INTERNATIONAL DEVELOPMENT ASSOCIATION AND INTERNATIONAL MONETARY FUND REPUBLIC OF MALAWI Debt Relief at the Heavily Indebted Poor Countries (HIPC) Initiative Completion Point and Under the Multilateral Debt Relief Initiative (MDRI) Preparedby the Staffs o f the World Bank and the International Monetary Fund Approved by Gobind Nankani and Danny Leipziger (IDA) and David Nellor and Matthew Fisher (IMF) August 11. 2006 Table o f Contents Executive Summary ................................................................................................................. i . I Introduction.................................................................................................................. 1 I1. Assessment o f Compliance with Requirements for Reaching Completion Point ....... 2 A. Implementation o f Poverty Reduction Strategy............................................... 2 B. Macroeconomic Performance During 2001-05 .............................................. 8 C. Implementation o f Structural Triggers ........................................................... 11 D. U s e o f HIPC Initiative Interim Assistance ..................................................... 20 I11. Debt R e l i e f and Debt Sustainability Update .............................................................. 21 A. Updated Data Reconciliation for the Decision Point ..................................... 21 B. Status o f Creditor Participation and Revision o f HIPC Assistance ............... 22 C. Debt Sustainability After HIPC Assistance ................................................... 24 D. Considerations for Topping-Up o f HIPC Assistance ..................................... 25 E. Debt Relief Under Multilateral Debt Relief Initiative ................................... 29 F. Debt Sustainability Outlook after MDRI, 2006-25 ........................................ 31 G. Sensitivity Analysis ....................................................................................... 34 Iv. Conclusions ................................................................................................................ 38 V. Issues for Discussion.................................................................................................. 40 Boxes 1. Summary Assessment o f Malawi’s Progress in Implementing the Completion Point Triggers ......................................................................................... 3 2. Enhancing Growth in the Malawi Growth and Development Strategy .................... 6 3. Performance under IMF Programs. 2001-05 ............................................................ 10 4. Improving Malawi’s Public Expenditure Management ............................................. 12 5. Malawi’s Fight Against Corruption ........................................................................... 13 6. Macroeconomic Assumptions Underlying the Debt Sustainability Analysis over 2006-25 .............................................................................................................. 32 Tables 1. Evolution o f NPV o f Debt-to-Exports Ratio ............................................................. 27 2. ResourcesUsed on Protected Pro-Poor Expenditures. FY200 1/02- FY2004/06 ................................................................................................................. 42 3. Selected Economic Indicators. 2003-25 .................................................................... 43 4. Balance o f Payments. 2000-09 .................................................................................. 44 5. Comparison o f Discount Rate and Exchange Rate Assumptions at end-1999 and end-2005 .............................................................................................................. 45 6. Nominal and N e t Present Value o f External Debt at Decision Point as o f end-December 1999 ................................................................................................... 46 7. Estimated HIPC Assistance at Decision Point (Amended) ........................................ 47 8. Nominal and N e t Present Value o f External Debt at Completion Point. end-2005 ................................................................................................................... -48 9. Net Present Value o f External Debt. 2005-25 ........................................................... 49 10. External Debt Service After Full Implementation o f Debt Relief Mechanisms. 2006-25 ...................................................................................................................... 50 11. External Debt Indicators. 2005-25 ............................................................................. 51 12. Enhanced HIPC Initiative Assistance Levels and Possible Topping-Up at Completion Point ....................................................................................................... 52 13. Sensitivity Analysis. 2005-25 .................................................................................... 53 14. Delivery o f IDA Assistance Under the Enhanced HIPC Initiative and MDRI..........54 15a. Delivery o f IMF Assistance under HIPC and MDRI (without possible topping.up) ................................................................................................................. 55 15b. Delivery o f IMF Assistance Under HIPC and the MDRI (with possible topping-up) ......................................................................................... 56 16. Status o f Creditor Participation Under the Enhanced HIPC Initiative ...................... 57 17. Paris Club Creditors Delivery o f Debt Relief on the Bilateral Initiatives ................. 58 18. HIPC Initiative: Status o f Country Cases Considered Under the Initiative. July 28. 2006 .............................................................................................................. 59 Figures 1. Implied Savings Under the MDRI ............................................................................. 30 2. External Debt and Debt Service Indicators for Medium- and Long-Term Public Sector Debt. 2005-25 ...................................................................................... 35 3. Sensitivity Analysis. 2005-24 .................................................................................... 36 Appendices I. Joint World Bank/IMF Debt SustainabilityAnalysis Based on Low-Income Country Framework ............................................................................. 60 11. External Debt Management .............. ..................................................... ....................68 i EXECUTIVE SUMMARY The staffs of the International Development Association (IDA) and the International Monetary Fund (IMF) are o f the view that Malawi has met the requirements for reaching the completion point under the enhanced Heavily Indebted Poor Countries (HIPC) Initiative. Malawi has made satisfactory progress in implementing i t s Poverty Reduction Strategy Paper (PRSP) for at least one year, and maintained satisfactory macroeconomic policies as evidenced by i t s performance under a program supported by the Poverty Reduction and Growth Facility (PRGF) over the last fiscal year 2005/06 (July-June). Malawi has also met all the completion point targets in the area o f economic governance and public expenditure management, safety nets, and microfinance. In the social sectors, i t has met all but two o f the completion point targets. As a result o f implementing the completion point requirements, Malawi i s now poised to accelerate its pace o f growth and poverty reduction. The new strategy that i s being prepared to succeed the Malawi Poverty Reduction Strategy (MPRS), will be implemented within the context o f a stable macroeconomic environment, significantly improved public expenditure management system, and a conducive framework for improving health and education outcomes, as well as for protecting the most vulnerable in society. The t w o triggers that were not met required government to ensure that the share o f health expenditure reached at least 13 percent o f discretionary recurrent budget and that at least 6,000 students enrolled annually for teacher training. Although these targets were not met during the interim period, the authorities made some efforts towards achieving them. With regard to the health expenditure share, the average between 2001/02 and 2004/05 was 12 percent. Following approval o f a prioritized program o f policies for the health sector that i s supported through a Sector Wide Approach in 2004, preliminary actual figures show that the health sector’s share o f discretionary recurrent spending for 2005/06 increased to 18 percent. With regard to annual enrolment o f 6,000 students for teacher training, an attempt was made to increase enrolment through a crash course but this resulted in a deterioration o f quality o f trained teachers. A new program has now been introduced which should help increase the number o f properly trained teachers deployed in schools. Further, with support from donors, the government i s implementing construction projects that will increase the enrollment capacity in Teacher Training Colleges (TTCs). However, even with these efforts, the target o f 6,000 i s unlikely to be met in the near future and staffs now believe that this target was overly ambitious. The progress made to-date in implementing a broader strategy for raising the quality o f education and improving health outcomes justifies the government’s request for .. 11 waivers for the non-observance o f the t w o completion point conditions relating to the share o f health sector expenditure and teacher training. At the decision point in December 2000, the Executive Directors agreed that Malawi had met all the criteria to become eligible for debt relief under the enhanced HIPC Initiative. The analysis undertaken at the decision point indicated that H P C assistance in the amount o f U S 6 4 3 million in 1999 NPV terms was required to lower Malawi’s NPV o f debt-to-exports ratio to the HIPC threshold o f 150 percent. IDA and IMF commitments to this debt r e l i e f were U S 3 3 1 m i l l i o n and US$30 million, respectively, in NPV terms o f which US$99.9 m i l l i o n and U S 1 4 . 2 million, respectively were delivered as interim assistance as o f August 2006. Information from creditors and a downward revision in exports lead to an upward revision o f HIPC assistance at the completion point to US$646 m i l l i o n in 1999 NPV terms. The completion point analysis of Malawi’s external debt shows a substantial worsening in debt burden indicators compared to the projections made at the decision point. At decision point, the NPV o f debt-to-exports ratio at end-2005 was projected to amount to 169 percent assuming full delivery o f the assistance committed under the H P C Initiative at decision point. The completion point analysis shows the actual outturn to be 245 percent o f exports. After additional voluntary bilateral debt relief, this ratio declines to 229 percent o f exports. The substantial deterioration in Malawi’s NPV o f debt-to-exports ratio since the decision point i s primarily attributable to exogenous factors, which have led to a fundamental change in the country’s economic circumstances. These exogenous factors include: o lower-than-projected export receipts, which explains a third o f the higher NPV o f debt-to-exports ratio; the price o f Malawi’s main export commodity, tobacco, f e l l by 13.6 percent due to declining demand in international markets; o a lower discount rate, which explains about h a l f o f the unanticipated increase in Malawi’s NPV o f debt-to-exports ratio; while international interest rates have declined since the decision point, the nominal debt service burden facing Malawi has remained broadly unchanged as interest rates o n external debt are mostly fixed; o a depreciation o f the U S dollar against the Euro and SDR, although this was a relatively minor factor; o unanticipated new borrowing, which only lead to a small increase in Malawi’s NPV o f debt to exports ratio o f 3.8 percent. Finally, unanticipated increases in international o i l prices since the decision point have also contributed to the deterioration in Malawi’s debt servicing: caDacitv. “ I ... 111 I n circumstances where exogenous factors lead to a significant deterioration in debt ratios after the decision point, the enhanced HIPC framework allows for additional debt r e l i e f (topping-up) at the completion point beyond the relief already committed at the decision point. The staffs consider that Malawi’s case meets the requirements for topping-up at the completion point. Staffs therefore recommend that additional assistance under the enhanced HIPC Initiative o f US$411 million be granted to bring Malawi’s NPV o f debt-to-export ratio from 229 percent at end-2005, to the 150 percent HIPC threshold, after the application o f bilateral debt r e l i e f beyond HIPC assistance. Reaching the completion point under t h e enhanced HIPC Initiative, Malawi w i l l also qualify f o r additional debt cancellation under the Multilateral Debt R e l i e f Initiative (MDRI). As debt r e l i e f under the MDRI would cover all remaining debt service obligations on eligible credit balances to IDA, the IMF and the African Development Fund (AfDF) after any debt service r e l i e f available under the HIPC Initiative, the amount o f r e l i e f under MDRI depends o n the Executive Directors’ approval o f topping-up. MDRI debt r e l i e f (net o f HIPC assistance) would lead to debt service savings on debt owed to IDA, the IMF and the AfDF o f US$1.9 billion without topping-up and o f US$1.4 billion, if topping-up were to be approved. After HIPC debt relief, topping-up of HIPC assistance, and MDRI debt relief, Malawi’s external debt burden indicators fall to levels significantly lower than the average of low-income countries. In the long-term, the NPV o f debt-to-exports ratio i s expected to increase gradually, but will remain below the HIPC threshold o f 150 percent. This projection i s based on the assumptions that government maintains prudent fiscal policies, implements measures to insulate the economy from the debilitating impact of periodic droughts and keeps new borrowing to modest levels and on concessional terms. The staffs of IDA and the IMF recommend that the Executive Directors of IDA and the IMF approve that Malawi has reached the completion point under the enhanced HIPC Initiative and that Malawi b e considered for topping-up under the enhanced HIPC Initiative. I. INTRODUCTION 1. This paper presents an assessment o f Malawi’s progress in meeting the completion point triggers determined at the decision point under the enhanced Heavily Indebted Poor Countries (HIPC) Initiative. I t seeks approval from the Executive Boards o f the International Development Association (IDA) and the International Monetary Fund (IMF) o f Malawi’s completion point under the Initiative, including waivers for two o f the completion point triggers, revision and topping-up o f HIPC assistance. 2. Malawi reached the enhanced HIPC Initiative decision point in December 2000.’ At the decision point, H I P C assistance required to lower Malawi’s net present value (NPV) o f debt-to-exports ratio to the H l P C threshold o f 150 percent was estimated at US$643 million in NPV terms based on end-1999 debt data. Employing the principle o f equal burden sharing, all creditors were expected to reduce the NPV o f their claims o n Malawi by a common reduction factor o f 43.7 percent, after full use o f traditional debt-relief mechanisms. For the IDA and the IMF, the resulting commitments amounted to US$33 1 and US$30 million in NPV terms, respectively. During the interim period between the decision point and completion points, the IMF provided debt r e l i e f o f US$14 m i l l i o n in NPV terms, while IDA provided r e l i e f o f US$lOO million. Malawi has also benefited from interim assistance granted by the African Development Bank, a number o f other smaller multilateral creditors and Paris Club creditors. Total interim assistance to Malawi was about $15 1 million in NPV terms.‘ 3. The paper i s organized as follows: Section I1assesses Malawi’s performance in meeting the requirements for reaching the completion point under the enhanced HIPC initiative, as set out in the decision point document. Section I11reviews the status o f creditor participation and the delivery o f debt r e l i e f to Malawi under the enhanced HIPC Initiative and presents the results o f the debt sustainability analysis (DSA) based o n end-2005 debt data and parameters. This section also assesses the sensitivity o f debt indicators to changes in key economic variables. Section I V discusses the case for a topping-up o f H I P C assistance. Sections V and V I present the conclusions and issues for discussion by the Boards, respectively. See IDA and IMF, “Malawi. Decision Point Document for the Enhanced Heavily Indebted Poor Countries Initiative’, December 2000, IDA/R2000-234 and IMFIEBSI001260. ’ Paris Club creditors have provided additional interimr e l i e f beyond HIPC Initiative assistance. 2 11. ASSESSMENT OF COMPLIANCE WITH R E Q U I R E M E N T S FOR REACHING COMPLETION POINT 4. The decision point document sets out the conditions f o r reaching the completion point. These include: (i) preparation o f a full Poverty Reduction Strategy Paper (PRSP) and i t s satisfactory implementation for one year; (ii)maintenance o f macroeconomic stability and satisfactory implementation o f a PRGF-supported program; and (iii) implementation o f key structural and governance triggers aimed at strengthening public expenditure management, raising the quality o f education, improving health outcomes, fighting HIV/AIDS, strengthening land and credit markets, and creating an effective safety net system. This section assesses the progress in the implementation o f these completion point requirements. In addition, it also presents how Malawi has used the budgetary savings from interim relief. 5. I n t h e view o f the staffs o f IDA and t h e IMF, M a l a w i has made satisfactory progress in meeting the conditions f o r the completion point. All but two o f the completion point triggers have been implemented (Box 1). The f i r s t o f these two triggers required the share o f health expenditure to be at least 13 percent o f the discretionary recurrent budget. The second trigger required ensuring a yearly enrolment o f 6,000 students for teacher training. Based on progress in implementing a broader strategy for raising the quality o f education and improving health outcomes, as discussed below, it i s recommended that Executive Directors accept the government’s request f o r granting waivers f o r the non-observance o f these two completion p o i n t triggers. A. Implementation o f Poverty Reduction Strategy 6. The preparation o f Malawi’s f i r s t PRSP in 2001 reflected a highly participatory process that helped in identifying the key development challenges that faced the country and i t s implementation provided a good basis on which t o improve poverty outcomes. The government i s now in the process o f finalizing i t s second-generation strategy - the Malawi Growth and Development Strategy (MGDS) which places much greater emphasis o n growth as a basis for poverty reduction (Box 2). 3 Box 1: Summary Assessment o f Malawi’s Progress in Implementing the Completion Point Triggers Theme and specific triggers Assessment Implementation of Poverty Reduction Strategies The full PRSP has been prepared and satisfactorily Implemented. A full PRSP, the M a l a w i Poverty Reduction implemented for one year, as evidenced by the j o i n t Strategy Paper (MPRSP), was prepared by t he government and staff assessment o f the country’s progress report. was adopted in April 2002. The first Annual Progress Report in October 2003 indicated that MPRSP implementation was limited. The second APR and JSAN (looking at the period July 2003-June 2004) indicated that MPRSP implementation was s t i l l limited. The third APR (looking at the period July 2004-June 2005) and corresponding JSAN (submitted together with this document) show that implementation covering the period 2004-05 was broadly satisfactory. MacroeconomicPerformance Maintenance o f macroeconomic stability and Implemented. Macroeconomic stability has been maintained satisfactory implementation o f the PRGF-supported since mid-2004, initially under an IMF SMP and then under a program. PRGF-supported program. A new three year PRGF was approved on August 5, 2005. The f i r s t review, completed in February 2006, concluded that perfonnance through to end-September 2005 was satisfactory. The second review, covering performance through end-December 2005, will be discussed by the IMF Executive Board concurrently with this document. Improving Economic Governance Separation o f fiscal management and audit functions Implemented. Legislation was passed in 2003 to separate the under new legislation. financial management and audit functions o f government. Quarterly expenditure reporting as per format jointly Implemented. A format was developed jointly between the developed by MOF/IDA. Ministry o f Finance and the W o r l d Bank and pro-poor expenditures are published o n the government web site and in the press o n a quarterly basis. Implement Integrated Financial Management Implemented. Implementation o f the system in a l l ministries Information System (IFMIS) in four pilot ministries. commenced in November 2005. Raising the Quality of Education Share o f education sector expenditure in Implemented. The sector’s share o f discretionary recurrent budget discretionary recurrent budget o f at least 23 percent. has o n average been 29 percent for the period 2001/02 t o 2004/05, which i s above the required threshold o f 23 percent. Reallocate budgetary resources from secondary Implemented. Expenditure o n teaching and learning materials school boarding to teaching and learning materials. has been increasing o n a sustained basis (in real terms) over the past few years, and government subvention to secondary school boarding has decreased. The triggers have been originally specified in Malawi’s decision point document. (See IDA and IMF, “Malawi. Decision Point Document for the Enhanced Heavily Indebted Poor Countries Initiative,” December 2000, IDAiR2000-234 and IMF (EBS/00/260). 4 Theme and specific triggers Assessment Raising the Quality o f Education (Continued) Pre-packaging o f donor-supplied primary textbooks Implemented. Since 2002, donor-supplied primary textbooks are for each school and direct supply from the supplier pre-packed and directly supplied to schools. to the schools. Yearly enrolment o f 6,000 students for teacher Not implemented. (a) Yearly enrolment was 3,000 in 2000. I t training and institution o f in-service training for has not been possible to increase yearly enrolment with the primary teachers (at least once each year). existing number o f Teacher Training Colleges (TTCs), and the government has been unable t o allocate resources for the construction o f additional training institutions. Earlier attempts to increase enrolment through a crash course were not successful. Government has n o w put in place other measures to increase enrolment (b) In-service training for primary teachers was institutionalized in 2001 in the form o f a continuous professional development program following the phasing out o f the M a l a w i Schools Support Program (MSSP). Improving Health Outcomes Recruitment, training and deployment o f at least 200 Implemented. Over the implementation period, the sector has o n nurse technicians, 50 new medical assistants and 20 an annual basis been training over 300 nurse technicians, over 60 radiography technicians per annum. medical assistants and 2 0 radiography technicians. Completion o f ‘phase one’ reforms o f the Central Implemented. (a) With regard to completion ofphase one Medical Stores (CMS) and a budget for drugs and reforms o f the CMS, sufficient progress was made which included medical supplies in line with Better Health for Africa reviewing the essential drugs l i s t and undertaking the necessary (BHA) standard (US$1.25 per capita). actions towards the transformation o f the C M S into an autonomous body. (b) The average budget for drugs and medical supplies over the period i s US$1.36 per capita which i s above the BHA standard. Share o f health expenditure o f at least 13 percent o f Not Implemented. The sector’s share o f discretionary recurrent discretionary recurrent budget. budget has o n average been 12 percent for the period 2001102 and 2004105, which i s below the required threshold o f 13 percent. However, the implementation o f the health SWAP has resulted in the share for 2005106 rising to 18 percent, based o n preliminary actual expenditure figures as o f July 2006. Fighting H I V / A I D S Fully staffed, functional and autonomous National Implemented.National AIDS Commission (NAC) and i t s AIDS Control Secretariat. secretariat was set up in July 2001 as an autonomous body run and managed by a board o f trustees. The secretariat i s also h l l y staffed 75 percent o f all condom outlet points with condoms Implemented. There i s over 75 percent o f condom availability in in stock at any given time. the groceries, shops, and entertainment clubs, verified through NAC’s monitoring system. 5 Box 1: Summary Assessment of Malawi’s Progress in Implementing the Completion Point Triggers (continued) Theme and specific triggers Assessment I Fighting HIV/AIDS (Continued) Continuous availability o f testing k i t s at all blood Implemented. The number o f blood testing kits increased f r o m transfusion sites by increasing blood testing kits 1,500 in 2001 to 4,000 in 2005. (each allowing 100 tests to b e done) f r o m 1,500 to 2,500. Implementation of an effective Behavior Change Implemented. The Behavior Change Interventions (BCI) Strategy 1 Communication Strategy. was developed i n 2003 and i s the guiding framework for a l l H I V i A I D S behavior change interventions in Malawi. Syndromic Management o f sexually transmitted Implemented. All central hospitals, district hospitals, major infections (STI) in all Central, District and major C H A M hospitals and i n some districts even health centers are C H A M hospitals. using Syndromic Management o f STIs. Improving Access to Land and Credit Submission o f draft Land L a w to parliament. Implemented: A draft Land L a w was submitted to parliament on the June 13,2006. Approval by cabinet o f the ‘Micro-finance Policy.’ Implemented. cabinet approved the policy in October 2002 Increase number of micro-finance clients by 20 Implemented. Statistics covering 20 microfinance institutions and percent. initiatives show an increase o f 79 percent in the number of clients between 2000 and December 2005. Establishment o f a monitoring system covering a l l Implemented. The Reserve Bank o f M a l a w i established a micro-finance institutions. monitoring system covering a l l microfinance institutions in 2003 under the SADC microfinance observatory initiative. Creating an Effective Safety Net System Transform universal starter-pack distribution into a Implemented. The universal starter-pack was transformed into a Targeted Input Program (TIP) for 2001/02. TIP in the year 2000/0 1 reducing the number o f farmers targeted f r o m 2.86 million to 1.5 million. The program has n o w been changed to operate as a fertilizer price subsidy program, targeting 2 m i l l i o n households. Rationalization and prioritization o f existing and new Implemented. The g o v e m e n t has made attempts to rationalize programs, under the National Safety Net Strategy and prioritize the various donor-managed safety nets interventions, (NSNS). although co-ordination remains a challenge. Government i s n o w in the process o f developing a social protection policy to help improve coordination. Establishment o f a monitoring and evaluation Implemented. An M&E system has been set up in the National (M&E) system o f the National Safety N e t Strategy. Safety Nets Unit (NSU). 6 Box 2: Enhancing Growth in the Malawi Growth and Development Strategy Malawi Growth and Development Strategy (MGDS) reflects the authorities policy framework to reduce poverty through economic growth and empowerment of the poor. There are five strategic themes proposed: (i) achieving sustainable economic growth and economic empowerment, ( ii) protection o f the most vulnerable and enabling them to contribute to the economy. ( iii) creating a healthy educated and well nourished productive population, (iv) infrastructure development as a pre-requisite for achieving the objectives o f economic growth and social development, and (v) good governance including sound economic environment, high quality service delivery, effective institutions and r u l e o f law, an efficient and effective public sector, and reduction in corruption. The authorities plan to enhance growth by focusing on sectors that are identified as key for the medium and long term growth. I n the medium term, the driving force behind growth i s the agriculturally-based core sectors of the economy (tea, tobacco and sugar) by way o f further integration o f these sectors and smallholders into agro-processing to meet domestic and foreign demand. The authorities envision expanding and diversifying output and exports to meet demand in the region through irrigation, large scale farming, infrastructure expansion and rationalizing fees and tax policy toward cash crops and eliminating food insecurities. To enable private-sector led growth in these sectors, the authorities plan to improve access to financing (micro-finance schemes) and secure land registration. I n the long-term the strategy identifies tourism, mining, garmentkotton, and manufacturing as sources of high growth sectors and employment generators in the medium term. To enhance the tourism sector and attract FDI in the sector, the authorities plan to improve infrastructure and communication, enforce the regulatory framework for quality, standard and land access for tourism development. To increase mining output and value added the strategy aims at improving the technology and infrastructure to help create market outlet, and review o f tax policy. While in the garment sector, the goal i s to increase local content o f production, develop local textile industry geared toward exports and negotiating trade opportunities. In manufacturing, the goal i s to improve quality and productivity through training o f workers, better infrastructure, investment incentives and build capacity to evaluate o w n standards. 7 7. Malawi’s full PRSP was adopted in April 2002 with implementation planned to cover the period 2002/03 - 2004/05. The Malawi Poverty Reduction Strategy (MPRS) was prepared by the government through a participatory process that involved a wide range o f stakeholders including government officials, non-governmental organizations (NGOs), c i v i l society, the private sector, development partners, and members o f parliament. The MPRS was built around four strategic pillars as follows: (i) sustainable pro-poor growth; (ii) human capital development; ( iii)improving the quality o f l i f e o f the most vulnerable; and (iv) good governance and cross cutting issues. These pillars represented the main strategic grouping o f the various policies and activities that are believed to provide a coherent framework for poverty reduction in Malawi. 8. The government has established an institutional framework for participatory monitoring and evaluation o f the implementation o f i t s poverty reduction strategy. An MPRS monitoring committee was established soon after the strategy was adopted. The committee was served by a broad-based Technical Working Committee (TWC) whose role was to co-ordinate monitoring and evaluation efforts. The committee has since produced and published three annual progress reports (APRs) and one comprehensive review report covering three years o f MPRS implementation. 9. The f i r s t two APRs and accompanying Joint Staff Advisory Notes (JSAN) noted that implementation o f the MPRS during the f i r s t t w o years was limited. The first APR (covering the period July 2002 - June 2003) and the accompanying JSA were submitted to the boards o f IDA and the Fund in October 2003. The JSA concluded that despite initiating some o f the reforms anticipated in the MPRS, progress had been limited. Performance was also poor with regard to maintaining macroeconomic stability. The second APR and JSAN (covering July 2003-June 2004) were submitted to the Boards in June-2005 and indicated that MPRS implementation was s t i l l limited. 10. Staffs consider implementation o f the MPRS in i t s third year to have been broadly satisfactory. The third APR covers implementation o f the MPRS from July 2004 to December 2005. As indicated earlier, macroeconomic performance during this period has been satisfactory. Further, as outlined in the APR (and noted in the JSAN), progress has been made in implementingthe MPRS priority activities in agriculture, education, health, public expenditure management, public sector reform, and corruption prevention. Based on this performance, IDA and IMF staffs therefore conclude that the trigger on satisfactory implementation of the MPRS for at least one year has been fully met. 11. Even before the MPRS expired, the government started to prepare a successor strategy. The new strategy, the Malawi Growth and Development Strategy (MGDS) takes into account new information about poverty in Malawi from the poverty and vulnerability 8 assessment (PVA)4and incorporates improvements based o n lessons drawn from the comprehensive review o f the MPRS implernentati~n.~ Covering the period 2006/07 - 2010/11, the MGDS, which includes an explicit results framework, has been prepared through a participatory process and was discussed at cabinet o n M a y 30,2006. Cabinet adopted the strategy in principle, subject to the finalization o f a human resource and capital needs assessment. Government intends to formally adopt the strategy soon. 12. There has also been improved participation by various stakeholders in monitoring implementation of the MPRS, the preparation o f its successor strategy, and in the budget process. Although the MPRS was prepared through a participatory process, there were concerns after the production o f the first progress report that the monitoring o f MPRS implementation did not involve all the relevant stakeholders, in particular, the private sector. The latter years o f implementation have seen greater participation o f civil society and the private sector in the monitoring o f the MPRS. Similarly, there has been greater participation in the formulation o f the successor strategy. A significant improvement over participation in the preparation and monitoring o f the MPRS i s that members o f parliament have been more widely consulted in the preparation o f the MGDS. B. Macroeconomic Performance during 2001-05 13. After a period of uneven macroeconomic performance following the decision point in 2000, macroeconomic stability has been maintained since mid-2004, initially under an IMF SMP and then under a PRGF-supported program. In particular, all the quantitative targets under these programs have been met since mid-2004, and with the restoration o f fiscal discipline, domestic debt has started to decline. Similarly, once the economy has fully recovered from the effects o f last year’s drought induced food crisis, inflation i s projected to decline to single digits. 14. The decision point in December 2000 coincided with the approval o f a new PRGF arrangement. Policy implementation under the arrangement was poor and i t expired in June 2004, with only the first review being successhlly completed. This delayed the completion point being reached in late 2003 as originally envisaged. 15. Policy implementation deteriorated quickly under the PRGF-supported program following the decision point. Duringthe two fiscal years 2000/01 and 2001/02, fiscal slippages occurred principally o n account o f repeated bailouts o f public enterprises, a sharp increase in interest rates associated with rising domestic public borrowing, overruns o n The PVA was based o n data from the second integrated household survey (IHS) carried out by the National Statistical Office (NSO) covering the period March 2004-February 2005. Some o f the key lessons include the need to improve linkages between policy strategies and the budget, and to improve the use o f M&E as a management tool. 9 the wage bill, and overspending on other current expenditures. The policy slippages and consequent delay in completion o f the first PRGF review resulted in shortfalls o f external budgetary support. This set up a vicious cycle o f greater recourse to domestic financing, crowding out o f the private sector, rising interest rates, widening overall fiscal deficits, and worsening public debt dynamics. These trends were exacerbated in 2002 by a food crisis and the need for the importation o f maize and fertilizers that added some 4% percent o f GDP to fiscal expenditures and halved external reserves. By the end o f 2003104, domestic debt approached 25 percent o f GDP and domestic interest payments absorbed one quarter o f the budget. 16. Performance improved significantly following the election o f a new government in mid-2004. The new government demonstrated commitment to restoring macroeconomic stability by containing the spiral o f domestic debt. This strategy was implemented through sharply reduced domestic borrowing in 2004/05 and a general restoration o f fiscal discipline, such that by the end o f 2005/06, the domestic debt i s estimated to have declined to below 20 percent o f GDP. Attaining this objective was helped by donor support, but was also the result o f a fiscal effort that tightened the underlying balance (a barometer o f the domestic fiscal effort) since 2003/04 by 1% percent o f GDP. This objective was accomplished despite a severe food crisis in 2005/06, which necessitated substantial government food security spending. Although donor support was significant, the net cost to the budget o f the food security operations was 1.7 percent o f GDP. Policy implementation in 2005, however, was marred by weak exchange rate management. The government pegged the exchange rate which, because o f Malawi’s l o w reserves, resulted in the accumulation o f private external payment arrears on delivered imports o f goods and services. The exchange rate was allowed to depreciate in early 2006 and the backlog has been cleared end-July 2006. 17. Despite these challenges, Malawi met almost all the quantitative targets over the 18 months from mid-2004 to end-2005. These include all the quantitative performance criteria during the six months under the PRGF arrangement through end-December 2005. The outlook for performance through the end o f 2005/06 i s favorable. Under the program for 2006/07, a strong crop i s expected to sustain a rebound in real GDP growth to 7 percent and will support a deceleration in inflation to single digits. The government remains committed to policy implementation and a strong fiscal effort that will further reduce domestic debt to about 16 percent o f GDP. 18. The staffs of IDA and the IMF conclude that Malawi has met the trigger on the maintenance o f macroeconomic stability and satisfactory implementation o f the PRGF program. Though initially weak during the interim period, macroeconomic stability has improved significantly over the past two years, as evidenced by decelerating inflation and the falling domestic debt burden. 10 Box 3: Performance under IMF Programs, 2001-05 PRGF-supported program, 2001/02-2003/04: The IMF Executive Board approved a new three-year PRGF arrangement in December 2000. The program aimed t o restore macroeconomic stability by strengthening fiscal discipline in order to reduce inflation from over 30 percent in 2000 to 10 percent in 2001 and to single digits thereafter. T o reduce monetary expansion and make r o o m for private sector growth, the program targeted domestic debt repayments. Inflation was successfully reduced, though by not as much as envisaged, and largely at the expense o f credit to the private sector and by depleting official external reserves. The government was not able to meet the ambitious fiscal targets and domestic financing increased to over 7 percent o f GDP in each o f the first two years o f the program. In 2002103, the demands imposed o n the budget by the food crisis raised domestic financing to over 12 percent o f GDP and domestic debt t o about 25 percent o f GDP by the end o f 2003104. Poor program implementation delayed the f i r s t review to late 2003. Large fiscal slippages subsequently pushed the program irrevocably o f f track in early 2004 and the arrangement expired in late 2004. Staff Monitored Program, 2004/05: The newly elected g o v e m e n t implemented its 2004105 budget in the context o f an IMF Staff-Monitored Program. The program aimed to maintain real GDP growth around 4 percent and reduce core (non-food) inflation to about 11 percent. The inflation target was met, but output growth was weaker than expected because o f the drought that reduced agricultural production in 2005. The cornerstone o f the fiscal program was t o curtail domestic borrowing to reduce the stock o f domestic debt by 2 percent o f GDP. This was to be achieved through higher donor support as well as a domestic fiscal effort to improve the underlying balance by 2 percent of GDP. Virtually a l l the quantitative targets, including for domestic financing, were met. Further, as part o f the Bank’s FIMAG credit, the government implemented a major c i v i l service wage reform in October 2004 that realigned pay grades and monetized in-kindbenefits. PRGF-supported program, 2005/06: The IMF Executive Board approved a new three-year PRGF arrangement in August 2005. The 2005106 program objectives for real GDP growth and inflation were met. The cornerstone o f the fiscal program was the repayment o f domestic debt that would reduce the stock to below 20 percent o f GDP. The program also provided for spending o n maize and fertilizer o n account o f the emerging food crisis. The program included structural measures to strengthen public expenditure management and financial sector management. The program also included a ceiling o n the c i v i l service wage bill and a revision o f the civil service pension formula to offset the sharp increase in benefits resulting f r o m the wage reforms in late 2004. Malawi met a l l the end-September 2005 performance criteria for the f i r s t program review, which was approved by the IMF Board inFebruary 2006. However, performance was marred by weak management o f the exchange system and the use o f informal administrative restrictions to control the exchange rate, which resulted in a backlog o f unpaid import invoices. As the food crisis deepened, the revised program incorporated additional food security spending that received significant donor support. In a companion staff report, IMF staff has determined that M a l a w i met a l l the end-December 2005 quantitative performance criteria for the second program review. The government has acted o n its commitment to improve exchange rate management by allowing the Kwacha to depreciate since early 2006 and eliminating the stock o f unpaid import invoices. The prospects for the end-June 2006 targets are favorable. 11 C. Implementation of Structural Triggers Improving economic governance 19. Malawi has taken significant steps that will go a long way to ensuring that public resources are used for their intended purposes, and with greater efficiency. At decision point, Malawi’s legal framework for the management o f public finances and for curbing corruption had a number o f weaknesses. Similarly, the public expenditure management system was beset with problems o f expenditure laxity and lack o f fiscal transparency. During the interim period, the government made significant strides in improving the public expenditure management system and the governance framework in general. Boxes 4 and 5 provide additional details o f specific measures the government has undertakento improve the public expenditure management system and to fight corruption, respectively. 20. I n order to strengthen the legal framework f o r managing public finances, in 2003, the Finance and Audit Act was separated into t w o separate pieces o f legislation: the Public Finance Management Act (PFMA) and the Public Audit Act (PAA). The new Public Finance Management Act represented a change in emphasis from the previous, narrower notion o f dealing with public money to the wider and more comprehensive notion o f the economic, fiscal and financial management o f public finances. Further, the two Acts were designed to update the existing public finance and public audit laws in order to meet Malawi’s present and fbture requirements and at the same time introduce finance management and audit provisions reflecting modern trends and international best practice. 21. The Government of Malawi i s now more transparent in the usage o f public resources by reporting expenditures to the public on a quarterly basis. The government has continued to submit the Quarterly Expenditure Reports (QERs) to the Cabinet Committee o n the Economy and the Budget and Finance Committee o f parliament within six weeks o f the end o f the quarter. Furthermore, i t n o w posts o n i t s internet website the budgeted and actual protected pro-poor expenditures (PPEs) within twelve weeks o f the end o f the quarter. PPE reports have also been published in the press o n a quarterly basis. PPEs have been o f particular interest to the public because they represent expenditure items for which the government has fully committed i t s e l f to make resources available, even when there i s a cash flow problem. 22. Despite various hitches, IFMIS has been rolled out in all ministries. The government o f Malawi dramatically altered i t s previous IFMIS course in M a y 2005, after numerous problems with previous implementation attempts. The authorities chose to adopt the IFMIS framework successfblly implemented in Tanzania, including revision o f the chart o f accounts, centralization o f government banking and o f the government payment system. A review by the World Bank in late 2005 certified the robustness o f the system. Therefore, instead o f piloting the system, the government decided o n a full r o l l out, which commenced in November 2005. The system i s running o n two platforms, an electronic and a manual one. 12 The electronic system i s being used in eight ministries: Finance, Health, Agriculture, Education, Office o f the President and cabinet, the M a l a w i Defense Force, the M a l a w i Police Service, and State House, w h i c h account for over 40 percent o f the budget. In January 2006, the electronic system was extended to four other spending agencies. There i s an action plan to roll-out the electronic system in all the ministries within a two year period. Box 4: ImprovingMalawi’s Public Expenditure Management Malawi has made progress in improving formulation o f the budget. Firstly, as recommended by the HIPC Assessment and Action Plan (W), t he government has taken steps to widen the coverage o f donor support, thus improving the comprehensiveness o f the budget. Secondly, the formulation process i s also more participatory. In the past, pre-budget consultation meetings were seen as cosmetic. But c i v i l society and the private sector have commended the new government for taking into account their representations inthe formulation o f the budget. Further, enough time i s n o w allowed for the budget to be scrutinized before being passed. Amendments are made to t he draft budget to take into account comments by legislators and other stakeholders. T o ensure that the budget documents are easily understood by a l l stakeholders, the government (with assistance f r o m the donors) i s currently working o n M e r simplification o f the documents. Significant progress has also been made in the execution of the budget. Firstly, the government has improved the credibility o f the budget process by broadly remaining within the appropriated budget for the f i r s t time in over ten years. Secondly, several reforms have been undertaken in order to improve the execution o f the budget as follows: (i) a policy for clearing arrears and preventing their recurrence was approved by cabinet in 2005. The policy i s n o w being implemented, and the government has started clearing the backlog o f arrears; (ii) the office o f the Director o f Public Procurement (ODPP) became operational in 2004 in line with the new Public Procurement A c t that was passed in 2003. The provisions o f the new A c t conform to international standards and help ensure transparency and efficiency in public procurement; ( iii) after many failed attempts in the past, the government introduced I F M I S in November 2005. There has also been a centralization of the government payment system, which has led to the closure o f some 1,550 bank accounts that were susceptible to abuse; tightening o f the internal controls in the execution o f the budget, which has led t o improved alignment o f expenditures t o the approved budget and reduction in the build up o f arrears; and timely production o f expenditure reports. The government i s also currently working o n a new Human Resource Management Information System (HFWIS) that will ensure effective management o f the wage bill through improved payroll records. There has also been progress in reducing the time it takes to evaluate the implementation of the budget. Inparticular, good progress has been made in shortening the length o f time between the end o f the fiscal year and the production o f financial statements that are submitted to the auditor general. At the decision point, the lag was some 14 months after the end o f the fiscal year. This has n o w been reduced to 6 months, and M a l a w i i s o n course to meet the benchmark o f four months. Similarly, there has been significant improvement in the preparation and auditing o f the final accounts. With assistance f r o m development partners, the capacity o f the National Audit Office has been strengthened. Until recently there was a 2-3 years time lag between the end o f the fiscal year and the presentation o f the audited accounts and report to the legislature, implying that the official accounting records were not very useful for fiscal management purposes. The time lag has n o w been reduced to 9 months. With the rolling out o f IFMIS, the time i t takes to fully evaluate the implementation o f the budget will be reduced even further. 13 Box 5: Malawi’s Fight Against Corruption Perceived corruption in M a l a w i i s relatively better than most low income countries in Africa. Malawi’s score o n the Transparency International’s Corruption Perceptions Index (TICPI) in 2005 was 2.8 out o f 10. This score i s better than the average for other L o w Income Countries in Africa (2.5), including those countries that have already reached completion point. After a period o f laxity under the previous administration, this score reflects stabilization since 2004, when the new government of President Mutharika adopted a zero tolerance policy on corruption. In h i s inaugural speech in M a y 2004, the President made a personal commitment to fight corruption at a l l levels in h i s government. Specific measures that have been undertaken to fight corruption include the following: In 2004, the government amended the Corrupt Practices A c t o f 1995. Among the many improvements, the new A c t widens the definition o f corruption (which in the original A c t was restricted t o bribery only); criminalizes abuse o f office and possession o f unexplained wealth by public officers; and provides for the protection o f whistle blowers. Since most o f the corruption in the public sector takes place when awarding contracts, a new Public Procurement A c t was passed in 2003. The A c t creates a new Office o f the Director o f Public Procurement (ODPP) and strengthens controls and safeguards o n public procurement. This ODPP was created in 2004 and i s n o w fully operational. In 2005, the government adopted a new public payment system as part o f the IFMIS. This was out o f a realization that that theft o f public funds and corruption was taking place partly because it was difficult to keep track o f the many government accounts that were held in various commercial banks. The introduction o f the new payment system has led to the aforementioned closure o f some 1,550 bank accounts that were susceptible to abuse. A governance and corruption baseline survey has recently been conducted by the A C B . The survey has revealed the areas where corruption i s s t i l l rampant, and the A C B i s in the process o f developing a n action plan to help reduce corruption in those departments. With assistance from Norway since 2002, the capacity o f the National Audit Office has been strengthened. In September 2005, a US$20.9 million Threshold Country Plan was approved by the MillenniumChallenge Corporation to help M a l a w i fight corruption and improve fiscal management. Specifically, under the Plan, the financial assistance will help M a l a w i reduce by 75 percent the time it takes to process corruption cases, professionalize public procurement, build capacity in government auditing functions, and strengthen independent media coverage. Malawi has also signed an agreement with the W o r l d Bank Institute for support in the fight against corruption. These measures have started showing tangible results. Over the past two years, the Anti-Corruption Bureau (ACB) has launched several investigations o f high profile persons in government as well as in the opposition. These have led to arrests and convictions, while some cases are s t i l l in the courts. Some o f the notable corruption cases recently pursued include those o f the former Minister o f Education, Mayor o f City o f Blantyre, and the Secretary to the Treasury. The Minister o f Education and the Mayor o f City o f Blantyre were convicted for theft, while the case o f the Secretary to the Treasury i s s t i l l in court. Corruption charges have also been filed against the former President. His recent arrest o n these charges l e d to the suspension o f the Director o f the A C B (he has subsequently resigned) o n the grounds that h i s actions in the case had been politically motivated and had led to the impression that the charges would be dropped. The government has since issued a public statement to the effect that the charges against the former President have not been dropped and h i s prosecution will resume as soon as a new Director o f the A C B i s appointed in the coming weeks. 14 Raising the quality of education 23. Several steps have been taken to improve the quality of education since the decision point, and the results are beginning to show. The introduction o f free primary education in 1994 saw enrollment rates increase from 1.9 million to 3.2 million. This put a huge strain on the education sector as a whole. As a result, during the 1990s the quality o f education deteriorated at various levels o f Malawi’s education system. However, over the past four years, the authorities have undertaken policies that should soon translate into improved quality indicators (such as improved completion rates and reduced drop-out rates). Notably, as part o f the HIPC completion point requirements, there has been a significant increase in resources allocated to the sector, which have gone into building more schools, teacher training, and teaching and learning materials. As a result, some o f the intermediate indicators have already started improving. For example, the ratio o f pupils per qualified teacher has declined from 123 in 2000 to 83 in 2005. Similarly, the number o f pupils per permanent classroom has declined from 114 in 2000 to 99 in 2005. 24. The sector’s share of discretionary recurrent budget has on average been 29 percent for the period 2001/02 to 2004/05. This level i s well above the required threshold o f 23 percent agreed in the HIPC decision point document. However, based o n the approved budget for 2005/06, the share has dropped to 21 percent. The drop in the share has been due to the fact that government had to budget for drought r e l i e f and recovery programs (maize purchase and an expanded fertilizer subsidy program). 25. The level of resources allocated to teaching and learning materials has increased in real terms, but the subsidy to boarding secondary schools has not substantially decreased. I n2000/01, government policy o n the operations o f conventional boarding secondary schools changed such that responsibility for running boarding services, including the school fees charged to cover boarding expenses, i s now in the hands o f local communities. However, evidence suggests that the level o f the fees being charged per student in these schools i s not high enough to cover boarding expenses, indicating that the central government i s s t i l l partly subsiding boarding expenses. Although more progress i s desirable in reallocating the funding from boarding facilities toward teaching and learning materials, on balance this trigger has been satisfactorily implemented. 26. Donor-supplied primary textbooks for each school are now pre-packed and directly distributed from the supplier to the schools. Since 2002, donor-supplied textbooks are pre-packed and directly supplied to schools. The ministry o f education only provides enrolment figures per school and per district. 27. The government was not able to increase yearly enrolment of 6,000 students for teacher training on a sustained basis. Yearly enrolment was 3,000 in 2000 and climbed to 5,490 in 2005, nearly meeting the target. The latter was achieved since two cohorts were enrolled in one year under the crash course (the Malawi Integrated In-service Teacher 15 Education Program (MIITEP). This program has now been discontinued because it leads to a reduction in the quality o f trained teachers. Annual enrolment in TTCs has therefore reverted to the original 3,000. However, a two pronged approach to increasing the number o f properly trained teachers in primary schools has n o w been adopted. Firstly, since September 2005, the Initial Primary Teacher Education (PTE) also known as the one-plus-one teacher training program was introduced. Under this program, students will be in college for one year and then gain teaching experience for another year. Therefore, student teachers will be spending less time in college than under the previous two-year program, but more time than under the crash course. Although the new system does not increase annual enrolment in TTCs, the number o f teachers deployed in primary schools after every two years will b e twice (6,000) the number under the o l d two-year residential training program. 28. The second approach to increasing the number o f properly trained teachers in primary schools i s that the number o f places in TTCs i s also being increased, mostly with support from donors. G T Z i s financing the expansion o f five TTCs while construction o f a new college funded by IDA i s under way in Liwonde. I t i s expected that once the expansion program o f the existing five colleges i s complete in March 2008, enrolment will increase fi-om the current level o f 3,000 to 3,810. The new 500 capacity college that i s being built in Liwonde will become operational in 2009, after which total enrolment in all the colleges will increase to 4,310. Given these efforts, staffs now believe that the original target o f 6000 was overly ambitious. 29. In-service training for primary teachers was institutionalized in 2001 in the form o f a continuous professional development program following the phasing out o f the Malawi Schools Support Program (MSSP) funded by UK DflD. The Department o f Teacher Education and Development (DTED) identifies teacher training needs with the Malawi Institute o f Education (MIE) as the implementing agency. Most o f the in-service training has been delivered at the 3 15 Teacher Development Centers in the country while some have taken place at MIE. Improving health outcomes 30. At decision point, it was recognized that Malawi had some o f the worst health indicators in Sub-Saharan Africa. The authorities have since demonstrated a strong commitment to undertaking measures that would help improve these outcomes. In 2002, the government started consultations with various partners o n a prioritized program o f work that could be supported through sector-wide approach (S WAp) financing arrangement. The agreement for a SWAP was signed in 2004 and provides the basis for a significant scaling up o f resources allocated to the health sector. However, in parallel, the authorities have already been pursuing reforms to improve health outcomes. In particular, the government has increased the level o f front line staff, drugs, and other basic medical supplies. Reforms are also underway to improve the efficiency o f drug procurement and distribution. 16 3 1. Significant numbers o f nurse technicians, medical assistants, and radiography technicians have been trained and deployed. The government set up a human resources emergency program that has also been supported by development partners. Since the decision point, Malawi has been training and deploying over 300 nurse technicians, over 60 medical assistants and 20 radiography technicians. The thresholds for these health cadres were 200,50 and 20, respectively. Further, the government, with support from UK DflD, has embarked on a program o f topping-up salaries for health workers in order to retain them in the public sector. This i s in response to a recent trend where health sector workers, especially nurses, have left the public sector and joined the private sector or migrated in search o f better opportunities. 32. The average budget for drugs and medical supplies has been above the Better Health for Africa (BHA) standard and phase one reforms o f the Central Medical Stores were sufficiently completed. Over the period 2001/02 and 2005/06, the average budget for drugs and medical supplies has been U S 1.36 per capita, which i s above the BHA threshold o f US$1.25 per capita. In order to improve efficiency in the procurement and distribution o f these drugs, several reforms were undertaken. First, the essential drugs l i s t was reviewed in 200 1 when the government defined the Essential Health Package. Secondly, an information system to monitor compliance with agreed policies and financial allocations was also developed with support from U K ’ s DflD. Lastly, after initial delays, preparations were started to transform the CMS into an autonomous body (a trust). More recently, the government, following advice from the Health SWAP partners, has changed the strategy for reforming the CMS. A management contractor has been engaged to run the CMS for two years. The contractor will review various options for reforming the institution (based o n experiences elsewhere in the region), recommend the best option, and implement the adopted approach. Thus, while the new strategy i s being designed for reforming the CMS, the institution i s already operating with a very high level o f autonomy since i t i s being run by an independent team o f management consultants. 33. The health share o f discretionary recurrent budget has been below the 13 percent threshold that had been committed to at the decision point. On average, it has been 12 percent during the period 2001/02 and 2004/05. This trigger was therefore not met. As mentioned above, the reason i s that over this period, the government was preparing a six-year program o f work outlining health sector priorities that would be financed through a SWAP. The strategy was therefore to increase health sector spending once all SWAP arrangements were in place. Indeed, buoyed by the contributions from the SWAP partners, the 2005/06 approved allocation to health increased markedly to 18 percent o f the discretionary recurrent budget. Preliminary actual expenditures for FY2005/06, available as o f July 2006, show that health sector expenditures were 18 percent o f the discretionary recurrent budget.6 Final actual expenditures will be available end o f September 2006. 17 Fighting HIVIAIDS 34. A t the decision point, Malawi’s HIV prevalence rate for the working age population (15-49 years) was 16 percent, one o f the highest in sub-Saharan Africa. The five triggers were therefore aimed at strengthening the institutional framework for fighting HIV/AIDS, scaling up measures for prevention, and mitigating the impact o f HIV. The government’s efforts in these areas have been well supported by donors through a specialized HIV/AIDS SWAP and the Global Fund. To date, Malawi has made good progress in the fight against HIV/AIDS, and some results have already started showing. The latest HIV/AIDS monitoring report shows that HIV infection rates have stabilized in the past two years. 35. The National AIDS Commission (NAC) Trust Deed was revised to make it operationally more autonomous and the secretariat i s fully staffed. Previously, the N A C used to be a department in the Ministry o f Health. However, in 2005, the Trust Deed was revised providing for the appointment o f a more broad-based board o f trustees (government, private sector, faith community, NGOs, and c i v i l society). Operationally, the secretariat (which serves the N A C ) i s independent o f the government. For example, it has i t s o w n procurement manual. In order to strengthen the legal status o f the N A C , government plans to have the institution established under an A c t o f Parliament. 36. The availability of condoms in retail outlets and of testing kits at all blood transfusion sites has increased significantly. Through i t s monitoring system, the N A C certifies that there i s over 75 percent condom availability in various retail outlets (groceries, shops, and night clubs). These are mainly supplied by the two main reproductive health service providers: Population Services International (PSI) and Banja l a Mtsogolo. There i s also 70 percent availability o f condoms in public hospitals, and some private hospitals, which are supplied to clients free o f charge. Most o f these hospitals also have blood transhsion sites and the number o f testing kits has increased from about 1,500 at decision point to 4,000 in 2005.7 37. A Behavior Change Communication Strategy was developed in 2003 and i s now being implemented. The strategy outlines the desired behaviors that would help fight HIVIAIDS as well as the key interventions necessary to inculcate such behaviors in people. The results o f implementation o f the strategy have already started showing results. For example, according to the 2005 H I V / A I D S monitoring and evaluation report, condom usage amongst men, a key behavioral change, increased from 28.7 percent in 2003 to 30.1 percent in 2004. 7 Each kit allows 100 tests to be done. Therefore, with 4,000 kits, it means, 400,000 tests can be conducted. 18 38. Syndromic management o f sexually transmitted diseases (STDs) i s now routine practice in all central hospitals, district hospitals and major Christian Health Association o f Malawi (CHAM) hospitals. The NAC has also extended this practice even to some health centers. This has helped improve the diagnosis and treatment o f STDs, including H I V / A I D S without requiring sophisticated and time-consuming laboratory tests or advanced medical skills. Diagnosis and treatment i s based on classification by groups o f symptoms and signs to determine the nature o f an infection. A combination o f treatments i s then prescribed that are effective against the most common organisms that cause the symptoms and signs. In 2004-05,276,666 cases were managed in government, C H A M and BLM facilities. The NAC and stakeholders are now monitoring the training o f staff on STD management on a quarterly basis. Improving access to land and credit 39. Access to land and credit remain constrained in Malawi, but there has been progress. In line with the HIPC decision point requirements, the authorities have taken steps to ensure that land in Malawi i s more equitably distributed and that land r i g h t s are secured, so that households can use land as collateral for accessing credit. T o this end, the government has drafted legislation and introduced reforms to ensure that more rural households have access to land and credit. 40. The draft Land Bill has been submitted to parliament. Providing equitable and secure access to land has been the centerpiece o f the government’s land reform policy. A new National Land Policy was prepared in 2000 and approved by cabinet o n January 17, 2002. hJanuary 2003, a special L a w Commission was empanelled to review the existing land legislation and formulate a new legislative framework for land matters that would articulate the principles o f the approved Malawi National Land Policy. Following consultations, a draft Land Bill was prepared and submitted to parliament o n June 13,2006. The Bill adequately captures the main principles o f equitable and secure access to land. I n particular, the Bill now provides for the conferment o f individual title deeds to land previously owned under customary land tenure. This means that once registered, the title o f the owner will have full legal status and the land may be leased or used as security for a loan. Further, consistent with the on-going decentralisation process, the bill confers greater responsibility in the administration of land issues from the central government to districts and traditional authorities. 41. A microfinance policy has been approved by cabinet. At the decision point, a draft microfinance policy had just been prepared. The policy aims to promote best practices amongst micro-finance institutions in order to expand client outreach, improve coordination and increase capacity. I t also proposes a peer-regulatory structure for the industry and the establishment o f a monitoring system that can track lending volumes, number o f clients and areas covered with a view to improving coordination o f micro-finance activities. The 19 authorities committed themselves to having the policy approved by cabinet. This was done in October 2002. 42. Significant progress has been made to increase access by the poor to micro- credit. At the decision point, it was envisaged that the implementation o f a microfinance policy would spur the expansion o f micro-credit services in Malawi. The target was to increase the number o f clients by 20 percent. In 2000, there were 257,276 microfinance clients. By December 2005, the number had increased to 459,906, representing a 79 percent increase. 43. A monitoring system covering all micro-finance institutions has been established. The Reserve Bank o f Malawi established a monitoring system covering all microfinance institutions in 2003 under the SADC microfinance observatory initiative. The system i s run by the department responsible for the supervision o f non-bank financial institutions in collaboration with the Malawi Microfinance Network (MAMN). Data i s collected through the administration o f a comprehensive questionnaire that aims at obtaining information o n the institutional characteristics o f the microfinance organization itself, i t s market characteristics, financial services and non-financial services rendered, and the balance sheet. Creating an effective safety net system 44. There have been improvements in the efficiency and effectiveness o f the safety nets system, but more remains to be done and the reform process i s ongoing. As far back as 1999, the Government o f Malawi started working towards the creation o f an effective safety net system that would be affordable and effective. This was out o f a realization that resources were limited and hence, Malawi could not afford a safety net system that was not properly coordinated and targeted. I n collaboration with the World Bank, it produced a National Safety N e t Strategy which outlined the government’s medium t e r m objectives in terms o f type and size o f safety net programs. Although challenges s t i l l remain, several actions have been taken towards the creation o f an effective safety net system. 45. The universal starter-pack was transformed into a Targeted Input Program (TIP) in the year 2000/01. This reduced the number o f farmers targeted from 2.86 m i l l i o n to 1.5 million. The program was scaled down hrther in 2001/02 to only 1 million farmers but was subsequently scaled up again, and by 2004/05, the final year o f TIP, the number o f beneficiaries had climbed to 2 million. From the 2005/06 season, the TIP was transformed into a fertilizer price subsidy program designed to target 1.7 m i l l i o n poor smallholder maize and tobacco farmers, and taking up a slightly larger amount o f government expenditures. As in the case o f TIP, the beneficiaries are identified through village development committees. Unfortunately, the new program i s somewhat regressive compared to the TIP because the farmers need to complement the voucher scheme with their o w n cash in order to purchase the fertilizer, which potentially discriminates against the poorest farmers. The government tried to address this problem by scaling up the Public Works Program (PWP) which enabled some 20 o f the poorest farmers to purchase fertilizer. Overall, although further reforms may be necessary to improve the operation o f the new voucher scheme, the trigger has been satisfactorily implemented. 46. Some progress has been made to rationalize and prioritize existing and new programs under the National Safety Net Strategy (NSNS). In 2002, the government established a National Safety Nets Unit (NSU) to coordinate the rationalization and prioritization o f safety nets through four technical sub-committees, one for each o f the four types o f safety nets-Public Works Program, Targeted Inputs Program, Targeted Nutrition Program and Direct Welfare Transfers. The sub-committees have been meeting to discuss the scaling up and down o f various safety nets programs. For example, as recommended in the NSNS, the PWP has been scaled up in recent years. Further, a study to look at an appropriate wage rate for all PWPs was carried out although i t s recommendations are yet to be implemented. However, while the government has made some attempts to rationalize and prioritize the various donor-managed safety nets interventions, actual progress has been limited. There s t i l l exist many competing programs that need to be rationalized with respect to coverage and modalities. This i s partly due to the poorly coordinated positions o f donors, which are expressed in a broad array of relatively uncoordinated safety net instruments. The government i s aware o f the difficulties and the N S U i s now coordinating the development o f a Social Protection Policy which will provide a more definitive framework for the implementation o f various safety net programs. 47. A monitoring and evaluation (M&E) system of the National Safety Net Strategy has been established. An M&E system has been set up in the N S U for monitoring and evaluating a large number o f indicators (process, inputs, outputs, and outcomes) for the four priority programs, with provision to capture information on any other program being implemented in the country. A catalogue o f safety net programs has also been defined, and several report formats have been designed to extract information from the data-base. The N S U has also been involved in in-depth monitoring o f individual safety net programs through field visits. D. Use of HIPC Initiative Interim Assistance 48. As part o f the HIPC decision document, it was agreed that HIPC debt relief resources would allow the government, in the context o f the normal budget prioritizationprocess, to increase funding to poverty reducing areas, supplementing domestic revenues. According to information provided by the government, savings from interim HIPC assistance have been used broadly in line with the criteria set forth at the decision point. In order to ensure that these resources would be used well, a small sub-set o f 21 high-priority activities were identified from the interim PRSP (since the full MPRSP had not yet been completed) that would benefit from additional fbnding as a result o f HIPC debt relief. This l i s t was later expanded after the finalization o f a full PRSP. To ensure that the resources freed up through HIPC assistance would be used in line with the criteria set forth under the HIPC initiative, the government decided to the ring-fence funding for these expenditures. This meant that in the event o f shortfalls in revenues, funding for these priority activities would be protected to ensure unintempted service delivery. As a result, these expenditures have since been known as Protected Pro-poor Expenditures (PPEs). The level o f expenditures on PPEs during fiscal years 2001/02 to 2004/05 i s summarized in Table 2. To ensure transparency and accountability in the usage o f HIPC resources, the fimding allocations to PPEs and out-turns have been published on the Ministry o f Finance website and in the press on a quarterly basis. 49. Beyond HIPC completion point, the government remains committed to protect funding for PPEs. Although the government i s about to finalize i t s new policy strategy, the MGDS, it has indicated commitment to continue the ring-fencing o f funding for PPEs. Since some o f the activities may no longer be o f highest priority, it plans to revise the l i s t o f ' activities categorized as PPEs. The revisions will be done in consultation with various stakeholders, especially civil society and parliament. 111. DEBT RELIEF AND DEBT SUSTAINABILITY UPDATE A. Updated Data Reconciliation for the Decision Point 50. The staffs of IDA and the IMF, together with the Malawian authorities, have reviewed the stock o f debt at end-1999 against creditor statements. As a result o f this review, estimates o f the nominal stock and the NPV o f debt after traditional debt r e l i e f as o f end 1999 were reduced slightly from US$2,604 million and US$ 1,469 million to US$2,600 million and US$1,466 million, respectively (Table 6). 5 1, Multilateral creditors. The NPV o f debt o f multilateral creditors as o f end 1999 was reduced by US$3.7 million to US$1,094 million. This i s largely because European Union loans administered by IDA are now treated as loans from Paris Club creditors. Estimates o f the NPV o f debt to IDA, IBRD, African Development Fund (AfDf) and African These programs were in health (drugs, primary health care), education (teaching materials and teacher training), water (borehole construction and maintenance), gender, youth and community services and rural roads. 22 Development Bank (AfDB) were also reduced slightly, while the NPV o f debt to the P T A Bank was raised by US$2 rnilli~n.~ 52. Bilateral and commercial creditors. The estimate o f the NPV o f debt owed to Paris Club creditors was increased from US$294 million to US$320 million. This was because o f the reclassification o f EU loans administered by IDA and because debt owed to the United Kingdom that had been classified as commercial debt at the time o f the decision point i s now treated as bilateral debt. Consequently, estimates o f the NPV o f debt owed to commercial creditors declined from US$43 million to US$17 million. 53. Estimates of exports of goods and services used to evaluate HIPC assistance at the decision point have also been revised from an average US$55 1 million per year over 1997-99 to US$547 million.” B. Status of Creditor Participation and Revision of HIPC Assistance 54. As a result of these changes, the common reduction factor has climbed from 43.7 to 44.1 percent and total HIPC assistance in NPV terms has been revised upwards from U S 6 4 3 million to U S 6 4 6 million (Table 7).” Malawi has received financing assurances o f participation in the HIPC Initiative from creditors representing 97 percent o f the NPV o f HIPC assistance estimated at the decision point. All but one multilateral creditor, all Paris Club and all but one commercial creditor have confirmed their participation in the HIPC Initiative (Table 16). Multilateral creditors 55. The revised HIPC assistance from multilateral creditors totals US$482 million in NPV terms o r 75 percent of total HIPC assistance (Table 7). Except for the PTA Bank, all multilateral creditors have committed themselves to provide assistance once Malawi reaches the completion point. Debt owed to the P T A Bank, could not be reconciled with creditor statements. The debt data was revised based o n written correspondence between the Malawian authorities and the P T A Bank from December 1999 and early 2000 in the context o f the PTAs l a w suit against the Government o f Malawi. As a result o f t h i s l a w suit, M a l a w i agreed in March 2000 to pay a l l obligations to the P T A Bank o n specified due dates. PTA B a n k has not provided any H I P C assistance to Malawi. lo The revision was f i r s t reported in the staff report t o the Board at end-2003, during the f i r s t review o f the PRGF arrangement approved at end-2000. l1 M a l a w i qualifies for an upward revision o f H I P C assistance since it reached i t s decision point prior to the approval o f the new information reporting decision by the Boards. (See “Information Reporting in the Context o f H I P C Initiative Assistance,” IMF, March 4,2002, (EBS/02/06) and IDA, April 4,2002, (IDAISECM2002- 0131). 23 The World Bank: Revised HIPC debt relief from the World Bank will amount to US$333 million in NPV terms as o f end-1999 (Table 16). IDA delivered US$lOO million in NPV terms (US$118 million in nominal terms) as interim relief between January 2001 and August 2006, corresponding to a reduction o f 55.3 percent o f debt service falling due over this period. On reaching the completion point, the revised H I P C debt relief would equal an average o f 55.9 percent o f debt service due, provided till end 2020 (Table 14). The IMF: Revised HIPC assistance from the IMF would amount to SDR23.3 million (US$30.3 million) in NPV terms at the decision point.12 It represents an average reduction o f 33 percent in debt service over 2001-9, excluding 2002. Provision o f interim assistance by the IMF was disrupted in 2002 by delays in concluding the first review under the PRGF arrangement and, though resumed in 2003, was again disrupted when the program went off-track in 2004. During the interim period, IMF disbursed SDR 11.6 million (US$16.5 million) in assistance. A t the completion point, the IMF will disburse the remaining HIPC assistance o f SDR 11.7 million, together with accrued interest, currently estimated at SDR3.7 million, subject to satisfactory assurances from Malawi's other creditors. The African Development Bank Group: Revised HIPC debt relief from the AfDB would amount to US$71 million in NPV terms. The AfDB provided US$26 million o f interim relief in end-1999 NPV terms. At the completion point, the AfDB i s expected to provide the remaining assistance through an 80 percent reduction o f debt service on debt outstanding at end-1999, applied till July 20 16. Other multilateral creditors: The modalities o f assistance for all other multilateral creditors are summarized in Table 16. Bilateral and commercial creditors Paris Club creditors have agreed in principle to provide their share o f assistance under the enhanced HIPC Initiative (US$141 million in NPV terms) (Table 16). Interim assistance has been provided through a flow treatment under Cologne terms, as agreed on January 25,2001 .13 Bilateral agreements followed the extension o f the consolidation period to September 1, 2006 with most Paris Club creditors. All Paris Club creditors have indicated that they would provide additional assistance beyond HIPC relief, estimated at US$84 million in end-2005 NPV terms, o f which US$3.7 million in NPV terms have already been provided during the interim period. "IMF's HIPC assistance to M a l a w i approved at the decision point amounted to US$30.1 million. l3In the corresponding agreed minute, participating Paris Club creditors declared their readiness in principle to provide their full share o f assistance through a stock o f debt operation at the completion point, provided Malawi maintained satisfactory relations with the participating creditor countries. 24 Non-Paris Club creditors are expected to provide treatment comparable to that o f the Paris Club, with assistance under the enhanced HIPC Initiative amounting to US$15 million in NPV terms. South Africa agreed to provide HIPC debt r e l i e f beyond terms comparable to the Paris Club treatment, cancelling 100% o f all maturities as they fall due.14 The Kuwaiti Fund indicated in 2004 to deliver HIPC debt relief once Malawi would reach the completion point. Although the Malawian authorities formally requested debt r e l i e f in the context o f the HIPC Initiative in 2001 and 2006, Taiwan, Province o f China, has not yet manifested i t s intention o f delivering HIPC debt relief to Malawi. Most commercial creditors located in Paris Club countries have already provided the full amount o f HIPC debt relief on terms comparable to that o f the Paris Club.” Only two commercial creditors located in the Netherlands and South Africa have not yet provided the full amount o f HIPC debt r e l i e f as agreed at the decision point.16 C. Debt Sustainability After HIPC Assistance 56. The current estimate of Malawi’s debt stock updates the previous version prepared for the decision point document in December 2000. The new estimate i s based on loan-by-loan data as well as exchange and interest rates at end-2005 (Table 5).17 Based on 99 percent data reconciliation, Malawi’s nominal stock o f external debt reached US$2.97 billion at end-2005 (Table 8).18 Multilateral creditors were owed 88 percent o f the total nominal debt stock. The IDA and the AfDB Group remain Malawi’s largest creditors, respectively, accounting for 65 percent and 14 percent o f total outstanding debt. 57. The NPV of Malawi’s external debt at end-2005, after full delivery of the assistance committed under the HIPC Initiative at the decision point, i s estimated at US$1.3 billion, equivalent to 245 percent of exports. Voluntary debt r e l i e f beyond HIPC assistance provided by bilateral creditors would reduce the NPV o f debt to US$1.2 billion, corresponding to an NPV o f debt to exports ratio o f 229 percent. At the decision point, this NPV o f debt was projected to reach 169 percent o f exports at end 2005. I t therefore exceeds decision point projections by 60 percentage points and the HIPC threshold o f 150 percent by nearly 80 percentage points. 14 South Africa has also provided H I P C relief beyond terms comparable to the Paris Club. 15 This refers to the following commercial creditors: Banco Bilbao, S T D Bank, Skandinaviska Enskilda Banken, Chase Manhattan Bank and West Minister Bank. They provided H I P C debt relief through a 100% cancellation o f the debt service falling due during the interim period. 16 The Netherlands’ Development Finance Company (FMO) has not yet agreed t o the authorities’ requests o f HIPC relief. The South Africa Investment Development Corporation stopped the delivery o f interimassistance in2003. 17 Loan data refers to public and publicly guaranteed external debt outstanding and disbursed. ’* This corresponds to 100 percent reconciliation o f multilateral debt data and a 99 percent reconciliation o f bilateral and commercial debt data at end-2005. 25 58. Even with full delivery of HIPC assistance, and assuming reasonable export and GDP growth projections, the ratio o f Malawi’s NPV o f debt-to-exports will remain above the HIPC threshold for more than a decade. At the decision point, it was already anticipated that this NPV o f debt ratio would remain above the HIPC threshold till 2010, peaking at 180.7 percent in 2002.’’ However, under the current baseline scenarioY2’which assumes sound policy implementation, this NPV o f debt ratio would remain above the HIPC threshold for significantly longer, through to 2020, and debt service would remain above 8 percent o f exports till 2013.21 59. At the decision point, it was also already recognized that Malawi’s debt sustainability was vulnerable to exogenous shocks. The decision point document identifiedweak export growth and financing on inadequately concessional terms as the primary risks to sustainability. The sensitivity analysis showed that i f export prices were to remain at their 2000 level and if export volume growth would be 1 percent instead o f 4.6 percent as assumed under the baseline, Malawi’s NPV o f debt to exports ratio in 2005 would reach 187 percent instead o f 169 percent as projected under the baseline. Securing only 60 percent o f new loans on IDA terms (as opposed to more than 90 percent assumed under the baseline scenario), would have raised i t s NPV o f debt to exports ratio in 2005 by 23 percentage points. The alternative scenario r i s k assessments in the decision point document clearly indicated that, under either o f these circumstances, the NPV debt ratio would remain above the HIPC threshold through to the end o f the projection period. Reaching the completion point, the vulnerability o f Malawi’s external debt sustainability has been exacerbated by the deterioration in i t s debt indicators relative to decision point projections.22 D. Considerations F o r Topping-Up of HIPC Assistance 60. The enhanced HIPC Initiative framework allows for additional debt relief (“topping-up”) at the completion point if the HIPC has experienced deterioration in i t s debt burden indicators, which i s primarily attributable to a fundamental change in i t s 19 At the decision point, export receipts were projected to increase by an average o f 4.8 percent over 2006-20. The baseline scenario now assumes average growth o f 6 percent consistent with the stated government strategy to diversify and promote exports. 2o The baseline scenario, described inB o x 5, assumes MDRI. Projected debt burden indicators after H I P C assistance are based o n new borrowing, export growth and GDP growth assumptions that are consistent with the baseline. 21 Exports, revenues and GDP are assumed to be the same as in the baseline scenario discussed below, which assumes the full delivery o f H I P C assistance as w e l l as debt relief under MDRI. 22 See, also Appendix I “Malawi: Joint W o r l d BanldIMF Debt Sustainability Analysis based o n Low-Income Country Framework” 26 economic circumstances due to exogenous factors.23 Additional debt relief may then be provided by all creditors equiproportionately to bring the NPV o f debt-to-exports ratio down to 150 percent at the completion point. So far, four countries have received topping-up assistance: Burkina Faso, Ethiopia, Niger and Rwanda. Malawi’s NPV o f debt to exports ratio after full delivery o f HIPC assistance at end-2005 amounts to 245 percent, declining to 229 percent after voluntary bilateral debt r e l i e f beyond HIPC. This compares to 169 percent projected at the decision point. This section identifies the factors behind the increase in Malawi‘s NPV debt ratio at the completion point relative to projections made at the decision point. It discusses first the factors that lead to an increase in Malawi’s NPV o f debt to exports ratio and then addresses other factors that may have contributed to a fundamental change in Malawi’s economic circumstances. 61. Lower-than-projected export receipts explain a third of the higher NPV o f debt- to-exports ratio. A key strategic objective at the time o f the decision point was to enhance performance in the export sector and its share o f the economy. The strategy met with some success: non-traditional export receipts more than doubled over this period and merchandise export volume growth averaged 8.8 percent over 2001-05, versus an average o f 5.4 percent envisaged at the decision point. However, these gains were offset by weak merchandise export prices, whose growth averaged about % percent per year over this period versus more than 2 percent per year anticipated at the decision point. The main export commodity, tobacco, which constitutes about h a l f o f Malawi’s merchandise exports, was particularly hard hit: its price was expected to rise 20.4 percent between 2000 and 2005, but instead f e l l 13.6 percent. As a result, gains in overall receipts since the decision point have been weak and the export sector’s share o f economic activity i s l i t t l e changed since the decision point, even though Malawi increased i t s market share in the tobacco world market from 1.47 percent in 2000 to 2.41 percent in 2004. Furthermore, tobacco prices are projected to fall in real terms in the medium term as a consequence o f increasing health concerns related to tobacco con~umption.~~ 23 See I M F PRGF-HIPC Trust Instrument, Section 1 11, paragraph3(e); Box 1 in “Enhanced HIPC Initiative-- Completion Point Considerations,” IMF, EBS/01/141 (8/20/2001) and IDA, IDA/SecM2001-0539/1 (8/2 112001). 24 See, The World Bank, “Prospects for the Global Economy,” Washington DC, 2006. 27 Table 1. Malawi: Evolution of NPV o f Debt to Exports Ratio From H I P C Decision Point to end-2005 NPV of debt-to-exports ratio at decision point 150.0 Anticipated increase in ratio 19.0 1. Due to anticipated new borrowing 27.7 2. Due to anticipated change in exports o f goods and services -8.68 Change in exports ofgoods -7.87 Change in tobacco exports -13.38 Change in tobacco prices -5.19 Change in tobacco volume -8.19 Change in non-tobacco exports 5.51 Change in exports of service -0.81 3. Other 0.0 KPV of debt-to-exports ratio (as projected at end-2005) 1/ 2/ 169.0 Unanticipated increase in ratio 3/ 60.2 1. Due to changes in the parameters 40.5 Exchange rates 8. I Discount rates 32.4 2. Due to unanticipatednew borrowing 3.8 Higher than expected disbursements -9.7 Lower concessionality of new disbursements 13.6 3. Due to unanticipatedchange in exports o f goods and services 19.7 Change in exports of goods 18.3 Change in tobacco exports 31.1 Change in tobacco prices 21.2 Change in tobacco volume 9.9 Change in non-tobacco exports -12.9 Change in exports o f services 1.4 4. Other unticipated factors 41 -3.9 ' Actual NPV of debt-to-exports ratio 2/ 5/ 229.1 Source WB Staff esdmats li N P V of debt-to-exportsratio vnds assumption of full delivery O f HlPC assistancein percat. See "Malawi Enhanced HIPC Debt Initiative Decision Point Document" IDAIR2000.234 Z i Exports are bhree-year backward looking movingaverage o f exports of goads and sewices 31 Changer arc expressed in percentage paints. 4iOL5 f a cron caprure revision ofdebt data base and debt reliefasrumptians. as well as bilateral debt reliefbeyand HIPC assistance Si N P V ofdebt-to-exports-ratio afln 1 1 1 delivery ofHIPC assistance and bilateral debt relief beyond HIPC assistance 62. Changes in discount rates explain about half o f the increase in Malawi's NPV o f debt-to-exports ratio.25 W h i l e market rates have declined since the decision point, the nominal debt service burden facing Malawi has remained broadly unchanged as interest rates on external debt are mostly fixed. But a decline in the interest rates o n industrialized benchmark bonds (the discount rates used in HIPC documents) would reflect market expectations o f a lower rate o f inflation or a lower real interest rate. This i s normally associated with a lower level o f economic activity in industrialized countries, which could lead to a reduction o f Malawi's future export earnings, implying a heavier debt burden.26A 25 Under the H I P C Initiative, the NPV o f debt i s calculated at the reference year and for the subsequent 20-year projection period as the discounted value o f fkture debt service payments using the exchange rates and the discount rates prevailing at the reference year. The discount rates used in the calculation o f the NPV o f debt are the 6-months backward average o f long-term Commercial Interest Reference Rates (CIRRs) o f the OECD. 26 The discount rates used in the calculation o f the NPV o f debt are the 6-months backward averages o f the long-term Commercial Interest Reference Rates (CIRRs) o f the OECD. 28 recent analysis done at the IMF o n the informational content o f the CIRR discount rate27 supports the contention that a decrease in these discount rates significantly worsens the export outlook for HIPC countries. 63. The unanticipated depreciation o f the U S dollar against the Euro and SDR was also a factor, albeit minor, in the higher NPV debt ratio. More t h a n three quarters o f Malawi’s debt stock i s denominated in Euros and SDR while Malawi’s main export commodity, tobacco, is denominated in U S dollars. Consequently, the depreciation o f the U S dollar, accompanied by weaker U S dollar tobacco export prices, was responsible for a fundamental deterioration in the balance o f payments that was partly reflected in a worsening external reserve position. 64. Unanticipated new borrowing did not lead to a substantial increase in Malawi’s NPV o f debt to exports ratio. Lower than projected concessionality o f new loans led to an increase in the NPV o f debt to exports ratio by 13.6 percentage points. A t the decision point i t was assumed that the grant element o f new loans would amount to 71 percent, exceeding the grant element o f an IDA loan. The actual grant element over 2000-05 averaged 57 percent. The relatively l o w concessionality o f new loans was, however, largely offset by a smaller volume o f new borrowing than projected, lowering the NPV debt ratio by 9.7 percentage points. 28 65. An additional factor that has significantly affected Malawi’s economic circumstances i s the increase in import prices, especially for oil products, relative to decision point projections. At the decision point, import prices were expected to increase by 0.7 percent each year over 2000-05, but instead increased by 6.7 percent per year, o n average, largely due to the sharp increase in international petroleum prices. Moreover, current projections indicate that import price levels are expected to remain high relative to projections made at the decision point. Together w i t h weak export prices, high import prices contributed to the large deterioration in Malawi’s terms o f trade o f about 20 percent over 2000-05 and this deterioration i s expected to continue through the projection period, though at a more modest pace. W h i l e the raise in international o i l price has not directly contributed to the higher than anticipated debt-to-exports ratio (and therefore does not appear in Table l), they have weakened Malawi’s capacity to service i t s debt burden, while adding to the country’s external financing need and exerting pressure on i t s limited external reserves. 66. The staffs are of the view that the substantial unanticipated deterioration in Malawi’s NPV o f debt-to-exports ratio between the decision and completion points was primarily attributable to exogenous factors. Lower exports prices o f Malawi’s main export commodity, changes in discount and exchange rates, and overly optimistic new 27 See IMF H I P C Topping-UpThe Informational Content o f the CIRR Discount Rate, March 18,2004, FO/DIS/04/25. ’*Using the discount rate as o f the decision point, the grant element o f an IDA loans i s 65 percent. 29 borrowing assumptions at the time o f Malawi’s decision point were all unambiguously exogenous, outside o f the control o f the Malawian authorities, and fully explain the unanticipated increase in Malawi’s NPV o f debt-to-exports ratio. In addition, the unanticipated increase o f import prices also contributed to a worsening o f Malawi’s debt sustainability outlook. 67. I n line with the policy on topping-up approved by the Boards of IDA and the IMF, the staffs consider that Malawi’s case meets the requirements for topping-up at the completion point. Consistent with this policy, staffs therefore recommend that additional assistance o f US$4 11 million under the enhanced HIPC Initiative be granted to bring Malawi’s NPV debt ratio from 229 percent at end-2005 after the bilateral debt r e l i e f beyond HIPC assistance to the 150 percent HIPC threshold.29 E. Debt Relief Under Multilateral Debt Relief Initiative 68. I f Executive Directors approve the completion point for Malawi under the enhanced HIPC Initiative, Malawi will also qualify for additional debt relief under the MultilateralDebt Relief Initiative (MDRI). Three creditors would provide debt r e l i e f under the MDRI: IDA, the AfDF and the IMF. As debt relief under the MDRI would cover all remaining debt service obligations on eligible credit balances after any debt service r e l i e f available under the HIPC Initiative, the amount o f r e l i e f under MDRI depends on the Executive Directors’ approval o f topping-~p.~’ MDRI debt relief (net o f HIPC assistance) would lead to debt service savings on debt owed to IDA, the IMF and the African Development Bank o f US$1.9 billion without topping-up and o f US$1.4 billion, if topping- up were to be approved. Without topping-up IDA would provide debt r e l i e f under the MDRI through a debt stock cancellation o f debt disbursed before end-2003 and s t i l l outstanding on September 30, 2006.31 This would reduce Malawi’s debt stock owed to IDA by US$1.8 billion, o f which a reduction o f US$1.4 billion would be due to the implementation o f MDRI and the remainder to HIPC assistance (Table 14). Debt cancellation under the MDRI from IDA would result in average annual debt service savings (net o f HIPC assistance) for Malawi o f US$27 million between 2006 and 2010 and US$41 million over the next 38 years. Total debt service savings would amount to US$ 1.5 billion (or SDR 1.1 billion). *’ The share o f IDA’s and IMF’s assistance in total topping-up assistance i s 74 percent. 30 For IDA, eligible debt covers debt disbursed and outstanding as o f December 3 1,2003. For the IMF and AfDF, credits on debt outstanding and disbursed as o f December 3 1,2004 may be eligible for debt relief under the MDFX 31 See, International Development Association, “The Multilateral Debt Relief Initiative: ImplementationModalities for IDA,” November, 18,2005. 30 The IMF’s debt relief under the MDRI would cover the full stock o f debt owed to the IMF at end-2004 that remains outstanding at the completion point.32 This would lead to a debt stock reduction o f SDR37.9 million, o f which SDR22.4 million would be financed from the M D R I - I Trust and the remainder from the HIPC umbrella account (Table 15a). MDRI relief would yield debt service savings (net o f HIPC assistance) averaging SDR 3 million (or US$4 million) over the next 8 years, corresponding to total debt service savings o f SDR 22 million (or US$32 million). The Reserve Bank o f Malawi will transfer the flow o f savings on debt service owed to the IMF to the budget on an annual basis. Figure 1. Malawi: Implied Savings under the MDRI 1/ (Inmillions ofU.S. dollars) I 90.0 I 80.0 - 70.0 - :: - IDA 60.0 cd A D F 50.0 - 40.0 - 10.0 ~ b 1I 1 Sources: IDA and IMF Staff estimates. 1/ MDRI debt service savings without topping-up o f HTPC assistance. . 0 The AfDF would provide debt r e l i e f under the MDRI through a debt stock cancellation o f debt disbursed before end-2004 and s t i l l at the completion point,33 amounting to US$382.9 million, o f which US$54.4 million would correspond to HIPC assistance. MDRIrelief from the AfDB will yield annual debt service savings (net o f HIPC assistance) averaging US$27 million over the next 5 years and US$8 million over the next 45 years. Total debt service savings under MDRI would amount to US$347 million in nominal terms to be delivered in full at the time o f the completion point. 32 As defined in the MDRI-ITrust Instrument. 33See African Development Fund, “The Multilateral Debt Relief Initiative: ADF Implementation Modalities Paper,” November 28,2005, ADF/BD/IF/2005. 31 With topping-up IDA would cancel US$ 1.8 billion o f the debt stock owed by Malawi on October 1, 2006 (Table 14), o f which a reduction o f U S $ l . 1 billion would be due to the implementation o f MDRI. With topping-up, average annual debt service savings (net o f HIPC assistance) would decrease to US$8 million over the next 5 years and US$3 1 million over the next 38 years, corresponding to total debt service savings o f US$1.2 billion.34 0 The IMF would provide debt relief under the MDRI amounting to SDR37.9 million, o f which SDR14.5 million would be financed from the MDRI-ITrust, SDR15.4 million from completion point assistance disbursed to Malawi’s HIPC umbrella sub-account, and SDR8 million from topping-up assistance.(Table 15b). MDRI relief would imply debt service savings (net o f HIPC assistance) averaging SDRl.6 million (or US$2.4 million) over the next 8 years, amounting to total debt service savings o f SDR13 million (or US$ 19 million).35 0 The AfDF would cancel a debt stock o f US$383 million under the MDN, o f which US$95 million would correspond to HIPC assistance. This would imply annual debt service savings (net o f HIPC assistance) averaging US$2 million over the next 5 years and US$4 million over the projection period, totaling US$253 million over the entire projection period.36 E. Debt Sustainability Outlook After MDRI, 2006-25 69. The macroeconomic framework underpinning the debt sustainability outlook has been revised to take into account recent developments (Tables 3 and 4). Over the medium term, the macroeconomic framework i s in line with the government’s economic program supported by the PRGF arrangement with the IMF. Long-term assumptions are based on information provided by the authorities regarding sectoral strategies, including in the MGDS-the new poverty-reduction strategy-as well as latest WE0 prices and recent trends in macroeconomic variables. The main elements o f the long t e r m macroeconomic framework underpinning the debt sustainability analysis are outlined in B o x 6. 34 IDA allocations to countries receiving MDFU debt r e l i e f will be reduced by the amount o f MDRI relief to be provided in that year. (See, IDA “The Multilateral Debt Relief Initiative: Implementation Modalities for IDA,” November 18,2005). Since topping-up would reduce the amount o f MDRI debt relief in each year, the IDA allocation to Malawi would be higher if topping-up were to be approved. 35 If topping-up assistance i s approved by the Boards o f IDA and IMF, some o f Malawi’s p r e - M D R I cutoff date credit outstanding to the IMF w i l l remain outstanding pending the receipt o f financing assurances for disbursing topping-up assistance and the subsequent disbursement o f topping-up assistance. 36 Similar to IDA, MDRI debt relief provided by the AfDF i s netted out from AfDFs allocation. (See, AfDF, “The Multilateral Debt Relief Initiative: ADF Implementation Modalities Paper”, November 2005). Since topping-up o f HIPC assistance leads to a reduction in MDRI debt r e l i e f provided by AfDF, AfDFs allocation to Malawi would be higher if topping-up were to be approved. 32 Box 6: Macroeconomic Assumptions underlying the Debt Sustainability Analysis over 2006-25 Growth. Annual output growth i s projected t o amount to approximately 6 percent over the near term, and to drop to 4.5 percent in line with the regional long t e r m average and consistent with annual per capita growth o f 2.5 percent. This compares to a historical ten-year average o f real GDP growth o f 2.8 percent. Inflation and exchange rates: Inflation i s expected to fall and remain in single digits within the near t e r m The real exchange rate i s assumed to remain steady through the longer term. Net official assistance to M a l a w i i s assumed to increase gradually and modestly by about 2 percent o f GDP to about 23 percent o f GDP by 2015, mainly as a result o f debt relief. The share o f grants in gross aid inflows i s expected to increase f r o m 78 percent in the f i r s t h a l f o f the decade to about 84 percent. The higher aid flows are assumed t o have a high import content which will mitigate the threat o f an aid-driven appreciation o f the real exchange rate. External official debt: The outlook assumes the full delivery o f H I P C assistance and debt relief under the MDRI. New debt i s assumed to be issued on concessional terms consistent w i t h the experience since the decision point. N e w borrowing i s assumed to decline from 5.8 percent o f GDP in the first h a l f o f this decade to 3.8 percent o f GDP over the projection period. FDI and exports: Increasing and diversifyingMalawi’s export base i s a high priority in the MGDS. Possible areas o f export growth include tobacco and tea, other agricultural products, tourism, hydro electricity and mineral resources. If implemented, the export share o f the economy will be increased, supported by stronger FDI inflows and growth in private sector investment. Fiscal policy i s expected to target continued reduction o f domestic debt to around 2 percent o f GDP. The government i s assumed to maintain a stable domestic revenue effort relative to GDP. A lower domestic interest bill and higher net aid inflows are assumed to support an increase in the development budget by 4 percent o f GDP. In addition, poverty reducing current spending will be increased, including a rise in the wage bill to 8.5 percent o f GDP to cover increased employment in social sectors. The ability o f govemment to absorb additional aid will be a key constraint o n the scaling up o f aid. Current account: The current account balance i s expected to deteriorate modestly. Higher exports will be offset by higher aid-driven imports and the tilt in the composition o f gross aid toward loans. Gross official reserves are assumed to increase steadily to 5 months o f imports over the longer term. Improving reserve coverage i s a key priority because o f Malawi’s vulnerability to food crises and external shocks. 33 70. The MGDS aims to enhance growth by maintaining macroeconomic stability and implementing structural reforms to create an enabling environment for private sector investment (Box 2). In addition, there i s scope for output to recover from a prolonged period o f poor performance. A key assumption is that measures are implemented to insulate the economy from the debilitating impact o f periodic droughts.37Consequently, i t i s projected that Malawi will be able to attain real GDP growth o f around 6 percent per year o n average between 2006 and 201 1. Over the longer term, the outlook assumes a more cautious annual growth rate o f 4.5 percent, consistent with the regional average and annual ' i s also assumed that an increase in output growth by per capita growth o f 2.5 p e r ~ e n t . ~It one percentage point would accelerate the annual rate o f decline in the poverty headcount ratio by about 0.2 percentage points. 71. The outlook assumes only a modest increase in aid flows and does not incorporate a substantial scaling up o f aid. Borrowing projections are based on current information available regarding fbture commitments. These commitments are likely to be at odds with the level o f aid flows needed to meet the Millennium Development Goals. New borrowing i s assumed to be kept at modest levels and i s expected to decline as a share o f GDP as the composition o f aid shifts to grants. Moreover, new borrowing i s assumed to be o n concessional terms consistent with the average since the decision point (see Section IV.D above). The budget i s expected to benefit from the increased routing o f a portion o f aid, currently passed outside the budget, through the central government as its capacity to utilize aid effectively increases. 72. The outlook assumes full delivery o f HIPC assistance as well as debt relief under the MDRI. T w o variations o f the baseline outlook are considered: one with, and one without topping-up o f HIPC assistance. T o facilitate comparison, it i s assumed that any additional debt service savings arising in the second variation are accumulated as external reserves. Excluding topping-up o f HIPC Assistance 73. After HIPC and MDRI debt relief, Malawi's external debt i s expected to remain below the HIPC threshold throughout the projection period under the baseline. HIPC assistance, debt relief provided by bilateral creditors beyond HIPC assistance and the implementation o f the MDRI i s projected to reduce Malawi's NPV o f debt outstanding as o f 37 The govemment has made food security a top priority and i s implementing measures to improve performance int h i s sector. Measures include expanding the fertilizer subsidy scheme, investments to improve irrigation, measures to strengthen agricultural markets to aid crop diversification, and improving access to financial markets including weather-based insurance. 38 Long-term annual growth o f 4.5 percent i s less than the 5.5 percent annual average growth for 2010-20 assumed at the decision point and attempts to address the tendency for growth projections to be overly optimistic. 34 end 2005 from US$1.3 billion to US$242 million at end-2006. As a consequence, Malawi’s NPV o f debt to exports ratio would drop from 245 percent as o f end-2005 to 43 percent by end-2006. Because o f new borrowing, it would subsequently rise to about 89 percent at the end o f the projection period. The NPV o f debt-to-GDP ratio would decrease to 11percent at end-2006 and gradually approach 24 percent at the end o f the projection period. Finally, the NPV o f debt-to-revenue ratio would decline to 44 percent in 2006 and trend upwards above 102 percent near the end o f the projection period. 74. Debt service i s projected to remain low through the projection period. After H P C relief and relief under MDRI, annual debt service would average US$17 m i l l i o n o n average during 2006-15, the equivalent o f about 2 percent o f exports o f goods and services. Including topping-up of HIPC Assistance 75. After topping-up HIPC assistance and the subsequent implementation o f MDRI, the NPV of debt-to-exports ratio would further drop to 32 percent at end-2006. I t would then rise to 103 percent at the end o f the projection period. The NPV o f debt-to-GDP ratio would decrease to 8 percent at end-2006. I t i s expected to reach above 28 percent by the end o f the projection period. Finally, the NPV o f debt-to-revenue ratio would decline to 33 percent in 2006 and would average about 108 percent over 2016-25. 76. Debt service i s projected to remain low through the projection period. After HIPC relief, additional bilateral relief, topping-up and r e l i e f under MDRI, total annual debt service would decrease further to US$16 m i l l i o n on average during 2006- 15, the equivalent o f about 2 percent o f exports o f goods and services. Debt service would remain around 2 percent o f exports through the remainder o f the projection period. G. Sensitivity Analysis 77. Even with debt relief under MDRI, Malawi’s debt sustainability remains vulnerable in the long run. 39 Possible risks include the contracting o f new debt o n inadequately concessional terms; high levels o f new borrowing that, because o f poor policy implementation, are associated with poor g o w t h and weak export growth; and failure to insulate the economy from periodic shocks to which the country i s vulnerable. These risks are illustrated in the accompanying three scenarios that assume full delivery o f HIPC assistance, additional bilateral assistance and debt r e l i e f under the MDRI, and that exclude topping-up. A fourth scenario considers the implications o f a substantial scaling up o f aid and debt (Table 13). Given the small effect o f topping-up on debt burden indicators after the implementation o f MDRI (see figure 2), 39 Malawi’s debt sustainability outlook after MDRI remains unchangedwhen taking topping-up into account. 35 Figure 2. Malawi: External Debt and Debt Service Indicators for Medium- and Long-TermPublic Sector Debt, 2005-25 N e t Present Value o f External Debt-to-Exports 1/ 7"" -- - -- After traditional debt r e l i e f mechanism -- . After Enhanced HIPC assistance - 350 - After bilateral debt reliefbeyond HIPC assistance \ After topping-up \ After MDRI 21 300 - * 4 -After MDRI and topping up 21 \ \ 250 - 200 - 150 - - loot - - . ' . . . . , 50 ' . 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Debt Service-to-Exports ?< -- - After traditional debt relief mechanism --- - After Enhanced HIPC assistance After bilateral debt r e l i e f beyond HIPC assistance . \ \ - ~ A f t topping-up I After MDRI 21 --- \ - -After MDRI and topphg-up 21 \ \ \ 0 ' 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Sources: Malawian authorities; and IDA and IMF staff estimates and projections. 1/ Assumes full delivery o f HIPC assistance. 2/ Includes bilateral debt relief beyond HIPC assistance. 400 375 NPV of Debt to Exports Ratio 1/ - - B a s e h e scenano 350 325 - I Scenano 1:Less Concessional Debt - 1 ILower Exports Growth Scenano I :::1 300 I I I 275 - 1 - I Scenano IJI Draught Scenano \ Scenario N : Scaling Up 200 \ 150 125 1 nn 25 0 ' t 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 14 ........... .....Baseline scenario -Scenario 1: Less Concessional Debt External Debt Service to Exports Ratio 1/ 12 - I Scenario E Lower Exports Growth - I Scenario ID: Draught Scenario 10 Scenario N : Scaling Up 8 6 4 2 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Sources: Malawian authorities; and Bank-Fund staff estimates and projections. l / Baseline assumes debt after additional bilateral assistance and MDRI debt relief. 37 Scenario 1: Borrowing on less than fully concessional terms 78. Debt relief under MDRI opens the scope for new borrowing on less than concessional terms. Sound debt management i s required to ensure that new borrowing i s o n adequately concessional terms to ensure that the external debt burden does not become unsustainable again. This scenario explores the consequences o f new borrowing o n less than h l l y concessional terms and assumes a grant element o f 45 percent. T o isolate the implications o f poor debt management, this scenario assumes that output and export growth as well as gross aid flows are the same as in the baseline scenario. However, the higher cost o f new borrowing reduces the long-term scope for expanding the fiscal spending envelope and hampers the accumulation o f external reserves. As in the baseline scenario, Malawi’s debt remains below the HIPC threshold throughout the projection period. However, by the end o f the projection period, the lower concessionality raises the NPV o f debt above 117 percent o f exports and debt service above 7 percent o f exports Scenario 2: Higher borrowing and lower exports 79. Maintaining debt sustainability will depend critically on sound policy decisions as well as implementation. This scenario assumes that the government supplements the baseline levels o f aid with a higher level o f borrowing similar to levels witnessed in the f i r s t h a l f o f the decade. However, efforts to implement structural reforms to enhance growth are assumed to be unsuccessful. The scenario further assumes that long-term global prospects for tobacco prices are poor and that efforts to diversify Malawi’s exports from a reliance on tobacco meet with little success. As a result, output and export growth as well as external reserve accumulation are weaker than envisaged in the baseline scenario and the export sector’s share o f total output in the economy falls. Higher borrowing and weaker export growth lead to a steep increase in Malawi’s NPV o f debt-to-exports ratio. I t breaches the HIPC thresholds by 2019, reaching 196 percent the end o f the projection period. The debt service-to-export ratio also rises, climbing to 5 percent o f exports by 2025. Scenario 3: Failure to insulate the economy from periodic droughts 80. Debt sustainability i s vulnerable to the periodic droughts that Malawi has routinely experienced in the past. This scenario reflects this past experience and assumes that Malawi fails to implement measures that adequately insulate the economy from the shocks. It i s assumed that droughts were to occur every 5 years starting in 2010. During the year affected, drought reduces production, including exports. Despite increased donor support during drought periods, domestic government borrowing and external reserves are put under pressure, making it more difficult for the government to maintain l o w inflation and 38 real interest rates. The vulnerability o f the economy to shocks also has a longer t e r m negative impact on the business environment: domestic borrowing, inflation and real interest rates are generally higher than in the baseline leading to lower private investment as well as lower output and export growth. 0 After HIPC and MDRI, Malawi’s NPV o f debt to exports ratio remains below the HIPC threshold throughout the projection period. Given the assumption o f substantial donor support in terms o f grants during period o f droughts, debt burden indicators under the drought scenario closely mimics the baseline. Scenario 4: Scaling-up o f aid and new borrowing 81. Malawi i s likely to require a large scaling-up of aid if it i s to meet the MDGs and make significant inroads into poverty. However, scaling up aid through loans rather than grants could threaten Malawi’s external debt sustainability. T o illustrate this risk, this scenario assumes that aid to Malawi (including flows to the private sector and other institutions outside government) are increased by 5 percent o f GDP to about 26.5 percent o f GDP over 201 1-25. The composition o f aid between grants and loans remains broadly unchanged from recent experience, so that new borrowing rises to 6.8 percent o f GDP, about 3 percent o f GDP higher than in the baseline scenario. The additional aid i s assumed to be used effectively, increasing the annual growth o f both output and export growth by 0.5 percent above the baseline. 82. Despite higher output and export growth, t h e additional borrowing assumed in this scaling-up would induce the NPV of debt-to-export ratio to breach the HIPC threshold before the end o f the projection period. This clearly illustrates that Malawi would need to rely heavily on grant financing if i t i s to make faster progress towards achieving the MDGs while maintaining debt burden indicators at sustainable levels. 83. The sensitivity analysis shows that Malawi’s debt sustainability remains vulnerable to exogenous shocks. It i s therefore important that the authorities make prudent use o f the resources freed up through debt r e l i e f and strengthen their public expenditure management. Moreover, the government would need to continue with the implementation o f governance and structural reforms after the completion point in order to sustain strong economic growth and to avoid a deterioration o f i t s debt burden indicators. IV. CONCLUSIONS 84. The staffs o f IDA and the IMF consider that Malawi’s performance with regard to the conditions established in December 2000 for reaching the completion point under the Enhanced HIPC Initiative has been broadly satisfactory. 85. Malawi successfully formulated a full PRSP-the MPRS-in 2002. Implementation was initially weak largely because o f poor macroeconomic performance, but 39 has improved in recent years, as outlined in the second and third APRs. I nthe view o f IDA and IMF staffs, implementation o f the MPRS over the last year has been satisfactory. Malawi’s development strategy will henceforth be guided by the new M a l a w i Growth and Development Strategy. 86. Malawi has met the requirement for a minimum of six months satisfactory performance under a PRGF-supported program. Macroeconomic policy implementation was poor during the first three years after the decision point and the PRGF arrangement, approved at end-2000, expired with only the first review being completed. However, policy implementation improved significantly following the election o f a new government in early 2004. Malawi has now maintained almost two years o f satisfactory macroeconomic policy implementation, first under an SMP from July 2004 to June 2005 and subsequently under a new PRGF arrangement approved in August 2005. 87. Malawi has successfully implemented a range of social measures specified at the decision point as required to reach the completion point under the HIPC Initiative. The pace o f implementation was initially slow, but gathered pace in recent years. IDA and IMF staff have assessed that Malawi has implemented all but two o f the triggers, related to the share o f health expenditures and the number o f teachers in training college. In view o f the progress made to-date in implementing a broader strategy for raising the quality o f education and improving health outcomes, the staffs recommend that waivers be granted for non- observance o f these two triggers. 88. Achieving and sustaining strong economic growth will require, in addition to maintaining a sound macroeconomic framework, accelerated structural and governance reforms. I t will require that the government sustain the recent pace o f implementation o f reforms, increase and implement more effectively i t s public investment program, and strengthen partnership with donors. 89. Malawi’s debt burden at end-2005 i s higher than anticipated at the decision point. The full delivery o f assistance under the HIPC Initiative would reduce Malawi’s debt burden but would not be sufficient to make this burden sustainable. This reflects a detrimental shift in exogenous factors beyond the control o f the country. The IDA and IMF staffs recommend that Malawi be considered for additional and exceptional assistance under the HIPC Initiative. 90. On reaching the completion point under the HIPC Initiative, Malawi has also become eligible for debt relief under the MDRI. After full delivery o f the H I P C Initiative and additional debt r e l i e f from some Paris Club creditors and MDRI, the NPV o f debt-to- exports ratio would be reduced to about 43.0 percent at end-2006. Nevertheless, Malawi’s economy remains vulnerable to external shocks. The sensitivity analysis shows that Malawi’s external debt sustainability could be jeopardized by a return to high levels o f borrowing and a failure to implement strong macroeconomic and structural reform policies to 40 enhance output growth and improve the performance o f the export sector. Debt r e l i e f under the MDRIincreases the scope for new borrowing and highlights the importance o f prudent external debt management to ensure that new borrowing i s maintained within limits and on adequately concessional terms.40 Malawi’s debt sustainability could also b e jeopardized by a failure to implement measures to insulate the economy from periodic droughts to which Malawi i s susceptible and which have an impact on its main export commodity, tobacco. 91. Important challenges and risks remain on Malawi’s development path. First, pressures for higher spending in the post-completion point period, financed by external borrowing, could jeopardize macroeconomic stability, undermine debt sustainability, and endanger external competitiveness. Second, uncertainties continue to exist about the projected commodity output and prices. A sharp fall in these prices could jeopardize the sustainability o f the external position. Third, the government needs to maintain the pace o f governance and structural reforms beyond the completion point to attract private and official resources in order to sustain strong economic growth and reduce poverty. 92. In light of the above, the staffs of the IDA and IMF recommend that the Executive Directors determine that Malawi has reached the completion point under the Enhanced HIPC Initiative and that additional assistance under the Initiative be granted to lower Malawi’s NPV o f debt to exports ratio at end-2005 to 150 percent. v. ISSUES FOR DISCUSSION Executive Directors may wish to focus o n the following issues and questions: Completion point: D o Directors agree that Malawi has met all but two o f floating conditions for reaching the completion point under the enhanced HIPC Initiative, as established at the time o f the decision point? Data correction: D o Directors agree with staffs’ recommendation that the proposed revision in the stock o f debt in NPV terms and exports o f goods and services warrants a revision in the amount o f HIPC Initiative assistance? 40 In particular, the borrowing space created by MDRI debt relief should not be used to contract debt on non-concessional terms. IDA’S Board has recently approved a two-pronged package o f measures addressingfree riding on future borrowing by I D A grant-recipient as well as post-MDRI countries. (See, IDA, “IDA Countries and non-concessionalDebt: Dealing with the Free-Rider Problem in I D A fourteen Grant-recipient and post-MDRI countries,” June 2006, IDA/R2006-0137). On the creditor side, the package involves enhancing creditor coordination around an agreed framework. On the borrower side, it provides disincentives on new borrowing by reducing volumes and/or hardening the terms o f assistance. The I M F will continue to monitor and discourage non-concessional borrowing through the use of the debt sustainability framework for low-income countries in both surveillance and program contexts. 41 Topping-Up: D o Directors agree that the deterioration in Malawi’s debt sustainability i s primarily attributable to a hndamental change in i t s economic circumstances due to exogenous factors? If so, do Directors agree that exceptional additional HIPC Initiative assistance be granted to lower Malawi’s NPV o f debt-to-exports ratio at end-2005 to 150 percent? Ifso, do Directors agree that this additional assistance would be granted when the Boards decide that other creditors have provided sufficient assurances to participate in this exceptional effort? MDFU: D o IMF Directors agree that Malawi qualifies for an amount of debt r e l i e f by the Fund equal to SDR37.9 million, o f which SDR14.5 million would be financed from the MDRI-ITrust, SDR15.4 million from completion point assistance disbursed to Malawi’s HIPC umbrella sub-account, and SDR8 million from topping-up assistance, if topping-up i s approved. D o Directors agree that the authorities have adequate monitoring mechanisms to ensure that debt r e l i e f i s used according to i t s intended purposes? Creditor participation: D o Directors agree that sufficient assurances have been given by Malawi’s creditors to commit HIPC assistance to Malawi on an irrevocable basis? Debt Sustainability: D o Directors agree with staffs’ assessment that Malawi’s debt sustainability i s likely to be maintained over the medium and long-term? D o Directors share the staffs’ assessment regarding possible risks that may emerge if the authorities do not actively pursue policies that encourage export diversification and prudent fiscal and debt management policies? D o Directors agree that Malawi should continue to seek debt relief from i t s non-Paris Club creditors within the framework o f the HIPC Initiative and that the staffs should continue to monitor the delivery o f the debt relief from all creditors? 42 Table 2: Resources used on Protected Pro-poor Expenditures, FY2001/02-N2004/05 (In Millions o f US. dollars) 2001/02 2002/03 2003/04 2004105 Total (Actual) (Actual) (Actual) (Actual) Agriculture Agricultural Extensions 2.21 2.87 8.01 6.48 19.57 Small-scale Irrigation 3.38 1.87 5.25 Technology Generation and Technical Service 3.34 3.34 Water Development Rural Waster Supply 0.90 0.61 0.27 0.3 1 2.09 Borehole and Dam Construction 3.51 2.30 0.95 6.76 Rehabilitation 0.13 0.13 Education Teaching and learning materials 9.05 5.72 15.97 5.40 36.14 Teacher's salaries 30.72 49.77 45.88 126.37 Teachers' housing 1.61 0.37 0.02 2 Teacher training 1.97 4.99 3.40 3.78 14.14 Health Primary Health Care 8.69 9.97 18.66 Health Workers' Training 1.67 3.65 1.44 2.25 9.01 Curative Health Services 8.84 6.52 8.80 7.94 32.1 Infrastructure Development 1.02 1.10 2.12 Preventive Health Care 0.28 0.28 6.89 1.08 8.53 Health Technical Services 0.21 5.37 5.58 Drugs 14.80 12.48 12.23 13.16 52.67 Health Worker Salaries 9.64 9.64 Clinical and Population Services 0.08 0.08 Gender, Child Welfare and Community Services Gender Mainstreaming 0.59 0.59 Adult Literacy 0.91 0.54 0.53 1.98 Family Welfare and Gender Services 0.74 0.36 0.20 1.3 Child Care Services 0.1 1 0.07 0.18 Police Crime Prevention and Investigation 2.48 2.48 ' Community Policing 0.04 2.56 1.70 1.34 5.64 Police Officer Training 1.53 1.05 1.91 4.49 Labor and Vocational Training Technical and Vocational Training 1.52 1.97 1.64 2.13 7.26 Trade and Private Sector Development Industrial Development 0.14 0.14 Enterprise Development Promotion 0.63 0.29 1.32 0.26 2.5 Cooperatives Development 0.22 0.22 National Roads AuthorityLocal Government Rural Feeder Roads 10.68 4.60 0.76 16.04 Natural Resources Small-scale Fishing 0.94 0.34 0.58 1.86 Small-scale Mining 0.59 0.90 0.64 0.39 2.52 Tourism Promotion of Tourism 0.48 0.48 Tourism Services 0.39 0.42 0.41 1.22 Conservation and Protection o f Wildlife 0.70 0.56 0.74 2 Total 97.17 129.43 116.64 61.84 405.08 HIPC Debt Relief 30.7 40.2 50.9 46.9 168.7 Source: Malawian authorities 43 Table 4. Malawi: Balance o f Payments, 2000-09 (In millions of US dollars) Actuals Pmjecrions 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 1I 3 Current account balance (including grants) -51 -117 -216 -134 -178 -122 -169 -42 -27 -67 Trade balance -140 -158 -306 -351 -424 -473 -498 -456 -438 -511 Exports 402 427 421 441 470 524 572 593 611 630 Imports -542 -585 -727 -792 -894 -998 -1070 -1049 -1049 -1141 Services balance -66 -66 -154 -88 -85 -84 -85 -75 -76 -72 Interest public sector (net) -21 -18 -20 -26 -28 -26 -19 -4 -1 8 Receipts 1 2 9 3 2 1 1 3 5 9 1 4 Payments -33 -26 -23 -27 -28 -26 -22 -9 -10 -6 Other factor payments (net) -16 -15 -24 -16 -17 -17 -19 -20 -21 -22 Nonfactor (net) -29 -33 -109 -47 -40 -41 -47 -51 -55 -58 Receipts 45 54 50 40 41 41 42 43 46 48 Payments -74 -87 -77 -87 -81 -83 -90 -95 -100 -106 Unrequited transfers (net) 155 107 243 305 331 435 413 488 487 SI6 Private (net) 8 10 8 141 118 151 132 136 139 145 o f which Official aid to non-gvt 1 211 183 156 127 162 147 151 157 158 Official (net) 148 98 235 164 213 284 280 352 348 371 Receipts 148 98 235 164 213 284 280 352 348 371 Balance ofpayments assistance 78 51 13 42 64 97 46 99 92 98 Japan HIPC Initiative 2 i 0 0 1 1 1 7 0 0 0 0 0 0 Project and humanitarian 70 47 211 105 149 187 234 253 256 273 Payments - 1 - 1 0 0 0 0 0 0 0 0 Capital account balance (incl. mon and omissions) 39 85 61 96 152 92 111 89 90 108 Medium- and long-term flows 65 60 24 11 16 21 50 59 57 72 Official disbursements 125 127 81 97 95 98 113 91 86 100 Balance o f payments support 31 55 0 18 35 18 33 18 24 27 Project support 94 72 81 78 50 79 80 72 62 72 AmOrtizatiOn(amounrr due before HIPC debt relie0 -60 -67 -57 -69 -75 -77 -63 -32 -29 -28 Foreign direct investment and other inflows 27 28 38 43 44 26 30 32 34 36 MDRI debt forgiveness on debt due after current year 0 0 0 0 0 0 1844 376 0 0 MDRI grants from ADF 0 0 0 0 0 0 0 376 0 0 MDRI grants from IDA 0 0 0 0 0 0 1798 0 0 0 MDRI grants from IMF 0 0 0 0 0 0 4 6 0 0 0 Other liabilities (MDRI-IDA and ADP loans) 0 0 0 0 0 0 -1813 -378 0 0 Short-term capital and m o r s and omissions -53 -2 0 42 92 45 0 0 0 0 Overall balance -12 -32 -155 -38 -25 -30 -58 47 64 41 Financing (- increase in reserves) , 12 32 155 38 25 30 58 -47 -64 -41 Central bank 17 12 111 -3 -16 -49 6 -75 -85 -63 Gross reserves (- increase) 2 41 41 39 -6 -31 41 -93 -93 -63 Liabilities 15 -29 71 -42 -10 -18 -35 18 7 0 Ofwhich: IMP (net) -1 -6 17 0 -14 -11 11 18 7 0 Purchasesldrawings 8 0 2 3 9 0 8 25 18 7 0 Repurchasesirepayments -9 -6 -6 -9 -14 -19 -14 0 0 0 Loans 0 0 50 -50 0 0 -54 0 0 0 Commercial banki -6 -8 15 -7 -6 19 -9 -4 -4 -5 Arrears 0 0 0 0 0 0 0 0 0 0 Debt relief 0 27 29 48 47 60 46 30 26 27 MDRI debt forgiveness on debt due in current year 0 0 0 0 0 0 1 5 2 0 0 Residual financing gap (+ underfinanced) 0 0 0 0 0 0 0 0 0 0 Memorandum items Trade balance G&S -170 -191 -333 -398 -464 -514 -545 -507 -492 -569 Total exports G&S 446 480 471 481 511 566 614 636 657 678 Total imports G&S -616 -672 -803 -878 -975 -1080 -1159 -1143 -1149 -1247 Total net official aid inflows 181 364 465 370 369 493 515 600 584 621 Net aid flows to gvt 179 152 282 214 242 332 368 449 428 464 Gross official aid flows (incl IMF) 281 225 339 270 309 390 419 460 441 471 Grants 148 98 235 164 213 284 280 352 348 371 Share of total 53 43 69 61 69 73 67 76 79 79 Loans 133 127 104 106 95 106 138 108 93 100 Program 118 106 36 69 99 124 121 135 123 126 Project-Other 163 119 292 184 199 266 311 331 318 345 Debt service after relief 102 72 57 56 67 58 51 11 13 7 Official grant aid flows outside gvt 1 211 183 156 127 162 147 151 157 158 Total grants share o f total gross aid 53 71 80 75 78 81 76 82 84 84 Gross usable reserves 2246 1846 1034 1156 1193 1312 113.9 2065 2993 362.1 Gross reserves i n months o f current imports 44 33 15 16 15 15 1.2 2.2 3.1 35 Sources Malawian authonties and IMF staff estimates 45 Table 5. Malawi: Comparison o f Discount Rate and Exchange Rate Assumptions at end-1999 and end-2005 Discount Rates I/ 21 Exchange Rates (In percent per annum) (Currency per US. dollar) At Decision At Completion At Decision At Completion Point in 1999 Point in 2005 Point in 1999 Point in 2005 Austrian Schilling 5.47 3.95 13.70 11.66 Belgian Franc 5.47 3.95 40.16 34.20 Deutsche Mark 5.47 3.95 1.95 1.66 Danish Kroner 5.32 3.88 7.40 6.32 European Currency UniUEuro 5.47 3.95 1.oo 0.85 French Franc 5.47 3.95 6.53 5.56 British Pound 6.70 5.28 0.62 0.58 Irish Pound 5.47 3.95 0.78 0.67 Italian Lira 5.47 3.95 1,927.40 1,641.32 Japanese Yen 1.98 1.91 102.20 117.97 Kuwaiti Dinar 7.04 5.08 0.30 0.29 Luxembourg Franc 5.47 3.95 40.16 34.20 Netherlands Guilder 5.47 3.95 2.19 1.87 Norwegian Krone 6.64 4.17 8.04 1.oo Portuguese Escudo 5.47 3.95 199.56 169.94 Spanish Peseta 5.47 3.95 165.62 141.04 Special Drawing Rights 5.59 4.30 0.73 0.70 Swedish Krona 5.80 3.92 8.53 7.96 Swiss Franc 4.27 2.76 1.60 1.31 US. Dollar 7.04 5.08 1.oo 1.oo Sources: OECD; and IMF, International Financial Statistics. l / The discount rates used are the average commercial interest reference rates (CIRRs) for the respective currencies over the six-month period ending in December 2005 for the completion point and in December 1999 for the decision point. 21 For a l l Euro area currencies, the Euro CIRR i s used. For the Kuwaiti Dinar, the USD discount rate i s used. For a l l other currencies for which the CIRRs are not available, the SDR discount rate i s used. Table 6. Malawi: Nominal and Net Present Value o f External Debt at Decision Point as o f end End-December 1999 1/ (In millions o f US dollars) Nominal Debt Stock NPV o f Debt after Rescheduling21 Revisedat Completion At Decision Point A t Decision Point Revised a t Completion Point 31 Point 31 Total 2,604.2 2,600.3 1,469.3 1,466.5 Multilateral 2,187.1 2,174.5 1,097.6 1,093.9 World Bank Group 1,603.0 1,601.4 756.7 756.4 IDA 1,586.0 1,585.0 740.0 739.8 IBRD 17.0 16.3 16.8 16.6 African DevelopmentBank Group 32 1.7 323.9 162.0 160.0 AtDF 299.3 301.5 137.5 136.1 AtDB 22.4 22.4 24.6 23.9 IMF 87.6 87.6 68.8 68.8 EUEIB 95.5 88.6 65.5 62.2 EU 41 89.5 82.7 59.5 56.1 EIB 6.0 5.9 6.0 6.1 IFAD 50.4 50.4 25.9 25.9 PTA Bank 5/ 22.3 16.0 14.8 16.8 NDF 3.3 3.3 1.5 1.5 BADEA 1.9 1.9 1.4 1.4 OPEC Fund 1.5 1.5 1.0 1.0 Paris Club bilateral 337.8 366.4 293.8 320.5 Austria 20.2 20.2 15.6 15.6 EU-IDA administered loans 41 ... 5.3 1.5 France 14.0 14.1 9.8 9.9 Germany 0.5 0.5 0.2 0.2 Japan 293.8 293.8 262.1 262.0 Spain 8.2 8.2 5.8 5.8 United Kingdom 61 1.0 24.2 0.3 25.6 Non Paris Club bilateral 43.4 43.4 35.1 34.7 Taiwan, Province o f China 36.0 36.0 30.3 30.3 Kuwait Fund 4.2 4.2 3.0 2.6 SouthAfrica 71 3.2 3.2 1.9 1.9 Commercial 81 36.0 16.2 42.8 17.3 Sources: Malawian authorities and Bank-Fund staff estimates. 11 Public and publicly guaranteeddebt only. 21 Rescheduling assumes a Naples stock operation based on a cut-off date o f January I, 1982 from bilateral and commercial creditors. 31 Information based on latest data available at completion point. 41 Contrary to the decision point, I D A administeredloans from the European Union are treated as loans from Pans Club creditors at completion point. 51 Debt owed to PTA bank was revised based on written correspondencebetween the Malawian authorities and the PTA Bank from December 1999 and early 2000 that was exchanged in the context o f PTA's law suit against the Government o f Malawi+A3. 6/ The increase in United Kingdom debt level i s athibutable to the inclusion o f the CommonwealthDevelopment Corporation loans that were initially classified as commercial loans at the t i m e o f the decision point. The United Kingdom have recently agreed to classify these loans as bilateral loans to be treated under the Pans Club umbrella. 71 At the time o f the decision point South Africa was classified as a Pans Club creditor. But staff obtained recent information from the Pans Club confirming that although South Africa participated in previous Pans Club negotiations for Malawi (1983 and 1988), they decline the Pans Club invitation to participate in the 2001 Cologne flow ageement. A t the time o f the preparation o f this completion point document, staff did not yet receive indication that South Africa was willing to participate in the Pans Club negotiations for the HIPC completion point o f Malawi. 8/ The decrease in commercial debt level i s due to the reclassification o f two creditors (CommonwealthDevelopment Corporation and Banque Francaise pour le Commerce Exterieur ) as Pans Club bilateral creditors. Staff received c o n f m t i o n that these two creditors are treated under the Pans Club umbrella. Commercial creditors are Banco Bilbao, Chase ManhattanBank, Netherland's DevelopmentFinance Company (FMO), Skandinaviska Enskilda Banken, South Africa InvestmentDevelopment Corporation, STD Bank and West Minster Bank. vi vi m Table 8. Malawi: Nominal and Net Present Value o f External Debt at Completion Point, End-2005 1/ (In millions o f US dollars) Legal Situation 31 Net Present Value 41 Nominal Debt NPV o f Debt After enhanced HIPC After additional bilateral assistance Total 2,969.4 1,919.5 1,272.9 1,189.2 Multilateral 2,626.0 1,607.8 1,168.6 1,168.6 IDA 1,933.4 1,171.9 835.6 835.6 IBRD 0.030 0.029 0.03 0.03 AfDF 418.7 248.4 193.6 193.6 AfDB 10.5 11.3 5.6 5.6 IMF 75.2 41.3 43.3 43.3 E U 21 74.3 59.3 34.1 34.1 EIB 0.4 0.4 0.2 0.2 IFAD 63.8 40.4 23.7 23.7 BADEA 13.8 11.4 10.5 10.5 OPEC Fund 9.0 7.9 7.4 7.4 NDF 26.9 15.5 14.5 14.5 Paris Club bilateral 300.0 274.2 83.7 0.0 Austria 20.5 18.2 ... ... Belgium 3.0 1.7 ... ... EU-IDA administeredloans 21 4.8 3.2 ... ... France 15.9 12.0 ... ... Germany 0.2 0.2 ... ... Japan 192.7 178.4 ... ... Spain 9.6 5.9 ... ... United Kingdom 53.3 54.6 ... ... Non Paris Club bilateral 40.9 35.0 19.9 19.9 Kuwait 25.2 20.3 18.4 18.4 South Africa 0.4 0.4 0.0 0.0 Taiwan. Province o f China 15.2 14.3 1.5 1.5 Commercial 2.5 2.6 0.6 0.6 Sources: Malawian authorities and Bank-Fund staff estimates. 11Figures are based on data as o f end-December 2005. 21 European Economic Commission loans administered by I D A were classified as multilateral loans at decision point and have been reclassified as Paris Club bilateral loans at completion point. 31 Reflects the external debt situation as o f end-2005, including a Paris Club Cologne flow rescheduling. Since most o f Malawi's debt was contractedafter the original cut-off debt o f January 1, 1982, the Paris Club fixed a new cut-off debt ofJanuary 1, 1997 to deliver interim assistance. 41 Assumed delivered unconditionally. 49 r 0 * - -*-g w UN n e N w 0 0 10 VI a- VI- t 2 3 0 - e N c N 25- P 50 52 U 53 n 0 c 54 s c 0 * 0 * 0 W N Lo 0 Q 0 n Q N 0 o s * 0 * 0 c n * x a c W m 0 0 c * Y - m c 55 " c ! ? 0 0 0 2 - - 1< x '9 0 $8 x ol?" 2 P 2 2z " 2 0 VI 0 - d 1 r- 8 - 9 m - . . gz5; - 0 z. g .2 -- I 3 .2 5 'D - .e 0 0 .E .E e ,s g g O C C a 0 0 2 E E 3 V 56 m N N f ? . 0 W""! 0 0 0 -- N 0 N N " m - ! e m N N * 0 v 10 1 0 0 m -N N J *O 0 0 - 0 1 m 01N 0 0- I1 8 w r- w . - N" * Vll o P m o o m h VI f N N O m 10 P 0 N - - 0 - 0 0 0 0 N 0 0 0 0 0 0 - 0 0 0 0 0 0 0 57 Table 16. Malawi: Status o f Creditor ParticipationUnder the Enhanced HIPC Initiative Debt Relief Amended Percentage Satisfactory Modalities To inNPV T m Debt Relief o f Total Reply Deliver Debt Relief ( U S million) 11 in NPV ~ c r m ~ Assistance 21 333.3 51.5 Yes l n m m IDA assstance 13 bcing dclivned througb a I 5 3% rcducuoc o f 13A debt smm wlnl cnd-Scptcrrbcr 2006 and through a 55 9 ' r reducnon t ~ e r f f i k rToral debr rclref i s 10 bc pro\idcd o\er 20 )cars. cndlng 2023 A D B &up 70.9 70 5 11 0 Yes interimassistancewas provided equal to 80.0% debt service reduction until October 2004 Further invrims assisrance was provided i n 2005. Remaining assistance will be delivered at completion point equal to an 80% debt service reduction until July 2016. IMF 30 1 30.3 4.7 Yes The IMF provided interim assistance in 2001 and fmm 2003 onwards HIPC reliefis provided through grants from the PRGFiHiPC Trust to Malawi's Umbrella Account until 2009 EUEB 28 7 27.4 4.5 Yes interimdebt reliefprovided on identified EDF and E18 loans Debt reliefat completion point will be provided through grants to pay off EDF loans FAD 11.3 11.4 1.8 Yes Assistance will be delivered at wmplelion point through a reduction o f debt service payments on elipile debt by up to 100% until the target inNPV terms is reached PTA Banlr 65 7.4 1.0 No No debt relief provided PTA Bank suit the Government o f the Republic o f Malawi in December 1999 Consequently, the Malawian authoritis repaid all debt outstanding to the PTA Bank NDF 0.7 07 01 Yes A wnmiution to the HIPC Trust Fund will pay 100%o f the debt service o f selected loans due after approval ofthe completion point until full delivezy ofHIPC assistance BADEA 0.6 0.6 0.1 Yes Badea has agreed in principle to deliver debt relief through concessionaireschedulingo f new loans, incMing cancellation andlor decrcase of interest rates. OPEC Fund 04 04 01 YeS Rscheduling o f m o f selected loans a n n approval ofthe completion point Total multilateral 480.0 482 1 14 7 Paris Club crcditon 128.5 141 2 20 0 Yes Cologne flowpronded during interim period Stock-of-debtoperation under Cologne terms i s expected at completion point. Non-Paris Club crediton I5 4 15.3 2.4 Taiwan, ProvinceofChina 13 3 13.4 2.1 No Creditor has not manifested its inlentiono f d e l i v h g HIPC relief The Kuwaiti Fund promised to deliver debt reliefonce Malawi reaches completion point Kuwait Fund 13 I 1 0.2 No Modalitis ofdebt reliefwill be detmnined by the creditor at that stage Under a debt relief ageement signed before Malawi reacheddecision poinL the creditor bas South Africa 0.8 0.8 0.1 YS agreed to cancel 100%o f all maturities as they fall due Therefore. creditor has provided intcrimassistancebcyond the Paris Club comparable terms AU commercial credirors, with the exception o f two, did provide interim assistance beyond Colope terms and have delivered their full share ofHIPC reliefova h e interim period. Connnercialcrediton 18 7 7.6 2.9 Yes Despite the requests ,?om Malawi, FMO bas not yet agreed to negotiate debt relief The 0 t h ~ commercial creditor (South Africa) has not yel agreed 10 provide HIPC debt reliei, but has delivered interim assistance on comparable Cologne t m until 2003. Total bilateral and commercial 162.6 I64 2 25 3 Total 642 6 646 3 100.0 Sourw: Malawian authorities, and IDA and I M F staff estimates. I1 The amount ofassisrance i s estimated using the exchange r a m and creditor exposureat the decision point 21 Basedon data as ofdecision point. 58 Table 17. Paris Club Creditors' Delivery o f Debt Relief Under Bilateral Initiatives Beyond the HIPC Initiative 1/ Countries covered ODA (in percent) Non-ODA (in percent) Provision o f r e l i e f Pre-cutoff date debt Post-cutoff date debt Pre-cutoff date debt Post-cutoff date debt Decision point Completion (In percent) point (1) (2) (3) (4) (5) (6) 0 Australia HIPCs 100 100 100 100 21 21 21 Auseia HIPCs 100 100 . Case-by-case, flow Stock Belgium HIPCs IO0 100 100 100 flow Stock Canada HIPCs 31 - 41 - 41 100 100 100 flow Stock Denmark HIPCs 100 100 51 100 100 51 100 flow Stock France HIPCs 100 100 100 100 flow 61 Stock Finland HIPCs 100 - 71 100 - 71 Germany HIPCs 100 100 100 . 81 100 flow Stock Ireland Italy HIPCs 100 100 91 100 100 91 100 flow Stock Japan HIPCs 100 100 100 Stock Netherlands, t h e HIPCs 100 I01 100 100 90-100 flow 101 Stock Norway mpcs 111 111 121 121 Russia Case-by-case Stock Spain HIPCs 100 Case-by-case 100 Case-by-case Stock Sweden HIPCs - 131 100 Stock Switzerland HIPCs 100 100 Case-by-case 100, flow 141 Stock United Kingdom HIPCs 100 100 100 100 151 100 flow 151 Stock United States HIPCs 100 100 100 100 161 100 flow Stock Source: Paris Club Secretariat. I1 Columns (I) to (7) describe the additional debt reliefprovided following a specific methodology under bilateral initiatives and need to he read as a whole for each creditor. I n column (l), "HIPCs" stands for eligible countries effectively qualifying for the HIPC process. A "100 percent" mention in the table indicates that the debt reliefprovided under the enhanced HIPC Initiative framework w i l l be topped up to 100 percent through a bilateral initiative. 21 Australia: post-cutoff date non-ODA reliefto apply to debts incurred before a date to be finalized; timing details for both flow and stock relief are to be finalized. 31 Canada: including Bangladesh. Canada has granted a moratorium ofdebt service as o f January 2001 on all debt disbursed before end-March 1999 for 13 out o f 17 HIPCs with debt service due to Canada. Eligible countries are Benin, Bolivia, Cameroon, Dem. Rep. OfCongo, Ethiopia, Ghana, Guyana, Honduras, Madagascar, Rwanda, Senegal, Tanzania, and Zambia. 100% cancellationwill be granted at completion point. As of July 2004, Canada has provided completion point stock o f debt cancellation for Benin, Bolivia, Guyana, Senegal and Tanzania. 41 100 percent of ODA claims have already been cancelled on HIPCs, with the exception of Myanmar's debt to Canada. 51 Denmark provides 100 percent cancellation o f ODA loans and non-ODA credits contracted and disbursed before September 27, 1999. 61 France: cancellation o f 100 percent of debt service on pre-cutoff date commercial claims on the government as they fall due starting at the decision point. Once countries have reached their completion point, debt relief on ODA claims on the government will go to a special account and will be used for specific development projects. 71 Finland no post-COD claims 81 Germany proposes to cancel all debts incurred before June 20, 1999 depending on a consensus within Paris Club creditors 91 Italy: cancellation of 100 percent of all debts (pre- and post-cutoff date, ODA and non-ODA) incurred before June 20, 1999 (the Cologne Summit). At decision point, cancellation o f the related amounts falling due in the interim period. At completion point, cancellation o f the stock o f remaining debt. 101 T h e Netherlands: 100 percent ODA (pre- and post-cutoff date debt will be cancelled at decision point); for non-ODA in some particular cases (Benin, Bolivia, Burkina Faso, Ethiopia, Ghana, Mali, Mozambique, Nicaragua, Rwanda, Tanzania, Uganda and Zambia), the Netherlandswill ~ t off e100 percent o f the consolidatedamounts on the flow at decision point: all other HIPCs will receive interim relief up to 90 percent reduction o f the consolidated amounts. At completion point, all HIPCs will receive 100 per cent cancellation of the remaining stock o f the pre-cutoff date debt. 111 Norway has cancelledall ODA claims. 121 Due to the current World BankAMF methodology for recalculating debt reduction needs at HIPC completion point, Norway has postponed the decisions on whether or not to grant 100% debt reduction until after the completion point. 131 Sweden has no ODA claims. 141 Switzerland: I n principle 100 percent cancellation o f Pre-cutoff date non-ODA debt. However, Switzerland claims the right at the decision point to forgive only 90 percent in case ofmajor political and/or political weaknesses. 151 United Kingdom: "beyond 100 percent" full write-offof all debts o f HIPCs as of their decision points, and reimbursement at the decision point ofany debt service paid before the decision point. 161 United States: 100 percent post-cutoff date non-ODA treated on debt assumed prior to June 20, 1999 (the Cologne Summit). Table 18. HIPC Initiative: Status of Country Cases Considered Under the Initiative, July 28,2006 Target Estimated Total NPV of Debt-to- Assistance Levels 11 Percentage NominalDebt Decision Completion GOV (In millions o f U S dollan, present value) Reduction Service Relief Country Point Point E m o m revenue Bilateral and Multi- World in NPV o f (Inmillions of (in percent) Total commercial lateral IMF Balllt Debt 21 U S dollars1 Completion point reached under enhanced framework Benin Jul 00 Mar. 03 150 265 77 189 24 84 31 460 Bolivia 1,302 425 876 84 194 2,060 origmnlframework sep 97 Sep 98 225 448 157 291 29 54 14 760 enhancedfrarnework Feb 00 Jun 01 150 854 268 585 55 140 30 1,300 Burkina Faso 553 83 469 57 231 930 ongmnlframework Sep 97 Jul 00 205 229 32 196 22 91 27 400 enhancedframework Jul 00 Apr. 02 150 195 35 161 22 79 30 300 iopping-up Apr 02 150 129 16 112 14 61 24 230 Cameroon Oct 00 Apr 06 150 1,267 879 322 37 176 27 4,917 Ethiopia 1,982 637 1,315 60 832 3,275 enhnncedframework 'VO" 01 Apr 04 150 1,275 482 763 34 463 47 1,941 ropping-up Apr. 04 150 707 155 552 26 369 31 1,334 Ghana Feb 02 Jul 04 144 250 2,186 1,084 l,l02 112 781 56 3,500 Guyana 591 223 367 75 68 1,354 originnlfrnmework Dec 97 Mny 99 107 280 256 91 I65 35 27 24 634 enhancedframework Nov 00 Dec-03 150 250 335 132 202 40 41 40 719 Honduras lul. 00 Mar-05 110 250 556 215 340 30 98 18 1,000 Madagascar Dec 00 Ocl-04 150 836 474 362 19 252 40 1,900 Mali 539 169 370 59 185 895 originnlfrnmewark Sep 98 Sep 00 200 121 37 a4 14 43 9 220 enhoncedfrnrnework Sep 00 Mar 03 150 41 7 132 285 45 143 29 675 Mauritania Feb 00 Jun 02 137 250 622 261 361 47 100 50 1,100 Mozambique 2,023 1,270 753 143 443 4,300 originnlfrnmework Apr 98 Jun 99 200 1,717 1,076 641 125 381 63 3,700 enhoncedfrnrnework Apr 00 sep 01 150 306 194 112 18 62 27 600 Kicaragua Dec 00 Jan 04 150 3,308 2,175 1,134 82 191 73 4,500 Niger 663 235 428 42 240 1,190 enhancedfrnmework Dec 00 APT 04. 150 521 211 309 28 170 53 944 lopping-up Apr 04 150 143 23 119 14 70 25 246 Rwanda 696 65 63 1 63 383 1,316 enhoncedfromework Dec 00 Apr-05 150 452 56 397 44 228 71 839 tapping-up Apr-05 150 243 9 235 20 154 53 477 Senegal Jun. 00 Apr 04 133 250 488 212 276 45 124 19 850 Tanzania Apr. 00 Nov 01 150 2,026 1,006 1,020 120 695 54 3,000 Uganda 1,003 183 820 160 517 1,950 original framework Apr. 97 Apr 98 202 347 73 274 69 160 20 650 enhnncedfrornework Feb 00 May 00 150 656 110 546 91 357 37 1,300 Zambia Dec 00 Apr-05 150 2,499 1,168 1,331 602 493 63 3,900 Decision point reached under enhanced framework BWdi Aug. 05 Floating 150 826 124 701 28 425 92 1,465 Chad May 01 Floating 150 170 35 134 18 68 30 260 Congo, Democratic Rep o f Jul. 03 Floating 150 6,311 3,837 2,474 472 831 80 10,389 Congo Rep o f Mar 06 Floating 250 1,679 1,561 118 8 49 32 2,881 Gambia, The Dcc. 00 Floating I50 67 17 49 2 22 27 90 Guinea Dec 00 Floating 150 545 215 328 31 152 32 800 Guinea-Bissau Dec. 00 Floating 150 416 212 204 12 93 85 790 Malawi Dec. 00 Floating 150 643 163 480 30 331 44 1,000 S l o Tome and Principe Dec. 00 Floating 150 97 29 68 24 83 200 Sierra Leone Mar. 02 Floating 150 600 205 354 123 122 80 950 Total assistance providedicommined 34,756 17,239 17,377 2,588 31 8,203 61,221 Sources: IMP and World Bank Board decisions, completion point documents, decision point documents, preliminarj HIPC documents, and s t a f f calculations. 11 Assistance levels arc at counties' respective decision or completion points, as applicable. 21 Inpercent o f the net presentvalue o f debt at the decision or compleuon point (as applicable), after the full use of t,aditional debt-reliefmechanism. 31 Equivalent to SDR 1,750 million at an S D W S D exchange rate of 0.6764, as o f July 28, 2006. 1750.3561 0.676454 41 Nonrescheddable debt to non-Paris Club official bilateral creditors and the London Club, which was already subject to a highly COnCeSSiOMl rcsuuchiring, i s excluded bom the NPVof debt at the completion point in the calculation of this ratio 51 Equivalent to SDR 1,750 million at an SDRRTSD exchange rate o f 0.6764, as o f July 28, 2006 61 I t i s suggested that enhancedHIPC relief for Cbte d'lvoire overtake the commimcnts made u n d n the original HIPC tamework. 60 JOINT WORLD BANKDMF APPENDIXI MALAWI: DEBT SUSTAINABILITY ANALYSIS ON LOW-INCOME BASED COUNTY FRAMEWORK41 1. Malawi’s risk of debt distress after debt relief under the HIPC Initiative and the Multilateral Debt Relief Initiative (MDRI) i s moderate. 42 O n reaching the H P C Completion Point, Malawi’s NPV o f debt-to-exports ratio will drop from 191 percent in 2005 to 39 percent in 2006. Debt service as a share o f exports will decline from 22 to 16.2 percent between 2005 and 2006. Despite this drop in i t s debt burden indicators, Malawi will nevertheless remain vulnerable to exogenous shocks. If the government was not to implement i t s reform strategy to enhance growth, diversify exports and to improve governance, Malawi’s debt burden indicators would increase steeply and the external debt stock indicators would breach their thresholds within a decade. Even when assuming good policy performance accompanied by strong GDP and export growth and substantial inflows o f external financing in the form o f grants, all debt burden indicators are expected to deteriorate through the projection period. Under the most extreme stress test, Malawi’s NPV o f debt-to-GDP ratio breaches i t s threshold for a prolonged period o f time and the NPV o f debt-to-exports ratio also approaches it. Moreover, Malawi’s high domestic debt i s also vulnerable to exogenous shocks.43 I.EXTERNAL DEBT SUSTAINABILITY ANALYSIS 2. The implementation of structural reforms to support private sector development, export diversification and growth, while maintaining macroeconomic stability characterize the underlying macro-framework. 44 Annual output growth i s projected to be about 6 percent over the near term, recovering from a prolonged period o f 41 T h i s appendix updates the debt sustainability analysis (DSA) prepared in August 2005. I t was preparedjointly by the IMF and the World Bank, based on the common standard framework for low-income countries (LIC) approved by the Executive Boards o f the IMF and IDA.41T h i s LIC DSA makes use o f the updated debt data base which was reconciled for the HIPC completion point and also incorporates revised macro-economic projections. 42 The World Bank’s Country Policy and Institutional Assessment (CPIA) rates Malawi as a medium performer. Under the joint World Bank/ IMF debt sustainability framework the correspondingthresholds are 40 percent for the NPV o f external PPG debt to GDP ratio, 150 percent for the NPV of external PPG debt to exports ratio, 250 percent for the NPV o f external PPG debt to revenue ratio, 20 percent for the external PPG debt service to exports ratio, and 30 percent for the external PPG debt service to revenue ratio. (“Operational Framework for Debt Sustainability Assessments in Low-Income Countries - Further Considerations,” SMl05I109, 3/29/05). 43 Malawi’s domestic debt burden increases its vulnerability to exogenous shocks, but does not affect Malawi’s risk rating. 44 The macroeconomic framework underlying this DSA i s identical to the baseline underlying the HIPC DSA. Differences in debt burden indicators are the result of the methodological differences between the joint Bank-Fund Low-Income (LIC) DSA framework and the HIPC methodology. The LIC methodology uses a) a fixed 5 percent discount rate instead o f currency-specific discount rates under HIPC, b) WE0 exchange rate projections instead of fixed exchange rates as o f end-of the base date; and (c) annual exports instead o f a three-year average of exports in the NPV o f debt to exports ratio. 61 poor performance. I t i s assumed to drop to 4.5 percent over the longer t e r m converging to the regional average. Private sector investment and FDI inflows are projected to boost export growth in the long term, leading to an increase in the export share o f the economy from 27 percent in 2005 to 30 percent by the end o f the projection period. Donor support, as measured by net official assistance is assumed to increase gradually and modestly by about 2 percent o f GDP to about 23 percent o f GDP in 2015. I t i s assumed that even after HIPC completion point and implementation o f MDRI about 84 percent o f total aid, excluding HIPC debt relief grants, is provided in the form o f grants. The share o f loans remains relatively low amounting to around 3.8 percent. Although the volume o f new loans increases relative to the past five years, the grant element underlying the new borrowing assumptions i s in l i n e with past experience. 3. All external debt burden indicators are projected to remain below their thresholds under the baseline (Figure 1). Malawi’s NPV o f debt ratio to GDP i s projected to fall from 52 percent in 2005 to 11 percent in 2006, before increasing toward 24 percent by the end o f the projection period (Table 1). Similarly, the NPV o f debt to exports ratio drops from 191 percent in 2005 to 39 percent in 2006, before starting to climb to 8 1 percent by 2026. Malawi’s debt service to exports ratio would decline from 22 in 2005 to 16 percent in 2006, remaining on average at 4.1 percent throughout the projection period. Possible “topping-up” o f HIPC assistance would hrther reduce debt burden indicators in 2004.45 However, since “topping-up” would reduce MDRI relief provided by IDA, IDA’Sallocation to Malawi would be higher after possible topping-up. Assuming that growth assumptions remained unchanged, the additional IDA allocation would lead to a slight increase in Malawi’s debt burden indicators relative to the baseline projections in the medium term.46 4. Failure to implement reforms, lack of donor financing in the form o f grants and exogenous shocks would lead to a substantial deterioration o f Malawi’s debt burden indicators. If key macroeconomic variables, such as GDP growth, the current account deficit and FDI inflows, would assume their historical average, Malawi’s debt stock indicators would breach their thresholds within a decade (Figure 1). Debt stock indicators would also approach their thresholds toward the end o f the projection period if scaling up o f aid would be financed through concessional debt instead o f grants. Finally, under the most extreme stress test, Malawi’s NPV o f debt to GDP ratio would be lifted above i t s indicative threshold by 20 11 for a sustained period o f time. 45 Annual IDA allocations are reduced by the amount o f MDRI relief provided in a given year. See, IDA, “The Multilateral Debt Relief Initiative: Implementation Modalities for IDA,” November 2005. 46 Similar t o IDA, the AfDF “nets out” MDIU debt relief f r o m i t s annual allocation. See AfDF, “The Multilateral Debt Relief Initiative: ADF Implementation Modalities Paper,” November 2005. 62 11. PUBLIC DEBTSUSTAINABILITY ANALYSIS 5. Reducing the large domestic debt burden i s expected to remain the cornerstone of the government’s fiscal strategy through the medium term. Domestic debt reached almost 25 percent o f GDP in 2003/04 with interest costs o f 9 percent o f GDP (or one fifth o f the budget). When a new government was elected in early 2004, i t made reversing the domestic debt spiral i t s fiscal priority. By the end o f FY05/06 the government i s expected t o have succeeded in reducing domestic debt below 20 percent o f GDP and domestic interest costs to about 5.5 percent. This was achieved, despite the severe food crisis, through fiscal restraint, lower interest rates, as well as higher program support. Continued fiscal restraint, hrther reductions in interest rates in tandem with a sustained reduction in inflation, and debt relief under the MDRI are assumed to enable the government to reduce the domestic debt below 10 percent and interest payments to about 2 percent o f GDP. Over the longer term, the baseline scenario assumes that the government will target a stable domestic debt burden o f about 2 percent o f GDP at a cost o f less than 0.5 percent o f GDP in interest payments. 6. External debt relief combined with the government’s commitment to reduce domestic debt would lead to a substantial decline in Malawi’s public debt stock. Malawi’s public debt stock i s expected to drop from 159 percent o f GDP in 2005 to 37 percent o f GDP in 2006 as a result o f HIPC debt r e l i e f and the implementation o f MDRI. I t i s projected to decline and bottom out around 32 percent at the turn o f the decade. Similarly, the NPV o f public debt would decline from 74 percent o f GDP in 2005 to around 18 percent o f GDP at the end o f the decade. 7. The projected improvement in the public debt burden i s vulnerable to a deterioration in either the external or domestic debt indicators. M a n y o f the factors that could cause deterioration in the external debt burden would also threaten domestic debt sustainability. A failure to implement reforms or insufficient donor financing in the form o f grants could also lead to pressures to accumulate domestic debt. A reversion to the historical record o f poor macroeconomic policy implementation during 1999-2003 would retard the reduction in domestic debt and cause deterioration in the public debt burden indicators, even with the level o f external support assumed in the baseline (Figure 2).47 Under the most extreme stress test, Malawi’s NPV o f public debt to GDP would continue to rise indefinitely. 47 Over this period, real GDP growth averaged below 2 percent and the primary deficit (including grants) averaged about 2 percent o f GDP. 2004 and 2005 are excluded from this historical comparison as the primary balance was in surplus during these years. 63 111. CONCLUSION 8. Even after full delivery o f HIPC debt relief and implementation of the MDRI, Malawi would remain at a moderate risk o f debt distress. On reaching the HIPC Completion Point, Malawi’s NPV o f debt-to-exports ratio will drop from 191 percent in 2005 to 41 percent in 2006. Debt service as a share o f exports will decline from 22 to 16 percent between 2005 and 2006. Topping-up o f HIPC assistance would decrease the NPV o f debt to exports ratio further to 31 percent and the debt service to exports to 5.1 percent in 2006, but would not change Malawi’s risk o f debt distress classification. Notwithstanding good policy performance, the debt stock indicators are projected to increase during the projection period and to breach their policy-dependant thresholds if key macroeconomic variables would assume their historical average. Moreover, the NPV o f debt to GDP ratio would breach its threshold under stress tests. Although projected to decline, Malawi’s domestic debt i s currently high, increasing Malawi’s probability o f debt distress. For Malawi’s debt to remain sustainable in the future i t i s important that authorities make prudent use o f the resources freed-up through debt r e l i e f and strengthen their public expenditure management. Moreover, contracting o f new loans on less concessional terms or shifting from grants to loans would significantly deteriorate Malawi’s debt sustainability outlook. 64 a g ; 65 a "9'4 u o m 9 N c! N 2 66 65 f 0 NPV o f debt-to-GDP ratio 55 - / / 0 45 - M / 35 - 25 - 15 - - Baseline without topping-up -- Historical scenario 5 - , +Most extreme stress test Spaling up spenajo , -- , Threshold ;Ba$eline,with foppipg-uR , -5 300 NPV o f debt-to-exports ratio 250 / / / / 200 /* /* / / 0 ,_I Sqaling up sqenaco , --- , B,aseli?e with topping pp , 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 Debt service-to-exports ratio 2o t - Baseline without topping up - Historical scenario - +Most extreme stress test Threshold -Scaling up scenario I - Baseline with topping up / /I' / 4 + - - - - # + - - - -- -- M a - - - - - - - I I-l I - -I I I 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 Source: Bank-Fund staff projections and simulations. Figure 2.Malawi: Indicators o f Public Debt Under Alternative Scenarios, 2006-2026 1/ 60 NPV of debt-to-GDP ratio 50 . 40 . 30 -4 - - 20 t - Baselinewithout topping up Most extreme stress test - I Historical 0 " ' " " " " " ' ' ' ~ ' ~ 1 a 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 140 I NPV o f Debt-to-Revenue Ratio 2/ 120 - 100 - so - - - - d 60 - t - t 40 Baseline without topping up 2o -Most - extreme stress test Historical 0 ' " " " " " " ' ' ~ " ~ 8 I 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 201s 2019 2020 2021 2022 2023 2024 2025 2026 25 1 \ Debt Service-to-Revenue Ratio 2/ 20 - - -Baseline --- without topping up Most extreme stress test Historical :15 O: - 10 -. 5 - 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 Source: Staff projections and simulations. l/ M o s t extreme stress test is test that yields highest ratio in 2016. 2/ Revenue including grants. 68 APPENDIX11-MALAWI:EXTERNAL MANAGEMENT DEBT Malawi’s legal and institutional framework for debt management clearly defines roles and responsibilities. Under the Public Finance Management Act, the Minister o f Finance (MoF) i s the only authority to contract external debt. The Debt and Aid Management Division (DAD) o f the M o F i s responsible for managing and recording external debt. Being the fiscal agent o f the government, the Reserve Bank o f Malawi (RBM) i s responsible for making payments to external creditors upon receipt o f payment instructions issued by the MoF. Data recording and reporting need to be strengthened. External debt data and H I P C debt relief provided by creditors i s reconciled o n an ad-hoc basis, leading to inaccurate forecasts o f debt servicing obligations and to discrepancies between budget estimates and actual debt service payments due. Weak archiving practices make data reconciliation cumbersome and summary checks are not undertaken o n a regular basis. Reports on external debt are not published regularly. Malawi lacks a comprehensive debt management strategy. Although the Budget Division meets regularly with the Debt and,Aid Management Division (DAD) and the RBM to discuss macroeconomic policy, including debt related issues, there seems to be little formal coordination between the government’s cash management, debt management and overall budgeting. Although the government has increased the share o f domestic debt in total debt to meet i t s financing needs during the past years, it does not analyze the costs or risks associated with the different financing options and does not formulate a medium-term debt management strategy. Minimizing borrowing costs i s important to ensure that Malawi remains o n a fiscally sustainable path after having reached i t s completion point. Staff capacity could be bolstered. The DAD lacks trained staff. Only few staff members are capable o f interpreting loan agreements and reports sent by creditors and implement them in the debt recording system. U s e f u l and practical training has been provided by MEFM148, the Commonwealth Secretariat and Debt R e l i e f International, but turnover o f trained staff has been high, resulting in loss o f institutional memory and continuity in work. Technical assistance for building capacity with respect to debt negotiations, formulation o f portfolio and debt strategy as w e l l debt sustainability analysis (DSAs) would be useful. The D S A also suffers from a weak technological infrastructure. 48 Macroeconomic & Financial Management Institute o f Eastern & Southern Africa (MEFMI)