Country Report

Malawi Malawi at a glance: 2007-08

OVERVIEW The president, Bingu wa Mutharika, is expected to remain in office over the forecast period, although his support in parliament will continue to be tenuous. He is locked into a fierce power struggle with his former party, the United Democratic Front (UDF), which is intent on undermining him. Economic policy will continue to be guided by the current poverty reduction and growth facility (PRGF) with the IMF, which is expected to remain largely on track. Economic growth is forecast to moderate in 2007, to 3.5%, owing to the tailing-off of the agricultural recovery that followed the 2005 drought, but to rise to 4.3% in 2008 as mining production starts. Reduced pressure on food supplies will help to bring average inflation down from 14% in 2006 to 8.6% in 2007 and 8% in 2008. The kwacha is forecast to depreciate to an average of MK141.2:US$1 in 2007 and MK147.8:US$1 in 2008, owing to strong import demand against a background of low foreign-exchange reserves. The Economist Intelligence Unit forecasts that the current-account deficit will narrow from an estimated 9.6% of GDP in 2006 to 9.1% of GDP in 2007 and 8.5% of GDP in 2008, on account of the increase in nominal GDP rather than a decline in the current-account deficit.

Key changes from last month Political outlook • The legal debate over the enforcement of Section 65 of the Constitution, which forbids floor-crossing, has been resurrected, and the president is now appealing to the Supreme Court over the matter. Legal wrangling is expected to draw the issue out for as long as possible, allowing the Democratic Progressive Party to hold on to their seats (which were gained mainly from floor-crossing) in the interim. Economic policy outlook • The Malawi Growth and Development Strategy has been published, which aims to improve the macroeconomic environment further and boost spending on national infrastructure. The Reserve Bank of Malawi (the central bank) has lowered the liquid reserve requirement (LRR) from 20% to 15.5%. Economic forecast • New data from the National Statistical Office show that year-on-year inflation fell to 9.2% in February 2007, and a downwards adjustment to our international oil price forecast has led to a revision of our forecast for average Aprilinflation 2007 from 10.5% to 8.6% in 2007, and from 8.5% to 8% in 2008.

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Malawi 1

Contents

Malawi

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2007-08 7 Political outlook 8 Economic policy outlook 10 Economic forecast

13 The political scene

18 Economic policy

24 The domestic economy 24 Economic trends 25 Agriculture 27 Mining

27 Foreign trade and payments

List of tables 10 International assumptions summary 12 Forecast summary 19 Macroeconomic targets 20 Malawi Growth and Development Strategy: prioritisation and costing summary 25 Tobacco auction sales 28 Tobacco exports

List of figures 13 Gross domestic product 12 Consumer price inflation 23 Interest rates 24 Inflation 25 Domestic credit

Country Report April 2007 www.eiu.com © The Economist Intelligence Unit Limited 2007

Malawi 3

Malawi April 2007 Summary

Outlook for 2007-08 The president, Bingu wa Mutharika, is expected to remain in office over the forecast period, although his support in parliament will continue to be tenuous. The opposition parties are expected to continue their campaign to undermine the president. Economic policy will continue to be guided by the current poverty reduction and growth facility (PRGF) with the IMF, which is expected to remain on track. Economic growth will moderate as the agricultural recovery from the drought in 2005 tails off. Reduced pressure on food supplies and lower international oil prices from 2008 are expected to help to ease the average rate of inflation to 8.6% in 2007 and 8% in 2008. A small increase in exports, together with higher donor inflows and savings on interest payments on external debt, is expected to see the current-account deficit narrow to 9.1% of GDP in 2007 and 8.5% of GDP in 2008.

The political scene The president has been given permission by the Supreme Court to appeal against the Constitutional Courtrs ruling that Section 65 of the Constitution, which forbids floor-crossing, can be enforced. The vice-president of the Democratic Progressive Party, Uladi Mussa, has been sacked from his position and has attempted to form a new political party. He has also been charged with embezzlement and interrogated over allegations that he plotted to assassinate Mr Mutharika. The treason trial against the vice-president, Cassim Chilumpha, has begun, but is proceeding very slowly. The former president, Bakili Muluzi, has announced his intention to stand in the 2009 presidential election.

Economic policy The Malawi Growth and Development Strategy (MGDS) has been published, and focuses on improving the macroeconomic climate and developing infrastructure over the next five years. The IMF has completed its third review of Malawirs PRGF, praising the governmentrs macroeconomic management but urging greater progress with structural reforms. The Reserve Bank of Malawi (the central bank) has lowered the liquid reserve requirement from 20% to 15.5%.

The domestic economy According to the National Statistical Office, year-on-year inflation fell to 9.2% in February, owing mainly to improved food supplies. According to the Tobacco Control Commission (TCC), total tobacco sales improved in 2006, as high volumes offset lower prices at the auctions.

Foreign trade and payments New data from the TCC show that tobacco exports increased in 2006, and that export prices also increased marginally.

Editors: Nicola Prins (editor); Pratibha Thaker (consulting editor) Editorial closing date: March 26th 2007 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

Country Report April 2007 www.eiu.com © The Economist Intelligence Unit Limited 2007 4 Malawi

Political structure

Official name Republic of Malawi

Form of state Unitary republic

Legal system Based on English common law; constitution promulgated in May 1995

National legislature National Assembly of 193 seats, elected by direct universal suffrage for a five-year term

National elections May 2004 (presidential and legislative); next elections due by May 2009 (presidential and legislative)

Head of state President, elected by direct universal suffrage for a term of five years; Bingu wa Mutharika was elected in May 2004

National government Cabinet, chaired by the president; a new cabinet was named in June 2004 following the May election

Political parties The Malawi Congress Party (MCP) is the largest single party in the National Assembly and the second largest is the United Democratic Front (UDF); smaller parties include the Peoplers Progressive Movement, the Congress for National Unity, the Peoplers Transformation Party, the Republican Party, the Alliance for Democracy (Aford), the National Democratic Alliance (NDA) and the Movement for Genuine Democratic Change (Mgode); independent members of parliament currently form the third largest bloc in the legislature; Mr Mutharika has formed the Democratic Progressive Party (DPP)

President & commander-in-chief of the armed forces Bingu wa Mutharika Vice-president Cassim Chilumpha

Key ministers Agriculture & food security Bingu wa Mutharika Defence Davis Katsonga Economic planning & development Bingu wa Mutharika Education & vocational training Anna Kachiko Finance Goodall Gondwe Foreign affairs & international co-operation Joyce Banda Health Marjory Ngaunje Home affairs & internal security Bob Khamisa Industry, trade & private-sector development Ken Lipenga Information & tourism Patricia Kaliati Irrigation & water development Sidik Mia Justice & constitutional affairs Bazuka Mhango Labour & social development Khumbo Chirwa Lands, housing & service Henry Phoya Local government & rural development George Chaponda Mines, energy & natural resources Henry Chimunthu Banda Persons with disabilities & the elderly Clement Khembo Sports, youth & culture Jaffalie Mussa Transport & public works Henry Mussa

Central bank governor Victor Mbewe

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Economic structure

Annual indicators 2002a 2003a 2004 a 2005 a 2006b GDP at market prices (MK bn) 148.4 171.9 207.2 245.8 296.4 GDP (US$ bn) 1.9 1.8 1.9 2.1 2.2 Real GDP growth (%) 2.9 6.1 6.7 2.2 8.5 Consumer price inflation (av; %) 14.7 9.6 11.4 15.4 14.0a Population (m) 12.1 12.3 12.6 12.9 13.1 Exports of goods fob (US$ m) 422.4 440.6 470.0 524.3 560.3 Imports of goods fob (US$ m) 573.2 595.2b 680.7 b 783.5 b 832.1 Current-account balance (US$ m) -200.7 -190.2b -187.2 b -208.3 b -209.4 Foreign-exchange reserves excl gold (US$ m) 158.3 122.0 128.1 158.9 133.8a Total external debt (US$ bn) 2.9 3.1 3.4 3.2 0.5 Debt-service ratio, paid (%) 7.6 8.4b 11.6 b 16.5 b 13.4 Exchange rate (av) MK:US$ 76.69 97.43 108.89 118.38 136.01a a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2005 % of total Components of gross domestic product 2005 % of total Agriculture 35.5 Private consumption 115.1 Industry 17.5 Government consumption 16.8 Manufacturing 12.5 Gross fixed capital formation 8.9 Services 47.1 Change in stocks -2.1 Net exports of goods & services -40.5

Principal exports fob 2005a US$ m Imports fob 2004a US$ m Tobacco 256 Fertiliser 64 Tea 47 Diesel & other fuels 55 Sugar 41 Petrol 32 Cotton 23 Paraffin 8

Main destinations of exports 2005b % of total Main origins of imports 2005b % of total US 17.7 South Africa 37.6 South Africa 12.5 India 8.1 Egypt 7.8 Tanzania 7.8 Netherlands 6.6 Zambia 7.2 a Official estimates. b Based on partners' trade returns; subject to wide margins of error.

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Quarterly indicators 2005 2006 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr Central government finance (MK m) Revenue and grants 20,790.3 21,790.2 24,918.1 33,641.6 21,898.0 30,229.6 35,361.2 38,452.7 Revenue 15,071.7 15,756.4 16,338.8 15,293.4 16,843.5 18,907.8 19,439.3 19,819.5 Grants 5,094.6 6,033.8 8,579.3 18,348.2 5,054.5 11,321.8 15,921.9 18,633.2 Expenditure 25,601.2 22,499.6 22,966.3 32,138.9 30,811.7 24,373.1 32,227.0 37,834.6 Balance before grants -10,529.5 -6,743.2 -6,627.5 -16,845.5 -13,968.2 -5,465.3 -12,787.7 -18,015.1 Balance after grants -5,434.9 -709.4 1,951.8 1,502.7 -8,913.7 5,856.5 3,134.2 618.1 Output trends Industrial production index (1984=100) 120.0 99.1 97.1 101.3 115.5 n/a n/a n/a Industrial production index (% change, year on year) 1.1 -2.8 -5.8 -10.4 -3.7 n/a n/a n/a Prices National composite consumer prices (2000=100) 198.5 194.1 192.5 208.8 231.8 224.6 217.3 230.7 National composite consumer prices (% change, year on year) 14.3 15.5 15.5 16.2 16.8 15.7 12.9 10.5 Financial indicators Exchange rate: MK:US$ (av) 109.288 117.203 123.513 123.676 129.847 137.583 138.401 138.223 Exchange rate: MK:US$ (end-period) 111.500 122.985 123.588 123.781 133.760 138.987 138.252 139.343 Exchange rate: nominal effective rate (2000=100) 60.0 58.2 59.0 64.6 61.4 57.9 62.0 n/a Exchange rate: real effective rate (2000=100) 74.2 73.0 73.1 80.6 76.4 70.6 72.9 n/a Deposit rate (av; %) 10.67 11.00 11.00 11.00 11.33 12.00 12.00 8.67 Discount rate (end-period; %) 25.00 25.00 25.00 25.00 25.00 25.00 25.00 20.00 Lending rate (av; %) 33.33 33.00 33.00 33.00 33.00 33.00 33.00 29.00 Treasury bill rate (av; %) 24.50 24.38 24.24 24.33 21.64 19.19 18.85 17.40 M1 (end-period; MK m) 24,953 29,579 29,899 31,303 30,849 34,165 34,709 35,689 M1 (% change, year on year) 44.3 23.6 19.7 21.7 23.6 15.5 16.1 14.0 M2 (end-period; MK m) 45,502 51,749 52,483 53,995 55,800 60,000 62,455 62,859 M2 (% change, year on year) 25.0 18.4 18.0 16.2 22.6 15.9 19.0 16.4 Debt-service payments (MK m) 2,649.6 3,537.7 3,034.2 2,749.8 2,006.8 3,228.3 1,977.1 4,616.7 Principal 2,031.7 2,637.3 2,302.9 2,008.6 1,355.4 2,428.0 1,216.3 3,944.6 Interest payments 604.1 897.7 731.3 741.1 651.4 800.3 760.8 672.1 Sectoral trends Building plans passed (MK '000)a 382.7 1,106.4 1,157.8 n/a n/a n/a n/a n/a Electricity consumption (m kwh)b 271.7 278.8 281.6 285.8 267.7 280.9 n/a n/a Tea production (‘000 tonnes) 21.0 7.0 3.0 6.9 19.7 11.5 4.4 9.4 Tobacco auction sales (‘000 tonnes) 1.9 77.6 61.1 3.6 1.4 56.6 70.2 32.2 Tobacco auction sales (MK m) 209.6 10,528.8 8,263.4 444.5 197.2 7,541.2 9,439.7 6,260.7 Sugar production ('000 tonnes) 0.0 97.6 125.6 43.9 0.0 78.7 126.1 68.2 Foreign trade & reserves Exports fob (MK m) 13,706 14,251 17,034 14,058 13,888 n/a n/a n/a Tobacco 7,224 6,077 9,912 8,405 7,899 3,149 22,025 13,299 Imports cif (MK m) -27,048 -34,438 -32,045 -36,152 -30,303 n/a n/a n/a Trade balance -13,342 -20,187 -15,011 -22,094 -16,415 n/a n/a n/a Reserves excl gold (end-period; US$ m) 99.1 118.4 166.1 158.9 114.3 144.6 117.7 133.8 a Blantyre, Lilongwe & Mzuzu. b Units sold locally by the Electricity Supply Commission. Sources: National Statistical Office, Quarterly Statistical Bulletin; Reserve Bank of Malawi, Financial & Economic Review; Monthly Economic Review; IMF, International Financial Statistics.

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Outlook for 2007-08

Political outlook

Domestic politics The president, Bingu wa Mutharika, is expected to remain in office over the forecast period, but his support in parliamentwhich consists of his own party, the Democratic Progressive Party (DPP), a few other small parties and a number of independentswill be severely tested. The United Democratic Front (UDF), which originally brought Mr Mutharika to power but is now a minority opposition party, is bitter that he left to form his own party. The UDF is driving a fierce anti-Mutharika campaign, and has the support of the largest party in parliament, the Malawi Congress Party (MCP), which is hoping for some strategic gain, such as being allowed to take over the presidency if Mr Mutharika is forced to resign. The oppositionrs previous attempts to impeach the president having failed, it is now focused on trying to undermine Mr Mutharika through diminishing his partyrs position in parliament. As the DPP is a relatively new party, formed after the 2004 elections, its representation consists mostly of disgruntled members of other parties who crossed over, as well as five seats won in by-elections. The opposition are attempting to have Section 65 of the Constitution, which bars floor-crossing, enforced. The Constitutional Court ruled in their favour in November 2006, which would have entitled the speaker, Louis Chimango, to declare most of the DPPrs 70-odd seats vacant when parliament reopened in February 2007. However, the president has been granted permission to appeal to the Supreme Court over the ruling. The continued delays in resolving the controversy surrounding Section 65 are working in the presidentrs favour, allowing the DPP to hold on to as many of its seats as possible in the interim. Even if the Supreme Court rules against the appeal, the DPPrs legal team is likely to support the affected MPs in seeking individual court injunctions. Protracted legal battles could, therefore, make it nearly impossible for the courts to settle all of the Section-65 cases prior to the legislative and presidential elections in 2009. However, although the DPPrs parliamentary wing may survive the fallout from the Section 65 issue, in-fighting amongst the leadership continues to plague the partythis has recently led to its vice-president, Uladi Mussa, leaving to form his own party, taking a number of members with him. However, Mr Mutharika faces a more significant challenge to his leadership from his political arch-enemy, former president Bakili Muluzi, who recently announced his intention to stand as the UDFrs presidential candidate in 2009. The former president remains powerful and popular within Malawian politics, and because of this, combined with his experience of previous campaigns, he could be expected to present a very stiff electoral challenge. However, Section 83 of the Constitution limits a president to a maximum of two consecutive terms, which Mr Muluzi served between 1994 and 2004, and he is likely to face a legal challenge from Mr Mutharika over an attempted third term if he proceeds with his candidacy. The MCP has also stated that it does not support a third term for Mr Muluzi, and may decide to join Mr Mutharika in any legal or parliamentary challenge to the bid. There is also likely to be opposition from

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within the UDF: there are a number of ambitious party stalwarts who feel that they also deserve a chance to run for the presidency. Finally, there was widespread condemnation in Malawi of Mr Muluzirs previous third-term bid in 2004, and the issue could once again mobilise civil-society organisations to campaign against Mr Muluzi, resulting in widespread popular protest. It therefore appears that the third-term bid will bring considerable negative publicity for the UDF, and create divisions within it, and that the chances of Mr Muluzi succeeding to the presidency are again very slim. In the meantime, another of the presidentrs political rivals, the UDF stalwart and state vice- president, Cassim Chilumpha, will continue to be sidelined by his entanglement in a treason trial that shows little sign of being settled quickly. The extensive use of legal wrangling by feuding politicians has become a central feature of Malawian politics, which look set to continue in a state of turmoil throughout 2007-08.

International relations There will be no external threat 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 are expected to remain positive as the poverty reduction and growth facility (PRGF) will continue to make satisfactory progress, and this will ensure that donors remain supportive of Malawi. Moreover, now that Malawi has qualified for significant external debt relief, donors are likely to work even more closely with the country to address economic issues, providing an increasing amount of technical support. Given the critical role that donors play in providing the financial and technical support that Malawi is so heavily dependent on, they are able to exert considerable influence over Malawirs government. A good relationship already exists with the executive and key financial organs of government, but donors are also able to put considerable pressure on parliament to pass Mr Mutharikars key reforms and budgetsthe threat that donor funding might otherwise be suspended is always in the background.

Economic policy outlook

Policy trends Malawirs continuing dependence on donor support will ensure that the three- year PRGF agreed with the IMF in June 2005 will guide the overall direction of economic policy during the forecast period. In addition, the recently published five-year Malawi Growth and Development Strategy (MGDS) strongly supports the commitment to the PRGF as a central element of poverty reduction. The programme is strongly focused on improving expenditure as the key to restoring macroeconomic stability, reducing the domestic debt burden and clearing arrears to domestic creditors. Spending priorities are focused on improving food security, particularly through the development of agriculture- related infrastructure such as dams, irrigation schemes and the rural road network. This is expected to tie in with schemes to encourage subsistence farmers to grow cash crops and diversify away from growing mainly maize. Beyond agriculture, economic policy is expected to remain focused on boosting growth by developing the agro-processing, mining and tourism sectors. This will involve improving other areas of the national infrastructure, particularly

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electricity and water provision; addressing the excessively high transport costs charged by hauliers; and strengthening regulation to deal with anti-competitive behaviour and reduce bureaucratic obstacles to doing business in Malawi. The IMF has been upbeat in its assessment of Malawirs programme so far, and has confirmed that the government has met all of its quantitative targets to date. This led to extensive external debt cancellation in late-2006, which is helping to free up key resources for priority spending areas. However, improvements in service delivery and progress on development projects will be constrained by weak institutional capacity.

Fiscal policy In fiscal year 2006/07 (July-June) greater inflows of donor funding and increased revenue from the expanding manufacturing and services sectors will be offset by the tax cuts announced in the 2006/07 budget, resulting in modest overall revenue growth. Following large savings on debt servicing as a result of the external debt write-offs granted in 2006, as well as the tailing-off of drought-related assistance, in March 2007 the government introduced a supplementary budget that aimed to increase spending by a further 7%. Although this has been delayed in parliament, the spending plans are likely to be implemented, with the necessary approval being applied retroactively. Thus growth in expenditure is expected to outpace revenue growth slightly, causing the budget deficit to widen, although improved public-expenditure management will keep it within reasonable limits, at around 3.7% of GDP. Over the forecast period there will be significant pressure to increase social spending and undertake large-scale development expenditure, particularly on agriculture-related infrastructure. Expenditure pressures will intensify as the 2009 elections approach. At the same time, the government is also determined to continuing paying off the sizeable domestic debt and domestic arrears inherited from the previous government. However, the government is expected to broadly maintain fiscal discipline, which will help to ensure that donors remain committed to Malawi. The fiscal deficit is expected to increase only slightly, to 3.9% of GDP in 2007/08 and 4.3% of GDP in 2008/09. The deficit will be financed largely through donor funding as the government attempts to improve the overall domestic debt position further. However, another drought would push the budget deficit higher, and in consequence domestic borrowing might become necessary.

Monetary policy The Reserve Bank of Malawi (the central bank) reduced the liquid reserve requirement from 20% to 15.5% from February 1st. The decision was based on the central bankrs confidence that inflation is coming under control and will continue to decline. The decision also reflects pressure on the central bank to make it easier for businesses to access capital and thus support the governmentrs objective of private-sector-led growth. The finance minister has also hinted that the central bank is considering a further interest-rate cut, to take place in 2007 if current trends continue. The Economist Intelligence Unit expects that this will probably take place towards the end of 2007, and will be smaller than the previous cut, at around two percentage points. The central bankrs overall emphasis during the forecast period will be on trying to balance

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the need to keep inflation in check with its desire to find opportunities to reduce interest rates further.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2005 2006 2007 2008 Real GDP growth World 4.7 5.3 4.7 4.6 OECD 2.6 3.2 2.5 2.6 EU27 1.7 3.0 2.4 2.3 Exchange rates ¥:US$ 110.1 116.2 114.0 103.0 US$:€ 1.246 1.256 1.329 1.353 SDR:US$ 0.677 0.680 0.658 0.646 Financial indicators ¥ 2-month private bill rate 0.00 0.28 0.90 1.84 US$ 3-month commercial paper rate 3.38 5.04 5.15 5.00 Commodity prices Oil (Brent; US$/b) 54.7 65.3 61.0 58.0 Food, feedstuffs & beverages (% change in US$ terms) -0.5 16.1 5.3 -2.0 Tea (US$/kg) 1.6 1.9 1.8 1.8 Sugar (US cents/lb) 9.9 14.8 11.9 11.4 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. Global economic growth, on a purchasing power parity basis, is expected to remain robust, but to edge down marginally from 4.7% in 2007 to 4.6% in 2008. Fairly strong domestic demand is expected to drive average growth of around 4.5% in 2007 and 5.1% in 2008 in South Africa, Malawirs main trading partner. The prospects for Malawirs main commodity exports will be mixed in 2007-08. Auction prices for the countryrs burley tobacco are likely to remain below their historical average. Tea prices will decline to an average US$1.8/kg in 2007-08 as global production increases while demand remains relatively static. Rising global sugar stocks together with an easing-off of demand will also see sugar prices drop, from 14.8 US cents/lb in 2006 to 11.9 US cents/lb in 2007 and 11.4 US cents/lb in 2008. International oil prices are expected to remain relatively high in 2007, averaging US$61/barrel, but will ease to US$58/b in 2008 owing to an expected increase in oil-refining capacity.

Economic growth The recovery of the key sector, agriculture, from the 2005 drought will tail off over the forecast period, and the sector will experience growth of around 2.8% in 2007 and 2.2% in 2008. Most of Malawirs agricultural production consists of smallholder subsistence farming, which relies on seasonal rains and is highly vulnerable to the cyclical droughts that the country experiences. Manufacturing, which consists mostly of agro-processing, will continue to experience modest growth, with trends affected more by the limited supply of electricity and inflows of cheaper imports than by the weather (commercial agriculture benefits more from irrigation). Mining is forecast to experience high growth owing to the construction of two new mines, which will absorb a large amount of investment and result in the start of uranium production from 2008. General

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construction activity will also remain robust, and will focus increasingly on developing the countryrs national infrastructure, particularly the rural road network and dams. The services sector will benefit from increased dynamism and competition in the financial sector, the continued expansion of telecommunications due to the popularity of mobile phones, and the modest expansion in government spending. Overall, real GDP growth is forecast to moderate to 3.5% in 2007, in line with slowing agricultural recovery, before rising to 4.3% in 2008 with the start of mining production.

Inflation Improved weather conditions in 2006 boosted food production significantly, helping to lower year-on-year inflation to 10.1% by December, and inflation averaged 14% for the year. The downward trend has continued into 2007, with year-on-year inflation falling to 9.2% by February. Assuming continued favourable weather, food inflation is expected to moderate further over the forecast period. A moderation in international oil prices will also help to lower non-food inflation, but modest fiscal expansion and currency depreciation will exert some inflationary pressures, particularly given the high dependence on imported consumer goods. As a result, inflation is forecast to average 8.6% in 2007 and 8% in 2008.

Exchange rates The exchange rate depreciated in 2006 from MK130.8:US$1 in January to MK139.3:US$1 at the end of December. The kwacha depreciated rapidly in the beginning of the year owing to the late opening of the tobacco auctions, but stabilised after tobacco exports picked up later in the year. Over the forecast period we expect a steady depreciation as demand for imports remains high against a background of limited external inflows and low foreign-exchange reserves. Traditionally, over the course of a year the kwacha is strongly influenced by the seasonal pattern of tobacco exports: it depreciates in the first quarter of the year, ahead of the tobacco auctions, and again in the final quarter of the year, after the tobacco auctions have closed. Between these periods the kwacha stabilises and even occasionally appreciates, particularly if this coincides with the timing of donor disbursements. However, the onset of uranium exports in 2008 will not only provide an important additional source of foreign-currency earnings but will also help to ease currency fluctuations during the year. Meanwhile, the currency is expected to remain vulnerable to sharp falls: potential triggers could be a suspension of donor funding, a downturn in tobacco prices or political uncertainty regarding the presidentrs support in parliament. We therefore forecast that the kwacha will depreciate to an average of MK141.2:US$1 in 2007 and MK147.8:US$1 in 2008.

External sector Since Malawirs tobacco auction prices are at historical lows, the Tobacco Control Commission has warned that export volumes may be negatively affected as some farmers consider growing alternative crops or selling their tobacco over the border to higher-paying markets. However, a slight increase in international prices will compensate for this and see total tobacco export earnings remaining at around current levels. Although Malawirs exports are expected to remain dominated by tobacco, steady growth is expected in non- traditional exports and the completion of the uranium mine towards the end of 2008 will drive exports higher that year. Over the forecast period the fuel

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import bill will remain high, but will moderate slightly as international oil prices decline from 2008, while mining development will boost capital imports, resulting in an overall increase in imports. Tourism receipts, the main source of services credits, are expected to rise slightly over the forecast period. However, services debits will remain high owing to trade-related costs, keeping the services account firmly in deficit. Interest payments on external debt will be significantly reduced owing to the extensive external-debt write-offs received in 2006. Inflows of donor funding are expected to increase over the forecast period, 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 forecast to narrow from 9.6% of GDP in 2006 to 9.1% of GDP in 2007 and 8.5% of GDP in 2008.

Forecast summary (% unless otherwise indicated) 2005 a 2006 b 2007c 2008c Real GDP growth 2.2 8.5 3.5 4.3 Gross industrial growth 12.6 6.7 4.0 8.5 Gross agricultural production growth -9.0 11.5 2.8 2.2 Consumer price inflation (av) 15.4 14.0 a 8.6 8.0 Consumer price inflation (year-end) 16.5 10.1 a 8.5 8.0 Lending rate (av) 33.1 32.0 a 26.0 24.0 Government balance (% of GDP) -2.5 -3.7 -3.9 -4.3 Exports of goods fob (US$ m) 524.3 560.3 581.9 635.9 Imports of goods fob (US$ m) -783.5 b -832.1 -870.1 -897.9 Current-account balance (US$ m) -208.3 b -209.4 -211.1 -211.2 Current-account balance (% of GDP) -10.0 b -9.6 -9.1 -8.5 External debt (year-end; US$ bn) 3.2 0.5 0.6 0.7 Exchange rate MK:US$ (av) 118.38 136.01 a 141.21 147.82 Exchange rate MK:¥100 (av) 107.54 117.03 a 123.87 143.51 Exchange rate MK:€ (av) 147.47 170.79 a 187.70 199.92 Exchange rate MK:SDR (av) 174.93 200.13 a 214.53 228.99 a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

Gross domestic product Consumer price inflation (% change, year on year) (av; %)

Malawi Sub-Saharan Africa Malawi Sub-Saharan Africa 9.0 16.0 8.0 15.0 7.0 14.0 6.0 13.0 5.0 12.0 4.0 11.0 3.0 10.0 2.0 9.0 1.0 8.0 0.0 7.0 08 03 04 05 06 07 03 04 05 06 07 08 2002 2002

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The political scene

The Section 65 issue is still The latest opposition strategy for weakening the president, Bingu wa Mutharika,

being considered in court and his party, the Democratic Progressive Party (DPP), has resulted in a protracted legal battle. In mid-2006 the opposition United Democratic Front (UDF) and Malawi Congress Party (MCP) launched an attempt to force the speaker of parliament to enforce Section 65 of the Constitution, under which the seat of any member of parliament (MP) who was elected while standing for one particular party but then defected to another party after the election can be declared vacant (January 2007, The political scene). As the DPP is almost entirely composed of floor-crossing MPs, the opposition parties calculated that Section 65 could be used to substantially reduce the presidentrs parliamentary support. The president went to the Constitutional Court in an effort to block such a move, but the court ruled against him in November 2006, as well as rejecting an appeal in December. However, the president continued with his legal battle early in the new year, and on January 16th the matter went to the Supreme Court. A five-judge panel heard arguments from the presidentrs side that as Mr Mutharika was the referral authority, he could be granted permission to appeal and have a stay order against the Constitutional Courtrs November ruling on Section 65. Mr Mutharikars counsel argued that the Constitutional Court had made errors both in its ruling and the subsequent hearing of the appeal. Furthermore, they contended that the matter was too important to be dealt with at the Constitutional-Court level and that the deliberation over Section 65 should be handled by the Supreme Court. On January 23rd the Supreme Court ruled that the appeal could go ahead, but that it should begin within 45 days so as to prevent further lengthy delays. Meanwhile, parliament opened on February 19th and Section 65 did not dominate proceedings, as the speaker was awaiting the resolution of the matter in court.

The matter is unlikely to be The opposition, predictably, felt that the Supreme Court should not have

resolved soon allowed the president to appeal against the Constitutional Courtrs ruling. Opposition figures argued that such a development would be used as a delaying tactic by a government fearful of losing its parliamentary support. To some extent, this was borne out when the 45-day limit was missed in mid- March. The presidentrs lawyer, Maxon Mbendera, was quoted as saying that the appeal would be heard "within the next month"which implied some time in Aprilbut no precise date was announced. Both the UDF and the MCP expressed annoyance over the missed deadline, but did not counter with any further legal challenge to try to force an earlier resolution of the issue. Meanwhile, the continued delays in the resolution of the Section 65 issue have worked in the presidentrs favour, as his party has held on to the seats in question in the interim. The presidentrs legal team will aim to ensure that even if their appeal is rejected by the Supreme Court, they at least delay the courtrs decision for as long as possible, and also support those MPs who have their seats declared vacant in seeking individual court injunctions. Protracted legal battles have become popular amongst feuding politicians in Malawi in recent years, and the propensity for lengthy legal wrangling could make it near

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impossible for the courts to settle all of the Section-65 cases prior to the parliamentary elections in 2009. Thus, Mr Mutharika still has a good chance of maintaining his current support base in parliament for much of the rest of his current term; however, even at its peak of nearly 70 MPs in 2006, the DPPrs representation still only constituted a minority in parliament, and Mr Mutharika will continue to face considerable opposition in parliament. Donor pressure on the opposition will remain critical for getting key pieces of legislation passed.

The DPP sacks its Although it seems that the DPPrs parliamentary wing may survive the fallout

vice-president from the Section-65 issue, all is not well elsewhere within the presidentrs party. On January 13th the DPP hierarchy announced that the partyrs vice-president, Uladi Mussa, had been sacked from his position and expelled from the party. The decision was taken by the DPPrs National Governing Council (NGC) after it uncovered evidence that Mr Mussa was in the process of forming his own party and attempting to bring about a series of defections to it from the DPP. It became apparent that Mr Mussa had approached at least two members of the NGC, Greenwell Mwamondwe and Abdul Pillane, to join the new party. The sacking of Mr Mussa from the party came only a few months after he was dismissed as minister for agriculture following the controversy surrounding the fertiliser subsidy programme (January 2007, The domestic economy). Mr Mussa described his dismissal as unconstitutional, claiming that he had played an important role in the formation of the DPP. Nevertheless, he promptly announced that he was forming a new political party. A number of DPP members followed himmainly from Malawirs central district of Salima where Mr Mussars support is strongest. The most prominent defection was that of the partyrs candidate for the Salima North-West constituency, Mabvuto Kaipa, who had been chosen to contest an upcoming by-election for the seat after it fell vacant following the death of the incumbent, Steven Nankhumwa of the MCP. However, aside from Mr Mussa, no serving MPs left the DPP, so the DPPrs parliamentary representation has not been affected.

Mr Mussa soon comes On January 22nd Mr Mussa attempted to formally register his new party, which

under fire was to be called the Malavi Peoplers Party (MPP). However, apparently after government intervention, the registrar-general would not register the party. The dispute centred around the word "Malavi", which sounds like Malawi, and so needs special authorisation for use as a party name under electoral rules. The government also argued that the name "MPP" was too similar to DPP. As a result of the uncertainty surrounding the registration of Mr Mussars party, its launch was affected and the start to its campaigning delayedwhich was likely to have been the governmentrs intention from the start. To complicate matters for Mr Mussa, he was then arrested on January 26th on charges of having misappropriated coupons destined for the fertiliser subsidy programme during his time as minister of agriculture. After questioning, he was released, but he had not been out of police custody for long when he was again brought in for questioning on February 19th. This time, he was interrogated over allegations that he plotted to assassinate Mr Mutharika. Somewhat alarmingly, this is a familiar story in Malawi; the countryrs vice-president,

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Cassim Chilumpha, is currently being tried over a separate alleged assassination plot. The governmentrs allegations of a proliferation of assassination plots creates the impression of an increasingly paranoid regime; but the reality is probably that such allegations are convenient as tools that help to restrict the activities of Mr Mutharikars enemies.

Mr Muluzi intends to stand in The former president, Bakili Muluzi, has publicly confirmed his availability to

the 2009 presidential election stand as the UDF’s candidate in the presidential election due in 2009, raising the possibility of an intriguing head-to-head face-off with Mr Mutharika, his former protégée (January 2007, The political scene). There had been some doubt as to whether Mr Muluzi actually wanted to stand, and the UDF attempted to end the speculation by giving Mr Muluzi an ultimatum; in early March, the UDF leadership gave the former president seven days to declare his intentions. In response, at a rally in Blantyre on March 11th, Mr Muluzi formally declared his interest in becoming the UDFrs presidential candidate at the election. This announcement received an enthusiastic response from the UDF supporters at the rally. Mr Muluzi emphasised that he would follow democratic practices and formally seek the nomination via the ballot box at the UDFrs convention, which is expected in the second half of 2007. In declaring his intention to stand, Mr Muluzi launched a bitter attack on Mr Mutharika. Mr Muluzi said that he had been forced to come out of retirement as Malawirs democracy was under threat, alleging that Mr Mutharika is attempting to bring about a return to a one-party state. Addressing the issue of whether he is eligible to standhaving already served two terms in power he told the rally that he was not barred under the rules set out in the Constitution, as it only bars him from a third term if it is taken consecutively.

Barriers remain to Mr Muluzi However, the issue of a presidential third term is not as clearcut as Mr Muluzi

running for president would seek to make out, and considerable opposition to the idea has been raised in the press, and by numerous other civil society organisations and political parties, including the MCP. For his part, Mr Mutharika will almost certainly not want to face Mr Muluzi if he can at all help it. The former president remains powerful and popular within the southern region of the country where Mr Mutharika also has his main support base. Because of this, combined with his experience of previous campaigns, Mr Muluzi could be expected to present a very stiff electoral challenge. Therefore, it seems that Mr Mutharika and his supporters will attempt to prevent Mr Muluzi from standing. It is most likely that these efforts will be channelled via the Constitutional Court. Despite Mr Muluzirs assertion that there is nothing in the Constitution to prevent him from running for president again, there is enough uncertainty in the Constitutionrs wording on the matter to ensure lengthy legal debate. Section 83 of the Constitution limits a president to a maximum of two consecutive terms, which Mr Muluzi served between 1994 and 2004. However, the Constitution does not make it clear whether this two-term limit applies throughout a politicianrs lifetime or whether a politician can return to serve further terms at a later date. As has been the case in the failed impeachment attempt, the Section 65 floor-crossing debacle and now the ongoing Chilumpha

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trial, Mr Mutharika has shown that he is adept at tying up his rivals in time- consuming legal wrangling. Even if Mr Muluzi is deemed eligible to stand, he may encounter opposition from within his own party. Although there was much celebration from the UDF supporters present at the rally where the announcement was made, the event was well orchestrated and it remains to be seen whether this support extends to the party as a whole. There are many other big personalities within the UDF who fancy their chances of winning the presidential candidacy. Powerful people within the UDF, such as Sam Mpasu and Friday Jumbe, have repeatedly been linked with seeking the nomination and so may come out in opposition to Mr Muluzi. Were this to happen, divisions could well affect the UDF, to the detriment of its overall election campaign. Finally, the extent of Mr Muluzirs popularity within the country as a whole is still unclear. In 2004 when his supporters attempted to amend the constitution to allow him to stand for a third consecutive term, there were popular protests against the move (April 2003, The political scene).

The trial of Mr Chilumpha The treason case against the vice-president, Cassim Chilumpha, has proceeded

begins very slowly. Mr Chilumpha was arrested over a year ago on charges of treason relating to allegations that he had plotted an assassination attempt against Mr Mutharika (July 2006, The political scene). Since then, the slow progress with his case has helped to create the overriding impression that it is merely part of the wider political conflict between Mr Mutharika and Mr Muluzi. Mr Chilumphars trial finally began on January 30th 2007, but was immediately dogged by legal wrangling over various technicalities. The Malawi Law Society (MLS) objected to the staters decision to hire a British lawyer, Anthony Berry, to join the prosecution team. The fact that a specialist lawyer from overseas was brought in reflects how much the state, and Mr Mutharika in particular, wants to ensure a conviction. The MLS complained that the government had failed to comply with procurement laws in hiring Mr Berry, although it seems more likely that the real reason behind their objection was resentment that a local prosecutor had not been chosen. The issue was eventually resolved in the staters favour and Mr Berry was declared free to practise in Malawi. Before the trial could get under way, the prosecution then announced that charges were being dropped against one of Mr Chilumphars co-accused, Rashid Nembo, owing to a lack of evidence against him. Mr Nembo, who is a member of the opposition UDF, was angry that the charges had not been dropped sooner, having been incarcerated for nine months. The dismissal of the charges against him was an early blow for the state, and left Mr Chilumpha standing alongside Yusuf Matumula as the only two remaining defendants out of the 13 originally arrested in connection with the assassination plot. Following these early manoeuvres, the case was then adjourned until February 7th as the High Court Judge, Andrew Nyirenda, allowed time to hear arguments as to whether the identity of key state witnessesthe South African assassins alleged to have been engaged by the co-accusedshould be concealed. The director of public prosecutions, Wezi Kayira, felt that the identities should be concealed for security reasons, while the defence argued that witnesses should testify in an open court.

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Mr Chilumpha pleads not Once under way againit was decided that the witnesses should remain

guilty anonymousthe trial received another setback on February 8th when Mr Chilumpha refused to enter a plea. The defence team argued that the charges against Mr Chilumpha were not specific enough and that the state had failed to provide the vice-president with enough details concerning its case against him. The fact that the identity of the alleged assassins was being withheld was one such detail. Another issue that the defence said precluded Mr Chilumpha from making a plea was what they termed the "duplicity" of the charges. Mr Chilumpha faces charges of both treason and conspiracy to murder in relation to the assassination plot, but the defence argued that one event should not attract two charges. After further legal wrangling, the High Court eventually ruled against the defence plea on February 22nd, stating that Mr Chilumpha must stand trial as charged. Justice Nyirenda found no duplication in the charges and so Mr Chilumpha was ordered to face the accusations of both treason and conspiracy to murder. However, Justice Nyirenda also ordered that the accused be given an opportunity to gain a full understanding of the charges levelled against them. Following these rulings, on February 26th Mr Chilumpha pleaded not guilty to both charges. This should have paved the way for the trial proper to begin, but this was again adjourned as the trial became engulfed in a debate over the staters witnesses.

The media reveals identities of On February 15th a Malawian newspaper, the Nyasa Times, announced that it the state's witnesses had come into possession of a leaked memorandum of understanding (MOU) purportedly between the government and the alleged assassins implicated in the trial of Mr Chilumpha. The MOU set out the governmentrs obligations towards the witnesses, including the provision of safe accommodation and a monthly allowance of US$2,000. More importantly, the alleged assassins were specifically named as Graham Minnaar and Thomas Ndhovu, ending the state prosecutionrs efforts to keep their identities concealed. The domestic media, primarily the opposition-aligned publications, were quick to investigate the named men. It was soon discovered that Mr Minaar is a South African citizen who has previously worked as a mercenary, while Mr Ndhovu was born in Malawi but now has a South African passport and has also worked as a mercenary. Mr Chilumphars defence team immediately picked up on these developments, and accused the government of hiring mercenaries to pose as the alleged assassins in the treason case. The defence lawyer, Fahad Assani, claimed that the MOU represents a vindication of the defencers argument that the witnesses were paid to give their testimony by the government and that this represents bribery under Malawian laws. This, Mr Assani claimed, was clear proof that the entire case against Mr Chilumpha was nothing more than a witch-hunt.

The trial is expected to run for Following the revelation of the witnessesr identities and the "not guilty" plea of

some time Mr Chilumpha and his co-accused, the prosecution applied for another adjournment. Mr Berry requested a one-week period in which to examine the implications of the unmasking of the witnesses, which the court granted. Thus by late March, the trial was still not fully under way. It is unclear exactly how

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the state’s case will be affected, in particular whether it has been permanently undermined. But there are still many advantages in continuing with the case, for even if Mr Chilumpha is not found guilty, the trial is likely to drag on for a considerable length of time, thus continuing to sideline a popular political rival to Mr Mutharika. As a result of the long-running case, Mr Chilumpha has been prevented from carrying out his duties as vice-president in the Malawian government, where his presence as a Muluzi ally clearly irked the president.

Local elections are to be After a series of delays, election officials announced in January that the next

delayed until 2009 local elections would be held in 2009 alongside the presidential and legislative elections due that year. According to the Constitution, local elections should be held a year after general elections. This should have resulted in the local polls being held in 2005, the year after the last presidential and legislative elections. However, the government was forced to abandon them and redirect the funding allocated for them to the food crisis that was mounting at the time. Further delays followed, again owing to lack of funding, until September 2006 when a date of June 5th 2007 was finally set by election officials (October 2006, The political scene). At around the same time, the finance minister, Goodall Gondwe, announced that the government had set aside around US$11m for the elections and that additional funds were expected from Malawirs international donors. These events implied that the matter had been resolved and that the government had abandoned any desire to hold local and national elections at the same time. However, this position was seemingly reversed on January 23rd when a spokesman for the Malawi Electoral Commission (MEC), Fegus Lipenga, informed local media that donors and consultants had suggested holding tripartite elections in 2009. The previous government under Mr Muluzi and the UDF had made a similar attempt to alter the electoral system in 2003, arguing that there would be significant cost savings in holding a tripartite election, but was defeated in parliament owing to concern among the opposition that this would increase the chances of vote tampering, as well as confuse voters (January 2004, The political scene). But much to the consternation of the UDF, which is now in the opposition, the latest attempt appears likely to succeed. Delays in naming MEC commissionersdue to a lack of agreement between the president and oppositionhas left little time for arranging and holding elections during 2007. Nevertheless, Mr Muluzi attacked the MECrs decision, accusing Mr Mutharika of "raping the Constitution", before calling on MPs to demand local government elections by June 2007. While the government argues that delaying local elections until 2009 makes sense given logistical and financial constraints, the opposition insists that the delay owes more to the government wanting as much time as possible to bolster its uncertain grassroots support.

Economic policy

A new poverty reduction In early February the IMF published the Malawian governmentrs latest poverty

strategy paper is published reduction strategy paper (PRSP), which is to be known locally as the Malawi Growth and Development Strategy (MGDS). The MGDS runs from fiscal year 2006/07 (July-June) to 2010/11 and replaces the Malawi Poverty Reduction

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Strategy (MPRS), which expired in mid-2005. The MPRS was assessed by the IMF and World Bank as having failed to bring about any substantial decline in poverty: around 52% of the population were found to be living in poverty (surviving on less that US$1 a day) in 2005virtually unchanged from 2002 (July 2006, Economic policy). However, the IMF-World Bank review of the MPRS did acknowledge that there had been significant improvements in the macroeconomic environment, which would be key to making progress in reducing poverty in the future (January 2007, Economic policy). The government claims that the lessons learnt under the MPRS have been incorporated into the newly-published MGDS, which hopes to ensure that poverty reduction is achieved through creating a favourable macroeconomic climate and focusing on infrastructure development.

A favourable economic climate The government argues that adverse macroeconomic conditions in Malawi

is called for have been a significant barrier to poverty reduction in recent years. Largely because of fiscal indiscipline in the past, the country has been plagued by high inflation, unsustainable levels of debt, unstable exchange rates and low levels of economic growth. However in recent years, under the current regime, macroeconomic stability has improved considerably; inflation has moved into single digits, fiscal management has improved significantly and external debt has largely been forgiven. Commitment to IMF programmes is seen as a key contributory factor to the improvements, and thus the MGDS is premised on a continuing commitment to the poverty reduction and growth facility (PRGF). Based on performance to date, the current governmentrs commitment to the PRGF is not in doubt, and further gradual improvements in the macroeconomic environment are expected to materialise. But the targets contained in the MGDS are ambitious, and appear to be based on a best-case scenario, where economic policy is implemented exactly according to plan. However, exogenous factors pose a significant risk to this scenario; poor rains periodically affect food supply and tobacco exports, causing high inflation and a sharp rise in the current- account deficit every few years. Budget implementation also poses some risks: wage overruns, higher-than-expected costs for state pensions, overspending on the new parliament building and weak accounting systems are all areas that could contribute to public expenditure exceeding target levels. In addition, if more substantial improvements in the macroeconomic environment are to be made, significant structural reform will have to take place, but political feuding will make it difficult to get parliamentary support to pass key legislation.

Macroeconomic targets 2003 2004 2005 2006 2007 2008 2009 2010 2011 Inflation rate (%) 9.8 13.7 16.9 9.8 6.4 7.2 5.0 5.0 5.0 GDP growth (%) 3.9 4.6 1.9 8.3 5.6 6.0 6.0 6.0 6.0 Net domestic debta 22.3 22.6 21.5 23.3 20.8 17.6 10.0 10.0 10.0 Fiscal balancea -0.9 -4.1 -1.3 -0.9 -0.7 -1.1 -1.0 -1.0 -1.0 Gross reservesb 1.4 1.3 1.6 2.0 1.9 2.1 3.0 3.0 3.0 a % of GDP. b Months of import cover. Source: Malawi Growth and Development Strategy.

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There is a strong focus on In addition to stressing the importance of a more stable macroeconomic

infrastructure development environment, the MGDS also calls for poverty-reduction spending to be focused on six priority areas: • development of transport infrastructure; • agricultural and food security; • irrigation and water development; • integrated rural development; • energy generation and supply; and • the prevention and management of nutritional disorders, as well as HIV/AIDS. Most of the priorities are centred on the development of national infrastructure, and overlap somewhat with the common goal of boosting the key agricultural sector. This reflects the importance of agriculture to the economy: most people earn their livelihoods through subsistence farming and the small manufacturing industry is dependent on agricultural inputs. As with the 2006/07 budget, the strongest emphasis and largest amount of funding is given to the development of rural infrastructure, particularly roads, which are critical for linking farmers with markets and thereby encouraging the development of commercial agriculture (October 2006, Economic policy). The development of national infrastructure is also key if Malawi is to develop other industries, such as mining, tourism and other service industries. In particular, the currently inadequate and intermittent supply of electricity is negatively affecting most sectors and urgently needs to be addressed. The MGDS also places emphasis on improving health services, particularly with regard to combating HIV/AIDS. Given that diseases such as tuberculosis, malaria and HIV/AIDS are recognised as exacerbating poverty, not least by affecting the ability of sufferers and their families to earn a livelihood, it is appropriate that priority is given to improving health services under the MGDS. Interestingly, education is not listed amongst the top six priorities of the MGDS, even though it is normally heavily emphasised in most countries’ poverty reduction strategies.

Malawi Growth and Development Strategy: prioritisation and costing summary (MK m; fiscal years Jul-Jun) 2006/07 2007/08 2008/09 2009/10 2010/11 Total Agriculture & food security 3,067 2,886 1,692 1,650 1,605 10,901 Irrigation & water development 309 1,148 2,483 2,669 841 7,450 Transport infrastructure development 8,900 9,136 9,326 9,318 9,188 45,867 Energy generation & supply 990 874 386 346 466 3,062 Integrated rural development 1,413 1,631 2,042 1,987 1,521 8,593 Prevention & management of nutritional disorders and HIV/AIDS 2,007 2,054 1,852 1,825 1,750 9,488 Total 16,686 17,728 17,781 17,794 15,371 85,360

Source: Malawi Growth and Development Strategy.

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Capacity constraints will limit Owing to the significant emphasis that the MGDS places on developing

infrastructure development national infrastructure, a significant amount of construction and rehabilitation work will be called for. However, Malawi’s administration has a limited capacity to implement such projects, and it is not clear whether Malawirs construction industry has the capacity to scale up to this level so quickly. In previous years, development budgets have been underspent as a result of a lack of government or building capacity. Moreover, the Southern African region is expected to be heavily affected by construction trends in South Africa in the build-up to the Football World Cup 2010. Given that South Africa is already struggling to meet demand for engineering and construction personnel, as well as key building materials such as cement, its projects will pay a premium that will attract many personnel and resources away from construction projects elsewhere in Southern Africa. The timing of South Africa’s construction boom will clash with the MGDS, and thus, while there is likely to be progress with infrastructure development in Malawi, it will fall well short of the ambitious goals set out.

MonitoringOptimistic targets and evaluation for fiscal In its commentary on the previous PRSP, the IMF noted that a particular deficits are likelywill to be missedcrucial problem had been the lack of a functional national monitoring and evaluation (M&E) system (January 2007, Economic policy). The MGDS does address this, the government having acknowledged the need for an improvement in M&E if the scheme is to be a success. It is envisaged that the monitoring and evaluation secretariat of the Ministry of Economic Planning and Development will be responsible for the implementation of the MGDS. The secretary of state for economic planning and development, Patrick Kamwendo, said that in accordance with the MGDS, the government has begun a rigorous programme to revive the M&E system which he acknowledged was currently particularly weak. According to Mr Kamwendo, improving M&E systems will cost at least MK720m (US$5m), and half of the funding will be sourced from donors. Numerous civil society organisations are also likely to be involved in helping to monitor progress under the MGDS, but the strategy’s foremost problem is likely to be finding the capacity to implement the programme’s outcome, never mind measure it.

The IMF concludes its third On March 14th the IMF completed its third review of Malawirs three-year PRGF

review of the PRGF arrangement and released a further US$10m, bringing total disbursements to around US$33m. The IMFrs executive board was generally satisfied with macroeconomic management, and monetary and exchange-rate policy received specific praise. The Fund considered that the programmers objectives for the remainder of 2006/07 were realistic and noted that the governmentrs commitment to reducing the domestic debt burden was crucial for longer-term sustainability. The Fund believes that with a combination of greater macroeconomic stability, the award of significant external debt relief and the completion of the MGDS, Malawi has a real opportunity to tackle poverty. It cautioned, however, that for this to happen, the government must implement an ambitious range of structural reforms as well as maintaining stability. Another IMF paper on Malawi was also published in March, an update on fiscal reporting standards in Malawi. Although it was acknowledged that the

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legislative framework for fiscal transparency had been improved and the budget preparation process better developed, the Fund cautioned that there were critical weaknesses in the quality of fiscal data. A major problem was that payroll data were not accurate. In addition, the data were not effectively linked to the integrated financial management information system (IFMIS). Like many countries in Africa, Malawi suffers from a bloated civil service where so-called "ghost workers" remain a significant drain on resources. Tackling this problem will be difficult owing to the poor management and vested interests in some sectors of the civil service.

A supplementary budget is In a move that typified the difficulties faced by the government in moving

rejected by parliament ahead with implementing its economic agenda, the opposition rejected the supplementary budget proposed by the minister of finance, Goodall Gondwe, on March 14th. Mr Gondwe had asked parliament to increase budgeted expenditure by almost 7%, to MK148.3bn (US$1bn), using the resources freed up under the heavily indebted poor countries initiative. The opposition contended that no more money should be spent until government ministries are able to provide detailed accounts of where previous allocations were spent, in order to guarantee that public expenditure is not being misused. But the real grounds for rejecting the budget lay less in issues of governance, than in the political feuding between the opposition and government. This was the second defeat suffered by the government in less than 24 hours, as parliament also rejected the appointment of a new auditor-general, Steve Mchenga. As with Malawi’s main budgets, considerable pressure, from both local civil society organisations and international donors, may be required to get the opposition to agree to pass the supplementary budget. But rather than being held up by the delays this drawn-out process will involve, Mr Gondwe may opt to push ahead with his spending plans, and use various of his powers as minister of finance to get the additional spending approved retroactively.

The central bank reduces the The Reserve Bank of Malawi (the central bank) has lowered the liquid reserve

liquid reserve requirement requirement (LRR) from 20% to 15.5%, effective from February 1st. The central bank’s Monetary Policy Committee (MPC) met on January 31st and concluded that the economy’s response to the bank-rate cut on November 13th (from 25% to 20%) had been positive, an increase in commercial lending to the private sector having been observed. The MPC reported that during the period under review, which included December and an unspecified part of January, net credit to the private sector increased by MK3.3bn (US$24.3m) to MK27.7bn, a rise of 13.5%. However, the Committee also noted that large interest-rate spreads had persisted, and recommended that the LRR be lowered in order to address this. The previous reduction in the LLR took place in February 2006, when it was lowered from 27.5% to 20%. The IMF has long advocated cutting the LRR in the right circumstances, as it feels that Malawirs high LRR is a significant contributory factor to its substantial financial intermediation costs. Reducing the LRR frees money for banks to lend but, because it increases the money supply, such a move is inflationary. But with headline inflation on a downward trend, in February 2007 the MPC felt confident that it could reduce the LRR again without this having too great an

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inflationary effect. There is concern as to whether the latest reduction in the LLR will actually help to reduce interest-rate spreads by any significant degree. Banks in Malawi have traditionally been risk-averse, preferring to invest in government debt. This was the case with the February 2006 cut, when commercial banks responded by investing more in Treasury bills (April 2006, Economic policy). However, since then the government has intensified its commitment to reducing public borrowing, and commercial banks have begun to focus more on lending to the private sector. However, any narrowing of interest rate spreads is likely to be modest at first, until government borrowing shows a sustained and substantial decline, and competition amongst commercial banks for private clients becomes more intense.

Interest rates are expected to In addition to reducing the LRR, Mr Gondwe hinted in January that the bank

fal l further rate could also be cut further during 2007. Mr Gondwe felt that owing to the favourable outlook for inflation, combined with improved financial manage- ment by the government and central bank, it should be possible for interest rates to drop further in the short- to medium-term. The Economist Intelligence Unit forecasts that the bank rate will be cut by two percentage points in 2007, to reach 18%, probably towards the end of the year once inflation has proved to be keeping within single digits. Mr Gondwe also said that with lower interest rates in force, the government would be able to look once again at issuing bonds in Malawi. This has been a long-held ambition of the government, as it regards bond issuance as a convenient way of raising money for infrastructure projects whilst also restructuring public debt and developing the market for long-term maturities in Malawi. Since interest rates have ranged well above 20% for many years (the current bank rate of 20% and the 90-day Treasury-bill rate of 19.3% in December 2006 represent 15-year lows), bond issuance has been uneconomical. However, now that interest rates look set to edge down in the short- to medium-term, the government will almost certainly revisit the matter.

Interest rates (% change, year on year)

60.0 55.0 Bank rate 90-day Treasury bill rate 50.0 Average lending rate 45.0 40.0 35.0 30.0 25.0 20.0 15.0 10.0 1990 91 92 93 94 95 96 97 98 99 2000 01 02 03 04 05 06

Source: IMF, International Financial Statistics.

Country Report April 2007 www.eiu.com © The Economist Intelligence Unit Limited 2007 24 Malawi

The domestic economy

Economic trends

Inflation continues to Year-on-year inflation continued to decline in the first months of 2007, reaching

edge down 9.6% in January and 9.2% in February. This was the first time that inflation had entered single digits since 2003. The recent downward trend is mainly the result of developments in food prices, which are continuing to recover from the drought of 2005. Owing to an increased supply of food crops, primarily maize, food inflation fell to 9% in February, compared with 20% for the same period in 2006. Non-food inflation also fell, averaging 9.3% compared with 13.5% a year ago, owing mainly to falling international oil prices and tighter fiscal policy. Although better food crop production is expected to result in headline inflation inching down further, modest fiscal expansion and a loosening of monetary policy will limit the extent of the fall in inflation. The Economist Intelligence Unit forecasts that year-on-year inflation will reach 8.5% by year-end, and that overall inflation will average 8.6% for 2007, compared with 14% in 2006.

Inflation (% change, year on year)

22.0

20.0 Food Non-food 18.0 Overall

16.0

14.0

12.0

10.0

8.0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb 2006 07 Source: National Statistical Office.

Private-sector credit increases Total net domestic credit grew by 15.4% in 2006, reaching MK47bn (US$345m) by the end of December. The proportion extended to central government and statutory bodies declined to 41% of the total, from 62% of the total in 2005. This reflected a nominal decline in net government borrowing, from MK23bn in 2005 to MK18bn in 2006; and was a result of tighter fiscal policy. If this trend continues, it will improve the prospects for greater private-sector-led economic growth. Credit to the private sector rose by 58.5% in 2006, reaching MK27.7bn at the end of the year and accounting for 60% of total domestic credit. This represents a clear shift in lending patterns by commercial banks, which have had to adjust from their previous dependence on government debt. Reductions in the central bank rate and the liquid reserve requirement (LRR) since late-2005 have also contributed to banksr increased willingness to lend to the private sector. The major recipients of the lending have been the commercial and industrial sectors, primarily for capital purchases, and also the agricultural sector, for the purchase of fertiliser.

Country Report April 2007 www.eiu.com © The Economist Intelligence Unit Limited 2007 Malawi 25

Domestic credit (Mk m, end-period)

Private sector Central government (net) Non-financial public enterprises 50,000

40,000

30,000

20,000

10,000

0 2001 02 03 04 05 06 Source: IMF, International Financial Statistics.

Agriculture

Tobacco sales improved in The 2006 Malawian tobacco season officially closed on October 27th 2006. The

2006 despite poor prices depressed prices seen in recent years continued to affect the market: the average price paid by buyers, mainly via the auctions, was lower in 2006 (at US$1.05/kg) than the previous year (at US$1.12/kg). However, this fall was more than offset by a larger-than-expected volume of tobacco sold on the markets, which reached 160.5m kg. This represented an increase of over 10% on the total volume sold on the markets in 2005. The value of total earnings in 2006 stood at US$169m, up from US$163.7m in 2005. In terms of sales by variety, burley was again dominant, with 123.3m kg sold at an average price of 90 US cents/kg, contributing a total of US$111m. However, this was lower than the US$118.2m raised in 2005, owing to lower prices. Sales of flue-cured tobacco increased by 44% to reach 36.5m kg in 2006. This yielded sales of US$57.2m. Sales of the two other tobacco varieties, northern division dark-fired (NDDF) and southern division dark-fired (SDDF), also increased strongly, but they remain minor varieties on the Malawi market.

Tobacco auction sales 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Volume (m kg) 158.1 134.4 134.4 159.9 124.7 138.2 113.3 180.2 145.0 161.0 Price (US$/kg) 1.58 1.33 1.40 1.03 1.15 1.18 1.27 1.14 1.12 1.05 Value (US$ m) 249.3 179.0 187.5 164.8 143.9 163.1 144.1 205.6 161.9 169.0

Source: Tobacco Control Commission.

The prospects for 2007 are not The Tobacco Control Commission (TCC) officially opened the Lilongwe auction

encouraging floor for the 2007 buying season on March 26th, while the auction floors in Limbe and Mzuzu had yet to open at the time of writing. The TCCrs general manager, Godfrey Chapola, was not optimistic about the prospects for tobacco production in 2007 when he addressed an annual area meeting of the Tobacco Association of Malawi in February. He stated that the TCC expected burley tobacco output to drop to 114m kg and flue-cured output to drop to 27m kg. Total production is forecast to decline to 142m kg. Various reasons for the expected drop have been put forward. Heavy rains in some areas have

Country Report April 2007 www.eiu.com © The Economist Intelligence Unit Limited 2007 26 Malawi

destroyed crops, but it seems that the main reason behind the likely drop in production is the low prices that have plagued the sector in recent years. Low prices have made tobacco production uneconomic for some farmers who are now looking to plant more profitable crops, such as maize.

There is some hope that prices The reason for the crash in the prices paid in Malawirs auction houses has long

will improve been a subject of debate. The main factor appears to be exogenous in nature, in that the negative health effects of tobacco have reduced demand in many, mainly Western, countries. However, there is also the suspicion that part of the reason behind the low prices is particular to Malawi. Some commentators have claimed that the international buyers operating in Malawi operate a form of cartel to keep prices down. This has never been provedand is vehemently denied by the buyersbut the theory is widely accepted within Malawi. The president, Bingu wa Mutharika, took a confrontational stance when addressing this issue in 2006 by branding the international tobacco buyers operating in Malawi as "thieves". His efforts backfired when the buyers proved reluctant to agree to his proposed minimum price levels and prices fell further (October 2006, The domestic economy: Agriculture). However, it now appears that the government is refining its strategy. A number of talks have been held between the government and the main tobacco buyers aimed at finding a mutual solution to the low prices being paid. Mr Mutharika himself had talks with a delegation from US-based Universal Corporation, which is a major shareholder in the Limbe Leaf Tobacco Company. So far the talks have yielded little, but, in contrast to Mr Mutharikars previous efforts, they have not made the situation even worse. The government is also looking at other avenues. New floor managers have been appointed at some of the auction houses, which should help to smooth out the buying process. Potentially more significant are the governmentrs efforts to increase the number of buyers participating in the auctions, thus stimulating greater competition and potentially higher prices. The general manager of Auction Holdings Limited (AHL), Evans Chipala, said in an interview in March that he expected three new companies to join the five buyers that participated in the auctions last year. Companies set to participate this year include Limbe Leaf Tobacco, Alliance One, Premium Tama Leaf, Malawi Leaf, Africa Leaf and Premier Leaf, while the other two remain unnamed. Meanwhile, the government has developed a longer-term plan to work more closely with other tobacco producers in the region. In February it emerged that the government had signed a Memorandum of Understanding (MOU) with Zambia, Tanzania, Zimbabwe and Mozambique. The MOU contained a range of potential meas- ures, including collective marketing and increasing value-added production.

Country Report April 2007 www.eiu.com © The Economist Intelligence Unit Limited 2007 Malawi 27

Mining

A uranium deal is signed In late-February an Australian mining firm, Paladin Resources, announced that it had signed a development agreement with the Malawian government to develop the Kayelekera uranium project (January 2006, The domestic economy: Mining). The agreement followed the completion by Paladin of a positive feasibility study, under which the mine was deemed to be financially and technically viable over the projected 11-year lifespan of the project. Paladin owns 85% of the mining project, while the government owns the remaining 15%. Under the agreement, Paladin plans to spend US$185m and expects to produce 3.3m lbs of uranium over the first seven years of operation. In concluding the agreement, the government provided a number of tax breaks to Paladin: • the corporate tax rate applicable is reduced from 30% to 27.5%; • the applicable resource rent tax is reduced from 10% to zero; • royalty payments will be reduced from 5% to 1.5% for the first three years, rising to 3% thereafter; • there is to be no import tax or import duty; and • an immediate 100% capital write-off applies for tax purposes. For its part, Paladin has pledged significant social-development expenditure in the region of the new mine. This should include schools and health facilities. Construction is expected to begin by April 2007, and the commissioning of the plant is planned for September 2008. However, there is some domestic opposition to the mine, largely driven by the political opposition as part of their wider campaign to oust the president. They have demanded more details on the contract signed with Paladin and can be expected to attempt to obstruct the development of the mine. This could set back the planned commissioning date, which would be an embarrassment for the government.

Foreign trade and payments

Tobacco exports increase Tobacco exports improved slightly in 2006, despite the problems experienced on the domestic auction floors. By the end of December, 103.3m kg of tobacco had been exported, compared with the 101.6m kg exported in 2005. The average price paid was also slightly up, at US$2.35/kg in 2006 compared with US$2.33/kg in 2005. This was in contrast to the downward trend in prices paid to the domestic growers, and added some support to claims that the international buyers in Malawi are not giving local farmers a fair deal (see The domestic economy: Agriculture). International tobacco companies that are operating in Malawi act as middlemen in the international tobacco trade, buying tobacco from local farmers (either through the auctions or at a pre- determined price set out in a contract) and exporting it at a higher price to manufacturers overseas. The value of tobacco exports in 2006 reached US$242.7m, up 2.6% on the figure for 2005, and representing the highest level of tobacco exports in five years. In terms of individual export prices, burley

Country Report April 2007 www.eiu.com © The Economist Intelligence Unit Limited 2007 28 Malawi

tobacco recorded an increase in the export price, averaging US$2.34/kg compared with US$2.24/kg in 2005. Meanwhile, the average price for flue-cured tobacco declined to US$2.42/kg, from US$2.54/kg in 2005.

Tobacco exports 2001 2002 2003 2004 2005 2006 Volume (m kg) 124.2 114.7 100 103.7 101.6 103.3 Average price (US$/kg) 2.05 2.03 2.26 2.48 2.33 2.35 Value (US$ m) 254.5 232.8 206.0 229.5 236.7 242.7

Source: Tobacco Control Commission.

Country Report April 2007 www.eiu.com © The Economist Intelligence Unit Limited 2007