provide the necessary resources on a "just-in-time" basis through the Second Tranche which will be triggered by an acceptable civil service reform package, thus, preventing a situation in which expenditures for civil servant retrenchment impinge on the implementation of social sector programs. Impact of Food Price Increase on the Poor 6.17 After the initial round of maize price increases (following the 1995 move to a maize price band) it is possible that further liberalization will result in future 42 Chapter 6 jumps in maize prices. This would adversely affect food deficit households and receive significant attention from civil society and critics of adjustment programs--and could eventually lead to the reversal of liberalization policy under popular pressure. This risk will be managed through a mix of stakeholder consultations, targeted pro-poor activities (such as public works, targeted input distribution programs, and supplemental food programs), and drawdown from the Strategic Grain Reserve (SGR). In years with production shortages, price increases would be buffered by sales from the SGR. If excess demand remains, the consumer price would be maintained at or below import parity level through liberalized private sector imports. In extreme drought years, undue hardship to the poor can only be prevented through public food distribution programs-- transparently funded through the budget and in part or in total financed by donors. Outcome Risks 6.18 Even if Malawi does all the right things, vulnerability to external shocks will persist. The risk of drought is by far the highest and the least controllable of such shocks. The Base Case scenario projects a relatively low growth rate of 4% as it incorporates the effects of possible droughts, albeit mild ones, on income and production (on average one moderate drought in four years). 6.19 In the short term, the impact of a major drought cannot be offset by shifting external resources alone or by relying on substantial donor grants; additional aggregate demand management would be necessary to stay within the agreed fiscal framework. Some mitigating measures are being taken to reduce the burden on the poor; the MTEF will help to protect expenditure allocations in the social sectors and will identify low-priority areas from which to reallocate expenditures to drought-related operations. Over the medium term--and for a limited number of households--the proposed expansion of the smallholder tobacco quota is a measure to improve drought vulnerability. Over the longer term, the GOM and IDA intend to address drought vulnerability through a more systematic and integrated effort to promote alternative crops, disseminate alternative technologies and foster increased non-farm activities. 6.20 Although Malawi's terms-of-trade are expected to remain broadly stable, there is always the risk that world market prices may shift unexpectedly particularly in the tobacco market (Low Case Scenario 2). As long as the decline in export prices is moderate (10%) Malawi will be able to compensate for the shock through reduced accumulation of foreign reserves and if need be through the IMF's Compensatory Contingency Financing Facility (CCFF). However, lower tobacco revenues to the private sector would negatively affect private sector investment in 1996 and would somewhat reduce real growth in 1997 compared to the base case (Table 6.4: Sensitivity Analysis - Macroeconomic Scenarios). The Proposed Credit 43 Table 6.4: Sensitivity Analysis - Macroeconomic Scenarios Calendar Year Basis | 1995 1996 1997 1998 Growth (real GDP at Market Prices - %) 9. 9 10.5 4.0 4.0 Fiscal Deficit (cxcl. Grants - % of GDP) | 15.9 9.9 6.6 5.9 Current Account Deficit (excl. Transfers - % of GDP) 15.0 10.1 8.4 7.7 Growth (real GDP at Market Prices - %) 9.9 10 5 4.5 41 Fiscal Deficit (excl. Grants - % of GDP) 15.9 12.0 9.8 93 Current Account Deficit (excl. Transfers - % of GDP) I 15.0 10.6 8.6 8.0 Growth (real GDP at Market Prices -%) 9 9. 10.5 3.8 3.8 Fiscal Deficit (excl. Grants - % of GDP) 15.9 10.4 6.9 6.1 Current Account Deficit (excl. Transfers - % of GDP) 15.0 10.7 9.2 8.2 7. RECOMMENDATION 7.1 I arn satisfied that the proposed Credit would comply with the Articles of Agreement of the Association, and I recommend that the Executive Directors approve it. James D. Wolfensohn President April 3, 1996 44 Previous Adjustment Operations ANNEX A: PREVIOUS ADJUSTMENT OPERATIOS SAL 1 (FY81) Financing (USSM): IDA 45.0 Main Objectives * Diversify export base. * Encourage efficient import substitution. * Ensure appropriate price and income policy. * Improve public sector's financial performance. * Strengthen GOM's economic planning and monitoring capability. Main Actions Taken Exchange Rate Adjusted periodically. Agriculture Smaliholder producer prices increased annually, notably for maize, using methodology designed by IDA. Resources MobUizatlon and Management Expansion of the tax base and increasing tax rates. Strengthening GOM capability for macroeconomic and sectoral planning, and public debt monitoring and management. Increased recurrent budget allocation for agriculture and other key economic and social sectors. Parastatal Effickncy Improved financial structure of Malawi Development Corporation (MDC); and Press Holdings Ltd. (PHL). Increased tariffs for public facilities, for Malawi Airways and Malawi Housing Corp. Monetary Management Interest rates adjusted periodically. Annex A 45 SAL II (FY84) Financing (USSM): IDA 55.0 Main Objectives * Diversify export base. * Encourage efficient import substitution. * Ensure adequate incentives. * Improve public sector's financial performance. * Strengthen policy-making capabilities. Main Actions Taken Exchange Rate Continued to be adjusted periodically, and Kwacha was tied to a basket of currencies. Agriculture Smaliholder producer prices increased, using IDA methodology. ADMARC's financial management capability strengthened. Industry Reduction (by 41) of items subject to price control. Resources Mobilization and Management Improved buoyancy of tax system. Increased non-tax revenues from higher fees and levies. Preparation of 3-year Public Sector Investment Program. Further strengthening of the GOM planning capability with emphasis on formulation of medium-term strategy, project identification, evaluation and monitoring. Increasing of recurrent budget to key economic and social sectors. Parastatal Efflilency ADMARC (see above under Agriculture). Further financial restructuring of MDC and PHL. Further adjustment tariffs for public utilities. Monetary Management Interest rates adjusted periodically. 46 Previous Adjustment Operations SAL III (FY86) Financing (USSM) IDA 30.0 African Facility 40.0 Financing 22. 99.0 Main Objectives * Diversify export base. * Promote exports. * Strengthen GOM's policy-making capabilities. * Improve performance of Development Institutions. Main Actions Taken Exchange Rate Continued to be adjusted. Agriculture Smaliholder prices continued to be adjusted using IDA methodology. Agreement reached with IDA to postpone elimination of fertilizer subsidies to 1989/90. Divestiture of ADMARC's investments unrelated to marketing activities was initiated. Industry Elimination of items subject to price control, except petrol, low-grade beef, fertilizers, sugar, and vehicle spare parts. Export Promotion Preparation of an export promotion strategy. Establishment of export financing facility. Resources Mobilization and Management Further tax increases on selected items. Adjustment of the tax system to improve efficiency and incentives. Preparation of 3-year Public Sector Investment Program. Strengthening policy-making capacity and economic analyses capability. Introduction of a programmatic budget system. Parastatal Efflckncy ADMARC (see above under Agriculture). Further restructuring of MDC and PHL. Monetary Management Interest rates adjusted periodically. Annex A 47 SAL III Supplement (FY87) Financing (USSM) IDA 10.0 Special Joint Financing 30.0 USAID 10 55.0 Main Objectives * Expand role of private sector in marketing of smaliholder crops. * Improve financial performance and operational efficiency of ADMARC. * Strengthen GOM's policy-making capability. Main Actions Taken Exchange Rate Further adjusted. Agricuiture Intra-regional differentiated producer and consumer maize prices implemented to expand the role of private sector in marketing smallholder crops except tobacco and cotton. The GOM took over, from ADMARC, the financing of strategic grain reserves. Divestiture of ADMARC's investments unrelated to marketing activities was accelerated. Parastastal Effickncy ADMARC (see above under Agriculture). Monetary Management Interest rates adjusted periodically. 48 Previous Adjustment Operations Industrial and Trade Policy Adjustment Credit (FY88) Financing (USSM) IDA 79.0 Japan 25.0 EEC 15.0 ADF 17.2 USAID 35.2 Germany 10.2 Netherlands 12 186.5 Main Objectives Improve policy environment for the manufacturing sector to increase efficiency of resource use including imports and expand exports. Main Actions Taken Exchange Rate Further adjusted. Agriculture Beef prices decontrolled. Industry Reduction of scopes of industrial licensing requirements, and elimination of authority to grant exclusive product rights. Export Promotion Reduction of the scope of export licensing. Revision of duty drew back. Introduction of surtax credit system. Resources Mobilization and Management Reduction of financial deficit. Preparation of a 3-year rolling Public Sector. Expansion of excise tax base and move to ad valorem rate. Introduction of current payment system for corporate income tax. Import Liberalization Removal of requirement for prior allocation by the Reserve Bank for 65% of all imports. Monetary Management Revision of Reserve Bank Act. Revision of Banking Act. Annex A 49 Agriculture Sector Adjustment Credit (FY90) Financing (USSM) IDA 79.0 UK 25.0 Netherlands 10.6 Germany 2 123.6 Main Objectives * Increase efficiency and improve incomes of smaliholders, particularly smaliholder ones. * Increase efficiency of land use and protect environment. * Improve macroeconomic environment through further import liberalization and public expenditure and restructuring. Main Actions Taken Exchange Rate Continued monitoring. Agriculture Smallholder prices continued adjustment. Two-payment price system for smallholder tobacco introduced. Other agents allowed to market fertilizer. Improved cash flow management for FFRFM. Fertilizer economic subsidy reduced. Rationalization and GOM financing of ADMARC development functions. Smallholders allowed to grow burley tobacco. Maize research shifted to develop high-yielding flint varieties. Estate land rents adjusted more frequently. Rent raised in 1990/91 and again in 1992/93 to real 1985 level. Transfer of land from customary areas to estates halted except in low population density areas. Enforcement of woodlot environmental convenants strengthened. Resources Mobilzation and Management Preparation of 3-year rolling PSIP, and maintenance of satisfactory fiscal deficit. Parastatal Efficiency ADMARC (see above under Agriculture). Monetary Management Final removal of prior foreign exchange control except for small negative list. 50 Previous Adjustment Operations Entrepreneurship Development and Drought Recovery Program (FY92) Financing (USSM) IDA 120.0 Japan 70.0 ADF 20.0 Main Objectives * Support an improved environment for entrepreneurial activity and investment in labor-intensive activities. * Support adoption of policies aimed at deepening financial markets. * Support reorientation of fiscal and labor policy toward human capital development. * Help alleviate impact of drought. Main Actions Taken Exchange Rate Maintaining exchange rate at level consistent with external competitiveness in line with trade liberalization. Agriculture Expand smallholder access to burley tobacco production. Industry Issuance of Investment Policy Statement acceptable to IDA, with wide distribution and high visibility. Legislation for the establishment of investment promotion center. Revision of policy directives so that business registration and incorporation of companies consist of only one step with the Registrar General. Replacement of Industrial Development Act with Industrial Licensing Act so as to eliminate industrial licensing process for investments, with the exception of a short list. Review of labor market imperfections and policy options including minimum wage policy, and formulation of action plan agreed with IDA. Resources Mobilization and Management Budgetary allocation to education of at least 15 percent of total expenditures in 1992/93. Budgetary allocation to education of at least 15.5 percent of total expenditures in 1993/94. Introduction of budgetary system for separating allocation and control of individual district and peripheral health care Annex A services in Ministry of Health Revenue Budget. Increase in peripheral services' share of health Revenue Budget. Expansion of the surtax base to electricity and telephone as well as certain other services. Increase in the surtax rate on electricity and telephone services to not less than 10 percent. Identification of target base surtax rate, review of increase in surtax rate on services already taxed to that rate, and review of expansion of surtax base to further services. Reduction of base surtax rate to 30 percent. Review of further decreases in corporate and personal income tax rates. Import Liberalzation Elimination of surtax exemption for domestically produced goods; consolidation of protective effect of domestic surtax exemption into existing tariff system; and limiting resulting consolidated tariff rates to maximum of 75 percent. Implementation of major tariff schedule revisions. Monetary Management Establishment of a Capital Market Department at the Reserve Bank of Malawi (RBM), to conduct periodic auctions for the issuance of RBM bills. Elimination of direct bank credit controls. Maintenance of free determination of interest rates. Continuing to actively seek applications from sound international and regional banks. Preparation of a restructuring program. Supplement to Entrepreneurship Development and Drought Recovery Program (FY95) Financing (USSM) IDA 40.0 Main Objectives * Help reduce Balance of Payments (BOP) pressure due to drought related imports. Main Actions Taken N/A for emergency operation 52 Annex B.: Environmentfor Higher Impact Adjustment Lending in Malawi ANNEX B: ENVIRONMENT FOR HIGHER IMPACT ADJUSTMENT LENDING IN MALAWI Major Actions/Evidence 1: Demonstrated Government Commitment: Track Record => removed all primary school fees => lifted all marketing restrictions on smallholder tobacco : replaced fixed producer/consumer prices for maize with market determined prices within a band => achieved macroeconomic stabilization (cash budget, market-based exchange system) =. retrenched 20,000 temporary civil servants in non-priority areas Broad regular briefings and workshops with private sector Consultation frequent communications with civil society and churches =, request for ED] assistance on systematic communications strategy =. Cabinet retreat to discuss medium-term development strategy, draft PFP. and Pre-appraisal Aide Memoire => Presidential Commission of Inquiry on Land Policy Self Design of r Agricultural Strategy Program =, Poverty Alleviation Program => Privatization Policy Framework =, Civil Service Census/Civil Service Reform => Medium-Term Expenditure Framework 2. Country-specific evidential basis for the proposed structural reforms: Agric. Sector =, smallholder growth strategy is inseparably linked to access in burley production Memo/ Ag =, access to land, inputs, and low-cost transport are main constraints to smaliholder growth Strategy Paper Poverty Profile = low quality and level of primary social services despite relatively high per capita spendiig =. need for improving effectiveness and quality of public social services n need to combine investment in human resources and deregulation of smaliholder sector with short-term income transfer scheme (such as public works) to protect food deficit households from undue hardship Manufacturing => access to industrial land is a major structural constraint Sector Survey _> some constraints (access to credit, license approval) are more binding for ethnic minorities Budget Managm. => reverse project-driven planning and budgeting sequence to link recurrent and development budgets Review =, reconcile program priorities and funding levels in a Medium-Term Expenditure Framework Civil Service Pay n effective control of the civil service wage bill requires linking establishment control to the budget and Employment process, developing departmental manpower plans and targets, abolishing the industrial class and all Study non-filled vacancies = rationalization of the pay structure is needed in conjunction with better personnel management to reverse the drift to non-transparent and inequitable remuneration through fringe benefits and allowances. 3 Simultaneous technical assistance and investment operations: Second => Civil Service Census/Civil Service Reform Institutional =, Preparation of Privatization Policy Framework Development =* Financial Management Information System Project => Technical support for Medium-Term Expenditure Framework Agricultural => Maize marketing and pricing reform Service Project Cross Border =, Tariff and tax analysis Initiative 4. Explicit measures on the level and composition of fiscal balance: Monitoring and > joint monitoring of overall fiscal targets with the IMF under the ESAF. control > annual update of quantitative inter-sectoral and intra-sectoral expenditure targets and quarterly monitoring of actual expenditure allocations Social expenditure : Agreement on quantitative allocations for critical social sector expenditure categories (such as primary targets health care, medical supplies and medication) Annex C. Supplementary Information S3 ANNEX C: SUPPLEMENTARY INFORMATION Time taken to 12 Months prepare 93 staff weeks Key Processing Identification: February 1995 Steps Preappraisal: May 1995 Appraisal: November 1995 Negotiations: Feb 27- Mar 1, 1996 Board: April 30. 1996 Effectiveness: May 1996 Closing Date March 31, 1998 Processing Cost US$342,000 Supporting Bank 6th PFP SecM95-1070 Documents Civil Service Pay and Employment Study Report # 13071 -MAI Agricultural Sector Memorandum Report # 12805-MAI Budget Management Review Green Cover Draft PCR: Agricultural Sector Adjustment Credit Report #: 13603 SAR: 2nd Institutional Development Project Report # 12668-MAI Malawi Poverty Profile Green Cover Draft PAR: Industrial and Trade Policy Adjustment Report # 12156-MAI Program 54 Privatization Program ANNEX D: PRIVATIZATION PROGRAM Malawi - Tentative Timetable for Privatization of SOEs 1996 1997 1998 1999-2005 Farms and Ranches Fwrms And Ranches Farms And Ranches Farms And Randt Kuti Ranch Mikonbngwe Ranch Bwemba Ranch Dwnmbadriz Ranch Meru Ranch Dzalanyama Rarnch Choma Ranch Gov Ftsh Farms Ngapamni Farm Lusangazi Farm Chipunga Farm . Stock Brokers Ltd National Bank of Malawi . Nasomba Farm Nataw Farm . Lake Servces Ltd. INDEBANK * South Rukuru Farm V Farm * PCC * Central Tobacco Properties . Zomba Trout Farm . Chemicals and . MDC Ltd Marketing Ltd. Packaging Industries . Cold Storage Co Ltd. * Cory Mann George Ltd . ADMARC (Malawi) Ltd The I & E Malawi Ltd. Opbchem (Malawi) Ltd. * Malawi Savins Bank * Malawi Housing Corporation The Portland Cement Co . Grain & Milling Ltd * Central Medical Stores * ESCOM (1974) Ltd. * Tourism Development and . Manica Freight Services * Goverrnent Hostel . Blantyre Water Board Investment Co of Malawi Ltd Ltd * Leopard Match Co. Ltd . Bain Hogg Insurance Cntral Government * ADMARC Holdings Brokers Ltd. Stores Ltd National Insurance Co. Ltd . Plstic Products Ltd * Forestry Resthouses L Llongwe Water Board * Commercial Bank of Malawi * Bats Shoe Co (Malawi) * The Nw Building Liknwe lnternational Ltd Ltd. Socity Airport Malawi Book Service . Maltew Finance Co. Ltd . Malawi Rural Finance . Dwangwe Sugar Co Ltd. Corporation * Limbe and Blantyre Rest . Finance Corporation Ltd . SUCOMA Houses Viply Ltd * Indefund Ltd. * Stagecoach (Malawi) Ltd. * Chillington Agrimal Ltd. * Malawi Tea Factory Co. * Mpico Holdings Ltd. Ltd B Brick STil Co Ltd * Malawi Dairy Industries * Mining & Investment * Air Malawi Ltd Develop Corp * Kasungu Flue-Cured * Air Cargo Ltd. Tobacco Authority Smallholder Sugar Plant & Vehicle Hire Authordy Organzation * Smallholder Coffee * Governmend Press Authority Smallholder Tea ALthority . Dnstnct Rest Houtse Chain * Lilongwe Smaltholder * Borehold Construction Poultry Project Fund iMzuzu Smaltholder Poultry * UNDP Housing Fund Project * Malawi Railways (1994) * Capital City Development Ltd Fund Charcoal Production Fund - Malawi Catenng Servces * VIPCOR * Mpwepwa Boat Yard * National Seed Co Ltd Malawi Posts &Telecom.Corp Annex D 55 Public Enterprises for Liquidation 1. Council for Social and Welfare Services 2. Secondary Centres Development Programme Fund 3. Primary School Fees Fund 4. Government Loans Board Fund 5. Manufacturing and Production Fund 6. National Celebrations Council 7. Fisheries Training Project 8. Salima Boatyard Fund 9. Central Lake Fish/Marketing 10. Blantyre Egg Marketing II. Lilongwe Egg Marketing 12. Mzuzu Egg Marketing 13. Salima Cultural Assistance Fund 14. Rural Housing Project Fund 15. Chichewa Board 16. District Water Supply 56 Prrvatization Program Public Enterprises for Integration into Line Ministries Public Enterprise Proposed Line Ministry Tree Nut Authority Agriculture & Livestock Development Tobacco Control Commission Agriculture & Livestock Development Agricultural Research and Extension Trust Agriculture & Livestock Development Malawi Export Promotion Council Commerce & Industry Malawi Bureau of Standards Commerce & Industry Malawi Industrial Research & Technology Commerce & Industry Development Centre Development of Malawian Traders Trust Commerce & Industry SEDOM Commerce & Industry Malawi Investment Promotion Agency (MIPA) Commerce & Industry Copyright Society of Malawi Culture Malawi National Examinations Education Malawi Institute Of Education Education Malawi National Commission for UNESCO Education Designated Schools Board Education University of Malawi Education Polytechnic Board of Governors Education National Library Service Education Malawi College of Accountancy Education Excluded Vehicles Fund Finance Christian Hospital Fund Health Police Rewards/Fines Home Affairs Scholarship Fund Human Resource Management & Development Malawi Broadcasting Corporation Information Prisons Rewards/Fines Justice Industrial Training Fund Labor & Manpower Development MEDI Labor & Manpower Development National Parks & Wildlife Fund Natural Resources Chiefs Advances Fund OPC Malawi Institute of Management OPC National Disaster Fund (Statutory Body) Relief and Rehabilitation Affairs National Disaster Fund (Treasury Fund) Relief and Rehabilitation Affairs National Herbarium Research & Environmental Affairs Tourism and Hotel Marketing Fund Tourism Hotel Staff Training Fund Tourism Kwacha Conference Centre Tourism National Road Safety Council Transport & Civil Aviation National Family Welfare Council Women, Children Affairs, Community Development & Social Welfare MACOHA Women, Children Affairs, Community Development & Social Welfare National Sports Council Youth, Sports & Culture Annex E 57 ANNEX E: MATRIX OF POLICY ACTIONS EXPENDITURE RATIONALIZATION ......................................... ....................................................................................................................................................................................... Objectives * Improve expenditure control. * Improve budgetary allocation process and ensure consistency of recurrent and capital budget with resource availability and development priorities. Actions I Timing/Status 7. Implement Cash Budget and complementary expenditure control and monitor measures. Completed before Appraisal ................................................................................................................................................................. ........................................................... 2. I Form four sectoral Working Groups to develop Medium-Term Expenditure Framework Completed before Appraisal (MTEF). .J............ ...... 3. Prepare Interim Report of sectoral working groups comprising standard cost analysis for Completed before Appraisal each program and altemative sectoral spending programs. 4 Complete MTEF for four sectoral working groups, submit sectoral reports and roll-out Completed before Negotiations plan for MTEF acceptable to IDA. 5 . Obtain Cabinet approval of sectoral budgets under the MTEF. Completed before Negotiations 6 . Conduct review of Development Budget and provide summary report acceptable to IDA Completed before Negotiat 7. . Announce sectoral envelopes and expenditure targets for critical categories in social Completed before Negotiations sector in the FY96/97 Budget Circular. CIVIL SERVICE REFORM Objectives . * Restructure the civil service to improve efficiency and control the growth of civil service wages and salaries #1 |Actions Timing/Status I . . Finalize TOR and nominate Intefministerial Task Force on civil service reform. Completed before Appraisal 2. Complete Civil Service Census exercise for October 1995. Completed before Appraisal ............. . 1~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. . . . .. . . .. . . . .. . . . .. . . . .. . . . .. . . . .. . . . 3. . Prepare retrenchment plan for temporary workers in non-priority areas . Completed before Appraisal 4. Implement retrenchment plan for about 20,000 temporary/non-established civil servants Completed during Negotiations and provide summary report to IDA. 5. Prepare and start implementation of Civil Service Reform Action acceptable to Second Tranche Trigger IDA. Action TARIFF AND TAX POLICY REFORM ......................................... .................... ........................ I.................................................................................................... I...................................... Objectives * Rationalize tariff and surtax and improve tax administration to increase efficiency and protect revenue collection. a Improve the administration of export promotion instruments. #] JActions J Timing/Status I . . Issue tender to expand pre-shipment inspection (PSI) to cover customs reconciliation. Completed before Appraisal 2 . Execute agreement with selected PSI company. Completed before Negotiations 3. . Finalize TOR for feasibility study to set up a National Revenue Authority. Completed before Negotiations .................................................................................... I.......................................................................................................................................... 4. , Approve expansion of surtax base to all services and submit draft legislation to Completed before Negotiations Parliament for FY96 budget. S Complete analytical work (on tariffs and surtax) and implementation plan to reduce Completed during Negotiations maximum tariff rates to 25% and average tariffs to 15% by FY98, revenues permitting. 6 Gazette extension of initial refund of 75% under duty drawback system to i00%. Completed before Negotiations ...........................................................................................I............................................................... 7__Gzteetnino oddfcoypoiint oriutr n gpoesn C..o..mp Ieted . '"'b''"fe..gotiat' . ' .. 58 Matrix of Policy Actions AGRICULTURAL POLICIES .......................... ...................................................................................................................................................................................... Objectives * Access To Land: Develop a comprehensive land policy to improve the efficiency of land use and develop a land market. # r Actions Timing/Status I . . Draft amendment to Land Act to allow annual increases in land rent and present to Completed before Appraisal Parliament. 2 . Gazette increase in land rents to MK 50 per hectare with effect from April 1996 and Completed before Negotiations compile list of estates and identify defaulters on land rents payments. ............. ........................................................... 3. . Issue administrative orders so that no new conversions are made from customary to . Completed before Negotiations estate tenure. 4 .Announce appointment of Presidential Commission on Land Policy Reform. Completed before Negotiations ........................................................................................................................................................... ..... .............................. 5. Appoint Presidential Commission of Inquiry on Land Policy and issue TOR. Completed before Board Presentation Objectives * Access to Cash Crops: Raise smallholder productivity and income by removing |quotas based on land title status. l_________________________________________ _ Actions Timing/Status I Increase 1995/96 smallholder burley quota from 22 million kg to 30 million kg. Completed before Appraisal 2. . Amend Special Crops Act. Completed before Negotiations 3. . Announce phase-out of smallholder burley tobacco quotas for 1996/97 crop season. and Completed before Negotiations switch from production quota to production registration system with 1997/98 crop season. Objectives * Access to Markets: Encourage efficient smallholder production and diversification through appropriate producer prices.___ Timing/Status | # | ~~~~~~Actions TingSau I . Replace fixed pricing system with price band. Completed before Appraisal 2. Prepare TOR and short-list of consultants to design operationalization of maize price Completed during Negotiations band, commercialization of ADMARC, and role of an independently managed SGR. Objectives * Access to Inputs: Improve input availability by removing regulatory restrictions. #1 |Actions I Timing/Status 1. Review licensing and registration requirements in seeds and fertilizer markets. Completed before Appraisal .p...................................................................................................................................................................................................................... 2. . Submit Amendment to Seeds Act to replace licensing and registration requirements on Completed before Negotiations seeds trade, provide breeders rights, and allow quality declared seed. 3. . Submit Amendment to Fertilizer, Farn Feeds, and Remedies Act to replace licensing Completed before Negotiations and registration requirements on fertilizer trade and sale with general business licenses. Objectives * Access to Transport: Improve competition and cost effectiveness in transport 7sector. Actions | Timing/Status I. Remove all restrictions on imports of second-hand trucks and spares. Completed before Appraisal ...................................................................................................................................................................... ........................................... 2. Review Road Traffic Act (RTA) and remove minimum tariff on domestic road Completed before Negotiations transport. Annex E 59 PRIVATE SECTOR DEVELOPMENT POLICIES ......... 4 .....I........ .......................................................................................................... e Objectives 1 * Improve operational and financial efficiency of the sector and support broad- based private sector development. Timing/Status Actions | Timing/Status 1. Prepare Privatization Policy Framework and discuss with stakeholder groups. Completed before Appraisal 2. Submit draft legislation on privatization for Parliament's approval. Completed before Negotiations 3 . Select SOEs to be reintegrated into parent ministries, those to be considered for-. Completed before Negotiations privatization, and those to be liquidated. 4. Estabis Privaiization Transaction Unit, recruit professional staff and secure funding . Completed before Negotiations Objectives * Liberalize investment regulations and increase competition in the private sector. l1 Actions T Timing/Status I. Identify steps to ease investment approval process. Completed before Appraisal 2. Identify suitable land to be rezoned for industrial development by private investors. Completed before Negotiations 3. Rezone and advertise suitable land for industrial development by private investors Completed before Negotiations 4. . Submit draft Bill to Parliament to repeal all laws containing restrictions on ethnic Completed before Negotiations grounds (e.g., Amendment to Business Licensing Act of 1978). 60 Supervision Chart ANNEX F: SUPERVISION CHART Maail - Fiscal ResuuclurIh and DsfeghdaUon Piogram Supevion Plan . 94 1995 1996 1997 1998 Task Nane O3t 43 i 10i1 2ptr 3p 1r 4pi 1r2 I rir 2r 3p i 2 3plr 4pt4 Ip 2 3 EXPENDITURE RATIONAUZATION _ AGREE ON MTEF i! PILOT MTEF (4 SECTORS) - _ SUBEMSSION Of PILOT MTEF BUDGETS FOR FY96197 TO IDA CABINET ENDORSEMENT OF FY96I97 SECTORAL ENVELOPES .l FINALIZE FY96197 BUDGET PLAN . ROLL-OUT MTEF PROCESS TO ALL MINISTRIES CABINET APPROVAL OF FY97/98 BUDGET ENVELOPES - FINALIZE BUDGET PLAN FOR FY971986 COMBINE RECURRENT AND DEVELOPMENT BUDGET . CIVIL SERVICE REFORI t M I RETRENCH 20.000 TEMPORARY WORKERS - CIVIL SERVICE CENSUS ANALYTICAL STUDIES IN PREPARATION OF CSR PREPARATION OF CSR ACTION PLAN AGREEMENT WITH IDA ON CSR ACTION PLAN IMPLEMENTATION OF CSR ACTION PLAN j - Task Sumimary RoNed Up Progress Date: Wed 3212196 Progress Rotled Up Task Milsuloneo Rolled Up Milesblne Pog I - p - sr4 I I Z~~~~~~~~~~~~~~~~~~~~~~~~~~m. z Im"! iRn m ~ 2 m 1: ?;; 2 9 2 II~~~~~~~~~~~~~~~~~~~~~~~~~~~~4 Ca', rn~~~~~~~~~~~~~~~~- * I I I~~~~~~~~~~~( 1 m~~~~~~~~~~~~~~~~~~~~~~~~~~~~1 Ca~~~~~~~~~~~~~p II I I~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~L I U co~~~~~~~~~~~~~~~~_ III~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~I * ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . co .... . ... . ..... ............... . .. .-- . .. .- ........ ..... ................................. ..... C- 1~~~~~~c i j F| i} Ui ' I ' ' - $L '-~~~t ii~~~~~~ ii I - .. 3.~~~~~~~~~~U 64 Disbursement Performance ANNEX G: DISBURSEMENT PERFORMANCE The Bank/IDA portfolio in Malawi currently contains 17 projects. The disbursement factor (disbursements divided by the approved amount net of cancellations and previous years' disbursements) has fallen from 36% in FY93 to 32% in FY95 and only 15% for the first seven months of FY96. Generic issues affecting project implementation have included: i) procurement difficulties stemming from a shortage of qualified staff and frequent turnover of existing staff, weakness in the Tender Board, and delays in reaching agreement on clauses of standard bidding contracts; ii) problems with counterpart funding as a result of fiscal pressures; iii) slow or incomplete preparation of reimbursement documentation, especially where implementing agencies have access to up-front budgetary financing; and, iv) a pattern of very slow project start ups reflecting a tendency on the part of the Government and the Bank to overestimate local implementation capacity. At the February 1996 Country Portfolio Performance Review (CPPR), the Govermment and the Bank agreed on a number of initiatives to improve project performance and disbursements. A Public Procurement Reform Study will be executed under an ongoing operation. Agreement was reached on a schedule of procurement seminars and workshops and updated procurement plans will be prepared for ongoing operations. The prioritization of activities under the MTEF is expected to assist in rectifying the counterpart funding problem. Finally, Government intends to strengthen disbursement practices by institutional strengthening of the Ministry of Finance Claims Unit, while the Bank will strengthen the role of the Resident Mission in project supervision. Projects with disbursement lags of over 50% or other disbursement-related issues are described in more detail below. Power V. Donors withdrew support for the project shortly after project approval, in protest against human rights abuses under the Banda regime and in support of pressure for democracy. Implementation was delayed 18 months. The project is now proceeding satisfactorily, although an extension of the closing date is likely to be necessary to compensate for the 18 month delay. Rural Financial Services: Project effectiveness was delayed by 15 months as a result of a breakdown in credit discipline following the 1994 elections and difficulties in completing the recruitment of staff and legal documentation for the newly established Malawi Rural Finance Corporation. During the 1994-95 season, lending was limited by the large number of ineligible borrowers and a shortage of fertilizer supplies. The project closing date may need to be extended to compensate for the initial delays and permit steps to privatize MRFC. Still, lending has accelerated and the project is proceeding satisfactorily. Annex G 65 Fisheries Development Project: The single greatest constraint limiting performance is the lack of an effective project management and administration system. Disbursement problems are directly linked to poor procurement planning (no major civil works have been completed during the first four years), though improvements have been made during the last year. The earlier restructuring was never really effected. This project is a problem project; a mid-term review in March will propose remedial measures. PHN Sector Credit. Project implementation was originally delayed at the Bank's instigation as discussions continued on the issue of rural focus. The project suffered from a series of personnel issues, including: (i) numerous shifts at the Permanent Secretary level; (ii) very slow recruitment of project staff; (iii) the lack of a Project Coordinator for several months; (iv) the death of Project Accountant, which resulted in a backlog of outstanding invoices; and, (v) staff salary issues affecting the Project Implementation Unit, which were resolved only recently. A number of procurement and disbursement issues have also caused delays. These issues have now been largely resolved and project implementation is expected to improve. Institutional Development II. The Malawi Institute of Management (MIM) component of the project, which constitutes 33% of all project funding, was not effective until June, 1995 (six months behind schedule). The slow start was caused by delays in the hiring of a professionally qualified accountant. The project was further delayed by the need for resequencing of some consultancies and procurement, as a result of slippage. After the initial delays, the project is proceeding satisfactorily. Ag Services.' The move to a cash budget which caused the closing or combination of a number of Government accounts also slowed allocations to implementing parties. In addition, a significant percentage of project expenditures are kwacha denominated local costs. With the devaluation of the currency, the actual amount of US dollars being disbursed fell dramatically, even though the kwacha expenditures remained the same. However, the situation has improved significantly, with the disbursement lag falling from over 60% to 38% between July and December, 1995. Disbursements are on track according to the revised disbursement schedule (updated each mission) and no need for restructuring is forecast. 66 Disbursement Performance Local Government: This project got off to a slow start as a result of a combination of project conditions and market forces. A central condition of the project was that onlending rates to local governments be linked to market rates. However, early in the project interest rates increased significantly to levels beyond what local governments were willing to bear. This issue has been resolved and project implementation is improving. A mid-term review is scheduled for May, 1996. Annex H: Letter of Development Policy 67 ANNEX H: LETTER OF DEVELOPMENT POLICY Tvlegrams: Fi,.%NcE. Lilongwe MINISTER OF FINANCE Telephone: Lilongwe 731 311 O X Telex: 44407 P.O. BOX 30049 LILONGWE 3 MALAWI Ref. No. C, 32/l/52 14th March, 1996 Mr. James Wolfensohn President International Development Association 1818H Street, NW Washington D.C. 20433 USA Dear Mr. President, RE: FISCAL RESTRUCTURING AND DEREGULATION PROGRAM 1. I am writing to request on behalf of the Malawi Govemment a Credit of US$106.4 million from the International Development Association (IDA) in support of our program of Structural Adjustment. This will be the first adjustment program designed and implemented by the democratically-elected Govemment, after 30 years of one-party rule. The structural reforms anchored in a medium-term strategy as reflected in the 6th Policy Framework Paper are supported by a three-year arrangement under the IMF's Enhanced Structural Adjustment Facility. The program is designed to support a critical new phase in Malawi's continuing macroeconomic reform program, aimed at the dual strategy of ensuring stability in the macro-economic fundamentals to allow economic growth with poverty reduction. The cornerstone of this phase of the program is a far-ranging overhaul of public expenditure planning and management, with a view to raising allocations in pro-poor expenditure categories while reducing the absolute level of public spending. In addition, the proposed program supports policy measures that will allow the poor to participate in the full range of economic activities especially in the agricultural sector. 2. The requested Credit will provide the needed financing to: (i) help fill Malawi's projected external financing gap through 1996/97; (ii) provide budgetary support for critical expenditures in the social sectors and a substantial net repayment to the domestic banking system; and (iii) smooth consumption to lessen the cost of stabilization and prevent undue hardship to the poor. BACKGROUND AND RATIONALE 3. Since 1981, Malawi has undertaken six adjustment operations, reflecting a pattem of recurrent periods of short-lived economic recovery and growth which were halted or reversed by external shocks followed by economic recessions. Although these repeated periods of economic recovery earned Malawi the reputation as a "strong adjuster", sustainable and broad-based growth has remained elusive. 4. The pre-1994 Government's lack of comrnitment to poverty alleviation, combined with Malawi's vulnerability to recurrent external shocks, forestalled any sustained and comprehensive transformation of the economy. Until a few years ago, Malawi's economy, and in particular the smallholder agricultural sector, was among the most regulated private sectors in Africa. Marketing and production restrictions excluded smallholders from growing profitable cash crops (especially burley tobacco) and from competing with the privileged estate sector. Until 1987, the marketing monopsony of Agricultural Development and Marketing Corporation (ADMARC) effectively taxed the smallholder sub-sector and prevented entry by private traders. Expanding tobacco exports provided a thin veneer of growth (almost exclusively in the estate sector) that concealed a fragile and narrow macroeconomic base, highly skewed income distribution, and lack of economic diversification. 5. The formal sector became increasingly dominated by a few public and private conglomerates, such as Press Corporation, Lonrho, ADMARC, and Malawi Development Corporation (MDC). Concentration of property ownership in the economy reinforced the increasingly autocratic political regime. A small number of Malawians became rich and powerful, while the lives of the vast majority became worse. 6. With the political transition in Malawi the odds for successful structural reforms, compared to previous programs, have substantially improved. In contrast to the previous regime, the new Government has firmly demonstrated its commitment to policy reform and has followed through in both word and deed to reduce the country's pervasive poverty levels. Within weeks of the 1994 elections, the new Govemment acted on a campaign promise and announced the removal of all primary school fees. This resulted in a dramatic, and largely unexpected, increase in the number of primary students from 1.9 million to over 3 million, with more equitable enrollment across gender, regions and household income levels. The Government's seriousness about putting poverty alleviation in the center of its development agenda was translated into a Poverty Alleviation Program. 7. In addition, the new Government of Malawi has begun to address a wide range of structural, economic, and social issues that have impeded progress toward self- sustained growth and poverty alleviation. Through the preparation of a Privatization Policy Framework, the Government has launched a broad-based private sector development. The new agricultural strategy commits Malawi to far-reaching deregulation and the promotion of smallholder development. In early 1995, marketing restrictions on smallholder tobacco growers were lifted and smallholder tobacco quotas were de facto replaced by a registration system to benefit the poor. Fixed producer and consumer prices for maize were replaced by a market-oriented price band; this should improve efficiency in production and mark-eting of maize and other food crops and help promote crop diversification and food security. 8. I wish to higlhlight here that the aforementioned structural reform process and the new Government's macroeconomic management was challenged from the first day in office by: (i) a series of civil service strikes; (ii) the deterioration of fiscal management during the months leading up to the elections; and (iii) the additional financing requirements to hire 22,000 additional teachers and provide textbooks to accommodate the "overnight" increase in enrollment after removal of primary school fees. The new Government acted accordingly and began to implement a series of corrective measures in the latter part of 1994 and in the context of the 1995/96 budget. I am happy to report that over the past year, we have made good progress in achieving macroeconomic stabilization. Since April 1995, public expenditures are being controlled under a cash budgeting system. The Government has let market forces determine the exchange rate and has resisted popular pressures to reverse the floatation of the Kwacha (February 1994), even when the Kwacha depreciated by 100% in October 1994. The exchange rate has been stable in the last 12 months. The Reserve Bank- of Malawi has been successful in smoothening seasonal fluctuations in foreign exchange demand and supply and, aided by tobacco earnings, had accumulated official reserves equivalent to more than 4 months of imports by end December 1995 which was well above the target of 0.7 months of imports stipulated under the ESAF program. Reflecting the Government's continued commitment to further liberalize the payments and exchange system, Malawi, on December 7, 1995, acceded to Article VIE of the Articles of Agreement of the International Monetary Fund. Thus, effective this date, Malawi no longer applies restrictions on current account transactions. Additionally the rate of inflation has continued to decelerate from a monthly average of 11.0 percent in the fourth quarter, 1994, down to 6.3 percent per month during, the last three months to end January, 1996. We are confident that the macroeconomic improvement will be sustained and are ready to embark on an even more ambitious effort of structural reforms. GOVYERNNIENT'S MIEDMNI-TERMI POLICY FRA NIEWORK 9. Economic management in the near term wvill continue to focus on macroeconomic stabilization to reduce fiscal imbalances and lower the inflation rate. The medium-term strategy places greater emphasis on policies and structural reforms to consolidate past reforms and provide a lasting framework for macroeconomic stability. Greater efforts will be made to promote domestic savings and investment, accelerate economic diversification, raise average productivity across all sectors, enhance domestic competition, and improve external competitiveness. The Government program aims to strengthen performance in the productive sectors through the removal of remaining distortions in pricing and market structures that suppress incentives and competition. Agriculture will continue to be a major source of growth, providing employment and subsistence for some 80% of the population and comprising the main source of primary inputs for the manufacturing sector. In the agricultural sector farmers will have incentives to take advantage of opportunities brought about by more efficient use of fertilizer and the adoption of high-yielding maize varieties, the removal of restrictions on the production of lucrative cash crops, including burley, agricultural diversification and more efficient use of currently underutilized lands; as well as addressing the Govemment's institutional weaknesses that constrain the supply and deliverv of inputs, credit and extension services. Growth ir. the manufacturing sector is expected to be supported by a liberalized exchange system, the rationalization of external tariffs, the reduction in external transport costs as direct routes to Nlozambican ports will become fully operational, and an expansion of the agriculture sector. The investment required for the diversification of manufacturing output and increased exports of manufactured goods will also depend on the success of efforts to broaden the ownership base and remove barriers to ently. The Government realizes that industrial supply response will be accelerated only if efficiency and competition are increased by promoting free and competitive markets and by addressing the highly concentrated and inter-locking ownership structure that characterizes the trade, distribution, manufacturing, and finance sectors. The continued development of human resources and investments in the social and physical infrastmicture will constitute critical elements of the development strategy. 10. The overall macroeconomic objectives for the period 1996-1998 are: (i) a recovery in real Gross Domestic Product (GDP) growth to an average of over 4.5 percent per annum; (ii) a sharp, early deceleration in the rate of inflation, with a decline to an average annual rate of less than 10% from 1998 onward; (iii) a reduction in external imbalances beyond 1996 with a view to attaining a more sustainable balance of payments position over the medium term; and (iv) the accommodation of pressing social needs within the constraint of fiscal sustainability by prioritizing Government expenditures in the context of a medium-term expenditure framework (MTEF). Expected substantial improvement in domestic savings and continued progress in structural reforms will significantly enhance long-run growth prospects. However, continued progress will require donor support in the form of external concessional resources over the medium term. 11. Expenditure policies will be guided by the dual objective of achieving the targeted improvement in the Government's financial position and the necessary reorientation of current expenditures towards a greater emphasis on outlays in key social sectors and the efficient delivery of services. To achieve this, the Government will expand the work already begun in several Ministries and, from 1996/97 onward, prepare a Medium-Term Expenditure Framework. The central Government investment program will be rationalized to ensure that the selection of investment projects is consistent with Malawi's development priorities. To complement these efforts, wage policy will be strengthened by the ongoing reforms aiming at rationalizing the civil service and establishing an adequate remuneration structure. Additionally, having phased out fertilizer subsidies, Government will maintain its policy of giving no subsidies to commercial public enterprises. On the revenue side Government's overall goal is to increase the revenue/GDP ratio from 16.2 percent in 1994/95 to 18.0 percent in 1997/98. To achieve this objective, Government intends to undertake comprehensive reform of indirect taxes coupled with improvements in tax administration. External sector policies will aim at maintaining competitiveness and moving towards medium term balance of pavments viability. Monetary policy will aim at achieving and sustaining a low rate of inflation, consistent with the overall growth and balance of payments objectives. In order to strengthen Malawi's capacity to implement macroeconomic and related structural reform, the Government has developed the National Capacity Building Program for Economic and Financial Management. THE FISCAL RESTRUCTURING AND DEREGULATION PROGRAM 12. Government has identified two binding constraints to the achievement of these goals: (i) the past anti-poor bias and low quality of social sector expenditures; and (ii) restrictions and regulations that prevent the poor from participating in the full range of economic activities. In order to achieve our set objectives and succeed in alleviating the country's pervasive poverty problem, the proposed program focuses on fiscal restructuring and deregulation. FISCAL RESTRUCTURING 13. Expenditure Reoiientation. Under the program, a MIedium Term Expenditure Framework is being developed with support from IDA to help Ministries prioritize inter-sectoral and intra-sectoral expenditures within the agreed overall macro-economic expenditure envelope. The program will help ensure that both the targeted fiscal deficit reduction and the concurrent expansion of social services are achieved rationally without compromising Govemment's pro-poor policy focus. The Govemment is aiming to protect the recent increase in the Ministry of Education's share (22% in 1995196) in total recurrent expenditures and subsequently increase it to 25% with the 1996/97 budget, and broadly maintain this level in the future. The share of primary education within recurrent expenditures of the NMinistry of Education will be increased from 47% in 1995/96 to at least 66% in 1996/97. Similarly, the expenditure share on primary health care is expected to increase from 8% in 1994/95 to not less than 14% in 1996/97 and reach an allocation for medical supplies and medicines equivalent to US$1.25 per capita by 1997/98. Within total recurrent expenditures for health care services 7% will be allocated to Family Planning Services in 1996/97. The share of the Ministry of Agriculture and Livestock Development in total recurrent expenditures will be maintained at around 4% - 5% of total recurrent expenditures with about 40% of this being allocated to extension services to ensure that an increasing share of smallholder farmers is being reached. Within the recurrent expenditures allocation to the Ministry of Works (about 5% of total recurrent expenditures) emphasis will be given to road maintenance and rural roads (50% of the Ministry's recurrent budget). 14. The Medium Term Expenditure Framework will be rolled out over the next six months to all ministries in preparation for the 1997/1998 budget. In this context, lessons learned from the pilot phase of the MTEF will be applied. (a) First, the Audit and Finance Committee of Permanent Secretaries will provide guidance to the MTEF Task Force. Tentative sectoral expenditure envelopes will be discussed by the Cabinet Committee on the Economy in early June 1996. Indicative sectoral expenditure ceilings will be given to line ministries for the next three fiscal years by June 30, 1996. (b) Second, increased focus will be put on the medium-term aspects whereby tentative expenditure needs and shares will be developed for a three-year rolling period. In this regard, by October 1996, ministries will carry out a line-by-line review of functions and identify those programs that will be phased out, functions that will be outsourced to the private sector, and those priority functions for which funding levels would be increased. (c) Third, line ministries will take into account changes in civil service staffing levels that will allow a reallocation of: (i) civil servants from low priority areas to high priority areas; and (ii) resources from the wages and salaries category to goods and services. (d) Fourth, the links between the Public Sector Investment Program (PSIP) and the MTEF will be strengthened. In particular, the PSIP will be rationalized in the context of the MTEF to ensure that the selection of investment projects is consistent with pro-poor development priorities and recurrent expenditure capacities. Government investment as share in GDP is targeted to be maintained between 7% and 8% over the medium-term. (e) Fifth, the Government intends to integrate the recurrent and capital budgets. For the 1997/98 budget, this integration is envisaged to be completed for the four MTEF pilot ministries. (f) Sixth, the program costing exercise will be improved , inter alia, through preparation of a MTEF manual. 15. Expenditure stabilization. In the short-term Govemment will continue with the cash budget system in order to effectively control expenditures. This is being supported by: (i) a monitoring system to ensure that cash books are kept up to date and reconcilcd with bank statements; (ii) the developmenc of a financial management information system (FMIS) to permit continuous monitoring of commitments; and (iii) periodic reconciliation of Government's accounts wvith parastatals to prevent accumulation of arrears. 16. Civil Service Refonn. In recent years, the size of the civil service has grown considerably, adding to the growth in the wage bill and fiscal pressures. Civil service productivitv has not kept pace, as is reflected in the weak public sector management and implementation capacity. Government considers a comprehensive civil service reform of major importance for the purpose of fiscal stabilization and restructuring expenditures so as to increase the efficiency of public service delivery. Under the Second Institutional Development Project supported by the Bank, Government is addressing some critical civil service reform issues, aiming at the strengthening of the personnel function, pay reform and training and skills development. A civil service census has been carried out to provide reliable benchmark data for an effective personnel management and control system. Government expects that the analysis of the census results will be completed by mid-April 1996 and that the payroll will be harmonized with the civil service census file from April 1996 onward. The overall objective of these reform measures is the enhancement of the efficiency and effectiveness of the civil service to ensure improved service delivery to the public. It is Government's objective to achieve a civil service size and remuneration structure that is consistent with a sustainable civil service wage bill of about 7% of GDP. 17. Because of the burden of the wage bill on the budget and Government's commitment to attain fiscal stabilization, several short-term measures were introduced during the past eight months to contain civil service wages. In July 1995, the Govemment reviewed the cost-effectiveness of its overseas representations and is now starting to reduce the number of diplomatic staff posted abroad. Funded vacancies that have remained unfilled for more than five years have been frozen and in August, 1995. Government started to remove these vacancies from the establishment. Between Februaxy and September 1995, the Government retrenched about 20,000 civil servants in non-established and temporary positions in non-priority areas, for instance, unskilled laborers, cooks, gardeners, bricklayers, plumbers, drivers, messengers, janitors. 18. The Government is also carrying out analytical work that will broaden and deepen the scope of civil service reform, including a systematic review of Government functions and a review of civil service pay and remuneration. The latter study has been completed and is currently being discussed by Government. The functional review is at an interim stage and is expected to be finalized by end April 1996. It is apparent that some ministries and departments are overstaffed, with considerable duplication of functions, while critical personnel categories such as health (i.e. doctors) remain understaffed. An Interministerial Commission has been appointed to oversee the implementation of the results of the Civil Service Census and prepare the plan for the next steps in civil service reform taking into account the findings and conclusions of the functional reviews, relevant recommendations from the Medium Term Expenditure Framework process and the analytical work relating to pay reform. 19. We expect to complete the Civil Service Reform Action Plan by September 30, 1996 drawing on the findings and conclusions of the civil service census, the functional review, the remuneration study and the ongoing MTEF exercise. The Action Plan will include, inter alia, the following timing and scope of: (a) establishment of a personnel information and control system that links the personnel data to the payroll data based on the census results; (b) identification of duplicating and overlapping Government functions that are currently being carried out by different agencies and will be eliminated or merged in the future; (c) identification of those Government functions that will be privatized or contracted out to the private sector; (d) realignment of civil service staffing levels in line with Government's pro-poor focus and a reduction in both Government programs and functions; (e) retrenchment program including transparent retrenchment criteria, appropriate safety net measures and quantitative targets for the size of the civil service; (f) identification of cost and source of financing of the civil service restructuring, retrenchment program, staff separation packages and safety nets; (g) restructuring of the civil service salary structure with improved incentives and levels of remuneration for a smaller civil service within a sustainable overall wage bill; (h) arrangements for implementing decentralization, including interGovernmental fiscal relations; and (i) completion of job evaluation exercise with a view to improving the present recruitment, posting and promotion practices. 20. The Government will start implementation of the aforementioned Action Plan and will have completed the following measures before we request release of the Second Tranche. Starting April 1996, Government shall not pay salaries or wages to civil servants who are not listed on the civil service census file. By September 30, 1996, we will have completed a detailed review of functions being carried out by Government departments and ministries and we will have identified those functions that will be eliminated, contracted out to the private sector or privatized, such as (i) car and vehicle hire services; (ii) security guard services; (iii) printing services; (iv) office cleaning services; (v) laundry services in major hospitals; (vi) the operation of medical stores; (vii) the management of the hotel training school; and (viii) the management of rest houses and inns. Within the context of the functional review, we plan to reduce the number of industrial workers and absorb this category into the civil service. Further, Government plans to adopt a civil service staffing plan which reflects our poverty alleviation policy in the education and health sectors and which will (i) focus on training of qualified teachers and lead to a student teacher ratio of 60:1 for primary education; and (ii) achieve adequate staffing of all health clinics with at least one general nurse and one maternity nurse. By September 30, 1996, Government will complete the Civil Service Remuneration Study and will adopt a plan for revising the civil service salary structure which will include, among other things, the integration of housing allowances into the wages and salaries. To improve the efficiency and effectiveness of common services cadres, we will put in place provisions for adequate authority of line managers in deploying, retaining, and evaluating performance of common services staff. In particular, we will have implemented such measures in respect of two common services cadres by end 1996. 21. Tax and Tariff Policy. Trade and indirect tax reforms in Malawi have two objectives: first, to increase the efficiency and competitiveness of the economy, and particularly of non-traditional exports sectors, and second, protect revenues collected from indirect taxes as part of restoring tax revenues to the level of around 17% of GDP over the next two years. GovernmenE appreciates that despite several rounds of tariff reforms in the past, the tariff levels on many important items continue to be high, and, equally significant, the tariff structure has become complicated by Common Market for Eastern and Southern Africa (COMESA) and bilateral trade agreements. The Government intends to carry out further tariff reforms to (i) increase competitiveness of local industry and agriculture by lowering tariffs on capital goods, intermediate inputs and raw materials; (ii) reduce the anti-export bias inherent in the some rates in the tariff structure; and (iii) ensure that exporters receive effective relief from border taxes and have access to necessary inputs at competitive world market prices. The Government appreciates that tax relief to exporters and tariff reductions have to take place within tax revenue and administrative constraints. Hence Government will also undeitake surtax refomis to compensate for losses in revenues that may take place as both maximum and average import tariffs are lowered as part of the Government's medium term macroeconomic program and its commitments under the Cross Border Initiative (CBI). 22. The Government's target is to reduce tariff rates to a weighted average of 15% with a maximum rate of 25%. In line with the agreement under the CBI and Uruguay Round, the number of tariff rates are to be confined to only four rates, including the zero rate. With the 1996/97 budget, the maximum tariff will be reduced from 45% to 40%, while average statutory tariff rates will be lowered to around 15%. In particular, average tariff rates for capital goods, and intermediate goods will be reduced to less than 15%. 23. At the same time reforms of tariffs have to be carefully integrated with surtax reform, including both adjustment of rates and expansion of base, so that Government revenues can be protected. The goal will be to shift to a base rate of 20% while allowing for zero rates and exemptions on exports and basic necessities. Increased reliance on surtaxes, as opposed to tariffs, help in leveling the incentives between Malawian producers and their external competitors both groups are equally affected by the surtax. With the forthcoming budget for 1996/97, Government will increase the surtax to the base rate to service sectors such as the main hotels, restaurants and other such establishments. The single most important option for broadening surtax is to extend it to wholesale and retail activities. The aim of the Government is to implement this measure in the 1997/98 fiscal year with a move to a full-fledged Value Added Tax (VAT) system. 24. Government has already made good progress in these policy areas. With a view to promoting exports the Government has implemented the Export Processing Zone Act, 1995. Duty drawback administration has been simplified in response to private sector complaints about delays in the reimbursement process. Now exporters are provided with 100% refund of duties after submission of appropriate documents within five working days of application. Government has also ensured that the Department of Customs and Excise has adequate resources to provide the needed refunds through providing for a revolving fund from which the Department can pay the duty drawbacks. 25. Limitations on the capacity of tax administration and an erosion of pay scales due to inflation have led to a lowering of revenue collection rates in recent years. Hence, improving administrative capacity should be part of an integrated strategy for strengthening revenue collections over the next few years otherwise tax collections will continue to deteriorate. The Government is currently reviewing proposals to increase salaries and introduce performance based incentives within the existing tax administration. As a further step, the Govemment has prepared the terms-of-reference to carry out a study to examine the costs and benefits of creating a national revenue authority with sufficient authority and resources to provide adequate incentives for its staff. The Government has finalized and improved arrangements for pre-shipment inspection of imports to strengthen the tax administration and revenue collection. DEREGULATION 26. AgicuWtume Policies: Agriculture is the source of 40% of GDP and 90% of the export earnings of Malawi, and will remain the mainstay of growth for the foreseeable future. Given that 85% of the population lives in the rural areas, the performance of this sector directly affects the welfare of most Malawians, including the most vulnerable people. In December 1994, the Government adopted a comprehensive sectoral strategy, "The Agriculture and Livestock Development Strategy and Action Plan" to help transform the agricultural sector from a subsistence/dualistic structure (over-dependent on maize and tobacco) to a more diversified and viable one that also functions as a catalyst for growth in the non-farm sector. The main objective of Government's strategy is to attain broad-based sustainable agricultural growth of at least 4.5% per annum in real terms by removing the most binding constraints (access to land, cash crops, inputs, and markets) to the integration of smallholders into the mainstream of development. 27. Access to Land. Malawi urgently needs a thorough re-examination of rules governing access and use of land, and comprehensive restructuring of public institutions involved in land administration in order to improve security of tenure to all categories of producers. Since independence, agricultural land-use policy for the private sector has remained strongly divided between freehold or leasehold and customary tenure, that is, between mostly export crop production by estates and mostly subsistence farming by smallholders. The gap between rich and poor has widened and subsistence farmers have been largely ignored. Privileges to grow burley tobacco (allocated exclusively to estates through a license and quota) fueled wide- spread reclassification of customary tenure to leasehold; the number of leasehold estates soared from 1,200 in 1979, to 30,000 in 1994, and average size dropped from 250 ha to less than 20 ha. The distinction between small estates (with areas between 10 ha to 20 ha) and smallholders has become blurred. Many small estates have all the characteristics of smallholder farms. Much of the conversion has taken place in an uncoordinated way and many small "'raduated" estates are claimed by more than one leaseholder. In addition, there is a large back log of unregistered lease applications. 28. The Govemment is open to discussions and is prepared to take action on these issues which were virtually taboo in the past. However, in view of Government's limited administrative capacities in this area dialogue is still at an early stage. We expect detailed principles of a new land policy to evolve within the next 18 months after substantial analytical work will have been carried out. Government has announced the establishment of a Presidential Commission of Inquiry on Land Policy in support of a participatory process (including, but not limited to, smallholders, traditional authorities, local government authorities, estate owners) for the complete review and reform of Malawi's land policies aiming at promotion of equitable access to land. security of titles and, improved procedures for land administration. The members of the Presidential Commission , its TOR and duration, will be gazetted shortly. The broad-based membership of the Presidential Commission and its exclusive reporting responsibility to the President will ensure that the investigation is carried out in a transparent manner at arms length from Government or any Government agency or ministry. As this review continues, the Government has declared a country-wide moratorium on conversions of customary land to leasehold tenure. This will allow a coherent review of existing leases to discover and revoke defective leases, resolve lease disputes, catch up with registration of the backlog of lease applications and establish efficient mechanisms for preventing harmful encroachment and development along the lake shore. To immediately raise incentives for more efficient use of existing estate land and facilitate the development of a more active land market, Government has increased land rents, effective April 1996, from MK35 per hectare to MK50 per hectare and improved efficiency of collection. Significant areas under leasehold are idle and it is expected that higher opportunity costs will create incentives for estate owners to sublease and subdivide land. In line with this objective, Government amended the legal framework, the Land Act, to allow for annual review of increases of land rents and three months notice before effectiveness. Government has put in place a process to repossess estate land from rent defaulters. In March 1996, a list of the 30 most severe cases of rent arrears for each of 24 districts was submitted to the Minister of Lands and Valuation for approval to register re-entry. We expect to start with actual repossessing of land by May 1996. We will continue this exercise until all defaulters have been prosecuted. Over the medium-term Government intends to classify estate land into three to four categories according to soil fertility and yield potential and then introduce a differentiated land rent structure. Government plans to develop an implementation plan to better enforce the environmental covenants on estate land requiring 10% of estate land to be kept under forest. As an added incentive Government is considering a discount on land rents for those estates who comply with these environmental covenants. 29. Access to Cash Crops. Over the past 4 years, important progress has been made with regard to granting smallholders gradual access to profitable cash crop production and marketing, including lifting the restriction of smallholder access to burley tobacco and eliminating the monopsony power of ADMARC. Smallholder access to burley tobacco production has (i) directly improved household income levels for over 60,000 smallholder households; (ii) enabled diversification in other agricultural and non-agricultural activities through forward and backward linkages; and (iii) reduced household vulnerability to drought effects. The amount of burley quota allocated to smallholders has gradually increased from 3 million kg in 1991/92 to 15 million kg in 1994/95. In 1995/96 the smallholder burley quota system was de facto lifted and all smallholders in tobacco clubs who wanted to grow burley were registered as growers. In addition alternative marketing outlets have been created for smallholders through the intermediate buyers program. The repeal of the Agricultural Crop and Livestock MIarketing Act has been approved and will be presented to Parliament in March/April 1996. Relevant sections in the Special Crops Act that excluded smallholders from growing high-value cash crops have been removed from the Act. In addition the Ministry of Agriculture and Livestock Development and Ministry of Statutory Corporations are currently designing an action plan to privatize those crop authorities that were formed under the Special Crops Act, convert them into voluntary grower associations, and consider abrogation of the Act. 30. The Government will eliminate the burlev tobacco quota system. An announcement of Government's policy made in January 1996 commits the Government to formally replace the smallholder quota system with a registration system. Specifically, for 1996/97 new and or existing production quota will be allocated to meet all production registrations by smallholder tobacco clubs (who will have access to auction floors). Individual smallholders will not be required to register and can sell to intermediate buyers. For 1997/98 the existing production quota system will be replaced by a production registration system. 31. The proposed changes in burley tobacco production and marketing for 1996/97 and 1997/98 are quite monumental and will require a concerted effort on the part of the tobacco industry to ensure a smooth transition. There are many logistical issues that need to be considered as soon as possible. A consultative group with representatives from Govemment and the tobacco industry will be forned to deal with these issues. Technical assistance miaht also be needed to plan this transition. 32. It is expected that the number of burley-producing smallholder households will increase to 200,000 -- 300,000 by the year 2000. Over the next two years this action is expected to inject an additional US$60 million into the smallholder sector. Nevertheless, the burley policy will not reach all smallholders, for instance many of those with less than 0.5ha land and no cash to purchase inputs, and will need to be augmented by other pro-poor policies and programs, for instance public works under the forthcoming IDA supported Social Action Fund. 33. Access to Inputs. A key part of Government's strategy to enhance agricultural productivity and diversification is to increase the access of farmers to improved and suitable technologies and inputs, such as fertilizers, farm feeds and seeds. Since 1994, private traders have been allowed to participate in the import and distribution of smallholder inputs. However, cumbersome licensing and compulsory approval procedures continued involving both the Ministry of Agriculture and Livestock Development and Ministry of Commerce and Industry in inhibiting smallholders' access to fcrtilizer, agrochemicals and improved seeds. This kept transaction costs high, discouraged private trader participation, and thus limited crop and Jivestock options for smallholders. 34. To accelerate agricultural diversification, Government has approved the streamlining of licensing, registration, and reporting procedures for the importing, selling and distribution of fertilizers, farm feeds and seeds. By requiring only a general business licence issued by the Ministry of Commerce and Industry and no additional reporting to the Ministry of Agriculture and Livestock Development, trade in fertilizers, farm feeds and seeds have been liberalized. The Ministry of Agriculture and Livestock Development will continue to monitor the labeling and composition of fertilizers, farm feeds and seeds. In addition, the Ministry of Commerce and Industry will help monitor and enforce standard business practices, including licensing and reporting, associated with the importation, selling and distribution of fertilizers, farm feeds and seeds. Technical assistance will be needed to evaluate our system of monitoring and enforcement and suggest how to make them more effective as we move towards greater market liberalization. 35. Access to Markets. Important progress was made over the past 2 years with the liberalization of virtually all agricultural producer prices and export controls. In May 1995, the system of fixed producer and consumer prices was replaced by a price band in which the actual price is determined by market conditions, and ADMARC has been mandated to defend the gazetted floor and ceiling prices. In practice, this year, ADMARC encountered numerous problems with implementing the maize price band, including: (i) its conflicting role as defender of the band and commercial operator; (ii) lack of liquidity at maize harvest and into the selling season; and (iii) reluctance to operate a flexible price system within the band. As we strive toward market liberalization and increased private sector participation, we feel that it is important to protect vulnerable producers and consumers from the potential harm caused by unstable maize prices. We believe that the price band is a sensible transitional phase toward fully liberalized maize markets. In the meantime we need to widen the price band and limit the amount of locations where it is defended, promote private sector market activity within the band, and design appropriate roles for ADMARC and the Strategic Grain Reserve (SGR). For example, we recently decided to establish a separate SGR account as a means for funding maize purchases in the future. We have also agreed to tender for maize purchases for the SGR and have a competitive bidding process for future management of the SGR. 36. The ultimate objective is to move toward border price parity, commercialization of all ADMARC's agricultural trading activities and establish an independently managed SGR. The independently managed SGR would receive its overall policy directive from the Government To carry out these changes efficiently we have commissioned a series of studies and requested technical assistance (under the Agricultural Sector Assistance Proaram and the IDA supported Agricultural Services Project) to provide support on implementation issues of the maize price band. It has been agreed that studies on "The Future of ADMARC" and "Expanding Private Sector Participation in Maize Marketing" be carried out, and technical assistance on "Implementation of the Mlaize Price Band", especially management of the SGR as a price stabilization facility. In addition, Government will undertake a study to design a comprehensive food security and drought management strategy to deal with a wide range of food production and consumption issues. 37. Access to Transport. In addition to the high costs of external transport, manufacturers and consumers alike suffer from inefficient and costly domestic road transport. Under the protective mantle of Government regulations and statutory minimum freight tariffs, the domestic road transport industry has grown over the last seven years from nearly nothing to almost 500 companies varying in size from one truck to over 200 trucks. However, while the objective of developing a substantial domestic trucking industry has been achieved, the objective of developing efficient domestic road transport service has not; many operations are poorly managed and inefficient. 38. Government is committed to facilitating competitiveness and cost efficiency in the transport sector so that smallholders can benefit from efficient road transport for produce and inputs. As a first step, Government has removed regulations and practices (including foreign exchange controls) that prohibited Malawian operators from importing second hand vehicles and spare parts, thus lowering the cost of fleet expansion and vehicle maintenance. Furthermore, Government plans to revise the Road Traffic Act. In this context, the Government has already removed the minimum tariffs on domestic freight transport to help ensure higher levels of competition in the sector. Recognizing that transport costs are a function of many factors, Govemment will carry out a comprehensive evaluation of transport policies under the IDA supported Railways Restructuring Project. Such a review would include a thorough examination of transit pricing and user fees (including permits, tolls and fuel taxes); road construction, maintenance and financing; and competition issues in transport supply. The elimination of the minimum tariff and the other reforms expected from the transport policy review should bring a direct benefit to the rural poor and facilitate agricultural diversification as it cuts transport costs and increases profit margins. 39. Private Sector Development Policies: The Government supports the development of a broad-based private sector. An active investment promotion campaign to attract investors is underway and a privatization campaign is gaining momentum. To create a more favorable environment for investors, Government has identified a number of measures to simplify the approvals required to launch new investments. In 1993, institutional constraints identified bv MIPA, the private sector, and a manufacturing sector survey carried out by IDA include: (i) discriminatory laws and practices; (ii) lack of serviced and unserviced sites for potential investors; (iii) slow approval and uncertain renewal of temporary employment permits (TEPs) for expatriate workers; and (iv) inconsistent and uncertain application of existing incentives. In addition the survey identified economic constraints and a lack of foreign exchange and high interest costs. 40. The institutional constraints are being addressed, starting with the Government's approval to repeal laws that discriminate against non-indigenous Malawi citizens. Specifically, Government has approved the repeal of Part IIA of the Businesses Licensing Act (the Bill will be presented to Parliament in March/April 1996), which limited citizens of Asian descent to doing business in prescribed "business districts". In addition, the Govemment has made enormous progress on the availability of industrial land. First, it has identified public lands in proximity to existing industrial estates in Lilongwe and Blantyre to be zoned as unserviced industrial plots and to be offered to private investors under long-term lease arrangements. In Lilongwe, this includes two areas with close to 300 unserviced plots in total. Some 110 serviced plots on privately owned freehold land are currently available in Blantyre and Ministry of Lands and Valuation is developing some 200 new serviced plots. This should address the immediate shortage of industrial land, but Government also intends to continue its efforts to streamline the process of supplying land for industrial development. Third, action has been taken on the rationalization of the TEP system, to eliminate the backlog and make it more transparent and automatic. Government is committed to a target of processing all TEP renewals within 30 days, with an absolute maximum processing time of 45 days. 41. Privatization. Compared to many other developing countries the parastatal sector in Malawi, comprising 12 major commercial parastatals and over 100 statutory entities accounting for 20% of GDP, has been well managed and for the most part profitable. However, large fiscal losses have been incurred by Malawi Railways, and to a lesser extent by Air Malawi and Viphya Timber Plantations. Some privatization of both ownership and management has taken place over the past few years. Examples of this are the divestiture of some of ADMARC's investments, and of some of MDC's portfolio, and, most recently, the restructuring and future privatization of Malawi Railways which is supported by an IDA project. 42. Government has embarked on a far-reaching privatization program to avoid a large potential drain on the budget, increase the efficiency of scarce capital investments, boost private sector development, and attract foreign investors. In October 1994, a Privatization Commission under the chairmanship of the First Vice- President was put in charge of developing a comprehensive privatization program. A Technical Committee prepared a draft Policy Framework for Privatization which has been finalized after several rounds of consultations and discussions between Government and the private sector. The Policy Framework was endorsed by Cabinet and issued as a Policy Statement in December 1995. The appropriate legal framework was agreed with IDA and approved by Government; the draft Bill has been forwarded to Parliament for consideration in the March/April session 1996. The institutional set- up for privatization has been finalized; a Privatization Transactions Unit located outside the civil service will be in charge of the actual divestiture process. The authorities have identified those State Owned Enterprises (SOEs) that will be offered for privatization during the forthcoming 5 year period (including the portfolios of ADMARC and MDC, Air Malawi, and Viphya Plantations). Further, subvented parastatals that will be liquidated and purely developmental statutory corporations that can be integrated into parent ministries have been identified. Government has already carried out a preliminary study to collect key data such as financial performance, employment, and legal status on selected SOEs. This study will be expanded into a divestiture prospectus for the most important SOEs which would be offered for privatization over the next 18 months. CONCLUSION 43. Since taking office in May 1994, the new Government of Malawi has initiated and implemented far reaching macroeconomic and structural reforms with the aim to attain sustainable growth and poverty reduction. We are strongly committed to continue and accelerate this reformn process under the Fiscal Restructuring and Deregulation Program. It is our intention to expedite the program and take whatever other complementary measures necessary to ensure its success. The Govemment views IDA support as an important input to this effort. Yours sincerely, Aleke K. Ban a blinister of Finance Annex 91 ANNEX I: STATISTICAL DATA H. Sdcafer: aft C5WINWORD6OAR:A CHANGES.1C April 3, 1996 3:52 AM Malawi at a glance Sub- POVERTY and SOCIAL Saharan Low-- Malawi Africa Income Development dlamond Population mid-1994 (millions) 10.8 575 3,178 Life expectancy GNP per-capita 1994 (US$) 140 500 390 Average annual growth, 1990-U4 Population (%) 2 7 2.9 1.9 Laborforce (%) 2 6 2 6 18 GNP Gros Most recent estimate (latest yearavailable since 1988) per - , pnmar captpa \/enrollme Poverty: headcount index (% ofpopulabon) 19 =' e Urban population (% of totat population) 14 30 28 Lde expectancy at birh (years) 45 52 62 i Infant mortality (per1O XoIs Jimbirths) 134 93 63 Child malnutrition (% of children under 5) 27 36 40 Access to safe water (% ofpopulation) 53 64 67 Access to safe water Illiteracy (% ofpopulation age 15+) 59 50 41 Gnoss primary enroltment (% of school-ge populaeon) 66 67 108 Ma/awi Male 72 74 16 Female 60 60 --~~~~~~~~~~~~~ Low-income group Female 60 60 101 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1975 1985 1994 1995 EconomIc rtios Gross domestic investment/GDP 33.7 18 6 13 2 15.8 Openness of economy Exports of goods and non-factor services/GOP 29.1 24 2 30 3 32 6 Gross domestic savingaiGOP 17.0 12.9 -0 5 4 1 Gross national savings/GOP 18.9 9 1 -2.7 08 | Cuwent account balance/GDP -14.1 -8 5 -18.0 -15 0 Interest payments/GDP 1.4 2.8 2.9 2.8 Savings , Investment Total debVGDP 42.4 90.0 156.9 160 1 Total debt service/exports 8.0 38.9 22.2 21 3 Present value of debtGDP 6. . 68.1 Present value of debliexports 231 8 i ~~~Indebtedness 1975-44 1965-95 1994 1995 1996-04 (average annual growth) GDP 2.9 2.4 -10 2 9.9 4 -7Malawi GNP per capita -1.1 -2.0 -14 0 8 4 2 4 Low-income group Exports of goods and nfs 2.3 1.5 10.8 7 1 6 6 STRUCTURE of the ECONOMY (% ol GOP) i97S 1S86 19S4 199S Growth rates of output and investment ( Agncullure 37 2 36 8 33.9 40 5 ea Industry 20.3 18.7 25.6 26 5 0 \ Manufacturing 13.1 12.3 16.7 17.5 20 . Services 42.4 44.7 30.5 22 4 o .20- Pnvate consumption S8 9 69 4 77 6 73 7 Jo - General govemmentconsumption 14 1 17 7 22 9 22 2 Imports of goods and non-factor servicea 45.9 29.9 44 0 443 3GI -.GDP (average annual growth) 197544 1965-95 1994 1995 Growth rates of exports and imports M%D Agriculture 1 7 1.0 -29 3 28.3 30- Industry 20 36 24 S 20 Manufactunng 2.7 3.4 3 2 6 3 Services 3.1 3 5 -1 3 -16 1 Pnvate consumption 2 3 -0a -28.2 33 .10 General government consumption 8 3 11 3 -0.8 5 9 .20 Gross domestic investment -5 3 2 4 -21 7 14 7 .30 Imports of goods and non-factor services -3 2 3.3 -28 3 7 8 Gross national product 2.2 2.5 -11 7 11 4 -Ejioi9 - Imr Note: 1995 dat are preliminary estimates. Figurs in italics re for yeas other than tmose specifed The diamonds show four key indicaors in the country (in bold) compared with ds ncorne-group average. If data are missing, the diamond will be incomplete. Malawi PRICES and GOVERNMENT FINANCE Done*tk plco 1975 193 1p" Ing InflatIon I%) (% change) 1w0- Consumer pnces 11.8 10.5 34.7 82.9
Группа Всемирного банка · President's Report
Malawi - Fiscal Restructuring and Deregulation Program Project
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