Country Report

Malawi Malawi at a glance: 2005-06

OVERVIEW The president, Bingu wa Mutharika, faces considerable opposition in parliament from his former party, the United Democratic Front (UDF), and the largest party in parliament, the Malawi Congress Party (MCP). Despite the gathering of substantial support behind Mr Mutharika’s newly formed Democratic Progressive Party (DPP), the president does not have majority support, and the passing of the 2005 budget and IMF-guided reform legislation are at risk. The most likely scenario is that some MCP members will ultimately realise the importance of passing these bills, as much-needed IMF and donor financial support is at stake.

Key changes from last month Political outlook • Should mounting opposition in parliament persistently block Mr Mutharika’s legislative programme, fresh elections may be called—which Mr Mutharika would be expected to win, given his current popularity. The UDF and the MCP are attempting to hold impeachment proceedings against the president, but their case is weak and they are unlikely to succeed. Economic policy outlook • The 2005 budget presented to parliament in June is consistent with policy objectives recommended by the IMF, notably raising spending on health and education. It is also a strongly expansionary budget, fuelled by a projected pick-up in donor financial support, but the extent of the expansion appears overambitious. The Economist Intelligence Unit expects that, after strenuous debate in parliament, the budget will be passed. We estimate a deficit of around 2.5% of GDP. Economic forecast • Recent drought conditions point to a large forecast contraction in agricultural production in 2005, and we have therefore revised our forecast for real GDP growth for the year from 2.2% to 1%. A steady rise in economic confidence and a recovery in agricultural production is expected to lift growth to 4% in 2006. The current-account deficit has also been subject to some adjustments in line with forecast lower tobacco exports: the deficit is now forecast to rise to 16.5% of GDP in 2005 (from our previous forecast of 9.6% of GDP), before easing to 13% of GDP in 2006. July 2005

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Contents

Malawi

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2005-06 7 Political outlook 8 Economic policy outlook 10 Economic forecast

12 The political scene

17 Economic policy

24 The domestic economy 25 Agriculture 28 Financial and other services

28 Foreign trade and payments

List of tables

10 International assumptions summary 12 Forecast summary 19 Government finances 20 Sub-Saharan Africa: HIV/AIDS prevalence in selected countries, 2004 24 Inflation 27 Tobacco production 27 Cumulative tobacco sales to May 26th, 2005 29 External debt

List of figures

12 Gross domestic product 12 Consumer price inflation 24 Inflation 25 Exchange rate, 2005

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Malawi July 2005 Summary

Outlook for 2005-06 The president, Bingu wa Mutharika, will concentrate on strengthening support for his newly formed Democratic Progressive Party and on countering attempts by the United Democratic Front (UDF) and the Malawi Congress Party (MCP) to block his reform agenda in parliament. However, the MCP is ultimately expected to yield sufficient support so that the bulk of the IMF-recommended economic reform policies can be passed through parliament during 2005-06. Real GDP is estimated to have increased by 4.2% in 2004, but an expected poor harvest will slow real GDP growth to a forecast 1% in 2005, before a recovery in agricultural production lifts growth to 4% in 2006. High international oil prices will exacerbate the effects of a poor maize harvest, causing the average rate of inflation to increase to 15% in 2005, before easing to 9.5% in 2006 as oil prices decline and maize crops improve. A decline in tobacco exports is expected to cause the current-account deficit to increase to 16.5% of GDP in 2005, before a recovery in tobacco production in 2006 reduces the deficit to 13% of GDP.

The political scene Mr Mutharika’s nomination of Mary Nangwale as inspector-general of the police has been rejected by the UDF and the MCP. The two parties have indicated that they are likely to engage in a fierce battle with the government over the approval of the budget for the fiscal year 2005/06, and have continued their attempts to have Mr Mutharika impeached, although Mr Mutharika is expected to triumph in both cases. The president has sacked his education minister, Yusuf Mwawa, for corruption, and investigations have started into possible corruption by other allies of the former president, Bakili Muluzi.

Economic policy The IMF has endorsed the government’s performance under the first nine months of the staff-monitored programme, and discussions are under way for a new poverty reduction and growth facility. The finance minister, Goodall Gondwe, has presented a fairly expansionary 2005 budget to parliament—the spending priorities are broadly in line with the IMF’s principal objectives.

The domestic economy According to recent data, year-on-year inflation rose to 15.5% in May, up from 15.3% in April, reflecting food shortages caused by the poor 2005 harvest. Foreign-exchange shortages have ended the local currency’s recent stability.

Foreign trade and payments According to recent World Bank data, Malawi’s external debt rose to US$3.1bn at the end of 2003, due mainly to cross-currency re-evaluations as the US dollar weakened. A number of donors have resumed financial support to Malawi.

Editors: Nicola Prins (editor); Pratibha Thaker (consulting editor) Editorial closing date: July 1st, 2005 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

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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 Until February 5th the ruling United Democratic Front (UDF) held an alliance with the Republican Party, the Alliance for Democracy (Aford), the National Democratic Alliance (NDA) and the Movement for Genuine Democratic Change (Mgode), creating a majority as a bloc; since Mr Mutharika’s resignation from the UDF on February 5th a considerable realignment of parties has taken place, and it is not yet clear who the majority coalition will be; the Malawi Congress Party (MCP) remains the largest single party in the National Assembly; smaller parties include the People’s Progressive Movement; the Congress for National Unity; and the People’s Transformation Party; independent members of parliament currently form the third largest bloc in the legislature; Mr Mutharika has formed the Democratic Progressive party (DPP), which has not yet been officially launched

President & commander-in-chief of the armed forces, minister of defence & civil service Bingu wa Mutharika Vice-president & minister for statutory companies Cassim Chilumpha

Key ministers Agriculture, irrigation & food security Gwanda Chakuamba Economic planning & development David Faiti Education & human resources Kate Kainja Finance Goodall Gondwe Foreign affairs & international co-operation George Chaponda Health & population Hetherwick Ntaba Home affairs & internal security Uladi Mussa Industry, science & technology Khumbo Chirwa Information, communications & tourism Kenneth Lipenga Justice & constitutional affairs Henry Phoya Labour & vocational training Vacan t a Lands, housing & service Bazuka Mhango Local government & rural development Jafali Mussa Mines, natural resources & environment Davis Katsonga Social development & persons with disabilities Clement Chiwaya Sports, youth & culture Henry Chimunthu Banda Trade & private sector development Eunice Kazembe Transport & public works Henry Mussa Women, child welfare & community services Joyce Banda

Central bank governor Victor Mbewe a The minister for labour and vocational training, Lilian Patel, lost her portfolio in February 2005; we are unable to confirm at the time of writing who has replaced her.

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Economic structure

Annual indicators 2000a 2001a 2002a 2003b 2004b GDP at market prices (MK bn) 97.2 121.5b 126.2b 142.2 163.5 GDP (US$ bn) 1.6 1.7b 1.6b 1.5 1.5 Real GDP growth (%) 1.1 -4.2 1.8 4.1 4.2 Consumer price inflation (av; %) 29.6 22.7 14.7 9.6a 11.2 Population (m)c 11.4 11.6 11.9 12.1 12.4 Exports of goods fob (US$ m) 403.1 427.9 422.4 402.0 476.2 Imports of goods fob (US$ m) 462.0 472.2 573.2 539.5 613.0 Current-account balance (US$ m) -73.4 -59.9 -200.7 -145.5 -152.8 Foreign-exchange reserves excl gold (US$ m) 243.5 203.1 162.0 126.5a 133.3a Total external debt (US$ bn) 2.7 2.6 2.9 3.1a 3.2 Debt-service ratio, paid (%) 12.4 8.0 6.3 7.8 12.7 Exchange rate (av) MK:US$ 59.54 72.20 76.69 97.43a 108.89a a Actual. b Economist Intelligence Unit estimates. c Mid-year estimates.

Origins of gross domestic product 2003a % of total Components of gross domestic product 2003a % of total Agriculture 40.1 Private consumption 88.0 Industry 12.2 Government consumption 16.9 Manufacturing 11.1 Gross fixed capital formation 10.3 Services 47.7 Change in stocks 0.9 Net exports of goods & services -16.1

Principal exports fob 2003b US$ m Imports fob 2002d US$ m Tobaccoc 206 Intermediate goods 435 Sugar 47 Fuel oils 76 Apparel & fabrics 35 Capital goods 73 Tea 26 Consumer goods 66

Main destinations of exports 2003e % of total Main origins of imports 2003e % of total South Africa 22.4 South Africa 48.2 US 12.9 Zambia 13.2 Germany 11.2 India 4.4 Egypt 5.4 Tanzania 3.4 a IMF estimates. b Actual. c Production marketed at auction. d Economist Intelligence Unit estimates. e Based on partners’ trade returns; subject to wide margins of error.

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Quarterly indicators 2003 2004 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr Central government finance (MK m) Revenue and grants 8,480.8 11,329.7 12,811.7 17,996.0 19,161.5 13,822.6 14,003.7 21,780.5 Revenue 7,344.8 8,727.7 9,931.6 10,315.6 10,936.3 11,393.2 12,772.4 13,240.3 Grants 1,064.1 2,602.0 2,880.0 7,680.4 8,225.2 2,429.4 1,231.4 8,540.3 Expenditure 14,120.9 15,010.2 16,852.6 19,581.1 19,604.2 20,506.6 16,956.0 21,641.9 Balance before grants -6,776.1 -6,282.5 -6,921.0 -9,265.5 -8,667.9 -9,113.4 -4,183.6 -8,401.6 Balance after grants -5,640.1 -3,680.5 -4,040.9 -1,585.1 -442.7 -6,684.0 -2,952.3 138.6 Output trends Industrial production index (1984=100) 109.1 91.8 93.5 102.6 113.3 101.1 106.1 113.1 Industrial production index (% change, year on year) 8.0 -9.8 -8.4 -0.1 3.8 10.1 13.5 10.2 Prices National composite consumer prices (2000=100) 157.3 150.9 149.8 159.1 173.6 168.0 166.6 179.7 National composite consumer prices (% change, year on year) 10.5 9.1 8.9 9.6 10.4 11.3 11.2 12.9 Financial indicators Exchange rate: MK:US$ (av) 89.597 91.329 100.866 107.938 108.791 108.897 108.956 108.944 Exchange rate: MK:US$ (end-period) 91.572 89.915 108.094 108.566 108.927 108.908 108.946 108.943 Exchange rate: nominal effective rate (2000=100) 65.5 69.3 63.4 56.5 58.6 60.8 60.8 59.3 Exchange rate: real effective rate (2000=100) 81.4 88.1 79.7 68.7 71.6 75.5 76.3 75.3 Deposit rate (av; %) 24.00 25.33 28.00 23.17 18.50 15.75 10.25 10.42 Discount rate (end-period; %) 40.00 45.00 45.00 35.00 35.00 25.00 25.00 25.00 Lending rate (av; %) 47.50 49.00 52.00 47.17 42.00 39.00 33.00 33.33 Treasury bill rate (av; %) 37.57 39.70 43.82 36.86 34.28 30.97 24.32 24.72 M1 (end-period; MK m) 14,361.3 17,493.0 18,343.7 17,763.4 17,294.2 23,926.5 24,988.6 25,723.0 M1 (% change, year on year) 42.1 33.1 32.3 27.1 20.4 36.8 36.2 44.8 M2 (end-period; MK m) 27,969 32,390 34,333 35,812 36,392 43,713 44,483 46,448 M2 (% change, year on year) 34.4 31.6 30.2 27.5 30.1 35.0 29.6 29.7 Debt-service payments (MK m) 2,248.1 2,372.0 2,357.2 3,056.0 2,914.3 3,131.7 2,371.5 4,314.4 Principal 1,560.3 1,808.3 1,781.6 2,296.0 2,213.0 2,326.6 1,713.1 3,648.6 Interest payments 676.4 563.7 575.2 753.4 669.1 788.2 650.7 963.5 Sectoral trends Building plans passed (MK '000)a 52.5 661.3 431.6 482.5 313.2 658.8 568.8 370.4 Electricity production (m kwh) 268.1 288.6 326.8 305.8 298.4 321.0 348.4 n/a Tea production (‘000 tonnes) 19.8 9.5 4.7 3.6 19.5 11.1 7.2 12.1 Tobacco auction sales (‘000 tonnes) 3.0 72.8 39.6 0.0 6.8 72.7 69.0 31.5 Tobacco auction sales (MK m) 256.6 7,689.3 4,634.6 0.0 798.8 9,803.1 8,690.1 3,081.4 Sugar production ('000 tonnes) 0.0 73.7 119.9 66.4 0.0 58.1 126.8 37.5 Foreign trade & reserves Exports fob (MK m) 9,103 9,648 20,298 12,623 9,545 10,496 20,118 7,922 Tobacco 3,176 3,706 10,984 6,326 3,433 3,115 12,074 3,034 Imports cif (MK m) -15,702 -19,145 -22,287 -19,516 -18,509 -18,695 -27,477 -21,624 Trade balance -6,599 -9,497 -1,989 -6,893 -8,964 -8,199 -7,359 -13,702 Reserves excl gold (end-period; US$ m) 122.3 113.6 104.4 126.5 118.9 100.5 138.0 133.4 a Blantyre, Lilongwe and 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 2005-06

Political outlook

Domestic politics Political activity in Malawi will continue to be dominated by the realigning of political loyalties between the former president, Bakili Muluzi, who is the chairman of the United Democratic Front (UDF), and the new president, Bingu wa Mutharika, who left the UDF on February 5th to form his own political party, the Democratic Progressive Party (DPP). Although a substantial support base is emerging behind Mr Mutharika, which includes many UDF members, a number of independent members of parliament (MPs), and most of the small opposition parties, it is not sufficient to guarantee a majority for Mr Mutharika in parliament. Approximately 80 out of 193 MPs have so far pledged their support for Mr Mutharika, but the political situation in Malawi is expected to remain fluid. More opposition MPs will be tempted to proffer their support for Mr Mutharika in return for access to the potential benefits of office, and the UDF is expected to continue to haemorrhage support to Mr Mutharika’s DPP as UDF politicians decide that supporting the president is more to their personal benefit. In the meantime, a decision by the Malawi Congress Party (MCP), which has the largest representation in parliament, to back the Muluzi faction means that parliamentary support for Mr Mutharika’s agenda cannot be guaranteed. Mr Muluzi is clearly intent on removing Mr Mutharika from power, owing to the anti-corruption drive launched by the new president that has ensnared people close to the former president. The motives of the MCP leader, John Tembo, are less clear cut, but he appears determined to test the backing for Mr Mutharika. There is a real risk that both factions will combine to block the passage of the budget for 2005/06 (June-July) and in doing so possibly risk the IMF refusing to agree to a new funded programme for Malawi. The most likely scenario is that some MCP members will ultimately realise how important passing a budget drawn up with heavy donor assistance is and back the president. Should Mr Mutharika find that his legislative programme is persistently blocked by parliament, he may choose to call fresh elections. The president’s anti- corruption campaign is popular with the public and the machinations of the political old guard are unlikely to have won the UDF or the MCP any additional support. Although the UDF is known to have the only countrywide support base, the 2004 election shows that its support has dwindled and, furthermore, the 2004 election campaign has placed it under great financial strain. The DPP appears to have substantial funds at its disposal (the source of which is unknown). Attempts are being made by the UDF and the MCP to have the president impeached, but the charges are weak and unlikely to succeed. Legal proceedings would require evidence that Mr Mutharika was guilty of serious misconduct that was in breach of the constitution. Even if Mr Mutharika were indicted and tried, to be successful an impeachment motion requires the

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support of two-thirds of parliament, and this would not be forthcoming. Outright support for Mr Mutharika from at least 80 out of 193 MPs guarantees him the support of more than a third of parliament, and were a secret ballot to be held he would be likely to gain far more support.

International relations There will be no external threats to Malawi over the forecast period, and relations with its main trading partners, South Africa and the EU, will remain good. Relations with the IMF remain positive, as the Fund has been encouraged by the first nine months of Mr Mutharika’s rule and is currently negotiating a new poverty reduction and growth facility (PRGF). Relations with the UK, one of Malawi’s biggest bilateral donors, remain positive, and financial assistance continues to be disbursed; a number of other donors have resumed their financial support in recent months. However, donors have warned that Malawi must continue to make progress with economic reforms, particularly good governance, in order for their financial support to continue.

Economic policy outlook

Policy trends Although a PRGF has not yet been agreed with the IMF to replace the 12-month staff-monitored programme (SMP) that ends in June 2005, Malawi’s economic policy is expected to remain consistent with the principal objectives of the SMP and new objectives being discussed for the PRGF. The budget for the fiscal year 2005/06 (July-June), presented to parliament in June 2005, reflects consistency with key objectives, such as a strong focus on expenditure control and fighting corruption, while prioritising spending on healthcare and education. Having endorsed the government’s performance under the first nine months of the SMP, particularly as key fiscal and monetary targets have been adhered to, the IMF is currently holding discussions for a new PRGF with the Malawi government. A final review of the SMP is scheduled to take place in July 2005, which is expected to be successful given that overall economic policy has remained on track with the programme’s targets. However, the 2005/06 budget must be passed before the IMF will agree to a new PRGF for Malawi. Given that strenuous debate is taking place in Malawi’s parliament over the approval of the budget, it may take several weeks before the budget is passed—agreement on a new PRGF is therefore likely to take place in the coming months. Once the PRGF is in place, Malawi will have to make sure that programme conditions are adhered to strictly, as the IMF and donors are unlikely to be sympathetic to policy slippages. There is a risk that Mr Mutharika will not be able to push his economic reform policies through parliament without protracted debate and delays, as he has not yet secured majority support. There is also concern that weak institutional capacity and corruption will continue to constitute significant obstacles to policy implementation throughout the forecast period. However, assuming that Malawi remains on track with the main PRGF targets, it is expected to reach completion point under the IMF- World Bank’s heavily indebted poor countries (HIPC) debt-relief initiative in the second half of 2006. Debt relief could be substantial given the G8 countries’ commitment to eliminating the debt to the World Bank, the IMF and the

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African Development Bank of countries reaching completion point under the HIPC initiative—under the new proposal, Malawi is eligible for debt relief in the second round, which would take place in 12-18 months’ time.

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

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

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Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2003 2004 2005 2006 Real GDP growth World 3.9 5.1 4.2 4.0 OECD 2.0 3.3 2.3 2.3 EU25 1.2 2.3 1.7 2.0 Exchange rates ¥:US$ 115.9 108.1 107.4 103.0 US$:€ 1.132 1.244 1.222 1.260 SDR:US$ 0.714 0.675 0.679 0.666 Financial indicators ¥ 2-month private bill rate 0.03 0.00 0.00 0.17 US$ 3-month commercial paper rate 1.10 1.48 3.31 4.63 Commodity prices Oil (Brent; US$/b) 28.8 38.5 50.5 46.5 Tobacco (US$/tonne) 2,646 2,740 2,700 2,720 Tea (US$/kg) 1.5 1.7 1.7 1.7 Sugar (US cents/lb) 7.1 7.2 8.9 8.9 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. Although global economic growth on a purchasing power parity basis is expected to slow during the forecast period, it will continue to be robust, at 4.2% in 2005 and 4% in 2006. The prospects for Malawi’s main trading partners are mixed. The pace of economic growth in the EU25 is expected to remain subdued, whereas South Africa’s economic growth is expected to be more robust. The prospects for Malawi’s main commodity exports will be mixed in 2005-06. Auction prices of burley tobacco, the main tobacco export, have been well below average and show little sign of rising, despite government subsidies of fertiliser to help to improve quality. Tea prices will remain static, at an aver- age of US$1.7/kg in 2005-06, as both global production and demand fall. Slower growth of global sugar stocks and growing demand are expected to lift sugar prices from an average of 7.2 US cents/lb in 2004 to 8.9 US cents/lb in 2005-06.

Economic growth Economic growth will continue to be strongly influenced by the country’s agricultural performance, as a result of the lack of economic diversification and exploitable natural resources. Owing to a long dry spell during February and March a sizeable contraction in the agricultural sector is expected in 2005. The 2005 maize harvest is expected to be well down on that of 2004, while tobacco production is estimated to be down by 20%. The manufacturing sector will continue to track developments in the agricultural sector, as food processing forms a large component. Growth in mining output is expected to pick up significantly following the opening of several mines, but as this rise will be from a very low base it will have little impact on headline growth. Services will benefit from an expansion in government spending due to the resumption of donor financial assistance. Overall, given the contraction in agriculture, real GDP growth is forecast at only 1% in 2005. The slowly improving business environment and the start of recovery in agriculture, assuming improved weather conditions, are expected to boost real GDP growth to 4% in 2006.

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Inflation Higher food price inflation lifted year-on-year inflation to 15.3% in April 2005, from a recent low of 10.9% in September. Food price inflation will increase throughout most of 2005, owing to the expected poor performance of the maize crop. Improved fiscal discipline will, however, allow a further slow decline in non-food inflation. We expect overall inflation to average 15% in 2005. Provided that a reasonable degree of fiscal discipline is maintained and a normal maize harvest recorded, we expect inflation to fall to an average of 9.5% in 2006. Inflation will continue to be vulnerable to any sharp falls in the kwacha throughout the forecast period, although we expect that the average annual exchange rate will experience only modest depreciation.

Exchange rates The kwacha has slid against the US dollar since March, after holding at MK108:US$1 since late 2003, to reach MK123:US$1 on July 1st 2005. With foreign-exchange reserve levels already low due to lower donor financial inflows in recent years, the central bank could no longer continue to support the currency as concerns mounted that a poor tobacco and maize harvest would be experienced in 2005, and as tobacco auctions returned low prices. However, we expect the kwacha to remain broadly stable for the remainder of the tobacco auction season (the auctions usually run until September), and as increased donor support, stemming from the resumption of IMF funding in the second half of the year, boosts foreign exchange inflows. We therefore expect that the kwacha will depreciate from an average of MK109:US$1 in 2004 to MK120:US$1 in 2005. Higher levels of donor inflows and (assuming normal weather conditions) a better agricultural harvest should slow the rate of depreciation in 2006, and we forecast an average of MK141:US$1. Foreign- exchange reserves are expected to rise from a low of 1.4 months of import cover in June 2005 to 2.1 months by end-2005 and 2.6 months by end-2006. However, these levels remain very low and provide the central bank with little ammunition to mitigate the impact of external shocks.

External sector Exports are expected to fall from an estimated US$476m in 2004 to US$372m in 2005, as the dry weather has cut the tobacco crop, the main source of export revenue. Other export crops are also likely to have performed poorly. Assuming normal weather conditions in 2006, exports are forecast to rise to US$408m. Imports are likely to rise sharply in 2005, owing to the need to import maize from external sources to compensate for the poor domestic harvest and because of higher oil prices. Increased economic activity, as domestic demand improves, will boost non-food imports in 2006 but, overall, imports will fall owing to our assumption of a better maize harvest. Tourism receipts, the main source of services credits, are expected to rise slightly in 2005-06, but the services account will remain firmly in deficit as trade-related costs will keep services debits high. Although interest payments on medium- and long-term external debt will continue to be reduced under the HIPC initiative, short-term interest payments are expected to increase alongside rising international interest rates, causing the deficit on the income account to increase slowly. Inflows of donor funding are expected to rise in 2005-06, provided that the government continues to make progress with donor-guided reforms, and this will keep the current-transfers account in surplus. Overall, the current-account

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deficit is expected to widen to 16.5% of GDP in 2005, before easing to 13% of GDP in 2006.

Forecast summary (% unless otherwise indicated) 2003a 2004a 2005b 2006b Real GDP growth 4.1 4.2 1.0 4.0 Gross industrial growth 1.2 4.5 2.0 3.0 Gross agricultural production growth 7.0 2.6 -6.5 4.5 Consumer price inflation (av) 9.6c 11.2 15.0 9.5 Consumer price inflation (year-end) 9.8c 13.7 18.5 7.9 Short-term interbank rate 48.9c 36.8c 35.0 30.0 Government balance (% of GDP) -7.6 -3.0 -2.6 -2.8 Exports of goods fob (US$ m) 402.0 476.2 371.8 408.3 Imports of goods fob (US$ m) 539.5 613.0 645.0 620.0 Current-account balance (US$ m) -145.5 -152.8 -258.6 -197.8 Current-account balance (% of GDP) -10.0 -10.2 -16.5 -13.0 External debt (year-end; US$ bn) 3.1c 3.2 3.3 3.0 Exchange rate MK:US$ (av) 97.43c 108.89c 120.21 140.64 Exchange rate MK:¥100 (av) 84.07c 100.71c 111.92 136.54 Exchange rate MK:€ (av) 110.32c 135.44c 146.95 177.20 Exchange rate MK:SDR (av) 136.49c 161.29c 176.99 211.05 a Economist Intelligence Unit estimates. b Economist Intelligence Unit forecasts. c Actual.

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

Malawi Sub-Saharan Africa Malawi Sub-Saharan Africa 5.0 30 4.0 3.0 25 2.0 20 1.0 0.0 15 -1.0 10 -2.0

-3.0 5 -4.0 -5.0 0 01 02 03 04 05 06 01 02 03 04 05 06 2000 2000

The political scene

Parliament starts to turn The president, Bingu wa Mutharika, has run into effective parliamentary oppo- against the president sition since he left the United Democratic Front (UDF) in February (April 2005, The political scene). As anticipated, the president has formed his own political party, the Democratic Progressive Party (DPP), which was officially launched on May 29th. Although the DPP has secured substantial support in parliament, it is not sufficient to counter opposition from the UDF and the Malawi Congress Party (MCP). This resulted in the president’s first parliamentary defeat, when his candidate to become the new inspector-general of the police was rejected.

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It has been clear for some time that Mr Mutharika could not count on the support of the UDF. He has aggrieved much of the parliamentary party with an anti-corruption campaign that has ensnared high-profile UDF members and threatened the position of the former president, Bakili Muluzi. Perhaps more surprising is that John Tembo, the leader of the MCP, the party with the largest representation in parliament, has also turned against the president. The MCP had originally stated that they had no objections in principle to Mr Mutharika’s policy agenda, and it appeared that they would support his legislation in parliament. Moreover, Mr Tembo and Mr Muluzi have been fierce rivals in the past, and the MCP’s unofficial alliance with the UDF therefore appears to have been born out of considerations of political expediency—the MCP is hoping that Mr Mutharika can be impeached so that Mr Tembo, the runner-up in the 2004 presidential election, may be made president. Between them, Mr Tembo and Mr Muluzi command a following sufficient to jeopardise the passage of legislation through parliament.

The president suffers his first The first sign of co-ordination between the UDF and the MCP in parliament parliamentary defeat was the rejection of the nomination of Mary Nangwale as inspector-general of the police. While both parties claimed that Mrs Nangwale, who would potentially be the country’s first female chief of police, had violated the human rights of politicians and journalists, the vote was clearly a demonstration by enemies of the president that he cannot rely on parliamentary support. The combined support of the majority of MCP and UDF members of parliament (MPs) saw the candidature defeated by 88 votes to 83 (13 MPs missed the vote, eight abstained and one has died and is yet to be replaced) on March 30th. This was the first time that a police chief had been rejected by parliament since the advent of multiparty politics in Malawi. Despite the vote, Mr Mutharika appointed Mrs Nangwale to her new position and ordered the courts to review parliament’s decision. The High Court in Malawi then granted an injunction for Mrs Nangwale to continue working in her position as inspector-general, pending a judicial review of parliament’s decision. Should the court find that the original vote was flawed in any way, it can order parliament to resubmit the bill and vote again.

Impeachment of president is The UDF is pursuing the impeachment of the president, and the MCP appears unlikely to succeed to be supporting it in doing so. Initial steps were taken towards this on June 16th, when parliament unanimously approved an amendment to parliamentary procedure so that a secret ballot could be used in the case of an impeachment vote. The government’s support for change clearly indicates its confidence that Mr Mutharika would survive any impeachment attempt. Indeed, the use of a secret ballot makes it easier for those MPs, particularly in the MCP, who favour Mr Mutharika, to give him their backing without facing undue pressure for breaking party discipline. Legislation has yet to be passed that clarifies the legal proceedings for impeachment. However, even if impeachment proceedings do start, it is highly unlikely that the president will be impeached. The grounds for impeachment are weak, whereas a serious of breach of the constitution by the president must be proved in order for him to be indicted and tried (the authority that would indict and try the president is likely to be a specially constituted parliamentary committee or the highest court

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authority), and even then the impeachment would need to be backed by two- thirds of parliament—Mr Mutharika has the support of more than a third of parliament, and under a secret ballot would command far more than this (April 2005, The political scene).

A fierce battle over the budget Battle lines are being drawn over the budget for the fiscal year 2005-06, is anticipated delivered on June 1oth, with political commentary from the media adding further fuel. The budget is being discussed at a sitting of parliament that is likely to run for at least a month. The debate over the budget is being taken as a trial of strength between Mr Mutharika and Mr Muluzi. In the main, the opposition is putting itself in the position of trying to show Mr Mutharika that he cannot govern the country without accommodating them politically. The UDF and the MCP are expected to engage in some substantial horsetrading, under the pretext of concern that the budget must contain adequate measures to improve the living standards of normal Malawians—something that their previous budgets have conspicuously failed to do. The two parties have warned that they may not pass the budget if it does not meet with their satisfaction, and there are, unfortunately, no procedures laid down in the event that parliament does not pass the budget. Certainly, the outcome of the debate will indicate the underlying strength of the opposing parties.

Fresh elections cannot be Should Mr Mutharika fail to win sufficient support to allow the budget to pass, ruled out it is possible that he will call fresh elections. These would be aimed at giving him a clear and untarnished mandate (the opposition case into the election results headed by the MCP continues—July 2004, The political scene). It would also ward off the threat of impeachment—which, although unlikely, is an ongoing issue that is drawing increasing attention—and would obviously assist with the implementation of the president’s programme of legislation. Should a new presidential election take place, Mr Mutharika is expected to win. It is clear that his campaign against corruption is popular and that he has exceeded public expectations that he would simply be a stooge of Mr Muluzi. However, the DPP has yet to build up the grassroots infrastructure that is vital in a country where most of the voters live in rural areas. The UDF, on the other hand, is generally considered to be the party with the most effective nationwide support mobilisation network, but despite this it performed poorly in last year’s polls. Also, there are now indications that the party’s finances, which are vital to sustaining any campaign, are in disarray. This is evidenced by the UDF’s attempts to force Mr Mutharika to redeem the MK200m (US$4.9m) that the party states that it spent on the campaign to bring him to power. By implication, the UDF is indicating that it would have expected these funds to be reimbursed should Mr Mutharika have remained in the party, presumably through the use of government funds. Although the DPP appears to be well funded, it is unclear from where these monies are being sourced.

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Education minister is sacked On May 17th Mr Mutharika sacked the education minister, Yusuf Mwawa, only fo r corrup tio n hours after he was arrested on corruption charges. The charges relate to allegations that Mr Mwawa used MK165,500 (US$1,176) from his ministry to pay for part of the cost of his wedding in March. Mr Mwawa has consistently denied the allegations. Although Mr Mutharika can legitimately claim that Mr Mwawa was dismissed solely for breaching the president’s policy of zero tolerance for corruption, the money involved is small compared with many other cases that have been pursued with far less vigour, and the president may have ulterior motives—such as wanting to remove Muluzi loyalists from his cabinet. Mr Mwawa was formerly minister of health under Mr Muluzi and is known still to be a close aide of the former president. Mr Mwawa’s dismissal is a further indication that the political climate in Malawi is changing, and the president is keen to pursue his anti-corruption drive. Mr Mwawa was replaced as education minister by the former MCP secretary- general, Kate Kainja. Mrs Kainja had been sacked from the MCP in late April, ostensibly after falling out with the party leadership over its failure to support the appointment of Mary Nangwale as inspector-general of the police. It seems that the real reason for her sacking was that she had had a meeting with Mr Mutharika prior to the vote on Mrs Nangwale without the knowledge of the rest of the party.

Mr Mutharika continues his The removal of Mr Mwawa is a continuation of Mr Mutharika’s targeting of the pursuit of UDF hierarchy former UDF hierarchy. The former finance minister, Friday Jumbe, and the former UDF treasurer, Humphrey Mvula, continue to be pursued through the courts for charges relating to the maize scandal of 2001/02 and the disappearance of funds from the state bus company (January 2005, The political scene). It also appears that increasing public pressure has now led to the re-opening of an investigation into the disappearance of MK187m (US$1.3m) from the Ministry of Education (July 2001, The political scene). Much of the support that Mr Mutharika has gained during his presidency has been through his pursuit of the eradication of corruption and his calls for those responsible to be held to account. However, progress on a number of corruption-related cases is currently proceeding at a very slow pace in the courts.

Corruption cases against An investigation has begun into the suspended Alliance for Democracy (Aford) Muluzi allies are in motion leader, Chakufwa Chihana. It is alleged that Mr Chihana bribed electoral officials in order to claim victory in his Rumphi Central constituency at last year’s parliamentary elections. He is also being investigated over allegations that he bribed party members to support the motion (which ultimately failed) to amend the constitution to allow Mr Muluzi to run for a third term in office (April 2003, The political scene). Another current case that remains active is a probe into the state-owned investment body, the Malawi Development Corporation (MDC), which has been found to be bankrupt and carrying huge debts following a recent a forensic audit into its financial mismanagement during the Muluzi era. Eunice Kazembe, the minister of trade and private sector development in the new Mutharika government, was previously the general manager of the MDC, and is closely allied to Mr Muluzi.

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Local elections are postponed The first test of public opinion following the formation of the DPP should be the local elections. These were scheduled for May but were postponed owing to a lack of funding, and no new date has been proposed. The 2004 national elections cost around US$20m and the bill for local polls is likely to be similar. Local elections were held in 2001 and attracted a low voter turnout (January 2001, The political scene). Although this throws into doubt the wisdom of spending such a sum on another round of elections, the fact that decentralisation is being stepped up may well encourage a greater turnout the next time round. The Commission for Africa

The Commission for Africa, set up in 2004 by the British prime minister, Tony Blair, delivered its report in mid-March 2005. It is a weighty volume—running to 453 pages—but, despite appearances, not a particularly ground-breaking one. The report maps out a number of ways in which rich countries can dramatically increase their role in tackling poverty in Africa. The British government is keen to use its presidency of the G8 and overlapping six-months’ presidency of the EU in the second half of 2005 to win the backing and, importantly, the financial support of rich states. In July the issues of world poverty, aid and debt will be top of the agenda at the G8 summit in Scotland; in September the UN will host a UN Millennium Summit of the General Assembly, which will highlight the progress, or lack of it, with the Millennium Development Goals (MDGs); and in December there will be a meeting of the World Trade Organisation (WTO) in Hong Kong, which is supposed to see the launch of a new round of world trade talks. The Commission calls for:

• the immediate doubling of donor aid to Africa, from US$25bn to US$50bn, over the next three to five years; • a renewed focus on the war against HIV/AIDS; • the cancellation of 100% of the debts of low-income African states; • the dismantling of developed-world trade barriers to African agricultural imports; and • more rapid progress by African administrations on democratisation, improved governance and the eradication of corruption.

None of this is new. Indeed, the Commission’s call for “a big push” simultaneously on all fronts to break Africa’s poverty trap is strikingly similar to a recent UN study, led by Jeffrey Sachs, entitled A Practical Plan to Achieve the Millennium Development Goals. The main thrust of the report is that, although the UN does not expect many Sub-Saharan African countries to meet its MDGs if the current status quo is maintained, this would be possible if there were a large increase in aid in the coming decade. Moreover, the report forcefully sets out the case that, despite decades of academic work that has led to the prevailing pessimism about what development aid can achieve, there is now new research which shows that aid can be effective in reducing poverty.

Education and health are also flagged as priority areas for additional aid and investment, which implies increased opportunities for firms in construction and engineering, healthcare, educational publishing and computers. The Commission wants African governments to allocate 15% of their budgets to healthcare, supported by an additional US$10bn a year from donors. In addition, donors are asked to commit resources to meet the US$3.2bn shortfall in the fund to fight HIV/AIDS, malaria and tuberculosis. The Commission also wants US$3bn to be spent on the development of scientific and technological centres of excellence in Africa over the next ten years.

The Commission believes that Africa needs to invest an extra US$20bn a year in physical infrastructure, half of which should be funded by donors until 2010, with the possibility of a further increase, to US$20bn a year, thereafter. As part of wider measures to promote agriculture and rural development, Africa must double the area of arable land under irrigation by 2015, again with substantial financial support from donors. In a related move, rich countries must agree to the immediate elimination of support programmes for crops like cotton and sugar, and all tariffs should be reduced to zero by

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2015, according to the Commission. In the interim, quota- and duty-free access should be extended to exports from low- income African countries. Time to change tactics The report’s call to channel more aid through African governments rather than through non-governmental organisations (NGOs) harks back to the past and clearly reflects the make-up of the Commission, which includes African leaders. The best way to deliver support, according to the report, “is to put aid into African government budgets and let them prioritise the spending of it”. Many will regard the Commission’s call to channel more aid through African governments rather than NGOs and the private sector as an open invitation to even greater corruption, which the Commission itself concedes is already “systemic”. Moreover, putting more aid money through African government budgets implies that the capacity and governance are in place to ensure that the funds are spent wisely. This is far from clear. There is also an implicit assumption that aid agencies are willing to hand over control of their funding to African governments. Is the money there? The Commission calls on rich countries to double aid, but has no means—other than moral suasion—to enforce this. Even if the will is there, rich countries may not be able to afford the extra funding as easily as the aid lobby imagines. Two years ago the World Bank warned that several developing countries that had in the past relied on net capital inflows would find it harder to do so over the period to 2015. By 2015, it said, some low- and middle-income countries that are currently capital importers will have become capital exporters. Over the same period a number of rich countries—particularly the US and Japan—which currently export US$67bn a year to emerging economies, will become capital importers. If the World Bank is right, funding the doubling of aid could become much more problematic than the Commission envisages.

If the Commission’s proposals are implemented, even in part, there are a number of implications for companies. Clearly, a stronger, faster-growing and eventually more self-reliant Africa means bigger and better business opportunities. In terms of infrastructure alone, the Commission’s plans imply extra spending of some US$20bn a year, much of which would go to suppliers and firms in OECD countries, Asia (notably China and South Korea) and—very probably—South Africa. Much the same can be said of aid-funded public spending on education, healthcare and information technology, although OECD and South African firms are more likely to have the edge here. However, there is a risk that the Commission’s demands on Western administrations in respect of aid and trade, coming at a time when governments are preoccupied with global terrorism and trade relations between the EU and the rest of the world, could lead to a backlash in 2010 and beyond. If the hugely optimistic aid and trade targets are not met—given past performance, the size of the US budget deficit, and the pensions and social-services crises in the EU—the Commission will have given African leaders one more excuse for economic failure, and for attacks on the West. Economic policy

The IMF endorses Malawi’s Following its staff mission to Malawi in the second half of April, the IMF has recent performance given a positive review of Malawi’s overall performance under its staff monitored programme (SMP) though to end-March (October 2004, Economic policy). With the exception of the government’s wage bill, all agreed targets were met. Targets for this criterion have consistently been missed since the introduction of a new civil service pay structure that reduces the scope for corruption by abolishing remunerative allowances and increases transparency by consolidating pay scales (January 2005, Economic policy). As the IMF has acknowledged that the government had tried to model the impact of the new pay system, it has not penalised it for expenditure overruns in this area. Given the continued positive reporting from the IMF, it is inevitable that a new poverty reduction and growth facility (PRGF)—which, unlike the SMP, will involve the disbursement of funds—will be awarded once the final review of

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the SMP has been completed (which is likely to be in late July). The IMF has indicated that discussions are already under way on the economic policies and framework for the new PRGF. Strengthening healthcare, education and expenditure management are likely to be among the principal objectives.

Ambitious budget for 2005 is On June 10th the finance minister, Goodall Gondwe, delivered a highly presented to parliament ambitious budget for the 2005/06 fiscal year (July-June). Substantial fiscal expansion is projected to coincide with a large increase in revenue, mostly from a pick-up in donor financial support. Although this may be overambitious, the budget at least gives a strong focus to: • the continued improvement of expenditure management, and has given priority to spending on healthcare and education, which is likely to be in line with the IMF and donors’ expectations ahead of agreement on a new PRGF for Malawi; • pro-poor spending, providing emergency support to Malawi’s drought- stricken farmers; • a job creation scheme through a major road-works project; and • tax relief for smallholder farmers—this also reflects an attempt by the government to meet the opposition parties’ demands for a strong pro-poor budget. Obtaining the opposition’s approval of the budget is critical, even if it entails modifying some of the details (except for those relating to the IMF’s key demands), as the budget needs to be passed before the IMF will approve a new PRGF. The importance of passing the budget was stressed by Mr Gondwe in his budget speech—the opposition has been widely expected to launch a fierce battle over the budget, particularly over whether sufficient measures aimed at alleviating poverty have been included.

Smallest deficit yet is Total revenue and grants for 2005/06 are projected at MK116.2bn (US$826m), projected, but unlikely compared with total expenditure of MK118.8bn, resulting in a deficit of just MK2.6bn, which represents around 1% of GDP. This is a substantial cut on the 2004/05 estimated deficit of MK7.8bn (equivalent to 3% of GDP), and would represent one of the lowest fiscal deficits in Malawi’s post-independence history. However, it is unlikely that such a small deficit will be achieved, since revenue projections are over-optimistic, as not all the projected donor funding is likely to be disbursed owing to the likelihood of some targets being missed; the scope for increasing tax collection is limited by the small size of the formal sector and the expected economic downturn; and the economic impact of the current drought will also affect profit levels in the mainly agriculture-dependent business sector. Furthermore, pressure for higher spending will remain high, particularly as additional maize and fertiliser may be needed. The Economist Intelligence Unit therefore expects a fiscal deficit of 2.5% of GDP, reflecting continued fiscal discipline but difficulty in attaining all fiscal targets laid out.

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Government finances (MK bn unless otherwise indicated; fiscal year Jul-Jun) 2004/05 2004/05 2005/06 Budgeted Estimates Budgeted Total revenue & grants 77.2 80.1 116.2 Generated domestically 52.0 n/a 65.4 Donor funded 25.2 n/a 50.8 Total expenditure 85.6 87.6 118.8 Recurrent 65.8 64.2 84.1 Development 19.8 23.4 34.7 Balance -8.4 -7.5 -2.6 % of GDP 3.9 -3.0 -1.0

Source: Ministry of Finance and Economic Planning, 2005/06 Budget Statement.

Capital expenditure is targeted Capital expenditure is set at MK34.7bn, an increase of 48% on 2004/05. Of the to rise by 48% total, donors are earmarked to provide just over MK30bn. Such a jump in capital spending is unlikely, as donor disbursements are tied to various con- ditions, within both Malawi and the donor country, that will often not be met during the fiscal year. The main focus of development spending for the year is road rehabilitation and maintenance. Roads in all districts of the country are to be upgraded to gravel, with the road programme intended to create many rural employment opportunities. Recurrent expenditure is also targeted to rise substantially, owing partly to civil service salary increases, the levels of which have not been specified, as the government has not settled anomalies from the previous year’s salary increases. Recurrent expenditure increases also reflect higher spending on healthcare, education and emergency assistance to farmers.

Priority is given to education By sector, education and healthcare are allocated the largest shares of the and healthcare budget, at MK15.4bn and MK12.8bn respectively, representing an increase of 25% and 35% respectively. Substantial increases in recurrent expenditure are also awarded to both ministries (a doubling in the case of health) to help to maintain staff who would otherwise be lured elsewhere, such as South Africa, by higher pay. In addition to the healthcare budget, an amount of MK5.3bn has been allocated to the National Aids Commission for tackling HIV/AIDS. According to UNAIDS (the UN body co-ordinating the fight against AIDS), 14.4% of the adult population is estimated to have been infected with the HIV/AIDS in 2004, while the number of orphans created by the death of a mother, father or both parents due to the disease is estimated at 500,000 as at the end of 2003. Malawi’s infection rate therefore remains amongst the highest in Sub- Saharan Africa, although it is not as high as those of a number of other Southern African countries, such as Botswana, where the HIV/AIDS rate is estimated at 37.3%. Tackling the disease clearly poses a major challenge for the authorities, and the allocation of funding to the prevention and treatment of the disease is expected to remain a priority.

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Sub-Saharan Africa: HIV/AIDS prevalence in selected countries, 2004 No. infected (m) % of adult populationa Botswana 0.4 37.3 Zimbabwe 1.8 24.6 South Africa 5.3 21.5 Namibia 0.2 21.3 Zambia 0.9 16.5 Malawi 0.9 14.4 Mozambique 1.3 12.2 Tanzania 1.6 8.8 Côte d’Ivoire 0.6 7.0 Kenya 1.2 6.7 Cameroon 0.6 6.9 Nigeria 3.6 5.4 Ethiopia 1.5 4.4 Democratic Republic of Congo 1.1 4.2 Uganda 0.5 4.1 Total 25.4 7.4 a Aged 15-49. Sources: UNAIDS; IMF.

Emergency support is Agriculture is awarded the third largest total, of MK12.6bn. This includes provided for agriculture MK5.6bn for importing 250,000 tonnes of maize to meet the bulk of the country’s considerable food shortage, which is to be distributed freely throughout the country. A further MK2.2bn is allocated to fertiliser subsidies. In his budget speech Mr Gondwe acknowledged problems with the distribution of the subsidised fertiliser, which contributed to the current famine, and said that for the fiscal year 2005/06 (July-June) only one company will be responsible for the distribution of fertiliser, rather than several as was the case last year (January 2005, The domestic economy). The budget also confirmed the cessation of the targeted input programme (TIP; under which smallholder farmers were allocated packs of seed and fertiliser) in line with donor recom- mendations. The government will also organise public works programmes— focused on the rehabilitation and maintenance of roads—and the wages paid to workers are intended to enable them to purchase the subsidised fertiliser. This is seen by donors as creating less of a dependency culture than the TIP, and the EU is backing the endeavour with additional funding of US$5.5m.

Large increase in revenue is Total revenue and grants are projected to rise by 45%, owing mainly to a jump projected in donor support. Higher donor support is a reasonable assumption owing to the improvement in relations with donors, although previous Malawian governments had a record of overestimating how much donors would disburse. Domestically generated revenue is targeted at MK65.4bn, of which MK57.3bn is tax revenue. Revenue collection targets for the specific tax changes were not presented in the budget, but it appears likely that much of the increase was the result of changes to customs and excise duties on various products. No mention was made of the privatisation of any state assets in the budget; instead, the poor state of many of the country’s parastatals was highlighted, which the government intends to rectify by closing one of them, the Malawi Development Corporation (MDC)—which has recently been found

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to be bankrupt and highly indebted—and restructuring and rationalising most of the rest.

Changes are made to tax The budget also contained a commitment to implementing the findings of the regime comprehensive tax review that was announced during the 2004/05 budget speech. These included an acceleration of the payment of tax refunds and a removal of ministerial power to grant tax waivers, which has been abused in the past. Perhaps the most important innovation was the introduction of commercial courts (funded by the EU) to adjudicate on tax cases (as well as on trade, banking and other commercial cases). Fully functioning, these courts would greatly enhance the business environment. However, in many other African countries commercial courts tend to be under-resourced, leading to large case backlogs. Among other changes to the tax regime to be implemented in 2005/06 are the following. • Income tax thresholds have been increased and the number of tax bands reduced from five to four. The threshold for the starting-rate of tax has been raised from MK36,000 (US$300) to MK60,000 a year, which means that the majority of smallholder farmers will not pay tax. The top rate of income tax, for those earning more than MK1.2m (US$9,980), was cut from 40% to 35%. All other income tax rates were unchanged. • Capital gains tax was modified so that only 60% of the capital gain will be subject to tax. Previously, assessing the present value of the asset on which the capital gain was being calculated required deflation using inflation indices, which was complicated and open to dispute. • Income tax for companies with low profitability or in lossmaking situations has been adjusted downwards considerably—companies with a turnover of up to MK500,000 will be taxed at a rate of MK30,000; companies with a turnover between MK500,000 and MK2m will be taxed at a rate of MK60,000; and companies with a turnover of above MK2m will be taxed at a rate of MK250,000. • Surtax was renamed value-added tax (VAT) in order to bring it into line with international norms. The rate was left unchanged, at 17.5%, and applies to the wholesale, retail, import, manufacturing and most of the services sectors.

Strong focus is given to The budget has aimed to continue with the strong focus on tightening improving fiscal management expenditure controls that was initiated last year. This is to be assisted through the full implementation of a public-accounting computer system, the Integrated Facility Management Information System (IFMIS), which centralises the government’s payment system, replacing the current system under which each ministry has its own bank account. This forms part of a wider reform trend of diverting control over expenditure away from ministries, indicating that the ministries are seen as key obstacles to fighting corruption. It was encouraging that the finance minister set aside MK2bn (US$16.6m) for clearing government arrears, which stood at MK10.3bn at the end of June. The government’s poor payment record is clearly detrimental to those who provide goods and services to the public sector, and government arrears to parastatals

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have also contributed to the poor state that many are in today. In addition, the budget hopes to reduce the domestic debt, which currently stands at around MK10.3bn. The government is aiming to partly reduce the debt stock by changing the composition of the debt from consisting mostly of short-term Treasury bills to mostly longer-dated registered stocks with lower interest rates.

Macroeconomic assumptions The budget speech also included the country’s official forecasts for key are optimistic macroeconomic variables in 2005. • Real GDP growth is forecast to slow to just under 3%, owing to the dry spell that has damaged agricultural production. However, we believe that the government has underestimated the impact of contraction in the agriculture sector, and our forecast for real GDP growth is much lower, at 1%. • Year-end inflation is forecast to rise to 16.9%, up from 15.5% in May, the latest available figure, again owing to the higher food prices stemming from the poor harvest. However, our forecast for year-end inflation is higher, at 18.5%, owing to our expectation that domestic fuel prices will be increased substantially—local price adjustments have fallen considerably behind increases in international oil prices. In addition, exchange-rate depreciation is expected to add significantly to imported inflation; and the projected expansion in government spending will also have an inflationary impact as it accelerates money supply growth.

Fiscal performance for 2004/05 According to the budget statement, a fiscal deficit of MK7.86bn (3% of GDP) was has improved substantially recorded in 2004/05, compared with a budgeted deficit of MK8.4bn in 2003/04 (3.9% of GDP). Mr Gondwe gave a very brief overview of 2004/05 performance in which he indicated that fiscal performance had improved substantially compared with the fiscal deficit of 3.9% of GDP in 2003/04, when the then ruling United Democratic Front (UDF) spent a substantial amount of the government’s money on its election campaign. The improvement in fiscal performance in 2004/05 has consistently been acknowledged by both the IMF and bilateral donors. The lower fiscal deficit in 2004/05 stemmed partly from an improved performance by the Malawi Revenue Authority, which benefited from internal reforms to enhance efficiency. Compared with 2003/04, total revenue and grants were up by nearly 25%, at MK80.1bn. In contrast, expenditure is estimated to have increased by only 12%, to MK87.6bn, only MK2bn above target—the overspending was largely the result of the civil service wage reforms implemented in October (January 2005, Economic policy). It should be noted that the figures given in the budget for 2004/05 are likely to be subject to revision owing to the proximity of the budget speech to the end of the previous fiscal year.

Financial power is being The government’s process of political decentralisation has moved ahead. In devolved to local government mid-May the president, Bingu wa Mutharika, put district commissioners and chief executives of city and town assemblies in charge of public funds allocated to their jurisdictions for health, agriculture and water. The decentralisation is being conducted on a trial basis, as, despite attempts by donors to build

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capacity, it is not clear whether there will be effective management of these funds at the local level. The president has also announced that, from the 2005/06 fiscal year, money for government districts will be allocated directly as a lump sum, rather than through the respective line ministries. Donors have been pushing the decentralisation process for some time, partly in order to decrease the scope for corruption at the central government level. Political interference at the local level is not yet obvious, but it is inevitable that this will grow with the increased allocation of funds. In an attempt to reduce the temp- tation for corruption at the local level, accounts from each district commissioner will be audited by the parliamentary Public Accounts Committee.

A trial land redistribution In April the government’s trial land redistribution programme started, programme has begun supported by a US$28m credit from the World Bank. It has begun to buy land to resettle around 20,000 landless families—the criteria for choosing these families is not clear. Unlike the mishandled land redistribution programme in Zimbabwe, land reform in Malawi is being conducted on a “willing buyer- willing seller” basis. Initially the government is procuring land in the south, in areas dominated by tea, coffee and tobacco estates, where there are large tracts of land lying fallow. In the event that the trial proves successful, it is likely that the scheme will be extended to other parts of the country. However, the success of the programme will require that the land acquired has not been over-farmed, and that the new farmers are properly equipped and able to afford the necessary agricultural inputs. Malawi’s land policy

The pattern of land ownership in Malawi remains largely skewed in favour of large plantation owners (mostly descendants of white settlers), who hold the best agricultural land—a hangover from the colonial era, which has left many hundreds of thousands of Malawians either landless or occupying plots that are too small to be viable for farming. An inquiry into land reform, carried out in 1999, found that 13% of land in Malawi is held by large plantation owners and 69% is held by smallholders, but 55% of smallholder farmers have less than 1 ha of land to cultivate, and this does not meet their basic food needs. This also reflects the fact that Malawi has a very high population density—at 105 inhabitants per square kilometre, the population is amongst the highest in the world. The inquiry advocated the abolition of freehold land (to be substituted with 99-year leases in urban and rural areas), formalising the role of traditional chiefs in administering land ownership and the imposition of taxes on under-utilised estate land. The inquiry was particularly concerned about southern areas of the country, where claims by rural peasants that land had been stolen from them by the regime of the country’s first president, Hastings Banda, led to violent riots in the Mulanje tea-producing area in 1995. A new land policy, based on the inquiry’s recommendations, was drawn up in 2002, approved by cabinet in 2004, and is expected to be put before the country’s lawmakers within the next year.

The new land bill seeks to address some pressing issues. For instance, customary (tribal) land, which makes up the majority of rural smallholders’ land, is to be recognised as private land under the new policy. This recognition will result in title deeds being given to the beneficiaries, giving them the right both to borrow against

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the land and to pass it on to their descendants. However, the bill has also attracted some controversy. For instance, foreign owners of freehold land will have seven years to become Malawi citizens or have their freehold land revert to the state and be replaced with 50-year leases (alternatively, foreign owners can form a partnership with Malawians, with no limit on foreigners’ holdings in these arrangements). Also, the role of traditional chiefs in administering land will be replaced by elected bodies, in order to introduce greater transparency in land administration—traditional chiefs have reacted angrily to the proposal to reduce their powers and interfere with long- held customs. The domestic economy

Inflation rises to 15.5% in May Recent data indicate that higher food prices have continued to lift inflation. Year-on-year inflation rose to 15.5% in May, from 15.3% in April, the highest level of inflation since 2002, when Malawi experienced a severe drought. Food price inflation is accelerating, and has now increased to 18.6% in May, compared with 17.8% in April. Food prices constitute 58.1% of the basket of goods and services used to calculate the consumer price index, and the poor maize crop is therefore likely to put upward pressure on headline inflation over the remainder of the year—although widespread donor assistance will have a somewhat dampening effect on the rate of price increases. Non-food inflation maintained its downward trend over the last 15 months, to reach 12.1% in May, compared with 12.4% in April, owing largely to a slowdown in money supply growth. The Economist Intelligence Unit expects that food price inflation will increase throughout most of 2005, and we forecast average annual inflation for 2005 at 15%.

Inflation (% change, year on year)

20

15

10

Food 5 Non-food Overall

0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May 2004 05 Sources: National Statistics Office.

Inflation (% change year on year, unless otherwise stated) 2004 2005 Jan Feb Mar Apr May Inflation (av) 11.2 14.0 14.2 14.9 15.3 15.5

Source: National Statistics Office.

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Foreign-exchange shortages After holding at a level of around MK108:US$1 since August 2003, the kwacha end recent kwacha stability began to slide in mid-March 2005, and by July 1st it stood at MK123:US$1. The fall was due to a lack of foreign exchange. Foreign-exchange reserves had fallen to just US$88.5m by April 22nd (the latest available data) according to the Reserve Bank of Malawi (the central bank), which calculated that this was equivalent to only 1.4 months of import cover. It appears that the central bank had tried to hold the kwacha at its old level for as long as possible, but there was an acute shortage of foreign exchange in the first quarter, and by March the central bank was forced to suspend foreign-exchange sales temporarily.

Exchange rate, 2005 (Kwacha:US$) 125

120

115

110

105 Jan Feb Mar Apr May Jun Source: Bloomberg.

In the absence of significant donor inflows we had long considered the kwacha to be vulnerable to depreciation, and the trigger appeared to be projections for a disappointing tobacco harvest (tobacco exports are the leading source of foreign exchange). Hoarding by some commercial banks and foreign-exchange bureaux was also a contributory factor, and caused the central bank to suspend the licence of one commercial bank and increase the minimum capital requirement for foreign-exchange bureaux (see Financial and other services). As the tobacco auctions are now in full swing and there are clear indications that the IMF will resume funding soon, the pressure on the kwacha is expected to ease. We forecast that the exchange rate will reach MK132:US$1 by the end of 2005, and will average MK120:US$1 for the year.

Agriculture

Poor maize harvest points to Malawi is set for another famine in 2005. As anticipated, the six-week dry spell another famine in 2005 that ran through February and March has caused a significant downward revision to the projected maize crop for this year. According to the latest set of crop estimates released by the UN Food and Agricultural Organisation (FAO) in May, the maize crop is projected at 1.25m tonnes, the lowest in a decade (April 2005, The domestic economy) and 26% lower than last year’s crop. The area devoted to maize was virtually unchanged from last year, with almost all of the decline due to lower yield. This was confirmed by the Famine Early Warning Systems (FEWS) network supported by the US Agency for International Development (USAID), which calculates that average yield was

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854 kg/ha this year, the lowest in the last ten years, compared with a high of around 1,600 kg/ha in 1998/99 and a theoretical potential yield for local maize of 3,000 kg/ha. Production of roots and tubers—including sweet potato, cassava and Irish potatoes—is estimated at 3.8m tonnes, which is down by 9% on last year and 15% below the previous five-year average. Aggregate domestic cereal production, including roots and tubers, is estimated at 2.51m tonnes, whereas the domestic requirement is estimated at 3.35m tonnes, creating a domestic deficit of 834,000 tonnes.

Famine is due to poor weather The deterioration in the crop yield stems from a combination of two factors: and late fertiliser distribution first, poor weather conditions—good early rains meant that the maize-growing season had started well, but the dry spell happened when the plants needed moisture the most—and, second, the late distribution of inputs. The government normally supplies smallholder farmers with fertiliser and other inputs ahead of the planting season. However bureaucratic changes to the distribution system introduced by the new government contributed to a delay in fertiliser distrib- ution to well beyond the optimum time for its application (January 2005, The domestic economy). There is anecdotal evidence that crops planted with fertiliser had good yields despite the poor weather conditions, while those in neighbouring plots that were planted late and without fertiliser have had disastrous yields. Although the current estimates of the maize crop would make this one of the worst harvests in history, its impact is unlikely to be as severe as the famine of 2001/02 (October 2001, The domestic economy: Agriculture), as this was the result to two consecutive poor harvests. Furthermore, the 2001/02 drought affected virtually the whole of Southern Africa, causing informal food imports to be limited and raising the cost of official imports.

Maize imports are needed to Although the FAO estimates the food deficit for 2005/06 (April-March) at fill the gap 834,000 tonnes, estimates by Malawi’s Ministry of Agriculture, Irrigation and Food Security in April indicated a lower food deficit, of 482,000 tonnes (after allowing for reserves and unofficial imports of 100,000 tonnes). It is not clear why there is such a large discrepancy between the two data—it may partially reflect the fact that the FAO has converted root and tuber weights into cereal equivalents, which are much heavier. However, although the FAO observes that 767,000 tonnes of maize needs to be imported to meet the deficit, the government budget indicates that a forecast of 300,000 tonnes of maize needs to be imported, and the discrepancy here is even harder to explain. Never- theless, the FAO expects that commercial imports of maize will be equivalent to 300,000 tonnes and aid imports will be at least equal to 33,000 tonnes; the government has pledged to import 250,000 tonnes and has purchased options from South Africa to acquire additional maize. It therefore appears that official plans are in place to cover most, if not all, of the food deficit.

Outlook for the tobacco Prospects for the all-important tobacco crop are not good. According to the harvest is also poor Tobacco Control Commission, the total harvest for 2005 is projected at 143.1m kg, compared with 179.9m kg in 2004. This is almost entirely due to a 22.5% fall in the burley crop, which is the main variety grown by smallholder

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farmers. The significant reduction in burley volumes is partly a function of the poor weather conditions, with the end to the rains hindering the leaf’s growth and also affecting quality. This will also cause a decline in prices that the burley crop fetches at auction this year—already by May 26th the price had averaged below US$1/kg, around 33% lower than last year and 40% lower than the previous five-year average. While the burley crop quality is an important factor in the lower pricing for this season, another major area of concern remains foreign-object contamination, in particular plastic strands from polypropylene sacks, which caused a major disruption to the tobacco auctions last year (July 2004, The domestic economy: Agriculture). Furthermore, low pricing in previous years has reduced farmers’ ability to acquire imported inputs, which, combined with problems in the distribution of fertiliser, is another factor affecting crop quality.

Tobacco production (m kg) 2004 2004 2005 Type Forecast Actual Forecast Burley 115.0 151.4 117.4 Flue cured 19.4 23.1 24.6 Dark fired n/a 5.4 1.1

Source: Tobacco Control Commission.

Flue-cured crop is likely to be The size of the flue-cured crop was also a little disappointing. Although below original expectations production is expected to rise by 6.5%, to 24.5m kg, a crop of more than 30m kg was originally anticipated. Again, climatic conditions are largely to blame, and an overestimation of the yield potential in Malawi has perhaps been a contributory factor. Much of the tobacco grown by merchants on their own account has been done with management provided by farmers displaced from Zimbabwe on a contract basis. However, crop management requirements are significantly different in Malawi from those in Zimbabwe, while environmental differences—lower average growing heights together with higher rainfall levels— generally account for lower yields and qualities compared with the Zimbabwean crop. Furthermore, because the displaced Zimbabwean farmers are no longer growing on their own account, but rather for tobacco merchants, the profit incentive is lower, thus providing less motivation to maximise production levels.

Cumulative tobacco sales to May 26th, 2005 Type Weight (kg) Average US cents/kg Burley 44,108,067 98.34 Flue cured 100,781 147.41 Dark fired 8,233,948 159.25

Source: Tobacco Control Commission.

Merger of leading tobacco The emergence of contract production is not the only development that has merchants increased the influence of the tobacco merchants. Two of the major global tobacco merchants, Stancom and Dibrell, merged in May 2005 to form a new company, Alliance. This has reduced the number of buying companies operating in Malawi from three to two, and thereby limits competition for the growers’ crops. Worldwide, Dibrell is the dominant partner in the newly

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merged company. However in Malawi, as with most of the region, Stancom has traditionally been the dominant operator, and most managerial positions in Alliance’s Malawi operations have been taken up by Stancom personnel. Despite this, the dominant corporate philosophy will be that of Dibrell and so potential conflict on strategy can be expected with Stancom managers. In particular, Dibrell has not been especially active in growing on its own account nor in supporting growers through the provision of loans of foreign exchange, whereas Stancom has, and there is like to be conflict within Alliance on whether to continue these operations, with important consequences for contract farmers. However, as Universal Leaf, the other tobacco merchant operating in the country, is likely to continue this strategy, Alliance may well have to follow suit.

Financial and other services

Finance Bank licence is On May 18th the central bank suspended the licence of Finance Bank of suspended Malawi, the first time that a bank has had its licence revoked in the country. Although the bank is operationally sound and is cash rich, its licence was suspended owing to the foreign-exchange activities that it conducted on behalf of its clients. Although details have yet to be released, it appears that the bank was hoarding substantial amounts of foreign exchange in anticipation of a devaluation of the kwacha. It is believed to have been taken to task on several occasions by the central bank for similar indiscretions, but to no avail. Despite a High Court challenge the bank remains closed. It is unlikely that Finance Bank will be allowed to reopen, and it is expected that depositors will be reimbursed by the central bank. In another move to prevent the hoarding of foreign exchange, on April 26th the central bank increased the minimum capital requirement for foreign-exchange bureaux to US$100,000, with effect from July 1st, from $10,000. This appears to be an attempt to ensure that only legitimate bureaux can operate. There is evidence that a number of small bureaux were solely concerned with holding foreign exchange so that they could force a devaluation of the kwacha and then reap the benefits when converting the foreign exchange into local currency. The policy has been criticised by bureau owners, who claim that they were not consulted.

Foreign trade and payments

External debt rises in 2003 The latest data from the World Bank’s Global Development Finance, the benchmark source of debt data, show that Malawi’s total external debt stock rose from US$2.9bn at end-2002 to US$3.1bn at end-2003, equivalent to a hefty 208% of GDP. The increase in debt was the result of a build-up of arrears and revaluations of non-US-dollar-denominated debt due to the depreciation of the US dollar in 2003. Total external debt service was almost unchanged, with the debt-service ratio rising only marginally, to 7.7%, in 2003. The Economist Intelligence Unit estimates that external debt rose to US$3.2bn by end-2004, owing to further US-dollar depreciation and external borrowing. The debt-

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service ratio is estimated to have increased to 12.7%, reflecting higher repayments to multilateral creditors as the government sought to reduce the principal arrears that had accumulated.

External debt (US$ m unless otherwise indicated; debt stocks as at year-end) 1999 2000 2001 2002 2003 Public medium- & long-terma 2,600 2,560 2,480 2,690 2,960 Private medium- & long-term 0 0 0 0 0 Total medium- & long-term debt 2,600 2,560 2,480 2,690 2,960 Official creditors 2,582 2,551 2,470 2,679 2,949 Bilateral 520 490 413 417 422 Multilateral 2,060 2,050 2,060 2,260 2,530 Private creditors 19.0 17.9 9.5 9.9 10.6 Short-term debt 67.4 78.4 48.2 130.0 71.8 Interest arrears 23.9 36.8 27.4 37.3 45.8 Use of IMF credit 87.6 82.5 72.8 94.6 102.0 Total external debt 2,755.0 2,720.9 2,601.0 2,914.6 3,133.8 Principal repayments 49.9 38.3 25.3 14.2 18.5 Interest payments 18.9 20.4 13.7 15.7 17.0 Short-term debt 1.5 2.9 1.0 1.0 0.7 Total debt service 68.8 58.7 39.0 30.0 35.5 Ratios (%) Total external debt/GDP 154.9 166.8 154.6 177.1 207.5 Debt-service ratio, paidb 13.1 12.4 8.0 6.3 7.7 a Long-term debt is defined as having original maturity of more than one year. b Debt service as a percentage of earnings from exports of goods and services. Source: World Bank, Global Development Finance.

Debt relief could be Malawi has been receiving relief on debt servicing under the IMF-World substantial in 2006 Bank’s heavily indebted poor countries (HIPC) debt-relief initiative since December 2001. To receive relief on debt stock, an IMF lending programme needs to have been in place and its implementation approved for at least one year. We expect that a new poverty reduction and growth facility (PRGF) will be agreed in or around July, meaning that the earliest that Malawi can expect to receive a significant write-off of debt stock will be the middle of 2006. Following a meeting of G8 finance ministers in June, an announcement was made that full debt relief would be granted to 18 countries that had reached HIPC completion point on debts owed to the IMF, the World Bank and the African Development Bank. This arrangement could be extended to a further nine countries, including Malawi, that are due to reach completion point in the short term. However, the details of the arrangement have yet to be decided, including the cut-off date up to which debt will be considered for relief, the manner in which relief is to be written off and the timing of debt relief.

Donors are resuming financial In recent months a number of Malawi’s key donors, including the following, support to Malawi have resumed financial support to the country. • Sweden has broken a four-year freeze on aid to Malawi and approved US$5.5m in budget support, citing the country’s good progress in controlling public expenditure and fighting corruption.

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• The African Development Bank has approved a US$18m loan for budgetary support, which Malawi’s treasury secretary, Milton Kutengule, has claimed is due to the progress made on good governance, particularly fighting corruption. • The World Bank has approved US$37m for a project to upgrade Malawi’s ageing irrigation scheme. The project aims to restore irrigation schemes in four areas of the country, which were established in the 1960s and 1970s, and to introduce new irrigation schemes in a further seven areas. The project also aims to train local communities in new farming techniques and raise awareness of the potential benefit of crop diversification; • Norway has already resumed financial assistance, after an aid freeze at the beginning of 2004 due to budget irregularities, and released US$3.5m in February 2005, with a further US$6m disbursement scheduled to take place in 2005/06. • The UK, through the Department for International Development, continues to be one of Malawi’s biggest bilateral donors, and has earmarked US$38m in budgetary support for Malawi’s 2005/06 fiscal year (July-June), provided that progress on good macroeconomic and fiscal management continues. More of Malawi’s donors are expected to announce the resumption of financial support, particularly budgetary support, after a new PRGF is agreed—which we expect will take place in the second half of 2005.

World Bank awards US$23m In April the World Bank granted US$32m for an education-sector programme. for education project The principal component of the programme is a US$15.5m credit for teacher capacity development. This aims to make the teaching methodology more effective and improve teaching conditions. Under the programme, basic learning materials and a health and nutrition package will be provided for school attendees under the age of ten. Increasing the number of qualified teachers is vital. According to the World Bank, the pupil:teacher ratio for primary education stood at 62:1 in 2002, and the ratio is likely to have worsened, as teacher numbers have been badly hit by the HIV/AIDS pandemic. The programme is unlikely to be able to tackle another critical problem, the exodus of skilled teachers for better paid jobs in South Africa.

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