Malawi at a Glance: 2006-07

Country Report

Malawi

Malawi at a glance: 2006-07

OVERVIEW The president, Bingu wa Mutharika, is expected to remain in office over the forecast period, although his support in parliament is likely to remain tenuous, owing to the ongoing power struggle with his predecessor, Bakili Muluzi. Economic policy will continue to be guided by the current IMF-prescribed poverty reduction and growth facility (PRGF), which is expected to remain on track. Malawi should reach completion point under the IMF-World Bank's heavily indebted poor countries (HIPC) debt-relief initiative in the second half of 2006, and also to become eligible for debt relief from the IMF and other multilateral creditors under the Multilateral Debt Relief Initiative (MDRI) in the forecast period. Economic growth will continue to be strongly influenced by the performance of the agricultural sector, given the lack of economic diversification and of exploitable natural resources. Reduced pressure on food supplies is expected to help to bring the average rate of inflation down from 15.4% in 2005 to 15.3% in 2006 and 13% in 2007. A recovery in exports, together with higher donor inflows, is expected to result in a narrowing of the current- account deficit from an estimated 11.2% of GDP in 2005 to 9% of GDP in 2006 and 6.1% of GDP in 2007.

Key changes from last month Political outlook • Recent tributes by Mr Mutharika to the Zimbabwean president, Robert Mugabe, and the late former president of Malawi, Hastings Banda, have caused controversy in Malawi and may have undermined the president's ability to increase his small support base. Economic policy outlook • The 2006/07 (July-June) budget announced on June 16th proposes a strong emphasis on improving the ability of the agriculture sector to cope with drought, with a substantial allocation of funds to the ministries of agriculture and food security and of irrigation and water development. The Reserve Bank of Malawi has adopted a managed float, which it hopes will help to ease the management of the exchange rate. Economic forecast • There have been no changes to the Economist Intelligence Unit's economic forecast from last month. July 2006

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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 2006-07 7 Political outlook 8 Economic policy outlook 10 Economic forecast

13 The political scene

17 Economic policy

20 The domestic economy 20 Economic trends 21 Agriculture

24 Foreign trade and payments

List of tables 10 International assumptions summary 12 Forecast summary 15 Key changes in the Malawian cabinet 21 Average inflation 21 The kwacha's path against its major trading currencies 23 Comparison of regional harvests 24 Balance of payments 26 Malawi's trade with the US

List of figures

12 Gross domestic product 12 Consumer price inflation 26 Total external debt stock, April 2006

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Malawi 3

Malawi July 2006 Summary

Outlook for 2006-07 The president, Bingu wa Mutharika, is expected to remain in office over the forecast period, although his support in parliament will remain tenuous. With the help of pressure from various internal and external organisations, he is expected to be able to gain sufficient support to pass key reforms, as well as the 2006/07 (July-June) budget by the end of July. 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. Continued recovery in agriculture is expected to drive higher overall economic growth over the forecast period. Reduced pressure on food supplies is expected to help to ease the average rate of inflation to 15.3% in 2006 and 13% in 2007. A recovery in exports, together with higher donor inflows, is expected to result in a narrowing of the current- account deficit from an estimated 11.2% of GDP in 2005 to 9% of GDP in 2006 and 6.1% of GDP in 2007.

The political scene The vice-president, Cassim Chilumpha, has been arrested on charges of treason. The attorney-general, Ralph Kasambara, who had been advising the president in his dealings with Mr Chilumpha, has been sacked. Mr Mutharika has reshuffled his cabinet and appointed three senior opposition members. The government has warned that local elections may not be held until 2007. Tributes by Mr Mutharika to the Zimbabwean president, Robert Mugabe, and the late former president, Hastings Banda, have caused controversy in Malawi.

Economic policy The finance minister, Goodall Gondwe, has announced the 2006/07 budget, which includes a strong focus on agriculture, food security and water, in order to improve the country's ability to cope with persistent drought. The budget has also proposed a number of tax cuts, to make Malawi's business climate more competitive. The Reserve Bank of Malawi (the central bank) has adopted a managed float, to ease the management of the exchange rate.

The domestic economy Inflation has edged downwards, but fuel price increases of between 3% and 7% were announced in May. The kwacha has depreciated rapidly in the first half of the year, following the removal of restrictions imposed on foreign-exchange transactions. The Ministry of Agriculture and Food Security has estimated that the 2006 maize crop will be sufficient to meet domestic needs.

Foreign trade and payments According to the central bank, the current-account deficit increased in 2005, alongside a widening trade deficit, owing to drought-related imports.

Editors: Nicola Prins (editor); Pratibha Thaker (consulting editor) Editorial closing date: June 30th 2006 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

Country Report July 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 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 People's Progressive Movement, the Congress for National Unity, the People's 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, minister of civil service Bingu wa Mutharika Vice-president Cassim Chilumpha

Key ministers Agriculture & food security Uladi Mussa Defence Davis Katsonga Economic planning & development David Faiti 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 2001a 2002a 2003 a 2004 b 2005b GDP at market prices (MK bn) 123.9 148.4 171.9 204.6 a 229.2 GDP (US$ bn) 1.7 1.9 1.8 1.9 a 1.9 Real GDP growth (%) -4.9 1.8 4.4 5.1 c 1.9c Consumer price inflation (av; %) 22.7 14.7 9.6 11.4 a 15.4a Population (m) 11.8 12.1 12.3 12.6 a 12.9 Exports of goods fob (US$ m) 427.9 422.4 530.3 b 483.3 464.7 Imports of goods fob (US$ m) 472.2 573.2 615.0 b 613.0 645.0 Current-account balance (US$ m) -59.9 -200.7 -148.7 b -175.8 -216.7 Foreign-exchange reserves excl gold (US$ m) 198.8 158.3 122.0 128.1 a 158.7a Total external debt (US$ bn) 2.6 2.9 3.1 3.2 3.3 Debt-service ratio, paid (%) 8.0 6.3 6.0 b 12.3 13.4 Exchange rate (av) MK:US$ 72.20 76.69 97.43 108.89 a 118.37a a Actual. b Economist Intelligence Unit estimates. c Official estimates.

Origins of gross domestic product 2005a % of total Components of gross domestic product 2005a % of total Agriculture 29.4 Private consumption 107.3 Industry 20.9 Government consumption 11.2 Manufacturing 20.2 Gross fixed capital formation 7.4 Services 49.7 Change in stocks 1.3 Net exports of goods & services -27.8

Principal exports fob 2004a US$ m Imports fob 2002c US$ m Tobaccob 259 Intermediate goods 435 Tea 47 Fuel oils 76 Sugar 41 Capital goods 73 Cotton 20 Consumer goods 66

Main destinations of exports 2004d % of total Main origins of imports 2004d % of total South Africa 17.7 South Africa 37.6 US 12.5 India 8.1 Germany 7.8 Tanzania 7.8 Egypt 6.6 Zambia 7.2 a IMF/official estimates. b Production marketed at auction. c Economist Intelligence Unit estimates. d Based on partners' trade returns; subject to wide margins of error.

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Quarterly indicators 2004 2005 2006 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr Central government finance (MK m) Revenue and grants 13,822.6 14,003.7 22,052.6 20,166.3 21,790.2 24,240.1 36,478.0 20,986.5 Revenue 11,393.2 12,772.4 13,150.9 15,071.7 15,756.4 16,338.8 15,533.5 16,843.5 Grants 2,429.4 1,231.4 8,901.7 5,094.6 6,033.8 7,901.3 20,944.5 4,143.0 Expenditure 20,506.6 16,956.0 22,148.6 25,601.2 22,499.6 23,983.3 38,859.6 28,816.7 Balance before grants -9,113.4 -4,183.6 -8,997.7 -10,529.5 -6,743.2 697.3 2,287.6 -11,973.2 Balance after grants -6,684.0 -2,952.3 -96.0 -5,434.9 -709.4 -7,644.5 -23,326.1 -7,830.2 Output trends Industrial production index (1984=100) 100.9 105.9 109.8 118.9 97.7 96.0 n/a n/a Industrial production index (% change, year on year) 9.9 13.3 7.0 5.0 -3.2 -9.3 n/a n/a Prices National composite consumer prices (2000=100) 168.0 166.6 179.7 198.5 194.1 192.5 208.8 231.8 National composite consumer prices (% change, year on year) 11.3 11.2 12.9 14.3 15.5 15.5 16.2 16.8 Financial indicators Exchange rate: MK:US$ (av) 108.897 108.956 108.947 109.288 117.203 123.513 123.676 129.847 Exchange rate: MK:US$ (end-period) 108.908 108.946 108.943 111.500 122.985 123.588 123.781 133.760 Exchange rate: nominal effective rate (2000=100) 62.9 62.8 59.9 60.0 58.3 59.0 64.6 61.5 Exchange rate: real effective rate (2000=100) 73.6 74.8 72.7 74.2 72.9 73.0 80.6 76.5 Deposit rate (av; %) 15.75 10.25 10.42 10.67 11.00 11.00 11.00 11.00 Discount rate (end-period; %) 25.00 25.00 25.00 25.00 25.00 25.00 25.00 25.00 Lending rate (av; %) 39.00 33.00 33.33 33.33 33.00 33.00 33.00 33.00 Treasury bill rate (av; %) 30.97 24.32 24.72 24.50 24.38 24.24 24.33 21.64 M1 (end-period; MK m) 23,927 24,989 25,723 24,953 29,579 29,899 31,302 n/a M1 (% change, year on year) 36.8 36.2 44.8 44.3 23.6 19.7 21.7 n/a M2 (end-period; MK m) 43,713 44,483 46,448 45,502 51,749 52,483 53,994 n/a M2 (% change, year on year) 35.0 29.6 29.7 25.0 18.4 18.0 16.2 n/a Debt-service payments (MK m) 3,131.7 2,371.5 4,314.4 2,649.6 3,537.7 3,034.2 2,749.8 2,006.8 Principal 2,326.6 1,713.1 3,648.6 2,031.7 2,637.3 2,302.9 2,008.6 1,355.4 Interest payments 788.2 650.7 963.5 604.1 897.7 731.3 741.1 651.4 Sectoral trends Building plans passed (MK '000)a 940.5 1,124.4 857.0 382.7 1,106.4 1,157.8 n/a n/a Electricity production (m kwh) 321.0 348.4 338.6 332.7 342.8 357.0 n/a n/a Tea production ('000 tonnes) 11.1 7.2 12.1 21.0 7.0 3.0 6.9 n/a Tobacco auction sales ('000 tonnes) 72.7 69.0 31.5 1.9 77.6 61.1 3.6 n/a Tobacco auction sales (MK m) 9,803.1 8,690.1 3,081.4 209.6 10,528.8 8,263.4 444.5 n/a Sugar production ('000 tonnes) 58.1 126.8 37.5 0.0 97.6 125.6 n/a n/a Foreign trade & reserves Exports fob (MK m) 10,807 23,520 8,848 13,706 14,251 17,034 n/a n/a Tobacco 3,142 12,985 3,078 7,224 5,863 9,749 8,405 n/a Imports cif (MK m) -25,905 -30,654 -23,501 -27,048 -34,438 -32,045 n/a n/a Trade balance -15,098 -7,134 -14,653 -13,342 -20,187 -15,011 n/a n/a Reserves excl gold (end-period;US$ m) 95.9 132.5 128.1 99.1 118.4 166.1 158.7 113.3 a Blantyre, Lilongwe & Mzuzu. 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 2006-07

Political outlook

Domestic politics Malawi's president, Bingu wa Mutharika, is expected to remain in office over the forecast period, but his support in parliament will remain tenuous, consisting of his own party, the Democratic Progressive Party (DPP), a few other small parties and a number of independents. He is likely to be able to win the support of the biggest opposition party, the Malawi Congress Party (MCP), when key legislation is being considered, and can also count on donors to exert considerable pressure on opposition politicians to pass key reforms. However, his ability to further grow his support base may have been undermined by his recent political manoeuvrings, which have created much controversy in Malawi. For instance, his recent honouring of the late former president, Hastings Banda, and of Zimbabwe's president, Robert Mugabe, provoked widespread protest in Malawi, including amongst civil society organisations that are normally fairly supportive of Mr Mutharika. The motives behind these developments are as yet unclear, especially given his normally ideologically neutral, reform-minded and technocratic style. However, the statements do raise concern over whether he intends to continue with his steadfast pursuit of good political and economic governance, which has won him so much goodwill, both domestically and internationally, or whether this is an early indication of a more authoritarian leadership style emerging. Mr Mutharika has had to fight continuously for his political survival since becoming president in 2004, and his recent political posturing may simply be an extension of his constant search for internal and regional allies. The inability of his predecessor as president, Bakili Muluzi, or the United Democratic Front (UDF) to influence Mr Mutharika after he came to power led to a falling-out that saw the launch of an intensive campaign to have him removed from power, which has often attracted the support of the MCP. However, Mr Mutharika has fought back fiercely, with the launch of his own party as well as an anti-corruption campaign that has targeted many senior UDF officials. He has also survived an attempt to have him impeached, and his party continues to win over opposition members, from both the UDF and the MCP, although it remains small. It is still too early to tell if the UDF is now in retreat but, if it becomes clear that the balance of power has definitely fallen on Mr Mutharika's side, he stands a much stronger chance of winning over the MCP, which will be crucial to strengthening his standing in parliament. Although the political battle with the UDF has absorbed much of the president's attention since he came to power, there is now further concern that it may have a destabilising effect on Malawi's politics, given the serious nature of recent developments concerning the vice-president, Cassim Chilumpha. Following Mr Mutharika's earlier attempts to have Mr Chilumpha charged with corruption, and then to have him sacked, he has recently been charged with treason. The way that this case unfolds will be an important indicator of the direction in which Malawi's very fluid politics is moving: if allegations of an assassination plot are true, then this implies a radical departure from the

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traditionally peaceful political culture in Malawi, in which there is an entrenched respect for the principle of a change of power occurring only through constitutional means. However, if the charges are shown to have been fabricated, then this will reflect poorly on the president, who has supported the charges, and will add to the concern about the direction that Mr Mutharika's leadership style is taking. In the meantime, an indication of where Mr Mutharika stands in terms of parliamentary backing will emerge as he attempts to draw support for the 2006/07 (July-June) budget—a feat that proved to be a major political challenge in 2005. The MCP and the UDF have already warned that they are not inclined to support the budget. As in 2005, Mr Mutharika will ultimately receive sufficient parliamentary support for the budget only if donors, many local and international non-governmental organisations, and a number of prominent African dignitaries exert considerable pressure on the opposition to pass it. The Economist Intelligence Unit expects the budget to be passed by the end of July, possibly with a few small concessions being made to the opposition on some budget items.

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 are positive—a poverty reduction and growth facility (PRGF) is in place and is progressing well—and many donors have resumed funding. However, donors have warned that Malawi must continue to make good progress with economic reforms, particularly good governance, if their financial support is to continue. The IMF and donors are proving to be useful allies for the president, as they are willing to put considerable pressure on opposition parties when Mr Mutharika's key reforms and budgets come up against resistance in parliament, with the threat that donor funding might otherwise be suspended.

Economic policy outlook

Policy trends Malawi's three-year PRGF agreed with the IMF in June 2005 will guide the overall direction of economic policy during the forecast period, as the government is well aware of the necessity of continued donor support. The programme is strongly focused on improving expenditure control as the key to restoring macroeconomic stability. Greater fiscal discipline should also help to reduce the domestic debt burden, which is estimated to have decreased to 20% of GDP by mid-2006, and to make arrears payments to domestic creditors. Spending priorities are expected to remain focused on education, healthcare and infrastructure, and boosting the private sector, with a strong overall focus on developing rural areas (notably by improving roads) and promoting export diversification. The budget announcement for 2006/07 (July-June) has proposed a strong emphasis on strengthening the agriculture sector's ability to cope with drought and to remain self-sufficient in food supplies.

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The IMF has been upbeat in its assessment of its programme so far, and the government has met all quantitative targets to date. Assuming that the PRGF remains on track, Malawi should reach completion point under the IMF-World Bank's heavily indebted poor countries (HIPC) debt-relief initiative around the middle of 2006, and should also become eligible for debt relief from the IMF and other multilateral creditors under the Multilateral Debt Relief Initiative (MDRI). However, Malawi remains an extremely poor country, even by African standards, and weak institutional capacity and corruption will continue to constitute significant obstacles to policy implementation throughout the forecast period.

Fiscal policy In fiscal year 2005/06 (July-June), the resumption of donor financial assistance and increased efficiencies in domestic revenue collection will have lifted revenue considerably. However, the cost of maize imports and fertiliser subsidies will have been substantial, offsetting the gains from improved discipline in fiscal management, and we estimate a budget deficit of 3.8% of GDP. In 2006/07, inflows of donor funding and the efficiency of tax collection are expected to improve further, but to be offset by tax cuts proposed in the 2006/07 budget. However, with further reforms to fiscal management and the need for drought- related assistance tailing off, there is scope for growth in expenditure to moderate. Nonetheless, there are still strong pressures for social spending and for measures to address the persistent vulnerability of agriculture to drought; the budget deficit is, therefore, forecast to decrease only slightly, to 3.6% of GDP. Trends in 2007/08 will be influenced by the continuation of improving revenue and fiscal discipline, although strong spending pressures will remain—including the need to strengthen social services and to pay off domestic debt—and the budget deficit is, therefore, forecast to decrease to 3.1% of GDP. Over the forecast period the deficit will be increasingly financed through donor funding.

Monetary policy The Reserve Bank of Malawi (the central bank) is expected to keep monetary policy relatively tight over the forecast period to try to bring inflation down. It will attempt to achieve this primarily through the use of open-market operations to control money-supply growth and by keeping the bank rate at its current high level of 25%. At the same time, however, the central bank is concerned that high interest rates are making it difficult for business to access capital, thus posing a major constraint to the government's objective of private- sector led growth. To offset the high interest rates, it has lowered the liquid reserve requirement from 27.5% to 20%, which should allow commercial banks to lend more funds (although they will continue to be hampered by structural constraints to lending and the small size of the market).

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Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2004 2005 2006 2007 Real GDP growth World 5.6 5.0 5.0 4.4 OECD 3.2 2.7 2.9 2.3 EU25 2.4 1.7 2.3 2.1 Exchange rates ¥:US$ 108.1 110.1 110.5 98.5 US$:€ 1.244 1.245 1.278 1.390 SDR:US$ 0.675 0.677 0.670 0.635 Financial indicators ¥ 2-month private bill rate 0.00 0.00 0.16 0.58 US$ 3-month commercial paper rate 1.48 3.49 5.43 5.37 Commodity prices Oil (Brent; US$/b) 38.5 54.7 70.0 66.0 Food, feedstuffs & beverages (% change in US$ terms) 8.5 -0.5 4.0 -4.2 Tea (US$/kg) 1.7 1.6 1.7 1.7 Sugar (US cents/lb) 7.2 9.9 16.4 16.0 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, at 5% in 2006 and to moderate to 4.4% in 2007. Rising domestic demand in South Africa, Malawi's main trading partner, is expected to drive up growth there to 4.7% in 2006 and 5.1% in 2007. The prospects for Malawi's main commodity exports will be mixed in 2006-07. The slump in auction prices for Malawi's tobacco is expected to continue, with buyers unlikely to pay the minimum prices set by the government in March 2006. Tea prices will remain unchanged, at an average of US$1.7/kg in 2006-07, as both global production and demand will be relatively static. Uncertainty over global sugar stocks is expected to keep sugar prices high in 2006, at 16.4 US cents/lb, but the deficit is expected to ease in 2007, allowing prices to moderate marginally, to 16 US cents/lb. International oil prices are expected to remain relatively high, at US$70/barrel, in 2006 but to ease to US$66/b in 2007, based on known capacity expansion plans and the projected slowdown in global growth.

Economic growth Economic growth in Malawi will continue to be strongly influenced by the performance of the agricultural sector, given the lack of economic diversification and of exploitable natural resources. After a significant fall in production in 2005, owing to the current drought, a gradual recovery in the agricultural sector is anticipated for 2006, assuming normal weather conditions. Based on the same assumption, modest agricultural growth is expected in 2007. However, the accumulated effects of drought over recent years in impoverishing many farmers, in addition to difficulties with fertiliser supply and the high prevalence of HIV/AIDS, may slow the rate of recovery, and agricultural production may not return to long-term average production levels in the forecast period. 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

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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 over the forecast period. Donor support will also keep growth in the construction sector healthy. Services will benefit from an expansion in government spending due to the resumption of donor financial assistance. As a result of these trends, overall real GDP growth is forecast to recover to 5.1% in 2006, easing somewhat, to 4%, in 2007.

Inflation The severity of the famine in 2005 resulted in the declaration of a national state of emergency; nearly one-half of the population experienced chronic food shortages and annual average inflation reached 15.4%. However, weather conditions have improved in early 2006, prompting the authorities to estimate that the 2006 maize crop will be sufficient to meet domestic needs. The onset of a recovery in agriculture over the forecast period will help to lower food price inflation, the main driver of the overall inflation rate. Improved fiscal discipline will also help to slow non-food inflation and, from 2007, forecast lower international oil prices and US dollar depreciation will exert further downward pressure on inflation. However, the rate at which inflation falls will be slowed by currency depreciation over the forecast period. As a result, inflation is forecast to average 15.3% in 2006 and 13% in 2007.

Exchange rates Under pressure from the IMF, restrictive foreign-exchange practices were abandoned in early 2006, leading to the kwacha depreciating sharply, from MK130.8:US$1 in January to MK140:US$1 in June 2006—a loss of 7% of the currency's value—according to Bloomberg. In June a managed float was introduced, which is targeted at improving export competitiveness. With the kwacha still considered to be somewhat overvalued, this means that rapid depreciation is expected to continue for the rest of 2006, with the kwacha averaging MK138:US$1 for the year. In 2007 the average rate of depreciation is expected to slow as the current-account deficit narrows. During the year the exchange rate is expected to fluctuate according to its usual seasonal pattern, although the fluctuations are expected to be smoothed out somewhat, following the adoption of a managed float. Under this, it depreciates in the first quarter of the year, ahead of the tobacco auctions, and again over 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, it is expected to remain vulnerable to sharp falls: potential triggers could be a suspension of donor funding, a further downturn in tobacco prices or a serious deterioration in political stability. We therefore forecast that the kwacha will depreciate to an average of MK150:US$1 in 2007.

External sector The current-account deficit is estimated to have increased to 11.2% of GDP in 2005, owing to reduced tobacco exports, higher levels of food imports and rising trade-related costs. A recovery in the agricultural sector over the forecast period should drive a pick-up in exports, although this will largely come from non-tobacco exports, as tobacco prices are forecast to remain below average. A pick-up in economic growth over the forecast period will also stimulate demand for imports, although the effect will be moderated by a forecast fall in

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emergency food imports and in international oil prices in 2007. Tourism receipts, the main source of services credits, are expected to rise slightly over the forecast period. However, services debits will remain high on account of trade-related costs, keeping the services account firmly in deficit. Although interest payments on medium- and long-term external debt will be reduced under the HIPC initiative, the fall-off in debt repayments will initially be only modest. Inflows of donor funding are expected to rise 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 expected to narrow to 9% of GDP in 2006 and 6.1% of GDP in 2007.

Forecast summary (% unless otherwise indicated) 2004 a 2005 a 2006b 2007b Real GDP growth 5.1 c 1.9 c 5.1 4.0 Gross industrial growth 6.5 7.5 6.0 5.0 Gross agricultural production growth 2.7 -9.1 2.5 2.8 Consumer price inflation (av) 11.4 d 15.4 d 15.3 13.0 Consumer price inflation (year-end) 13.7 d 16.5 d 14.0 12.0 Short-term interbank rate 36.8 d 33.1 d 33.0 30.0 Government balance (% of GDP) -4.2 -3.8 -3.6 -3.1 Exports of goods fob (US$ m) 483.3 464.7 481.1 522.7 Imports of goods fob (US$ m) 613.0 645.0 654.7 674.3 Current-account balance (US$ m) -175.8 -216.7 -178.8 -129.5 Current-account balance (% of GDP) -9.4 -11.2 -9.0 -6.1 External debt (year-end; US$ bn) 3.2 3.3 3.0 3.1 Exchange rate MK:US$ (av) 108.89 d 118.37 d 138.00 150.06 Exchange rate MK:¥100 (av) 100.71 d 107.53 d 124.92 152.34 Exchange rate MK:€ (av) 135.44 d 147.34 d 176.40 208.58 Exchange rate MK:SDR (av) 161.29 d 174.92 d 205.86 236.22 a Economist Intelligence Unit estimates. b Economist Intelligence Unit forecasts. c IMF estimate. d Actual.

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

Malawi Sub-Saharan Africa Malawi Sub-Saharan Africa 8.0 25

6.0 20 4.0

2.0 15 0.0

-2.0 10 -4.0

-6.0 5 02 03 04 05 06 07 02 03 04 05 06 07 2001 2001

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The political scene

The vice-president is arrested The turmoil in Malawian politics has continued, with the vice-president,

fo r treason Cassim Chilumpha, charged with treason. On April 28th heavily armed police came to Mr Chilumpha's official residence in the commercial capital of Blantyre and arrested him. The vice-president was charged with treason shortly after- wards. The charge related to meetings that Mr Chilumpha was alleged to have held with other members of his United Democratic Front (UDF) party, during which the toppling of the government of the president, Bingu wa Mutharika, was allegedly discussed. Subsequently, another 12 UDF members were arrested. Further details about the arrests from both the government and the police followed—Mr Chilumpha and his co-accused were charged with attempting to arrange the assassination of Mr Mutharika. The local press reported that the government claimed to have taped evidence of Mr Chilumpha discussing plans to assassinate Mr Mutharika. Mr Chilumpha's arrest capped a turbulent six- month period in his embattled relationship with the president, during which time the vice-president has been charged and arrested for corruption and sacked by the president (April 2006, The political scene).

There is tension between the On May 7th ten of the accused were released, with a police statement saying

president and Mr Chilumpha that there was not enough evidence available to prosecute them. Remaining in police custody was Mr Chilumpha, together with two businessmen, Yusuf Mtumula and Rashid Tembo. The High Court began its bail hearing on May 12th, and all the accused were granted bail, except for Mr Chilumpha, who was placed under house arrest. The presiding judge, Charles Mkandawire, ordered that Mr Chilumpha be confined to his official residence unless granted presidential permission to go elsewhere. Visitors to the vice-president's house have been limited to family members, physicians, spiritual advisers and defence lawyers. Immediately after the bail hearing concluded, Mr Chilumpha spoke to the assembled press, claiming that he was being persecuted because he had failed to follow Mr Mutharika when the president left the UDF to form the Democratic Progressive Party (DPP; April 2005, The political scene). The strained relationship between Mr Chilumpha and Mr Mutharika takes place against the background of a protracted power struggle between the president and his predecessor, Bakili Muluzi. When Mr Muluzi failed in his attempt to remove the two-term presidential limit prior to the 2004 polls, he selected the then little- known Mr Mutharika as his successor (July 2003, The political scene). However, Mr Mutharika showed unexpected independence with regard to Mr Muluzi and his allies, culminating in the new president leaving the UDF.

This is the second alleged The case involving Mr Chilumpha is not the first time that Mr Mutharika has

assassination case believed himself to be the target of an assassination plot. In January 2005 three UDF members were arrested and charged with breach of the peace after arriving at a meeting with Mr Mutharika carrying guns. The charges were later increased to treason, before being dropped with no official explanation (April 2005, The political scene). The lack of evidence in the public domain made it difficult to assess how credible the assassination plan was, but it did

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provide Mr Mutharika with the pretext for replacing many of the staff at the National Intelligence Agency—most of which were Muluzi appointees—claiming that some of its agents were involved. The government is confident that the police have sufficient evidence—tape-recorded—to pursue the case against Mr Chilumpha, although Mr Chilumpha's defence counsel has dismissed the recordings, claiming that they were manipulated by the government.

The attorney-general is sacked As the campaign against Mr Chilumpha gained pace, the attorney-general, Ralph Kasambara, played a central role. First, it was Mr Kasambara who had advised Mr Mutharika that he could sack his vice-president for not attending to his duties. However, this advice backfired when the courts insisted that Mr Chilumpha be reinstated while a judicial review was performed. Subsequently, when Mr Chilumpha was arrested, Mr Kasambara was believed to have favoured trying the vice-president himself, until the presiding judge in the case stated that only state prosecutors could try criminal cases. Finally, Mr Kasambara attempted to lobby the presiding judge to jail Mr Chilumpha prior to his trial. This was rejected, and the vice-president was duly released on bail. As a result, the attorney-general was accused by many in the opposition of siding too openly with the president. Certainly, his failings have reflected badly on Mr Mutharika, who ultimately sacked Mr Kasambara on May 17th. The UDF were quick to call for an investigation into Mr Kasambara's office and its conduct, although the government has rejected this.

Mr Mutharika reshuffles his On June 1st Mr Mutharika reshuffled the cabinet, dropping two ministers and

cabinet giving appointments to three senior opposition members. The new cabinet was increased to 36 members, with four new deputy ministerial positions created. The two sacked from the cabinet were the minister for health, Hetherwick Ntaba; and the minister for trade and private sector development, Martin Kansichi. The removal of Mr Ntaba comes on the back of a drug-procurement scandal at the health ministry, and his exit from the cabinet had been widely anticipated. The reasons behind the sacking of Mr Kansichi, on the other hand, were not as clear cut, as Mr Kansichi was widely recognised as one of the better-performing cabinet ministers. The three opposition members who joined the cabinet were Bob Khamisa, the treasurer-general of the UDF, who was appointed the minister for home affairs and internal security; Ted Kalebe of the Malawi Congress Party (MCP), who becomes the deputy minister of finance; and Bintony Kuntsaira also of the MCP, who became the deputy minister of agriculture and food security. Elsewhere in the cabinet, the minister for foreign affairs and international co- operation, David Katsonga, was hastily moved to the Ministry of Defence after causing the president some embarrassment during a visit from a Scottish delegation in May. The delegation, which included the Scottish first minister, Jack McConnell, shunned Mr Katsonga after it was brought to light that Mr Katsonga had served time in prison in the UK for blackmail.

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Key changes in the Malawian cabinet Ministry Previous minister New minister Health Hetherwick Ntaba Marjory Ngaunje Industry, trade & private sector development Martin Kansichi Ken Lipenga Justice & constitutional affairs Henry Phoya Bazuka Mhango Home affairs & internal security Anna Kachiko Bob Khamisa Foreign affairs & international co-operation Davis Katsonga Joyce Banda Lands, housing & service Bazuka Mhango Henry Phoya

Source: Local press.

The opposition are unhappy The government presented the inclusion of opposition members in the

with the new cabinet reshuffled cabinet as an attempt to better represent the Malawian people. The opposition, however, saw it very differently. The day after the reshuffle an angry John Tembo, the leader of the MCP, was interviewed on Malawian radio. He described the appointment of two of his members of parliament into the cabinet as "true theft and interference with other political parties". The MCP is currently Malawi's largest opposition party in parliament, and Mr Tembo has long been thought to have presidential aspirations. Mr Mutharika is well aware of the electoral threat posed by Mr Tembo and the MCP, and the opportunity to undermine them through co-opting MCP members is of obvious appeal. This has occurred before, for instance when Kate Kainja left the MCP in April 2005 to take up the position of minister of education (July 2005, The political scene). Mr Tembo described those leaving the MCP to join the government as "a collection of fortune seekers"—the tendency for Malawian politicians to change parties frequently in pursuit of their personal ambitions has intensified in recent years, with politicians constantly seeking to align themselves with whichever political party they believe to be in the ascendancy at the time.

The local government The Electoral Commission (EC) announced in April that it might be necessary

elections are delayed to delay local government elections until 2007 owing to a lack of funding. 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 following the last presidential and legislative elections. However, the government was forced to abandon them and redirect the funding to the mounting food crisis of the time. The fact that funding still had not been released by mid-2006 prompted criticism of the government by civil society and opposition groups, who questioned how continuing delays in local polls could fit in with the government's stated aim of promoting decentralisation (July 2005, The political scene). Towards the end of April there were reports in the local press that the government was once again debating the idea of holding local elections at the same time as the presidential and legislative elections in future. The government 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 opposition concern that this would increase the chances of vote tampering, as well as confusing voters (January 2004, The political scene). The government is making the same arguments about logistical and financial factors this time round, pointing out that having local elections in 2007 followed by presidential and legislative

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elections in 2009 would be a waste of resources. However, the opposition has retorted that the government is merely attempting to further delay the local polls because the ruling DPP is not sure of its grassroots support. This is a plausible argument; the DPP is a relatively new party and lacks the grassroots network of the more established opposition parties. Indeed, the UDF (which was in power at the time) won 612 of the 860 contested wards during the 2000 local government polls—although it is likely to have lost considerable ground since then owing to a decline in its popularity.

There will be funding for local In the face of mounting criticism over the local election delays, the government

elections in 2006/07 appeared to backtrack in early June, announcing that funding for the local polls would be available in the 2006/07 financial year. The minister for local government and rural development, George Chaponda, announced that MK1bn (US$7.3m) was available for the preparatory work. It is unclear when the money for holding the polls themselves will become available, with the EC estimating the total cost of the elections at around US$25m. Furthermore, the EC has estimated that 18 months would be needed for preparation, so the local election date could well be late 2007 or early 2008. If the elections are likely to take place in 2008, the government would be in a stronger position to argue that the local polls should be combined with those for the legislature and presidency. By that time, the DPP will have hoped to have built a strong position for itself from which to contest the elections.

Tributes to Mr Mugabe and Two public works were unveiled in Malawi in May that caused controversy

Mr Banda cause controversy both domestically and internationally. First, on May 4th the controversial Zimbabwean president, Robert Mugabe, visited Malawi to formally open a newly refurbished highway named after him, which links Malawi's commercial capital, Blantyre, and the Mozambican border. The naming of the road came despite strong protests from local opposition and human rights groups who were angry that a figure widely seen as responsible for Zimbabwe's dire economic and political situation could be honoured in such a way. For his part, Mr Mutharika said that the road was honouring an African hero who deserved a legacy in Malawi for his efforts against colonial domination. It is not clear why Mr Mutharika—who has won much praise for his steadfast pursuit of good governance in Malawi—would seek now to align himself politically with Mr Mugabe, as this comes at the expense of creating considerable controversy at home, which will have cost him some of his current support. The road- naming caused much consternation with Malawi's international donors when it was first believed that the MK1.4bn, 49.5-km road had been funded by the EU—an organisation that has, ironically, placed a travel ban on Mr Mugabe. The government later denied that any monies from the EU had gone towards the project but, nevertheless, those opposed to the road-naming argued that this sent the wrong message to donors about how political governance is being viewed in Malawi, thus undermining their confidence in the country. Second, on May 14th Mr Mutharika formally unveiled a mausoleum for Hastings Banda, Malawi's first president after independence. At a cost of US$600,000, the mausoleum consists of two storeys and also contains a library and museum. At the ceremony, Mr Mutharika described Mr Banda as a national

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hero, and to some sections of the population he certainly was a hero for bringing independence from Britain to the country in 1964, as well as presiding over a country that had rarely struggled for food security—a stark contrast to the situation in current times. However, Mr Banda was also accused of large-scale human rights violations and of instituting widespread political repression, and it is unclear why Mr Mutharika would want to identify himself with such a controversial figure. Nonetheless, there is a strategic political gain to be had for the president, as the mausoleum will have delighted many in the MCP, Mr Banda's old party, which Mr Mutharika has been eager to win over to his side since coming to power. However, as with the Mugabe road, Mr Mutharika's apparent admiration of someone with a dire governance record has generated concern about whether this is an indication that his leadership style will become more autocratic and his commitment to good governance slip, resulting in donors reducing their support for the Malawi government.

Economic policy

The 2006/07 budget is The finance minister, Goodall Gondwe, announced the 2006/07 budget (July-

announced June) on June 16th. The top priority, according to the budget, was to improve the ability of the agriculture industry to cope with drought, such as the most recent one experienced in 2005. In announcing his proposed budget, Mr Gondwe asserted that "never again shall we become so hopeless and be forced to beg for food", referring to the food aid needed by Malawi in recent years following repeated periods of drought. Central to this plan were large increases of resources for the ministries of agriculture and food security, and irrigation and water development. It was proposed that the allocation to the agriculture ministry would increase by over 200% from 2005/06, to MK16.8bn (US$43m), which includes continuing the fertiliser subsidy that the government believes has improved agriculture production, despite this going against IMF recom- mendations (see The domestic economy: Agriculture). The amount allocated to water and irrigation more than doubles, to MK2.6bn. The allocation to these ministries translates into 12.2% of total expenditure. Meanwhile, the social sectors will still receive the largest share of the budget, totalling 34.6% of expenditure, with education allocated MK20.5bn and health MK22.6bn. Spending on roads is projected at MK10.5bn, in support of a major road works project that began in 2005. Remarkably, despite such large increases going towards improving agriculture, the government anticipates that overall expenditure as a proportion of GDP will fall, from 32.2% in 2005/06 to 28.7% in 2006/07. Some of this can be explained by the anticipated robust growth in GDP—Mr Gondwe expected real GDP growth to reach 8.4% in 2006—but it will presumably also necessitate some cutbacks elsewhere. However, no details of such spending cuts were given during Mr Gondwe's first presentation.

A number of tax cuts are The second priority in Mr Gondwe's budget speech was the restructuring of a

proposed number of Malawi's taxes in an attempt to make the system more attractive to both existing and potential businesses operating in the country. Reforms were proposed to income taxes, with the top tax-rate bracket reduced from 35% to 30%, while the tax-free income for salaried workers was raised from MK5,000

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(US$36.50) to MK5,500 a month. Meanwhile, the budget advocated abolishing the minimum turnover tax and reducing capital gains tax on assets over eight years old from 21% to 18%. The introduction of rollover relief was also proposed, which would mean that businesses would not pay capital gains tax on any asset sold as long as the funds released were reinvested in assets of greater cost and similar type. Despite these cutbacks, the budget proposes an 11% increase in total revenue, to MK134.7bn, and a budget deficit of 1.3% of GDP, compared with the planned budget deficit of 2.6% of GDP that was planned for 2005/06. Although there have recently been positive developments with regard to the efficiency of tax collection, inflows of donor grants and improved fiscal management, the achievement of such low budget deficits still seems to be more of a long-term goal, given that there is still likely to be some resistance from vested interests to fiscal reforms, while considerable pressure remains to expand social spending and address the problems faced by agriculture.

The proposed budget is In general, there was a positive response to the budget proposals from business,

generally welcomed civil society and donors. Most Malawians agree that the country's priorities include tackling the food crisis, reducing the tax burden and improving infrastructure, so they were pleased that the government had announced its intentions to deal with these. Some business leaders commented that they would have liked to see income tax reduced further, but the more pragmatic accepted that tax revenue could not be reduced by a great deal if greater improvements to public services were expected. What did impress many business leaders was that the government had taken on board many of their suggestions. The initial reaction from donors was similarly positive, with the World Bank country economist, Khwima Nthara, stating that it was a sensible budget that balanced the government's various priorities.

The opposition may still try to Despite the widespread positive response to the proposed budget, the

block the budget opposition—which outnumber the government in parliament—may still attempt to block its implementation. Rather than to any major aversion to the contents of the proposed budget, any attempt by the opposition to block the passage of the budget in parliament would be down to the broader power struggle currently taking place around the president, Bingu wa Mutharika. Tensions between the executive and the legislature created considerable difficulties in passing the 2005/06 budget, and it was only after the intervention of the IMF, a number of non-governmental organisations and a few prominent African dignitaries that the opposition agreed to pass the budget (October 2005, The political scene). With this in mind, at the opening of the budget session of parliament in early June—before the proposed budget had even been announced—the president pleaded with the opposition to "rise above partisan politics and to focus on the need to pull our country out of poverty". Any impasse in the approval of the budget will be to the obvious detriment of the Malawian people, as the funds aimed at easing their plight will be delayed. Another potential pitfall to delaying the budget is the risk that it provides to Malawi's successful completion of the IMF-sponsored poverty reduction and growth facility (PRGF). Following a visit to Malawi in June, the IMF is reviewing whether the government's performance has been satisfactory. Were PRGF

approval to be delayed, Malawi could also stand to lose out on substantial debt relief, as the successful completion of the PRGF forms a central part of reaching completion point under the heavily indebted poor countries (HIPC) initiative and Multilateral Debt Relief Initiative (MDRI). As in 2005, these implications are likely to be outlined by the government and civil society organisations to the opposition, to put pressure on them to allow the budget to pass through parliament smoothly.

A review of progress under the In early May the IMF published the Malawian government's third and final

PRSP is published annual review on the progress made under its poverty reduction strategy paper (PRSP)—known locally as the Malawi poverty reduction strategy (MPRS)—which dealt with developments in 2004/05. The overarching point made by the report was the lack of progress being made in reducing poverty. In 2004/05 the poverty rate for the country was 52.4%, translating into 6.3m people, and representing almost no change since the MPRS was first implemented in 2002. The lack of progress is not surprising, given that the report notes that in 2004/05 there were large increases in recurrent expenditure, which crowded out allocations to the various planned pro-poor initiatives. Other factors were largely beyond the government's control: targets for increasing agricultural output as a way of boosting rural livelihoods were not met, as drought severely affected crop production, while the rise in fuel costs and instability in the exchange rate helped to create an unfavourable macroeconomic environment of subdued economic growth and high inflation. However, the success of the IMF staff-monitored programme (SMP) during the review period was highlighted, which led to a poverty reduction and growth facility being agreed shortly into 2005/06. The government was relatively happy with its fiscal and monetary performance under the SMP, with the fiscal deficit falling from a high of 12.9% of GDP in 2003/04 to 3.5% of GDP in 2004/05. However, it was also noted that high levels of domestic debt had accumulated during this time, from MK60.6bn at the end of 2004 to MK74.5bn by the end of 2005, as the government relied more on domestic borrowing to finance the fiscal deficit. The review also highlighted the continued lack of institutional capacity to monitor and evaluate the implementation of government programmes. In 2006/07 the MPRS will be replaced by what the government is calling the Malawi development and growth strategy (MDGS), which will face many of the same challenges as its predecessors, such as the need for prudent fiscal and monetary policy, adequate funding for pro-poor activities, and improved capacity at all levels of governance for monitoring and evaluating the programme's implementation.

The central bank has adopted In early June the governor of the Reserve Bank of Malawi (the central bank),

a managed float Victor Mbewe, released a statement on exchange-rate management, in which he announced that a managed float would now be adopted. Mr Mbewe elaborated on the difficulties faced by exchange-rate management in Malawi, which included the following factors: • the economy's small export base, which means that demand for foreign exchange exceeds supply, leading to a persistent lack of foreign-exchange reserves;

• the impact of recurring drought, which necessitates large increases in food imports while depressing exports, further worsening the economy's ability to generate foreign-exchange reserves; • additional problems in the export sector, such as low prices in the key tobacco sector in recent years, together with the lack of any major alternative export commodity alternatives to rival the dominance of tobacco; • the underdeveloped nature of the financial market in Malawi, in particular of the exchange-rate market, which Mr Mbewe believes has undermined the ability of "market forces" to determine an appropriate exchange rate; and • the low levels and unpredictability of donor inflows, despite the resumption of an IMF programme, which are insufficient to help to meet the country's needs for foreign exchange. With these factors in mind, Mr Mbewe stressed the difficulty of managing the exchange rate in Malawi. Although, on the one hand, supply of foreign exchange is weak and unpredictable, demand for foreign exchange is, on the other hand, growing steadily and is inelastic owing to the need to pay for essential items such as fertiliser, maize, medicines, machinery and other raw materials. The governor confirmed that the central bank had deliberately intervened in the second half of 2005 to stem the kwacha's depreciation (it remained at MK123:US$1 between July and December 2005) because critical imports needed to be paid for during this time. With the currency overvalued, the policy is now expected to switch in order to realign it to its appropriate level and ensure that it helps to stimulate exports, especially non-tobacco exports. This policy is expected to be carried out using mainly market-based intervention and occasionally moral suasion. The IMF's reaction to the central bank's announcement is not yet known, but the Fund was critical of the central bank intervening to defend the currency in the second half of 2005 and is at least likely to welcome a policy that more accurately tracks movements in the real effective exchange rate (April 2006, Economic policy).

The domestic economy

Economic trends

Inflation edges down, but fuel Inflation fell in March 2006, bringing to an end seven months of continual price increases are announced rises. The annual rate for the month of March was 16.6%, compared with 17.1% in February. April saw another drop, with inflation falling to 16.1%. Behind the falls were better prospects for food production following an improved harvest in most parts of the country (see Agriculture). The annual food inflation rate fell to 18.5% in April 2006, from 19.2% in March and 19.9% in February. Meanwhile, non-food inflation edged down to 13.3% in April, compared with 13.4% and 13.5% in March and February respectively. However, the prospects for a rapid fall in inflation over the year were dealt a blow in early May, when the government announced that it intended to increase domestic fuel prices by 3-7%, owing to international price rises and the weakening of the kwacha against its major trading partners. Together with the continued rapid depreciation of the kwacha

forecast for the year, the prospect of reaching single-digit inflation by the end of 2006 has become more remote, and the Economist Intelligence Unit expects inflation to average 15.3% in 2006, with year-end inflation still well into double- digit figures, at 14%.

Average inflation (% change year on year unless otherwise indicated) 2005 2005 2006 Year Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar 15.4 15.9 15.6 15.4 15.8 15.9 16.2 16.5 16.7 17.1 16.6

Source: Reserve Bank of Malawi.

The kwacha continues to The kwacha continued to depreciate over the early part of 2006, despite the

depreciate opening of the tobacco auction in March—a major source of foreign-exchange earnings. The kwacha depreciated by almost 8% against the US dollar between January and April, while falling by over 9% against the euro and 7.5% against the rand in the same period. The rapid depreciation reflected the loosening of restrictions on the sale of foreign exchange, which had been in operation in the second half of 2005. The backlog of import payments helped to accelerate demand for foreign currency in early 2006, while some loss of confidence in the currency as a result of the erratic exchange-rate policy will also have played a part. For 2006 as a whole, we expect the kwacha to average MK138:US$1 in 2006.

The kwacha's path against its major trading currencies Per US dollar Per euro Per rand Buying Selling Mid-rate Buying Selling Mid-rate Buying Selling Mid-rate 2005 May 115.9 117.1 116.5 147.1 148.6 147.9 18.3 18.5 18.42 Jun 121.2 122.5 121.9 147.6 149.0 148.3 18.0 18.2 18.09 Jul 122.7 123.3 123.0 147.9 149.3 148.6 18.3 18.6 18.44 Aug 123.0 124.0 123.5 151.0 152.6 151.8 19.0 19.2 19.10 Sep 123.0 124.2 123.6 150.7 152.3 151.5 19.3 19.3 19.35 Oct 123.0 124.2 123.6 147.9 149.3 148.6 18.7 18.9 18.82 Nov 123.0 124.2 123.6 144.9 146.4 145.6 18.5 18.5 18.50 Dec 123.2 124.4 123.8 146.0 147.5 146.8 19.4 19.6 19.46 2006 Jan 124.3 125.5 124.9 150.7 152.2 151.5 20.5 20.7 20.57 Feb 130.6 132.0 131.3 156.2 157.8 157.0 21.6 21.5 21.55 Mar 132.7 134.0 133.3 159.4 161.0 160.2 21.4 21.3 21.38 Apr 134.1 135.4 134.8 164.4 166.1 165.3 22.0 22.2 22.13

Source: Reserve Bank of Malawi.

Agriculture

The maize harvest is set for an In early April the Ministry of Agriculture and Food Security announced its

impressive turnaround second round of crop estimates, which contained encouraging news on the country's maize crop—a staple food for the majority of the population. The maize harvest in 2006 (which takes place between March and August) was expected to reach 2.35m tonnes, a 92% increase on the disastrous 2005 harvest and significantly above the estimated level of domestic consumption of

2m tonnes. The first round of crop estimates was published in January, with maize production projected to reach 2.5m tonnes, but adverse weather conditions in some areas since then led to a downward revision to the current estimate (April 2006, The domestic economy: Agriculture). For instance, in the northern region heavy rains caused flooding, which ruined the area's crops, while there was a lack of rain in other areas, such as the Kasunga district, which was forced to reduce its estimated maize harvest by 42% between the two agriculture ministry surveys. However, it needs to be borne in mind that the 2.35m-tonne figure is an estimate; the actual level will not be known until the agriculture ministry conducts a number of surveys as harvesting begins. It is a positive sign that market prices for maize have begun to fall in many areas of the country, reflecting the fact that the supply of maize is increasing and also that households are able to support themselves more with food grown in their own fields. However, at the same time, other parts of the country will continue to need food aid until later in the year when surpluses elsewhere can be better assessed and then moved to where they are needed.

The government credits its In explaining the factors behind the probable upturn in Malawi's harvest this subsidy policy year, the government was quick to attribute much of the success to its policy of subsidising seed and fertiliser for those least able to afford it. They contrasted this against the experience in 2005, when delays in agreeing and releasing the subsidy were believed to be partly to blame for the disastrous harvest. This time round, the subsidy programme began when farmers were first planting the crop and involved a coupon system, which allowed small-scale farmers to purchase 147,000 tonnes of fertiliser and 6,000 tonnes of seeds at around half the commercial price. The positive outlook for the 2006 harvest soon drew comment from a number of domestic and international sources who were critical of donor involvement in the region. They pointed out that it was institutions like the IMF and the World Bank that had first encouraged African countries to phase out their subsidy programmes, but claimed that this policy must have been wrong, as subsidies seemed to be helping to alleviate the food crisis in Malawi. However, this analysis misses a number of points. Donors are not against all subsidies; the IMF raised no objections when the Malawi government announced its intention to subsidise fertiliser for those who could not afford it. However, donors do often warn against the pressure that more general subsidies place on fiscal policy, as well as the adverse effect that subsidies can have on the efficient operation of the free market. This view has been supported in Malawi, with business leaders arguing that the government programme has undermined many domestic fertiliser and seed producers who cannot compete with the subsidised prices.

Weather is also an important Fertiliser and seed subsidies may not be the only, or even the dominant, factor

facto r behind the upturn in the 2006 harvest. More favourable weather conditions during the most recent season have certainly also played an important role. This is borne out by a recent report from the Southern African Development Community (SADC), which looked at food prospects across its member states,

which include Malawi. The poor rainfall and subsequent poor harvests that Malawi has experienced in recent years have also occurred in Malawi's neighbours, with Mozambique, Zambia and Zimbabwe all having been affected by drought since 2000. Also like Malawi, each of these countries is now projecting a significant upturn in its 2006 harvest. The countries have differing agricultural polices, but each also tends to experience broadly similar weather conditions, which indicates that perhaps weather is a more important determinant to crop production than government policy.

Comparison of regional harvests ('000 tonnes) Sorghum/ Maize Wheat Rice millet All cereals 2004/05 2005/06 2004/05 2005/06 2004/05 2005/06 2004/05 2005/06 2004/05 2005/06 Estimate Forecast Estimate Forecast Estimate Forecast Estimate Forecast Estimate Forecast % increase Malawi 1,225 2,350 2 3 41 53 34 76 1,302 2,482 90.6 Mozambique 1,382 1,534 0 0 110 183 343 382 1,836 2,098 14.3 Zambia 866 1,424 137 94 9 9 48 69 1,060 1,597 50.7 Zimbabwe 600 1,352 150 150 0 0 130 148 880 1,651 87.6

Source: Southern African Development Community, Food Security Update, May 2006.

Buyers respond poorly to The president, Bingu wa Mutharika, officially opened the 2006 Malawi tobacco

minimum tobacco prices auction period at the end of March at the Lilongwe Auction Floors. In opening the auctions, Mr Mutharika announced that the government would be setting a minimum price threshold for tobacco sales. He stated that buyers should pay a minimum price of US$1.10/kg for low-quality tobacco and a minimum of US$1.70/kg for the higher-grade leaf. The setting of the minimum price was a reaction to the steadily declining prices offered at Malawi's auctions in recent years—from an average US$3/kg in 1997 to US$1.5/kg in 2005, with prices occasionally reaching as low as 70 US cents/kg—which culminated last year in farmers repeatedly disrupting auction floors in protest and a significant migration of Malawi tobacco to neighbouring countries (October 2005, The domestic economy: Agriculture). The reason for the declining prices is the subject of much dispute in Malawi. Many farmers, as well as a number of local business forums, accuse the main buying companies of monopolistic practices, in which farmers are giving little alternative but to accept the low prices on offer. Given the importance of the crop to the Malawi economy—it contributes around 15% of the country's GDP, 25% of its tax earnings, 70% of its foreign- exchange earnings and is directly or indirectly responsible for over 70% of its employment—it is not surprising that Mr Mutharika felt under pressure to intervene. However, the move rapidly backfired when buyers immediately refused to offer the minimum prices and the auction was forced to close after just one day of trading. Attempts by the government to negotiate with the buyers saw the auction soon recommence, only to close a further three times during April and May as buyers refused to submit to the president's wishes. At the end of May the minister for agriculture and food security, Uladi Mussa, announced that a number of the differences between the government and the buyers had been resolved during five days of negotiations. A particular bone of contention had been the grading of the tobacco leaves. Buyers were unhappy that much of the

tobacco offered in the auction was a mixture of lower- and higher-quality leaves, for which they did not want to pay premium prices. The government agreed to address this, and Mr Mussa was confident that prices would increase rapidly when the auction re-opened. However, early indications in June were that prices have remained depressed, with offers of 70 US$ cents/kg for burley leaf at the auctions persisting.

The government still predicts Despite the problems concerning the tobacco auction, the government remains

tobacco sale increases confident that tobacco sales in 2006 will outstrip those of the previous year. The Tobacco Control Commission (TCC) announced in early June that it forecast revenue to reach US$178m in 2006, a 9.8% increase on the 2005 figure. It attributes this to higher forecast production levels; in 2006 production is expected to reach 158,000 tonnes, compared with 145,000 tonnes in 2005. However, this forecast appears over-optimistic, as it implies higher average prices in 2006 than in 2005, and there is still no indication that auction prices will reach even the 2005 level. Moreover, incidents of tobacco smuggling are reported to be on the increase. Many farmers who have been unable to sell their crops at auction have turned instead to smuggling produce to neighbouring countries. Felix Mkumba, the executive secretary of the Tobacco Association of Malawi, confirmed that he had received several reports of incidents of smuggling, although the general manager of the TCC has denied that smuggling was increasing as a result of the problems at the auctions. It was estimated that Malawi had lost MK7bn (US$59.2m) to smuggling in 2005, with around 50,ooo tonnes leaving the country illegally.

Foreign trade and payments

The current-account deficit The Reserve Bank of Malawi (the central bank) has recently published its widened in 2005 version of the country's balance of payments for 2005. The central bank uses a differing methodology from that of the IMF and the Economist Intelligence Unit in compiling its data—for example, the central bank does not include official transfers in the current-account balance—but the trends tend to be comparable. Once again, import growth has outstripped that of exports, resulting in an increase in the trade deficit. Exports did not grow as strongly as in 2004, which mainly reflects a poorer year for tobacco, whilst imports increased significantly as fuel prices accelerated and food imports were stepped up. The deficit on the services account increased, owing largely to the need to finance the transportation of additional maize imports. Private transfers, while remaining small, increased substantially in 2005, with the sharp rise in payments likely to include drought-related funding received from non-governmental organisations and payments from Malawians working abroad to their families.

Balance of payments (MK m) 2001 2002 2003 2004 2005 Trade balance -3,225.5 -13,895.4 -24,400.3 -33,888.9 -45,046.4 Exports of goods, fob 30,798.0 31,713.1 42,252.0 54,419.6 59,592.5 Imports of goods, fob 34,023.5 45,608.4 66,652.3 88,308.4 104,639.0 Non-factor services (net) -8,085.1 -12,679.7 -14,545.1 -18,521.6 -21,229.6

Balance of payments (MK m) 2001 2002 2003 2004 2005 Factor services (net) -2,302.7 -2,794.1 -3,267.8 -4,992.8 -5,162.4 Private transfers (net) 702.0 623.2 610.6 1,888.9 5,562.6 Current-account balance -12,911.3 -28,746.1 -41,602.6 -55,514.3 -65,875.8 Capital account balance 20,241.4 15,151.1 14,012.0 29,441.9 35,100.8 Long-term capital balance 19,463.3 14,324.8 15,316.0 29,376.9 35,030.2 Government transfers (net) 9,150.9 9,185.3 11,779.6 24,186.2 26,858.4 Government drawings (net) 9,838.2 4,194.1 2,125.9 3,625.7 6,426.9 Public enterprises (net) 214.6 669.6 1,060.0 1,173.1 1,319.2 Private sector (net) 259.6 275.7 350.6 391.9 425.7 Short-term capital (net) 778.0 826.4 -1,304.0 65.0 70.6 Errors & omissions -13,596.8 19,498.4 22,216.5 18,565.8 25,130.9 Balance before debt relief -6,266.8 5,903.5 -5,374.1 -7,506.7 -5,644.1 Debt relief 820.3 2,244.0 4,634.2 5,125.2 5,644.1 Overall balance after debt relief -5,446.5 8,147.5 -739.9 -2,381.5 0.0 Change in net foreign assets of the banking system 5,446.5 -8,147.5 739.9 2,381.5 0.0

Source: Reserve Bank of Malawi.

Exports to the US stagnate, but Malawi's trade with the US has grown steadily in recent years, but new data

improvement is likely raise some concerns that the trade balance between the two countries is shifting. As an export destination, the US is Malawi's second most import market (behind South Africa), according to the IMF. Malawi has benefited from the US government's African Growth and Opportunity Act (AGOA) and generalised system of preferences (GSP), which allows certain goods to be exported to the US with lower or no duties applied. Whereas many African countries have focused on the provisions of AGOA that allow the duty-free access of textiles to the US market, Malawi has primarily benefited from the greater export of agricultural products under the GSP. However, recent data released by the US international trade commission indicate that Malawi's exports to the US have stagnated over the past two or three years, whilst imports from the US have continued to grow. Exports of agricultural products to the US fell in 2004, to US$51.7m, and increased only slightly in 2005, to US$55.3m. This was almost certainly another reflection of the negative impact of the drought that gripped the country in those years. In addition, textile exports have also struggled, falling in 2005 to US$22.8m from US$26.8m in 2004. This largely reflects the expiry of the Multi-Fibre Arrangement at the end of 2004, which opened up the international textile market to competition from lower-cost producers in Asia. The prospects for 2006 are much better for agricultural exports; in the first quarter of 2006 agricultural exports to the US were US$24.9m, compared with US$4.3m during the same period in 2005. The minister for trade and private sector development, Martin Kansichi (who was later moved in the cabinet reshuffle; see The political scene), in May encouraged Malawian farmers to take advantage of the opportunities provided under AGOA and the GSP. Away from tobacco, there are opportunities for Malawi to export greater quantities of such diverse products as dried fruits and macadamia nuts. The prospects are not so

good for textile exports; in the first quarter of 2006 such exports totalled US$3.9m, compared with US$6.7m during the same period in 2005.

Malawi's trade with the US (US$ '000) Jan-Mar 2003 2004 2005 2005 2006 Agricultural products Exports 56,811 51,706 55,342 4,253 24,853 Exports under AGOA & GSP 36,858 38,926 43,249 3,759 10,953 Imports 4,356 9,874 7,516 1,668 8,220 Textiles & apparel Exports 23,173 26,775 22,781 6,651 3,911 Exports under AGOA & GSP 22,389 25,482 22,648 6,651 3,911 Imports 342 461 705 270 187 All sectors Exports 80,076 79,356 82,444 10,926 28,784 Exports under AGOA & GSP 59,256 64,421 65,902 10,409 14,864 Imports 16,507 21,514 27,368 7,043 24,795 Trade balance with US 63,569 57,842 55,076 3,883 3,989

Source: US International Trade Commission.

Debt developments According to the central bank, Malawi's total medium- to long-term external debt stock stood at US$2.9bn at the end of April 2006, compared with US$3bn at the end of 2005. Not much change in the debt stock is expected now until Malawi reaches completion point under the IMF-World Bank's heavily indebted poor countries (HIPC) initiative, which the government hopes will take place around the middle of 2006. Once HIPC completion point is reached, the country would also become eligible for debt relief from its multilateral creditors under the Multilateral Debt Relief Initiative (MDRI). The MDRI write-offs in particular would have an enormous impact on Malawi's debt situation, owing to the composition of debt; in April multilateral debt accounted for US$2.6bn of the total debt stock, equivalent to 89.7% of the total.

Total external debt stock, April 2006 (US$ m)

Commercial debt Bilateral debt Multilateral debt

Total: 2,899m

Source: Reserve Bank of Malawi.