Malawi Malawi at a Glance: 2005-06

Country Report

Malawi Malawi at a glance: 2005-06

OVERVIEW The president, Bingu wa Mutharika, is expected to remain in power over the forecast period, despite attempts by his former party, the United Democratic Front (UDF), and the largest party in parliament, the Malawi Congress Party (MCP), to remove him by legal means. Real GDP growth is forecast to slow from 4.2% in 2004 to 1% in 2005 as drought affects agricultural production. Assuming that the drought ends, a recovery in agricultural performance is forecast to lift real GDP growth to 4% in 2006. High international oil prices in 2005 will exacerbate the effect of a poor harvest, causing the average rate of inflation to increase to 15.4%, before easing to 9.5% in 2006 as the maize harvest rebounds. The current-account deficit is expected to widen from 8.3% of GDP in 2004 to 14% of GDP in 2005, reflecting lower tobacco exports, before narrowing to 10.6% of GDP as tobacco exports pick up again.

Key changes from last month Political outlook • The recent dismissal of the vice-president, Cassim Chilumpha, who was known to be loyal to the former president, Bakili Muluzi, increases the probability that the political battle between Mr Mutharika and his predecessor will continue to dominate Malawi’s politics. Economic policy outlook • The IMF has agreed to a new poverty reduction and growth facility (PRGF) for Malawi, worth US$55.9m, which will run from July 2005 to June 2008. The PRGF has a strong focus on improving fiscal discipline and promoting macroeconomic stability. Additional aims of the programme include improving private-sector access to finance, developing the rural economy and increasing spending on healthcare, education and infrastructure. Although Mr Mutharika’s government is likely to be strongly committed to implementing the PRGF, it is expected to encounter considerable resistance to the reforms from opposition forces in parliament, while ministerial and civil service capacity to implement much of the PRGF will be weak. Economic forecast • There are no changes to the Economist Intelligence Unit’s economic forecast from last month.

September 2005

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Outlook for 2005-06

Political outlook

Domestic politics The political scene in Malawi will continue to be dominated by tensions between the former president, Bakili Muluzi, who is the chairman of the United Democratic Front (UDF), and the new president, Bingu wa Mutharika, who left the UDF in February to form his own political party, the Democratic Progressive Party (DPP). Much of Mr Mutharika’s attention is being absorbed in ensuring that he is surrounded by loyal supporters in government—most recently the vice-president, Cassim Chilumpha, known to be loyal to Mr Muluzi, was dismissed. In parliament a sizeable support base has emerged behind Mr Mutharika, which includes many UDF members, a number of independent members of parliament (MPs) and most of the small opposition parties, but it is not sufficient to guarantee a majority for Mr Mutharika in parliament. However, more opposition MPs are likely to proffer their support for Mr Mutharika in return for access to the benefits of office, and the UDF in particular is expected to haemorrhage support to the DPP as UDF politicians decide that supporting the president is more to their personal benefit. Mr Muluzi is clearly intent on removing Mr Mutharika from power, owing to the anti-corruption drive launched by the new president, which has ensnared people close to the former president. The current strategy for achieving this is to try to have Mr Mutharika impeached. However, the proceedings—delayed until September—are unlikely to be successful: the Economist Intelligence Unit believes that the grounds for impeachment are weak and that the two-thirds majority support in parliament needed for the motion to be passed is unlikely to materialise. Although Mr Muluzi and the UDF look set to receive some support in their campaign from the Malawi Congress Party (MCP), which has the largest representation in parliament, the MCP may decide not to vote for impeachment if this is unlikely to result in its leader, John Tembo, assuming the presidency. Mr Tembo is ambitious to become president and is backing the case for having the 2004 presidential poll results annulled, as he came second in the 2004 poll and expects to be made president if the vote is reassessed—however, the legal proceedings appear to have made little headway. Meanwhile, Mr Tembo refused a recent offer from Mr Mutharika of the post of second vice- president, which has been vacant since the 2004 election. Beyond Mr Tembo’s political ambitions, the MCP’s motivation for backing the UDF’s campaign against Mr Mutharika is not clear cut, and the current very fluid political situation could change quite suddenly. However, the MCP is aware of the need to guard its reputation as an independent party, as this could prove to be a key factor in winning the next election, which may explain why it does not want to be seen as being too closely associated with either the UDF or Mr Mutharika. The battle over the passing of the budget in July demonstrates the difficulty that Mr Mutharika is facing in parliament as the UDF and MCP continue to oppose him. The two opposition parties had raised a number of objections to items within the budget, such as the removal of the universal fertiliser subsidy, and an impasse developed. This is unusual in Malawi, where the passage of

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legislation, including budgets, is normally quite smooth. The impasse was overcome only after considerable mediation between parties and some compromise by the government on issues such as the fertiliser subsidy. The opposition parties are expected to continue to oppose Mr Mutharika by attempting to block his reform agenda in parliament, although the IMF and donors are likely to prove to be a useful ally to the president in this regard, as the opposition are concerned not to provoke a suspension in donor funding, which could ensue if reform bills are not passed.

International relations There will be no external threats to Malawi over the forecast period, and relations with its main trading partners, South Africa and the EU, will remain good. Relations with the IMF remain positive and the Fund has now granted a new poverty reduction and growth facility (PRGF) for Malawi. We expect that this will be followed by a resumption of funding by a number of other donors. However, donors have warned that Malawi must continue to make progress with economic reforms, particularly good governance, in order for their financial support to continue.

Economic policy outlook

Policy trends The IMF has agreed a new PRGF for Malawi, worth US$55.9m, which will run from July 2005 to June 2008, following the successful completion of the 12-month staff-monitored programme (SMP) in June 2005. The PRGF is strongly focused on improving expenditure control and restoring macro-economic stability. Greater fiscal discipline is central to the programme’s target of reducing the domestic debt burden, which in turn is expected to free up resources for additional spending on education, healthcare and infrastructure. The programme also aims to promote the private sector, with lower fiscal borrowing expected to help to reduce high real interest rates; there is a greater emphasis on developing rural areas, by promoting export diversification and developing rural road networks. The programme’s ultimate aim is to boost economic growth to higher levels than in the past by making the private sector a strong engine of growth. After the previous PRGF went well off track, Mr Mutharika’s government has demonstrated a strong political will to reform. By meeting the conditions of the SMP he has helped to pave the way for the new PRGF. However, the IMF has emphasised that the conditions of the new programme have been kept well within realistic bounds and is unlikely to be sympathetic to policy slippages. However, despite top-level commitment, Mr Mutharika is likely to face protracted debate and delays to push economic reform policies through parliament, as he has not secured majority support. In addition, weak institutional capacity and corruption will continue to constitute significant obstacles to policy implement-ation throughout the forecast period. Even if the PRGF policies can be successfully implemented, the timeframe for reforms to result in rapid private-sector growth may be somewhat optimistic—in particular, commercial banks are likely to be reluctant to increase lending to the private sector, and developing infrastructure is a medium- to long-term project. Nevertheless, assuming that it remains on track with the main PRGF targets,

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Malawi is expected to reach completion point under the IMF-World Bank’s heavily indebted poor countries (HIPC) debt-relief initiative in the second half of 2006.

Fiscal policy In the 2005/06 budget, which was passed by parliament in July 2005, total revenue (including external support) is forecast to rise by 45%, to MK116.2bn (US$967m), whereas total expenditure is forecast to rise by 36%, to MK119.5bn (up from MK118.8bn in the proposed 2005/06 budget, owing to an amendment to provide universal fertiliser subsidies rather than targeted fertiliser subsidies). Although the resumption of donor financial assistance and increased efficiencies in domestic revenue collection are expected to lift revenue substantially, the increase is unlikely to be as great as 45%. Not all projected donor funding is expected to be disbursed, and the scope for increasing domestic revenue collection is limited by both the small size of Malawi’s formal economy and the effect of the drought on the mainly agriculture- dependent business sector. Although expenditure on donor-funded projects may be lower than projected, the cost of maize imports and fertiliser subsidies may be higher than budgeted owing to the depreciating exchange rate and the possible need for additional maize and fertiliser to offset the negative impact of the drought. The budget projects a fiscal deficit of 1% of GDP, but we expect a slightly larger, though still reasonable, fiscal deficit of 2.5% of GDP in 2005/06. This may limit the scope for reducing net domestic debt and payment arrears to domestic creditors as quickly as anticipated in the budget. In 2006/07, provided that the government continues to meet donor expectations, external financial assistance will provide a substantial share of total revenue, while domestic revenue inflows should benefit from a pick-up in economic activity if, as expected, the current drought ends. However, strong spending pressures will remain, as there are many competing needs in Malawi that require funding—it is possible that further maize imports and fertiliser subsidies will be required as agriculture begins to recover from drought, the domestic debt burden remains and increased investment in the country’s development is urgently required to diversify the economy and support sustainable economic growth. We therefore expect that it will be difficult for the government to reduce the fiscal deficit much below 2.5% of GDP.

Monetary policy The Reserve Bank of Malawi (the central bank) is expected to keep monetary policy relatively tight over the forecast period in order to try to bring down inflation. The central bank is aware that, at 25%, the bank rate is very high and a constraint on business, but the scope for reducing the bank rate in 2005 is likely to be constrained by mounting inflationary pressure. The central bank is monitoring underlying inflation for evidence of a consistent and sustainable downward trend; although improved fiscal discipline over 2004/05 initially reduced underlying inflation, the trend has become more inconsistent recently, and underlying inflation may increase in 2005/06 as the government embarks on increased spending following a pick-up in donor funding. Because of this, and with broad money growth still in double figures, we do not expect any major change in interest rates during 2005. In 2006, given the expected easing of inflationary pressures, the outlook for interest rate cuts is more positive.

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Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2003 2004 2005 2006 Real GDP growth World 3.9 5.1 4.3 4.1 OECD 1.9 3.3 2.5 2.3 EU25 1.3 2.4 1.6 2.0 Exchange rates ¥:US$ 115.9 108.1 107.8 103.0 US$:€ 1.132 1.244 1.265 1.313 SDR:US$ 0.714 0.675 0.670 0.657 Financial indicators ¥ 2-month private bill rate 0.03 0.00 0.00 0.17 US$ 3-month commercial paper rate 1.10 1.48 3.46 4.79 Commodity prices Oil (Brent; US$/b) 28.8 38.5 55.5 53.5 Tobacco (US$/tonne) 2,646 2,740 2,700 2,720 Tea (US$/kg) 1.5 1.7 1.7 1.6 Sugar (US cents/lb) 7.1 7.2 8.9 9.4 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. Although global economic growth on a purchasing power parity basis is expected to slow during the forecast period, it will remain robust, at 4.3% in 2005 and 4.1% in 2006. The prospects for Malawi’s main trading partners are mixed. The pace of economic growth in the EU25 is expected to remain subdued, whereas South Africa’s economic growth is expected to be more robust. The prospects for Malawi’s main commodity exports will be mixed in 2005-06. Auction prices of burley tobacco, the main tobacco export, have been well below average and show little sign of rising, despite government subsidies of fertiliser to help to improve quality. Tea prices will remain relatively static, at an average of US$1.7/kg in 2005 and US$1.6/kg in 2006, as both global production and demand fall. Slower growth of global sugar stocks and growing demand are expected to lift sugar prices from an average of 7.2 US cents/lb in 2004 to 8.9 US cents/lb in 2005 and 9.4 US cents/lb in 2006.

Economic growth Economic growth will continue to be strongly influenced by the performance of the agricultural sector as a result of the lack of economic diversification and exploitable natural resources. Owing to a long dry spell during February and March at a critical stage of crop development, a sizeable contraction in the agricultural sector is expected in 2005. The 2005 maize harvest is expected to be well down on that of 2004, and tobacco production is estimated to be down by 20%. The manufacturing sector will continue to track developments in the agricultural sector, as food processing forms a large component of this sector. Growth in mining output—mainly based on coal—is expected to pick up significantly following the opening of several mines, but as this rise will be from a very low base it will have little impact on headline growth. Services will benefit from an expansion in government spending due to the resumption of donor financial assistance. Overall, given the contraction in agriculture, real

GDP growth is forecast at only 1% in 2005. The slowly improving business environment and the start of recovery in agriculture, assuming improved weather conditions, are expected to boost real GDP growth to 4% in 2006.

Inflation Higher food price inflation lifted year-on-year inflation to 15.9% in June 2005, from a recent low of 10.9% in September. Food price inflation will increase throughout most of 2005, owing to the expected poor performance of the maize crop. Improved fiscal discipline will, however, allow a further slow decline in non-food inflation. We expect overall inflation to average 15.4% in 2005. Provided that a reasonable degree of fiscal discipline is maintained, the kwacha depreciates at a slower rate and a normal maize harvest is recorded, we expect inflation to fall to an average of 9.5% in 2006. However, inflation will continue to be vulnerable to any further problems in the agricultural sector or sharp falls in the kwacha.

ExchangeInflation rates The kwacha fell sharply, from MK108:US$1 in March 2005 to MK124:US$1 in late June, before stabilising in July and August. The recent stability appears to be the result of central bank intervention, funded by increased foreign-exchange inflows from tobacco exports. Furthermore, agreement on a new IMF programme is likely to have restored confidence that donor inflows will pick up in the short term. However, we expect that the kwacha will continue to depreciate in the second half of the year, as central bank intervention in the market will prove too costly to be continued. The rate of depreciation will, however, be slowed by export revenue from the tobacco auction season (the auctions usually run until September but can last until November) and as increased donor support further boosts foreign-exchange inflows. We therefore expect that the kwacha will depreciate from MK109:US$1 at end-2004 to MK132:US$1 at end-2005. Higher donor inflows and a better agricultural harvest should slow the rate of depreciation in 2006. This will allow the central bank to build up foreign-exchange reserves from a forecast 2.1 months of import cover at end-2005 to 2.6 months at end-2006. We forecast an exchange rate of MK146:US$1 at end-2006.

External sector Exports are expected to fall from an estimated US$476m in 2004 to US$364m in 2005 as the drought impacts negatively on the tobacco crop, the main source of export revenue. There are also reports that low prices at domestic auctions have driven many farmers to smuggle their tobacco out to neighbouring countries, where prices are higher, which could further reduce official export earnings for 2005. Other export crops are also likely to have performed poorly. Assuming normal weather conditions in 2006, exports are forecast to rise to US$409m. Imports are likely to rise sharply in 2005, owing to the need to import maize from external sources to compensate for the poor domestic harvest and because of higher oil prices. Increased economic activity, as domestic demand improves, will boost non-food imports in 2006 but, overall, imports will fall owing to our assumption of a better maize harvest. Tourism receipts, the main source of services credits, are expected to rise slightly in 2005-06, but the services account will remain firmly in deficit, as trade-related costs will keep services debits high. Although interest payments on medium- and long-term external debt will be reduced under the IMF-World Bank’s heavily indebted

poor countries (HIPC) initiative, the fall-off in debt repayments will initially be only modest. Inflows of donor funding are expected to rise in 2005-06, provided that the government continues to make progress with donor-guided reforms, and this will keep the current-transfers account in surplus. Overall, the current-account deficit is expected to widen to around 14% of GDP in 2005, before narrowing to 10.6% of GDP in 2006.

Forecast summary (% unless otherwise indicated) 2003a 2004b 2005c 2006c Real GDP growth 4.4 4.2 1.0 4.0 Gross industrial growth 4.3 4.5 2.0 3.0 Gross agricultural production growth 9.2 2.6 -6.5 4.5 Consumer price inflation (av) 9.6 11.2 15.4 9.5 Consumer price inflation (year-end) 9.8 13.7 16.0 7.9 Short-term interbank rate 48.9 36.8a 35.0 30.0 Government balance (% of GDP) -8.1 -4.2 -2.5 -2.5 Exports of goods fob (US$ m) 402.0b 476.4 364.4 408.6 Imports of goods fob (US$ m) 539.5b 613.0 645.0 620.0 Current-account balance (US$ m) -145.4b -148.1 -261.0 -191.6 Current-account balance (% of GDP) -8.5b -8.3 -14.0 -10.6 External debt (year-end; US$ bn) 3.1 3.2 3.3 3.0 Exchange rate MK:US$ (av) 97.43 108.89a 120.21 140.64 Exchange rate MK:¥100 (av) 84.07 100.71a 111.53 136.54 Exchange rate MK:€ (av) 110.32 135.44a 152.03 184.59 Exchange rate MK:SDR (av) 136.49 161.29a 179.34 214.18 a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

Editors: Nicola Prins (editor); Pratibha Thaker (consulting editor) Editorial closing date: August 18th 2005 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule