AFRICAN DEVELOPMENT FUND

Language: English Original: English

MALAWI

GOVERNANCE AND POVERTY REDUCTION SUPPORT GRANT GPRSG II

APPRAISAL REPORT

OSGE – ORSB - MWFO

31 March 2010

Appraisal Team

Team Leader: Kate Tench, Technical Advisor, OSGE.0 Team Members: Martha Phiri, Country Economist, MWFO Fenwick Kamanga, Governance Expert, MWFO/OSGE.1 Joachim Harnack, Consultant, OSGE.1 Resident Representative: Frank S. Kufakwandi, MWFO Sector Manager: Carlos Santiso, OSGE.1 Sector Director: Gabriel Negatu, OSGE Regional Director: Frank Black, ORSB

Peer Reviewers

Internal reviewers: Martim de Faria e Maya, Chief Country Program Officer, ORSB Takem Enaw, Legal Consultant, GECL.1 Victor Ndisale, Chief Governance Expert, OSGE.1 Shirley Chinien, Senior Economist, OSGE.1 Kalayu Gebre-Selassie, Senior Governance Expert, OSGE.1 Carlos Mollinedo, Macroeconomist, OSGE.2 External reviewers: Janet Stotsky, IMF Mission Chief for Malawi, IMF Manu Manthri, Economic Adviser, DFID Malawi

TABLE OF CONTENTS

CURRENCY EQUIVALENTS, FISCAL YEAR, WEIGHTS AND MEASURES, ACRONYMS AND ABBREVIATIONS, GRANT INFORMATION, PROGRAM TIME-FRAME, PROGRAM EXECUTIVE SUMMARY, RESULTS-BASED FRAMEWORK i-viii I.  THE PROPOSAL.......................................................................................................................1  II.  COUNTRY AND PROGRAM CONTEXT...............................................................................1 2.1.  Government overall development strategy and medium-term reform priorities.....................1 2.2.  Recent economic and social developments, perspectives, constraints, and challenges..........2 2.3.  Bank Group portfolio status....................................................................................................5  III.  RATIONALE, KEY DESIGN ELEMENTS, AND SUSTAINABILITY..............................6 3.1  Link with the CSP, analytical works underpinnings, and country readiness assessment .......6 3.2  Collaboration and coordination with other development partners .......................................7 3.3  Outcomes of past and on-going similar operations and lessons.............................................8 3.4 Relationship to other Bank operations…………………………………………………………… 9 3.5 Bank’s comparative advantages…………………………………………………………………….9 3.6 Application of good practices principles on conditionality…………………………………….10 3.7 Application of Bank Group nonconcessional borrowing policy……………………………….11 IV.  THE PROPOSED PROGRAM AND EXPECTED RESULTS ...........................................10 4.1.  Program’s goal and purpose ................................................................................................10 4.2.  Program’s pillars, operational objectives, and expected results..........................................11 4.3.  Financing needs and arrangements ......................................................................................14 4.4.  Beneficiaries of the program.................................................................................................15 4.5.  Impacts on gender.................................................................................................................15 4.6.  Environmental impacts .........................................................................................................16  V.  IMPLEMENTATION, MONITORING, AND EVALUATION.............................................16 5.1  Implementation arrangements ..............................................................................................16 5.2  Monitoring and evaluation arrangements ............................................................................17  VI.  LEGAL DOCUMENTATION AND AUTHORITY............................................................17 6.1  Legal documentation.............................................................................................................17 6.2  Conditions associated with Bank’s intervention ...................................................................17 6.3  Compliance with Bank policies.............................................................................................18  VII.  RISK MANAGEMENT........................................................................................................18  VIII.  RECOMMENDATION ....................................................................................................19 

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ANNEXES A. MANDATORY ANNEXES

I Letter of Development Policy II The Government’s PFEM Priority Action Plan (PAP) III Relations with the International Monetary Fund (IMF) IV Recent evolution of Macroeconomic Indicators V CABS Group Undertakings

A. CABS Performance Assessment Framework (PAF) 2009 B. CABS partners budget support commitments for FY 2009/10 as of Jan. 2010

VI Use of Development Budget Support Instruments (DBSL) VII Projects under ADF

A. Ongoing and Approved Projects B. Summary of the Malawi Portfolio

VIII Latest Socio-economic Indicators IX Map of Malawi B. TECHNICAL ANNEXES X Summary of PFM Performance Assessment Report (PEFA) for 2008 XI Millennium Development Goals (MDGs) XII Selected Governance Indicators A. Ease of Doing Business in Malawi B. Worldwide Governance Indicators, 1998/2003/2008 C. Mo Ibrahim Index of African Governance 2008 D. Country Policy and Institutional Assessment (CPIA) XIII. Impact of the financial crisis (economic and poverty) XIV. Impact of the fertilizer subsidy (economic and poverty)

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Currency Equivalents As of 2 December 2009

UA 1 = MK 222.77 UA 1 = US$1.61

UA 1 = € 1.07

Fiscal Year

1 July–30 June

Weights and Measures

1 metric ton = 2,204 pounds (lbs)

1 kilogram (kg) = 2.204 lbs

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ACRONYMS AND ABBREVIATIONS

ACB Anti-Corruption Bureau ADF African Development Fund AGD Accountant General Department CABS Common Approach to Budget Support CPIA Country Performance Institutional Assessment CSO Civil Society Organization DBSL Development Budget Support Lending DFID Department for International Development (UK) EC European Commission ECF Extended Credit Facility (IMF) ESF Exogenous Shock Facility (IMF) FY Financial Year GDI Gender-Related Development Index GFEM Group on Economic and Financial Management GPRSG Governance and Poverty Reduction Support Grant HDI Human Development Index IFMIS Integrated Financial Management Information System IMF International Monetary Fund LDP Letter of Development Policy MDA Ministry, Department, and Agency MDRI Multilateral Debt Relief Initiative MGDS Malawi Growth and Development Strategy MTEF Medium-term Expenditure Framework MWFO Malawi Field Office NAO National Audit Office ODPP Office of the Director of Public Procurement PAF Performance Assessment Framework PAP Prioritised Action Plan PBL Policy Based Lending PEFA Public Expenditure and Financial Accountability PEMRU Public Enterprise Management Reform Unit PFEM Public Financial and Economic Management PFM Public Financial Management PPA Public Procurement Act PRGF Poverty Reduction and Growth Facility PRSG Poverty Reduction Support Grant RBM Reserve Bank of Malawi UA Units of Account UNDP United Nations Development Programme

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GRANT INFORMATION

Client’s information BENEFICIARY: Government of the Republic of Malawi EXECUTING AGENCY: Ministry of Finance Financing plan for the two fiscal years 2009/10-2010/11

Source Amount (UA) Instrument ADF 11.6 million Grant

ADF key financing information

Grant Currency Unit of Account (UA) Repayment currency N/A Maturity N/A Grace period N/A Principal Repayment N/A Service charge N/A Commitment fee N/A

PROGRAM TIMEFRAME

Concept Note approval October 2009 Program approval March 2010 Effectiveness April 2010 Completion June 2011 Last repayment N/A Milestones: Meeting first tranche disbursement

conditions Meeting second tranche disbursement conditions

March 2010 August 2010

Potential bottlenecks Going off-track under IMF’s ECF

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Program Summary

Program name Geographical scope Expected outputs Overall timeframe Program cost

Governance and Poverty Reduction Support Grant II Republic of Malawi Improved financial governance through greater efficiency, transparency, and accountability in the use of public resources, more efficient budgeting process, and better provision of social services, especially to the poor. July 1, 2009-June 30, 2011 UA 11.6 million in two tranches: UA 8.12 million in May 2010 (FY2009/10) and UA 3.48 million in August 2010 (FY2010/11)

Program context The economy is on a much stronger footing now than it was at the beginning of the decade as a result of strong macroeconomic reforms and fiscal discipline. These positive developments nonetheless took place against the background of structural challenges that make Malawi vulnerable to external shocks. The volatility in export earnings has combined with a narrow export base and emerging supply side challenges to growth (notably the generation and supply of electricity) to aggravate Malawi’s chronic low international reserves in the context of a fixed exchange rate regime. Also, pressure on the budget mounted after 2008. The expansionary fiscal stance has made foreign exchange less available for the private sector, combining with other challenges to jeopardize growth. Government has requested a frontloading of GPRSG II hence the tranching will be split 70% and 30% of the programme total respectively. November 2009 negotiations between the Government and an IMF mission on an Extended Credit Facility (ECF, approved by the IMF Board on 19 February 2010) focused on the adoption of a crawling exchange rate peg, improving foreign exchange reserves and government commitment to terminate unbudgeted outlays. Consistent implementation of these actions would set the stage for an improved macroeconomic environment, positively influencing development partners. The goal of the Governance and Poverty Reduction Support Grant (GPRSG) II is to contribute to Malawi’s targets on poverty reduction and macroeconomic stability through improved financial governance and increased pro-poor expenditures. In this way, it will support achievement of more effective and accountable government which are established priorities of the Malawi Growth and Development Strategy (MGDS) and Public Financial and Economic Management Priority Action Plan (PFEM PAP). To that end it builds upon the Government’s recently redesigned PFEM PAP. By improving financial governance through greater efficiency, transparency, and accountability in the use of public resources, the GPRSG II seeks to make the budgeting process more efficient and enable better provision of social services, especially to the poor. The GPRSG II has three pillars (public financial management (PFM) reforms, external audits, and public procurement) supporting the Government’s PFEM PAP. Program overview The program’s UA 11.6 million is allocated from the ADF XI to finance the general budget in implementing MGDS and to support the reforms prioritized in the Government’s PFEM PAP. To achieve greater alignment, the design of the GPRSG II is being fast-tracked, so that, owing to its two-year coverage, the Bank budget support cycle will be realigned with the Malawian budget cycle in advance of ADF XII. The GPRSG II is consistent with Malawi’s Results-Based Country Strategy Paper for 2005-09 (extended to 2010), which focuses on promoting economic growth by improving governance and human resources development. There have been several similar operations by the Bank in Malawi, notably the PRSG I. Its Project Completion Report concluded that it was implemented as planned and substantial progress was made, notably in strengthening PFM and preparing a successor programme.

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Program Outcomes and beneficiaries The GPRSG II aims to intensify dialogue with the Government on PFM processes. It focuses on budget formulation and execution, reinforcing checks and balances, financial discipline, and accountability of public entities. This will allow aligning budget implementation with the macroeconomic framework. The operation is expected to generate several benefits. At the general level, the increased pro-poor expenditures and more effective and accountable government would sustain a stable macroeconomic environment. This would strengthen budget management and therefore credibility, improving confidence in government policies. The GPRSG II will directly benefit the Ministry of Finance and other key public sector institutions (such as the PFEM Secretariat and NAO) in the short term by allowing them to speed up reform processes that promote transparency and accountability in the management of public resources. It should lead therefore to improving the ranking of Malawi in key international governance indicators, in particular CPIA and those related to Doing Business. Needs Assessment The PFM process in Malawi has been weak and requires refocusing, and the economy is at a watershed as regards maintaining macroeconomic impetus. The GPRSG II targets the recently launched PFEM PAP and actions to support prudent macroeconomic policies. The convergence of the Government’s attempt to reinvigorate PFM and difficult choices for economic policy make it urgent and effective for the Bank to complement other budget support donors in providing budget support to Malawi (namely DFID, EU, Germany, Norway, and the World Bank). Bank’s Added Value The Bank in particular can contribute significantly with its experience in the area of budget support and as Chair of the Common Approach to Budget Support donor group in Malawi. The GPRSG II lends itself to attain the government’s objectives of achieving fiscal discipline; strategic, efficient, and effective allocation and use of budget resources; value for money; and probity in the use of public funds. Institutional Development and Knowledge Building The program supports the reforms prioritized in the Government’s PFEM PAP, which overwhelmingly target improved management of government entities. It is consistent with Malawi’s Country Strategy Paper for 2005-09 (extended to 2010), which focuses on promoting economic growth by improving governance and human resources development. Furthermore, by using country systems consistent with the Paris Declaration on Aid Effectiveness and the Accra Agenda for Action, it will contribute to institutional capacity building. A coordinated separate though complementary technical assistance capacity building program will reinforce these institutional development effects.

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RESULTS-BASED LOGICAL FRAMEWORK (Aligned with the PAF)

HIERARCHY OF OBJECTIVES

EXPECTED RESULTS REACH PERFORMANCE

INDICATORS INDICATIVE TARGETS

TIMEFRAME ASSUMPTIONS / RISKS

Goal Reduce poverty (MDG 1)

Increased access and quality of basic services (MDG 2, 3, 4 & 5)

Sustain stable macroeconomic environment

Program Objectives: Enhance efficiency, transparency and accountability in the use of public resources More public service delivery (for the poor)

Outcomes: Reduced poverty Increased access and quality of pro-poor sectors Improved capacity and pace of PFM reform Greater accountability on public budget Greater transparency on public budget Increased pro-poor spending

Beneficiaries: Malawian population Government of Malawi Malawian population

Outcome indicators:

(i) Poverty headcount

(ii) Pupil per qualified teacher ratio in primary schools

(iii) Under-5 mortality rate

(iv) Proportion of births

attended by skilled health personnel

(v) Positive GDP growth and

IMF macroeconomic assessment

(i) CPIA Governance rating (ii) Transparency International

rating (iii) In-year expenditure

reallocation between primary votes

(iv) Timeliness and quality of expenditure reporting

(v) Public Procurement Act (PPA) Review

(vi) Pro-poor spending

Progress anticipated in the medium term :

(i) Reduced from 52.4% in 2005 to 27% by 2015

(ii) Reduced from 90:1 in 2008 to 60:1 by 2015

(iii) Reduce from 122 per thousand in 2009 to 78 per thousand in 2015

(iv) Increase from 45% in 2008 to 80% in 2015

(v) Sustaining GoM target of 6.5% real GDP growth pa 2009-2029

(i) Improves from 3.6 in 2009 to 3.65 in 2011

(ii) Rises above the 89th ranking of 2009 in 2011

(iii) (a) Variance remains <10% of total approved budget for 2010/11 as of 2008/09; (b) Improved PEFA indicator PI2 (budget exec from C to C+ )

(iv) All 29 district assemblies on-line with IFMIS

(v) Review finalised and proposed amendments to the PPA submitted to the Minister of Finance by Dec 2010

(vi) Pro-poor spending to increase from 5.8% in 2008/09 to 6.5% in 2010/2011

Assumptions: Government remains committed to good governance as articulated in the MGDS. Stable macroeconomic environment and sustained commitment to pro-poor reforms KEY RISKS Inconsistent performance under IMF supported program Mitigation: Continued engagement with Government through GFEM and CABS on sustaining macroeconomic stability Pace of PFEM reform implementation improves Both tranches, totaling UA 11.6 million, under the GPRSG II are disbursed Strengthened policy dialogue with the Government Risks: PFM and other institutional capacity constraints. Mitigation: Capacity building for PFM implementation.

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HIERARCHY OF OBJECTIVES

EXPECTED RESULTS REACH PERFORMANCE

INDICATORS INDICATIVE TARGETS

TIMEFRAME ASSUMPTIONS / RISKS

Data sources 2010 and 2011 CPIA reports, CABS PAF Review Reports, 2011 PEFA Report, MGDS annual monitoring reports.

Time Frame: 2010/11-2011/12.

Activities:

Strengthen PFM reforms (items i-iii)

Enhance external audits (items iv-vi)

Reinforce public procurement (items vii-ix)

Outputs (policy actions): Strengthened leadership and better implementation of PFEM reform Improved budget allocation, implementation and monitoring Increased independence of external audit and reduced delays in submission of reports to Parliament More efficient use of resources and reduced opportunities for corruption

Beneficiaries: Ministry of Finance Accountant General’s Department National Audit Office Public Accounts and Budget and Finance Committees Public Procurement Directorate

Output indicators: (i) PFEM Secretariat active

and fully staffed (ii) Capacity building

program for PFEM staff (iii) IFMIS roll-out to districts

and local assemblies (iv) Timely submission of

FY2007/08 audit report to parliament

(v) Timely submission of FY2008/09 audit report to parliament

(vi) Increased Audit coverage (vii) Procurement plans for

largest public spending entities linked to the budget

(viii) Capacity building program for ODPP staff

(ix) Preparing amendments to the PPA

Data Sources: IMF reports; 2010/11 and 2011/12 Government budget statements, CABS and GFEM reports

Progress anticipated in the short term: (i) PFEMS actively monitoring

PAP March 2010 (ii) Adoption of revised PFEM

PAP by July 2010 (iii) IFMIS roll out to districts

increased from 5 in 2009/10 to 10 districts in 2010/11

(iv) 2007/08 audit report submitted to parliament by March 2010

(v) 2008/09 audit report submitted to parliament by December 2010

(vi) 2009/10 audit coverage includes assemblies

(vii) 50% of 10 largest public spending entities have procurement plans linked to their annual budgets as of FY2009/10, by March 2010

(viii) Programs defined by March 2010

(ix) Amendments submitted to the Minister of Finance by December 2010

Time Frame: FY2009/10-FY2010/11

Assumptions: IMF Board approves the ECF for Malawi in February 2010. GFEM revitalization takes place and PFEM Secretariat is strengthened. Technical Assistance program (complementing the GPRSG II) being implemented. Risks (i) Government fails to fulfill

IMF prior conditions. Mitigation: Review alternative ways of channeling funds to Malawi.

(ii) Government fails to restore fiscal discipline. Mitigation: Closer monitoring and regular dialogue through CABS, GFEM, and Heads of Cooperation chairmanship

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REPORT AND RECOMMENDATION OF THE MANAGEMENT OF THE AfDB GROUP TO THE ADF BOARD OF DIRECTORS ON A PROPOSED GOVERNANCE AND POVERTY REDUCTION SUPPORT GRANT (GPRSG) II FOR MALAWI I. THE PROPOSAL 1.1. Management submits the following Report and Recommendation on a proposed grant to the Republic of Malawi for UA 11.6 million to finance the Governance and poverty reduction support Grant (GPRSG) II in Malawi. It is a Direct Budget Support Grant and will be applied on two years from March 2010 to June 2011. The program was appraised in November 2009. It results from an initial request of the Government dated November 2009 and a request for frontloading dated December 2009 and is in line with the Malawi Growth and Development Strategy (MGDS) for 2006/07-2010/11; the Bank’s Country Strategy Paper (CSP, 2005-09 extended to 2010); and, its 2008 Midterm Review Report. 1 The MGDS was endorsed by donors in November 2006. The design of the program took into account good practice principles on conditionality and Bank Group provisions on non-concessional debt accumulation policy; to achieve greater alignment, its design is being fast-tracked, so that, owing to its two-year coverage, the Bank budget support cycle will be realigned with the Malawian budget cycle in advance of ADF XII. 1.2. The program’s overarching purpose is to reduce poverty through improved governance. Its operational objectives are improving efficiency, transparency, and accountability in the use of public resources as laid out in the country’s MGDS and Public Financial and Economic Management Priority Action Plan (PFEM PAP). It has the following expected outcomes: (i) improved budget process; (ii) enhanced external audit and scrutiny in the use of public resources; and (iii) bolstered public procurement capacity. 1.3. The authorities have provided the Bank with a Letter of Development Policy (LDP; Annex I), which they have also submitted to other institutions, indicating how they intend to use the funds. II. COUNTRY AND PROGRAM CONTEXT 2.1. Government overall development strategy and medium-term reform priorities 2.1.1. The MGDS is structured around five pillars: (i) sustainable economic growth; (ii) social development; (iii) social protection; (iv) infrastructure development; and (v) good governance. These pillars are linked to specific strategies; 2 costed action plans were prepared to deliver the key priority areas. The MGDS implementation progress and results are being monitored through annual reviews, which present the opportunity for realigning implementation practices.3 In the short term, the implementation of the MGDS is being supported by strengthening public resource management and encouraging budget support from development partners to sustain economic growth. Importantly, this will include making more effective the medium-term expenditure framework (MTEF), in collaboration with AFRITAC.

1 In concluding the midterm review on 4 November 2008, the Board endorsed more focus on transport, water and irrigation infrastructure, tertiary education, private sector development and budget support for governance. 2 The pillars are supported by six key priority areas (agriculture; water; transport; energy; rural development; prevention of nutrition disorders, HIV and AIDS). Three new priority areas (education, science and technology; youth; and climate change, natural resources and environment) have been added from FY2009/10 onwards. 3 Given that the MGDS is nearing the end of its implementation period (June 2011), a successor program, covering 2011/12-2015/16, is being prepared.

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2.1.2. President Bingu wa Mutharika was first elected in May 2004 and re-elected in May 2009. His Democratic Progressive Party (DPP) will, for the next five years, command a majority in Parliament, which should allow for a smooth transaction of its business and thereby accelerate the development agenda, notably by deepening the delivery of basic social services and further strengthening its PFM systems. President Mutharika has made his top priority the implementation of the Government’s MGDS covering 2006/07-2010/11, which contains its medium-term reform priorities and development program and provides the basis for donor support to Malawi.

2.1.3. The reform impetus has slowed recently, in part because of administrative changes after the elections that delayed decisions. Nonetheless, the macroeconomic framework is adequate for the purposes of the proposed operation: an ECF was approved by the IMF Executive Board in February 2010, after macroeconomic and structural prior actions were taken. This indicates the Government’s renewed commitment to the implementation of prudent macroeconomic and structural policies.

2.1.4. To consolidate governance reforms, the authorities designed the PFEM PAP for 2009/10-2011/12 (Annex II). This program is an interim step towards a longer term PFEM Sector-Wide Approach (SWAp) that would improve coordination and dynamism of the reform process. The GPRSG II, by focusing on improving financial governance and supporting the PAP, will allow the Government to show increased commitment to and ownership of reform.

2.2. Recent economic and social developments, perspectives, constraints, and challenges 2.2.1. Recent economic and social developments – The economy is on a much stronger footing now than it was at the start of the decade as a result of macroeconomic reforms and fiscal discipline. This helped Malawi reach the Highly Indebted Poor Countries (HIPC) Initiative completion point in 2006 and obtain subsequent debt relief under the Multilateral Debt Relief Initiative (MDRI), which reduced the external public debt stock/GDP ratio from 143% to 14.4% in 2007/08. The broad macroeconomic indicators suggest the economy is on the right track: average GDP growth during 2006-09 was 8.4%, sustained by strong international tobacco prices, good weather, and coordinated support by development partners (Table 1 and Annex IV).4 Average annual inflation declined from 16.1% in 2005/06 to 8.6% in 2008/09, allowing interest rates to decline (to 15% in 2009). 2.2.2. These positive developments nonetheless took place against the background of structural challenges that make Malawi vulnerable to external shocks. Malawi is an agriculturally-based economy with agriculture accounting for almost 40% of Malawi’s GDP. Although the impact of the international financial crisis and subsequent economic slowdown has been moderate in Malawi (see Annex XIII), commodity prices for Malawi’s export crops (notably tobacco—the principal export—as well as coffee, tea, and cotton) fell significantly after 2008 (see chart 1 of Annex XIII).

2.2.3. The volatility in exports has combined with a narrow export base and emerging supply side challenges to growth (notably the generation and supply of electricity) to aggravate Malawi’s chronic low international reserves in the context of a fixed exchange rate regime. Also, pressure on the budget mounted after 2008, owing to overspending on the national census, elections (related to overruns of automation costs), and fertilizer subsidies (Annex XIV). The fiscal deficit increased from 2.7% of GDP in 2007/08 to 5.7% in 2008/09, financed by an increase in domestic debt.

4 GDP growth remains strong in comparison with the average forecast for sub-Saharan African countries of 4% (IMF, WEO October 2009). A large uranium project, where exports started in 2009, could add 10% to total GDP, despite a fall in international prices from some US$90 per pound of uranium U3O8 in October 2007 to US$42 in October 2009.

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Table 1. Malawi: Key macroeconomic indicators (In percent of GDP, unless otherwise indicated)

Source: IMF. 2.2.4. The expansionary fiscal stance has made foreign exchange less available for the private sector, combining with other challenges to jeopardize growth: (i) companies have been unable to obtain foreign exchange through the commercial banks, increasingly leading to defaults on credit lines extended by foreign suppliers; (ii) the government has intervened in private sector activities, including setting agricultural minimum buying prices above world prices; (iii) shortages in the generation and supply of electricity and water are affecting both producers and consumers;5 and (iv) crime, theft, and corruption is interfering with business decisions.

2.2.5. The persistent low foreign exchange reserves were a key focus during the November 2009 negotiations between the Government and an IMF mission on an Extended Credit Facility (ECF).6 In particular, the adoption of a crawling exchange rate peg 7 and a government commitment to terminate unbudgeted outlays related to fertilizer subsidies have set the stage for an improvement in the macroeconomic environment, positively influencing development partners.

2.2.6. Governance performance and trends – Malawi has made good progress during the last decade in key aspects of governance, including improvement in political freedom and rights and fighting of corruption. Nonetheless, further improvements are needed in addressing fiduciary risks, particularly as regards within-sector variance of budget forecasts and outturns, external audit quality and follow-up, and procurement capacity challenges. Furthermore, the oversight afforded by checks and balances to the system may be weakened because government now has a strong majority in Parliament. 2.2.7. Overall, Malawi was ranked as an average country in international governance indicators in 2009. Nonetheless, this generally denotes some degree of improvement over 2008. Thus, Malawi ranked 89th out of 180 on Transparency International’s 2009 Corruption Perceptions Index, a significant improvement over 2008, when it was in 115th position. Similarly, the 2009 Mo Ibrahim Index of African Governance (Annex XII C) shows a somewhat improving score of 53 for Malawi (out of 100; data for 2007), compared to 51 in 2005.

2.2.8. Although the country’s ranking in the 2010 Doing Business Report of the World Bank Group (Annex XII A) has remained stable overall, at position 132 (out of 183 countries), some notable improvements were achieved: in the category of paying taxes, its best ranking, Malawi’s position jumped to 24th ranking (from 60th in 2008). Other good rankings include employing workers (92nd position), getting credit (87th), and protecting investors (73rd). Its worst ranking is trading across borders (173rd), owing to the fact that importing and exporting takes some 10 days longer than the average for sub-Saharan Africa. 5 To the extent that these constraints are worsening, they are beginning to affect the investment decisions of companies. The high cost of on/off operating schedules not only decreases output but also puts an extra strain on maintaining equipment. The shortage of water supply in some parts of the country also affects the agricultural sector, the engine of growth and exports. 6 The ECF is the successor to the Poverty Reduction and Growth Facility (PRGF). Although Malawi’s strong performance under the PRGF allowed it to be the first country to benefit from the Exogenous Shock Facility (ESF), introduced in 2008, the disbursement of the second tranche was withheld—with the program subsequently suspended—when a March 2009 IMF mission raised concerns about Malawi’s macroeconomic policy stance. 7 The crawling exchange rate peg adopted by the Government allows fluctuation of the exchange rate around a central rate that gradually depreciates according to a predetermined formula.

2007/08 2008/09 2009/10 2010/11 Real GDP growth (%) 9.2 8.6 6.7 6.1 Consumer prices (%) 8.5 8.5 11.4 7.6

Fiscal balance, excl. grants -13.5 -17.3 -12.8 -12.6 Fiscal balance, incl. grants -2.7 -5.7 -2.2 -2.5

Current account, incl. grants -4.9 -7.1 -4.8 -2.0 External debt 14.4 16.0 19.1 21.8

Usable gross official reserves (months of imports) 1.4 1.3 0.6 1.4

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2.2.9. Consistent with the preceding analysis of other governance indicators, significant improvements in the governance elements of CPIA in the mid 2000s have flattened out and governance scores were broadly stagnant between 2008 and 2009, Malawi’s overall CPIA ratings fell in 2009 to 3.54 from 3.66 in 2008 (Annex XII D). The fall was driven by declining performance in 2009 on economic management and structural policy (including missed targets under the IMF program). However, the 2009 total remains stronger than the 3.26 and 3.41 totals obtained in 2005 and 2006 respectively. Ratings should increase again in 2010 if the new ECF remains on track. Similarly, the World Bank’s Worldwide Governance Indicators (Annex XII B) show Malawi at only 30%, and much remains to be achieved. Nonetheless, the country had made gains between 2003 and 2008 in all of the six areas covered—especially in voice and accountability, and control of corruption—raising indicators from the 24% attained in 2003.8 2.2.10. Poverty profile– Poverty in Malawi is deep and widespread, reflecting its dense population (Annexes VIII and IX). Per capita GNI (Atlas method) was US$290 in 2008, and an estimated 40% of the population lives below the national poverty line, compared to 52% in 2005. Even though growth has been strong since 2005, poverty has not fallen since 2007. This points to inequalities in the distribution of growth, and a falling Gini coefficient (which in 2007 stood at 39, compared to 50 in 1997; Zambia’s coefficient was 51 in 2007).9 2.2.11. The poor still have inadequate socio-economic indicators, with food security continuing to be a threat to better living conditions. The poorest people live in the southern region, which had the highest poverty rate (at 45%), followed by the Northern region (44%) and the Central region (33%). Poverty in rural areas is higher in than urban areas (44% versus 11% poor). Persons living in female-headed households were more likely to be poor than those living in male-headed households, 48 % and 38% respectively. 2.2.12. The UN Human Development Index (HDI) 2009 (2007 data) ranks Malawi 160th out of 182 countries. Infant mortality rates are high, and life expectancy at birth is 53.1 years. There is a high adult prevalence rate of HIV/AIDS, with almost 1 million adults (or 12.3% of the population) living with the disease in 2003.

2.2.13. However, the Bank’s operations have had some positive impact on key cross-cutting issues. Improved productivity and enhanced incomes of target groups of the Bank’s agricultural projects have contributed to poverty reduction. The proposed budget support operation will reinforce these social and human development projects by promoting pro-poor expenditures in the strategic priorities set out in the MGDS. This will provide a welcome boost for actions regarding MDG goals 2 through 4 (education, gender, child mortality), which are still considered feasible to attain (see Annex XI)10. However, although maternal mortality has been reduced somewhat, it is still high (at 807 per 100,000 live births), in part reflecting lags in promoting gender equality. 2.2.14. Medium-term perspectives - Assessments by the UNDP suggest that Malawi is making progress in meeting its targets for the Millennium Development Goals (MDGs) by 2015 (Annex XI). The Government has been budgeting annual poverty reducing outlays at 5.8% of GDP, with donors providing additional aid. For example, development partners contributed some US$567 million in FY2008/09, equivalent to 12.3% of Malawi’s GDP.

2.2.15. Implementation of the Malawi Growth and Development Strategy (MGDS) has been positive. As each of the five pillars specifies medium-term outcomes and strategies to achieve them, progress has

8 A rank of 25% implies that three quarters of all countries are better off than Malawi. 9 A value of 0 represents absolute equality, and a value of 100 absolute inequality. 10 www.mdgmonitor.org Although reaching only the child mortality MDG is considered feasible by GoM’s own monitoring of MDGs.

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helped improve poverty indicators.11 In particular food security has improved: a result of the fertilizer subsidy program. While the extra-budgetary outlays on fertilizers have created significant budgetary difficulties, the program itself has helped Malawi turn around food insecurity since 2007 to the point of exporting excess grain within the region and donating maize to the World Food Programme. In 2009, the fertilizer subsidies were increasingly targetted to smallholder food crops rather than cash crops, generating particularly beneficial gender effects, because vulnerable small-scale producers of food crops are mainly women. Nevertheless, there is further to go in better targeting the subsidy and this is an ongoing focus of policy dialogue in Malawi through CABS. Civil society is concerned that the subsidy has not gone far enough in targeting women specifically as the poorest small-scale producers for example (Annex XIV explores the program’s evolution, challenges and benefits). 2.3. Bank Group portfolio status 2.3.1. Since 1969, the Bank Group has funded 92 lending and non-lending operations in Malawi. Total net commitments have amounted to UA 595.5 million (UA 532.1 million in loans and UA 63.4 in grants), less UA 62 million in cancellations. The active portfolio contains seven investment projects and one budget support operation, with a total commitment of UA 118.54 million (Annex VII). The disbursement rate in the third quarter of 2009 reached 48.5%, significantly higher than the 39% attained in 2008. 2.3.2. The Malawi portfolio continued to improve in terms of performance and quality during January-September 2009. The commitment of the country’s ADF XI allocation reached 73% cumulatively, while the average size of approved operations was above UA 10 million. Commitments-At-Risk (CAR) fell from 10% in the second quarter to just 1% in the third quarter. The Projects-at-Risk (PAR) was maintained at 9% (Table 2)

Table 2: Q4 2009 Portfolio Scorecard Summary Problem Projects 1 i.e. Lake Malawi Artisanal Fisheries Development Project Potential Problem Projects 0 ( changed from Q 2 where Health Sector Program was rated PPP) Project-at-Risk 9% (unchanged from Q 3 2009) Disbursement Rate 51.4% (up from 48.5% in Q3 2009) Disbursement Ratio 28.3 % (up from 23.9% in Q 3 2009)

11 However, discrepancies between voted budget allocations and actual funding has led some sectors to fall short of their targets—including, unfortunately, the energy sector, where only 39% of the budget allocation was funded (MGDS, Annual Review 2008, Executive Summary, p. x).

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III. RATIONALE, KEY DESIGN ELEMENTS, AND SUSTAINABILITY 3.1 Link with the CSP, analytical works underpinnings, and country readiness assessment

3.1.1. Link with the CSP - This operation is consistent with Malawi’s midterm review of the CSP for 2005-10, endorsed by the Board on 4 November 2008. Two CSPs have been prepared, covering 2000-2004 and 2005-2010, respectively, which have guided the identification of new projects. The 2005-2010 CSP has been designed around the two pillars of “expansion of rural infrastructure” and “development of human capital and institutional capacity”; it is aligned with the priority sectors identified in Malawi’s MGDS. Looking forward, in line with the CSP, the AfDB will focus on infrastructure sectors and PFM reforms. The CSP midterm review concluded that the Bank’s priorities for Malawi should focus more on budget support, good governance, and PFM reforms. Like the PRSG I, the proposed GPRSG II therefore supports the fifth pillar of the MGDS - improving governance - and the second pillar of the CSP - developing human capital and institutional capacity including governance. 3.1.2. The institutions and systems of PFM, especially the Ministry of Finance, have a critical impact on service delivery and implementation of the MGDS. Bolstering PFM needs to be a central element of the governance agenda. Therefore, since the DBSL budget support instrument provides financing directly to the government budget, it has a greater systemic impact on PFM than Policy Based Lending/Import support. It was therefore deemed preferable to structure the program as budget support rather than PBL support. 3.1.3. Analytical Works Underpinnings - Various analytical diagnostic works mould the design of the GPRSG II. Foremost among these are the Public Expenditure and Financial Accountability (PEFA, 2008), Public Procurement Assessment Report (PPAR, 2007), ADB-WEF African Competitiveness Reports (2007-2009), African Economic Outlook (2009), and the DFID/AfDB Fiduciary Risk and Country Governance Assessments (2009). There are also Technical Assistance (TA) reports by DFID, the EC, the World Bank, and the IMF, which review the PFM reforms.

3.1.4. In addition to these diagnostic reports, program design also benefitted from extensive consultations with country stakeholders, especially government PFM institutions, Parliament, private sector and civil society organizations, and development partners (notably the Common Approach to Budget Support Group (CABS) and the IMF). Specific consultative roundtable meetings were held with civil society including umbrella groups. One meeting was held with CSOs representing poverty and gender issues including smallholder farmers and a separate meeting covered PFM and economic management issues. Private sector representatives from the sugar, tea and construction industries as well as representative groups were met in Blantyre. 3.1.5. Important conclusions from this diagnostic work are that:

while government has put in place a PFEM Prioritized Action Plan and progress was noted by the 2008 PEFA assessment, implementing the PAP has been slow;

there is need for further reforms to strengthen capacity in PFM institutions, in order to improve public service delivery; and

low foreign exchange reserves resulting from important distortions, notably exchange rate and structural weaknesses, risk undermining the macroeconomic improvements attained since 2004.

3.1.6. Country Readiness Assessment - Malawi has demonstrated its ability to take on successively more demanding programs, notably the PRSG I, the IMF’s PRGF (which was successfully completed), and ECF (for which negotiations were recently successfully concluded) (see IMF Assessment Letter in Annex III).

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3.1.7. Malawi adequately meets the general and technical prerequisites for direct budget support as set out in the Bank’s 2004 Guidelines on Development Budget Support Loans (DBSL) (Annex VI). In particular, the country meets the two criteria for delivering budget support: economic and political stability and a commitment to growth and poverty reduction (with a demonstrated positive trajectory for reform on public financial management). Enhancing budget support is also justified by the opportunities provided by the majority government elected peacefully in May 2009, which through this instrument has the incentives to accelerate urgent PFM reforms. 3.2 Collaboration and coordination with other development partners 3.2.1. The Government, through the CABS and GFEM (where the Bank is a member), coordinates budget support financing. Besides the Bank, which is chairing CABS in 2010/11, major development partners providing budget support include the EU, World Bank, DFID, Norway, Germany, and Ireland in CABS. IMF, USAID, JICA and the UN agencies also provide significant aid but not through budget support. A Joint Framework of Agreement (JFA) was signed in 2005 that sets out the criteria for providing budget support. The CABS conducts two semi-annual reviews: in October/November, to review the budget, and in March/April, to assess overall performance. In that context, CABS updated the Performance Assessment Framework (PAF) as well as the JFA in March 2010 to better reflect the CABS mechanism. The Bank actively participated in the review processes to monitor progress and improve policy dialogue. The Bank encouraged the Government to enhance its cooperation with development partners in the pursuit of strengthened PFM reforms. 3.2.2. During its November 2009 review, CABS partners agreed that the overall government stance remained positive, and that the Government is committed to reducing poverty and improving governance. However, commitment to prudent macroeconomic policies was highlighted as crucial to be able to maintain aid levels of previous years and forestall moves by some development partners to delay budget support.12 This becomes especially important since two of the three PEFA indicators relating to donor practices received a score of “C” in 2008. 3.2.3. The design of the GPRSG II helps implement the commitments of the Bank and Government to harmonization and aid effectiveness under the Paris Declaration (which Malawi signed in February 2005) and the Accra Agenda for Action, agreed in September 2008. The operation will use country systems for implementation (notably the budget and public procurement systems) and for monitoring (annual MGDS reviews, national audit) thus building on Malawi’s institutional structure. The triggers for the two disbursements have been synchronized with CABS partners to avoid duplication of conditionalities, and are taken from the shared PAF. While the Bank could not disburse early in 2009/10 because of slippages in PBOs from previous years13, the GPRSG II has been designed as a two-year program to allow re-aligning the Bank cycle to the Government’s by disbursing (i) the first tranche still during FY2009/10 and (ii) the second tranche early in FY2010/11.

12 Budget support to Malawi suffered from severe delays in both 2007 and 2008 due to development partners’ concerns about macroeconomic policies and unbudgeted expenditures. 13 The PRSL was significantly delayed by the Parliamentary ratification process.

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3.3 Outcomes of past and on-going similar operations and lessons 3.3.1. The Bank Group has so far approved four policy-based operations for Malawi, amounting to UA 51.9 million:

(i) Structural Adjustment Loan (SAL) of UA 15 million, approved on December 15, 1998, was designed to support reforms for achieving fiscal sustainability, improvement in the delivery of social services, as well as privatization and diversification of agricultural production and export. (ii) Support for Good Governance Loan (SGGL) of UA 12 million, approved on December 8, 2004, was designed, in coordination with other donors, to support the implementation of the country’s first poverty reduction strategy 2001-2005 with a focus on strengthening public sector governance. (iii) Poverty Reduction Support Loan (PRSL) of UA 14.9 million, approved on April 11, 2007, was a one-tranche operation aimed at stimulating social sector and PFM reforms. PRSL suffered significant delays at the point of ratification by Malawi’s Parliament; and (iv) Poverty Reduction Support Grant (PRSG I) of UA 10 million, approved on 6 March 2009, sought to increase the Government’s capacity to deliver on its priorities, namely, fostering economic growth by augmenting budgetary resources.14 The PRSG I was a one-year single tranche operation because of the uncertainty surrounding the May 2009 elections and the potential negative implications for future budget support.15

3.3.2. Clear lessons from these and other donor policy-based programs along with lessons from the 2009 CABS review have been identified and have shaped the design of the GPRSG II. Major lessons and how they have informed design are highlighted below:

(v) Lesson: The Bank and other budget support donors should place more reliance on government budget processes and PFM systems. Using national systems simplified the design, implementation, supervision and monitoring of the PRSG I operation. How it has been used: This lesson is at the heart of continued engagement through budget support. National systems of budgeting, procurement, monitoring and audit are being used by GPRSG II and strengthened both by this programme and through the complementary technical assistance. (vi) Lesson: Alignment with the budget cycle was weak in former operations, and disbursements did not occur in the first half of the fiscal year as they should. How it has been used: because of delays under PRSL and subsequent knock on effects on PRSG I, GPRSG II is designed as a 2 year program partly to allow the Bank to catch up with the national budget cycle. Because the Bank’s appraisal process takes several months and can only commence once the previous operation has been reviewed, the first disbursement will necessarily be late in the Malawian 2009/10 budget year. Because GPRSG II is a 2 year program, the second disbursement is programmed in the first quarter of 2010/11 and will allow greater alignment with the Malawian fiscal year in future budget support operations under ADF 12. (vii) Lesson: Where the performance of PFM institutions is critical, budget support alone is insufficient to ensure progress and should be complemented by coordinated technical assistance; How it has been used: the design of GPRSG II incorporates the design of a separate but complementary technical assistance programme (see box 2 below). Under ADF 12, additional resources will be allocated to complementary technical assistance for PFM.

14 The grant was linked to the fifth pillar of the MGDS - improving governance- and the second pillar of the 2005-2010 CSP- developing human capital and institutional capacity, including governance. It focused on improvements in PFM reforms aimed at improving the budget, audit and procurement functions of the government as key instruments for attaining economic growth. 15 The election was peaceful and subsequently, there is no further political uncertainty (see paragraph 2.1.2). Therefore GPRSG II is able to span two years to complete the envisioned 3 year program under ADF 11.

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(viii) Lesson: The need for specificity in the selection, definition, and evidence of disbursement conditions required so as to ease program implementation. Hence the importance of joint appraisal with other donors, the use of the PAF and engagement of the Bank’s Legal Department in the appraisal of GPRSG II; How it has been used: Appraisal included consideration of evidence required with Government and CABS partners, the PAF details were adhered to in identifying conditions and feasibility verified with Government, the Bank’s Legal Department were engaged as Peer Reviewers (ix) Lesson: Shared risk analysis, including fiduciary risk and macroeconomic analysis, is critical to the success and sustainability of budget support in Malawi. How it has been used: The macroeconomic, fiduciary risk and other underlying analysis were conducted jointly with other donors (IMF and DFID respectively) as well as Government.

3.4. Relationship to other Bank operations

3.4.1. The GPRSG II builds upon the lessons learnt from the previous policy-based programs, as well as from the CSP. To that end, it will enhance the fiduciary arrangements for the implementation of Bank Group investment projects and contribute to additional funds for social service delivery. Thus, it will reinforce the social dimension of the Bank’s overall portfolio in Malawi (currently at 39.4%) by supporting higher pro-poor expenditure, such as in the Poverty Reduction and Institutional Support (PRISP) as well as Skills Development and Income Generation (SDIG) projects.16 The GPRSG II will build on these achievements in the context of the CABS framework. 3.5. Bank’s comparative advantages

3.5.1. The GPRSG II builds on the Bank’s experience and competency across the continent in promoting transparency and accountability in the use of public resources. Since adopting its GAP for 2008–2012, the Bank has streamlined its approach to governance focusing on PFM. In so doing, it has scaled up its resources and reoriented its policy and institutional actions to respond to the challenges in key PFM reform areas, namely budgeting, public procurement, and auditing. 3.5.2. The Bank will use its Field Office to actively support Malawi’s reform efforts. It will apply its comparative advantage in the context of the CABS Group, both as the 2010 CABS chair and through contributing a significant share of the combined CABS total budget support (around 9 and 10% of the 2009/10 and 2010/11 budget support, respectively). This will allow it to play a central role in steering CABS partners regarding the reform agenda in Malawi.

3.5.3. The GPRSG II complements the programs of the other CABS members, reinforcing their commitment to provide predictable resources to pro-poor expenditure for enhanced social service delivery. Furthermore, Malawi will benefit from the fact that these budget support resources are untied and therefore fully available for the implementation of the MGDS, boosting foreign exchange reserves to maintain macroeconomic stability in the face of increasing demand for imports. 3.5.4 Knowledge of Malawi’s governance challenges, specifically as regards PFM, will be a particularly important asset. The Bank has been involved in Malawi’s policy and institutional reforms through its policy-based operations and dialogue for some time. Support for capacity building in PFEM government entities will be provided in a separate though complementary technical assistance project, in conjunction with other development partners. MWFO will be collaborating closely with the Ministry of Finance, monitoring the program, and providing continuous feedback to headquarters. More specifically, the Bank will use its field presence to contribute governance expertise that adds value to the dialogue in Malawi.

16 The PRISP has resulted in 288 district executive committee members trained in participatory extension; 1,704 Village Action Plans produced; 7 district socioeconomic profiles produced; and 507 community sub-projects supported. The SDIG has resulted in 36,419 people made literate, 25% of whom now have business skills; 8,394 people trained in production skills; and 10,058 people trained in business management.

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3.6. Application of good practices principles on conditionality 3.6.1. Each of the two tranches is subject to two substantive disbursement triggers, considered both reasonable and necessary. For 2009/10, the triggers are drawn from the PAF (Annex V), and the conditionality of the GPRSG II therefore does not require negotiations with development partners. The PAF covering 2010/11 was negotiated in March 2010 during the CABS review, when the second tranche disbursement triggers were incorporated. 3.6.2. In addition, the following principles were followed:

• Reinforce ownership: The MGDS was prepared by the Government after broad-based consultations

with stakeholders. Thus, it is a fully country-owned program accepted by the development partners as the main framework for supporting Malawi’s poverty reduction efforts. The Government is committed to the successful implementation of the program, and supporting analytical work is helping in policy formulation (see section 3.1). The GPRSG II reinforces this ownership.

• Agree on a coordinated framework: The Government and the CABS Group have agreed on a JFA for direct budget support, with a PAF as the accountability framework for measuring progress. The Bank, like the other development partners, bases its program and disbursement triggers on the PAF.

• Customize the accountability framework and modalities of Bank’s support to country circumstances: The GPRSG II reflects government priorities, as do the modalities and timing of disbursements as far as Bank due process allows. Being a grant, the GPRSG II is tailored to a country emerging from debt distress, like Malawi. The program will also use country systems and monitoring mechanisms built around the CABS/PAF framework.

• Select only actions that are critical for achieving results as conditions of disbursement: The policy prior actions chosen by the Bank as disbursement triggers for the GPRSG II are critical for ensuring success of the Government’s PFM reform program to deliver greater accountability and transparency. They focus primarily on PFM, thus ensuring convergence between the focus of the Government and Bank. Conditionality design within the CABS Group is further developed in paragraph 5.1.

3.7. Application of Bank Group non-concessional borrowing policy 3.7.1. The GPRSG II complies with the principles of the Bank Group policy on non-concessional borrowing and debt accumulation. Specifically: (i) there is strong partnership and coordination with sister multilateral development banks and bilateral agencies; (ii) measures are effective; (iii) measures are implementable; and (iv) diversity of country circumstances has been taken into account, with the program incorporating flexibility and a case-by-case approach. Having reached the HIPC Initiative completion point and benefited from MDRI, the Government’s borrowing policies are consistent with maintaining debt sustainability. The joint World Bank and IMF debt sustainability analysis of 2007 indicated improved debt sustainability. IV. THE PROPOSED PROGRAM AND EXPECTED RESULTS 4.1. Program’s goal and purpose 4.1.1. Program’s goal - The broad goal of the GPRSG II is to reduce poverty as laid out in Malawi’s MGDS. More specifically, the program’s objective is to enhance the efficiency, transparency and accountability in the use of public resources (improve financial governance) while helping increase public service delivery. To that end it builds upon the Government’s reform program as defined in the Government’s Letter of Development Policy (Annex 1), which lays out the Government’s challenge of stimulating the implementation of its recently redesigned Public Financial and Economic Management (PFEM) Prioritised Action Plan (PAP) (Box 1 and Annex II A). By improving financial governance through greater efficiency, transparency, and accountability in the use of public resources, the GPRSG

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II seeks to make the budgeting process more efficient and enable both more and better provision of social services, especially to the poor.

Box 1. Main Elements of the PFEM PAP, how the GPRSG II supports it

The PFEM PAP is the Government’s umbrella program for strengthening PFM systems in FY2009/10-2010/11. It has seven major areas (planning; resourcing the national development strategies; budgeting; budget execution; accounting and financial systems; reporting; and PFEM administration and programming) containing 130 indicators, of which 49 are priorities (see Annex II). The implementation of the PAP is divided into Phase 1 (the preparatory phase, May-December 2009) and Phase 2 (the implementation phase, January 2010 –June 2011). Phase 1 places the emphasis on identifying issues in budget management, so as to establish a credible base from which to prioritize PFEM actions. Phase 2 provides a prioritized and sequenced action plan to deepen progress in PFEM. The GPRSG II supports the PAP’s aims to increase fiscal discipline; strategic, efficient, and effective allocation and use of funds; value for money; and probity in the use of public funds. Its output is expected to improve the provision of social services—health and education—to the Malawian population. Specifically, GPRSG II covers three of the PAP’s major themes: PFM reforms, external audits, and public procurement reinforcement. In addition, correcting weaknesses in internal audits is receiving special attention. The GPRSG II also links to capacity building in the context of the PAP. Under a complementary coordinated Technical Assistance project, UA 260,000 is being made available to PFEM, upon receipt of costed plans from the PFEM Secretariat, NAO, Central Internal Audit Unit (CIAU), and ODPP. The aim is to improve the quality and coverage of output of these entities (see Box 2).

4.2 Program’s pillars, operational objectives, and expected results

4.2.1. Program’s pillars –The three pillars of the GPRSG II support the Government’s PFEM PAP, as summarized in Box 1. The GPRSG II includes two substantive triggers for each disbursement, as shown in Box 3; benchmarks are described in the Results-Based Framework. The triggers for 2009/10 are drawn from the relevant indicative targets in the PAF17; those for 2010/11 will be incorporated into the PAF during the review scheduled for March 2010. Benchmarks are shown in the results-based logical framework (see also Annex V). Its components are:

(i) PFM reforms – The program will address shortcomings in pushing forward PFM reforms. The PFEM Secretariat has fallen short during 2008/09 of reaching scheduled goals, in part because of a lack of leadership in taking decisions owing to the election process. Even though during the first half of 2009/10, the Government has redesigned the PAP, narrowing the focus and putting more realistic timelines, the operational matrix was still too broad to allow an effective focus on actions central to improving PFM in Malawi. The GPRSG II will help the Government crystallize the most effective actions based on international best practice, including by identifying disbursement triggers, benchmarks, and engaging in dialog. This scoping will be undertaken in the context of the GFEM through which CABS partners, under the chairmanship of the Bank, support the PAP.18 Other development partners are also supporting the PAP aiming to increase the quality of budget planning, preparation, and implementation. (ii) External audit –The NAO has since 2008 been able to significantly strengthen its operations: a new leadership was appointed, staff was hired, a strategic plan was adopted, and work was intensified on submitting the annual audit reports to Parliament. As a result, by end-June 2009, the reports of the three fiscal years 2004/05-2006/07 had been tabled in Parliament (at which point they are considered published). Nonetheless, the Public Accounts Committee (PAC) has not yet tabled its findings on the reports, and there is still a submission/publication backlog of the audits for 2007/08 and 2008/09. Furthermore, more staff is needed, and the NAO needs to expand its coverage of

17 Subcomponents of relevant PAF targets with revised timings have been adopted to ensure feasibility of GoM delivery and therefore to avoid delays in disbursement. 18 Prioritising PFEM reforms in the prior actions for tranche two disbursement is also aimed at assisting the Government in increasing its absorptive capacity for reform.

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audits. To that end, the Government has asked donors to step up their support of NAO. The GPRSG II has designed its support for the NAO to be fully coordinated with that of development partners, in particular Norway, which have provided additional assistance. The program will push for the tabling in Parliament of the annual audit reports for 2007/08 and 2008/09, for which two disbursement triggers were included. A special issue exists as to the independence of the NAO, and the GPRSG II supports the Auditor General in ensuring his independence from the central government, consistent with the Public Audit Act of 2003, by sending his report directly to Parliament and then requesting the Minister of Finance to table it in Parliament. (iii) Public procurement – The ODPP has made significant progress since 2008, although it still faces important challenges. The procurement functions of Government need to be strengthened, especially with respect to capacity building (both at ODPP and ministries) and to bringing the legal framework up to international best practices. The Government has designed its strategy along three prongs. One prong is aimed at increasing the number of government entities that develop procurement plans, as of FY2010/11, to ensure a more efficient and measured implementation of the spending plans and to step up procurement audits (thirty have been done since 2008). A second prong aims to increase the quality of staff at the ODPP, both through recruitment and training. And a third prong targets preparing amendments to the PPA, to modernize and to close loopholes, since procurement procedures are still being circumvented.19 The GPRSG II supports the Government’s strategy through specific disbursement triggers and benchmarks.

4.2.2. Special attention is also being paid to capacity building. As in other African countries at similar stages of development, capacity constraints exist primarily because of a lack of trained government officials and lack of funds to fast-track training. Efforts are underway to reducing this constraint, with noticeable results (as in public procurement). A separate though complementary Technical Assistance project is being designed by the Bank to stimulate this endeavor, aiming to strengthen the PFEM Secretariat, external auditing, and public procurement processes. Box 2 outlines the major features of this project which will complement GPRSG II.

Box 2: Technical Assistance (TA) linked to GPRSG II

A separate but coordinated TA project is being designed to complement the GPRSG II. The project is under the leadership of MWFO, which will design it based on costed plans from the envisaged beneficiaries (PFEM Secretariat; NAO; CIAU; and ODPP). It is expected to be approved by ORSB and become effective in 2010/11. The TA project aims to maximize the impact of DBSL on delivering effective economic and financial governance reforms to achieve transparency, reduce opportunities for corruption, and enhance accountability. It is being prepared as a standalone project for 2010/11, with a view to the Bank supporting an eventual joint capacity building program being developed by the Government in conjunction with the successor to the PFEM PAP, to come on line in 2011/12. The TA project envisages disbursing UA 260,000 (some US$420,000), drawn from ADF XI loan resources should Government agree. It is calibrated on enhancing transparency and accountability through the three pillars of the GPRSG II, namely PFEM capacity, audit, and public procurement:

• Overall PFEM capacity (tentatively costed at UA 80,000): provide assistance in strengthening the macro fiscal unit of the Economic Affairs Department in the Ministry of Finance, paving the way for the adoption of a more effective elaboration of MTEFs (together with AFRITAC), and (ii) PFEM Secretariat to help carry out, coordinate and monitor the implementation of the PFEM PAP; • Audit (tentatively costed at UA 100,000): (i) Improve the quality of external audits by the NAO, in coordination with Norway, including through support of a pilot audit manual and extending the coverage to key public enterprises, namely ESCOM and the water boards; and (ii) help maintain sound internal audit practices at CIAU, following the completion of the World Bank’s FIMTAP (which led to reduced funds available to CIAU to the point where the fragile internal audit functions have begun to backslide). The aim is to support both the central and ministerial audit committees, ensure preparation of evaluation reports, and strengthen the functions of the internal audit staff. • Public procurement (tentatively costed at UA 80,000): support ODPP to activate the IFMIS procurement module. This will allow real-time interaction of ODPP with other government departments, enable more effective control of public procurement activities, and reduce opportunities for corruption.  

19 In particular, the rule to publish only awarded contracts for supplies that exceed a certain threshold (which varies by government entity) has resulted in incentives for splitting contracts to remain below the threshold.

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4.2.3. Operational objectives – The GPRSG II aims to allow the Bank to intensify dialogue with the Government on PFM processes. It focuses on budget formulation and execution, reinforcing checks and balances, financial discipline, and accountability of public entities. This will allow aligning budget implementation with the macroeconomic framework.

4.2.4. Expected results –The operation is expected to generate several benefits. At the general level, the increased pro-poor expenditures and more effective and accountable government would sustain a stable macroeconomic environment.20 This would strengthen budget management and therefore credibility, improving confidence in government policies. The frontloading of tranche one with 70% of the programme resources responds to Government’s request to assist in maintaining pro-poor expenditure in the context of the 2009/10 global economic slowdown. The GPRSG II will directly benefit the Ministry of Finance and other key public sector institutions (such as the PFEM Secretariat and NAO) in the short term by allowing them to speed up reform processes that promote transparency and accountability in the management of public resources. It should lead therefore to improving the ranking of Malawi in key international governance indicators, in particular CPIA and those related to Doing Business. 4.2.5. Principal specific expected results are :

(i) More effective implementation of PFEM reform (as measured by attaining the activities scheduled in the PAP) by the PFEM Secretariat, leading to improved budget allocation, implementation and monitoring to prevent unbudgeted expenditures;

(ii) improvement in the independence of the NAO and a reduction in the delay with which annual audit reports are tabled in Parliament, improving the checks and balances of the branches of government; and

(iii) strengthening internal audit and public procurement procedures, notably as regards increases in staffing and internal oversight, allowing a more efficient use of resources and reducing opportunities for corruption.

4.2.6. GPRSG II Policy dialogue and the coordinated technical assistance program will also contribute to:

(iv) improved capacity of government officials to implement reforms, leading to a more efficient PFEM; and

(v) greater delivery of social services, particularly for the poor.

Box 3. Summary Conditions of the GPRSG II

Pillar Triggers for disbursement A. TRANCHE I CONDITIONS (FY2009/10) achieved by March 2010: External audit

Submission of the 2007/08 external audit report to Parliament is the first disbursement trigger for first tranche release. Evidence: Copy of the Report of the Auditor General on the Accounts of the Government of the Republic of Malawi for the year ended 30th June 2008 and letter from the Auditor General to Parliament that submits this 2007/08 audit report to Parliament Rationale: This condition will promote timeliness and validate the important role of the National Audit Office in providing checks and balances for government operations.

Public procurement

The second disbursement trigger for first tranche release is that 50% (5 out of 10) of the largest spending procurement entities have procurement plans linked to their annual budgets, starting with FY2009/10. Evidence: Letter from the Minister of Finance stating that procurement plans for FY2009/10 have been received from five out of the ten largest procurement entities21. Rationale: Procurement plans are crucial to help boost the efficiency of scarce public resources.

20 Consistent with CSP pillar 2 (development of human capital and institutional capacity). 21 Expected to be Ministry of Education, Ministry of Health, Ministry of Agriculture, Ministry of Irrigation and Water Development and the Roads Authority

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B. TRANCHE II CONDITIONS (FY2010/11) expected to be achieved by July 2010: Core PFM reforms

The first disbursement trigger for second tranche release is the adoption by the Ministry of Finance of a further revised PFEM Priority Action Plan (PAP) with less than 39 priority actions validated by the GFEM that crystallizes the most effective actions culled from the 2009 action plan. Evidence: Revised PAP and letter from the Minister of Finance stating that the revised PAP has been adopted following validation by the GFEM. Rationale: Consistent with the Government’s priorities, adoption of a revised PAP that has been validated by the GFEM is crucial for reinvigorating PFEM reforms. Prioritizing such reforms will also assist in managing the Government’s absorptive capacity for reform. Validation by the GFEM will allow financial support by the CABS partners and a move towards the envisioned joint capacity building program under ADF-XII.

External audit

Submission of the 2008/09 audit report to Parliament is the second disbursement trigger for second tranche release. Evidence: Copy of the Report of the Auditor General on the Accounts of the Government of the Republic of Malawi for the year ended 30th June 2009 and letter from the Auditor General to Parliament that submits this 2008/09 audit report to Parliament. Rationale: This condition will validate the important role of the National Audit Office in providing checks and balances for government operations.

4.2.7. The GPRSG II takes into consideration the 2008 PEFA assessment (Annex X). To ensure that this diagnostic tool continues to monitor progress in financial governance, a PEFA update is scheduled by CABS partners in 2011, which will be reviewed in the GPRSG II PCR. 4.3 Financing needs and arrangements

4.3.1. The Government must maintain a prudent borrowing policy for the MGDS period and beyond, in light of the high dependence on development partners’ aid in covering the US$5.9 billion needed to implement the MGDS during 2006/07-2010/11.22 Pushing forward PFM reforms will provide the Government with important tools to keep fiscal policies on track and enhance value for money during this challenging period. 4.3.2. The GPRSG II provides UA 11.6 million to the Government for the two fiscal years 2009/10-2010/11, to be disbursed in two tranches of 70% (UA 8.12 million) and 30% (UA 3.48million) respectively. The GPRSG II will help reduce the US$29 million (MK 4 billion) financing gap in the revised 2009/10 budget that has emerged as a result of an unanticipated shortfall in revenue. This shortfall is primarily the result of lower than expected receipts from the 30% tax on profits of the tobacco sector. 4.3.3. Malawi continues to be highly dependent on external assistance (Table 3).23 In 2009/10, development partners (other than the Bank) are expected to contribute on a net basis the equivalent of 27% of total expenditure, with 9% in the form of budget support. This implies that two thirds of the country’s capital expenditure budget will be financed by development partners. Total disbursements planned by development partners in 2009/10 are UA 329.0 million, equivalent to MK73.3 billion. Of that, over 30%, or UA 103.59 million, is in the form of budget support by CABS partners (EC UA 67.6 million, DFID UA 19.73 million, Germany UA 9.1 million, and Norway UA 7.3 million).

22 Development partners have pledged US$1.2 billion for 2009-11. 23 The Debt and Aid Division in the Ministry of Finance coordinates donor funding and the Government has in place a Development Assistance Strategy (DAS) aimed at enhancing effectiveness of donor funding and donors’ approaches to conditionality.

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Table 3. Malawi: Fiscal Indicators, 2008/09–2009/10 24 (In billions of Malawi kwacha, unless otherwise indicated)

2008/09 Bgt. 2008/09 Act.

2009/10 Bgt . 2009/10 Est. 2010/11 Est.

Total Revenue and Grants 208.072 210.270 244.193 253.661 292.846 Of which: budget support 19.440 19.875 20.643 24.547 1/ 31.733 2/ Total Expenditure and Net Lending 229.525 247.519 256.769 270.153 312.781 Total Expenditure 229.525 247.519 254.769 269.153 312.781 Current Expenditure 172.306 200.780 188.182 187.581 213.361 Of which: subsidies and transfers 40.891 58.779 46.171 44.227 51.337 Capital Expenditure 57.219 46.740 66.587 77.447 99.421 Of which: foreign financed 44.082 32.167 45.292 48.752 67.189 Overall Balance including grants -21.453 -36.722 -12.576 -16.861 -21.936

Foreign (Net) 22.863 13.338 18.975 21.713 32.914 Of which: program 7.193 7.298 4.650 6.232 2.490 Domestic (Net) -1.410 24.528 -6.399 -9.274 -12.979 Financing gap 4.000 2.000 Memorandum items: GDP(Nominal) 651.301 651.301 760.842 760.842 881.120 Expenditure as a% of GDP 35.2% 38.0% 35.2 38.0 35.5 Overall balance as a% of GDP -3.3% -.5.7 -1.7 -2.2 -2.5

Source: IMF; and Bank staff estimates. 1/ Excluding the Bank’s UA 8.12 million (MK1.83 billion). 2/ Excluding the Bank’s UA 3.48 million (MK0.79 billion). 4.4 Beneficiaries of the program 4.4.1. The GPRSG II will directly benefit the Ministry of Finance and other key public sector institutions (such as the PFEM Secretariat and NAO) in the short term by allowing them to speed up reform processes that promote transparency and accountability in the management of public resources. Since the GPRSG II grant provides foreign currency, it will contribute to macroeconomic stability, benefitting the population at large in the medium and long term. 4.4.2. At a secondary level, the program will benefit the people of Malawi in the long term through the improved resource availability and efficiency for service delivery. The support to the enabling environment for private sector-led economic growth will benefit the whole population. 4.5 Impacts on gender 4.5.1. The GPRSG II impacts gender equity as a cross-cutting issue affecting the six MGDS pillars. The Government views gender equity as a means of reducing poverty, enhancing justice, and promoting development in the country. It is addressing gender inequalities by promoting access to productive resources, development opportunities and overcoming the marginalization of women in social and economic spheres so that they can effectively contribute to the social, economic, and political development of Malawi. Through supporting MGDS, GPRSG II is therefore supporting cross cutting activity in promoting gender equality. Furthermore, the PAF includes gender-specific indicators in several areas: education, the HIV/AIDS, and the gender-based violence indicator as a proxy for human rights. 4.5.2. Education is a key factor for women’s empowerment. The main challenges to overcome are social/cultural factors, limited access to means of production, and limited participation in social and economic activities. The abuse of human rights or gender-based violence is tilted towards women and children and has accelerated other factors in their disfavor, such as spread of HIV and AIDS. In addition, the coordination and implementation of gender related policies is weak in Malawi. When using UN indicators to measure gender inequalities on human development achievement, Malawi's

24 The exchange rate is MK 140/US$.

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gender-related development index (GDI) value of 0.49 in 2007 was 99.4% of its HDI value (0.493); out of the 155 countries with both HDI and GDI values, 133 countries have a better ratio.

4.5.3. Furthermore, increasing access to water has helped free time for women to engage in other productive activities and for girls to attend school. The Bank has also contributed to improving the health of the rural communities by providing sanitation and health facilities. This has empowered women to control population growth and the spreading of HIV/AIDS.

4.5.4. In Malawi, women and girls constitute most of the small-holder producers and the majority of the agricultural labor force.25 As such they are major beneficiaries of the fertilizer subsidy program which the GPRSG II is indirectly supporting through the provision of finance. Regarding trade, they carry out the majority of activities in rural areas and play a vital role in linking rural and urban markets through their informal networks. In urban areas, women and girls predominate in small-scale trade, often in the informal sector. As Malawian women spend a higher proportion of their income than men on food and education, the aid extended will have positive effects on family welfare and food security. 4.6 Environmental impacts 4.6.1. The actions under the three GPRSG II components involve no adverse physical intervention in the environment and induce no adverse environmental or social impact. Beyond categorization, no further Environmental and Social Assessment (ESA) action is required for this category of project. In accordance with the Bank’s ESA Procedures, this program falls under environmental/social Category 3 pertaining to institutional development and capacity building. V. IMPLEMENTATION, MONITORING, AND EVALUATION

5.1 Implementation arrangements 5.1.1. The implementing agency for the GPRSG II is the Ministry of Finance. Other entities are responsible for their own programs and respective performance indicators, as drawn up with development partners in the context of the PAF. All appropriation, allotment, and expenditure will be made through existing country systems, in conformity with the Public Procurement Act, subject to audit by the NAO. 5.1.2. Disbursements under the DBSL instrument will be made in two tranches; the first for 70% of the programme (UA 8.12 million), the second for the remaining 30% (UA 3.48 million). Disbursements will be made following Board approval of the 2 year program and upon fulfilling the separate conditions for each tranche agreed with the Government, as described in section 6.2. This includes, prior to each disbursement—expected in March 2010 for FY2009/10 and in August 2010 for FY2010/11—the validation by the IMF of remaining on track under its ECF with Malawi. 5.1.3. The CABS partners are using a common PAF with agreed indicators, which they use for their disbursement decisions. While annual PAF assessments are made jointly, the actual disbursement decisions are made independently. The EC divided its budget support into a fixed and a variable, performance-based tranche. It bases its disbursement decisions for the fixed tranche on an assessment of adherence to three basic principles;26 the level and timing of their variable tranche disbursements are determined primarily by progress of the PAF indicators. The World Bank bases its disbursement decisions on the above principles and on performance against its prior actions introduced into the PAF. 25 According to Action Aid, women produce some 60% of agricultural products and play a critical role in the production of food crops. 26 The implementation of sound macroeconomic policies, as evidenced by satisfactory progress under an IMF program; a commitment to implement policies aimed at reducing poverty, as evidenced by satisfactory progress in PRS (MGDS) implementation; and continuous improvements in economic and financial governance.It also assesses respect for human rights and good governance.

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All members of the CABS Group, except the World Bank, are using audit specific conditions for disbursement. 5.1.4. The Government’s LDP (Annex 1) details how the budget support anticipated from the Bank will be used, particularly as regards the funds that the Government will channel to the core components of the PFEM PAP. 5.1.5. It is proposed that the budget support proceeds will be disbursed into the Consolidated Malawi Government Account maintained at the Reserve Bank of Malawi (RBM) through a financial institution acceptable to the Bank, for which the beneficiary will communicate, in writing, the specific account number. The Bank will rely on national audit reports of the NAO but reserves the right to require an audit of the Consolidated Malawi Government Account and/or to review the movement of that account by its representatives.

5.2 Monitoring and evaluation arrangements 5.2.1. Country monitoring and evaluation systems will be used. The progress in meeting the PAF indicators will be monitored semi-annually by the CABS Group. During these meetings, the strategies will be adapted to recent developments. MWFO will represent the Bank in these meetings and will contribute to a dynamic implementation of the GPRSG II. In this way, the Bank will seek to ensure that the funds provided under the GPRSG II are being utilized according to the spirit of the Government’s intentions. The Bank, through MWFO, will participate in the GFEM, where the Government intends to present periodic reports regarding the PAF and PFEM PAP progress. 5.2.2. Within six months after the second and last GPRSG II disbursement, the Bank will prepare a joint PCR with the Government comprising the overall evaluation and lessons learnt. The PCR will pay particular attention to the timeliness of the government’s actions based on the relevant commitments for each tranche disbursement. Emphasis will be given to the performance indicators (and their outturn) the CABS established following the start of the GPRSG II. The PCR will also review the alignment of the government’s actions with the goals set out in the MGDS as well as programs and projects by development partners. Special consideration will be given to the link with the Bank’s complementary TA project, by incorporating the lessons learnt from that program. Last but not least, the PCR will evaluate the achievements under the results-based logical framework, given the fundamental importance of this tool in designing the overarching goals and targetted outputs for the Bank and Malawi. VI. LEGAL DOCUMENTATION AND AUTHORITY

6.1 Legal documentation

6.1.1. Grant Agreement between the Republic of Malawi and the African Development Fund.

6.2 Conditions associated with Bank’s intervention

6.2.1. Condition precedent to Entry into Force of the Grant Agreement: The entry into force of the Grant Agreement shall be subject to its signature by the recipient and the Fund. 6.2.2. Conditions precedent to Disbursement of the First Tranche (UA 8.12 million): Aside from the entry into force of the Grant Agreement, the disbursement will also be subject to the commitment by the Government to maintain on track its ECF with the IMF. To that end, the Government will (i) transmit to the Bank a letter from the Minister of Finance indicating such commitment and (ii) authorize the Bank to ask the IMF for a statement, including in the form of an Assessment Letter or through a PIN, if available, that the negotiations for the ECF have been concluded successfully. In addition, the following conditions must be observed:

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(i) Submit to the Bank a duly completed and signed disbursement request in accordance with the Disbursement Letter indicating inter alia the account information for the Consolidated Malawi Government Account of the Recipient maintained at the Reserve Bank of Malawi into which the proceeds of the Grant shall be deposited by the Bank [Duly completed and signed disbursement request in accordance with the Disbursement Letter and Handbook]

(ii) Provide evidence that the 2007/08 external annual audit report has been submitted to Parliament. [Copy of the Report of the Auditor General on the Accounts of the Government of the Republic of Malawi for the year ended 30th June 2008 and letter from the Auditor General to Parliament that submits this 2007/08 audit report to Parliament].

(iii) Provide evidence that 50% (5 out of 10) of the largest spending procurement entities have

procurement plans linked to their annual budget as of FY2009/10. [Letter from the Minister of Finance stating that procurement plans for FY2009/10 have been received from five out of the ten largest procurement entities. Expected to be Ministry of Education, Ministry of Health, Ministry of Agriculture, Ministry of Irrigation and Water Development and the Roads Authority]

6.2.3. Conditions precedent to Disbursement of the Second Tranche (UA 3.48 million): Second tranche disbursement will be subject to maintaining on track the IMF’s ECF. To that end, the Government authorizes the Bank to ask the IMF for a statement, including in the form of an Assessment Letter, or through a PIN, if available, that the ECF is on track.27 The following conditions must also be observed: (i) Provide evidence that a further revised PFEM Priority Action Plan (PAP) with less than 39

priority actions, validated by the GFEM, has been adopted by the Ministry of Finance [Revised PAP and letter from the Minister of Finance stating that the revised PAP has been adopted following validation by the GFEM].

(ii) Provide evidence that the 2008/09 external annual audit report has been submitted to Parliament

[Copy of the Report of the Auditor General on the Accounts of the Government of the Republic of Malawi for the year ended 30th June 2009 and letter from the Auditor General to Parliament that submits this 2008/09 audit report to Parliament].

6.3 Compliance with Bank policies 6.3.1. This program complies with the: (i) 2004 Guidelines for DBSL operations; (ii) 2008 GAP for 2008-12; (iii) 2008 Appraisal Report Formatting Rules and Annotated Format; (iv) Malawi’s MGDS for 2009-12; and (v) the Government’s PFEM PAP for 2009/10-2010/11. VII. RISK MANAGEMENT

7.1. Malawi is vulnerable to external economic and financial shocks in the context of low international reserves. This includes weak macroeconomic policies as well as terms of trade shocks in the context of the international economic crisis. To mitigate these risks, the Government is committed to successfully implement its three-year ECF with the IMF that, in the short term, aims at using fiscal and monetary policy to optimize foreign exchange usage, inflationary pressures, and fiscal deficits compatible with macroeconomic stability. Furthermore, MWFO will continue its ongoing close dialogue with the Government as well as the IMF and CABS partners.

27 In order to safeguard the Bank’s funds, given that Malawi has to reestablish a prudent macroeconomic stance, it is deemed reasonable to request a second IMF validation of the ECF being on track, even if it is only a few months after the proposed first disbursement.

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7.2. Climatic fragility and falling demand for tobacco, Malawi’s main export, pose prime external risks that could destabilize macroeconomic recovery. To mitigate these risks, the Government will continue to strengthen its food security program, notably by a prudent usage of its fertilizer subsidy program, and stand ready to adjust its macroeconomic policies. 7.3. Limited technical capacity constitutes an important internal risk. This risk not only applies to government commitment to its PFEM reforms (particularly improving quality and timeliness of accounts and audits), but also to the level and quality of capacity in the Debt and Aid Division of the Ministry of Finance to manage budget support resources. Slippages in these areas could lead to the non-attainment by the government of the agreed disbursement triggers. The risk for non-attainment of the triggers could be due to (i) the reform agenda slipping or adjustments to segments of it, or (ii) the government’s shortcomings to share information on the PAF, producing delays in monitoring. This risk would be mitigated by the government’s capacity building program—included in the PFEM PAP—that is supported by the Bank and other development partners, complemented by a separate capacity building project currently under preparation by the Bank. Further mitigation is obtained through a careful design of conditions precedent to the second disbursement under the GPRSG II; revised PAF indicators (as of March 2010) regarding PFEM and strengthened oversight through MWFO, as the Bank is now chairing the CABS Group. To optimize mitigation, close policy dialogue from MWFO would be required. 7.4. A further risk is that oversight, scrutiny, and accountability of public spending is being weakened owing to the government majority in Parliament. This risk would be mitigated through support to the NAO to improve local level audit coverage, and encouraging the Ministry of Finance to engage in dialogue with Parliamentarians and civil society. The Bank would also undertake special efforts through CABS dialogue to encourage further openness in CABS monitoring by involving civil society and Parliamentarians in reviews. 7.5. Finally, there is the risk of the government not attaining disbursement triggers because of matters beyond its control, including exogenous shocks. To mitigate this risk, the Bank will systematically monitor risks and mainstream mitigating actions together with other development partners. Nonetheless, in the event of failure by the government to adhere to its reforms, the Bank could opt to suspend the operation if no other solutions are found. VIII. RECOMMENDATION Management recommends that the Board of Directors approve that an African Development Fund grant not exceeding UA 11.6 million be made available to the Government of Malawi for the purposes, and subject to the conditions, stipulated in this report.

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I. LETTER OF DEVELOPMENT POLICY

Telephone: 01 789 355 Telefax: 01 789 173 Telex: 44407 Email:finance@finance.gov.mw

MINISTER OF FINANCE

MINISTRY OF FINANCE P.O. BOX 30049, CAPITAL CITY, LILONGWE 3.

Ref: DAD/5/1/7/12 21st December, 2009 Dr. Donald Kaberuka President The African Development Bank Tunis Dear Dr. Kaberuka,

MALAWI: LETTER OF DEVELOPMENT POLICY

On behalf of the Government of Malawi, I write to request for the second Poverty Reduction Support Grant (PRSG-II) of UA 11.6 million equivalent from the African Development Fund ADF) in support of improved governance reform agenda whose framework has been provided for in the Malawi Growth and Development Strategy (MGDS), Malawi's second poverty reduction strategy paper. The proposed PRSG-II will serve three purposes: (i) it will help the Government bridge a financing gap that exists in the implementation of the MGDS through the provision of funds to improve public financial management and accountability and transparency required for the MGDS to meet its medium-term poverty reduction goals; and (ii) it will be a source of foreign exchange which Malawi needs to fill in an existing balance of payments financing gap (iii) it will also provide resources to Government to meet its counterpart fund obligations and support the effectiveness of the Bank group funded investment projects.

The program goal is to contribute to economic growth and poverty reduction through improved economic governance. Its operational policy objective is to improve public financial management accountability and transparency by supporting reforms of the budget, audit and public procurement systems. It has the following expected outcomes:

(i) increased credibility of the budget process, (ii) enhanced external audit and scrutiny in the use of public resources, and (iii) improved management of the public procurement system.

The proposed PRSG-II will support governance reforms in the following areas: (i) Budgeting

process, (ii) External audit and scrutiny in the use of public resources, and (iii) Management of the public procurement system. In the budgeting process, the reforms will focus on improving linkages

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between MGDS and the budget. In external audit and scrutiny in the use of public resources the focus will be on ensuring the Audit reports are submitted to Parliament within the specified period under the law and that recommendations made by Auditor General are followed. In Management of the public procurement system, emphasis will be put on strengthening the procurement systems in all ministries, departments and assemblies. More details on the proposed reforms to be supported under PRSG- II are set out in Part C of this letter. A. Recent Macroeconomic Performance

Economic performance in Malawi has improved significantly since 2004 after several years of weak policy implementation. This improvement is a result of the change in the Government’s agricultural policy, favourable weather conditions for the agricultural sector, strict Government expenditure controls, buoyant domestic revenues and the attainment of HIPC Completion Point in August 2006. Macroeconomic performance continued to be favourable in 2008. The economy grew by 9.7 percent, in 2008 real terms higher than the 7.9 percent recorded in the previous year and also far above the 6.0 percent target as stipulated in the Malawi Development and Growth Strategy. In addition, the rate of annual average inflation was recorded at 8.7 % sustaining single digit levels that were attained in 2007. Inflation has trended downward during 2009, reflecting moderation in food and fuel prices and restrained credit growth. It is estimated that by the close of 2009 inflation will be 8.3 percent. Low inflation levels have necessitated other policy changes, where interest rate that reached a high of 35 percent in 2003 was reduced to 15 percent and has been maintained at that level to this date. Domestic debt that had accumulated to 25 percent of Gross Domestic Product (GDP) at the beginning of 2004 was reduced to 7.7 percent of GDP at the close of 2008/09 fiscal year.

The overall fiscal deficit including grants increased from 2.6 percent of GDP in 2007 to 6.7 percent in 2008 and it is expected to reduce to about 1.7 percent of GDP in 2009. In the external sector, the situation remained weak. The current account deficit in relation to GDP worsened from -3.0 percent in 2007 to -10.3 percent in 2008. The current account gross official usable reserves increased to US$256.5 million, which is equivalent to 1.5 months of imports in 2008 compared to 1.2 months of import in 2007. The increase reflected receipts of more donor inflows.

The forecast for 2009 indicates that the economy will grow by 7.7 percent in real terms while inflation is projected at 8.3 percent. The overall fiscal deficit is projected at 1.7 percent of GDP while the current account excluding grants is expected to be -6.3 percent of GDP. Gross usable official reserves are estimated to increase further to US$274.5 million, approximately 1.5 months of imports on account of more donor inflows. The slowdown in the real GDP growth rate relative to 2008 is mainly attributed to the deceleration in activity by the agriculture sector mainly due to reduced proceeds from Tobacco which fetched lower prices this year than in the previous year. However, some sectors like construction, distribution and manufacturing are expected to register high growth rates. The decrease in production for some agriculture food crops together with impacts of rising international oil prices will somehow exert pressure on domestic prices, hence the slight increase in the 2009 inflation rate compared to 2008.

Real GDP growth is expected to average 6.5 percent during the 2009-2029 periods. Agriculture will continue to be the largest contribution of GDP. Accelerated growth will be attributed to the full operation of the Kayelekera Uranium mine .Increased production in the tourism and manufacturing sectors will also contribute to this growth. It is projected that growth in the agricultural sector will emanate from significant investment in irrigation. Subsequently, this will entail an increase in the agro processing and manufacturing activities resulting into job creation and export growth. The

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mining industry is one of the key areas of growth in the Malawi Growth and Development Strategy (MGDS). Inflation, as measured by the GDP deflator, is expected to average 5.2 percent between 2009 and 2029. Tight fiscal and monetary policies aimed at reducing aggregate demand and controlling broad money supply (M2) will keep inflation in check. Towards the end of 2009 the exchange rate regime is a managed float within a specified

Growth of exports of goods and non-factor services in US dollar terms is expected to average 7.8 percent in the period 2009-2029. This will mainly come from an increase in the production of Uranium at the Kayelekera mine. The production of cotton, sugar, tea and other agro processing activities are also expected to contribute to growth based on the new Government growth strategy. On the other hand growth of imports goods and non-factor services in US dollar terms is expected to average 5.6 in the period 2009- 2029. The proportion of net foreign direct investment (FDI) inflows in GDP is expected to average 4.0 percent over the 2009-2029 period.

Government budget revenue (excluding grants) as a percentage of GDP is expected to average 19.9 percent and 16.3 percent during the 2009-2014 and 2015-2029 periods, respectively. The share of Government expenditure in GDP is projected to average 34 percent between 2009 and 2014, and 26 percent from 2015 to 2029.

Despite this improvement, Government’s macroeconomic management still faces some challenges. These include the need for continued expenditure controls, intermittent power supply, erratic weather conditions and high public domestic debt. The Malawi Government remains committed to sound macro-economic management continue with the current programme of structural and public sector reforms.

B. The Malawi Growth and Development Strategy

In November 2006, the Government of Malawi finalized its second poverty reduction strategy, the MGDS, which covers the period 2006 to 2011, prepared using participatory processes.' The strategy's overall objective is to reduce poverty through economic growth and is organized around five thematic areas as follows:

(i) sustainable economic growth;

(ii) social protection and disaster risk management; (iii) social development; (iv) infrastructure development; and (v) good governance. From these thematic areas, the strategy has identified key focus

areas that are seen as central to achieving the strategy's overall objective of reducing poverty through economic growth.

These focus areas are agriculture and food security; infrastructure development; energy

generation and supply; irrigation and water development; human development, integrated rural development; and prevention and management of nutrition disorders, HIV and AIDS.

The MGDS emphasizes the need for Malawi to register sustained private sector and export-led growth in order to make a noticeable dent on poverty. The long-term vision of the MGDS is to transform Malawi from a predominantly importing and consuming country into a predominantly producing and exporting country. It seeks to achieve growth rates of at least 6 percent a year. The

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strategy concentrates on agriculture as the driver of growth. It focuses on increasing agricultural productivity and integrating smallholder farmers into commercial activities. In the long term, the Government has also identified four sectors with potential for high growth: tourism, mining, manufacturing, and agro-processing.

The MGDS also acknowledges the role of social development in health, education, economic empowerment and social protection among others. It recognizes that a healthy and educated population is necessary if Malawi is to achieve sustainable economic growth. The strategy further recognizes the importance of increasing the assets of the poor and vulnerable so they can contribute to and benefit from economic growth.

The strategy has identified long-term goals, medium-term outcomes, and constraints to achieving these outcomes. It then outlines the strategies and key actions that will contribute towards achieving the defined outcomes. Implementation of the strategies and actions will entail undertaking capital investments, maintenance of assets, and implementation of policy and institutional reforms. However, in this endeavour, Malawi is faced with the challenge of mobilizing resources to implement the MGDS.

Although the various strategies and actions have been prioritized, there exists a financing gap for the Government to implement even the top priorities, and hence this request for financing. C. Specific Reforms to be implemented

In line with the MGDS, and in consultation with the Government, African Development Bank has outlined its proposed medium-term support to Malawi. In this context, I would like to highlight the various reforms that the Government of Malawi intends to undertake not just for purposes of the proposed PRSG- II to which this financing request directly relates, but also under subsequent PRSGs so as to present a holistic picture of the Government's reform program. Public Sector and Finance Management Reforms

In order to consolidate the gains achieved in restoring macroeconomic stability, the Government plans to undertake several policy reforms in the area of budget process, payroll management, external auditing, debt management, and Public Finance and Economic Management. (i). Budget processes

With regard to the budget process, the reforms seek to set a foundation for improved linkages between the budget and the MGDS. The Government has continued to put in place reforms in order to meet the internationally recognized classification of the Government Financial Statistics (GFS). The adoption of the new classification brings our budget closer into line with international standards making it easier to compare budgets across countries. The Government has also changed its budget structure so as to more accurately reflect and monitor its strategic objectives as outlined in the Malawi Growth and Development Strategy. The revised budget structure makes it easier for users of the budget documents to clearly understand what various sectors are delivering on. To reflect these changes, the Government has introduced a new Chart of Accounts. Going forward the Government will build on these successful reforms to further improve the budgeting process. First, the government will be ensuring that the 2010/11 budget implements the new Chart of Accounts , the revised functional classification and revised economic classification. Secondly, the government will

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continue to pursue reforms to improve its output targeting and performance management regime, including liaising with the IMF on possible steps towards full programme budgeting in the medium term. Thirdly, there are on-going projects to review and potentially amend the legal basis of the budget through a new budget law and revised Appropriation Bill. (ii). External audit and scrutiny in the use of public resources

An evaluation of how well the budget has been executed is a critical element of sound public financial management. In this connection, the Malawi Public Audit Act provides for internal auditing, external auditing and Parliamentary scrutiny of the audit reports. Although some progress has been made in the area of internal and external auditing, there are still some challenges in terms quality, coverage and timeliness of the audits. Firstly, due to limited human capacity, not all ministries and departments are audited in a year. Secondly, there are weak follow up on audit recommendations made by the Auditor General and the Public Accounts Committee of Parliament.

In order to deal with these problems, the government has put in place several measures. Firstly, the capacity of National Audit Office has been strengthened by the recruitment of new graduate trainees.. This means that more ministries will now be audited than in the past. . This percentage is expected to increase further in the next few years. Secondly, the roll out of IFMIS to Local Assemblies will go a long way to ensuring the timeliness of the final accounts. . In the medium term, the aim is to be able to submit the reports within 6 months as required by law. Finally, the government plans to improve follow up of recommendations in the audit reports. In this regard, the government will start producing reports indicating actions taken by ministries and departments on audit related recommendations by the Public Accounts Committee. In addition the Government is supporting the National Audit Office to implement its strategic plan which among other things is emphasising on having competent and motivated staff in place, development of infrastructure, procurement of equipment and vehicles to facilitate timely audits. (iii). Management of public procurement systems

Although there has been progress in the area of public procurement management, it is being felt that there is still room to improve. The Government has now established procurement units in all ministries and departments,. However, the major challenge has been the shortage of qualified personnel on the labour market. In this regard, Government has embarked on initiatives that will strengthen procurement capacity in ministries and departments. The Government in collaboration with various public training institutions like the Malawi Institute of Management, the University of Malawi and the Staff Development Institute has mounted various long-term training courses to train various cadres of procurement specialists. Some of the graduates from these institutions are already being absorbed by the Government. Going forward the Government will continue to strengthen the capacity of all public procurement entities. In terms of procurement audit, Government plans to increase the number of ministries and departments covered each year and ensure that the ODPP is well staffed to take on this challenge. (iv). Payroll management

The Government would also like to continue with reforms it has been undertaking with regard to the public sector wage system. The focus is now on strengthening the management of the payroll in order to reduce wastage of public finances through ghost workers. Since 2006 the Government has been using a new system for managing personnel and payroll records, the Human Resource

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Management Information System (HRMIS) which replaced the then existing system, the Personnel, Payroll, Pensions and Advances Integration (PPPAI).. Implementation of the new system has resulted in significant financial savings. Huge expenses were being incurred under the previous PPPAI system, including licensing fees as well as system maintenance costs. The system has reduced payroll volatility. Ministries can budget for Personal Emoluments through the HRMIS. The problem of duplication of employee records and ghost workers has been minimized. There is increased control through the use of audit reports and the centralized control of engagement and transfer of employees. In 2008 the Government carried out an independent review of the HRMIS in order to establish its robustness. Going forward the Government would like to implement some of the recommendations of the review including the interface of the HRMIS with the IFMIS. The Government will continue to build the capacity of the DHRM&D Technical so that they are able to support the system on a full time basis focused exclusively on the system. They will also need to be capacitated to take over the system fully. The Government realizes that the HRMIS might ultimately fail if the officers in DHRM&D fail to gain the capacity to manage and maintain the system with no assistance from outside.

(v). Debt and aid management

Malawi’s external debt indicators have improved significantly after receiving debt relief under the Heavily Indebted Poor Countries (HIPC) and the Multilateral Debt Relief Initiative (MDRI) in 2006. According to a recent Debt Sustainability Analysis (DSA) conducted by Government, the ratio of the present value of external debt to exports is projected at 60% in 2009, which is below the sustainability threshold of 150% for medium policy performers under the World Bank CPIA. All the other debt indicators are projected to remain below the respective thresholds over the period 2009-2029 under the baseline macroeconomic scenario. However, stress tests show that Malawi’s external debt is subject to moderate risks of debt distress, particularly arising from lower GDP and export growth. In addition, the overall fiscal sustainability of the public debt is still fragile mainly due to the high domestic debt burden. Domestic debt is unsustainable due to its short term nature which requires frequent roll-over and will require significant resources to redeem it.

Dealing with the debt problem will require more than exercising fiscal discipline: systems of debt management would also need to be improved. In order to improve the management of public debt, the Government is planning to implement a multi-year debt management reform program. First, it has conducted a comprehensive and systematic debt management performance assessment with technical assistance from the World Bank in September 2009. This exercise has provided a systematic assessment of strengths and weaknesses of Malawi's debt management system, and identified possible areas for improvement. Secondly, the Government plans to finalize the debt management policy that is currently in draft form and have it approved by cabinet. The policy will outline clear guidelines for contracting of both domestic as well as external debt.

The Government is continuously strengthening the staffing levels and capacity in the Debt and Aid Division (DAD) of the Ministry of Finance (MOF), and will establish mechanisms to improve the coordination between the Reserve Bank of Malawi and the Ministry of Finance. The expectation is that the MOF will among other things work with the Reserve Bank of Malawi in determining and forecasting liquidity needs of the government when deciding how much to borrow on the domestic market. The MOF, through the DAD, will also analyze the costs and risks associated with different financing options and therefore advise the Government on least-cost financing options. Finally, the DAD will be preparing debt management reports for submission to Parliament.

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(vi). Public Financial and Economic Management Reforms

Finally, the Government realizes the importance of having robust Public Finance and Economic Management (PFEM) systems in place. In this regard the Government has set a specialized unit which will champion and coordinate various PFEM reforms within the public sector. The capacity of the PFEM unit is being enhanced through training and appointment of additional staff. In addition the Government has set up a Public Financial and Economic Management Technical Team to provide support to the PFEM unit. To date the Government has come up with a prioritized action plan covering seven major areas as follows: (i) planning, (ii) resourcing the national development strategies, (iii) budgeting, (iv) budget execution, (v) accounting and financial systems, (vi) reporting, (vii) PFEM administration and programmes. The Government is confident that implementation of the action plan will improve and bring our systems in line with international best practices. I am confident that the outlined policies, programs and reforms will create a conducive environment for the effective and efficient utilization of any assistance the African Development Bank may provide, towards enabling the government to implement its poverty reduction goals set in the MGDS.

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II. THE GOVERNMENT’S PFEM PAP A. Operation Policy Matri

PFEM PRIORITY ACTION PLAN 2009

Code Results required Key Tasks Verifiable Output Prime Responsibility

Target Date PEFA Indicator

Donor involved

A Planning

A1 Systems and models for national, sector and district planning:

MGDS Sector groups set up Sector groups set up and working

PD Dec-09 12 DFID, UNDP, GTZ

Undertake consultative meetings for New Development Strategy (NDS)

Reports from Consultative meetings

PD Oct-09 14

Develop database for macroeconomic material

Database developed PD/EAD Dec-09 14 DFID

A2 Public Investment Planning Include briefs for each project in PSIP

PSIP has project briefs DD Apr-10 21 JICA, GTZ

Harmonise PSIP and planning with budgeting systems

Systems harmonised DD Mar-10 6 JICA, DFID, GTZ

B Resourcing the National Development Strategies:

B1 Effective mobilisation of tax revenue (also reduce transaction costs for compliance)

Develop tax payment through banking system

Tax payment through banking system implemented

MRA Dec-09 13

Introduce self assessment for appropriate tax payers

Self assessment of taxes introduced

MRA Dec-09 13

B2 Effective mobilisation of non tax revenue

Introduce a budget line for paying incentives under Appropriation - I n - Aid

Incentives paid to institutions that beat their revenue targets

RD Jun-10 16

B3 Customs Collection Improvements

Improve effectiveness of customs tax collection system through destination inspections

Post-clearance audit and risk management programs developed

MRA Dec-09 14

B4 Effective mobilisation of donor and credit resources

Ensure all donor funding through Government captured in Budget

Donor funding in budget DAD Dec-09 3,6,D2

28

Ensure contractual agreements for counterpart funding are included in Part 2 of budget

Part 2 to include contractual obligations for counterpart funding

DAD Dec-09 6

Input donor data into IFMIS through terminals in DAD

IFMIS to include data from DAD on donor data

DAD Sep-09 14

B5 Debt Management Formulate debt management strategy

Approved Debt management strategy in place

DAD Jun-10 17

C Budgeting

Budget Structuring and Classification

Ensure expenditure is aligned to MGDS activities and priorities through budget allocation mechanism

Improvement in allocation according to MGDS

BD FY09/10 5 GTZ, DFID, NOR

Proposals and funding to Development budgets aligned to MGDS with standardised definitions

New procedure implemented for relating funding to MGDS

BD FY09/10 5

Revise programme and economic classification structure in budget

Budget reports able to align with GFS standards

BD FY09/10 5

Procure Active Planner for incorporating budgeting into IFMIS

Active Planner in Use BD Dec-09 5

Restructure IFMIS to adopt new COA to align budget with GFS

Budgets prepared using new CoA

BD Dec-09 5 AFRITAC

C2 MTEF Develop programme for capacity building in Budget Division for MTEF

Programme developed and initiated

BD Oct-09 12 DFID, GTZ

C3 Budget Calendar Review Budget preparation process to follow more closely the budget calendar

Monitored report on budget preparation

BD Nov-09 8,11

C4 Budget Legislation and Documentation

Ensure timely dissemination of Economic and Fiscal Policy Statement to members of parliament and other key stakeholders

Economic and Fiscal Policy statement to be disseminated by 1st April every year

EAD Jun-09 8,10,11

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D Budget Execution

D1 Procurement Implement a training programme -based on TNA and Training Plan

30 public officers trained at Bachelors degree level, 50 officers trained at Certificate/Diploma level and 10 officers trained at Masters degree level

ODPP Jun-11 19 WB, UNDP

Further develop market analysis for costing/pricing database

The Market price index for Goods and Works is produced quarterly and used by majority of PEs

ODPP Jun-10 19 WB, UNDP

Provide for procurement planning in 5 major MDAs

Procurement plans produced linked to their budgets

ODPP Jul-09 19 WB, UNDP

D2 Budget Monitoring Develop programme for improving overall Public Expenditure Reviews

Programme developed and initiated

BD Nov-09 24,25

Follow up on actions taken in ministries where salaries for ghost workers that were identified by the 2008 personnel audit were not brought on charge

Report on actions taken by ministries produced

DHRMD Dec-09 18 WB

Conduct specific sectors expenditure review starting with Fertilizer subsidy

Expenditure review report on fertilizer subsidy

EAD Mar-10 24

D4 Parastatals Complete systematic review of parastatals financial management systems

Reports from PERMU PERMU Dec-09 9

Develop and implement improved cash management systems

Revised system in place AGD Jul-09 5

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E Accounting and Financial Systems

E1 Cash Management Implement an automated system of account reconciliations of the IFMIS cash book and IFMIS bank statement.

Monthly bank reconciliation statements compiled

AGD Jul-09 16,22 AFRITAC

Develop automated funding from budget

System in place BD Dec-09 7,16

Develop and implement improved cash management systems

Revised system in place AGD Jul-09 17

E2 IFMIS and related Developments

Incorporate debt repayment through IFMIS

Debt repayment using IFMIS AGD Sep-09 17

Complete IFMIS coverage to ensure timely production of expenditure reports.

Timely expenditure reports available

AGD Jul-11 4,16,17

Review business processes, procedures and policies that negatively impact on payroll management and establishment control

Business Processes Re-engineering review reports

DHRMD Dec-10 22 WB

Roll out to Districts Customise IFMIS to suit Local Government situation

Local Government IFMIS in place.

NLGFC Dec-09 17

Installation of IFMIS in 5 pilot District Assemblies

IFMIS operational in 5 pilot District Assemblies.

NLGFC Jul-09 18 GTZ

E5 Internal Auditing (Systems) Strengthen Capacity for Internal Auditors through appropriate training programme

internal auditors with appropriate skills and training reports

CIAU Jul-11 21 WB

Procure Computer audit tools for auditing automated systems

Audit Management Software and Risk Management Software

CIAU Dec-09 21 WB

E6 Internal Auditing (Institutional)

Facilitate the review of the Government Financial Management Internal Control Systems.

Updated Government Financial Management Internal Control Systems.

CIAU Sep-09 20

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F Reporting

F1 Financial Reports Institute system for providing annual reports using financial statements

Annual Reports provided AGD Dec-10 24,25

Connect, map and customise fiscal data used for EAD to IFMIS in line with GFS accounts for producing fiscal table

Fiscal tables produced timely AGD Jul-09 25

F2 M&E Data and Indicators Harmonise framework for data capturing and databases for analysis and dissemination at district and national levels

All data capturing frameworks for district, sectoral data sources harmonised and linked to LA database through to MEPD and NSO

M&E Aug-09 6 UNDP

Indicator verification exercise for appropriateness especially for performance assessment.

All outcome and Impact indicators verified

M&E Jul-09 17

F3 MGDS Review process Undertake revision of MGDS review kit

MGDS Review kit revised M&E Jul-09 6 UNDP, GTZ

Establish timely MGDS review for future planning and budgeting, starting with 2008/09 to begin in July 2009

MGDS Review for 2008/09 completed and disseminated

M&E Jul-09 6 DFID, UNDP, GTZ

F4 Performance Reporting Review system for harmonising reporting on planning budgeting and implementation

Review report completed OPC PRMEU Dec-09 6,8,25

F5 Audits Procure servers for network, print, antivirus and domain

Network, print, antivirus and domain servers in place

NAO Dec-09 26 WB

Build capacity to enable Audit staff audit automated systems

Numbers given through training reports

NAO Jun-10 26 NOR

Undertake backlog of Local Assembly audits

Backlog completed NAO Jul-09 28 DFID

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G PFEM Administration and Programming

Fully establish PFEM Unit and programme capacity building

PFEM Unit established with capacity building programme

PFEM Oct-09 EC, GTZ,DFID

Undertake Programming for different components of the PFEM AP in conjunction with beneficiary agencies

PFEM Programme Developed PFEM Dec-09 DFID, GTZ

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B. Elements of the Public Financial and Economic Management Action Plan

1. The PFEM PAP is the successor program to the PFEM Action Plan (AP), which covered 2006-08. While the activities under that AP were substantially completed, the Government realized that it was at an early stage in PFM reform, and concerted action to improve PFM in Malawi was needed. 2. The PAP therefore carries forward the achievements of the earlier AP, but in itself is only an intermediary program towards an integrated PFEM Reform Program that will be developed following the completion of the PAP at the end of FY2010/11. The PAP will be administered and monitored by the PFEM Secretariat in the Economic Affairs Department of the Ministry of Finance, under the leadership of its Director. 3. The PAP was developed, prepared, and adopted in mid-2009. Its elements were identified through a consultative process, with each of the stakeholders (government entities) providing inputs. This initial collection (the "full" second Action Plan) was then narrowed down to the present PAP during the second half of 2009, and target dates were attached. The prioritization phase was completed in November 2009, with activities grouped according to the public financial cycle, identifying seven stages from planning through auditing.

Box 1. Activities Completed

A2.3 Include briefs for each project in PSIP This is now being done on a continuous basis so database is being built up including project briefs

B1.1 Develop tax payment through banking system The law was passed. Large taxpayers are now paying taxes through banks

B1.4 Introduce self assessment for appropriate tax payers Law was passed in July and the scheme already commenced.

C1.1 Ensure expenditure is aligned to MGDS activities and priorities through budget allocation mechanism All activities are coded according to the MGDS and so MGDS alignment can be monitored both across government and within Ministry.

C1.3 Revise programme and economic classification structure in budget Classification has been revised and Softech are currently working on New Chart of Accounts.

D1.2 Implement a training programme - based on TNA and Training Plan for the ODPP This training programme has been implemented and is now well underway and on schedule

D1.5 Provide for procurement planning in 5 major MDAs This was successfully done D3.5 Develop programme for Capacity building on Parastatal financial re-engineering This has been

completed and has been submitted for approval E2.1 Incorporate debt repayment through IFMIS Debt repayments are now inputted into IFMIS by hand. It is

planned that this would be automated when the software is available later in 2010. E3.2 Customise IFMIS to suit Local Government situation The system has been procured, customized, and is

running on Serenic Navigator F3.1 Undertake revision of MGDS review kit A revision has been undertaken and used during this year’s

review. Further Progress Reports

4. However, even during this prioritization phase, activities were being implemented, with 11 of them are already completed (Box 1). Nonetheless, even of those activities reported as completed, the Government is defining further complementary actions to pursue additional strengthening of PFEM. This strategy will make the PFEM PAP a “live” program that will continuously adapt to the evolving situation regarding PFEM in Malawi. 5. The PFEM Secretariat will constantly monitor progress, combined in regular progress reports to the Government and donors. The next progress report is scheduled for February 2010.

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III. RELATIONS WITH THE IMF

Malawi—Assessment Letter for the European Union, the African Development Bank, and the UK Department for International Development

January 17, 2010

The Malawian authorities have recently been holding discussions with IMF staff on a new macroeconomic program that would build on the improvements in policy management seen over recent years, address important weaknesses in the economy, and set the stage for sustained growth and poverty reduction in the years ahead. Key goals in the new program would be to sustain economic growth and alleviate poverty by restoring external balance and strengthening reserves, supported by a sound fiscal position and monetary restraint and structural measures to reduce fiscal risks and strengthen financial markets. On the basis of understandings reached ad referendum with the authorities, including measures that need to be completed by late-January 2010, IMF Executive Board approval of the new program would be sought in February at the same time as the completion of the Article IV consultation. Recent economic developments and short-term outlook

Malawi has weathered the global economic storm relatively well. Growth in 2008 is estimated to have reached almost 10 percent, driven by a record tobacco harvest and rapid expansion in maize and the service sectors. While moderating somewhat in 2009, growth is estimated to have remained robust at about 7.6 percent, reflecting strong tobacco and maize crops, the start of uranium production, and expanding wholesale and retail trade. Production of maize over recent years has benefited from favorable rainfall and the government’s subsidized distribution of fertilizer to small farmers. Some further slowing in growth to 6 percent is projected for 2010, with downside risks to the outlook arising from foreign exchange shortages and the possibility of adverse weather. Inflation has trended down during 2009, reflecting moderation in food and fuel prices and restrained credit growth, and is expected to remain in the 8 to 10 percent range over the coming year.

Although strengthened policy implementation contributed to improved macroeconomic stability, expenditure overruns in FY2008/09 (ending in June 2009) led to a widening of the fiscal deficit. In particular, the government missed its target for domestic borrowing by a substantial margin, owing mainly to overspending on imported fertilizer and goods and services. Preliminary data indicate net domestic borrowing of 3.8 percent of GDP, compared with an initial program target under the Exogenous Shocks Facility (ESF) of a 0.1 percent of GDP repayment of domestic debt.

The balance of payments remains weak. Tobacco prices, in the now-completed harvest season, were lower than in 2008 but remained above the average for the past five years. Strong tobacco revenues buoyed domestic incomes and exports, but rapid import growth (especially in 2008), a slowing of foreign investment, and clearance of import payment backlogs have led to continued weakness in the overall balance of payments. Official reserves are low at about 1 month of prospective imports, well below the three months of import cover or more that is essential to reduce Malawi’s vulnerability to weather, terms of trade, aid, and other shocks. In addition to low reserves, foreign exchange queues in commercial banks and gaps between the official rate and bureau and informal market exchange rates suggest that there is a serious imbalance in the foreign exchange market.

Economic policy response

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Discussions on a program that could be supported by a new arrangement with Malawi have focused on a macroeconomic policy framework that would help address Malawi’s balance of payments difficulties.28 The key elements in the policy strategy are promoting growth and poverty reduction through reform of the macroeconomic framework to strengthen fiscal and external sustainability. The program is premised upon maintenance of a sound fiscal position, monetary restraint to sustain low inflation, and liberalization of the foreign exchange market to produce a properly valued and unified exchange rate and eliminate multiple currency practices and foreign exchange queues.

The authorities recognize that a strong 2009/10 fiscal policy stance is essential, and have approved a budget that is appropriately prudent while depending heavily upon donor inflows that are critical to closing financing gaps. Under the program, the government would target a net repayment of domestic borrowing of around 1½ percent of GDP in 2009/10, almost ½ percent of GDP more than was envisioned in the legislated budget owing mainly to higher-than-expected donor aid. Any shortfalls in anticipated donor funding or other revenues would be offset through further fiscal measures, while safeguarding pro-poor spending. The government has also agreed that costs associated with the new presidential jet, and subsidies to ADMARC and other parastatals will be absorbed within budget ceilings. Over the medium term, fiscal policy would continue to be anchored by a net repayment of domestic borrowing and a modest overall deficit.

The government recognizes that, over the medium term, it is essential to continue to strengthen public services in education and health care, and widen the social safety net to assure that all households are lifted out of poverty. Given that continued improvement in revenue collection is also needed to reduce dependence on donor money, the government has set as a key fiscal objective a gradual increase in the tax revenue to GDP ratio. The Reserve Bank of Malawi (RBM) intends to maintain monetary policy restraint by mopping up excess liquidity.

The authorities are committed to liberalizing the exchange regime and supporting the development of the private foreign exchange market, which would lead to a better balance between the supply of and demand for foreign exchange. The modest depreciation in the currency and the reduction of the surrender requirement to the RBM on nontobacco exports over recent weeks are important first steps in this reform, and the authorities are committed to further liberalization of the foreign exchange market and adjustment of the exchange rate to build reserves and reduce foreign exchange market queues.

In addition to the exchange regime reforms noted above, the authorities intend to implement a wide range of other structural measures to underpin macroeconomic objectives, improve the business and investment climate, and sustain growth and development. To ensure that scarce public resources are effectively deployed, the authorities will push forward with their public financial management action plan, including measures to strengthen the monitoring and reporting on budget performance (where the Fund is currently providing technical assistance), and to strengthen management and targeting of the fertilizer subsidy program.

The government is committed to taking measures to address the financial weaknesses of the parastatals. Such reforms are needed to prevent the budget from being exposed to additional fiscal 28 The arrangement would be made under the Extended Credit Facility (ECF), the successor to the PRGF, which has recently been established as the Fund’s standard lending instrument for low income countries with a protracted balance of payments need. The access norm for Malawi under an ECF arrangement would be 75 percent of quota (around $77 million).

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risks, and to set the stage for much-needed service improvements. Key steps include increasing utility tariffs at least to operating cost recovery levels, and restructuring parastatals, without putting at risk key social spending priorities. In summary, the government’s program aims to build on the improvements in economic management that Malawi has experienced over the last five years, address remaining weaknesses, and support sustained growth and poverty reduction. On the basis of understandings reached and commitments made by the authorities, including those that need to be fulfilled by late-January 2010, IMF Executive Board approval of a new program with Malawi would be sought in February 2010, at the same time as the conclusion of the Article IV consultation. The Debt Sustainability Analysis shows that Malawi remains at moderate risk of debt distress but has adequate capacity to repay the Fund.

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Malawi: Press Release Following the IMF Board Meeting on February 19, 2010

IMF Executive Board Approves Three-Year US$79.4 Million Extended Credit Facility Arrangement for Malawi

Press Release No. 10/52 February 19, 2010

The Executive Board of the International Monetary Fund (IMF) today approved a three-year, SDR 52.05 million (about US$79.4 million) arrangement for Malawi under the Extended Credit Facility (ECF) 1 to support the authorities’ economic program for the period 2010-2012. A one-year Exogenous Shocks Facility (ESF) arrangement also for SDR 52.05 million (see Press Release) expired on December 2, 2009. The ESF arrangement was preceded by an arrangement under the Poverty Reduction and Growth Facility (PRGF) that was completed on August 4, 2008. Malawi reached the completion point for the enhanced Heavily Indebted Poor Countries (HIPC) Initiative on August 31, 2006. The ECF arrangement approved today represents 75 percent of Malawi’s SDR 69.4 million quota in the Fund, of which the country became a member in July 1965. Following the Executive Board’s discussion of the request by Malawi, Mr Takatoshi Kato, Deputy Managing Director and Acting Chair, made the following statement: “Malawi’s economic program, supported by the Extended Credit Facility, aims to support Malawi’s Growth and Development Strategy by restoring internal and external equilibrium and addressing key structural constraints. The authorities have adopted a prudent fiscal stance in the 2009/10 budget by reigning in discretionary spending on goods and services while safeguarding priority social spending, and shoring up revenues. The budgetary impact of deficits in key parastatals will be limited by allowing for greater cost recovery and initiating a medium-term plan for restructuring Air Malawi’s debts. Progress is also made toward a more transparent accounting of the fertilizer subsidy program and enhanced fiscal accounting and reporting. “The Malawian authorities have tightened monetary policy and intend to control the growth of monetary aggregates by ensuring fiscal discipline and prudent credit growth. The development of financial markets over the medium term would allow greater reliance on interest rate adjustments to help control inflation. “The program is designed to build reserves and achieve a properly valued exchange rate to support growth and stability. The adoption of a flexible exchange rate and the steps taken to liberalize the foreign exchange market are welcome. The authorities have committed to undertake further policy adjustments, including of the exchange rate, if evidence emerges of continued excess demand for foreign exchange. Continued exchange rate flexibility will help to avoid an overly contractionary fiscal and monetary stance. “Malawi’s structural reform agenda aims at strengthening the Public Financial and Economic Management unit in the Ministry of Finance, and enhancing the social safety net program through improved targeting of households and a possible expansion of the donor-financed pilot transfer program. Tax administration will be further strengthened and the tax base broadened to allow the value-added tax rate to be reduced to regional norms. “The authorities intend to continue their efforts to create an enabling environment for private investment and growth by: developing a comprehensive strategy for reforming the utility companies and expanding access to utility services; strengthening the regulatory environment; and adopting market-friendly agricultural sector policies.”

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Recent Economic Developments Malawi’s agricultural-based economy has weathered the global economic storm well. Record agricultural harvests in recent years led to economic growth of 9.8 percent in 2008 and an estimated 7.6 percent in 2009. Inflation has remained moderate. The financial sector was only modestly affected by the global turmoil and remains well-capitalized and profitable. A loosening of fiscal and monetary policies during the run-up to elections in May 2009 led to high government domestic borrowing in fiscal year 2008/09 (ending in June 2009), and rapid money and credit growth. This easing contributed to low international reserves. The end-June 2009 ESF program targets for net domestic repayment of the central government, and net domestic assets and net international reserves of the RBM were missed by wide margins. The fiscal year 2009/10 budget reflects a prudent fiscal stance, targeting a repayment of net domestic borrowing in line with the medium-term objectives to maintain a low deficit and create room for private sector credit. A weak balance of payments threatens exchange rate and price stability and medium-term growth. The de facto pegging of the Malawi kwacha to the U.S. dollar from 2006 to late 2009 helped to moderate inflation. But persistent inflation differentials with trade partners and the peg led to some appreciation of Malawi’s real effective exchange rate. Rapid growth of domestic incomes and exchange rate appreciation have led to an imbalance between the growth of imports and exports and widened external current account and balance of payments deficits. The authorities have recently adopted a number of measures to address the external imbalance, including initial steps at market liberalization, gradual depreciation of the exchange rate, and strengthened budgetary spending controls. However, continued policy adjustment and external support are critical. Program Summary The authorities’ ECF-supported economic program aims to: • Restore external equilibrium by liberalizing the foreign exchange regime for current account transactions to allow a market-clearing exchange rate to emerge and to eliminate measures inconsistent with the IMF’s Articles of Agreement by end-2011; and by attaining international reserve coverage of a minimum of three months of imports to buffer against external shocks by end-2012. • Maintain internal equilibrium by pursuing prudent fiscal and monetary policies, as reflected in the fiscal year 2009/10 budget and through restrained monetary aggregate growth, to contain aggregate demand and inflation pressures and shift demand toward domestic output. • Sustain poverty reduction efforts by creating room in the budget for more social and pro-poor spending and improving the structure of the social safety net to protect poor households from shocks and policy adjustments, including exchange rate depreciation. • Build competitiveness by improving public financial management, tax administration, and the efficiency and solvency of public utilities, and by enhancing the business climate by expanding the capacity and quality of infrastructure, promoting investor access to finance, and reforming legal and regulatory frameworks governing financial supervision and the operation of other key economic activities. The program also encompasses structural measures to underpin macroeconomic objectives and sustain high growth. The authorities have provided, as a prior action of the ECF-supported program, a transparent accounting of the execution of the fertilizer subsidy program in the fiscal year 2008/09 budget and of the budgeted figures in fiscal year 2009/10. The authorities committed to undertake further structural measures in three areas during the first year of the program: (i) improving public financial management by making fully operational the PFEM unit; (ii) developing a time-bound plan to restart and liberalize the interbank foreign exchange market; and (iii) continuing with implementation of financial sector reforms, and improving monetary and exchange

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rate policy transparency. Over the final two years of the program, they intend to continue improving transparency and solvency of the public utilities.

Malawi: Selected Economic Indicators, 2007–111

2007 2008 2009 2010 2011

Act. Act. Prel. Proj. Proj.

National accounts and prices (percent change, unless otherwise indicated)

GDP at constant market prices 8.6 9.8 7.6 6.0 6.3

Consumer prices (end of period) 7.5 9.9 7.7 9.2 8.5

Consumer prices (annual average) 7.9 8.7 8.5 10.1 8.3

Central government (percent of GDP)

• Revenue and grants 31.6 31.2 30.1 35.2 32.2

• Tax and non tax revenue 18.7 19.9 21.4 22.6 22.8

• Grants 12.9 11.3 8.8 12.7 9.4

• Expenditure and net lending 36.0 36.2 36.1 36.0 33.9

• Overall balance (excluding grants) -17.2 -16.5 -14.6 -13.5 -11.2

• Overall balance -4.3 -5.0 -5.8 -0.8 -1.8

Money and credit (change in percent of broad money at the beginning of the period, unless otherwise indicated)

Money and quasi money 36.9 33.1 19.4 16.7 13.9

Net foreign assets 2 41.9 -10.1 -18.4 13.6 10.4

Credit to the rest of the economy (percent change)

32.8 45.5 27.9 28.4 19.4

External sector (US$ millions, unless otherwise indicated)

Exports, f.o.b. 731.7 969.2 1,004.8 1,119.9 1,229.7

Imports, c.i.f. -1,182.3 -1,722.8 -1,809.6 -1,739.8 -1,843.0

Usable gross official reserves 2 217.1 239.0 114.0 276.9 407.3

(months of imports) 1.2 1.3 0.6 1.4 2.1

(percent of reserve money) 93.2 35.0 81.3 126.6

Current account (percent of GDP) -1.5 -6.4 -8.6 -1.8 -2.2

Current account, excl. official transfers (percent of GDP)

-15.5 -21.8 -21.9 -18.7 -15.9

Nominal effective exchange rate (percent change)

-8.8 20.2 ... ... ...

Real effective exchange rate (percent change) -7.8 24.9 ... ... ...

Overall balance (percent of GDP) 0.5 -1.0 -1.8 4.4 3.6

Terms of trade (percent change) -1.7 5.9 13.7 -3.1 -2.9

Debt stock and service (percent of GDP, unless otherwise indicated)

External debt (public sector) 14.4 16.0 19.1 21.8 23.3

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NPV of debt (percent of avg. exports) 0.0 42.1 64.3 62.1 65.4

NPV of debt (percent of avg. exports) 41.9 51.5 58.7 66.4 72.3

External debt service (percent of exports) 3.2 6.7 1.3 1.8 2.2

Net domestic debt (central government) 11.8 19.0 20.3 14.0 11.0

Treasury bill rate (period average)3 13.9 10.9 11.9 ... ...

Sources: Reserve Bank of Malawi, Malawi Ministry of Finance, and IMF staff estimates and projections.1 The ECF scenario assumes an initial depreciation and that the real exchange rate is kept constant during the program period. Correcting the underlying exchange rate misalignment is a key element of the macroeconomic framework.2 Programmed usable reserves in 2009 excludes the SDR allocation, while the projection includes the SDR allocation.3 Average t-bill rate. Data for 2009 are shown as of November 30th.

1 The Extended Credit Facility (ECF) has replaced the Poverty Reduction and Growth Facility (PRGF) as the Fund’s main tool for medium-term financial support to low-income countries by providing a higher level of access to financing, more concessional terms, enhanced flexibility in program design features, and more focused streamlined conditionality. Financing under the ECF currently carries a zero interest rate, with a grace period of 5½ years, and a final maturity of 10 years. The Fund reviews the level of interest rates for all concessional facilities every two years.

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RECENT EVOLUTION IN KEY MACRO-ECONOMIC AND FINANCIAL INDICATORS

2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14Prel. EBS/08/128 Proj. Proj. Proj. Proj. Proj. Proj.

National accounts and pricesGDP at constant market prices 9.2 7.6 7.7 5.2 4.4 4.1 3.8 1.8Nominal GDP (billions of kwacha) 550.8 638.0 645.0 735.6 831.3 939.3 1,060.7 1,195.0Nominal GDP per capita (U.S. dollars) 290.6 329.0 332.6 371.8 411.9 458.5 507.5 560.5GDP deflator 8.2 8.3 8.8 8.5 8.2 8.5 8.8 8.9Consumer prices end of period) 8.5 8.5 8.5 5.9 8.2 12.3 8.7 9.0Investment and savings (percent of GDP) 7.7 8.4 9.3 9.6 6.8 6.7 10.4 8.8

Investment and savings (percent of GDP)National savings 20.1 18.6 14.0 15.3 18.3 17.4 16.7 16.2

Government 8.9 5.0 0.2 4.2 6.5 5.2 5.7 6.3Private 11.3 13.6 13.8 11.0 11.8 12.2 10.9 9.9

Gross investment 25.1 24.5 20.2 20.7 23.7 21.9 20.8 19.9Government 11.6 8.7 5.8 7.5 10.9 9.6 10.0 10.7Private 13.5 15.9 14.4 13.2 12.9 12.4 10.7 9.2

Saving-investment balance -4.9 -6.0 -6.2 -5.4 -5.5 -4.5 -4.1 -3.7Government -2.7 -3.7 -5.6 -3.2 -4.4 -4.3 -4.3 -4.5Private -2.3 -2.3 -0.6 -2.2 -1.1 -0.2 0.2 0.6

Central government (percent of GDP)Revenue and grants 29.9 32.5 31.4 29.3 29.9 28.3 27.8 27.3

Grants 19.0 19.4 20.8 20.4 20.4 20.4 20.4 20.4Grants 10.8 13.2 10.6 9.0 9.6 8.0 7.4 7.0

Expenditure and net lending 32.6 36.2 37.0 32.8 34.3 32.6 31.0 29.5Overall balance (excluding grants) -13.5 -16.9 -16.3 -12.5 -13.9 -12.3 -10.6 -9.2Overall balance -2.7 -3.7 -5.7 -3.5 -4.4 -4.3 -3.2 -2.2Foreign financing 1.4 3.8 1.7 2.9 3.4 2.4 2.3 1.8Domestic financing 1.3 -0.1 3.8 0.6 1.0 1.9 0.9 0.4

Money and credit (percent change)Money and quasi money 41.3 9.5 20.0 11.6 13.1 13.0 12.9 12.7Net foreign assets -7.8 -18.9 -84.2 -225.1 208.1 -13.8 -7.2 13.0Net domestic assets 65.7 17.3 48.7 18.5 19.2 10.8 11.7 12.7

Credit to the government 282.7 3.2 40.3 1.9 11.3 2.5 5.9 0.9Credit to the rest of the economy 46.8 26.5 37.3 32.2 19.4 13.1 16.3 17.1

External sector (millions of U.S. dollars) Exports, f.o.b. 782.8 1,030.6 885.0 953.3 1,069.8 1,090.9 1,135.1 1,168.8

percent change 28.3 ... 13.1 7.7 12.2 2.0 4.1 3.0Imports, c.i.f. -1,298.9 -1,447.5 -1,388.3 -1,369.3 -1,578.9 -1,678.6 -1,763.3 -1,816.0

percent change 13.9 6.9 -1.4 15.3 6.3 5.0 3.0Usable gross official reserves 202.6 256.5 157.6 136.5 52.4 64.7 60.0 45.0

(months of imports) 1.6 1.5 1.0 0.8 0.3 0.4 0.5 0.2Current account -4.9 -6.0 -6.2 -5.4 -5.5 -4.5 -4.1 -3.7Current account,excl. official transfers (percent of GDP) -16.9 -17.5 -15.2 -14.2 -14.5 -12.7 -11.4 -10.1Nominal effective exchange rate -2.2 ... ... ... ... ... ... ...Real effective exchange rate -3.7 ... ... ... ... ... ... ...

Domestic debt (percent of GDP)Net domestic debt (central government) 16.9 14.6 18.0 16.4 15.6 15.7 14.8 15.1Of which: excluding recapitalization of RBM 11.5 9.9 13.4 12.4 12.0 12.5 12.0 12.6Net consolidated domestic debt (central bank and central government) 11.4 7.8 9.6 6.7 4.0 4.1 3.0 3.0Domestic interest payment 2.1 2.6 2.7 2.7 2.4 2.2 2.2 1.7Treasury bill rate (period average) 1/ 10.1 ... 13.1 ... ... ... ... ...

Sources: Malawian authorities; and IMF staff estimates and projections.1/ T-bill rate shown as of July 24, 2009.

Table 1. Malawi: Selected Economic Indicators on a Fiscal Year Basis, 2006/07 – 2013/14

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Table 2. Malawi: Central Government Operations 2008/09–2013/14 (Millions of kwacha)

2008/09 2009/10 2010/11 2011/12 2012/13 2013/14

Prel. Est. Budget Baseline Proj. Budget Proj. Proj. Proj. Proj.

Total revenue and grants 210,269.6 208,071.6 243,201.1 257,661.4 244,193.0 292,845.7 318,031.0 367,492.1 418,082.2

Revenue 134,290.6 118,166.6 156,575.0 168,773.5 163,100.0 199,325.9 232,077.1 269,679.4 310,367.4

Tax revenue 119,021.7 107,300.0 135,429.0 143,400.3 139,900.0 169,941.7 198,307.0 231,019.8 266,376.7

Taxes on income and profits

50,548.7 44,550.0 60,503.9 63,328.6 … 74,895.0 88,573.7 103,898.3 120,225.6

Taxes on goods and services

57,845.1 49,550.0 63,238.3 67,559.8 … 80,556.8 93,080.6 108,057.7 124,458.5

Taxes on international trade 13,570.6 12,800.0 13,774.7 14,616.9 … 16,927.6 19,454.2 22,271.0 25,342.1

Other -2,942.6 400.0 -2,087.8 -2,105.0 … -2,437.7 -2,801.6 -3,207.2 -3,649.5

Nontax revenue 15,268.9 10,866.6 21,146.0 25,373.1 23,200.0 29,384.2 33,770.1 38,659.6 43,990.7

Grants 75,978.9 89,905.0 86,626.0 88,887.9 81,093.0 93,519.7 85,953.9 97,812.6 107,714.8

Budget support 19,875.2 19,440.0 28,033.0 28,547.1 20,643.0 33,733.0 22,680.8 30,006.1 34,186.7

Project 1 24,347.1 31,318.0 31,558.6 31,770.2 29,499.0 34,038.8 38,655.0 41,994.6 46,538.8

Dedicated grants 31,756.6 39,147.0 27,034.4 28,570.6 30,951.0 25,747.9 24,618.1 25,812.0 26,989.3

Total expenditure and net lending

247,519.4 229,525.0 258,261.2 270,153.5 256,768.6 312,781.2 333,693.9 385,407.0 437,589.0

Current expenditure 200,779.5 172,306.0 186,411.2 187,581.3 188,181.6 213,360.7 228,228.4 263,833.5 297,500.3

Wages and salaries2 37,595.0 37,256.0 43,539.7 43,539.7 43,539.0 51,422.7 59,597.9 69,727.1 81,842.3

Of which: health SWAp3 1,424.8 1,748.0 7,900.0 7,900.0 2,100.0 9,148.9 10,514.4 12,536.8 15,265.6

Interest payments 17,862.7 16,169.0 21,137.7 20,366.4 19,794.0 20,705.1 18,673.1 14,689.4 9,779.6

Domestic 17,322.7 15,368.0 20,214.8 19,750.8 18,622.0 19,109.1 16,818.2 12,510.5 7,234.0

Foreign 540.0 669.1 922.9 615.6 1,172.0 1,596.0 1,854.9 2,178.9 2,545.6

Goods and services 86,136.7 77,703.0 77,788.7 79,448.4 78,678.1 89,896.0 95,103.1 114,503.2 131,682.6

Generic goods and services 43,877.1 37,564.0 32,358.0 33,098.0 42,800.0 37,180.3 40,979.8 49,913.2 57,561.1

Census 1,681.1 1,531.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Roads 6,256.9 0.0 6,342.8 6,376.8 7,664.9 7,384.9 8,487.2 9,716.0 11,055.8

Health SWAp3 12,546.7 11,967.0 20,184.9 20,184.9 9,744.0 23,375.8 26,864.9 32,754.6 38,271.4

National / local elections 7,683.5 5,000.0 300.0 300.0 2,250.0 0.0 0.0 0.0 0.0

Statutory expenditures 2,503.4 834.0 4,097.0 4,096.6 1,396.3 4,744.2 4,702.3 7,383.2 9,401.3

National AIDS Commission (NAC)

9,557.5 18,271.0 12,506.0 13,392.1 12,823.0 17,210.8 14,069.0 14,736.1 15,393.0

Maize purchases 2,030.5 2,536.0 2,000.0 2,000.0 2,000.0 0.0 0.0 0.0 0.0

Subsidies and other current transfers

58,778.5 40,891.0 43,945.2 44,226.8 46,170.5 51,336.9 54,854.2 64,913.8 74,195.9

Pension and gratuities 5,106.2 6,451.0 6,048.0 6,947.7 7,400.0 7,581.1 8,183.7 11,777.3 13,529.4

Transfer to NRA and MRA 3,646.4 6,100.0 4,239.7 4,478.8 4,309.5 5,098.3 5,949.2 6,930.6 7,991.3

Transfers to public entities 12,202.5 8,910.0 11,898.0 12,497.8 11,897.0 15,473.5 16,033.1 18,354.5 20,885.5

Fertilizer and seed subsidy 37,823.4 19,430.0 21,022.0 21,860.9 22,564.0 23,184.0 24,688.3 27,851.5 31,789.7

Development expenditure 46,739.9 57,219.0 69,850.0 77,447.4 66,587.0 99,420.5 105,465.5 121,573.5 140,088.6

Part I (foreign financed) 32,167.1 44,082.0 48,555.0 48,752.0 45,292.0 67,188.8 68,422.9 74,167.6 81,145.6

Part II (domestically financed)

14,572.8 13,137.0 21,295.0 28,695.4 21,295.0 32,231.7 37,042.6 47,405.9 58,943.1

Net lending 0.0 0.0 2,000.0 1,000.0 2,000.0 0.0 0.0 0.0 0.0

Overall balance (including grants)

-36,721.9 -21,453.4 -15,060.2 -12,860.9 -12,575.6 -19,935.5 -15,662.9 -17,914.9 -19,506.8

Total financing (net) 36,721.9 21,453.4 15,060.2 12,860.9 12,575.6 19,935.5 15,662.9 17,914.9 19,506.8

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Foreign financing (net) 13,337.6 22,863.0 20,042.9 21,712.7 18,975.0 32,914.4 28,782.5 33,187.8 33,753.8

Borrowing 14,550.4 24,503.0 21,498.4 23,212.9 20,443.0 35,639.9 32,363.4 37,552.1 40,234.8

Program 7,298.0 7,193.0 5,624.2 6,231.6 4,650.0 2,489.9 2,595.4 5,379.2 5,628.1

Project 7,252.4 13,165.0 15,874.1 16,981.3 15,793.0 33,150.0 29,767.9 32,173.0 34,606.7

Other concessional 0.0 4,145.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Amortization -1,212.8 -1,640.0 -1,455.5 -1,500.2 -1,468.0 -2,725.5 -3,580.9 -4,364.3 -6,481.0

Domestic financing (net) 24,528.1 -1,410.0 -4,982.7 -9,273.6 -6,399.4 -12,978.9 -13,119.6 -15,272.9 -14,247.1

Domestic borrowing (net) 24,075.5 -1,410.0 -6,982.7 -11,729.6 -6,399.4 -12,978.9 -13,119.6 -15,272.9 -14,247.1

Other financing 452.6 0.0 2,000.0 2,456.0 0.0 0.0 0.0 0.0 0.0

Asset related financing4 452.6 0.0 2,000.0 2,456.0 0.0 0.0 0.0 0.0 0.0

Discrepancy 0.0 0.4 0.0 -53.0 … … … … …

Memorandum items:

Nominal GDP 37865.74 … 753931.4 760842.4 … 881119.8 1159254 1319111 1447395

Net domestic debt5 117295.2 … 123090.3 104430.1 … 91451.17 103434 77284.96 58622.47

Sources: Malawi Ministry of Finance and IMF staff estimates.

1 Includes estimate for project loans not channeled through the budget.

2 Wages and salaries grow faster than nominal GDP to reflect salary increases for educational and health workers.

3 Health SWAp expenditures in 2009/10 are higher than budgeted owing to a reclassification of spending from generic goods and services,

which have been reduced correspondingly.

4 Programmed fertilizer expenditures in FY2008/09 are higher than budgeted, reflecting an increase in fertilzer procurement from 170,000 tons to 243,000 tons.

4 Kwacha 2 billion in FY2009/10 represents a transfer from the Petroleum Stabilization Fund.

5 Excluding recapitalization of the RBM.

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2008 2009 2010 2011 2012 2013 2014Prel. Est. Proj. Proj. Proj. Proj. Proj.

Current account balance (including grants) -271.2 -426.9 -100.3 -115.3 -94.5 -164.1 -196.9Current account balance excluding grants -933.6 -1091.9 -983.0 -895.2 -890.3 -973.4 -1025.1

Merchandise trade balance -753.6 -804.8 -624.5 -611.0 -569.9 -621.7 -685.3Exports 969.2 1004.8 1119.9 1229.7 1340.3 1407.4 1473.1

Of which: Tobacco 586.5 569.8 512.8 528.2 544.0 560.3 577.2Uranium … 24.0 182.0 203.0 200.0 198.0 176.0

Imports -1722.8 -1809.6 -1744.4 -1840.7 -1910.2 -2029.1 -2158.4Of which : Petroleum -212.9 -184.1 -231.3 -255.3 -277.1 -298.9 -323.6

Services balance -311.2 -427.5 -568.3 -510.5 -557.4 -595.4 -591.8Interest public sector (net) -5.5 -3.7 -7.8 -9.1 -10.2 -11.7 -13.1

Receipts 0.4 0.4 0.0 1.2 1.2 1.2 1.2Payments -5.9 -4.1 -7.8 -10.3 -11.4 -12.9 -14.3

Other factor payments (net) -29.3 -74.9 -194.4 -134.9 -184.9 -211.4 -196.0Nonfactor (net) -288.1 -348.9 -366.1 -366.5 -362.3 -372.3 -382.7

Receipts 82.9 73.2 75.0 87.8 101.1 105.0 108.9Payments -371.0 -422.1 -441.1 -454.3 -463.4 -477.3 -491.6

Unrequited transfers (net) 793.5 805.4 1092.6 1006.2 1032.8 1053.0 1080.1Private (net) 131.9 141.2 210.6 227.0 237.7 244.4 252.7

Receipts 144.0 154.3 223.8 240.3 251.2 258.1 266.6Payments -12.1 -13.2 -13.2 -13.4 -13.5 -13.7 -13.9

Official (net) 661.6 664.3 882.0 779.2 795.1 808.6 827.4Receipts 662.3 665.0 882.8 779.9 795.9 809.4 828.1

Budget support 86.3 102.9 255.0 171.1 159.6 164.4 169.4Project related 1 576.1 562.2 627.8 608.8 636.2 644.9 658.8

Payments -0.8 -0.8 -0.7 -0.7 -0.7 -0.8 -0.8

Capital account balance (incl. errors and omissions) 227.6 338.0 325.7 331.0 369.6 384.5 381.3Medium- and long-term flows 138.1 189.9 185.7 175.8 182.9 187.2 172.8

Disbursements 190.2 112.0 197.4 187.5 205.6 213.2 215.8Budget support 22.5 34.0 40.0 15.0 30.0 30.0 30.0Project support 167.7 56.0 157.4 172.5 175.6 183.2 185.8Other medium-term loans 0.0 22.0 0.0 0.0 0.0 0.0 0.0

Other investment assets -45.0 0.0 0.0 0.0 0.0 0.0 0.0Amortization -7.1 -8.5 -11.7 -11.7 -22.7 -25.9 -43.0SDR allocation … 86.5 … … … … …

Foreign direct investment and other inflows 215.0 110.0 140.0 150.2 176.7 187.3 198.5Short-term capital and errors and omissions -125.5 38.1 0.0 5.0 10.0 10.0 10.0

Overall balance -43.6 -88.9 225.4 215.7 275.1 220.4 184.4

Financing (- increase in reserves) 43.6 88.9 -225.4 -215.7 -275.1 -220.4 -184.4Central bank 68.6 124.4 -221.9 -211.8 -270.7 -215.6 -179.0

Gross reserves (- increase) -21.9 125.0 -162.3 -136.8 -208.9 -132.0 -95.0Liabilities 2 90.5 -0.6 -59.6 -75.0 -61.9 -83.6 -84.0

Of which: IMF (net) 93.9 0.0 21.5 20.8 21.2 4.4 -26.6Purchases/drawings 93.9 0.0 21.5 21.6 25.2 12.9 0.0Repurchases/repayments 0.0 0.0 0.0 -0.8 -4.0 -8.5 -26.6

Commercial banks -25.0 -35.5 -3.5 -3.9 -4.4 -4.8 -5.3

Memorandum items: Gross official reserves 3

Including crown agents 239.0 116.9 … … … … … Excluding crown agents … 114.0 276.3 409.2 618.0 750.0 845.0Months of imports 4 1.3 0.6 1.4 2.1 3.0 3.4 3.7

Current account balance (percent of GDP)Excluding official transfers -21.9 -22.0 -18.9 -15.8 -14.4 -14.4 -14.0Including official transfers -6.3 -8.6 -1.9 -2.0 -1.5 -2.4 -2.7

Value of exports (percent change) 32.5 3.7 11.4 9.8 9.0 5.0 4.7Export price index (2001=100) 177.2 152.0 133.3 133.0 135.4 137.1 141.5Export volume (percent change) -3.0 17.8 23.8 10.0 7.0 3.7 1.4

Value of imports (percent change) 45.7 5.0 -3.6 5.5 3.8 6.2 6.4Import price index (2001=100) 195.7 157.3 171.7 177.4 180.3 182.5 185.0Import volume (percent change) 14.3 27.9 -9.9 2.1 2.1 4.9 5.0Nominal GDP(millions of US dollars) 4272.2 5648.4 6193.4 6748.6 7337.4 7901.2 8408.7

Sources: Malawian authorities; and IMF staff estimates and projections.1 Includes estimate for project loans not channeled through the budget.2 Excluding SDR allocation.3 Figures for 2009 onward take account of Malawi's SDR allocation (SDR 55.4 million).4 Months of prospective imports of goods and nonfactor services.

Table 3. Malawi: Balance of Payments, 2008–14(US$ millions, unless otherwise indicated)

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IV. CABS GROUP UNDERTAKINGS

A. CABS PERFORMANCE ASSESSMENT FRAMEWORK (PAF) April 2009

The fundamental principles of Malawi’s budget support cooperation are based on commitment to poverty reduction and respect for human rights, democratic principles, sound macro-economic management and good governance, including sound public financial management, accountability and effective anti-corruption programs. The PAF provides a jointly agreed set of indicators for measuring progress against those commitments, in line with the Malawi Growth & Development Strategy 2006-2011. Each Development Partner’s bilateral agreement will outline how the PAF will be used. The PAF 2009 forms the basis for the March 2010 review. The PAF is a public document. CABS can discuss collaboratively the wider context of a number of the above areas without seeking benchmarks or indicators. Assessment of mutual accountability and the balance of aid instruments in the context of the Paris Declaration are covered under the Development Assistance Strategy.

No

Indicator

Baseline

Target for 2010 review

Indicative Target

2011 review

Trigger or variable tranche?

1 Macroeconomic program PRGF 4th and 5th reviews completed in December 2007 and an Exogenous Shock Facility (ESF) approved in December 2008

ESF 2nd Review completed and new IMF program agreed

New program on track as of latest IMF review

2

Credibility of the budget: In-year expenditure reallocation between primary expenditure votes

In-year expenditure reallocation between votes in 2006/07 was 9% of originally approved budget: In 2007/08 the deviation was 7.8%.

For 2008/09 in-year expenditure reallocation between votes amounts to less than 10% of total approved budget

For 2009/10 in-year expenditure reallocation between votes amounts to less than 10% of total approved budget

EU variable tranche

3

Expenditure on essential public services: budgeted ORT

Approved budgeted ORT expenditure for nominated institutions and programs was 15.9% in 2007/08 and 17.97% in 2008/09

For 2009/10 budgeted ORT will be no lower as a proportion of primary expenditure than their 2008/09 level

Nominated spending areas will receive at least a real terms increase in their ORT expenditure in 2010/11 compared to 2009/10

EU variable tranche

4 Improved budget process IMF 2007 Review of Budget Process. A revised structure of the budget classification and associated Chart of Accounts (CoA) were developed in 2008

Budget structure to have programs and sub-programs which are GFS 2001 Compliant by March 2010

New budget classification and chart of accounts introduced in the 2010/11 FY

PRSC trigger - proposed

5 Improved payroll management An Action Plan based on recommendations from the HRMIS Review and Payroll Audit was developed by December 2008

(i) Produce at least 5 monthly audit trail records by December 2009 (ii) Produce report on actions taken in ministries where ghost workers were identified (iii) Develop and implement electronic payroll data transfer between HRMIS and IFMIS

(i) Current functional modules fully activated and four more HRMIS modules operational (ii) Review personnel events reporting procedures to streamline them

PRSC trigger – proposed AfDB EU variable tranche

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No

Indicator

Baseline

Target for 2010 review

Indicative Target

2011 review

Trigger or variable tranche?

6

Expenditure reporting: timeliness and quality

2006/07 Annual Appropriation Accounts submitted within the statutory deadline (31 October) Draft IFMIS generated Annual Consolidated Accounts for 2007/08 was submitted to NAO within 31 October 2008. Final Accounts only submitted in December 2008

IFMIS roll out to 5 Pilot Local Assemblies (LAs) completed and another 12 District Assemblies computerised and online with IFMIS

The remaining 12 Local Assemblies computerised and online with IFMIS

AfDB EU variable tranche

7 External audit: timeliness and follow-up

By December 2007 the last audit submitted to Parliament was for 2003/04. Follow up to the audit had not been completed. By December 2008 the Auditor General’s Report for FY 2004/05 and 2005/06 were submitted to Parliament, and Treasury Minute on PAC reports before 2003/04 was submitted

By December 2009: 2007/08 and 2008/09 audit reports submitted to Parliament

By December 2010: 2009/10 audit reports submitted to Parliament

Norway AfDB EU variable tranche PRSC trigger

8 Resource Mobilisation: borrowing and domestic revenue

2007: (i) Debt and Aid Management Policy in draft form (ii) IMF tax administration review available By December 2008: The Debt Coordination Committee was Constituted

(i) By December 2009: Debt Management Strategy should be in place (ii) Introduction of Electronic Banking for all large tax payers

Improved tax administration through introduction of on-line filling of tax returns by all large taxpayers

9 Public procurement: improved capacity

(i) Procurement Audit Report for 2005/06 and 2006/07 was finalised in 2008 and recommendations for improving procurement system developed (ii) As of 2008, only Ministry of Health had Procurement Plans linked to their Annual Budget (iii) Drug leakage study identifying weaknesses in supply chain was produced in 2007. By 2008 a monitoring and evaluation tool for tracking the drug supply chain was developed

By December 2009: Implementation of the following two (2) identified recommendations from 2008 procurement audit:- (i) 50% ( 5 out of 10) of largest spending Procuring Entities (PEs) have Procurement Plans linked to their Annual Budget[1]; (ii) 80% (8 out of 10) of largest spending Procuring Entities able to submit improved

By December 2010: (i) 50% (5 out of 10) of the remaining largest spending PEs have procurement plans linked to their annual budget (ii) All (100%) of ten largest spending Procuring Entities able to submit improved procurement specifications and evaluation reports

EU variable tranche AfDB

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No

Indicator

Baseline

Target for 2010 review

Indicative Target

2011 review

Trigger or variable tranche?

(iv) Progress in drug availability 2007/08 was as follows by June 2008: SP/LA: 100%; ORS: 96%; TT: 100%; Oxytocin: 99%; Diazepam:87%; Cotrim.: 100% ; HIV Test kits: 100%; TB drugs: 100%

procurement specifications and evaluation reports[2] By December 2009: (i) Maintain drug level availability above that of June 2008 (ii) Increase drug availability by at least 2% on all drugs less than 100%

By December 2010: (i) Maintain drug level availability above that of June 2009 (ii) Increase drug availability by at least 2% on all drugs less than 100%

10 Predictability Not all CABS donors provide estimates of budget support disbursements in the medium term in accordance with Joint Framework. (i) DFID, Norway, and the World Bank disbursed as planned. AfDB did not disburse its projected budget support for 2007/08 FY because Parliament could not ratify the loan agreement. (ii) DFID, EU, Norway and the World Bank provided indicative amounts for 2009/10 FY and 2010/11 FY, not AfDB. (iii) Action plan to accelerate use of country systems has not yet been developed

(i)CABS budget support disbursements in 2008/09 and first two quarters of 2009/10 in line with estimates provided to GOM. (ii) CABS provide indicative information on budget support disbursements for 2008/09 and 2009/10. (iii) Develop Action Plan to accelerate use of country systems

(i)CABS budget support disbursements in 2009/10 and first two quarters of 2010/11 in line with estimates provided to GOM. (ii) CABS provide indicative information on budget support disbursements for 2009/10 and 2010/11. (iii) Start implementing priority actions in the Action Plan that will ensure Increased use of GoM procurement systems by CABS members

11 Improved business environment: contract enforcement and business licensing

(i) Commercial cases filed prior to the launch of Commercial Division are still at the General Division of the High Court By December 2008 an audit was completed and 300 cases to be transferred from the General Division to the Commercial Division of the High Court were identified.

(i) All backlog cases meeting Commercial Court threshold requirements are transferred from the General Division of the High Court to the Commercial Division (ii) Adoption of the new National Investment Policy of Malawi

(i) Publish the revised Companies Bill (ii) Publish a bill to establish a Credit Reference Bureau

PRSC trigger - proposed

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No

Indicator

Baseline

Target for 2010 review

Indicative Target

2011 review

Trigger or variable tranche?

(ii) Business licensing procedures are cumbersome The Malawi Investment and Trade Centre (MITC) Bill was gazetted on July 11, 2008.

(iii) Issue new regulations for closing a business, including a new schedule for liquidator’s fees (iv) Publish the revised Single Business Licensing Bill.

12 Improved functioning of agricultural output markets

Since 2007/08 was a bumper harvest year, a repo was expected to be implemented to support producer prices and complement physical maize stocks. However, this was not done because Government introduced a temporary ban on private sector trading in maize A macro weather insurance was implemented on a pilot basis, with the premium financed by DFID

(i) Operational strategy for commodity risk management is completed and under implementation (ii) At least one commodity risk management strategy (price hedging or weather derivatives) implemented

(i) Agricultural Commodity risk Management unit staffed and operational

PRSC trigger - proposed

13 Improved functioning of agricultural input markets

By March 2009 the medium-term action plan for input market development in consultation with fertilizer and seed associations had not been prepared.

(i) Legume seed subsidy of at least 300 mt (groundnut, beans, soybean, pigeonpea) is implemented through private retail outlets (ii) At least 50% of redeemed fertilizer coupons are returned to the Logistics Unit and 50% of associated top-up payments are returned to Treasury by the end of January 2010. (iii) Discrepancy between MoAFS and NSO count of the number of smallholder households is reconciled by 30 December 2009

(i) At least two agreed priority recommendations derived from the comprehensive review of the input subsidy program undertaken in 2009 are being implemented (ii) At least two agreed priority actions derived from the medium term action plan for input market development are reflected in the design of the 2010/11 input subsidy program

PRSC trigger - proposed

14 Pupil per qualified teacher ratio in primary schools in rural areas

2005 baseline 74:1 The ratio had risen to 95:1 by 2007 and to 97:1 in 2008

2009 SY 87:1 2010 SY 85:1 AfDB EU variable tranche

15 Survival rate in standard 5 and Girl’s survival rate in Std 8

(i) 51.8% in 2005 for Boys (std 5) – had increased to 53.6% by 2007 and to 78% in 2008 (ii) 47.6% in 2005 for Girls (std 5) – had increased to 50.7% by 2007 and 73.6% in 2008

(i) 79.5% or above for 2009 SY for Boys (ii) 76% or above for 2009 SY for Girls (iii) 47.8% or above in 2009 SY for Girls (std 8)

(i) 80.9% for Boys (ii) 78.5% for Girls

EU variable tranche

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No

Indicator

Baseline

Target for 2010 review

Indicative Target

2011 review

Trigger or variable tranche?

(iii) 22.9% in 2005 of girls (Std 8) – had increased to 26.1% by 2007 and 44.9% in 2008

(iii) 50.8%r Girls

16 Proportion of one year olds immunised against measles: i) National level ii) Districts below 75% level 29

As at June 2005: national level at 82% As at June 2007: national level at 80%, 4 districts below 75% As at June 2008: national level at 84%, The minimum measles immunization rate in all districts was 77%,

As at June 2009 (i) Maintain national level at least at the level of June 2005 and (ii) reduce the number of districts below 75% to a maximum of two

As at June 2010 (i) Maintain national level at least at the level of June 2005 and (ii) reduce the number of districts below 75% to a maximum of two

EU variable tranche

17

Proportion of birth attended by skilled health personnel.

38% in 2005 42% in 2007 45% in 2008

48% as at June 2009

52% as at June 2010

EU variable tranche

18 Nurse to population ratio (i) Registered nurses: 1: 4000 in 2005 1: 3304 in June 2007 1: 3062 in June 2008 (ii) Practicing nurses 1: 3217 by June 2008

By June 2009: 1: 2900 (registered nurses) (355 nurses graduated in October 2008. Another lot will graduate in April 2009)

By June 2010: (i) Registered nurses: 1:2800 (ii) Practicing nurses: 1:3100

EU variable tranche

19 HIV/AIDS Indicator30 (i)% of health facilities with at least the minimum package of PMTCT services: 2005 is 7% 2007 is 44% 2008 is 83% (ii)% of HIV+ pregnant women receiving complete course of ARV prophylaxis to reduce mother to child transmission: 22% in 2007

By June 2009 (i)% of health facilities with at least the minimum package of PMTCT services = 90% (ii)% of HIV+ pregnant women receiving complete course of ARV prophylaxis to reduce mother to child transmission of HIV = 35%

By June 2010: % of HIV+ pregnant women receiving complete course of ARV prophylaxis to reduce mother to child transmission of HIV = 55%

EU variable tranche

20 Gender Indicator Women in Decision making positions: 15% in 2005 19,2% in 2007 19.2% in 2008

(i) Affirmative action plan on recruitment developed by March 2010 (ii) One gender audit focusing in recruitment in the civil service by December 2009

(i) Number of women in decision making positions = 23% in 2010

AfDB

29 Districts below 75% as at June 2007 are: Ntcheu (74%), Mangochi (71%), Thyolo (67%), Chiradzulu (64%) – both Dedza and Nkhotakota were exactly 75%. 30 Sub-indicator (i) will be measured until the 2010 review, after which it will be dropped. Sub-indicator (ii) will be measured from the 2010 review onwards.

- 50 -

21

Government compliance with the Constitution and rule of law.

(i) 1,130 homicide cases awaiting trial (at least 2 years old) By December 2008: 120 homicide cases were handled, representing 12% of the baseline; (ii) Last convention reported against was in September 2007 (CRC) MoJ agreed to submit at least two state party reports. However, only one report was actually submitted in 2008.

(i) Number of pending homicide cases reduced by further 300 (26% of baseline) by December 2009 (ii) 1 state party report submitted

(i) Number of pending homicide cases reduced by further 400 ((% of baseline) by December 2010 (ii) 2 state party reports submitted – Convention On Civil and Political Rights and African Charter on Human and People’s Rights

22

Elections judged free and fair by local civil society and international observers

2009 elections are generally on track, though (a) disbursements against agreed budget are delayed, (b) there are slight deviations from agreed activities calendar and (c) MEC staffing is not fully in place. (ii) Communication Act has not yet been modified to provide for independent Board for public media Freedom House assessed media as partly free in 2005. Score is 54 in 2005; 55 in 2006; 53 in 2007; 55 in 2008

(i) 2009 Elections deemed free and fair by local and international observers (ii) Potential parliamentary by-elections held as required by law (iii) Local Government elections are on track including: (a) budget for LGE passed; (b) disbursement against agreed budget; (c) deviation from agreed activities calendar (iv) Freedom House Media Freedom annual rating for 2009 at 53.

(i) Local Government elections are (a) on track including disbursement against agreed budget; (b) deemed free and fair by local and international observers (ii) Local Assemblies are legally functioning (iii) potential by-elections are held as required by the law (iv) Freedom House Media Freedom annual rating for 2010 at 50.

23 Corruption: ACB performance

(i) 226 investigations concluded in 2007, and increased to 410 in 2008 (ii) 17 cases in court for longer than 2 years by end of 2007, reduced down to 9 in 2008 (iii) 10 institutional inquiries/audits completed during 2007, increased to 13 during 2008, and 72.5% of recommendations from 2007 reports were implemented, exceeding the target of 70%.

(i) 70% of authorised cases investigated by end 2009 (baseline= 55 in 2007) (ii) Cases in court for longer than 2 years down to 7 by end of 2009 (iii) 15 institutional inquiries/audits completed during 2009 and 70% of 2007 recommendations implemented

(i) 75% of authorised cases investigated by end 2010 (baseline= 55 in 2007) (ii) Cases in court for longer than 2 years down to 5 by end of 2010 (iii) 16 institutional inquiries/audits completed during 2010 and 80% of 2010 recommendations implemented

24 Corruption: broad progress (i) World Bank Control of Corruption indicator 25.7 for 2008 falls slightly short of the target of 25.1. (ii) The National Anti Corruption Strategy was

(i) Governance and Corruption Survey implemented

(i) 50% of recommendations from Governance and Corruption Survey implemented by February 2011.

- 51 -

launched on 5th February 2009, but the 5 institutional integrity committees were not yet established.

(ii) 10 Functional Institutional Integrity Committees (IICs) with Anti-corruption plans for their organisations

(ii) 15 Functional Institutional Integrity Committees (IICs) with Anti-corruption plans for their organisations

25 Human Rights- Implementation of the national strategy for eliminating gender based violence

(i) Prevention of Domestic Violence Act enacted (ii) National Program on Combating Gender Based Violence developed

(i) Strengthen data collection in relevant criminal and restorative justice systems – database developed in the Malawi Police Service (target for 2010)

(ii) Review the proposed

amendments to the PDVA -bill ready (target for 20101)

(i) Strengthen data collection in relevant criminal and restorative justice systems – database developed in Local Government (target for 2011)

(ii) Enact the proposed amendments to the PDVA

(iii) Reduced number of acts of gender based violence reported to Victim support units/police and Traditional leaders (target to be based on baseline data in 2010)

- 52 -

- 52 -

B. CABS development partners budget support commitments for FY 2009/10 as of January 2010.

CABS

Member Budget support Commitment

for FY 09/10 Budget support

disbursed to date Outstanding budget support

commitment Disbursement triggers for outstanding commitments

Potential disbursement

date for outstanding

commitments Foreign

Currency Local

Currency Foreign

Currency Local

Currency Foreign

Currency Local

Currency

AFDB UA 8.12 mn MK 1.83 bn UA 0 MK 0 UA 8.12 mn MK 1.83 bn (i) Positive feedback from IMF Assessment Letter including evidence that the program has been approved by the IMF Board, (ii) Evidence that the 2007/08 audit report has been submitted to parliament, (iii) Evidence that 50% of procurement plans for the largest spending entities are linked to their budget.

May 2010

DFID £ 19 mn NB: Cut from

£22 mn original commitment

MK 4.95 bn £ 0 MK 0 £ 19 mn Up to approximately MK 4.95 bn, but could be less if PRBS contribution is reduced.

Specific disbursement triggers not yet identified, and there may not be any. Ministerial approval and disbursement has been delayed because of ongoing policy dialogue on the purchase of the Presidential plane and agreeing a new macroeconomic programme.

February 2010

EU (i) Maximum of € 30.5 mn (PRBS III) (ii) € 15.9 mn (Food Facility) [a] (iii) € 25 mn (V-Flex) [b] [a] – initial 'pledge' made in December 2008; funds allocated by Commission decision in December 2009. [b] – initial pledge made in September 2009; funds allocated by Commission decision in December 2009

(i) MK 6.47 bn (ii) MK 3.37 bn (iii) MK 5.30 bn

(i) € 0 (ii) € 0 (iii) € 0 + € 2.82 m (Flex 2007), + € 8.89 m (Food Crisis special allocation).

MK 560.52 mn (Flex 2007) MK 1.78 bn (Food Crisis special allocation)

(i) € 28 m [a] (ii) € 15.9 m (iii) € 25 m - - [a] Allocation reduced because of PAF indicators not being met, or only partially met. Could be reduced further subject to HQ interpretation, to €26.75

(i) MK 5.94 bn (ii) MK 3.37 bn (iii) MK 5.30 bn

For all three allocations, the outstanding issue from the Delegation’s perspective is the receipt of an assessment letter from IMF that there is a firm agreement with GoM that will allow a new programme to be proposed to the Board (a Board decision is not, in principle, a pre-requisite for disbursement which could thus take place, subject to time/process, before Board decision). The disbursement decision rests with EU HQ.

February 2010

- 53 -

- 53 -

Germany

€ 10 mn MK 2.12 bn € 5 mn MK 1.06 bn € 5 mn MK 1.06 bn (i) No breach of fundamental principles and no extraordinary circumstances which hinder implementation of the programme (see section 9 of JFA), (ii) Satisfactory outcome of the February Review (scheduled for March 2010) (see section 4 of JFA).

Depends on conclusion of

March Review - March/April

2010.

Norway NOK 70 mn (annual allocation based on a 5 year agreement of NOK 350 mill)

MK 1.63bn NOK 35 mn

MK 814,511,525

NOK 35 mn MK 814,511,525

Overall satisfactory progress from the March 2009 CABS review. Decision rests with HQ, with a specific focus on audit backlog: Submission of Audit Reports 2007/08 and reported progress for 2008/09.

March 2010

World Bank

$ 40 mn MK 5.9 bn $ 0 MK 0 $ 40 mn MK 5.9 bn Four out of the ten triggers remain to be resolved/have been overtaken by events. All four relate to agriculture: (i) Maize grain REPO deal is implemented, (ii) Medium-term action plan for input market development drafted; (iii) Publish revised guidelines for identification of beneficiaries for the fertilizer subsidy programme; (iv) Undertake procurement audit of the fertilizer subsidy program for FY2008/09 and commence implementation of agreed key recommendations contained in a time-bound action plan.

May 2010

Exchange rates used

1 UA: MK230.54 £1: MK 225 €1: MK 212.11

- 54 -

- 54 -

V. POLITICAL AND TECHNICAL PRIOR CONDITIONS FOR BUDGET SUPPORT

UNDER THE DBSL Prior to the Bank’s decision to participate in a budget support operation, it will ensure that two sets of pre-requisites are met—the general and technical requirements. General prerequisites: Economic and political stability and strong government commitment are two conditions that are given prominence:

Economic and Political Stability. Malawi is making good economic progress. It reached the HIPC Initiative completion point in August 2006; the CPIA indicators improved between 2006 and 2008; and a new macroeconomic framework and IMF facility, the ECF, was approved by the IMF Board in February 2010. The political situation has remained peaceful, and the majority government elected in June 2009 is expected to improve the political climate and decision-making processes.

Government Commitment. Since 2004, Malawi’s macroeconomic growth has been robust at levels significantly higher than the sub-Sahara African average. The Government has recently redesigned its PFEM strategy with the aim of raising budget standards—including budget preparation, execution, and reporting—and is addressing capacity and financing constraints openly.

Technical prerequisites: The key features are:

Implementation mechanisms of the MGDS. The MGDS for 2006/07-2010/11 is well designed and focuses on priorities aimed at enhancing the delivery of employment and wealth. Significant shares of current expenditures are going to Government’s priority areas (almost one half going to agriculture, road and transport development, health, and education and irrigation). The Government has begun preparing a second MGDS for 2011/12-2015/16, which will involve participatory approaches with civil society and potential beneficiaries by way of workshops and consultations.

A viable macroeconomic and financial medium-term framework. The IMF Board approved in February 2010 the current ECF for Malawi, covering 2010-12. The main objectives of the Government’s three-year program are to create a stable macroeconomic environment and strengthen economic governance. In that context, the Government is moving towards a three-year MTEF that is aligned with the MGDS priorities, with technical assistance from AFRITAC.

Partnership. The CABS Group is the primary forum for aid harmonization and alignment, under which a Performance Assessment Framework (PAF) was adopted in 2005. Malawi signed the Paris Declaration in 2005.

Fiduciary review. A 2009 joint DFID/AfDB Fiduciary Risk Assessment (FRA) showed that Malawi’s fiduciary risk is ‘moderate’ (there has been improvement in PFM, but there is room for further strengthening). More recently, the Government has developed a medium-term PFEM Priority Action Plan, informed by a PFM needs assessments undertaken by the UNDP. Procurement and external audit procedures have been strengthened since 2007, with additional measures being prepared, further reducing fiduciary risks. The Bank is preparing a targeted capacity building project to help strengthen entities involved in PFEM reform. A new PEFA Assessment has been scheduled for 2011.

- 55 -

- 55 -

VI. CURRENT ADF PORTOLIO IN MALAWI A. Ongoing and Approved Projects

B.

Proj

ect N

ame

(On-

Goi

ng &

A

ppro

ved)

App

rova

l Dat

e

Sign

ing

Dat

e

Eff

ectiv

enes

s Dat

e

Peri

od to

Eff

ect.

(Mon

ths)

Clo

sing

Dat

e

Age

yrs

Net

Com

mitm

ent A

mou

nt

Tot

al D

isbu

rsem

ent

% D

isbu

rsed

Am

ount

Dis

burs

ed in

200

9

Proj

ects

-At-

Ris

k

Lat

est I

P

Lat

est D

O

No

of R

isk

Flag

s

Con

ditio

ns p

rece

dent

to lo

an e

ff.

Proc

urem

ent

PIU

Per

form

ance

Cou

nter

part

Fun

ds

Lon

g-te

rm p

roje

ct-a

t-ri

sk

Del

ayed

Eff

c (A

ppro

val t

o E

ffc.

)

Slow

Loa

n D

isbu

rsem

ents

Slow

Gra

nt d

isbu

rsem

ents

Agi

ng P

roje

ct (8

) /T

AF

gran

t (5)

Del

ayed

Eff

c (S

igna

ture

to E

ffc)

Mon

ths s

ince

last

Rat

ing

OSAN

Lake Malawi Artisanal Fisheries Development 29/1/03 5/5/03 8/9/03 7 31/12/09 6.8 7.8 5.6 72% 1.5 2.15 1.75 1 x 7

Smallholder Crop Production & Marketing 26/7/06 9/11/06 2/5/07 9 31/12/13 3.2 15.0 2.5 17% 1.1 2.62 2.00 0 4 Agriculture Infrastructure Support 9/9/09 15.0

Awaiting effectiveness

OWAS

National Water Development Programme 2/7/08

19/11/08 11/6/09 11 31/12/13 1.3 29.3 0.7

2% 0.7

8

OSHD Support to Secondary Education Phase IV 21/11/01 5/8/02 26/11/02 12 30/9/09 7.9 15.0 13.4

89% 1.3 2.54 3.00 1 x 1

Skills & Income Generation Project 16/1/02 5/8/02 5/3/03 16 30/6/09 7.8 9.6 9.5

99% 2.0 2.23 2.33 1 x 5

Support to Secondary Education Phase V 7/6/06 18/7/06 18/7/06 1 31/12/12 3.3 15.0 1.5

10% 1.1 1.52 2.00 1 x 1

Support to Health Sector Program SWAp 24/11/05 23/1/06 23/1/06 2 30/6/10 3.8 15.0 6.6

44% 3.4 PPP 1.82 3.00 3 x x x 5

Local Economic Development 24/9/08

19/11/08 13 31/12/14 1.0 14.0

Awaiting effectiveness

OINF Trunk Road Rehabilitation 22/5/09 0 31/12/13 0.0 24.1 Awaiting effectiveness

Multinational: Nacala Corridor Phase I (regional) 24/6/09 0 30/7/15 0.0 14.3

Awaiting effectiveness

TOTAL 174.1 39.9 11.0 9% 7 2 1 0 0 2 0 1 0 8

AVERAGE 6 3.2 15.8 47.7% * 2.15 2.35

* for all projects disbursing in 2009

- 56 -

B. Summary of the Malawi Portfolio Seven (7) ongoing investment operations commitments amounting to UA 108.54 million

o Two agriculture sector operations o Four social sector operations o One water and sanitation sector operation

Four (4) investment operations amounting to UA 67.42 million are awaiting effectiveness: o One social sector operation: Support to Local Economic Development o Two transport infrastructure sector operations: Trunk Rehabilitation of Blantyre-Zomba

road and Multinational: Nacala Road Corridor, phase I – Lilongwe Bypass o One agriculture operation: Agriculture Infrastructure Support

Portfolio Distribution and commitments:

Table 1: Q4 2009 Portfolio Scorecard Summary

Problem Projects 1 i.e. Lake Malawi Artisanal Fisheries Development Project Potential Problem Projects 0 ( changed from Q 2 where Health Sector Program was rated PPP) Project-at-Risk 9% (unchanged from Q 3 2009) Disbursement Rate 51.4% (up from 48.5% in Q3 2009) Disbursement Ratio 28.3 % (up from 23.9% in Q 3 2009)

Table 2: Evolution of Portfolio KPIs in 2009 (Summary) Selected KPIs Q 3 2009 Q 4 2009 Disbursement Rate (%) 48.5 51.4 Disbursement Ratio (%) 23.9 28.3 Average Project size ( UA m) 15.8 15.8 Project-at-risk (%) 9 9 Parallel PIUs (#) 4 4 Average project age (years) 3.2 3.2 Overall project performance rate 2.35 2.22

- 57 -

VII. LATEST SOCIO-ECONOMIC INDICATORS

Year Malawi AfricaDevelo-

ping Countrie

Develo- ped

CountrieBasic Indicators Area ( '000 Km²) 118 30 323 80 976 54 658Total Population (millions) 2008 14,8 986 5 523 1 229Urban Population (% of Total) 2008 19,0 39,1 44,2 74,6Population Density (per Km²) 2008 120,6 32,6 66,6 23,1GNI per Capita (US $) 2008 290 1 428 2 405 38 579Labor Force Participation - Total (%) 2008 41,4 42,3 45,6 54,6Labor Force Participation - Female (%) 2008 49,9 41,1 39,7 44,9Gender -Related Dev elopment Index Value 2005 0,432 0,482 0.694 0,911Human Dev elop. Index (Rank among 182 countries 2007 160 n.a. n.a. n.a.Popul. Liv ing Below $ 1 a Day (% of Population) 2005 … 34,3 25,0 …

Demographic IndicatorsPopulation Grow th Rate - Total (%) 2008 2,8 2,3 1,4 0,3Population Grow th Rate - Urban (%) 2008 5,4 3,3 2,5 0,6Population < 15 y ears (%) 2008 46,4 56,0 40,0 16,6Population >= 65 y ears (%) 2008 3,1 4,5 3,3 15,6Dependency Ratio (%) 2008 98,4 78,0 52,8 49,OSex Ratio (per 100 female) 2008 98,7 100,7 96,7 106,0Female Population 15-49 y ears (% of total populatio 2008 22,4 48,5 53,3 47,2Life Ex pectancy at Birth - Total (y ears) 2008 53,1 54,5 65,7 77,1Life Ex pectancy at Birth - Female (y ears) 2008 54,1 55,5 67,6 80,6Crude Birth Rate (per 1,000) 2008 40,2 35,8 22,2 11,2Crude Death Rate (per 1,000) 2008 12,3 12,4 8,1 10,1Infant Mortality Rate (per 1,000) 2008 82,5 83,9 51,4 6,3Child Mortality Rate (per 1,000) 2008 118,6 134,5 77,4 7,9Total Fertility Rate (per w oman) 2008 5,5 4,6 2,7 1,6Maternal Mortality Rate (per 100,000) 2004 984,0 683,0 450,0 9,0Women Using Contraception (%) 2006 41,7 29,7 61,0 75,0

Health & Nutrition IndicatorsPhy sicians (per 100,000 people) 2004 2,1 39,6 78,0 287,0Nurses (per 100,000 people)* 2004 56,3 120,4 98,0 782,0Births attended by Trained Health Personnel (%) 2006 53,6 51,2 59,0 99,0Access to Safe Water (% of Population) 2006 76,0 68,0 62,0 100,0Access to Health Serv ices (% of Population) 2005 … 61,7 80,0 100,0Access to Sanitation (% of Population) 2006 60,0 37,6 53,0 100,0Percent. of Adults (aged 15-49) Liv ing w ith HIV/AID 2005 14,1 4,5 1,3 0,3Incidence of Tuberculosis (per 100,000) 2005 14,1 315,8 275,0 19,0Child Immunization Against Tuberculosis (%) 2007 95,0 83,0 89,0 99,0Child Immunization Against Measles (%) 2007 82,0 83,1 81,0 93,0Underw eight Children (% of children under 5 y ears 2004 22,0 25,2 27,0 0,1Daily Calorie Supply per Capita 2004 2 077 2 436 2 675 3 285Public Ex penditure on Health (as % of GDP) 2005 8,7 2,4 1,8 6,3

Education Indicators Gross Enrolment Ratio (%) Primary School - Total 2007 116,5 99,6 106,0 101,0 Primary School - Female 2007 118,6 92,1 103,0 101,0 Secondary School - Total 2007 28,3 43,5 60,0 101,5 Secondary School - Female 2007 25,7 40,8 58,0 101,0Primary School Female Teaching Staff (% of Total) 2007 37,7 47,5 51,0 82,0Adult Illiteracy Rate - Total (%) 2007 28,2 38,0 21,0 1,0Adult Illiteracy Rate - Male (%) 2007 20,8 29,0 15,0 1,0Adult Illiteracy Rate - Female (%) 2007 35,4 47,0 27,0 1,0Percentage of GDP Spent on Education 2003 4,2 4,5 3,9 5,9

Environmental IndicatorsLand Use (Arable Land as % of Total Land Area) 2007 31,9 6,0 9,9 11,6Annual Rate of Deforestation (%) 2005 … 0,7 0,4 -0,2Annual Rate of Reforestation (%) 2005 … 10,9 … …Per Capita CO2 Emissions (metric tons) 2007 0,1 1,0 1,9 12,3

Sources : ADB Statistics Department Databases; World Bank: World Development Indicators; last update :UNAIDS; UNSD; WHO, UNICEF, WRI, UNDP; Country Reports.

Note : n.a. : Not Applicable ; … : Data Not Available.

COMPARATIVE SOCIO-ECONOMIC INDICATORSMalawi

janvier 2010

75

80

85

90

95

100

2003

2004

2005

2006

2007

2008

Infant Mortality Rate( Per 1000 )

Malawi Africa

0

500

1000

1500

2002

2003

2004

2005

2006

2007

2008

GNI per capita US $

Malawi Africa

0,0

0,5

1,0

1,5

2,0

2,5

3,0

2003

2004

2005

2006

2007

2008

Population Growth Rate (%)

Malawi Africa

111213141516171

2003

2004

2005

2006

2007

2008

Life Expectancy at Birth (years)

MalawiAfrica

- 58 -

VIII. MAP OF MALAWI