POVERTY REDUCTION SUPPORT LOAN

Transcription

1 AFRICAN DEVELOPMENT FUND Language: English Original: English REPUBLIC OF MALAWI POVERTY REDUCTION SUPPORT LOAN APPRAISAL REPORT DEPARTMENT OF GOVERNANCE, ECONOMIC OSGE AND FINANCIAL REFORMS FEBRUARY 2007 SCCD: G.G.

2 TABLE OF CONTENTS EXECUTIVE SUMMARY AND PROGRAMME MATRIX Page iv-vii 1. INTRODUCTION Background and Recent Economic Developments Performance of Past Bank Group Policy-Based Operations The Bank Group Strategy 4 2. SOCIO-ECONOMIC CONTEXT Poverty Profile Recent Macroeconomic Performance, Outlook and Debt Sustainability 6 3. THE GOVERNMENT S POVERTY REDUCTION STRATEGY MGDS : Preparation, Goals and Components Envisaged Reforms and the Medium-Term Reform Agenda Programme Costing and Financing Requirements ASSESSMENT OF THE PREREQUISITES FOR DIRECT BUDGET 13 SUPPORT 4.1 Government Commitment and Political Stability Macroeconomic and Financial Framework Institutional Capacity Fiduciary Arrangements and Analytical Underpinnings Donor Coordination and Partnership THE PROPOSED POVERTY REDUCTION SUPPORT LOAN Objective and Resources Available Description of the Areas of Focus of the PRSL Implementation Schedule Disbursement Monitoring, Evaluation and Audit JUSTIFICATION, IMPACT AND RISKS Justification and Benefits and Rationale for Budget Support in Malawi Potential Impact of the Programme Major risks and Mitigating Factors CONCLUSIONS AND RECOMMENDATIONS Conclusions Recommendations 26 This report was prepared following Preparation and Appraisal Missions to Malawi in September 2006 and January The appraisal mission was undertaken by Andrew Clark, Macro-Economist, OSGE, and Sunita Pitamber, Principal Socio-Economist, OSGE. They were joined on the Appraisal Mission by Appolenia Mbowe, Officer in Charge for Malawi. Any questions related to this report should be forwarded to Mr. G. Negatu, Director OSGE, Ext

3 i LIST OF TABLES Table 1 SAL and SGGL (Reform Areas and Performance) Table 2 Financial Envelope and External Resources Table 3 Budget Support Programme Disbursement and Pledges ( ) Table 4 Impact on Poverty of MGDS LIST OF ANNEXES ANNEX I Administrative Map of Malawi ANNEX II Summary Malawi Country Report DAC Joint Evaluation of General Budget Support ANNEX III PAF Matrix for 2006 ANNEX IV Fiduciary Risk Assessment ANNEX V History of the Malawi Harmonisation Framework ANNEX VI Table of Economic and Financial Indicators ANNEX VII Balance of Payments, ANNEX VIII Bank Group Operations in Malawi ANNEX IX Development Policy Letter CURRENCY EQUIVALENTS February 2007 Currency Unit = Malawian Kwacha 1 UA = Malawian Kwacha 1 UA = US$ 1 US$ = 140 Malawian Kwacha FINANCIAL YEAR 1 July to 30 June WEIGHTS AND MEASURES Metric System

4 ii AFRICAN DEVELOPMENT FUND Temporary Relocation Agency B.P. 323, 1002 Tunis Belvedere, Tunisia Tel: (216) Telefax: (216) PROGRAMME INFORMATION SHEET Date: February 2007 The following information provides some general guidelines to all suppliers, contractors, consultants and any other person interested in the procurement of goods and services for projects approved by the Boards of Directors of the Bank Group. More detailed information can be obtained from the Borrower. 1. COUNTRY : Republic of Malawi 2. TITLE OF PROGRAMME : Poverty Reduction Support Loan 3. BORROWER : Government of Malawi 4. PLACE OF IMPLEMENTATION: National Territory 5. EXECUTING AGENCY : Ministry of Finance 6. PROGRAMME DESCRIPTION : The objective is to support the implementation of the Government s Poverty Reduction Strategy 7. TOTAL COST : UA 84.7 million (CABS donors) 1 8 LOAN SOURCE : ADF 9. LOAN AMOUNT : UA 14.9 million 10. OTHER SOURCES OF FINANCE: DFID : UA 27.1 IDA : UA 17.4 European Union : UA 18.2 Norway : UA APPROVAL DATE : April DATE OF EFFECTIVENESS : April 2007 for 11 months AND DURATION 13. PROCUREMENT : n/a 14. DISBURSEMENTS : The loan will be disbursed in one tranche after the borrower meets the conditions 1 All donor figures are indicative and will be confirmed at the March 2007 CABS review.

5 iii ACB ADB ADF CABS CPAR CPIA CPR CSP DAC DBSL DP ESAF GoM GFEM HIPC IFMIS IHS JF JSA M&E MDG MDRI MFAAP MGDS MPRS MSCE MTEF NAO OECD ODPP PAA PAF PBA PBL PCR PD PEFA PER PFM PFMA PGBS PRGF PRSP SAL SGGL SMP SWAP UA UDF ACRONYMS AND ABBREVIATIONS Anti-Corruption Bureau African Development Bank African Development Fund Common Approach to Budget Support Country Procurement Accountability Review Country Policy and Institutional Assessment Country Portfolio Review Country Strategy Paper Development Assistance Committee Direct Budget Support Lending Development Partners Enhanced Structural Adjustment Facility Government of Malawi Group on Financial and Economic Management Heavily Indebted Poor Countries Integrated Financial Management Information System Integrated Household Survey Joint Framework Joint Staff Assessment Monitoring and Evaluation Millennium Development Goals Multilateral Debt Relief Initiative Malawi Financial Accountability and Action Plan Malawi Growth and Development Strategy Malawi Poverty Reduction Strategy Malawi School Certificate of Education Medium Term Expenditure Framework National Audit Office Organisation for Economic Cooperation and Development Office of the Director of Public Procurement Public Audit Act Performance Assessment Framework Performance Based Assessment Policy Based Loan Project Completion Report Paris Declaration Public Expenditure and Financial Accountability Public Expenditure Review Public Financial Management Public Financial Management Act Partnership General Budget Support Poverty Reduction Growth Facility Poverty Reduction Strategy Paper Structural Adjustment Loan Support for Good Governance Loan Staff Monitored Programme Sector Wide Approach Unit of Account SDR United Democratic Front

6 iv EXECUTIVE SUMMARY CONTEXT This appraisal report proposes a one-tranche Poverty Reduction Support Loan (PRSL) to the Republic of Malawi for UA 14.9 million, on standard ADF terms. The proposed operation is an integral part of the Bank Group s Country Strategy Paper (CSP) to support the implementation of Malawi s Growth and Development Strategy (MGDS), and the Performance Assessment Framework (PAF) agreed among the external partners. The ADF loan represents the revised Performance Based Allocation for ADF X and reflects an increase in CPIA rating and improved policy environment. The Government of Malawi has indicated that general budget support is a preferred mode for delivery of official development assistance. PROGRAMME OBJECTIVE In the medium-term through the MGDS, the Government aims to reduce poverty headcount from 52.4% to 44.4% between 2006 and It will promote strong and sustainable growth, building an educated human resource base, whislt protecting and empowering the vulnerable. It envisages carrying out necessary reforms for the economy to grow at a minimum rate of 6% per annum in the next 5 years through investment and by providing the requisite policy and institutional framework to promote agriculture and food security, infrastructure development, energy generation, irrigation and integrated rural development. The ADF s proposed loan will deepen the Bank Group s support for the reform agenda by: (i) ensuring sound macroeconomic management whilst strengthening public financial management; (ii) increasing access to education and health services whilst training front-line service providers, and; (iii) increasing the effectiveness of the justice system and reducing corruption. In doing this, the PRSL will help contribute towards the implementation of the MGDS. PROGRAMME DESCRIPTION The PRSL constitutes an operation to align the policy agenda supported by the Bank Group s CSP and other donors with the national priorities as articulated in the MGDS. The operation has been designed to fully integrate and harmonise with the joint donor and government Common Approach to Budget Support (CABS) process. This one-tranche operation is for the 2007/08 Malawian budget year, expected to be released in July The operation fills an identified financial gap (within the MGDS and the Medium Term Expenditure Framework). While the PRSL operation will provide financial support for implementation of the MGDS, it will disburse against the successful assessment of the reform measures and targets in the PAF. PROGRAMME IMPLEMENTATION A rolling PAF has been agreed upon between the Government and donors providing budget support as a framework for monitoring progress. They are a subset of indicators that the Government is monitoring as part of the assessment of implementation of the MGDS. The PAF will serve as the framework for the proposed loan. The Bank Group participated in the annual and mid-year CABS review, which formulated the PAF. It helped to define the appropriate indicators in the PAF. It will continue to participate in the Government and donor annual and mid-year reviews, which are held in March and September respectively. The Government has encouraged donors, particularly those providing budget support, to align their annual review and decision making processes with the Government s calendar.

7 v COORDINATION WITH OTHER DONORS A one-tranche budget support is proposed to align the Bank Group s Budget Support to the Malawian budget cycle and to fully integrate into the CABS annual and mid-year reviews. It will represent a significant operation and, coupled with the opening (in December 2006) and staffing of the Malawi Country Office, will increase the profile and influence of the Bank Group in Malawi. Looking forward, this PRSL and subsequent budget support will serve as a vehicle for policy dialogue on key issues for the Bank Group. Furthermore, disbursing the PRSL funds on the basis of the PAF at the start of the financial year will ensure consistency with good practice principles of budget support. DISBURSEMENTS A one-tranche ADF loan was requested by the Government and agreed to by the CABS donors and adheres to the Joint Framework (JF) rules for disbursement of budget support. Future budget support operations will continue to follow the rules of the JF. The Bank will disburse funds in a foreign exchange account indicated by the Government and held in the name of the Reserve Bank of Malawi. The Government will acknowledge receipt of the Kwacha counter value in the Consolidated Government Account in writing to the Bank Group. CONCLUSIONS Malawi s economic reform effort has gathered momentum over recent years and there is a more determined and coherent approach to the daunting task of poverty reduction. There has been dramatic improvement in macroeconomic management. A new PRGF was agreed in August 2005 and Malawi will complete its third review in March Moreover, in August 2006, Malawi reached completion point under the enhanced HIPC initiative. In response, Bank Group operations need to be sustained and broadened if progress towards poverty reduction is to be accelerated. The Government has demonstrated a strong commitment to reform, and there is now a greater sense of ownership of the reform process. This greatly enhances the likelihood of success of the budget support being provided by the donor community. The proposed PRSL will support priority policy actions outlined in the MGDS and CSP. Malawi s poverty reduction strategy is ambitious and will require strong donor support in the coming years. The PRSL is therefore timely and will augment resources that other donors are providing which target poverty reduction programmes. RECOMMENDATIONS It is recommended that an ADF loan not exceeding UA 14.9 million be extended to the Government of Malawi on standard ADF terms as direct budget support in one tranche, in addition to the resources availed by other donors. It will be disbursed after the borrower satisfies the conditions as indicated in this report.

8 vi Programme Matrix * Malawi Poverty Reduction Support Loan (PRSL ) STRATEGIC REFORM AREAS OVERALL OBJECTIVE: PRSL Reinforce economic reforms and good governance policies to accelerate growth and reduce poverty. MACROECONOMIC AND PFM REFORMS Ensure sound macroeconomic management reform whilst strengthening public financial management ACTIONS INDICATORS To be assessed at the CABS Joint Review I Successful approval and commencement of the implementation of the MGDS II Overall macroeconomic programme implemented as evidenced by an on-track PRGF I Composition of expenditure out-turn compared to original approved budget within a 10% deviation II Composition of expenditure out-turn compared to original approved budget for Pro-Poor Expenditures within a 5% deviation III Reconciliation of the payroll with personnel data to ensure effectiveness of payroll controls IV Internal Audit is operational for central government entities covering 50% of primary expenditure to ensure the effectiveness of Internal Audit V Consolidated GoM statement is submitted for external audit within 6 months of end of FY to ensure timeliness of annual financial statements VI Central GoM entities representing 50% of expenditures are audited and FY 04/05 Audit Report submitted to parliament, to expand nature and follow up of external audit PRSL OBJECTIVES VERIFIABLE PERFORMANCE INDICATORS Projected at appraisal I Annual average GDP growth during is maintained at the level of 6%. II Fiscal revenue maintained at 21 percent of GDP in 2006, 2007 and III Incidence of poverty is reduced from 52.4% in 2006/07 to 44.4% by 2010/11. I Variance in expenditure composition exceeded overall deviation in primary expenditure maintained and by no more than 10%. II Variance in actual expenditure exceeds overall deviation in primary expenditure maintained and by no more than 5%. III Payroll audit is conducted by June Payroll for FY 07/08 is supported by full documentation for all changes made to personnel records on a monthly basis. IV Internal audit is operational for all central government entities. Reports adhere to fixed schedule and distributed to audited entity, NAO and MOF. V Consolidated GoM statement is submitted for external audit within 6 months of the end of FY. VI Central GoM entities representing 75% of expenditures are audited. Audit report submitted to legislature within 4 months from receipt of consolidated government statement by NAO. MEDIUM TERM OUTCOMES (CSP) Improvement in the social well-being of the Malawian population Pillar III Stable macroeconomic environment: Malawi stays on track with the IMF PRGF and proportion of national budget spent on pro-poor expenditure increases Improved compliance of expenditure outcomes with original objectives, increased coverage of internal and external audit and National Audit Office reports submitted to parliament RISKS AND ASSUMPTIONS No exogenous shocks Successful implementation of Theme 2 of the MGDS on Social Protection and Disaster Management Continued government commitment to public financial management reforms and Government having the requisite capacity to undertake the relevant reforms Consistent and predictable donor support, including capacity building and budget support, and sufficient donor disbursement

9 vii DEVELOPING HUMAN AND INSTITUTIONAL CAPACITY Increasing access to education and health services whilst training front-line service providers IMPROVING THE POLICY AND INSTITUTIONAL FRAMEWORK FOR GOVERNANACE Increasing the effectiveness of the justice system and reducing corruption I Hire teachers to ensure pupil per qualified teacher ratio in rural primary schools maintained at 75:1 II Female Literacy rate improved to 55% III Improving school infrastructure to ensure drop out reduced in standard 5 by percentage of pupils progressing beyond standard 5 to 49.8% (Boys) and 47.6% (Girls) IV Increase the provision of drugs leading to the proportion of one year-old children immunized against measles to increase to 85% V Improved health care facilities including proportion of birth attended by health personnel to increase to 40% in 2006 VI Increase retention of health workers to ensure nurse population ratio to increases to 1:3900 I Government compliance with the Constitution and rule of law through clarification of policy on local elections II Average number of months for corruption cases to be completed reduced to 16 months III % of corruption cases completed within 12 months to increase to 50% IV Government Ministries complying with quarterly reporting to ODPP on procurement to include Health, Education, Agriculture, Transport, Irrigation and Water and Privatisation Commission I 75:1 or less in 2007 II 60% by Dec 2007 III Retention Rates at 51% for Boys and 50% for Girls in 2007 IV 86% in 2007 V 50% in 2007 VI 1:3700 by 2007 I Preparations for 2009 elections in line with Constitution II 12 months in 2007 III 60% in December 2007 IV Quarterly reporting requirements met as in 2006 and extended to all Ministries Pillar II Schools physically upgraded, increase in qualified teachers and number of pupils passing the MSCE increased. Increase in the number of deliveries attended by skilled health workers and reduced maternal and child mortality rates. Pillar III Reduction in the incidence of corruption, increased implementation of the rule of law and responsiveness of the judiciary Government maintains commitment to prioritising education and health expenditures in the budget and continued progress on halting the spread of HIV/AIDS Strengthening GoM systems for prioritising public expenditure and PAF indicators protecting health and education shares of the budget. Government retains its zero tolerance towards corruption and political stability Donor support to the Parliament and regular donors reviews of the Governance indicators in the PAF which address corruption and political stability V Actual recurrent expenditure to Governance institutions in 2005/06 maintained at 2004/05 levels in real terms V As a minimum actual recurrent expenditure in FY 2006/07 is maintained at 2004/05 in real terms * All Baseline figures, definition of indicators and source of data is presented in the PAF matrix in 2006 in Annex III

10 1. INTRODUCTION 1.1 Background and Recent Economic Developments The historical macroeconomic environment in Malawi has been characterised by large fiscal deficits, rapid money supply growth and high real interest rates. Poor fiscal management led to rapid growth in money supply, thereby increasing domestic interest costs, stoking inflation and adding pressure on the Kwacha to depreciate. As a result the IMF suspended disbursement twice - in 2001 and again in early The new Government, in a short period of time since 2004, has built a track record of appropriate and robust fiscal and monetary policies. Consequently the IMF resumed its financial support under a new three-year Poverty Reduction Growth Facility (PRGF), following a successful Staff Monitored Programme (SMP), implemented since July In March 2007, the Government will complete the third review under the PRGF. The economy has been stable since mid In August 2006, Malawi reached completion point under the enhanced HIPC initiative The Government of Malawi (GoM) has made commendable strides with economic reforms. There has been dramatic improvement in macro-economic management since 2004 under the present Government. It has kept strictly to the budget approved by parliament and has virtually stopped new borrowing. A new PRGF was agreed in August As a result of these achievements donors resumed budget support. This contributed to reductions in the domestic debt: GDP ratio (from 24.8% in June 2004 to 20.0% in June 2006) and the GoM domestic interest bill (from 9.1% to 5.4% of GDP). This has released resources for other purposes. Interest rates have come down and private investment is picking up. The GoM has just completed implementation of its first Malawi Poverty Reduction Strategy (MPRS) and recently completed its second PRSP, the Malawian Growth and Development Strategy (MGDS). The MGDS is a home grown development agenda, which has been designed by the government, in partnership with all relevant stakeholders (civil society, private sector and donors). The preparation of the Bank Group s Country Strategy Paper (CSP), which also involved stakeholders consultation, is based largely upon the analysis and strategy of the MGDS. At the same time the CSP noted the longer-term objectives of Vision 2020 and the MDGs, all of which are complementary and supportive of the goals contained in the MGDS Despite a severe food crisis, real GDP growth was around 5 percent in 2005/06. Current projections indicate that growth in 2006 will be in the order of 8%, following the good rains in 2005/06. Year-on-year inflation fell from a peak of 17% in February 2006 to 12% in August. Since mid-january 2006, the authorities have taken clear steps to better manage the exchange rate system. The authorities policy decision to let the exchange rate depreciate by implementing a more flexible exchange rate policy, combined with stronger export receipts from tea, contributed to protecting international reserves. Official reserves remain at 2 months of imports, and are expected to rise. The overall fiscal deficit, including grants, remains at 2 percent of GDP. The current Government continues to prioritise macroeconomic stability and sound public finances The Malawian authorities have taken measures to improve efficiency in the utilisation of public resources. The Finance and Audit Act was divided into two separate legislations, the Public Finance Management Act (PFMA) and the Public Audit Act (PAA) in order to strengthen the legal framework for public finance. To improve transparency in public finance, public expenditures are reported on a quarterly basis. An Integrated Financial Management Information System (IFMIS) has been introduced and is in place in eight Ministries and will be available in all Ministries by The new Government has adopted a zero tolerance policy towards corruption. Specific measures have been taken, including: (i) amendments to the Corrupt Practices Act to widen the definition of corruption and provide protection for whistleblowers; (ii) the passing of a new

11 Procurement act to create a new Office of the Director of Public Procurement (ODPP) for strengthening controls and safeguarding public procurement; (iii) the introduction of a new public payment system as part of IFMIS to keep track of government accounts; (iv) the strengthening of the capacity of the National Audit Office (NAO), and; (v) a governance and corruption baseline survey through the Anti-Corruption Bureau (ACB) In addition to progress on these key policy areas, the GoM has taken key steps in improving service delivery and key social sector policies. In education, these include: (i) an increase in the sector s share of discretionary recurrent budget exceeding the agreed HIPC threshold; (ii) increasing enrolment in teacher training colleges, and; (iii) increasing the number of properly trained teachers in primary schools. As a result, enrolment in primary schools has increased from 1.9 million to 3.2 million and the ratio of pupils per teacher has declined from 123 in 2000 to 83 in In terms of the health system, the Government - through the Health SWAp (also funded by the Bank Group) - has increased the resources allocated to the health sector. The average budget for drugs and medical supplies has been above the Better Health for Africa standard. The first phase of the reform of the Central Medical Services has been completed and the level of front-line staff, drugs and other basic medical supplies has increased. In terms of fighting HIV/AIDS the Government has introduced measures to strengthen the institutional framework for fighting HIV/AIDS as well as mitigating against its impact. Progress has been made as evidenced by the latest HIV/AIDS monitoring report which shows HIV infection stabilising Despite these gains, Malawi continues to be one of the poorest countries in Sub-Saharan Africa. About 52.4% (in 2005) of the population live below the poverty line. Within the regional differences the Southern Region recorded about 67% of the population being poor. The level of human development is low, and the UN s Human Development Report of 2006 ranked Malawi as 166 in the Human Development Index out of 177 countries. According to the draft Poverty and Vulnerability Assessment (2006) about 28% of heads of households have no education and 55% only have primary education It is against this background, a recognised need, and a request from the GoM that the Bank Group and other Development Partners (DPs) will provide financial support, specifically in the form of Direct Budget Support Lending (DBSL). Budget Support is increasingly being provided in a coordinated and harmonised way. The Common Approach to Budget Support (CABS) has become the focus point for dialogue around a recently agreed Performance Assessment Framework (PAF). The main long term rationale for the CABS is to increase resources available for the GoM s plans to reduce poverty. Macroeconomic stability has now been achieved, and the GoM has more control over its expenditure. The CABS process will increase its attention to the poverty focus and efficiency of the budget. 1.2 Performance of Past Bank Group Policy-Based Operations The Bank Group to date has provided two policy-based operations in Malawi amounting to UA 27 million, which is around 5% of the Group s commitments (net of cancellations) to the country. These include a Structural Adjustment Loan 2 (SAL) (December 1998, two-tranche UA 15 million) and a Support for Good Governance Loan (SGGL) 3 (December 2004, UA 12 million). Table 1, below summarises the key reform areas and a performance benchmark rating for Direct Budget Support Lending. 2 Structural Adjustment Loan, ADF/BD/WP/97/ Loan for Good Governance, ADF/BD/WP/2004/71.

12 Table 1: SAL and SGGL (Reform Areas and Performance) The SAL was designed to support the GoM reforms in achieving fiscal sustainability, prioritising social services and improving their delivery, accelerating privatisation and promoting diversification of agricultural production and exports. The PCR 4 concluded that certain goals relating to the second tranche conditionalities appeared to be unrealistic when considered against the project budget and timeframe. As a result the second tranche conditions were never met and the proposed second tranche of UA 5 million was cancelled at the request of Government. It is important to note that during the same time period the Government went off track with the Enhanced Structural Adjustment Facility (ESAF) which led to the suspension of IMF and other donor funding. Unlike other donors, the Bank Group did not attempt to redesign the second tranche conditions, which in hindsight reduced the effectiveness of the operation and harmonisation in the medium-term. It impacted the sustainability of the original intervention, which was maintained by consistent but adjusted support from other donors which led to tangible outcomes. Clear lessons were identified, namely; (1) the targets in the programme (especially those associated with the second tranche) were very ambitious and did not take into consideration the weak GoM capacity, implying the need to reduce the number of conditionalities or move to general conditionalities and more multi-year single tranche operations; (2) the need to work closely with other donors to support the Public Financial Management (PFM) systems in Malawi and related fiduciary areas, including 4 Malawi Structural Adjustment Loan Project Completion Report, ADF/BD/IF/2006/167/Rev.1

13 through the PAF and the Group on Financial and Economic Management (GFEM) mechanisms, and; (3) the lack of a joint Monitoring and Evaluation (M&E) framework and the necessity for a full and comprehensive level of coordination with co-financiers The SGGL was designed in coordination with other donors to contribute towards the promotion of good governance in Malawi s public sector, with a view to achieving the goal of poverty reduction. It was provided to support the Government of Malawi s efforts in implementing the MPRS for the period. The programme had two major components; (i) Improving accountability and transparency of public financial management, and; (ii) Promoting the rule of law and improving access to justice. The funds were successfully disbursed in one-tranche when the conditions were met in May Clear lessons from the SGGL and other donors budget support were identified; (1) significant improvements in PFM were made, especially in the areas of fiscal transparency and accountability; (2) the budgets of key governance institutions were protected, notably the ACB, NAO and ODPP, and; (3) the need for the Bank Group to provide systematic support within the CABS framework, to maintain progress in key reform areas in the medium-term The overarching conclusions are that Bank and the CABS partners should place more reliance on the Government s own budget process, including internal and external audits and political oversight by the Assembly, as reflected in an improved policy environment, and in parallel with the Government s own monitoring and review. This coupled with continued donor technical support in this area will help strengthen local institutions 5. The Bank should provide DBSL to the GoM in support of its overall economic and reform programme, as a complement to focused sector activities. The Bank should join the Joint Framework (JF) and the CABS, and future operations should use the PAF as the principal mechanism of goal setting, performance monitoring and auditing. This will contribute to simplification of processes for the Borrower and the Bank Group. In addition, the Bank Group should increase the use of single tranche multi-year budget support operations. In response, the preparation of the PRSL has adopted the joint government and donor led PAF. This has enabled a greater focus and depth of discussions with the relevant Government Ministries and agencies, as well as increased the ability to assess the Government s capacity to implement proposed reforms. 1.3 The Bank Group Strategy The Boards of Directors of the Bank Group approved the CSP for Malawi in October 2005 covering the period The objective of the CSP is to provide the Bank Group with an assistance strategy in Malawi that contributes to poverty reduction and socio economic development. The CSP is directly linked to the MGDS, which runs from , and is driven by: (i) the Bank Group s experience and lessons learned from the implementation of previous interventions; (ii) discussions with other donors relating to their current activities; (iii) the ADF-X policy guidelines, and; (iv) a focus on selectivity. The CSP will be financed partly by the ADF-X ( ) and partly by the ADF XI allocation ( ), yet to be confirmed. The CSP has three core principles: (i) support the implementation of the new MGDS to achieve its goals and contribute to the attainment of Malawi s Vision 2020 goals and MDGs; (ii) provide a clear focus on results and outcomes to improve the rate of return on the Bank Group s interventions, and; (iii) improve the coordination of Bank Group activities with government and other donors. Other DPs continue to use similar basic principles and are increasingly channelling their assistance through budget support programs following Paris Declaration (PD) principles. Within this context the Bank Group s interventions will continue to provide project and policy-based support. Based on the above criteria, the CSP pillars of Expanding Rural Infrastructure, Developing Human Capacity and 5 This is consistent with the recommendations of the recent OECD DAC review on Budget Support for Malawi. 6 Malawi Country Strategy Paper, ADF/BD/WP/

14 Institutional Capacity, and Improving the Policy and Institutional Framework for Governance were chosen The CSP specifically states the Bank will join the CABS and help improve the policy and institutional framework for good governance through policy-based lending. According to the recently completed 2006 Country Portfolio Review 7 (CPR) a greater level of coordination is required to improve expected outcomes, including commitments made under the Paris Declaration on Aid Effectiveness. To date, the Bank Group s support to the Health SWAp is the only on-going project, in any sector, that is co-financed with other donors. Given this, the CPR states that in order to improve portfolio performance, the Bank Group will; (i) increase harmonisation and coordination with other donors; (ii) increase quality at entry of interventions; (iii) avoid complex and large numbers of commitments; (iv) design fewer but larger projects, and; (v) utilise the Country Office to manage day to day activities, including donor dialogue. This PRSL is a cofunded programme, consistent with the CSP and implements the recommendations from the CPR on improved portfolio performance Now that the MGDS has been approved by Government and donors, and the revised ADF X allocation for Malawi increased under the revised Performance Based Assessment 8 (PBA), the Government and the Bank discussed the option of using the additional resources for DBSL. The CSP had allocated UA47 million across the three pillars identified above. The additional resources for ADF X, based on increased performance under the PBA, provide Malawi with UA 59.9 million. These extra resources, plus additional loan resources previously allocated to grant based capacity building projects, will be allocated to DBSL. Therefore under the revised ADF X allocation, UA 14.9 million will be allocated to budget support. The GoM has indicated that DBSL is within their priority programmes for Malawi The Bank Group undertook missions during March and September 2006 to participate in the annual and mid-year CABS reviews, to help formulate the PAF and to assess progress against PAF indicators. The Bank and the Government agreed that the Bank should provide DBSL together with other DPs within the context of the ongoing harmonisation framework (MGDS, the CABS JF and the PAF). The GoM requested that the Bank Group should provide budget support in 2007 and align the support to the 2007/08 budget cycle. International best practice suggests 9 that budget support should be provided at the start of the respective budget cycle due to problems with unbudgeted expenditure, the cyclical nature of revenues and to ensure predictability of finance. The Government has expressed a preference for this arrangement and it is enshrined in the basic principles of the Joint Framework. 2. SOCIO-ECONOMIC CONTEXT 2.1 Poverty Profile Malawi is one of the poorest countries in Sub-Saharan Africa. Poverty is widespread. Malawi s social indicators are among the lowest in the world. The Human Development Index has stagnated since the mid-1990s. While there have been some improvements in education and literacy, several health indicators have worsened over the past decade. Among others, the number of physicians per population has fallen by half, and life expectancy has fallen from 46 years in 1987 to 37 years in 2005, largely due to HIV/AIDS. Childhood immunization has also decreased from 82 percent in 1992 to 64 percent in Maternal mortality rates increased from 620 in 1992 to Malawi Country Portfolio Review Report, ADF/BD/WP/2006/37. 8 ADF-X Country Resource Allocation for the Year 2006 Revised, ADF/BD/IF/2006/185/Rev.2. 9 OECD DAC Guidelines and Reverence Series: Harmonising Donor Practices for Effective Aid Delivery, Volume 2 Budget Support,

15 in 2004, although they are now on a decreasing trend. Child malnutrition has remained virtually unchanged since According to the draft Poverty and Vulnerability Assessment (2006) about 28% of heads of households have no education and only 55% have primary education. Poverty is still pervasive 10. This is a reflection of poor fiscal management and lack of priority given to poverty reduction prior to Data from two Integrated Household Surveys (IHS) supports this hypothesis According to the poverty analysis undertaken in 2000, based on the 1997/98 IHS, around 64% of Malawians lived below the poverty line, including 66% of the rural population, compared to around 55% in urban areas. At the time, regional and gender based variations in the incidence of poverty did not appear to be overly significant. The incidence of poverty in the Southern Region was 68% compared to 63% in Central Region and 63% in the Northern region. The incidence of poverty among female-headed households was 29% while it was 26% amongst male-headed households. The poverty gap index (the level of incomes required to lift the poor to the poverty line), was estimated at 20%. Income distribution was highly unequal. Gini coefficient data for income per capita was 0.89 for urban areas and 0.72 for rural areas. The wealthiest 20% of households accounted for around 50% of goods and services while the poorest 20% consumed around less than 5%. Little progress was made in reducing poverty prior to Poverty levels have not changed significantly for the past seven years. According to the IHS 2004/05, the current status of poverty shows that 52.4 percent of the population lives below the poverty line 11, i.e. about 6.3 million Malawians are poor, with the poorest people in the Southern Region. Those in the rural areas are generally poorer than urban areas (where poverty rates are at 25%). Inequality has worsened. The poor still have low socio-economic indicators with food security (due to high dependence on rain-fed agriculture practices) being a continuing threat to better life and problems of malnutrition. Female headed households are worse off and make up 67% of the population below the poverty line whilst only 53% of the female population is literate. Income inequality persists in Malawi with the richest 10% of the population having a median per capita income eight times higher than the median per capita income of the poorest 10%. Approximately 30% of the poor moved out of poverty between 1998 and 2005, while 30% of the non-poor moved into poverty. This suggests that there is continued economic vulnerability in Malawi. The Poverty Vulnerability Assessment for 2006 lists the major factors affecting the level of household poverty to be: household size, education, access to non-farm employment, access to irrigation, proximity to markets and trading centres, and access to tarmac roads. Access to landholdings and engagement in cash crop production also play an important role. While data remains weak, and projections subject to a high degree of uncertainty, current extrapolations of targets in the MGDS suggest that Malawi will only meet two of the MDGs, child mortality and access to safe drinking water. 2.2 Recent Macroeconomic Performance, Outlook and Debt Sustainability Economic growth in Malawi has been highly variable since 2000 and below the targeted rate of 6% per year. Drought, combined with poor government policy and the suspension of donor assistance, retarded real GDP growth to 1.9% in The recovery in maize production pushed real GDP growth to 4.4% in However, low rainfall levels in the 2004/05 growing season reduced the harvest, and slowed real GDP growth to an estimated 4.2% in Overall, fluctuations in GDP are a result of the high dependence on rain-fed agriculture. There has been 10 For a detailed analysis of the incidence of Poverty and Human Development, including on Gender, see Malawi CSP, Malawi Country Strategy Paper, ADB/BD/WP/2005/ The data from the IHS2 is not directly comparable to the past poverty levels. A change in survey instruments and methodology required an effort to compute the poverty rates for the previous IHS. The IHS1 poverty rates were calculated at 54%.

16 little noticeable diversification of the economy - the industrial sector remains basic and constrained by an unfavourable investment environment, weak entrepreneur class, undeveloped human capital and high transport and power costs. High oil prices also weakened real GDP growth The economy of Malawi still relies heavily on the agricultural sector. On average it accounts for around 40% of GDP and about 75% of total export earnings. It generates incomes for 84% of the population. Low agricultural productivity and limited investment in the sector compounded with problems of land tenure, reliance on rain, lack of rural credit, inadequate physical infrastructure and poor marketing institutions keep the country s capacity for food production and exports at a low level. The manufacturing sector, which accounts for 10% of GDP, is constrained by small market size, quality issues, high dependence on imported inputs and a lack of competitiveness. Malawi is deficient in many forms of infrastructure. The transport sector is dominated by roads, which accounts for over 85% of total transport operations but their quality hampers free movement around the country. Rail infrastructure is in a poor state. Fuel wood remains the main source of energy. Malawi s electricity supply is unreliable, power cuts and fluctuating power levels are a major problem for manufacturers and act as a disincentive to new investment, while the water and sanitation sector is characterised by an uneven distribution of resources, poor coordination and fragmented institutional arrangements Weak fiscal management was a consistent problem since Until 2004 expenditure exceeded original budget estimates and revised estimates. Total revenue and donors funds (grants and loans) have fluctuated during this time and this unpredictability exacerbated fiscal instability and the subsequent macro crisis. The fiscal deficit widened to an estimated 7.3% of GDP in 2003/04. This fiscal laxity was the main cause of rapid money growth, which fed through into high inflation through much of the decade. This money supply growth, along with high oil prices, has kept prices high lifting average inflation to 11.2% in Malawi s external sector experienced a structural deficit on its current account mainly as the result of a high deficit on the services account. Excluding official transfers, the current account deficit has been over 15% of GDP during the four years prior to Since the end of 2004, donor flows, now that the Government is on track with the IMF, have increased in volume and predictability and provide regular surplus on the current transfers account. This has been in response to macroeconomic performance, which has improved dramatically following the change of Government. 2004/05 was the first fiscal year in over ten years that the Government stayed within the approved budget. Domestic debt and interest payments have come down. All but one of the IMF SMP targets for 2004/05 was met. As a result, the IMF Board approved a new PRGF for Malawi in August This progress was achieved as a result of a strong commitment to fiscal discipline. Subsequently the GoM has progressed through two PRGF reviews. A rise in aid inflows has also contributed to Malawi s strong performance in 2005 and Despite some difficulties, mostly exogenous, the Government has met PRGF targets. Given forward-looking policies and Malawi s steady track record, including achieving enhanced HIPC completion point, an approved Joint Staff Assessment (JSA) of the Annual Progress Report of its MPRS, and completion of the MGDS, it suggests that progress will be maintained Despite a severe food crisis, real economic activity has unfolded largely as expected with the key macroeconomic objectives for the fiscal year 2005/06. Real GDP growth is expected to be 5.3 percent. Macroeconomic performance has been good and the economic outlook for 2006/07 is favourable. According to the latest crop estimates, agricultural output should rebound significantly. Reducing the domestic debt burden will remain the cornerstone of the fiscal strategy. Tax cuts will reduce the tax/gdp ratio but this will be more than offset by expenditure restraint and the underlying fiscal balance will improve. Planned pension reforms will put the pension systems on a sustainable track over the medium term. A flexible exchange rate policy will continue to be

17 implemented, and the authorities will aim to protect their reserve cover. External reserves are projected to rise and better management of the exchange system should prevent the recurrence of arrears. On the basis of the second PRGF review, the IMF and World Bank recommended Malawi qualify for debt relief under the Multilateral Debt Relief Initiative (MDRI). Malawi comfortably met all performance criteria In March 2007, Malawi is due to complete the third review of the Three-Year Arrangement under the PRGF. The Government has made commendable strides in restoring macroeconomic stability. This, coupled with significant debt relief and the launching of the MGDS, provides Malawi with an opportunity to advance an ambitious agenda of structural reform to enhance growth. The second review reached a satisfactory rating. It reviewed the performance under the PRGF program and found that most of the program targets were met for end-june While the targets on government domestic borrowing and discretionary expenditure were exceeded, this largely reflected additional spending on food security toward the end of the food crisis in early Fiscal performance has been sound through September 2006, facilitated by buoyant tax collections. Temporary factors caused some end-september indicative monetary policy ceilings to be exceeded, but in October, the monetary program was back on-track. The government recognizes the importance of deepening reforms to strengthen growth prospects for Malawi. Key elements of the envisaged reform agenda for the coming years include: (i) strengthening economic management capacity, in particular through public financial management reforms and the development of an external debt strategy; and (ii) reducing the cost of doing business and improving financial intermediation. The authorities continue to implement sound macroeconomic policies and adhere to fiscal discipline In reaching HIPC enhanced completion point, on August 31, , Malawi fulfilled all three key conditions of; (i) preparation of a full PRSP and its implementation for at least one year; (ii) a satisfactory implementation of a PRGF - supported program, and; (iii) implementation of key structural and governance triggers. Total debt relief to Malawi under the enhanced HIPC is estimated at US $646 million, in end-1999 NPV terms, this is US $ 482 million and US $ 157 million from multilateral and bilaterals, respectively. In terms of debt sustainability after HIPC assistance, Malawi s nominal debt stock of external debt at-end 2005 is estimated at US $ 2.97 billion in nominal terms and 1.9 billion in NPV terms. IDA and the ADB are Malawi s largest creditors accounting for 65 percent and 14 percent of total outstanding debt respectively. Malawi s external debt after full delivery of assistance under the HIPC Initiative is estimated at US $1.3 billion in NPV terms, equivalent to 245 percent of exports. Voluntary debt relief by bilateral creditors after the HIPC debt relief would further reduce the external debt to US $1.2 billion, equivalent to 229 percent of exports. Despite this debt relief, the NPV of debt to exports ratio exceeds the projected 169 percent ratio by 60 percentage points and the HIPC threshold of 150 percent by 79 percentage points. Debt burden analysis shows that even after full delivery of HIPC assistance, and assuming reasonable export and GDP growth, Malawi s NPV of debt to exports ratio would still be above the HIPC threshold for more than a decade. Furthermore, Malawi s debt sustainability is highly vulnerable to exogenous shocks Upon approval of enhanced completion point debt relief under the HIPC Initiative, Malawi qualifies for further debt relief from the ADF under the MDRI. With the approval of the topping up, the total debt relief under MDRI would amount to US $ 1.47 billion in nominal terms spread over 50 years, with the Bank Group s portion being US $ 253 million. According to latest estimates, after full MDRI relief Malawi s external debt will be $ 450 million, in NPV terms. Overall Malawi s debt situation is within IMF estimates of debt distress, and could rise in the case of 12 Malawi qualified for ADF HIPC assistance on the 15 th November 2006, see Malawi: Completion Point Document under the Enhanced HIPC Initiative ADF/BD/WP2006/124.

18 increases in non-concessional external commercial borrowing. The MGDS reflects the additional expenditures financed by HIPC and MDRI. In addition, according to the IMF, debt forgiveness programs will not have a considerable impact in the short term. Rather, they will have a gradual effect (over the medium to long term). In the short-run, increasing donor resources in the form of budget support will assist with the external debt position. The GoM commitment to create sufficient fiscal space for priority investments, outlined in the MTEF, will require enhanced revenue mobilisation and additional assistance in the form of budget support as well as continued prudent borrowing policies. Enhanced concessional budget support donor flows in the short run, such as this PRSL, are necessary to ensure a sustainable debt stock and to support a sustainable fiscal and external position in the medium to long term. Successful implementation of the PRGF will depend critically on continued budget support. Domestic revenue performance (at 24% of GDP) is already one of the best in the region and is probably close to its sustainable limit Despite positive macroeconomic developments, the country remains poor ($170 GDP per capita); infrastructure is inadequate, there are serious unmet education and health needs, and poverty rates remain high. Many of the reforms associated with market liberalisation have yet to be completed. The country now faces the prospect of further tightening of macroeconomic constraints, a need for institutional improvement to make growth sustainable, an increasing need for better prioritisation and management of public expenditures to eliminate absolute poverty, and large investment in infrastructure to promote growth and further reduce poverty. The MGDS presents a detailed plan to address these constraints and this PRSL will go directly to supporting MGDS priorities. By using the PAF, the PRSL targets critical PFM, macroeconomic and social sector reforms as highlighted by numerous analytical studies, as well as the preceding and forthcoming analysis. In addition, the PAF is consistent with the constraints identified in the Bank Group s Country Governance Profile (CGP) and various sectoral reviews. 3. THE GOVERNMENT S POVERTY REDUCTION AND MEDIUM TERM STRATEGY 3.1 MGDS: Preparation, Goals and Components Malawi s medium-term poverty reduction strategy, the MGDS aims to reduce poverty headcount from 52.4% of population in 2006/07 to 44.4% in 2010/2011. The MGDS centres on achieving strong and sustainable economic growth, building a healthy and educated human resource base, and protecting and empowering the vulnerable. Overall, it is expected that the economy will grow at a minimum annual rate of 6% over the MGDS period. If these growth targets are realised and inequality indexes remain at similar levels, poverty will decrease by 8% by Alongside this overarching objective, the strategy seeks to: (i) decrease the proportion of the population who suffer from hunger; (ii) increase enrolment in primary education to 95 percent by 2011; (iii) integrate targeted programs for women, including business development and microfinance; (iv) decrease child and maternal mortality, the prevalence of HIV/AIDS and malaria, and; (v) increase access to water. 3.2 Envisaged Reforms and the Medium-Term Reform Agenda The MGDS sets out the GoM s poverty reduction strategy within five main themes: (i) Sustainable Economic Growth; (ii) Social Protection and Disaster Risk Management; (iii) Social Development; (iv) Infrastructure Development, and; (v) Improved Governance. Theme 1 Sustainable Economic Growth is a key to realising economic growth in the longer term, taking away the constraints to growth and increasing employment in the medium term. By identifying key areas of development and growth, reducing the cost of doing business, and increasing access to land and privatisation, it will contribute to an enabling environment for private sector development.

19 Theme 2 Social Protection aims to protect the most vulnerable by increasing the assets of the poor, enabling them to engage in economic development activities whilst reducing the impact of disasters and building a strong disaster management mechanism. Theme 3 Social Development is centred on the basic conditions for economic growth and poverty reduction, such as providing essential healthcare and strengthening service delivery, improving the quality and access to education at all levels and promoting gender equity. It includes agreeing a collective action framework for HIV/AIDS, one national coordinating authority and a country level monitoring and evaluation system. Theme 4 Infrastructure Development including transport infrastructure linking production and markets and reducing transport costs, providing reliable, sustainable and affordable energy and providing an accessible and efficient telecommunications system. Theme 5 Improved Governance includes the following objectives: sustaining macroeconomic management, strengthening public policy formulation, improving service delivery and accountability at the local level through decentralisation, developing a strong justice system and the rule of law, establishing an institutional setting for good corporate governance and promotion of human rights Within these six main themes the Government has committed to undertake a number of key activities. In order to enable Sustainable Economic Growth the Government has committed to focus on a number of key sectors, including Mining, Manufacturing and Fisheries. This includes strengthening the institutional capacity of the Geological Surveys to provide the private sector with the requisite information on mineral resources and increasing the investment by private sector companies. In terms of manufacturing it will reduce the cost of doing business by streamlining the business registration process and tax policies. It will enhance the capabilities of the Malawi Bureau of Standards. In terms of providing the requisite infrastructure the GoM intends to increase access to reliable electricity, water and improved transport through direct investment and privatisation and to focus on regional linkages. It intends to increase the provision of microfinance and land registration and provide tax reforms for small businesses. To facilitate exports, the Government will streamline customs regulations, harmonise rates with cross border neighbours and improve the provision of information for exporting firms. In order to increase the productivity of rural communities and increase economic empowerment the Government will develop rural cooperatives, strengthen the policy environment for rural microfinance and innovative credit schemes as well as offering vocational training for small businesses whilst explicitly targeting women Social Protection remains a necessity as there is a significant proportion of Malawians that are still chronically vulnerable. Social protection strategies will include measures to decrease the risk of shocks and strengthening resilience to shocks. The main activities will include undertaking public works programmes in targeted vulnerable areas, whilst providing capital for income generating activities through the Malawi Rural Development Fund. The Government will also strengthen the institutions responsible for disaster risk management and institute risk management mechanisms, including early warning systems Social Development remains a corner stone of achieving sustainable economic growth and as such the Government will target specific activities within Health and Education including integrated gender programmes. Key activities include increasing the retention of health workers through targeted incentive programmes, increasing the availability of drugs, improving health care facilities through construction and the upgrading of existing health care facilities. It will expand its comprehensive health services package across the country as well as enhance current programmes, including increasing the awareness and challenges of HIV/AIDS. In the education sector, the Government has plans to rehabilitate existing schools and build additional school infrastructure. It includes plans to train more teachers, review the school curricula and improve the facilities available to teachers. The Government will also undertake affirmative action to increase participation of women in specific sectors.

20 3.2.5 Infrastructure is identified as one of the key prerequisites for economic growth. It envisages key investments in roads, transport, energy and water and sanitation. It will promote competition in the air transport industry and improve the operational efficiency and commercial viability of existing railway infrastructure. In terms of the provision of roads, the upgrading of the road system will be undertaken by key investment programmes for new and important inter-regional road networks. It will ensure additional electrification and accelerate regional interconnectivity through the construction of hydro power stations The Government acknowledges explicitly that successful implementation of the first four themes depends much on the prevalence of good governance. Key activities in these areas include adherence to the budget as prescribed in relevant public financial management acts, including the Public Audit Act and Public Procurement Act, in order to improve budget monitoring and evaluation. It will improve public access to timely and accurate information through community information centres. It will enact and enforce anti-corruption legislation and train specialised personnel in the field of corruption and fraud whilst strengthening the capacity of the ACB, Auditor General and Accountant General. In terms of fiscal management it will eliminate extra budgetary resources and continue implementation of the IFMIS system. 3.3 Programme Costing and Financing Requirements The Government s financing requirements for the MGDS period as well as the 2007 and 2008 period can be derived from projections in MGDS and the Medium Term Expenditure Framework (MTEF), which has programmed in expected debt relief (see Table 2). The projected gap in resources through the MGDS cycle retains a heavy reliance on external aid as part of the total resources available to the Government. It is anticipated that the value of external funds, as a percentage of GDP, will remain significant from 2006 onwards, with a slightly decreasing trend. Table 2 presents the medium term financial envelope and the need for external resources (in millions of US $). Table 2: Financial Envelope and External Resources (US$ million ) 2005/ / / / /10 Total Expenditure Needs Domestic Resources/Revenue Principal External Resources Budget Support (PGBS) Grants Loans Project Financing Grants Loans as % of GDP Total Resources State revenues External Resources Grants Loans Source: Ministry of Finance, MGDS, MTEF and estimates The expenditure needs for the 2007/08 budget cycle is as follows. In 2007/08, total expenditure needs are projected at $1.16 billion. Government will utilise its own resources amounting to $754.9 million and require external budget support amounting to a minimum of $118 million (of which approximately $21.4 million are ADF funds). Additionally, $287.8 million are external project activities. Any remaining gap, or in the absence of this PRSL, will have to be financed through domestic borrowing, which could have implications for sustainable debt levels.

21 The split between the use of loan and grant resources are presented above, although all loans are provided on a highly concessional basis Taking into account projected government resources from all sources and total expenditures there will remain a significant financing gap in Malawi in the medium-term. The proportion of external funds subject to the budget process, and the level of discretionary expenditure in the budget have increased. More fundamentally, the level of funds allocated as general budget support have increased from around $48 million in 2004/05 to $85 million in 2006/07, and are scheduled to be $118 million in 2007/08 (see Table 3), including those of the Bank Group. In terms of the percentage of total external aid (including non-cabs members) as programme or budget support, in 2005/06 around 15% went in DBS, although these proportions are likely to be even higher in 2006/07 and 2007/08. In terms of CABS donors approximately 33% of aid went as Partnership General Budget Support (PGBS) in 2005/06. Current projections for 2006/07 indicate 35% aid will go in budget support. Therefore, the amount allocated to this PRSL is consistent with other CABS donors. Table 3 presents Budget Support Disbursements and Pledges from 2004/05 to 2007/08 (current indicative commitments), reflecting the increase in budget support being provided to Malawi. Table 3: Budget Support Programme Disbursements and Pledges ( ) Direct Budget and Balance of Payments Support USD USD USD USD 2004/ / / / / /07 % of Aid in GBS to GoM % of Aid in GBS to GoM ADB EC Norway United Kingdom World Bank * * 25 * Total CABS Source: CABS Review and Ministry of Finance, Annual Debt and Aid Report (2006). + The ADB figure represents the average over the ADF X cycle. * World Bank s commitments for 2006/07 and 2007/08 subject to Board Approval in May/June Direct Budget Support Figures do not include funds provided as emergency food relief during 2005/ It is important to emphasise not only the recent completion of the MGDS but also the significant improvement in implementation of the MPRS as assessed by the World Bank and IMF s Joint Staff Assessment (JSA). The third annual JSA progress report of the MPRS was produced in August It concluded that despite resource constraints, MPRS implementation during the review period (July 2004 December 2005) had improved significantly compared to the first two years. It noted the successful macroeconomic performance underpinned by a Fund SMP and later by the PRGF. Despite being constrained by a large domestic interest bill inherited from the past and food related expenditures in the wake of a drought, substantial progress was made in implementing MPRS priority activities in agriculture, education, health, safety nets, public expenditure management, public sector reform and corruption prevention. In addition, budgetary allocations earmarked for pro-poor expenditures were released timely and fully. Staffs commended the authorities for this satisfactory progress and for continuing to implement priority activities The JSA for the MGDS concluded that it differs from its predecessor, in that compared to the MPRS, Government ownership of the MGDS has been stronger and that it is a development strategy driven by a domestic process. The Government views the MGDS as the primary vehicle for driving its structural reform agenda to enhance growth and reduce poverty. In this, it places a greater emphasis on the role of economic growth in poverty reduction and has improved on the 13 Malawi: Poverty Reduction Strategy Paper Third Annual Progress report Joint Staff Advisory Note, IMF County Report No. 06/339.

22 results framework. The JSA report noted continued commitment to a sound macroeconomic framework in line with the economic programme supported by the PRGF arrangement. It also welcomed the continued commitment to reducing domestic debt as a means of creating the fiscal space for other fiscal priorities and redirecting financial resources towards private sector growth. It noted that the MGDS, although ambitious, provides a framework for the Government to achieve a significant reduction in poverty. The review importantly noted that meeting the objectives of the MGDS will require a substantial increase in external financing to supplement Malawi s low domestic savings, and to date, donors have not committed to scaling-up aid flows. This PRSL, in conjunction with the increasing provision of budget support by other donors, directly addresses the identified financial need within the MGDS and by the JSA The MGDS has a clear and focused plan for promoting key economic and institutional reforms, and the IMF and World Bank JSA have officially reviewed and endorsed the new MGDS, as well as assessing original MPRS implementation as satisfactory to qualify for enhanced HIPC relief. The review concluded that the MGDS broadly provides a comprehensive framework for growth and poverty reduction in Malawi and that: (i) the MGDS has built on the experience of MPRS, with a substantial increase in participation; (ii) the GoM took a clear leadership role and there was strengthened domestic engagement; (iii) the MGDS is better integrated into domestic processes and emphasises continued and strengthened partnership with domestic stakeholders and the international community, and; (iv) the quality of poverty diagnosis has improved and the MGDS is judged consistent with sectoral strategies and programs. It is based on a financial envelope supporting both capital and current expenditures, (as articulated in the MTEF) with plans to develop clear and monitorable implementation mechanisms (see Section 5.5). 4. ASSESSMENT OF THE PREREQUISITES FOR DIRECT BUDGET SUPPORT 4.1 Government Commitment and Political Stability After 30 years of one-party rule, multi-party democracy was ushered into Malawi with the adoption of a new constitution and elections in The presidential election was won by the United Democratic Front (UDF). The ten-year era of the UDF was characterised by political competition and wrangling, as well as weak governance that led to an unstable macroeconomic situation. The subsequent May 2004 presidential election was won by a hand-picked UDF candidate who was expected to follow the party s advice, securing 36% of votes cast on a turnout of 54%. In the concurrent legislative election, the UDF came second to the Malawi Congress Party, forcing the newly elected president to co-opt some opposition parties to join his UDF members to gain a governing majority in the 193-seat Parliament. Subsequently, the president fell out with the UDF due to his policy of zero tolerance for corruption and insistence on the rule of law. He therefore resigned from the UDF to set up his party, the Democratic Progressive Party, in February The current Government has made clear its commitment to reforms in promoting good governance, sound economic policies and institutional capacity building. Consequently, macroeconomic performance has improved markedly since it took office. In spite of this, the Government faces challenges in developing political institutions, policy decision-making and implementing capacities, efficient delivery of public services and coping with exogenous shocks. The Government is increasingly focusing on these constraints by working with donors to overcome the challenges. The provision of budget support is therefore justified given the Government s strong and continuing commitment to sound governance, fiscal discipline and poverty reduction. The peaceful conclusion of the third Presidential and Parliamentary elections held in 2004 attests to the continued stability of Malawi s political situation and therefore satisfies this prerequisite.

23 4.2 Macroeconomic and Financial Framework With regards to the macroeconomic reform effort, as outlined elsewhere in this report, Malawi has made remarkable progress since the fiscal crisis of The IMF will conclude its third review under the PRGF arrangement in March The main conclusion of the first review was that performance in 2005 was generally satisfactory. Malawi met all the quantitative and structural performance criteria for It also met all indicative targets, except one on the wage schedule which was duly completed in early In August 2006, Malawi completed the second review successfully, with all quantitative performance criteria met. While structural targets on government domestic borrowing and discretionary expenditure were exceeded, this largely reflected additional spending on food security toward the end of the food crisis in early Under the third review period of the PRGF, the Government has made commendable strides with economic reforms and continues its improvement in macro-economic performance. Fiscal performance has been sound through September 2006, facilitated by buoyant tax collections. Temporary factors caused some end-september indicative monetary policy ceilings to be exceeded, but in October, the monetary program was back on-track. External vulnerability will be reduced as a result of HIPC and MDRI and increased donor budget support. Given the significant progress in this area and continuing reform efforts the Government presented in the MGDS within a MTEF, Malawi meets this prerequisite for budget support. 4.3 Institutional Capacity The capacity of the Government in terms of human and financial resources, institutions, systems and processes is critical to the implementation of Malawi s MGDS and hence this programme. Malawi s recent reform programme started from a very low position, with low economic activity and very weak institutional capacity in the public sector. As a result, implementation of the MPRS was slow. The situation has improved in recent years and the final JSA review of implementation of the MPRS was deemed satisfactory, especially in areas of institutional capacity. Increasing technical assistance provided to the GoM, is improving institutional capacity from a low base. Levels of educational attainment are relatively low and few professionally qualified individuals are choosing the public sector for their careers. An important aspect of future support to the government should therefore include capacity building, particularly for the institutions directly involved in the implementation of the reform programme. Outside the major cities, public sector capacity is low, is being eroded by HIV/AIDS and public services are rudimentary. The generic problems facing the public sector in Malawi have a clear negative impact on the GoM s capacity to deliver basic services to all Following years of neglect under the previous Government, the generic weaknesses in state capacity include lack of economic and technical expertise in the public sector. This seriously undermined the government s capacity to develop evidence-based sector strategies or deliver services. Rural areas are particularly poorly served. The current President s first action to improve the efficiency of Government concentrated Government departments in the capital and reduced their number. The Ministry of Finance introduced an improved and comprehensive pay policy. The Emergency Human Resources Programme is an experimental approach to resolving binding human resource constraints. It is a model for all sectors, and will have an impact where appropriate sector policies and finance are in place. Donors have responded and now finance more than fifty capacity building projects Notwithstanding these weaknesses, the Government demonstrated ownership and a high level of commitment to implementation of donor programmes by taking all necessary steps to meet budget support loan conditions since It is now managing a developed and detailed coordination system of PGBS. Although institutional capacity remains low, significant progress has

24 been made with targeted donor interventions. There is a donor group focused solely on the effectiveness of technical assistance, and an increasing number of donor capacity building projects. Within the Ministry of Finance, the Executing Agency of this Programme, there are more than ten technical assistance projects. The ADB currently have a project in the pipeline to address capacity constraints at the district level. Given this is the third DBSL operation in Malawi, and the first within the MGDS and CABS framework and the increasingly detailed system of PGBS, the Government has the capacity to satisfy this prerequisite. Moreover, where institutional capacity is weak there is a donor and government process to identify and coordinate support where necessary. The Government has initiated a Joint Country Portfolio Review directly after the CABS review where the needs and plans for coordinated institutional support will be formalised. It is now coordination of technical assistance that remains important in Malawi. 4.4 Fiduciary Arrangements and Analytical Underpinnings A number of recent analytical assessments of the fiduciary and governance situation in Malawi have been completed, which provide the analytical underpinnings of this PRSL and the PAF 14. This includes a Country Procurement Assessment Report (CPAR), a Country Governance Profile (CGP) and, most notably, an overarching PFM review using the Public Expenditure Financial Assessment (PEFA) methodology. A Public Expenditure Review (PER) is close to completion and will be ready for dissemination and integration into the 2007/08 budget With regards to procurement, a CPAR was completed and agreed by the Government in It made several recommendations to address weaknesses in the procurement system. It concluded that the Government made good progress with establishing a new, and relatively good, legal framework for procurement reform. It noted that implementation had been slow in terms of the institutional and practical oversight of the procurement system. It noted delays in the procurement process, insufficient capacity and procurement management. It concluded that Malawi remained on a positive path and commended the plans to set up an independent ODPP as well as its plans to decentralise procurement authorities to implementing agencies through Internal Procurement Committees and the establishment of a cadre of public procurement professionals. Despite the lack of capacity and knowledge and the weak enforcement of existing rules, the review concluded that the overall risk, compared with other African countries is average. It presented a detailed action plan, which has been enhanced by the PEFA review and incorporated into GFEM and the PAF. The PEFA review conducted in 2006 concluded that procurement systems have been strengthened further since Key actions include the creation of the ODPP and public procurement units within each Ministry. The legal framework for Procurement was deemed to be robust and critically the ability to review and audit procurement activities exists The PEFA PFM review provided a detailed review of the current status of PFM reforms and processes as well as a comprehensive overview of reforms and perspectives for The objective was to provide a benchmark against which to track progress in PFM performance over future years and to permit comparisons with other countries undertaking PEFA assessments. Moreover it provided a comprehensive evaluation of the priorities and the optimal focus of efforts in PFM. The report made a number of significant conclusions including the acknowledgement that since 2004 there have been major improvements in PFM systems, which have served to establish the essential legal and institutional structure for PFM. It noted numerous improvements whilst presenting some challenges and recommendations. It shows that progress is being made in a number of important areas and that these are beginning to have an impact. Although some parts of the review of the previous PEFA Assessment cannot be directly compared, of the 30 comprehensive indicators used to assess a country s PFM system 19 have improved, 7 have remained the same and 4 have shown a 14 Annex IV provides a detailed fiduciary review.

25 slight decline. Overall, PFM systems have improved sufficiently to qualify for HIPC. Moreover, they have improved since the provision of previous Bank Group PBLs Overall, in conclusion, the budget is an increasingly credible document in the sense that out-turns are more closely consistent with the initial approved budget. This is an essential first requirement of any PFM system and is also reflected in the generally sound macroeconomic performance of Malawi. In terms of Budget Credibility, prior to 2004/05, the GoM budget was characterised by a lack of effective control over Ministry spending, failure to reduce expenditure in line with reduced inflows of donor support, together with high levels of politically-driven expenditure. This tended to result in high levels of domestic debt and arrears. These trends have been reversed with the new Government that came to power in 2004 largely through the implementation of the new accounting system IFMIS and the introduction of tighter payment controls. In terms of the Comprehensiveness of the Budget, improvements have been made through the introduction to the Chart of Accounts and through the introduction of IFMIS. There have been improvements in the comprehensiveness of the budget documents produced by the GoM. The review stated that a structured, rules-based system of determining allocations amongst intergovernmental bodies is being applied and that the system of Policy Based Budgeting exists and is the basis by which the Ministries provide their estimates to the Ministry of Finance. In terms of the predictability and control in budget execution, it found the effectiveness of controls within the taxpayer registration and tax assessment systems have improved. It found that the current system to assess the predictability in the availability of funds for the commitment of expenditures works well. IFMIS, together with the centralisation of the payments function, appears to have resulted in significant improvements in the timeliness and regularity of the account reconciliation systems. All IFMIS transactions are now paid through only five core bank accounts held at the Reserve Bank. Budget execution and the reporting picture at a national level appears to have improved as a result of the production of two budget execution reports at monthly intervals (or on demand) by IFMIS Despite clear improvements, the report highlights areas where the quality of the PFM systems could improve. This includes GoM s ability to ensure that resources are allocated to defined priorities and to guarantee that there is value for money in public spending. The report was concerned about long delays in the production of Annual Assembly Accounts, despite improvements resulting from the introduction of a team of experts to bring all Assembly accounts up to date by August Concerns also remain about public and stakeholder access to key fiscal information. The current documentation remains very detailed and, although fiscal information is published in the newspapers and is available on the Government website, it is not comprehensive. It noted the lack of direct link between the Human Resources Management Information Systems and IFMIS to enable more effective controls to be exercised over payroll expenditure. Improvement is required to increase the effectiveness of existing payroll control systems. The report concluded that the effectiveness and comprehensiveness of internal and external auditing is an area where improvements are necessary, although it acknowledged staff are applying the GoM s systems of internal control effectively. As such, the quality of individual audit reports should improve. The report identifies only marginal progress in external auditing mainly due to limited capacity, although the National Audit Office has made progress There remain high levels of off-budget spending, particularly from external project finance, which continue to create problems for the integrity of the budget and for the effectiveness of treasury management systems. Off-budget projects also undermine the ability to plan strategically and to cater for recurrent costs effectively. Given the emphasis on harmonisation and alignment, this is especially disappointing and reflects poorly on Malawi s DPs. Rhetoric needs to be turned urgently into concrete actions to improve donor practices and raise the predictability of both budget support and project support to the Government.

26 4.4.7 Government actions, within an agreed PEFA PFM action plan, and important benchmarks to address the constraints listed above are included in the PAF. Therefore this PRSL will assist in these key areas as well as other weakness identified in the report. The GFEM and PAF have specifically taken into account the recommendations from the PEFA review. This PRSL is also the first step to improve the predictability, harmonisation and alignment of the Bank Group s support. Although weaknesses remain in the public financial management systems, they are increasingly being strengthened in a coordinated and systematic way. This is evidenced by the increasing reliance donors are placing on Budget Support. They are deemed satisfactory for ADB s continued provision of budget support in Malawi. Overall, as outlined by the Fiduciary Risk Assessment in Annex IV, PFM systems are of average standards compared to other countries where budget support is being provided. Overall PFM systems in Malawi are becoming increasingly robust, the Government has a credible reform programme through its Financial Accountability Action Plan (MFAAP) and Corruption within the PFM system is being addressed within the MFAAP and PAF. The PEFA Assessment concluded that the plan for reform is credible and the Government has embraced a framework that allows progress to be assessed on a regular basis, with conclusions being integrated into the MFAAP. Significantly, the provision of direct budget support by donors has increased from $50 million in 2004/05 to over $100 committed in 2007/08. This reflects increasing confidence in PFM systems and reflects improvements made in the area of Fiduciary safeguards within national systems The African Development Bank, in 2004, completed a CGP for Malawi 15. It was carried out and structured in accordance with the five elements of good governance emphasised in the Bank Group s Policy on Good Governance, namely: Accountability, Transparency, Stakeholder Participation, Legal and Judicial Reform, and Fight against Corruption. The review concluded that accountability of government institutions remains inadequate and corruption is of concern. As with other African countries, the State is over-extended and faces difficulties in delivering services. The Public Sector Reform Program requires more practical implementation. Illiteracy and poverty are the main factors that limit Stakeholder Participation whilst the accountability and operational efficiency of local government is low. Parliament is expected to become more active in regard to the GoM s overall Legal and Judicial reform process. The main concern is the inefficient functioning of the courts, as a high percentage of processes were not concluded due to lack of budget, capacity constraints, insufficient judges as well as corruption within the system During the past two years, the GoM has made progress in combating corruption. Much will rest on continued implementation of Anti-Corruption Initiatives. The CGP concluded that the Bank Group should channel support to good governance through budget support or institutional capacity building. Since the completion of the CGP, in 2004, significant progress has been made, including the convictions of senior Government officials. The ACB was established and continues to make institutional progress. The number of concluded cases continues to rise, and the backlog has been cleared. A recent survey suggests that ACB is performing well. 60% of households interviewed ranked ACB as having effectively contributed to fighting corruption, second only to religious bodies. More than 80% of households and public officials surveyed believe that the current government has a genuine desire to fight corruption. These are high ratings compared to other countries. This PRSL embraces and addresses a number of these key recommendations. The CGP assisted the Bank Group during the CABS dialogue process. Specific benchmarks on decentralisation, anti-corruption and legal and judicial reform are within the PAF. 15 Malawi: Country Governance Profile Report, ADF/BD/IF/2004/66.

27 4.5 Donor Coordination and Partnership MGDS aid coordination is undertaken at the sector and national levels. The MGDS provides a framework for all donors interventions in the country over the medium-term. The MGDS provides a similar framework to that of the MPRS. Harmonisation of donor interventions under the MPRS and the MGDS has been assisted by the participatory processes of both strategies. In addition to the frameworks of the MPRS and the MGDS, Round Tables and National Workshops are also frequently organised to discuss sectoral and thematic policy issues. Moreover, there are regular meetings held by donors resident in Malawi, especially the CABS and the GFEM. They have agreed on a joint program for providing budget support and a Joint Framework. Until now the ADB has observer status, but through the signing of the JF and provision of this budget support, it will become a full member. This budget support program is aligned with MGDS priorities and will increase donor coordination, harmonization and alignment. Malawi is perceived to have an embryonic but progressively harmonised framework for the provision of DBSL Consequently the Government and other DPs are encouraging convergence of intervention instruments and are starting to increase the use of DBSL in the context of the CABS and PAF mechanisms. DPs provide support within this framework and it is the intention of the Bank Group to provide its budget support operation within the PAF framework. In response to the harmonisation initiatives taking place in Malawi, the Bank Group, being signatory of the Paris Declaration on donor harmonisation, has committed itself to the harmonisation and alignment efforts being made by the Government and DPs. The commitment will be manifested through implementation and reporting against CSP targets and providing UA14.9 million in DBSL. The Bank Group also notes the fact that alignment and harmonisation requires not only strong participation in joint instruments with other DPs, but full participation in donor and country dialogue. As such the Bank Group will increase its participation in country dialogue, through the newly established Country Office and increased provision of DBSL in the future. 5. THE PROPOSED POVERTY REDUCTION SUPPORT LOAN 5.1 Objective and Resources Available The Bank and the Government agreed that the Bank should provide DBSL together with other DPs within the context of the ongoing harmonisation framework (MGDS, PAF and JF). The GoM requested that the Bank Group use the CABS process to disburse funds in the first quarter of the Malawian fiscal year 2007/08. The Bank Group is planning to follow the JF rules and commit its budget support to 2007/08 at the Joint Review of March The CABS donors have expressed a preference for this arrangement. This one-tranche PRSL is consistent with the Bank Groups, Guidelines on Development Budget Support Lending 17, to move to an ex ante performance-based multi-year DBSL that assures regular inflow and predictability of resources to facilitate the implementation of PRSPs and National Development Plans 18. The Bank s objective in continuing to provide Budget Support to Malawi is to align as much as possible with the country s budgetary and accountability systems, including the budget cycle, under ADF X, and to harmonise with the efforts by other development partners, so as to: (i) (ii) Further enhance ownership and effective implementation of the country s poverty reduction initiatives in MGDS; Increase the predictability and efficiency of the Bank s assistance to Malawi; 16 For a detailed history of the Harmonisation Framework in Malawi, see Annex V. 17 Guidelines on Development Budget Support Lending, ADB/BD/WP/2003/145/Rev Guidelines on Development Budget Support Lending, p2.

28 (iii) (iv) (v) Further strengthen the country s fiscal transparency and accountability by participating in the ongoing Public Finance Reforms and to promote allocative efficiency in public spending; Increase the Government s institutional capacities in fiscal planning, implementation, monitoring and evaluation of its programmes, and; To respond to a specific request from the GoM whilst reducing the administrative burden on the Government whilst at the same time increasing the profile of the Bank Group amongst DPs The main benefit of the operation is to help the GoM make further progress in reducing absolute poverty, improving delivery of services and accelerating progress on the MDGs. It is aligned with the direct budget support programs of four other donors and ensures a joint focus on the priorities set out by the Government in its comprehensive poverty reduction strategy and on a common set of indicators to measure progress. The resource flow and improved aid effectiveness should accelerate progress towards the MDGs. Furthermore, through the PAF indicators, the operation will help the Government maintain macroeconomic stability while pursuing an ambitious reform agenda that cannot be fully financed from domestic sources In accordance with the CSP under the revised ADF X allocation and lending programme, the policy based resources amount to UA 14.9 million and will be part of the direct budget support that will become available to Government during 2007/08. The increase in country allocation reflects an increase in CPIA and improved policy environment from 2004 to Malawi has progressed under the CPIA rating from a poor policy environment to a medium policy environment. Reflecting this increase in performance, the additional funds allocated to Malawi under the PBA have been allocated to DBSL. This DBSL will represent a significant operation with measurable impact on poverty. It will raise the profile of the Bank Group and assist in deepening the harmonisation process. The programmatic policy - outside of investment operations between the Bank Group and the GoM is now starting to take place through the increasing participation in working groups and the CABS structures. This new approach by the Bank Group of seeking consensus among partners and with the Government rather than carrying out a separate policy dialogue is in line with the PD. With this operation and the opening of the Country Office, the ADB should become a critical aid partner and lead voice within the donor community in Malawi. 5.2 Description of Areas of Focus of the PRSL Increasingly PAFs are being used by DPs and Regional Member Countries as a focal point for dialogue and as the basis of disbursement of budget support funds. One of the distinct conclusions from the recent OECD DAC review of General Budget Support 19 is that PAFs play a valid role in seeking to operationalise National PRSPs and it is important that they converge with national systems. Increasingly PAFs are becoming a subset of PRSP matrices and hence solidify monitoring and implementation. In the case of Malawi, the PAF is now becoming the focal point for donor decisions on budget support. The commitment, to disburse on the basis of a common PAF assessment places no additional transaction costs on the Bank Group or the Government, as all reviews and disbursement decisions are based on a joint assessment. Given that the Bank Group participated in the last CABS review and mid-year review, where the PAF matrix was formulated, this is a more suitable mechanism on which to base disbursement. The Bank Group helped define the appropriate indicators in the PAF and ensured alignment with ADB priorities. It allowed the Bank Group to influence a wider set of benchmarks within the 2006 PAF. It represents a significant commitment by the Bank Group in Malawi, as this would be the first DBSL operation to be 19 Joint Evaluation of General Budget Support , OECD DAC, April 2006,

29 designed through the PAF framework. It is aligned with the commitment to mainstream harmonisation in the Malawi CSP and consistent with the CSP indicators. A one-tranche operation, using general progress against the PAF will allow the Bank group to disburse early in the Malawian 2007/08 fiscal year which will aid government planning in the short-run, help address the cyclical nature of revenues and place little additional burden in terms of capacity in the medium term. The PAF is consistent with the CSP projected indicators and objectives (see Annex III for the 2006 PAF and Programme Matrix for a summary of the expected outcomes). Objective 1: Macroeconomic Stability and Public Expenditure Management Reform Key Activities The key activities as articulated in the MGDS and PAF which will achieve the outcomes listed below include; (i) ensuring the composition of expenditure out-turn compared to original approved budget remains within a minimum bound; (ii) reconciliation of the payroll with personnel data; (iii) internal audit operational and covering 50% of primary expenditure, and; (iv) a consolidated GoM statement submitted for external audit and entities representing 50% of expenditures audited. Objectives and Performance Benchmarks Variance in expenditure composition exceeds overall deviation in primary expenditure by no more than 10% and in pro-poor primary expenditure by no more than 5% Payroll for FY 07/08 is supported by full documentation for all changes made to personnel records on a monthly basis Consolidated GoM statement is submitted for external audit within 6 months of the end of financial year Central GoM entities representing 75% of expenditures are audited Outcomes The main outcomes in this area include; (i) continued macroeconomic stability through the PRGF; (ii) increased budget implementation and compliance with original objectives; (iii) proportion of national budget spent on pro-poor expenditure increases, and; (iv) improved coverage and function of internal and external audit. Objective 2: Developing Human Capital and Institutional Capacity Key Activities The key activities prioritised in the MGDS within this objective include; (i) training and hiring more teachers; (ii) building and rehabilitating new and existing schools; (iii) reviewing the school curriculum; (iv) increasing the retention of health workers, and; (v) increasing the provision of drugs and improve health care facilities. Objectives and Performance Benchmarks Pupil per qualified teacher ratio in rural primary schools at 75:1 Female literacy rates increased to 60% Retention rates in primary education at 51% for boys and 50% for girls Proportion of one-year old children immunised against measles to 86% Proportion of birth attended by skilled health personnel increased to 50% Nurse population ratio increased to 1:3700 Outcomes The main outcomes in this area are: (i) upgrading schools to minimal physical standards; (ii) increase in qualified teachers; (iii) increase in pupils passing the Malawi School Certificate of Education (MSCE); (iv) increase in girls passing the MSCE; (v) increase in the number of

30 deliveries attended by health workers; (vi) reducing maternal mortality, and; (vii) reducing child mortality. Objective 3: Improving the Policy and Institutional Framework for Governance Key Activities The key activities within this objective are; (i) clarification of policy on local elections; (ii) increase the number and percentage of corruption cases completed; (iii) and increase in the number of Ministries complying with quarterly reporting to ODPP, and; (iv) recurrent expenditure to Governance institutions maintained in real terms. Objectives and Performance Benchmarks Satisfactory implementation of the MGDS as assessed by JSA progress reports Continued compliance with the Constitution on local elections for 2009 Average number of months for corruption cases to be completed at 12 months Number of corruption cases completed within 12 months to reach 60% All Government Ministries comply with quarterly reporting to ODPP Actual real recurrent expenditure to Governance institutions for 2006/07 maintained at 2004/05 levels Outcomes The outcomes in this area are: (i) a reduction in the incidence of corruption; (ii) an increase in the implementation of the rule of law, and; (iii) an improved response and effectiveness of the judiciary. 5.3 Implementation Schedule The proposed PRSL will be implemented over 12 months from the date of Board approval. The indicative implementation schedule for the PRSL is as follows: Activity Time Frame Board presentation April 2007 Loan effectiveness April 2007 Release of tranche July 2007 Supervision and Mid-year CABS Review September 2007 Closing and PCR March 2008 The Bank s supervision of this DBSL operation will be aligned with supervision of the joint Direct Budget Support Program of the CABS process in Malawi. To reduce transaction costs for the Government, the Bank Group will carry out all supervision jointly with the other donors. The Bank Group mission will utilise the annual Joint Reviews of the PAF in March and September each year. These reviews will be both forward-looking to assess the appropriate benchmarks for the following year plus appraise whether progress against the PAF has been satisfactory to enable disbursement. In addition the supervision of this DBS operation will be done on a continuous basis in harmonisation with other direct budget support donors through the Bank s office in Malawi. The proposed DBS operation will follow disbursing and auditing procedures per the Joint Framework agreed amongst the CABS donors. This PRSL operation will be disbursed and audited accordingly.

31 5.4 Disbursement To facilitate disbursement and effective monitoring of the loan, the Bank will disburse funds in a foreign exchange account indicated by the Government and held in the name of the Reserve Bank of Malawi. The Reserve Bank will promptly credit the counter value in Kwacha to the Consolidated Malawi Government Account of the Ministry of Finance. The Reserve Bank will immediately acknowledge receipt of the foreign exchange funds, in writing, to the Bank Group. The Government will immediately acknowledge receipt of the Kwacha counter value on the Government account to the Bank Group. The proposal to use one tranche is based on the need to disburse in the first quarter of the subsequent fiscal year, which is consistent with the CABS principles and international best practice. The financial requirements are based on those articulated in the MGDS and the MTEF. This will enable the Government to smoothly execute its budget in early 2007/08. This supports the Treasury Plan to enhance planning processes. It is in light of these considerations that the PGBS donors align their support early in the fiscal year. 5.5 Monitoring, Evaluation and Audit The Government and donors have developed an institutional mechanism to monitor the impact of the MGDS and Budget Support. The system for monitoring the impact of budget support is centred on the dialogue between GoM and the CABS donor group 20. The CABS group established a Joint Framework 21 for Budget Support Cooperation between the GoM and donors. Six-monthly joint reviews of GoM macroeconomic, budget and public financial management performance have been undertaken regularly since Review findings are presented in joint aide-memoirs. The JF provides for a PAF, comprising set of agreed indicators for measuring progress towards poverty reduction and better governance derived mainly from the GoM s Monitoring and Evaluation (M&E) framework and the Public Expenditure and Financial Accountability (PEFA) framework. The March 2006 CABS Review, in which the ADB participated, was the first to assess GoM performance and base budget support disbursement on the basis of the PAF. Increasingly the PAF is being used as the basis of donor disbursement. The JF provides jointly agreed terms and procedures for budget support to the MGDS Programme and serves as the coordinating framework for consultations with the Government, for joint reviews of performance, reporting and auditing. The donors base their support and measure progress using indicators drawn from the MGDS and articulated in the PAF Donors are supporting the Government to implement a robust nationally-led M&E system. This includes support to Government leadership in implementation of its M&E Action Plan and development of a Statistics Master Plan. The monitoring of the MGDS will be in accordance with the monitoring and evaluation Master Plan developed by the Ministry of Economic Planning and Development, the Ministry of Finance, the Ministry of Local Government and Rural Development and the National Statistics Office. In parallel to this, the Government worked with the external partners to develop a single plan of actions for the partnership, with a tight prioritised set of actions and indicators. The PAF Matrix is assessed during donor annual and mid-term reviews and through quantitative and qualitative poverty analysis. Monitoring of this PRSL will be undertaken within these processes The proposed loan will follow disbursing and auditing procedures as per the JF. The JF provides details of the disbursement and auditing arrangements as agreed and signed by the CABS. As the loan will support the Government expenditures under the budget, procurement will follow Government processes. The recent PEFA highlights improvements in the GoM s procurement 20 The CABS currently comprises the EU, Norway and DFID. Germany, The World Bank and the ADB are observers. This operation would move the ADB from observer status to full membership. 21 The ADB has signed the JF and will become full members during the CABS Review in March 2007.

32 process. The Government will furnish all Donors with copies of the annual report of the Auditor General on the Public Accounts. The annual report will be presented to the Donors promptly after the submission by the Government of the annual report to the national parliament. Donors may request the Government to arrange for an audit of selected components or samples from the accounts, by an auditor acceptable to the Donors. 6. JUSTIFICATION, IMPACT AND RISKS 6.1 Justification, Benefits and Rationale for Budget Support in Malawi The rationale for Budget Support in Malawi is clear. This budget support operation has been designed in light of recent evaluations of budget support 22. See Annex II for a detailed summary of these findings 23. An increasingly important factor in explaining the increase in PGBS is the relationship of trust that is being established between government and core donors since This PRSL represents the Bank Group s further integration into the CABS framework. The clearest and most direct effects of GBS will be: (i) (ii) (iii) Positive effects with regard to service delivery, to service responsiveness and access, to the reduction of income poverty, and to the empowerment of poor people. Strengthening of planning and budgeting systems, policy processes, and macroeconomic performance. Harmonisation between a large number of partners and their increasing alignment to national systems The main weaknesses that were identified by the OECD DAC review were the need for technical assistance and capacity building and the unpredictability of funding provided by donors (though this has improved since 2004). It concluded that domestic accountability and promotion of policies related to private sector development should improve. It stressed that with the change in Government in 2004 there has been improved donor-government trust justifying the restarting of PGBS. The CABS have developed a robust PAF and introduced a JF agreement with the Malawian Government. Its overall conclusion was that the medium and long term view is optimistic where PGBS can play a positive role. These factors have been taken into account during the design of the PSRL and the CABS process. The issue of predictability has been addressed through integrating fully within the CABS review and disbursement process. Looking forward, to 2008 and beyond, the Bank Group should continue to focus on predictability issues and the possibility multi-year commitments, and move to a Programme-based approached, which is consistent with the Bank s Guidelines on Budget Support and the Joint Framework The PRSL will support the implementation of Malawi s MGDS. The loan will provide financial support that will go towards narrowing the gap between the cost of implementing key elements in the MGDS and resources available from the Government s own revenue and other donor support. In addition, the facility provides the Bank Group with an opportunity to contribute and participate in the policy dialogue on various issues that are central to improving the environment for growth and poverty reduction in the country. It will allow the Bank to leverage on donors monitoring ability and technical expertise (across numerous sectors) in the short-run, whilst in the medium term increase its presence and influence on key policy issues that are of high priority to the Bank Group. The PRSL specifically addresses key areas in Malawi s Development Agenda and is fully consistent with current donor support in Malawi. The proposed PRSL is designed to 22 Joint Evaluation of General Budget Support , OECD DAC, April 2006, and the Joint Evaluation of General Budget Support : Malawi Country Report, OECD DAC, April 2006, 23 Annex II presents as summary of the OECD DAC evaluation of Budget Support in Malawi.

33 help the Government implement its MGDS and reach the growth and poverty reduction goals articulated in the strategy. Through its conditionality, the Loan will support key reforms in PFM and governance and social sector reform envisaged as the reforms necessary to accelerate growth and poverty reduction. By specifically focusing on these measures, the PRSL will help the Government to make progress towards achieving the MDGs. 6.2 Potential Impact of the Programme Impact on Growth and Poverty Reduction: The PRSL will support the Government to pursue its policy objectives spelt out in the MGDS, by providing financing for the execution of the Government s 2007/08 budget in a more predictable way. Table 4 below outlines the expected outcome of MGDS and hence this PRSL. Table 4: Impact on poverty of MGDS Status in Figures MPRS MGDS 2011 MDG 2015 Indicator / Year Target Target Proportion of population living below the poverty line Share of poorest quintile in national consumption n/a n/a Net primary enrolment Maternal Mortality (per 100,000) Child Mortality (per 1000) Source: MGDS, Malawi NSO and UN Social Impact: The PRSL will contribute to human development by increasing the budgetary allocation to key social sectors such as Education, Health and HIV/AIDS. This will strengthen human competencies and enhance prospects of reducing poverty on a sustained basis. In addition, the programme is expected to have a positive impact on women, since the Government has made strides in mainstreaming gender concerns in its development policies and strategies. The MGDS addresses gender by integrating targeted programs for women to enable them to be part of economic growth, including programs for business development and micro-finance. The gender strategy aims to mainstream gender issues into the programs of Government as well as providing gender-disaggregated information. The MGDS considers the consolidation of social stability and progress on social justice as basic conditions for the achievement of its growth and poverty reduction targets. On the specific issue of gender equality, MGDS fares well. It places gender inequality as one of the key issues to be addressed over the coming years. The PAF includes a number of indicators specifically addressing gender equity in education and literacy. Moreover, it specifically targets an increase in women in decision making positions. The large gap in literacy rates between men and women, and the disproportionately high rates of HIV infection among women are indicative of the unequal power relations between men and women and the marginalisation of women in Malawian society. However, the MGDS spells out a series of prioritised actions to promote gender equality and the empowerment of women Environmental Impact: In accordance with the Bank s Environmental and Social Assessment Procedures, this programme has been classified as Category 3 since it is not expected to generate any negative environmental and social impacts. Environmental sustainability remains a key focus of the MGDS. The poor in Malawi are heavily dependent on the environment and natural resources for sustaining their livelihood, income generation and consumption. Environmental issues and natural resource depletion are being pursued through donor and government policy dialogue on growth, agriculture and social protection policies. The MGDS highlights the important role of natural resources and the environment to combat poverty. It identifies the environment as one of the cross-cutting issues within the MGDS. In particular, the strategy promotes environmental

34 sustainability in the forestry and fisheries sectors, supports the enforcement of the environmental legal and regulatory framework and the definition of environmental standards. The final annual progress report on the MPRS noted significant progress made during implementation in strengthening the legal and institutional framework for environmental management, in particular the revision of the National Environmental Plan and the Environmental Management Act. This implies that support to the MPRS has led to policy, legal and regulatory reform, including the definition of environmental standards as well as a strengthening of the authorities at the central and local level. The JSA reconfirms this progress although highlights the improvements necessary in terms of compliance with some aspects of the law. The challenge during the implementation of the MGDS will be to ensure licensing authorities and developers comply with the application of the law. 6.3 Major Risks and Mitigating Factors One set of risks concerns the potential political risks which could impact fiscal and macroeconomic stability. These include a change of political leadership at senior levels of Government. In Malawi s political system, the influence of individual personality is extremely important. There are few mitigating factors in the short term. Other political risks are that the Government does not establish a majority in parliament and is unable to pass the budget or puts unsound populist measures before sound macro-economic practices. An additional but related risk is the Government announces policies without adequate advice or consultation, undermining GoM s commitment to poverty reduction. Mitigation measures include the fact that: (1) the Government values its international reputation, and key ministers are determined to protect it and are determined to stay on track with the IMF; (2) donors have helped improve public understanding of the importance of fiscal discipline through public seminars; (3) there is donor support to Parliament to strengthen the scrutiny of actual expenditure, and; (4) the presence of increasing budget support, including this PRSL, and more intensive dialogue by all donors around the CABS process Another set of risks includes the risk that resources released by interest savings do not benefit the poor. Increasing resources does not automatically lead to increases in service delivery outcomes. Government has to ensure that allocations to pro-poor sectors are increased and protected. In addition, there has to be capacity to deliver basic services. Mitigation measures include: (1) donor support to the Budget and M&E Divisions to strengthen GoM systems for prioritising public expenditure; (2) donor support to the Parliament and civil society oversight roles; (3) continued and increasing capacity building support provided by all donors including the Emergency Human Resources Programme, and; (4) the PAF indicators protecting health and education shares of the budget There are a number of exogenous risks, particularly another drought or extensive flooding caused by increased weather variability which could, and in the past has, forced government plans off track. It is possible that weather extremes will increase in frequency in the medium term because of climate change. The Government is planning to address the food consequences over the medium term and food aid will no doubt be provided, but in the short term it is difficult to offset the impact on economic activity. There are mitigating measures within Theme 2 of the MGDS on Social Protection and Disaster Risk Management. As outlined in Section 3.2, there are a series of prioritised activities to reduce external vulnerable in terms of prevention and reducing impact, including the Bank Group s recently approved smallholder crop production project. Providing direct budget support in the medium term will also assist in reducing this risk.

35 6.3.4 The final set of risks involves fiduciary risks which could undermine any progress with service delivery outcomes. Although fiduciary risks exist they are decreasing and the GoM has a track record of managing a framework of joint budget support that use government systems, in the context of shifting aid modalities over the last 3 years. Regular PFMAs, using the PEFA methodology 24, will be undertaken with yearly updates and the PAF dialogue process will continue to prioritise PFM issues. 7. CONCLUSIONS AND RECOMMENDATIONS 7.1 Conclusions Malawi s economic reform effort has gathered momentum over recent years and there is a more determined and coherent approach to the daunting task of poverty reduction. There has been dramatic improvement in macroeconomic management. A new PRGF was agreed in August 2005 and Malawi will complete its third review in March Moreover, in August 2006, Malawi reached completion point under the enhanced HIPC initiative. In response, Bank Group operations need to be sustained and broadened if progress towards poverty reduction is to be accelerated. The Government has demonstrated a strong commitment to reform, and there is now a greater sense of ownership of the reform process. This greatly enhances the likelihood of success of the budget support being provided by the donor community. The proposed PRSL will support priority policy actions outlined in the MGDS and CSP. Malawi s poverty reduction strategy is ambitious and will require strong donor support in the coming years. The PRSL is therefore timely and will augment resources that other donors are providing which target poverty reduction programmes. 7.2 Recommendations On the basis of the above analysis, it is recommended that an ADF loan not exceeding UA 14.9 million be extended to the Government of Malawi on standard ADF terms as direct budget support in one tranche, in addition to the resources availed by other donors. Conditions Precedent to Entry into Force. The entry into force of the Loan Agreement shall be subject to the fulfilment by the Borrower of the provisions of section 5.01 of the General Conditions. The release of the ADF Poverty Reduction Budget Support loan shall also be conditional upon the following condition: The Borrower shall have, to the satisfaction of the Fund, the following condition: (i) Achievement of a broadly satisfactory assessment of the implementation of the Performance Assessment Framework during the joint Government/CABS Group review in March This will be evidenced by the Joint Aide Memoire prepared by the CABS Group. 24 Annex IV provides a full Fiduciary Risk Assessment.

36 ANNEX I: Administrative Map of Malawi This map was provided by the African Development Bank exclusively for the use of the readers of the report to which it is attached. The names used and the borders shown do not imply on the part of the Bank and its members any judgment concerning the legal status of a territory nor any approval or acceptance of these borders.

37 ANNEX II: Summary Malawi Country Report DAC Joint Evaluation of General Budget Support The broad conclusion is that the Malawi case suggests that political governance is a key entry criterion for PGBS. Moreover the intentions of the Government with respect to sound financial management and poverty reduction need to be established rather than assumed. It stated that conditionality cannot substitute for, or promote, ownership. It stressed that with the change in Government in 2004 there has been improved donor-government trust justifying the restarting of PGBS. The CABS have developed a robust PAF and introduced a JF agreement with the Malawian Government. PGBS is more promising, based on a limited set of objectives and improvements in governance and fiscal discipline. It noted that PGBS should be developed with a long-term view to avoid short-term fiscal shocks. It concluded that the medium and long-term view is optimistic where PGBS can play a positive role. 2. The Evaluation divided Malawi s experience with GBS into three periods: , when the World Bank and IMF led the dialogue, emphasising macro stabilisation, trade liberalisation and structural reforms , when the dialogue was increasingly led by CABS, emphasising PFM and support to Malawi s PRSP. This period was marked by suspension of budget support following non-compliance with PRGF conditionality, culminating in the abandonment of the 2000 PRGF just before the 2004 elections. Since July 2004, when the new government established fiscal discipline, successfully completed an IMF Staff Monitored Program and agreed a new PRGF. 3. The suspension of GBS between 2000 and 2004 is largely attributed to the lack of government commitment to poverty reduction and PFM reform. While donors took the 2000 PRSP at face value, the deterioration in fiscal management over the period and the resulting accumulation of debt completely undermined PRSP implementation. The conclusions of the review stated, The intentions of the government with respect to sound financial management and poverty reduction need to be established rather than assumed. It stressed that, Analysis of the appropriateness of PGBS must include political analysis as the basis for design of PGBS in addition to fiscal management reviews and assessment of PFM capacity. 4. Although most GBS was explicitly tied to Malawi remaining on track with its PRGF, this condition was ineffective in promoting sound financial management. The GoM was surprised when GBS was suspended but, instead of taking measures to control expenditure (to get back on track) expenditure continued to far exceed budget ceilings despite the shortfall in PGBS receipts. The result was an accumulation of increased domestic debt, increasing debt service costs and adverse effects on private investment and on prospects for growth. The review states, Conditionality is neither a substitute for nor does it promote ownership. 5. During the post 2004 period the emphasis has been on macro stability rather than supporting the PRSP. Post-2004 the Malawi Government and politicians have learned that the donors sanction of suspension of PGBS is real, while the donors have appreciated that a more limited objective is perhaps in the circumstances more appropriate for continued PGBS. Suspension needs to be managed well, especially in the short term, to avoid fiscal shocks. While the focus on this new PGBS is on macroeconomic stability, the rationale is to prevent the potential poverty impacts of a severe economic crisis. Thus the view of PGBS looking forward is an optimistic one in which PGBS can play an important role. 1

38 6. The main recommendations for the continued provision of PGBS in Malawi should remain focused in four main areas. Firstly, Political Governance and PGBS Design. The assessment of whether to go ahead with PGBS should be taken based on an assessment of political governance and commitment in addition to reviews of fiscal performance and PFM capacity. Political governance and commitment are key issues to address along with reliable PFM systems and capacity for effectiveness of PGBS. More effort by donors and the GoM needs to be put into capacity development of GoM systems to enable real leadership on aid coordination and more emphasis is needed by donors and GoM in developing policy formulation and implementation. Secondly, Harmonisation, in which continued effort is required to make PGBS a vehicle for improving harmonisation for a wider group of donors. Thirdly, in the use of Conditionality and sanctions donors need to carefully consider the impact of suspension of PGBS on macroeconomic stabilisation, and to the extent possible, make a gradual reduction in the medium term rather than completely withdraw in the short term. Finally in terms of Predictability and Donor Commitment, the impact on predictability in the short term can be mitigated by disbursement arrangements which provide for suspension only in the medium term. Conditions should be fully harmonised with full transparency on conditions for release. Where donors undertake PGBS in difficult policy contexts (like Malawi) they should commit medium to long term. Donors need to make clearer the relationship between conditionalities on PGBS and their commitment to other aid programmes. 7. The Bank Group has specifically designed this operation in light of the OECD DAC conclusions listed above, some of which are consistent with the Bank s PCRs conclusions and recommendations. In addition, most of the recommendations are consistent with the pre-requisites for the provision of DBSL by the Bank Group, as outlined in the Bank Group s Guidelines to Budget Support. The issues highlighted in the OECD DAC review have been systematically assessed and addressed in the main sections of the Appraisal Report and Donors and Government have embraced the recommendations by deepening the dialogue around an ever increasing harmonised CABS process. 2

39 ANNEX III: PAF Matrix for 2006 EC No Indicator Baseline Target for 2007 review Public Finance Management Indicators 1 Overall macroeconomic programme implemented PRGF programme signed in August 2005 On track with IMF as of the latest IMF quarterly review. Indicative Target for 2008 review On track with IMF as of the latest IMF quarterly review. Comments 2 Financial information provided by donors (within GoM deadline) for budgeting and reporting on project and program aid to government is reflected in budget documentation. 3 Composition of expenditure out-turn compared to original approved budget. 4 Composition of expenditure out-turn compared to original approved budget: for PPEs. FY 05/06 for Feb 2007 review. FY 06/07 for Feb 2008 review. FY 05/06 for Feb 2007 review. FY 06/07 for Feb 2008 review. FY 05/06 for Feb 2007 review. FY 06/07 for Feb 2008 review. For FY 2006/07: World Bank (IBRD), AfDB and from HIPC, DFID, EU, Norway, Sweden, Germany, USAID, Global Funds. Variance in expenditure composition exceeded overall deviation in primary expenditure by no more than 10%. Variance in actual expenditure exceeds overall deviation in primary expenditure by no more than 5%. For FY 2007/08: Same as for FY 06/07 + UNsystem, JICA and CIDA Variance in expenditure composition exceeded overall deviation in primary expenditure by no more than 10%. Variance in actual expenditure exceeds overall deviation in primary expenditure by no more than 5%. Source: MoF Definition: PEFA Performance Measurement Framework - June Primary expenditures exclude debt service repayment and donor funded project expenditure. Deviation is calculated for the 20 largest headings. 25 Source: MoF Definition: PEFA 2005 Primary expenditure comprises: (i) Wages & salaries, (ii) Generic goods & services, (iii) Transfers & subsidies, (iv) Development part II Primary expenditures exclude debt service & donor funded project expenditure. Deviation is calculated for PPE expenditures as per Table 11, Budget Document No.3 for FY 2006/07. Source: MoF Definition: PEFA largest headings are: Judiciary, National Assembly, National Audit, Ministry of Agriculture, National Statistical Office,, Ministry of Health, Ministry of Education, Ministry of Women and Child Welfare, Ministry of Finance, Police, Prisons, ODPP, ACB, Ministry of Irrigation and Water Development, Ministry of Transport and Public Works, Department of Nutrition HIV/AIDS, DHRMD, MEPD, Ministry of Justice, Ministry of Local Government. 1

40 5 Composition of expenditure out-turn compared to original approved budget: for Health ORTs. 6 Composition of expenditure out-turn compared to original approved budget: for Education ORTs. FY 05/06 for Feb 2007 review. FY 06/07 for Feb 2008 review. FY 05/06 for Feb 2007 review. FY 06/07 for Feb 2008 review. Variance in actual expenditure exceeds overall deviation in primary expenditure by no more than 5%. Variance in actual expenditure exceeds overall deviation in primary expenditure by no more than 5%. Variance in actual expenditure exceeds overall deviation in primary expenditure by no more than 5%. Variance in actual expenditure exceeds overall deviation in primary expenditure by no more than 5%. Primary expenditures exclude debt service repayment and donor funded expenditure. Deviation is calculated for health ORTs expenditures. Source: MoF Definition: PEFA 2005 Primary expenditures exclude debt service repayment and donor funded expenditure. Deviation is calculated for education ORTs expenditures. Source: MoF Definition: PEFA Effectiveness of payroll controls 8 Effectiveness of Internal Audit 9 Timeliness of annual financial statements Situation as of end December 2006 for Feb 2007 review. Situation as of end of December 2007 for Feb review. No action is being taken on audit findings by management For FY05/06 for Feb 2007 review. For FY 06/07 for Feb Reconciliation of the payroll with the backlog of personnel data takes place by Dec Internal audit is operational for central government entities representing at least 50% of primary expenditure. Reports are issued regularly to audited institutions, NAO & MOF. Consolidated GoM statement is submitted for external audit within 6 months of the end of FY. Payroll audit is conducted by June Payroll for FY 07/08 is supported by full documentation for all changes made to personnel records on a monthly basis. Internal audit is operational for all central government entities. Reports adhere to fixed schedule and distributed to audited entity, NAO, MOF. Consolidated GoM statement is submitted for external audit within 6 months of the end of FY. IPSAs or corresponding national standard are applied. Source: MoF Note: Reconciliation of the payroll is an on-going exercise Source: MoF Public Finance Management Act specifies that financial statement should be communicated within 4 months of the end of FY. Source: MoF 2

41 10 Scope, nature and follow up of external audit. 11 Legislative Scrutiny of external audit report Social Sector Indicators 12 Pupil per qualified teacher ratio in primary schools in rural areas For FY04/05 for Feb 2007 review. For FY05/06 for Feb For FY 02/03 for Feb 2007 review. For FY 03/04 & 04/05 for Feb baseline for rural 74:1 School Year 2006 for 2007 review. School Year 2007 for 2008 review. Central GoM entities representing 50% of expenditures are audited. FY 04/05 Audit Report submitted to legislature by Dec 2006 Scrutiny of Audit Report for FY 02/03 is completed by the legislature by Feb Central GoM entities representing 75% of expenditures are audited. Audit report submitted to legislature within 4 months from receipt of consolidated government statement by NAO. Clear evidence of effective and timely follow up. Scrutiny for FY 03/04 and 04/05 is completed by the legislature by Dec Recommendations to the executive are issued and evidence of implementation exists. Public Audit Act requires audit report to be submitted to parliament within 6 months from end of FY. Source: MoF Definition: PEFA 2005 Source: MoF, NAO, Parliament 2006 SY 75:1 or less 2007 SY is 75:1 or less Target for 2006 on the basis that there will be no new trained teachers in Source : EMIS. Definition: number of pupils divided by number of qualified teachers, in rural areas. 13 Female Literacy rate 50.5% in % in Dec % in Dec 2007 MGDS 2011 target is 85% Source : NSO Definition: Proportion of female adult popn. aged 15 years & over which is literate 14 Drop out in standard % in 2005 for Boys 50.5% in 2005 for Girls 49.8% in % in % in % in 2007 Source : EMIS. Definition: number of student who promoted minus number of students who are repeating, out of total number of student In the future consider monitoring survival rate. 3

42 15 Proportion of one year-old children immunized against measles. 82% in EPI 85% by June % by June 2007 MGDS Target based on 2011 target at 85% Source : MoH / EPI Definition: Number of children administered Measles vaccine by their first birthday during the reporting period divided by the estimated under one population for the same year. In future consider monitoring immunisation rates in the worst affected districts. 16 Proportion of birth attended by skilled health personnel. 38% in 2005 HMIS 40% by June 2006 MGDS and SWAp framework 50% by June 2007 MGDS MGDS 2011 target is 75% Source: MoH/HMIS. Definition: Births attended by skilled health staff are the percentage of deliveries attended by personnel trained to give the necessary supervision, care, and advice to women during pregnancy, labour, and the postpartum period, to conduct deliveries on their own, and to care for the newborn. (WHO) 17 Nurse population ratio 1:4000 in :3,900 by June :3,700 by June 2007 MGDS 2011 target at 1700 Source: MOH Definition: Total population divided by the total number of nurses (including midwives). In future consider monitoring nurse to population ratio in rural areas 18 Number of people who are alive and on ART at end of the year 28,110 in December ,000 in ,000 in 2007 MGDS 2011 target is 208,000 Source : MOH/HMIS. Definition: total number of people alive and on ART at end of year. In future consider using an indicator on PMTCT in rural areas. 4

43 19 Women in Decision Making Positions 15% in % as at December 2006 Governance indicators 20 MGDS implementation N/A Approval by December 2006, including M&E Road Map adapted to 21 Government compliance with the Constitution and rule of law. 22 Elections judged free and fair by local civil society and international observers (a) Local elections not held in line with the Constitution (b) Weak compliance with constitutional provisions on declaration of assets 2004 elections judged free but not entirely fair because of abuse of incumbency by ruling party MGDS (a) Position on local elections regularised by Feb 2007 (b) Standing Orders or legislation approved by Feb 2007 for implementing declaration of assets and sanctions for failure 19% as at December st Annual Review (FY 2006/07) report available. (a) Preparations for 2009 elections in line with Constitution (b) Asset Declaration Standing Orders or legislation implemented by Dec 2007 MGDS 2011 target not available. Source : MOGWC Definition: Women in decision making positions in government sector, i.e. from P5 (Asst. Dir) to P2 (Principal Secretary) and in Para-statals (Deputy General Manager, Director or Chief Executive, Executive Secretary Constitution currently requires elections to Local Assemblies by May 2005, which could be resolved by changing the requirement or by its urgent implementation (a) MEC in need of reform to be more competent and impartial (a) MEC Strategic Plan revised and Action Plan being implemented with Electoral Commissioners (a) As for

44 appointed according to objective criteria (see APRM indicator) 23 Corruption: Average number of months for corruption cases to be completed (b) MEC weak in managing election environment. Freedom House assessed media as partly free in (b) Malawi judged partly free media (Freedom House press freedom indicator) (b) Communications Act modified to provide for independent Board for public media 18 Months 16 months 12 months Definitions: Number of cases times duration of case in court in months divided by total number of cases brought to court. For this indicator, cases start when pleas is taken in court (Source ACB). 24 % of corruption cases completed within 12 months 25 Corruption: Transparency of DPP s response to requests for consent to prosecute corruption cases and adherence to Corrupt Practices Act in cases where consent is refused 26 Procurement: Number of Govt Ministries complying with quarterly reporting to ODPP on procurement, as set out in Public Procurement Act, and action taken by ODPP & line ministries to address problems raised in reports As at December 2005=33% DPP has not refused any requests from ACB Some delays in processing requests Only MoF and ACB complying with reporting in 2005 As of December 2006=50% Continued agreement to consent requests or compliance with CPA if a request is refused. Monitor length of time for consents to be processed In addition to MoF & ACB, quarterly reporting requirements met by Health, Education, Agriculture, Transport, Irrigation & Water & Privatisation Commission As of December 2007=60% Quarterly reporting requirements met as in 2006 and action taken by ODPP and line ministries to address problems raised in 2006 Definition: Total number of cases completed brought to court after July 2004 and completed in 12 months divided by total number of cases brought to court since 2004 Source: ACB Source: ACB, DPP and Legal Affairs Committee of Parliament Source: ODPP, line ministries 6

45 27 Actual recurrent expenditure to Governance institutions Actual disbursements for FY 2004/05 At a minimum actual recurrent expenditure in FY 2005/06 is maintained at 2004/05 level in real terms At a minimum actual recurrent expenditure in FY 2006/07 is maintained at 2004/05 level in real terms Governance institutions monitored: Parliament, Law Commission, MEC, ACB, MHRC, Ombudsman, Auditor General s Office, Legal Aid Department Definition: Expenditure in real terms measured by applying headline inflation rate to 2004/05 figures. Source: MoF / Accountant General s Department, NSO (inflation) 28 Prison conditions : (a) Number of pre-trial detainees (remand prisoners) in prisons exceeding the maximum permitted remand period 3,580 on average in ,790 average for % of 2006 figure Definition: total number of Pre-trial detainees / remand prisoners in prisons exceeding the maximum permitted remand period (b) No of deaths in prison as result of poor nutrition, HIV / AIDS, etc 14 deaths per 1,000 prison population in per 1,000 57% of the 2006 figure Source: Malawi Prisons 7

46 ANNEX IV: Fiduciary Risk Assessment The PEFA PFM Assessment 1. Malawi has demonstrated an increasingly positive track record in directing its limited public resources towards the reduction of poverty. Also, significant improvements have been made and continue to be made in PFM. However, PFM weaknesses remain, and these coupled with low levels of human capacity and oversight institutions mean that fiduciary risks exist but are reducing. 2. Malawi recently undertook a PFM assessment in August 2006, which used the PEFA Assessment methodology. The assessment looked at the full budget and accounting cycle. PFM in Malawi is centralised with the Ministry of Finance and also sector Ministries represented at provincial level. 3. The main statutory document which sets the framework within which PFM is exercised in Malawi is the Public Finance Management Act (2003). This specifies the responsibilities of the Minister of Finance, together with the powers he may delegate to senior officials. The Act also defines the responsibilities of the Secretary to the Treasury, as well as those of the Controlling Officers, who are appointed by the President to be the Head of a Ministry or Department and are responsible for the collection, receipt, disbursement, etc. of public money. 4. Another key PFM-related Act is the Public Procurement Act also of This established the office of the Director of Public Procurement, who is responsible for regulating and monitoring public procurement arrangements throughout Malawi. It also enables the setting up of internal procurement committees, as well as specialised public procurement units within each Ministry, Department or Agency. The Act describes the rules for and methods of public procurement, which are to be applied, as well as setting out the main principles and procedures for the different types of procurement available to the Ministry, Department or Agency. Finally, it identifies the tenderer s right to request a review, as well as the need to undertake an audit of procurement activities and the production of an annual report by the Director to the Minister of Finance. 3. The PEFA assessment in Malawi is one of six that have been completed (these include Zambia, Ghana, Afghanistan, Kyrgyz Republic and Mozambique). It was undertaken in full collaboration with the Government of Malawi, which has accepted the findings and has drawn up an action plan to prioritise and take forward the numerous recommendations. Malawi achieved 2A (top marking), 7Bs, 9Cs and 12Ds these results compare reasonably with reports undertaken in other countries and reflect approximately average scores found in other countries The PEFA assessment is retrospective but it also includes a prediction of performance at the end of 2006 and early 2007, based on reforms and improvements 26 For a detailed summary of the findings of PEFA reviews see, PFM Performance Measurement Framework: Report on Early Experience from Application of the Framework, November

47 planned or already underway. The team s prediction is for further strengthening of the overall position and individual indicators during 2006, although there have been some delays in implementation of Malawi Financial Accountability Action Plan (MFAAP), mainly due to capacity and its ambitious nature. A June 2005 PEFA based public financial management review revealed that the new government, which came to power in May 2004 inherited an economy in fiscal crisis with high interest payments on domestic debt and significant level of arrears throughout government. The PFM system at the time, although based on a sound legal framework, was typified by noncompliance with rules and regulations, lack of enforcement of sanctions and political interference in processes and procedures. Since then, the new Government has shown strong and high level political commitment to reversing this trend. Government Response to the PFM Assessment 5. The Government of Malawi has accepted the findings and recommendations in the PEFA report. In response the Government intends to revise the MFAAP to ensure it is more focused and simplified to take account of the capacity levels in the key implementing Ministries. The Government intends to review the plan in detail and produce an updated plan with prioritised activities and sequencing through the GFEM which has representatives from government, the donor community and the PFM support programmes. 6. The Minister of Finance places high priority on updating and implementing this plan and it will be critical for the Ministry of Finance itself to clearly take the lead. Not only does the Ministry have responsibility for the resource mobilisation functions of Government, it also has responsibility for resource allocation (the distribution of revenues across all government priorities to achieve agreed objectives in the most efficient way). If it is to undertake these roles effectively, therefore, it must be willing to take the lead in managing the process of continuity, improving the way in which these functions are discharged. It will be important for the Bank Group coupled with other donors to monitor this through the GFEM process. 7. The PEFA assessment is a structured methodology, which enables country PFM performance to be measured and evaluated over time. It concentrates on the national government s PFM system and the operations at the sub-national government level. The main areas that are covered are: Credibility of the budget whether the budget is realistic and is implemented as intended. Comprehensiveness and transparency whether the budget and the fiscal risk oversight are comprehensive and whether fiscal and budget information is accessible to the public. Policy-based budgeting whether the budget is prepared with due regard to government policy. Predictability and control in budget execution whether the budget is implemented in an orderly and predictable manner and there are arrangements for the exercise of control and stewardship in the use of public funds. 2

48 Accounting, recording and reporting whether adequate records and information are produced, maintained and disseminated to meet decisionmaking control, management and reporting purposes. External scrutiny and audit whether appropriate arrangements are in place for scrutiny of public finances and whether the Executive follows up these views. Donor Practices whether donors are predictable in their provision of budget support and provision of financial information and proportion of aid using national systems. 6. Of the 12 D scores in the PFM assessment (two of which are related to donor practices), nearly all are expected to be improved in the short to medium term either through: the roll-out of IFMIS and the Centralised Payment System as well as continued fiscal stability. In addition, a focus and consolidated effort to streamline and implement the MFAAP should lead to improvement in a number of the C scores. There remains concern on the limited progress in the areas of external audit, especially the lack of appointment of a successor to the Auditor General which may delay the audit of the 2006/07 fiscal accounts. 7. Credibility of the Budget: Prior to 2004/05, the GOM budget was characterised by a lack of effective control over Ministry spending, failure to reduce expenditure in line with reduced inflows of donor support, together with high levels of politicallydriven expenditure. This tended to result in high levels of domestic debt and arrears. At the overall budget level, these trends have tended to be reversed by the new Government that came to power in 2004 largely through the implementation of a new accounting system, IFMIS, and the introduction of tighter payment controls. Comparison of the main expenditure types confirmed, that wide variations occurred between budgeted and actual expenditures in the recurrent budget during the three financial years 2001/02 to 2003/04 (in excess of 10%). The 2004/05 Budget was the first budget to have remained within the approved limit. 8. Comprehensiveness and Transparency: Improvements are being introduced to the Chart of Accounts through the introduction of IFMIS, including the capture of government assets and liabilities, as well as codes for Ministry outputs and activities. The review of the comprehensiveness of the budget indicates that despite minor improvements, the budget documents remain difficult to read and interpret due to the level of detail provided. Nevertheless continued improvement is being made. Concerns remain about public and stakeholder access to key fiscal information. The current documentation remains very detailed and, although some fiscal information is published in the newspapers and is available on the Government website, it is not comprehensive. 9. Policy Based Budgeting: A broad timetable exists within which ministries provide their estimates to the Ministry of Finance (MoF). Comprehensive guidelines and spreadsheets are also provided by the MoF for budget preparation. The Budget Circular is also normally issued to Ministries before the annual budget ceilings are announced (usually in April) and the Budget has normally been presented to Parliament before the beginning of the fiscal year. Concerns remain as to the lack of a regularly updated annual budget calendar. Although the MGDS is costed, significant 3

49 improvement could be made multi-year planning, expenditure policy and budgeting systems indicates, that while multi-year forecasts are prepared, they do not flow from the overall GoM national strategy as much as is necessary and the multi-year plan is not used as the basis for the annual budget. 10. Predictability and control in budget execution: The effectiveness of controls within the taxpayer registration and tax assessment systems suggests some improvements have occurred. A review of the effectiveness of existing penalties for non-compliance with registration and declaration obligations indicates that existing penalties are largely ineffective, since the courts have been unwilling to apply them. The review had concerns as they could not find a direct link between the Human Resource Management Information System and IFMIS to enable more effective controls to be exercised over payment expenditure. There has been improvement in the functioning of the ODPP in terms of competition, value for money and procurement controls. 11. Accounting, Recording and Reporting: IFMIS together with the centralisation of the payments function has resulted in significant improvements in the timeliness and regularity of the account reconciliation systems. The budget execution and reporting picture at a national level appears to have improved as a result of the production of two budget execution reports at monthly intervals (or on demand) by IFMIS. The reports were of a high standard and were produced in a timely manner. The review believes that significant improvements are likely in terms of the quality and timeliness of annual financial statements, once the IFMIS system has been fully operational for at least one full fiscal year. 12. External Scrutiny and Auditing: There has only been marginal progress in these areas. The NAO continues to have low capacity and resources to enable it to discharge its responsibilities effectively. The scope and nature of the audit work (including adherence to auditing standards) undertaken by the NAO also has been assessed. Only very recently has there been a certification of the National Accounts for 2004/05. These problems have been made worse, as a result of the continuing vacancy of the Auditor General. The NAO has made some limited progress in 2005/06, especially through specific audits of Education Pensions and Development contracts as well as the Health Payroll and it is undertaking a payroll audit of most Ministries. It will be critical for Donors and Government to ensure improvement in the external scrutiny and audit functions in Malawi. The area of external scrutiny remains the weakest part of the PFM system in Malawi and in the area in which fiduciary risks are most significant. It will be important for the Bank Group to monitor progress in this area. Corruption in public financial management 13. As described elsewhere in the appraisal report, corruption in Malawi is evident and few cases have been pursued through the courts. Malawi became steadily more corrupt after democratisation in The major form of corruption was inappropriate political interference in decisions about public sector spending, allowing diversion of funds for personal or party purposes. This led to a more generalised failure to implement rules and procedures systems and the collapse of the systems of checks 4

50 and balances. No action was taken against those who abused public resources. The execution phase of the budget process and procurement processes are the most vulnerable areas for corruption. Malawi s position on the Transparency International Corruption Index worsened during the final years of the previous administration, leaving it at number 90 out of 145 countries in the 2004 Corruption Perceptions Index. 14. Many of these problems stemmed from the patrimonial politics practised by the previous president. The actions of the new president have substantially changed the incentives on corruption. These include: Former Ministers and civil servants tainted by corruption were not offered office in the new government Ministers and senior civil servants from the past and current government have been prosecuted for corruption, with the first ever conviction of a former Minister secured in February 2006 The Director of Public Prosecutions has granted consents to prosecute, rather than protecting the politically well connected, as the former Director did Increasing funding and replacing senior staff in accountability institutions such as the Anti-Corruption Bureau. 15. A Governance and Corruption baseline survey carried out in Malawi at the end of 2005 found that more than 80% of households and public officials surveyed were convinced of the government s desire to fight corruption. The Anti-Corruption Bureau got an exceptionally high rating with 60% of households ranking the agency as having effectively contributed to fight corruption, second only to religious bodies. However, the President s initial commitment to separating state and party funding appears to have diminished since 2004, evidenced by the reversal of progress in freeing up state media to different political parties, and the use of para-statal resources, such as vehicles, for party political events. In conclusion, tangible progress has been made in the fight against corruption and especially in the areas of PFM and although the risk still exists credible progress continues to be made. Credibility of the Reform Programme 16. Despite the over ambitious MFAAP, the PFM reform programme in Malawi is credible in that: Parliamentary approval of the new Public Finance Management, Public Audit and Public Procurement Acts provides a robust legal framework for instilling fiscal discipline and strengthening accountability and transparency. The establishment of the overarching Financial Accountability Action Plan, the MFAAP, provides a comprehensive Government owned strategy around which donor capacity building support can be aligned. The establishment of the joint Government-donor Group of Financial and Economic Management meeting regularly to discuss PFM issues. The establishment of the Secretariat and Steering Committee have been established within the Accountants General s office. 5

51 The establishment of fiscal discipline. In 2004/05 the Government for the first time in over a decade stayed within the approved budget. This has been maintained and has increased significantly the credibility of the annual budget. Critically the rolling out of the IFMIS and the specific allocation of Government resources to the roll out of the IFMIS system. Linked to the IFMIS system, the establishment of a Centralised Payment System which along with IFMIS has been operating in the main spending Ministries. 17. Progress on the reforms and the quality of what is delivered is monitored both through individual project and programme mechanisms and at a higher level through the CABS Joint Reviews, specific benchmarks in the PAF and the GFEM working group. Together these mechanisms provide a systematic and thorough monitoring process to review progress. Problems are now not avoided but they are identified relatively early, and although the speed at which they are addressed can be slow, the machinery exists to raise them with the GoM and to address them. 18. There is the risk that weak human and institutional capacity will inhibit the realisation of benefits from PFM reform. The wide ranging capacity development initiatives of donors and Government need to be implemented and monitored in a more coordinated way. The combined focus on the weaknesses of public financial management over the last few years has resulted in a proliferation of programmes which seek to strengthen public expenditure management have been poorly coordinated and sequenced. The Government has initiated a Joint Country Portfolio Review for March 2007 to address this concern. Support to PFM is therefore significant and is in fact one area where substantial amounts of training are already being delivered and it is more an issue of focus and coordination. The increasing use of the CABS process and GFEM will assist in this area. Future PFM/PEFA Assessments 19. Annual reviews of PFM in Malawi and of progression in the PFM reform programme will be carried out in the context of the CABS process (The Bank Group as part of the decentralisation process will deepen its participation in the CABS and GFEM Group). In addition, it is expected, that there will be a full PEFA exercise in 2008 and at 18 month intervals in accordance with the PEFA assessment teams recommendation. This PRSL specifically addresses a number of the key weakness highlighted in the report, through using the PAF indicators. In this, the Bank Group places a significant emphasis on key reforms in PFM. It also highlights to the Government of Malawi the importance of transparency and accountability in the use of the Bank Group and its own resources. Although fiduciary risks exist in Malawi, this PRSL, together with the CABS and GFEM working groups and increasing Government commitment will ensure it is possible to mitigate against these fiduciary risks. 6

52 ANNEX V: History of the Malawi Harmonisation Framework 1. The movement to increased donor coordination started in the 1990s and was formalized in To support the MPRS donors established the Common Approach to Budget Support (CABS) as a covenant for continued balance of payments support. It was initially based on performance against the IMFs PRGF, underpinned by a MOU known as the Joint Framework (JF). This agreement provided a common focus and allowed for regular dialogue through an annual and mid-year review, known as the CABS Annual and mid-year review. 2. In Malawi there has been three distinct periods of donor-government dialogue related to DBSL. In the period the IMF and the World Bank led the dialogue with the new government, emphasising trade liberalisation and structural reforms, in particular related to the prioritisation of state enterprises dominated by the previous political regime. The Bank Group in designing its Structural Adjustment Loan (SAL) was part of this process and coordinated its conditionalities with the IMF and World Bank. 3. From more emphasis was placed on public expenditure management and support for the MPRS which was introduced in A covenant for continued balance of payments/budget support from many donors was based on performance under the PRGF with the IMF. The CABS group of donors linked their support specifically to performance in PFM and on implementation of the MPRS. During this period GBS was frequently suspended due to high and increasing expenditure overruns. 4. Since July 2004, with a new government taking office, a SMP with the IMF served to gradually build more trust with Malawi s external partners and harmonisation started to take hold. The Bank Group designed a Policy Based Loan during this period which disbursed in It was designed in conjunction with other donors but not aligned to the emerging harmonisation framework. During this period the CABS donors developed a PAF and introduced a Joint Framework agreement with the Government of Malawi. External partners such as the World Bank and Germany are considering becoming part of the CABS group but maintain observer status until later in Increasingly GBS is being provided through the CABS group specifically linked to support the implementation of the MPRS and now the MGDS in a harmonised and coordinated manner. 5. The PGBS by the CABS group represented a more closely coordinated effort among the donors by serving as a joint working arrangement to harmonise reviews and have one rather than several avenues for the Government and donor dialogue. The CABS has been the vehicle for improved dialogue and coordination. Within this process, there were some improvements in alignment with key Malawi GoM policy instruments including the MPRS, although these instruments were in an earlier stage of development. 6. While the CABS PGBS led to one coordinated dialogue with respective donors, the funding from each of the donors was guided by bilateral agreements. These bilateral agreements revealed that the donors maintained different emphases, conditions and 1

53 triggers for the release of funding (e.g. not all donors required the GoM to have a PRGF programme with the IMF). The CABS group, initially, can be said to have created a joint working relationship for improved coordination of the donor Government dialogue but did not initially achieve full harmonisation of conditions linked to the support. Increasingly however donors started using simply the PAF assessment of the CABS review as their decision making mechanism. 7. In 2005 the CABS donors agreed on a common PAF to serve as a tool for review of GoM performance in implementing PFM and policy measures. The various CABS donors used the PAF benchmarks differently. Initially, while they all intend to use PAF as a joint framework for review, the focus on different benchmarks differed between them. Some applied the benchmarks for review of performance while others used them as triggers for the release of funds. The PAF was being used as the sum of individual donors preferences rather than a prioritised set of benchmarks equally shared by all. The March 2006 CABS review was the first to use the PAF as the basis of all CABS disbursement. The Bank Group are observers but will become full members at the CABS joint review in March

54 ANNEX VI: Table of Economic and Financial Indicators Table 1a. Malawi: Selected Economic Indicators, Act. Act. Act. Act. Prog. Proj. Prog. Proj. Proj. National income and prices GDP at constant market prices Nominal GDP (billions of kwacha) Nominal GDP per capita (U.S. dollars) GDP deflator Consumer prices (end of period) Food Nonfood Consumer prices (annual average) Investment and savings (percent of GDP) National savings Of which : domestic savings unrequited transfers Gross investment Foreign savings Central government (percent of GDP) Revenue (excluding grants) Expenditure and net lending Underlying balance Overall balance (excluding grants) Overall balance Money and credit (change in percent of beginning-of-year M2) Money and quasi money Net foreign assets Net domestic assets Credit to the government Credit to the rest of the economy Velocity External sector (millions of U.S. dollars) Exports, f.o.b Imports, c.i.f ,070-1, , Usable gross official reserves (months of imports) Current account (excluding transfers, in percent of GDP) Nominal effective exchange rate (percentage change) Real effective exchange rate (percentage change) Terms of trade Debt stock and service (percent of GDP) External debt (public sector) NPV of debt (percent of avg. exports) External debt service (percent of exports) Net domestic debt (central government) Domestic interest payment Treasury bill rate (period average) =AVERAGE(DBT!O13:R13)RAGE(DBT!S13:V13)AGE(DBT!W13:Z13) =AVERA Sources: Malawian authorities; and IMF staff estimates and projections. 1 A measure of domestic adjustment effort (i.e., domestic primary balance excluding maize and the Health SWAp). Definition: Overall balance plus statistical discrepancy, excluding grants, revenue and expenditure from maize, interest, foreign-financed development expenditures, and the Health SWAp.

55 ANNEX VII: Balance of Payments, Table 4a. Malawi: Balance of Payments, (Millions of U.S. dollars, unless otherwise indicated) Act. Act. Act. Act. Prog Proj. Prog Proj. Proj. Proj. Current account balance (including grants) Merchandise trade balance Exports Of which: Tobacco Imports Of which : Petroleum Emergency Maize Services balance Interest public sector (net) Receipts Payments (amounts due before HIPC debt relief) Other factor payments (net) Nonfactor (net) Receipts Payments Unrequited transfers (net) Private (net) Receipts Payments Official (net) Receipts Balance of payments assistance Japan HIPC Initiative Donor humanitarian grants Project related Drought related Food Security Payments Capital account balance (incl. errors and omissions) Medium- and long-term flows Disbursements Balance of payments support Project support Other medium-term loans Other investment assets Amortization (amounts due before HIPC debt relief) Foreign direct investment and other inflows MDRI debt forgiveness on debt due after current year MDRI grants from ADF MDRI grants from IDA MDRI grants from IMF Other liabilities (MDRI-IDA and ADF loans) Short-term capital and errors and omissions Overall balance Financing (- increase in reserves) Central bank Gross reserves (- increase) Liabilities Of which: IMF (net) Purchases/drawings Repurchases/repayments MDRI liabilities (repayment) Commercial banks Arrears Debt relief MDRI debt forgiveness on debt due in current year Residual financing gap (+ underfinanced) Memorandum items: IMF MDRI debt relief Gross official reserves Millions of U.S. dollars Months of imports In months of imports Usable gross official reserves 5 Millions of U.S. dollars Months of imports Months of imports Current account balance (percent of GDP) Excluding official transfers Including official transfers Export value growth (percent) Merchandise imports, excluding all maize Percent change Sources: Malawian authorities; and IMF staff estimates and projections. 1 The implications of MDRI were incorporated before the DSA was completed and may therefore differ from the figures presented in the HIPC completion point document. 2 For , relief was provided through grants in yen. From 2004 onward, debt will be written off and recorded under debt relief. 3 In previous staff reports, the delivery of debt relief by Paris Club creditors was presented as exceptional financing. Following the completion point, the delivery of Paris Club debt relief through a stock operation is now reflected through a reduction in projections of amortization owing and a corresponding reduction in exceptional financing. 4 In months of following year's imports of goods and nonfactor services. 5 In months of current year's imports of goods and nonfactor services.

56 ANNEX VIII: Bank Group Operations in Malawi

57 Telephone: Telefax: Telex: ANNEX IX DEVELOPEMNT POLICY LETTER MINISTRY OF FINANCE P.O. BOX 30049, CAPITAL CITY, LILONGWE 3. MINISTER OF FINANCE Ref: DAD/5/1/7/47 28 th February 2007 Mr. Donald Kaberuka, President, African Development Bank, B.P. 323, 1002 Tunis, Belvedere, Tunisia. Dear Mr. Kaberuka, LETTER OF DEVELOPMENT POLICY On behalf of the Government of Malawi, I write to request the approval of Budget Support of UA14.89 million from your Bank. The loan will help to accelerate the implementation of the Malawi Growth and Development Strategy (MGDS). It will also facilitate the implementation of programs that have been the focus of poverty reduction budget support, namely: improving financial and economic management, and the quality of social service delivery, and accelerating governance reforms. I provide in this letter information on recent macro-economic developments and a statement of development policies to assist your Board in considering this request we have made. RECENT MACRO - ECONOMIC DEVELOPMENTS Economic Growth Malawi has sustained strong macroeconomic performance characterized by high GDP growth and low inflation. This strong growth reflects good performance in agriculture sector, which increased by 11.5 percent in 2006 from a decline of 0.9 per cent registered in Annual average inflation declined from 15.4 per cent in 2005 to 13.9 percent by close of 2006 despite rising oil prices within the year. Overall, the economy grew by 8.5 percent in 2006 compared to 2.1 percent in This was also as result of 1