Docnsntof

The VWorld Bank

FOR OMfCLAL USE ONLY

MICROFICHE Copy

Report NO, P- 5461-MAI Type: (pR) qu P56MA

SCHAFER, H/ X3442 1 / J11O4 6 / AF6co Repo!N P-5461-MAI

REPORT AND RECOMMENDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL DEVELOPMENT ASSOCIATION

TO THE

EXECUTIVE DIRECTORS

ON A

PROPOSED CREDIT

OF SDR 85.4 MILLION (US$120 MILLION EQUIVALENT)

TO THE

REPUBLIC OF MALAWI

FOR AN

ENTREPRENEURSHIP DEVELOPMENT AND DROUGHT RECOVERY PROGRAM

JUNE 1, 1992

lThis document has a restricted distribufion and may be used by recpients only in the performance ofdtir offici duties. Its contents may not otherwise be dbcosed widtu Wodd Dank authorizadon.

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OVRREM] ,AND M= EQUIVALERNTS

Amua A,xu Excch=neRt

Kwacha get US Dollars

1985: 1.7191986: 1.8611987: 2.2091988: 2.5611989: 2.7301990: 2.729

WEIGHTS AND MEASURIES

1 cubic foot (cu ft) = 0.0283 cubic meters1 cubic met (mn) = 35.3 cubic feet = 264 US gal1 kilometer (kim) - 1,000 meter = 0.621 milesI hectare (ba) = 10,000 square meters - 2.47

acres

GLOSSARY OF ABBREIATIONS

ADMARC - Agricultura Development and Marketng CorporationASAC - Agricultural Sector Adjustment CreditDevPol - S of Development PoliciesDOLV - Department of Lands and ValuationEDDRP - Entrepreneurship Development and Drought

Recvery ProgramESAP - Enaced Structura Adjustment FacilityESW - Economic and Social WorkFlAS - Foreign Investment Advisory ServiceFSEDP - Financial Sector and Eteprise Development ProjectINDEFUND - Investment and Development Fund of MalawiITPAC - Industial and Trade Policy Adjustmnt_ CreditMDC - Malawi Development CorporationMT1 Miistry of Trade and IndusyMOH - Ministry of HealtihOECF - The Overseas Economic Corporation Fund of JapanPOSB - Post Office Savings BankPSIP - Public Sector Investm ProgramRBM - Reserve Bank of MalawiUNDP - United Nations Development PtogramUSAID - United States Agency for Internaional DevelopmentSEDOM - Small-scale Enterprise Development of MaawiWID - Women in Development

Government of Malawi FsWa Year

April 1 - March 31

FOR OMCJAL USE ONLY

MfALAW

libbotCOnbeSM IC= RORATable of Contumat

PROGRAM SUfMMAY ............................................... 1-iii

PART L COUNTRY POUCIES AND BANK GROUP ASSISTANCE STRATEGY ... 1

A. Ba .rnd .......................................... IB. The Adjustment Process To Date and Economic Perfor m nene ........... 3C. Cenra Imues and Govenmens Adjutmt Strategy ............... SD. Izrpacofl9 lDrought .................................. 8E. BankCowitryAssistanceStrategy ........................... 10

1. Lending Strt .......................................... 112. Economic and Setor Work ...................... 123. SectorSpecificBankOperatons ........................ 134. PrivateSectorandCollaboraonnwlh IFC ................... 155. AidCoordiation .................................. 166. ReatiomnswiththeMF ............................... 16

F. Bank Group Opeaos ........ ......................... 17G. Projectmpleetationssues ............................. 18B. Perfbonance hIdicators . . . 18L Exte Financing r.. ......................... 19L. Summary Assessment ........ .......................... 20

PART . THE GOVERNMENrS ENTREPRENERSHIP DEVELOPMENT ANDADJUSTME1 PROGRAM .............................. 20

A. OverallCObjeciv .................................... 20B. Macreconmic Framework and Fnancing Requirements ............ 21C. Investment men ................................. 24

1. InvestmentPolicy ................................. 242. SmallandMcero-EnterprseSector ....................... 253. TradeRebozn .................................... 26

Ths report is based on the findinp of an appraisal mison which viidb M in June 1990.The mission conised of Ms. Kathie Knunm (Mion Leader and Senior Economist); Mr. SimonBell (iancial Economist); Messrs. Claudo Frisdcak, Friedrich Kabnert, Jom Kniht andChades MdLe (Consltants). Thi mission was followed by post-apprais mions in Agu1991 by Ms. K. Krumm, and in November 1991 by Mr. Hartw*i Sdafer (Country E mist).Mr. Djordje Jovanovic (Senior Country Officer) also contibuted to the report. Mr. Prafid Patb the mnaging Division Chief and Mr. Stephen D g the Department Director for the

his document has a restricedbdbution ad may be usd by recipients only in the perforzance f theirofcd duties. s contents may not otheise be dislosed witho World Bankhorion

D. Accs to Finncial Capitd ............................... 281. MonetaryControl and btrRst Roe MaMaemont .............. 282. BankingCompton ............................... 293. Capl Market Dveyopment ........................... 30

E. Access to Human Capid ................................ 311. PublicEad km Reorientation ........................ 312. T Ban ........................................ 333. FUncouing of Labor Markets. ......................... 33

PARTDL. THE DROUGHTRECOVERY PROCRAM ..................... 3S

PART IV. THE PROPOSED CREDIT ................................ 39

A. Objecve andRationalefbr IDA Fincnig .. 39B. FiangPlan .................... 40C. Procurement, Dibsm t AccountsandAudit . ............. 40D. MonitoringandTrandieR eilea ............................ 41E. ImpactonGrowth ..................................... 44F. Impacton Poverty Reduction .............................. 44G. Rism .................................... 45

PARTV. RECOMMENDATION . ................................. 46

ANNEXI Social and Economic Indicator

A. Soial ncator Data SheeB. Key Macaoecomic dcators 1987-95C. Externl Fiacing Requiremens 1987-1995D. Detailed Balancef-Payments Projections 1987-97E. ForeignExchag Requireme and Debt Service Assumptions, 1987-9S

lANNXI Staus of Bank Group eatios

A. Staeus of Bak Group OpeatiB. Statement of IFC Investments

ANNEX m Performance Under Past Adjustment Opratis

ANNEXI Supplementary Crdit Data Sheet

AlN V Letter of Development Policy

ANMM Vl Agenda of Policy Actions

MALAWI

Republic of Malawi

Republic of awi

I:DA: SDR 85.4 million (US$120 million equivent)

The opera is supported under the Specal Program of Assistceto Low-come Debt-Dbtessed Counties in Sub-Sabara AfiricaCofinancing of this program has bee araged by the AfricanDevelopment Bank in the amount of FUA 11.2 mi}lion (US$13.4

Standard IDA terms; 40-year mauty with a 10-year grace period.

Endo MOREn " RDegm=ni. The Govnment's adjusotmprogram aims at removig constaint thst have inhibited privaesector en nd initative. Ihe structural reformprogram andimpovm n short-tem maroeconomicmanag_ment in the 1980s have created a stable macroeconomic

and more liberalized product markets. Nonetheless,movement ho new producte acvities in reponse to thetaditonal adjustment measures bas been consuained by polciesthat confine privat en t both large and small-se,throgh investment controls, limted access to fianci capial, andinadequate human resource development.

The core of the adjustment progm supported by the proposedCredit is a set of specific policy reforms which wll remove theseconstrains. To create an enabling envronmet for private sectorentrpeneu trespond and Invest in physical capital, the programincludesregulatory, administrf amt and poliqc measures toencourage investment by both small- and large-scale enterprises andextend trade reform to ensure an outward orienton of the privatesector response. To promote access to financial captal for newcliens and activitie, the program focs on increasing financialsector c itn, including htoduction of market-orientedmonetary contol intuments and open entry of new domestic andforeig inttun into banking actvities. To broaden access tOhuman capital and expand employment oppotunies, the programInchudes the reorienton of puelc d in favor of humancapital combied with measures to improve funcong of lbormarkets.

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Drougbl Re2oq. A serious drought has affcted the entreSoutherm African region. Malawi has exprienced a nearly 60percnt reduction in the output of its ma staple-maize-in 1992.Mm Government has approaced the donor community to meetaddiional maize impott requrmn of 656,000 MT to avoidwidespe huwr and food insecurity among significant segmenof the Malawi populatio As immediate and ffective,the Credit would provide balace of payments suWort of US$50milliofor the purchm of maz equivet to 21 peent of thetotal foeign cost of maize imports. The entire drought-relatedcompont of the Credit will be disbursed with the first trahe.

Benefits and Riss: ne proposed Credt is epected to broaden economic patirdcand enable a sustainable supply response consistt with medium-term balanceofpayments viability, growth, and poverty reduction.he proposed rorm measur will have a potive and immediate

Impact on economic growth by remvig obsac'cs to pivae sectorinvestment from large to mi pr and expanding the flowof fnacial resoures into new productive actvities. Ihe iceasedemphasis on human capital and labor market tUf a willensu sustainability by making use of Malawi's abundant laborresources.

Simuasly, these growth masures wfill contbute greatly topovrty reduction. Labor-intensive growth beneft the poor whooen have insufficient land resources and require other employmentopportLLities. The program would directy increase employmentopportunities tugh expanded invesmet, and the outwardorientation would ensure a focus on labor-intensive acdvities whereMalawi Is cmpetitive. Financial reorms wil result in incteasedresource flows into sectors with increased partcipadon of the poor,i.e., in sectors other ta the narrow foma sector. Improvedsocial services will ensuret the poor can take advantage of thesenew employment and finan deelopmets as well as other

in key produedve sectors such as agricutre.

The Cret woud provide for a significant proporti of thedrought-eatd ficng reqre s, thus hlping to reducewidespred starvion and food insecurity. The main beneficiariesof the drougt-related Credit component are the rural and urbanpoor, including landless labor and food deficit smhoIders.

A potent risk is the political resistance to loosening contol andwidenimg economic participation that i itcal for any frtherprogress under the adjustm progrm. However, the Govenmentis convinced of the importce of easing constrit onentrpeeuria actvity in order to create a positive investmentclimate. The Govenme has comrmed Its by takinga number of politically difficut meaes prior to Board

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presentatin with certain othe as condit of the secondtranche.

Anodha major risk is the possible failure of the Government tomeet the concerns of bieral donors, expressed at the receConstive Group (CO) meeting, regartg the need to impovegovance, especialy basic freedoms and human rig. Bleraldons are sking tangible and irreverible evideo of a basictransformation in the way Malaw aproaches these matters, so dththere s a fundamena shift in the way human rgs In Malawi areviewed.

The proposed Credit will provide condtnu in etwe support andto keep the adjustment program on track over the next six montis.The gene bancef-payme suport under the firt8 tranche ofthe Credi wil sustain the Goverments adjustent program forthe rmnder of 1992. Additional blaterad balanoc-fwaymentssupport from 1993 onward will depend on reahig agr withbiatera donors. Govement's faiure to resolve the woernance,Issues with bilateral donors by end-1992 would result in postponingthe second tramche release until additonal xerl financing issecured to sustain the Government's adjustment program from 1993onward.

An additonal-though smaller-risk is the GovmeW s failure toseue exr fnancing in order to flly meet the drought-reatedimpo rqiements, mainly maize. Ibis risk shoud d be mimizedfollowing the recent CO meetig where all donors ehzed thathumantarian and drought-related aid would not be affected bv the

ntroversy over goverace. Several donors indicated hatpledges on drougt relief were forthcoming as they were finizingtheir respectve regional drought relief strategies.

Except for an amount of SDR 0.4 million earma forconsultancy services, the prceeds of the Credt will be disrsein two tranches: SDR 57 million upon oan effedtivees, which isexpected in July 1992, and the remaing SDR 28 million after theimplementtion of key actions and resolving the govenace issueswith blater donors on whIc& the sustainability of the adjustmentprogram depen. Release of the second tranche is aepected in thesecond quarter of calenda 1993. The Credit proceeds forconsltacy services would be disbursed over a peiod of 18months.

Thi Is a combined Presdent's and Staff Appraisa Reprt

INTRNATIONAL DEVELPNT ASSOCIATIONREPORT AND REOMMENDATION OF THE

TO TE EXECUTIVE DIRECTORSON A PROED CREDIT TO TIlE REPUBLIC OF MALAWI FOR AN

ENRERENEURSHIP DEVELOPMT AND DROUGHT RECOVERY PROGRAM

1. I submi the lowing report and reconion on a proposed IDA Credit of SDR85.4 million (US$120.0 million equivalent) to Malawi for an Enrepreneurship Development andDrught Recovery Program (EDDUP).

* Ei= dhe Credit supports rdorms aimed at removing conaS that have inhibitedprivate secr e and initative and limited access to financial and humancapita. This will broaden economic paricipation and enable a sustainable spplyresponse consstent with medium-term balancef-payments viability, growth, andpoverty reducdon.

* Seomdv the Credit provides IWnediue and efectve baleof-payments support forfood and othr impors t alleviate theimpact of a severe drought and to preventwidesped food insecuriy.

The Credit wfll be on standad IDA tem, with a 40-year matui. The African DevelopmentBank cofnancing this program and is planig to increase the allocated amount (US$13.4million) by VIS$10 million emaked for drought relief imports.

2. A deaied aalysis of the Main economy can be found in the Country EconomicMXemrandum etited 'Malawi: Growth Through Poverty Reducdton (Report No. 8140-MM),whch was circlaed to the Executive Directors in March 1990. A fourth-year Policy FrameorkPaper (P) was reviewed by the Comminee of the Whole in September, 1991. Basic oountysocil and economic data are given in Annex I.

PART L COIRY ROLL= AND BANK 6MTEGY

A. 1

3. Despite a series of adjustment programs, Malawi remains one of the poorest couniesin te world. Maai already ranks low with regard to human resource development and socialindicaors, and its popation growth rate and population density are among the highest in Africancounoies. he major pillar of Malawi's economy is agriculture, comprised of the estate andsmaliholder sub-sector. Malawi is extremely vulnerable co extra shocks because of itsgeographicaly land-locked position and narrow resource base. Despite considerable progress onhe m fron over the past four years, the medium-term economic outlook is higlyuncertain because of.

* the advese impact of an drougbt in 19 throughout Soutern Africa;and

* ddterioratn reons wih bflatera donors due to unresolved issues rlated togovernan.

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4. Eady d.gvel y . Malawi's developmene str fllowi in1964 by and large emphsized inhfstucu and agriculture as vehicles for increased produedomWhile the estate sub-secor was deemed the driving force for export growth, producer prices tothe saflholder sub-sector we kept below world market levels to transfer resources from thesmallbolder sector into the ate and aprocessing sub-sectors. Ihe country successUllyexploited its endowmeut during the 1960s and 1970s when real GDP morm than doubled and reaper capita Incom gew by 3 percet per yer.

Sp. Maawi s period of strNg growth came to a halt in the early 1980swith the onse; of a series of economic problems and exteal shocks, inuding a makeddedoration in the teams of trade, high international intr rates, and weather-related shodc.Ihe fist series of adjustment operaons was a response to this set of shock. However, while theGovernmnt was responing to these, the country was hit in the mid-1980s by a worsenig of thewar and civil strife in neigboring Mozambique, which not only led to a debilitaftng increase ininternaonal trsportaon costs but also to increased security-related expenditu and a largeinflux of refgees. This led to sharp deterioration in the maroeconomic balance and policysetbacks, cuminat in an economic crisi in 1986-87. Despite the recent partial reopening ofthe Nacala rail route and peace overtures, the Mozambique situation has not yet eased andremais highly unmceta. Certain policy responses to this second and more drmaic set ofsocs, including expanded fiscal deficits and implementaton of import controls, compounded thedifficulties and discouraged private sector investment and output. Widesprd poveny and foodInecrt emerged as importat social dimensions to the economic difficulties.

6. IM Drught. A severe drought is the latest In the series of extal shock whichhave affected Malawi. The sharp reduction (nearly 60%) in the 1992 maize crop will reult indditional foreign eage requirements of US$236 million for maize imports in order to avoid

widespread food shortages, malmution and starvation. In addition, drought-rela expendituresfor ital distibution of emergency food aid, water supply rehabilitation and health programswill further exacera the Government's fiscal constain.

7. Govemanc. At the CG meeting hed In P on May 11-13, 1992, there was adiscussion of issues related to governance. At the meeting, the Goverment and the donorsagreed on the objective of good goverment. The meeting helped specify the areas in which theblatera doos saw problems, incudig freedom of speech, freedom of association, freedom ofthe press, and basic human rights such as the release or trial of detainees, and mai prorconditions in the prions. The meeting helped confirm that the bilatw donors were not seekingto impose multi-party democray or any other system of goverunent on Malawi. Bilater donorsindicated that fiuther non-Irn co I would depend, as the CG press releaseindicated, on 'tangible and iversible evience of a basic trformaion in the way Malawiapproaches thw matters, so that there was a fidamental shi in the way human right Iues InMalawi are viewed.' A pridpan agreed that there should be further consultations among tieConsutatve Group as soon as substative progress has been made in the area of govenan,preferably with six monffis, as a basis for reassessment for fure external assistce to MaawL

8. Despite the outcome of the CO meeting-where bilatral donors declined to pledgeaddtion assistanco and in some ases redWced exisng commitments, the Goverment hasconfrmed its commiment to proceed with the adjustment program as plamned. TheGoverments generally good economic maragement was unanimousy endorsed by donors at theMay 1992 Consultative Group meedng.

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B. mmD s c fQ TO Do aqd Econig PerEnmc

9. As eay as 1981, the Governmt embarbed on a broad-based stcturaladjusn_t effort to ress the economic impact of eera shocd s and regain m cstabity and econmic viablity. Supported by three SALs frm the Bak and arrangemns wit

e Fund, this pvra encompassed sundard well-dend measures required for adjustmetThe major element of the program during ths perod wer: resuucturing of public &ectoresqwim; reformng smallholder agricultura picing and marketing; and estblsh fiscal

discipline. An expanded adjustment effort emerged fram the second set of eral difficiesand econmic crsis of the mid-1980s. Four Polcy Framework Pps (FP) have been agrdwith the Bank and Fund since 1988/89. Supportd by an Industry and Trade Policy AdjustmentCredit (QTPAC) and Agriculur Sector Adjustme Credi (ASAC) from the Bgnk and otherbier donors, as wdl as by su cessive arrangeme with the Fund, the adjustent program

cluded firther adju ts in fisc and agricutural policy and, in aWdion, the restoration of arelativey open excuhane and trade regime. However, by the end of the 1980M, it bm cleartat the well-defined adjustme measures already being taken were insfficet to overcome thestructuWal problems of Malawi, given s frile resource base and limited breadth of economicpatcipation. The scope of the progm began to exand to more subtde dimensions aimed atxpandi economic pattion and addring the problems of food Iscrt and povatywhich were diagnsed as ceal to Maawi's economic growth prospects. The proposed Crditraflects the expndd scope of the adjusment progm tat is aimed at addresing the seriousstutal pediment to susned growdt and poverty reduction in Malawi.

10. Public secto nite . Restructuring of the parast$ sector includedreorgnizat of the Agticulual Development and Marketing Corporain (ADMARC) andMalawiDevelopment Coqrotio (MC, as well as the divesure and restucBt of the larpquasi-public conglomerate, Press Group. ADMARC's financial position has improved

y with a ret to profitabiity, and a program to divest assets In non-core ar isongaing. MDC has shed a number of operto and became profitale. Financi performaof the parasatal sector as a wbolo has been fvorable, and financial targets under the PFP havebeen met. Profiabilit was restred t the Press Group sa in 1984.

11. Ekl nLlicies. Fiscal policy under the adjustment program established fiscaldiscipline, includig development of a tax reform program and tegthened budgetprodures. A substnt reduction in the central governnent budget deficit enabled a transfer offincial resouces from the Goverment to te pivate sector. The deficit declined itiay from16 percent of GDP in 1980181 to 8 peren in 1984/85, and, in reponse to the fisc imbalances

emmigfrotm the second series of sboes, the deficit again was reduced from 13 percet In1986187 to slightly above 5 percent in 1991192. Ihe private sector shar of domestic credit wasincreased from about 30 percet in the mid-1980s to about 70 pct by 1990191. Sctralreforms in budgetary planning included intoduction of a rolling Public Sector InestmentProgram and progr c budgeting. The Govenment als initiated a comprehensive taxrefom aimed at impowved tax .ah on and allocative efficiency, with a major restructuingof Idirect taxes. Revenue generaticn has remained strog at around 20 percent of GDP.

12. E alicies. In the early adjustme period, MalawPs trade and xchange regiewas rela y open. However, this trend was rversed by gradual increases in trd taxes and

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apreaton of the curmcy, compounded by the introduction of exchange controls on imports inreonsoe to the crisis In the mid-1980s. Beginnig In 1988, the Government phased out theseimport controls; the fnl stage of the import libealization program was completed in January1991. Over the past decade, the kwaca was devalued sver times against its basket in order torverse the loss in etal comp vess and to uppott the import liberization. The lastkwacha devaluation by IS percent in Mach f992 has restored enal compitveness to levelsequWivalent to 1987188, the period with the most depreciated real exchange rate. Ihe Govermeotis committed to fiuther excage rate action if exteral objectives so require.

13. Smallholder aggz IrL wlkiea. Smaholder agricultural policy rorm ialyfocused on strenening price incenives and expanding mketing participation to the privatesector. Rmallholder producer prices were increased significantly, wifth pricing for tradeablesbased on export-import price parity. In the cue of maize, which generally is not traded,domestic prices were set betwen export and import prices in line with domestic demand andsupply condidons. ADMARC's monopoly marketng role was eliminated. This rested inimproved performance among ager smallholders. Under ASAC, approved by the Board inMarch 1990, the scope of agsicula refrm was exended to remove more subtle barriers tobroader patcia0on of smaller smalholders and to provide Incenives for more efficient estfteproduction in light of land constraints. The licensing system which prevented smaliholderproduction of high -ale cash crops, including burley tobacco, was revised and a program toensure a steady increase in smallholder participation was put in place; focus on research and otherpublic expenditumes was shifted to smaller farmers; privae sector pardcipation in marketing ofcoops and inp was widely promoted rather than merely being condoned. To promote efficientland use and sound envint practes, pardcularly in the estae sub-sector, land res wereiceased, most recnty in 1992 to the real level prevaling in 1985, and enforcement ofenvironmena covenans was stengthened.

14. Toonoic nhe strucu reforms and improvements in short-termmacroeconomic management have created a stable macroeconomic enviroment, as Indicated bythe tables presented in Annex L After negative growth in 1986 and flat performance in 1987,GDP (factor cost) grew by 4 percent per annum during 1988-91, restoring per capita GDP growthto a positive level. TAe omprehensive import liberalization program and more stable financialconditons contiud to recovery in the ma, constuction, d distiuton setofrs.Real GDP grwth for 1991 was e at lightly below 8 percent, with real growth in thesmallbolder agricultural sub-secr in the double digits. The high growth rate In the agricultesector was party due to overall favorable weather conditions in 1991, but also indicates thepositive impact of suctur change In smallholder agriculture. Inflation decelerated shuply froman average of about 30 peren in 1987-88 to 16 percn in 1989 and 12 percent in 1990-91 as aresult of tight aggregate demand managemet Real wages have dedlined; in fact, labor bore asigfica part of the adjutmt burden. The Improved performance in output and relative pricestability supported a large increase in gross investmt, from 12 percent of GDP in 1986 to 19percet In 1991.

15. Despite the wide rae of policy refims, successfl implementation of measuresduring difficult perios, and sound economic growth during the past few years, the supplyresponse has not been adequawe for susined growth and balanceof-payments viability. Over thepast five years, export growth has been slower than import growth, with litte diversification outof the tadional exports of tobacco, tea and sugar, and limited development of the potenial for'naufactured exports. As a result, the current account deficit was only marginally reduced from

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entrprses. Private Invesme rcovered in 1988-1991, but It was concentrated In traditionalactivities (Wnuding agricultur and enegy). Investmeat in non-traditional sectors has respondedpositvely to macroeconomic stability and increased profitability, but not to the levels required forseructural change.

19. t alet is availUble in Malawi, and diverse groups witin the privatesector are prepared to It. However, actual investment response has been stymied by officialcaution, long delays in decision making, and geogrphical restrictions on investment by non-indigenous iestors. hee issues represent only one facet of the curn discussion on

sarency of desiomaking and govenam. Even well-positioned invesrs face contrls;entreprenas wishing to break Ino Malawi's tight business envroment fce even more rigorousscrutiny. lbe tade tax regime has not been sufficiently oriented toward export markets on whichMalawi's #ue producto and employment growth wil rely heavily. The small and micro-enterprise sector opeas amidst policies inappropriate for this scale of operation. Lack of accessto wider markets and to credit have additionally limited the ability of ftis sector to respond. TheGoveent's strateg is to tmsform the investment environment and increase access by small-and mico-enterprises to credit and markets. The detailed program is described in the context ofthe proposed Cedit.

20. Finamc a= r.BEarlier adjustmet operations made significant progress in ensuring;he the Goveoment parastatal sector, and Press Group limit their demands on the financialsystm to ense sufficient access to financial capital by the private sector. Ibis is reflected in theGovrnments net negaive omestic credit financig posion since 1988189, and the return toproftabUity of the Press Group and aU but a minority of commerci parastatals. However,increased financi flows to the private sector have not resulted in deepening of channels to non-tional clients and civies. In addition, the formal economy remains higly concentrated,with the contnuatin of the Press Group as a dominant player. Financial markets are narrow anduncompetiive so that bzns and other financia instiuions have been profitable without having toseek new cliets or new chanls of business. As a result, significant segments of the prvatesector uding smaller entprs and the poor still have limited access to the financial supportreqired to respond to policy cages in pricing, agricultural marketng, and the extr regimeamong others. The Govenmet's strateg is to reform the finacial sector and expand the role ofma forces in r.sorce allocation and monetary poHcy. Institutions for small- and micro-

tenise are being strengtened. lhis pgram is descrbed n detail in the context of thepropose Ct

21. About 90 percent of Malawian women live in rural areas and 30 percent ofhousholds are headed by women, many of them poor; also, women's role in the infrmal sectoris slgnifcanL There is a particular need for labor-saving tedcnologies that relieve the constraintson women's time and enable them to seek other income eaning opportunities. An instionalfiamework has been developed with the establishment of the National Commision on Women.Many women in development (WED) Initiatives such as credit and income generating actvities arerela y recent and will be given further support to reach their potential. Ihe Governmentstrategy also includes measures to reduce the consts on women's time such as programs inrural water and fielwood efficiency, enabling them to increase household income.

22. nE . In agrudclture, pricing and marketg reform supported byearlier adjustmnt opatin helped to achieve modest growth in estate agriculture and among therelatvely large smallholders. However, agriultura productvity has stagnated as a result of

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limited adopti of improved agculral techologies, particuarly among the marIty of poorsalholders, sharply reducing their abiity to take the niiative in r ning to refoms. Ibis,combnd with rapid population growth, has cotained domestic food seuty and impededefforts to chanmel agricultural production into export growth. In addion, land use in the estatesub-ector has not ben optim. Agriculture remains a key sect for growth and poveryredution hi the Qovernents strategy, especialy in light of the predoince of ural poverty.Reen refinemet in agricultul sector policy, embedded in ASAC, include particular measuresto support the smaller farmers who face the greatest food insecty and to Improve landutlization in the estate sub-ector.

23. a s . Rapid populaton growth and low productvity of existigagricultl techology have led to an increasingly umsusale demand on land and forestresources, as evidenced by increasing soil erosion rates, declining soil fertity, and widespaddeforestion. Other environm problems include increasing scarct of potable water incertain areas, water degradation, and over-fishing in localized areas. The limited opportitiesfacing the rur poor in Malawi encourage misuse of natural resources and exacerbate theseproblems. In additon to addressing the underlymg poverty which would relieve unsustiablepressure on the environmet, the Government has developed a relatively strong instional andpolicy framewok in resn to specific environmental problems, and exig programs supportimproved cutvaton and livestock practices, social forestry, and new enemr demand managementmeases. The Government stra is to strengten natural resource management, and todevelop an E irm l Action Plan that wfll map out a long-term investment and policyreform progam

24. Hu . Inadequate attention to human resourco developmenthas been an importt factor contributing to poverty and the weak spply response. Loweducaton and health levels have limited the ability of small farmers, particularly women, torespond to inceives. Low education also has limited the types of Investmt tha can be made inMalawi and the potenal for rtuturig the sources of icome for the economy. An improvedpublic investment planing proces achieved under earlier adjustment operatio s nw In place tofcilitate shiftig of resources in line with changig priorities, to be supported by the proposedCredit. The Govenment will contiue to strengthen basic social services delivery, and provideadequate budgety resources through restucring of other eeditue. Prioriies areexpan and quality enhaemnt of primay schooling, with special attention to access andretetion rates for girls; improved staffing of primary health care, matera ad child carefacilities, and strengthening of hospital management. Nutrton will receive specW emphasisthrough increased food security efforts and targeted supplemental food programs.

25. ion. To address the problem of high popation growi raes and ppulatindesity, the Govmeun is commitd to expansion of famfly planning acdvities, includingincreased popuation educatio in school curricula, exasion of dhild-spacg services, andsupport for a nw Family Welfare Coundcl, under the IDA-supportd Population, Health andNutiton Seor Credit.

26. n . The internl infrastructure network of Malawi is reladvely well-mai ed. The Goverme's strategy is to ensure that it does not become a bottleneck in fmtreprvte sector and export expansios The Goverment has contnued to pursue a number ofcomplementary srsategies to alleviate the economic burden resulting from the disrpton ofexerna transport routes tough Mozambique, including improvement of the Norther Transport

-8 -

Corridor (asted by the Bank) to Dar-eSalaam Th Govmt is developing a restructingplan for Maawi Railways, on of h remining public enteprises wh needs ni . atwill insite policies that ensure transport and commicatiom networks a are responsive andope to the priva sector.

27. Macreconomic and pdublc sema ng Ihe Govement places great emphasison maintainie I_ stability ta has been acieved during the recent austmetperiod. The Govenmen plans to cotinue to mainin tict fiscal discipline, follw a managedexchange rate policy in the fmwork of i g financial policies, and gearmnwetary policy twards acheving nd aiing a low inflation rate and protctig the Wance-ofpayments. Whe of popiate size, the civl service mce gy is beset by problems ofhigh turnover and low morale, in part due to adequate ibutso related theextrem top-down, corl-olried style of management i the public sector which hasdiscouraged iniiave and risk-taking. The Govenmwent staw is to enac civil serviceefficienc, includig restoring aprpriae nmp _ levels as wideaced by a wage increaseand decompression in the salary stucture in ApilM 1992, as we1l as to stregthen taining andimprove the working enviomen

28. In summary, the adjus_tm process in Malawi has rest mc stability,elimated the drain of resources by the public sector and bas, by and lare, ceated a set ofappropriate price signals. Nonetheless, broad-based economic particio continues to beinhibted by the politically sensiive 'cotol' aspects of te policy ironment, and povertyremains pervasive. Though it is reluctent to inse transfer progms which may have anegative Impact on producdon, the Government has begun to make efforts to alleviate povertythrough progms and policies itegrted into the ovel growth strategy, nmely, employmentopporunities through greae openmess in the private sector and financW sector, moretransparency, responsiveaess and accountability of governmet, as wel as particular attention tte constaints facing women, wider smaiholder access to the means to enhance agricualproductivity, and expaded access to socia services. To ensre a sucessful phasing-out of quick-disbursing external for the adjutmet process in Malwi in the 1990s and establish abroad base for poverty reduction and t growth, the focus of Government straegy isexpected to be the frwther removal of obsacles to prvate secor iitiative that cot a broad-based supply response in the critical areas of agriculture, fiWncial markes, trade, tnsport andcommunication, and human capital investment

D. Impact of 1992 Drout

29. As Malawrs Main staple food, maize is grown by some 1.7 mlion smallholder farmersproducing minly for subsice, with 55% of the households cultivating less than 1 ha. Ihecountry has managed to produce enough maize in most yeas to feed its population, though thecombination of low productivity and smal farms results in chronic food in rt even in normacrop years. This year, however, Malawi, in common with most other coustries in the SouthernAfica region, has been ded by the worst drought in decades. Following averageprecipitation for November to mid-December 1991, the rains faied by mid-January 1992 in thesouh and by end-Jamuay in the cener and norh of the country. The drought conditionscoincided wih a critical time in the growd cycle of the maize crop, when poinai and grainfilling takes place. Virty no more precpitation was recorded undil localized showers were

-9.

received at the end of March, too late to benefit maize crops. Overall, precipitation from Januaryonwards was no more dha 30 pecen of average. The worst affected areas in the country are thecentral and southern regom whe almost 90 percent of the populadon reside. Some areas of thesouthern region, particully the Lower Shire, where there is a large concentration ofMozambican refgees, harveted pradcally no cerel crops whatsoever.

30. Final maize production esmates for this year are now 660,000 MT, only 42 percen ofthe 1990191 harvest of 1.6 million MT. Output of other foodcrops such as groundmts, beans andsweet potatoes was also very poor, with only 40-70 percen of normal yields. Other crops, suchas cassava and banan, were less affected but cannot redress the devastation of the basic staplesneeded to maintain a mtritionaly balanced food basket. Some 4.7 million people In Malawi areesmated to be most seriously afece by the drought. Food security at the household level ismost precarious for the 55 percent of the population who have less than one hectare (ha) of land.Ihese households, even in a normal year, are unable to produce enough food to meet their full

tritional requirements. People most at risk are those living In marginal agricutural areas; thosewith small land holdings, particularly the 25 percent with less tm 0.5 ha; those normally relyingon agricultual casual labor to cover their food needs; and households with a high dependencyratio, notably femate-headed.

31. As a result of this year's extremely poor harvest, food imports on an unprecedentedscale are urgenty required. Southern parts of the county, in pardcular, are facing Imminet foodshorta and emegency food progms are already underway. It wJIl not, however, be possibleto meet the entire producdon shortfldl by commercial imports, and, even with the maxmmpossible drawdown of curret stocks (Inchding the Government's Stategic Grain Reserve),subantial intenational assistance is essendal to avert famine later in the year. Ihe currentdrought is not only a human tragedy of massive proportions, tut it also threatens to reverse therecent trend of econmic grwth in Malawi, and deplete the country's limited interm resources.In March 1992, the President of Malawi officially declared a national drought emergency andppealed for internaional humanirian assistance. This was supported by a special alert for aidrought-affected counies of the Southern Africa region ised on Apr 15, 1992 jointly by theFood and Agriculture gonaton and World Food Programme of the United Natios. The IDAbaance-of.pyments spport under the proposed Credit for drought-related imports would be aresponse to this apped.

32. In additon to the drastic reduction in food supplies, the drought is also severelyaffectg access to drinking water supply for the rural population, most of whom rely on protectedand unprotected hallow wells. An estimated 20-60 pent of these wells (depending ongeographica area and estng depth) are expected to go dry as a result of the drought. Inaddition, some 40 percent of the eisting 8,500 boreholes in the country are esmated to be out of -action at this time. The health status of children and women is already extremely poor throughoutthe country, with very high levels of chronic martion and Infectious disease. There are anestmated 1.4 milion children under the age of five, and 960,000 pregnant and lactating women.Infant and under-five mortaity rates are among the highest in the world at 159/1000 and257/1000 respectively; 56% of under-fives are normally cironcly stunted. Matenal health isalso among the worst In Africa The deficits of food and access to safe water resulting firom thedrought will lead to an extremely serious deterioration of the health and nutritiona staus of alarge portion of the Malawian populatin. The health service is already under constant sainthe drug supply system iS in crsis with regular periods of stock-outs of essenta drugs evn In themain hospitals, while trained manpower is in extremely short supply. As a result of the drought,

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the wil be icrase demands on the Imited resources available for health care, and it wil bevey difficult to maintain basic services.

B. Ba4k.X&SY

33. T Ihe Bank wfll contn to play an Importan role in the design andImp dI on of WMa s developmet program as well as in the mobilization and coordinatioof financial resouc required to support economic development. Thus, the Bank will help tocontnue the good economic management tbat was unaimously endorsed by the CG.

* El a main goal of the country assistamce strategy will be to upport critcal areas inthe Goverment's developmet agenda, namely:

- comehensie meaure toward poverty reducton;- hlbeaizaton of the envoment for the private sector;- name source conserain; and

xwllu~---c stability.

Ihese areas cannot be deliked and are mutually reinforcing. Support wvil be providedthrough a mix of economic and sector work, project and non-project lending, and aidcoordination.

SOnd tuture Bank assistace in Malawi is entering a transition phase which wMll takeinto acowunt the considerations brought into focus by the CG meeting of May 1992. Inpartiar, the Bank will help to ensure that the Government undestnds the bilatraldonors' concern on governance in Malawi in a clear and unambiguous fashion. Giventhe critcal importance of bilatera financial assistance to Malawi's developmentprgrm, an eveu resoltion of the issues telated to govenance is essenal to thesusinability of the Malawi program. Continuing its role as a polidcally neutralfacilitator in this area, the Bank is prepared to arrmge further consultations among theConsultative Group as soon as substantive progre has been made in the area ofgovence, prerly within six months, as a basis for reasessment for futureexte assistance to Malawi.

* Mhk4 the Bank wfll help the Govemment cope with the conseqences of a very seriousdrought. At the present levels of assisunce, including p Bank assistace for thedrout, we expect there will be widespread hunger and even starvation amongsignificant segments of the Mawi population later this year. We are therefore seekingways of proceedn with planmed Bank assistance as soon as practicable.

* Eiuh the Bank wil closely monior developments in donors' extea assistace toMaawi, in partlar with regard to lending Bank operations dependent on bilateracofinancing. In the m, planned Bank lending could be affected by the lowerlevd of available extemal fug if the Government is not able to resolve itsdifferencs with bilateal donors on governace issues. If the Government should falto rach consensus with donors on govanance issues, the Bank's lending program wilhave to be reconsidered in the light of reduced overall levels of eal financing.

1. Ldiag

34. IDA lending will emphasize dhre areas linked to the Government's integrated strtegof growth hough povety reduction:

* improve the agricultural producivity of small famers while ensuring nat resourceconsevato;

* increase socia sector epd and reduce fertily; and

* inres employmet opportunities through li izaion of investment, trade andfinancial secor, labor market rderm and income generatg programs for women andsmaler enterpises.

35. The precis scope and content of IDA lending will depend on the vigor and consistecyof the Govenmens efforts to Sa srcua adjustmt issus, and on the actions taken bythe authorites to respond to the challenges posed by the recent CG meeting.

36. Stmctural WTa lhe reforms supported by early adjustment operationsencompassed public etprse reform, agricultural pricing and marketg, and fiscal and enalpolicies, and have resulted in a resoration of macroeconomic stabiity and a markbasedeconomic structure with apprprit price s. Given the extreme poverty of the populnand the country's meager and fie resources, however, these adjustments did not generae asustained supply respone. More recent reforms are focused on underlying issues critical forgeneratig broad-based and equitable paracipation in the economy. in agricuture, ASACsupported key easures to ince the produciity of smaUholders and a broader range ofestates, and give smallholdees access to key high-value cash crops. The proposed Credit hasexanded the dialogue to remove policy obsacles to enteprene ip hat coninue to constaphysical capital investment and limit acces to financial and human capital. The next set ofstructural issues to be addressed by econonic work and adjustmet lending would conce tradeand distibution, and aim at reducing obstcles pose by market concentration and promoting easeof entry.

37. Bilateaul M ur te afutnL prag=. Bilateral donors indicated at the CGmeeting in May 1992, that teir future support of Malawi's program depends on actions byMalawi to adress goveane ues. As the susainabiity of the adjustment program depds onthe avalability of adequate extern financing, Malwis adjustment program is now In a criticaltransition phase. As an immediate respone to the CG, the authorities have confirmed theirinttion to continue the adjustme progm, despite dte absence of new bilatea commiments.The Government has adopted tighter monetary and fiscal policies, and taken other supportingmeasures to strenthe the bale of payments, tiereby closing the fnancing gap for 1992.However, contiaton of the adjustment program beyond 1992 will be extremely difficult withoutbilat financial support. Release of the second trche of the proposed Credit is condioned onthe mobilization of fiuding required to sustain carrying out the program. The Bak wil contineto work with the Govenment and donors, as a polticaly neut faclitator, to hep resolvegovernance issues on which bilatera financing depends.

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38. co and gnt of new Bank l din. The nue of Bank lendig in Malawi willdeped on the Govenme's abWiy to pursue adjtmt poLcies with adequae financing.

* For FY93, while fancal flows to Malawi wil depend in part on the outcome of thesebroader adjustme Issues, paiclary the release of the second trache of the proposedCredit, nw IDA commiments In FY93 would be unaffected by the outome of theadju dicussion and are expectedo comprise two Invemen operations, one forAgriuture Srvlces and one for Rurad Fiancial Sevices t, for a combhined toof arund US$65 mfllion.

* For PY94-96, on the assumption tdat the Government is able, as it plans, to undeakstrong implemenion o the economic adjustment progrm, addrsing strucra andpoverty issues, and to mobilize adequate extnal financial resources in support of it,then thevolume of IDA leadng for FY94-96 is expected to be on the order of US$80-100 million a year, with around three operations a year, including an adjustmenoperation in FY95 (a proposed Trade and Distribution Sector Adjustmen Credit).

* If the Govenment were to be unable to contne the economic adjustent program asplanmed or to mobilize adequate exena resources in support of it, then IDA lending inFY94-96 would comprise a core program of investment opetions that would besignificantly smaller both in terms of numbers of opeations and dollar amounts.

2. Economic and Secor Work

39. The ESW program in MOi will be tailored to support the evolution of the lendingstratey and will aim to:

stengthen the analydca base of our policy diaogue with Govment;

* Ientify investmn priorties for our proposed lending progr; and

* faciiae aid coordinaton by providing a framork for other donors.

40. In the area of ecwnomic gitb analysis. a comprehensive miew of theMM was completed in 1992; the report Identified a broad range of policy, investment, andtechical assistace measures to improve the efficiency of resource use in road and rail serWves.Work on an sector memorandum is underway. Future work is planned in the areasof: MM mid= which will sngthen the incentive framwork for the energy sector,sector developen uing trade and distribution, which wfll update unds i'g of privatesector response and address issues a ted with the high degree of concntration in the fomaleconomy; and human rewurm devmpmen with an education sector study to address growingdemands on the undeveloped num resource base.

41. In the area of Rty fhe Bank will coninue to monitor progress onimplemsing a comprehesive program to e Malavws poverty problem as ld out in theFY9I Couay Economic Mendum, and to support follow-up action on sectoral studies Inpopulatn, agriculture, integrated socia sectors, financal sector, and women in dievelopment. Apaper laying out a Population Acto Prgm will also be prepared.

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42. In the area of paSl u ea e cO Qtn, an economic report on enviromentalpolicy issues was prepared in FY92, laying out a medium-term policy reform and investmentprogm to ensure efficient and stainable use of the resource base, with emphasis on thepressing isues of deforestation, soil eosion, and water pollution. Ibis work is expected to formthe basis for the Govaerments Environmental Action Plan and futur Bank lending In the area.Land policy Issues Including lad rents a being reviewed in the Agricultural SectorMemrnum.L

43. In tlhe atee of nomcw manag orkonbudgetra aization wil updae the FY90 Public Endtue Review and assist the Goenmt inmaximining the benefits of budget outlays in a tight fiscal environment. aose monoring of thesize and composition of the aual Public Sector Investment Program wil continue to be a keyissue in the work program and the policy dialogue witfi Government A Public SectorManagemet Review completed in 1991, will serve as a basis for ientfying policy and technicalassistnmce m ures to improve the icentive framework for effective civil service and economicm_ngeent.

3. ScorSpofl AnLQpmn a

44. Agribtre. In view of the forthcoming Agricultural Sector Memoum (FY93), theBank will reassess its agriculture strategy to address the pressing issue of low productivity and theneed for export diversification. More emphasis is being ghien to raise sallholder productiontrough development of appropriate technology, credi and etension packages and to improve theeffiency of resource use among estates. The proposed Agicultural Services and Rural FianciaServices Ptojects Y93) wil focus largely on poverty aleviation measures through the expansionOf smaholder access to agrcultd serice and credit, and improved conseron of the natualresource base. The forcthoming Agtural Divesification Project (FY95) wiUl focus ondevelopment of oth cash crops which could provide an altenative to the currently dominanttobacoo in the medium- and longer-term.

45. Natra Rgau=. In response to the growing need for en nmna control andnatl resource consvaion, future Bank invetments are expected to expand on-going projectsin tural affirestaton and soil conservation and introduce new itiatives in customary forestmanagement, rural water pollution, and agroforestry sytems. Tne forthcoming National WaterDevelopment Project (FY94) and Natua Resources Coservation Project (FY96) are gearedtoward this direction. Support for y sound pracices will be part of theAgricuudl Services Project (FY93). These investment eft wil be comlemented by fuherstrnthening of the incentive framework for efficient resource use, pardculady adjustments Infuelwood and water pricing and stricter enfmnt of estate conservation and afforestationcovenants.

46. Social Sectors ad As part of the inced emphasis on poverty reduction,lending to social sectors has increased. Buig on several existing programs of bilaterad donors,the Population, Health and Nutr (PIN) Sector Credit (FY91) provides critical suot tostrengen primr health care programs, increase family planning acdvies, and improve medicalsupport services; PHN II (FY96) will focus on popWation control, following approprdae sectorworL Ongoing education credits, Icuding the Education Sector II Credit approved in FY90,focus on expansion and quality enh of primary schooling and increased efficiency inresource use. These effort will be followed by Educaton Sector M Credit (FY95). Finaly,

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aditonal investment in the development of rural water supplies, under the National WaterDevelopmnt Project (FY4), is expected to improve access to clean water, reduce the Incidenceof watr-bome disaes, and reduce the negative effects of ftre droughts. The proposed Creditwill support Increased budgetary allocations to these sectors.

47. 1dUs Ms Pinau and u mloymnreased soial sector nvem will bematched by an expansion of employment opporties and labor productivity, dircly benefigthe poor whose main as consists of labor. Ti is supord by the prposed Credit which isdesigned t remove tIhe policy constraints to private sector n and niive,particulaly in the areas of investment controls, small-scale business regulations, and limitedaccess to finacial capital. Conned macroecnomic policy reform under adjustmt operionswll prome inceased employment though geater labor-intsity of production and higherinvesmt levels. Te Bank is aso focusing on another key contint to Idustri developmentnamey, the thin, undeveloped financial market and lack of industri iructre, through tierecently approved Financial Sector and Enterprise Development Project QFSEDP) in FY91complemented by the proposd E n Development and Drought Recovery Ptogram(EDDRP). Mhe nem adjustment opeation, Trade and Distribution Policy Adjusment, wiU followUp on these poicy rern, in pardtclar, by removing reman legal ad institutional barders tobroad-based private sector entry, including in the fields of intern distribution and

48. W . Pardcular emphasis will be given to the role of women. To address theissues, a comprehensive report on Women and Development in Malawi was preaed in 1991which is to seve as a basis for assisaco through specific investmet opeaons. So far, severalprojects have included co _ments which direcdy or indirecdy assisted women (such asEducation, PHN, ASAC, Fisheries). Women's needs will also be addresed diety in the designof forthcoming projects uppot agriultmual services and rural water development, and in afor_toming project which wfll be entiely focused on WID.

49. . The Bank wil continue to support devdepment of the physicali Astructure quired for growth. Gien the constrained public expenditu program, emphasiswil be on inegrad, sector-wide investment operations that target high priorty Investments andprovide sufficient resources for the maintenance of the exdsting capital stok Reflecting thecentral role of tranort shocs in aw s maceconomic diuibium during the pat tenyeas, the strategy emphasizes rationizationof transport sector investments and policies, tho(i) owing projects inluding the Northern Transport Corridor Project of FY88 and theInfrastructr I Project of FY90; (n) the forthcoming Inrsructure I Project; and (ID) sectorwork on traort policies. The restturg of parastatal transport agnies, particularly MalawiRailways, wil be a focal point of Bank dialogue with the Governent. he strategy alsoemphasies the appropiate expansion and increased ned for maitenance of infastructure, aswell as implementation of the least-cost power development program.

50. Macroeconomic and4ub1iciomanag@muit. The Bank wil codtue to supportpolicy measres to sustain macecnmi stabilization and technical assistance requirements tostrengthen public sector Impleetat capability. In monetary policy, EDDRP and FSEDP willassist the Government in moving away from direct reuaion of commercial bank credit to amore market-ed monetary progra. In public fimace, future projects will emhasizecontnued fisc constraint, imroved budgeting systm, and n of the tax reformprogram

* 1S5-

51. *v 1 . Given implemntation constrats In several key ministries InvolvedIn planiAg and implementi mm policy reform, the Bank wil continue to providethcal ss to public sector manmgement through the ongoing InstittiondlDevelopment ProJect hd suppors t restucturing of the Miniy of Fmance and theestablishmt of theo Maawi nstitut of Mangement. In addidon, Instittional Development nFY94) Is envisaged t support fo to improve economic goverance and the performance of

the civil ervice. Over time, the capacty bulding efforts, like support to the Malawi Inst ofMnagement, will help to reduce iMa's dependence on foreign managers and consultants bybncraig te supply of hig levd manpower needed for effectve management of developmen

52. D R =ry. The Bank nds to handle its assistance so that bothi theInmediate and future needs in respont to the 1992 drught wfll be responded to. ThIus, theBank' assistance will be hanled in three different, yet complementary, ways:

* imediat atance which wiM provide for balance-of-payments support (JS$50million) under the proposed EDDRP for the purchase of maize;

* n adjtmets of selected ongoing projects (e.g. the Agricual ResearchProject, thie PHN Project and the Infrructwe Project) to cope with gdicutur Iputneeds, water supply bottlenecs and emergin drought-related health problems; and

* mid-tem assistance by designing fture projects h such a way as to better prepare dtcouty for possible natural disasers (e.g. the Agriculual Services Project to be

dpprased in June 1992, and the Natural Water Development Project to be appraised in1993).

4. Pda Sector and Coaboraion with IFC

53. In line with the Govnment's stte of giving the private sector a cenra role in thedevlopment of the economy, the Bank a nce stategy includes su1ppOt for policy refrms inareas of concen to IFC. The prposed EDDRP includes removal of constaint to prvae sectorentrepreneuhip and increased emphasis on exnding resources to the private sector. Furthereconomic and sector work is oriented toward private sector development, including the issues ofcncntration of ownehip, ive transport services, and micr terprise development.Specifically, an opeation geared to assist small and medium scale prvate sector businesses isenvsged in the lending progm

54. The Bank staff workd closely with the Foreli Investment Advisory Service (FAS)over the past yea in developing the agenda for recnt investment policy refoms, and wilcontne to coordinate with other arms of the Bank Group I expanding opporties for theprivate sector in Malwi. IFC has had sven opeation in Malawl, totalling US$32.6 million ingross co-mibnents, and is acdvely seekiDg new investments. Recetldy, IFC has launched amgnber of initaties to supplemet Is regul investment acvities in Africa, including the AfricaEntea e Fund (AEF), which has completed six projects. AEF has thractive projects inMalawi, and is cueny i an oil extraction project in Malawi. Bank strategy is to workclosely with IFC in Idenifyin options for further strengthening the flow of resources to theprivate sector In Malawi.

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S.S

55. Aid coordinaion with oter donors has emerged as an active partnersiip with acoordinated approach through COs and SPA. These meeting have served to achieve conseOu indevelopme stregies, in defnig epediu priorities and raising additioni fimds for thecountry, as well as providn donors with a forum to exprss their conern to the Govnment.Under die leaderhip of the Bank, local donor meeting in Malawi have also taken place on aqular basis. In additon to cof _iag of specific opeatio, the Bank continues to coordinateclosely with donors an key policy matters being pursued with the Govenmment, includingcoordiaton of donor assistance tou SPA activities.

56. The Bank epc to continue the active involvemeat in aid coordinaton to ensure that:

* donor project facing remais conisten with priorities agreed under the PSIPdialogue with the Government within a tight fiscal program, consistent with themareonomic fmework agreed with the Fund and the Bank;

* adequate balance-of-payments and recurrent financing support is made available tosupport currmnt accoumt and recurrent expendke requirements; and

the short-tem emergency assitac for refuges and disaster relief is consistent withMalawi's growth and stabilizadon objectives.

57. Recently, the dialogue on development strateg has also included the rigidities in thepreing political and nsitutonal system in Malawi which limit possibilities for sustaedgrowth. On the initative of the doos, and with Government concurrence, governance-bothpolitical and enmiC-was discused during the May 1992 CG meeting in Paris. The Bank willmaintain sict political neuait and will coniu to play the role of a facilitator with regard tothe dialogue on govance Is. The Bank is prepared to convene another CG meetng as soonas substantive progress has been made in this area.

6. Relatios wih *e

58. Reflect the importance of a stable macroeconomic envirornent to the adjustmentprocess in Malawi, Bank and Fund staff work in close collaboration on the macroeonomicprogram. The Fourth Policy Framework Paper (PFP), presented to the Bank ad Fund Boards inSeptember 1991, spells out the Government's maoeconomic and sectoral policies and programs.Malawi is now in the fourth-year ESAF program with the Fund; the first tranche release wasapproved by the IMP Board in 1991, and the second and final tranche is epcted to be releasedin the third quarter of 1992. As the Fund's ESAF enter Its final phase, various possibilities arebein considered for contnung BakFund involvement in macronomic stabiliation and thestuctual adjustnt program. The Goverment would welcome coopeaion in prepaing a fifth-year PFP later this yea which would enviage coniuing progress on the m noic firont aswell as frthe progress In economic lberaizaon. IM management has confirmed its suportfor the Bank tO proceed with the EDDRP to keep the adjustment program on track in 1992 and toprovide Immedite assIstance to cope with th negative impact of the droght.

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F.

59. Over the past 26 yeas, te Bank Board has approved 56 IDA credis (totallingUS$1,036 million ecluding canellons) and 10 Bank loans (totalling US$106 mfllion excludingcancellations), of which two were on tird window terms. About 30 percent of the totaUS$1,142 milion has been povied though struc and sectoral adjusment opeaions, In linwith th cial need for adjustm over the past decade. Other imporant areas wereinfstrture and waw (16 percet) to ovecome the constr nt aring fwom limited ruralinfrasructr, agriculte (16 percent) in iHe with the smailholder focus of the Govenmensdevelopment strategy, and educatIon (17 percent) to address the problem of Indequate access toprimary and seconday educaton. The balace has beean used for energy, health, developmentflnance, chnical astn, Industry, ura housing, and insional development. In receztyears, the dribuinof Bank lendi shied slightly, with more emphas on adjustmelending following the m c disequilibia of the mid-198s and less emphis nInfrastructure development with the completion of many key investment projects, as shown inTable 1.

60. Past lendig operatons have generay been implemented in a timely and effectivemanner. Adjustmet operaions have not ewperienced significant delays in tranche rdeases.Noneteless, the management capacity of the Governmen frequendy has become overstretched,partiularly as new exogenous dhcks (drougbt and soarig international transport cost) continuedto stabliaion and adjment efforts. In recognition of these impl ionconstains fte opera will be focused on a smailer, more manageable set of priority policy

Table -1: MALAWI: DISIUTION OF LENDING, FY86l91(US$ Mili;o)

Sector Amount % ofTotal

Adjustnt Lendig 197.1 36Agricultureand Foesty 63.3 11Indusy and Face 39.8 7Health and Populton 66.5 12Educaton 63.9 12Urban and Water 20.0 4T 1rasportation and Inucre 42.2 8Eer 46.7 8Insitutional Development lu

Total nu

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G. bf huslmnlm nbnlsueg

61. Project impleaton has been advety affected by reatively undeveloped humanrsouces with dsortages of tained personnel In project manament, aunting, and

. Proje3cs have also been afcted by declining public service productivity, maiyresulting fom inadequate pay. Ths project Implemeion isues were reviewed with theGovernment In November 1991 during a comprehensive Couny Ilemenin Review; anaction prgm Is now underway. Progress has aready been made in clearing a large backdog ofaudit reports, as well as in Improving the disbursement ratio. Issues perten to disbursementand procment are bing addressed tbrough workhops ornized by Bank staff in Malawi.Recet imp in project pefomance have been observed, due pardy to increasedresponsieess on the part of Governmen and partdy to inmovative approahes and increased Bankresources assigned to supervisio for example, through comprehensive sectoral supervision ofagricultual projects.

B. Pefm ceia

62. 'Me Bank will continUe to closely monitor Mas economic peformace. Theulimate indicators for judging progress on the implaion of Malawi's adjustment programareoomic growth, poverty reduction, and m nic stability. Contuation ofadjustment support and he investment lending program outlined above would be depedent onsatsfactory Govemen action in specific areas. Prinipal mes of the Govenmen's effortsto achieve m h include:

* libeization of the Invetment environm for indus and small-scale entprises,both foreign and domesti, as oudined in the prposed EDDRP;

* impleaon of a phased progrm for tariff and trade tax radonalization, as oudinedin the proposed EDDRP; and

* coninuaon of agricultural reforms to expand accs to services of poor smaliholders.

Principa measu of the Govment's efforts to reduce poverty include:

* continuation of expading smauholder access to high-value cash crops as oudined in theASAC program;

* fhr inreses in public expendi in fiwor of social services, as oudined in theproposed EDDRP and supported by the PHN and Educaton Sector Credits; and

* prepartion of a Population Policy Staement.

Prial measures of the Govment's efforts to achieve mac mic stabift include:

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* mnintenance of a lbalized trade regime and a effective exchange rate consistentwith exeal competitve and Import demand;

* mntence of strict fcl discipline to ensure adequate avaiability of resources to theprivate sectr; and

* all of these effr would be enhanced and facilitated by co ng Impv m Ingovenmance, both eonomic and political.

I. ExtmaDlRZcg R iements

63. Malawi is expeced to continue to face balanceof-payments pressures for a few years,paicularly due to exogenous faos like the ongoing drought. With a limited resource base,Malawi will continue to require btani amounts of etmal fining and debt allevaio Ifthe economic adjustment program is to conte. The projected ex al capil requireme forMalawi are consistent with a projected growth rate of 4.5 percent per annum. in the medium-tem-as laid out in the PFP. The current account deficit (excluding official tanrs ad drought-reated imports) is expected to decline moderately between 1992 and 1995 from US$166 mMionto US$151 million. IIs deficit would need to be covered by official transfes, grans, andconcessional loans (assuming evenul resolution of govenance issues with biateral donors).Average annual no-drought etal financing requirment are esdmated at about US$246million in 1992-94.

64. Existing bilater and mutilatera balanc-of-payments support wil allow gross officialreserves build-up to 3.5 months of non-drought imports, falling short of the target of 3.6 months'Imports. The fincing gap for 1992 has been closed by discrete fiscal and financial policymeasur, and reducdon In the rate of foreign reserves In tems of financialsupport, the atjustment program remains viable until end-1992. However, medium-ermsustinability of the adjustmet progam depends cdticaRy on donors' reuming er spportto Malawi. lf the Governent fails to respond in a satsfctry mmae to bilateral donors'concers on basic freedoms and human rights, the available extenal fncg will be nufficietto sustin the adjustment program.

65. Ihe financing requirements for drought-related maize impot are esmated at US$237million over the period April 1992 through March 1993. Existing comm_men in the form ofcmmodity aid and balancf-payme suwort from dos, including the US, UK, EuropeanCommuniy, Taiwan, Germany, and Save the Children Fund, amount to US$99 million equaentin grants. Expected concessional baance-of-pyments support thrugh of the WMsESAF argement (US$10 million) and US$50 mi=ll under the proposed EDDRP, woudreduce the financing gap t US$78 miion The Government is seeking addal blatehumanitarin aid to close the remainig drougt-related financing gap.

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66. Maawi has made marked progress in Implementaon of adjustment over the lastdecade. Hower, to ensure sustined growth for a wider range of beneficiaries in the economy,much rema to be done. The povty reduction and growth strategies oudined above will becompl_y and mutually reinforcing over time. The effectiveness of the program wil begready influenced by the vigor and cnistenc of Governmens commitment to this broaderscope of policies. Proset also depend critically on external factors, namely, the events Innighborin Mozambique, not only because of refugee-related issues, but also with regard tosoaring tsort cost along extnal coridors, and on developments In the tem of trade andweatler (as evidenced by the recent drought). Ithe Bank's stategy aims at O) attaining a balancebetween ensuring t bilatral donors' concerm on govenace issues is tak seriously by theGoverment, (U) helping the sound economic management in Malawi to continue; and (ii)providing prompt support to alleviate the impact of the drought. Bank assistance is in a transltionmodne its so and conten will dq?end on Government's ability to pursue adjusment oliciesfth ad== us fg

PARfT IL MMENE PROGRM

A. OveraUl Objctve

67. The entrepreurh development program to be supported by the proposed Credit isa inteal pa of the Goenmens mstrem g set out in DevPol and theGovermens ongoing stabilizaton and structural adjustment program for the period 1991192-1993/94 as reflected in the PFP. The program comprses policy reforms in vrious areas of theeconomy which foc on:

* improvement of the investment environment;

* increasn access to financial capitl;

* enhancing developmen of human capital.

The analyt framework for the program draws heafly on two recent economic reports by theBank tbat reviewed policy impediments to a broad-based supply response: the Country EconomicM entftled 'Malawi: Growth Through Poverty Reduction' (Report No. 8140-MAI,March, 1990); and a financial sector rport entitled 'Financial Policies for Sustaiable Growth'(Report No. 9009-MAI, March 1992). Specific detals of the program are reviewed in the Letterof Developmen Policy (Annex V) and Agenda of Policy Acton (Annex VI).

68. The ovel objective of the Govenment's adjustment progrm is to achieve sustainedgrowth In the context of poverty reduction and baoce-f-payments viability. Following oneadier pridcng and markt reforms, the entrepreneursip development program focuses on theremoval of key noico factors t have n Aned privt sector entrepreneurs and

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Initiative In response to past stmucld adjustnt measr. The Govenment increasinglyrecognizes that situl reom in Maawt has been ham d by a conative policyenvir t of cotol at has filed to promot Iitiative and flow of resources Into newproducdve activities by coolling Investnt in physical capita and limiing access to financiaand human capital. Mb cr of the new adjustnt program, therefore, is a set of detailed policyrerm tat eiminat dect and direc controls In selected high pdority areas to supportpivae sector Iaive and broadbasd economic participwion. Ihe Govne Is not satisfiedwith th investment response to date and has vigorously reexamined its Invesmen envionm .In order to create an enabling for pvawe sector enepreneurs to respond and investIn physical capital, the prorm includes policy measures to reduce investment delays, reorientland use, and ote policies to facta Invesnt by both small- and large-scale enterpris, andextend trade refom to ensure an outward orientaion of te private sectr response. TheGovernment has coized ht the fiancl sectr needs to play a more dynamic role inadjusent and developmaet of the economy, and has deveoped an ambidous fiancial reformprogram. To promote wider financial resource access and mobilization, the progrm focuses onitroduction of market-orented monetary instruments and increased competition through openentry of new instiatons into bakding activities. Finally, the Government has recognized thelimts at isufficient human capia deveopment places on farther growth in the ecnmy. Tostrengthen human resource development and expad employment opporunites, the programindudes the reorientan of public expedr In favor of human capital, oombined withmeasures to improve Aumctioning of labor marets. The tax base will also be broadened to enablea lowering of tax rates consis widt greatr investment whie maitainig adeque resourcesfor core huma capita exe_ ue.

69. Another importat objectve of the program is the reducdon of poverty. As reflected inthe dignosis and policy optons laid out in the 1990 Country Economic Memor Malawi:Growth Through Poenty Reduion, the policy iiiives being supported by the Credit willhave a favorable impact on the poor of Maawi, esimated to be roughly half of the popuion.With limited access tD assets other tan eir own labor, the poor will benf from incasedemloyment opportunities geed by reforms in the small and micro-eri sector, traderefrm, and financial and investment rebms which will increase fin g for non-tra nalactiviies. Given dteir low levels of educaton and health, the poor will also benefit from areorientatioof public etoward educaton, prmary health care, and rural water.These poverty reduction meamres will complement those upported by ASAC whih reorientagriculta services to iee the productivity of the smaler, poorer farmes (para. 22).

B. Macrcnmiac PFramework and Rosad Financn euieet

70. The ongoing sucual reform program and impoements In short-termmacroeconic management have created a stable macroeconomic vonment, with renewedper-capita income growth, dsply reduced inflation, and budgetary contol (para. 14). Thefurth-year Policy Framwok per outlines the Governments macroeconomic program forconned grwth and price stability. For 1991, rea GDP growth was esdmated at 8 percent,with exetonally strong pe in the snUholder agriculturl sub-etor. Short-ungrowth prospects bave been overhaowed by the impact of the curet drought; a real decline of4 percent in the 1992 GDP is lily given the most recet nrmaion on crop damage due tolak of ran. In the long run, real GDP is projected to grow between 4 and 5 percent per

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annum. Thi growth rat rdcts Q) proctivity gains In the smalUiholder and es sectorsgenerated by policy refom supported by ASAC, and (i) increased activity associated with higherlevels of investnt in response to hwesuen climate improvements, financial sector reform andimproved regltory environmt for smal and microscale enteprises supported by the proposedEDDRP.

71. The emphasi of the Gov erts growth strateg on private secor iniative implies acontin_ng need to dcand ources to the pdvate sector. Credit to the private sector isprojected to grow at 7 percet in nomina terms in FY92193. Governent net repayment to thebanldng system is projected to contue through 1994. The fisca deficit for 1992193 is projectedat 7 percent of GDP, accounting for maize purchases not finced by donors to alleviate thehmpact of the drought. Inflation is projected at 13 percent for 1992 in light of increased foodprices, stabilizing at about 5 pecent thereafter, in line with contained overall monetary growthand continued fisc discipline. The recent significant progress in reducing the fiscal deficit isewected to be restored in the post-drought period.

72. MTe str implies significant levels of invement over the medium-term, includigextensive human capital investmt, financed primarily by domesft savings. The major source ofinvestment growth will come from the private sector, primarily from domestic investors althoughforei investment levels are also eped to incrse, with Government fixed investeprojected to remain constant at around 5 percent of GDP. Domestc savings are projected tosnghen gradualy from about 13 percent of GDP in 1991 to 17 percent in 1995, based on acautious of the impact of financal sector reforms on domestic resource mobilization.Foreign savigs are expected to complement domestc savigs and ensue more rapidimplemetion of the sty. After an 8 percent increase in 1991, per capita consumption isexpeted to decline saply in 1992 due to the drought; gradual recovery of per capiaconsumptio is projected for the Goverment consumption is projected to increasedightly as a sbare of GDP in 1992-94 to ensue adequate attention to recurrent expendtu vitto critical government services, imcluding the social sectors.

73. The desigp of the growth and adjustment strateg Implies a gradual adjustm in thecurrent account The contung difficult external transport sitution, as well as the expected lagin supply responsiven, are reflected in the projected balanceof-payments shortfall for Malawiover the next couple of years. Part of the bala-of-payments pressure stems from the

agricultral tegy, which requires fertilizer imporls bO increase yields of food crops amongsmallholders t allow for a progressive release of land for cash and export crops. Additionalbalance-of-pyments pressure wil stem from the eWpected investment surge and the next stages oftrade reform support by EDDRP which will progressively encourap labor-intensive exportproducton. Import vo.ume gowth of about 4 percent per annum is anticipated in 199W5.Export volumes are also projected to grow on average around 4 percent. The release ofsmaliholder land for cash and export crop production Is expected to increase rapidly in the mid-1990s in line with fertilizer uptake and availability of appropriate food crop technology, and estatelad uage is expt to intensify, consistent with agricultural export growth of 3.5 percent.Non-taldona exports, particularly in the agro-industria sector, are projected to grow by 5percent in line with ineased investme in other export-oriented activities. This implies acurr acount deficit of 8.2 percent of GDP in 1992, falling gradually to 6 percent by 1995(excluding the drought effet).

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74. ghi-w1aie anWg irem ent. Extea finaing requireme for theabove scenaio ar ouined in Annex 1.3. Refureme or 1992-94 total US$736 milHon,exludig fbod aid requirements for the drougt which are stimted at US$237 million Current

account deficits of US$S50 million account for aroutd two-hirds of the tot finncingrequIremenIs. Other priority uses for nal resources arn forcign debt amrzation (US$150millon), IMP repurchases (US$30 million), and gr official reserve accmuatin (US$61mfilion). Ihe debt service burden would decline further to 16 percent of exports by 1994.Internatioa reserves would be manained around 3.5 months of non-drought related Imporht.ISe gross official reserves target was revsd downward following the CG and dnors' reluctanceto pledge for non4drought aid; part of the exten financig shorta was compensated throughlower reses accumuaion.

75. It is expected ta the improvemens in the policy environment wMI succeed in attractingmodest levels of direct foreign investment. Total expected disbsemens from estig b tand mltlatera commitmens for 1992-94 (excluding IBF) to the public sector are estimated atUS$425 million, with another US$311 million expected. Project related externa financing wouldprovide US$511 million, and the fna ESAF drawdown (third qua 1992) would provUS$7.5 million. Furthermore, the scenario assumes ta about US$224 million wil be providedthrough adjustmen lendig.

76. Rtsk ad u18es. A major rik in the viability of the adjustment program restIn the unresolved issues on governmce between bilateral donos and the Goverment. Thescenario assumes resumpton of bilaeral donors' balanceof-payments support from 1993 onwadin response to Government implementation of iTreversible and tangible measure regarding basicfreedoms and human rights. As a downside scenario, expected commitments of bilatera balance-of-payments support would be reduced from the levels presented in the amex tables, if theGoverment fails to itoduce govenance-related policy reforms which satisfy bilateral donors.In such a case, the adjusmn progam would not be sustiable beyond 1992. Release of thesecond tranche of the proposed Credit will depend on external financing being mobilized by theGovernment

77. Additonal unctn in the macoeconomic framework stems from the ternaltransport stuation and the crsis in neighboring Mozambique. The projections assume theopening of the Northern Transport Corridor through Tanzania but minimal traffic flowing throughMozambique on the recently reopened Nacala railway line. Resoluion of the conflict inMozambique would sharply improve Malawi's extenal position. However, the dming contimto be uncrtan, and additonal dme would still be required for raflway rehabilitaton

78. Another uncertnty concens the terms of trade in Malai's major export and importcommodities. Malawi currenty is heavily dependent on exports of tobacc, tea, and sugar whoseprices have htoricaRy fluctaed cosiderably. Mai also Is depndent on oil imports,currently about 12 percent of total, and fertilizer imports whose price alo is affected by oil pricetrends.

79. Maenance of sound macroeconomic polcis wil be essental to the success of thereform program and to the ability of the economy to respond to any adverse developments. TheGovenmet will condnue to monitor and evaluate its fiscal, monetay, and exchange ratemanagement with the Fund and Bank in line with the objectives for key economic variablesoutlined In the PFP.

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C. investmnt

80. Iwe resration of c stability and Govenment crediflity within theprivate sectr has resulted in a increasingly positive attitude among prodwers and traders, asdemonstraed by suIpis y strong suot provided by the Chamber of Commerce, theMalawi Export Prmotion Council, and other busin groups for the Government's adjustntprogram during the past year. Decisive action on the part of the Govement Is needed to turnthis busiess attitude ilna new or expanded efficient export-oriented and importsubstitutngacivities. Many blockages to investmet, both active and passive, con e to be exerted andneed to be rewoved.

81. With the growth In popuation and its small size, Malawi now is incrnl_y laborabundant, similr to certai South and East Asian countries. The country's greatest growthpotal is in uling its abndant labor and maling i more productie. Given tha the poorhave command over few resources other than der own labor, labor-itensive gowth also wilhave a favorable impact on poverty. The major costaint to increased ivestnt andemployment are: govement indecisiveness invunest rov Inappr y restictedsmall-scale enterprise sector, and continued trade protction of selected domestic ildusties. TheCredit supports policy chges in these areas.

1. b es Po

82. Ihe Government has stated its commiument to support the private sector and domesticand foreign investment in Malawi. The Governmt has been concemed with the weakinvestment response t date and taken a crical look at the investmn;t climat in MalawI. On argulatory and procedural level, the process for Initat investment involved has cosiderabledelays. First, applications for the crporation and regiation of companies were submitted tothe Office of the Registrar General ad refered to the Mistry of Trade and Industry WIM(which makes further reffals), and Inspector Genera of Police. The requied chain ofinstituonl resposibies rested in undue pcsing delays. Second, MI was also given themandate to issue strLicenses and to consult with other agencis prior to approval.Considerable delays ranging from 6 months up to 4 years have been eperienced in decisionmaking, wheter poskive or negative, despite the fact that virtuly all applicatons have beenapproved in the at couple of yeas, and procedures were Iroved under IPAC. Third, lndtansfer procedures for leasing of industrial and commercial land also imvolved delays, with theDeparmen of Lands and Valuation (DOLV) submiLig all applications for indhua use to MT.In addion, there is a shortage of serviced industria and commercial plots. DOLV was requiredto develop estates before leasing, even though i is not equipped to do so in a timely maner.The private sector was not allowed to sblease, fiurter inhibiting private developers. On theother hand, a pilot project for privae sector estate development has been successful.

83. Reflect its coner adequae investme response, the Govemnm ornized anintminsteria working group to prvie policy guidance and moved actvey to reoientinvestment policy. Under the proposed Credit, the Government is committed tD takg a numberof stp to stmuate and faciitate investment To ensure that the investment comi is fidlyaware of the rece chages as well as other elements of the Govaeres legal and

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nishy framework that are porive of private investment, the Govenment issued anIvetent Policy Stateme in ealy 1991. The legisve framework for invesent promodonwas established throug the Invesmnt Promotio Act, 1991. Scbedues to this Act Include theInvestm Policy Statement and its supplement, the Investrs' Guide, which outlines the wecificlaws and relons conduci to nventm This Statement and accompaning guide have beenaccorded high visbity and wide distributio In reiing Its investment policies, the Govermenthas worked closely with the Foreign Investnt Advisory Service AS).

84. In order to esablish a foca point for Governentpivat sector dialogue and to give adear signl of Its cmmitm to fiitating investment, the Governnt has established theMlawi bnvement Promoo Agency under the Invtment Promotion Act. Its powers arebrod, including authority to investgate and solve any problems tht may arise during theinvestnt process. A duly qualified general manager has been appointed nd a functonin gadministrtive unit has been established.

85. The policy package is suported by critical legislative, relo and procedurchanges. A far-raching reform is the elimination of the requiement for Industrial liceing, wihthe excqpion of a short negative List of enviromnently hazadous actvities, through theIndustril Licensing Act, 1991. In addition, as contained in the Investment Promotion Act, the

Government revised and simplified the incorporation and registation of companies Into one stepOf providing basic informaion on proposed business activities to the Regitrar of Companies,eliminating the rqiement of approval by MTI and the Police.

86. In addition to steps taken under ASAC to stre en land policy (para 13), major stepshave been tamen to aciliae obtaning land for investment in new actiities. First, theGovernment has streamlined the land lease approval process. The Investme Promotion Actrequires DOLV to issue leas and consent to lease trsfers and subleas within 90 days of thedate of application. The procedure of submitting industrial and commeria applications to MTI isno longer applicabe given the legislative changes with regard to industrial licensing. Second, theInvestnent Promotion Act enables DOLV to leae without seicing, which will increase theavailability of serviced plots. Third, as outined in the Investment Promotion Act, the privatesector is permitoed to lease large tracts of Ind for development of indus , commercial, ndreside state. The leases to pe developers wil be about 105 years, ta is long enoughto pemt development to take place widin a reasonable period of time and offer subleasa of thestdd 99 years.

87. Another importa element to encourage investment is lower tax rates. The corporaetax rate was redced from 50 percent to 45 perce in 1990/91, which, at the tme, wassignificantly above intationl rates and, as ientfied in the FIAS diagnotc study, disouragedfin investmt The reducton of rates i an important goal of the Govements tax policy.In 1991192 ad 1992193, meaes were also taken to widen the tax base in line wih further ratereductions to 40 percent and 35 percent, respectively, while resource mobilization for governmentfinaing was protected.

2. Small and NM&Mkdae Sector

88. Small and micO Nise sector aivity In Malawi h low, reflecti the lack ofmaouraemtfor economic Iine aM ddt b the secm t gf ste blitation and ae stongpoliX peo ibr econmic ontrol. In addion, thie sectr is cwonained by Himed acces tD

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Crat, a narrow demand base, and imited li to larger markes. Facilitating investment inthis sctor is critical to genratig a broader-based aupply response and one that is labor intensive.

89. EDDRP supports change to reotiet zoning and land use policies that have beenobstles tsma and m iccro-e se sector Investment. The policy objective is to offer thesmall an-d mi_ part of the busness sector a fidl range of choices regarding location ofbusiness promis, Wheir size, and the type of access to them. Along these lines, the Govementha modifled Its zoning nd land use policies in the reisd Town and Country Planning Actwhich came into force in 1991. The Goverment plans to contiue expanding business areaswitbin Utdiional housng aeas and in high-density moder resdentd developments, and toincrease tho aWlicatin of flle standds to allow for small commercial and industial plots incertain est depmens.

90. A cricl cosaint in the development of the smal-scale sector is access to credit,conasti with significant demand for credit at market risk-adjusted rates. The Governmentintends to review the policies of financial instutions serving the small and medium-scale secor,epeialy SEDOM and INDEEUND, with support from UNDP and other donors active m thesector, nding MDA in the context of the Financial Sector and Enterpis Develop (PSEDC).Until tecenty, interest rates chaged by these institutions were negative in real tems, thereby notnearly reflecting the risks inherent in lending to this sector and exacebading the ability of theseinstitutIORs to function sodly and to expand their client base. In 1989-90, interest rates wereinces and currently are positive in real terms. Under EDDRP, the Government is committedto agg these i to mobilize additional resoures and move towards a moremarkOieted interest rate policy tat reflects the risk and operating costs of lendig to thissector.

91. Mm final policy refor to support development of loca production, particularly of thesmallcale sector, involves Govermt prom nt regulaons. While the statd policy is toencourage domestic procurement, it uses unnecessarily stringent quality standards as well ascumbersome u hiat is, a 20 pecent procurement preferen for local producers. Inaddit, the empton of govenmet ageies from axaton, including tade taxes, eliminatesany protecdon that domestic producers otherwise have. ITe Governm will initiate in 1992 aninvestigato of its polces, practices and procedures, including evaluation of theopon for duty-drawback and rebate of surta on local purchases by government and internationalagencies. It wil commence impi on i the 1993/94 budget of recommendations that adaptpolicies to the potetal of local producers. In aitio, options to stengthen connections betweenmore sophiscated traeslpoucers and the small scale sector wil be reviewed in forthcominganalytil work on the trade and distributin sector in Maawi.

3. 3hd Relbm

92. Reduced domsc pction is ssev for enICs that investment is oriented toward_ _iwAb _ _sendw c e. In the early adjustet period, Malawi's trade and

exchaeo regime was relatvely open. Over time, trade taxes increasingly were used to strengthenfiscal performance. This was compounded by fte introduction of import exchange controls inrespons to the 198546 crisi. Begining in 1988 supported by JTPAC, te Government has

dualy rnmoved hes imt control. The final removal of exchmge controls with theœception of a short negaive Ist took place in January 1991. As part of its comprehensive taxrefom progm (par 113), tie Government reduced protecton by merging part of the import

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tax with the dometic surax in 1988/89. 'he remaining import duty rates were rationalized, witha maimum rate of 45 percent and minimum rate of 10 percent on raw materas and capitalgoods, with certain zero rated itams. Mawi allows the rebate of custos dudes on industrabputs subject to pproval by the Mister of Fane, thus increing the effective protectionImplied by the range of sttory taiff rates. In addiion, Maawi has used the stax system toincrea p ion. Namely, summax rate differts of 20 tD 75 percentage point have beenmaintaid beeen imports and domestically produced goods. The surtax rate differentials(surtax sspenuion)applicable to goods representing nearly half of Malawi's manulfct-ring valueadded-is equivalt to an additioal i rae of 20 to 75 percent. While th reform i 1988189decesed dispersion and brught down prteton, the remanig combination of statutory tariffrates, indusi rebates, and domestic surt suspension reslts in levels of effective protectionexceeding sveral hundred perceent in a number of industries.

93. To be consistent with the exten balance objective of encoug compeitive andexport-oriented actvities as well as the poverty objectve of encouraging labor-intensity, theGovenmen plans to reduce both the level and disprsion of potection. It would have beenpremature to reduce tariff rates while exchange controls were still in place, but by 1992rationaization of trade taxation can proceed. Based on comprehensive study of trade taxation andprotection under the second phase of its tax reform program, the Government is formulating adetailed phased program. The objectives, timeframe and quantiative targets of the tariff andtade tax reform progrm were laid out in the context of the 1992193 budget presentation. Tbetargets, to be reached in a period of no more than four years, are a cascaded tariff stucture witha maximum import tariff rate of no more thm 35 percen, in line with the targets of othersuccessfully reforming countries, and a minimum import tariff rate of 10 percent, except for ashort list of tariff-exempted goods such as medical supplies. Given other investment-enhancingmeaures to be implemented under EDDRP, the Govemment will have eliinated the industrialrebate opton and signiflcantly reduced protecton by the end of the program.

94. Specific measures are being take under EDDRP in the 1992/93 and 1993/94 budgets.Measures nnounced for the 1992/93 budget include elimination of the surtax exemption fordomesticallyproduced goods, with consolidation of its protective effect into the existing tariffstructure and limiting the consolidated tariff rates to a maximum of 75 percent, down from 125perceat in several cases. Other detailed data is being cur y assembled and analyzed to confirmthe precise nate and phasing of fiulrther meases, which will be implemerned with the 1993/94budget onward as a condition of second tranche release. For that budget the Government isexpected to reduce the maximum rate to not more than 40 percent, or 45 percent for thoseCommodities affected by the consolidation of the su suspension.

95. In designig the trade reform program, pressure from competing iports to ensureefficiency of the existng industrial base needs to be balanced with adequate transitional measuresto prevent sbuting down of actvities that may be viable in the medium-term. However,provision of any assistance will be explicit, temporary and qunitative and based on a tparentprocedure which ensures appropriate restructuring of the affected firms. The procedure includesthe following steps submission of a detaied proposal to Government by the affected firms, andGovernment review and consltation with IDA prior to considation of granting any ftrntionalrelief. One such example is the cloth sub-sector where a detailed proposal is under preparationprior to consieraon for the 1993194 budget.

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96. The Government is currently reviewing policies which affect the tile ector and sexpected to adopt a set of policies which wil ensure conimed access of low-income consumers toaffordale clothing while stimlting small-scale tailoring acdvity and garment production.Signficant progress already has been made in eliminatn import and export licensing

qire t, except for those justified on health grounds. Evidence indicates that licensing and atemporay ban on Impors of used clothing are not enforced for smal Importers, and sizeablquaniies are available for lowincome groups in boh rtura and urban Malawi. Given thecomplexiy of the used clothing issue and its irelationship with small-scale taioring and otherdomestic production, the Government will address the issue in the contex of its broader review ofthe textle sector.

97. Under the ongoing tax reform program, the Government is Implementing in the1992193 budget appropria measures to strengthen custwo admi n, increase taiffcompliance and increase customs revenues. A study on preshlpmet inspection Is beingconducted in 1992/93, and on that basis the Government will etend pre4sipment inspecdon to allimports if the study so recommends.

98. Approprate exchange rate policy is essenti for trade reform as well as the other extrobjectives of the adjustment program. u line with a flexible exdcnge rate policy to mintaincompetiveness, the Malawian ahorities devaued the kwacha six times agaist a trade-weightedbasket of curencies during 1984-88, resuling in a 42 percent nominal and 12 percent realdepreci on. The authorities devalued the curency a furter 7 percent in March 1990 to offsetappreciaon since 1988 and ensure an aproprie level during the next phase of importliberalization. Most recendy, on March 28, 1992, Government announced a further nottinaldevaluation of the kwacha of 15 percen, thus briging the real exchage rate down to levelseqaent to 1987/88. Under EDDRP, the Government will continue to closely monitor itsehage rate and make adjustm to improve compeiveness in lig of trade libeiion andother developments.

D. Access to nlancial Cpit

99. The second component of the Credit for removing obstaes to private sectorenrwre ship and iniative in the adjustment response is expanding access to finncia capital.To achieve the Val of greatr domestic resource mobilization and more dynamic finmcialresore allocation to SQJi R= StrUJh1 3S hang the Government has begun to Implement acomprehensive financial refbrm program. The major constraints have been: absence of market-oriented monetary contol and lack of com in the banking sector. The Credit propos tosupport policy changes in these two areas, plus other chages to support capital marketdevelopmt.

1. Mngaq Conrol and ILrest Rate gm

100. Unt recently, monetary policy focused on the direct control of credit and monetaryaggregates and the use of privae sector credit ceilings. In the early 1980s and again in the mid1980s, the loss of fiscal control resulted in excessive domestic borrowing by the Governmen,iding bank financing. Credit reqiemen of non-financiad public etp slightlyexacerbated the siu This resulted in the crowdingout of prvate sector access to credit and

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copeSy excs crdit demand. By 1988/89 and 1989/90, flscl onurol was restored andreected in negative net domestic credit financing of the Government, and commercial publiceterpris remained proftable. Nonetheless, the monery authories continued to maintin stictprivate sect credit ceilings, abet with large ineases. lhese credit conols have had adetrime effectL Ek competition was undermined hrough individual bank credt celligsbased on acquired maurt shares. uggd, exisfing patterns of credit flows were mainaidbecause commercia banks almost exclusively lent to established lines of business rather than newventrs. lhkr ceilings also entiled ratonig of credit by arbitrary administrative means ratherthan allocation according to investments' highest retr. Alhough formally liberalized In 1988,commrcial bank interest raes wers directed inrmally by the Reserve Bank until May 1990.Ewwlk, with a lack of alteratve remunerive oudets for investing excess liquidity, finanialinstitutions were discouraged frm mobilizing additiona savings; at one point, banks were notacpt certain term deposits.

101. The monetary authorities are committed to move towards more indirect, market-orientd monetary control. Under 1TPAC, the Reserve Bank of Malawi Act was revised in Aprl1989 and epanded the operations in which the centra bank can engage. New reserver were introduced in June 1989 and incrased in Januay 1990. A Capital MarketDevelopment Act was approved in April 1990, completng the legal framework for theintoduction of market-based inume of monary control. Commercial banks adjusted theirintr rate structures unilataly in May 1990. Dialogue among the bank and Reserve Bankconties, but any discssion of rates is indicative. In line with the deceleration of inflation, realiterest rates (ex-post) turned from negattve to positve thouou the last two years.

102. With the legal frmer k in place, the Credit would support Implementaio of keypolicy measures. A Capital Market Deartment has been established at the Reserve BankSeveral staff have undergone training and are in place. Periodic auctions of Reserve Bank paperhave commced. Thi, combined with other monety control insftments including reservepe emen already in place, enabled the elimination of direct credt controls in 1990/91. The

Reserve Bank's rediounting cilities have been redesged to facilitate use in monetary control.Positve real iterest rates will be maintained, with bank coninIng to have freedom to determinetheir interest rate stucture.

2. Baulm omaioni

103. The finmcial sWstem has been actcized by a large degree of market segmeionand . ihseciized mnstiXton Mmd in disfdac mwrlet micbes. Commercibanking operations were limitd to two commercial banks, with primarily domestic ownership byPress Holdings, ADMARC, Malawi Development Corporation and Goverment, with a smallforeign minority share in one of the bans. This high concentration has been an importat factorin inhibiting competition; it was inhibited further by two addWona facors. First, strong bankconseratim, which pardy arose in response to the financial difficuties of the early 1980s, hasdeterred banks from moving ino new areas. Second, the inboduction of credit controls as aninstrumt for moneutay control worked against bank competon. Without pressnre onprofitabili, the bandng system has been slow in reching out to new cients or new lines ofbusiness. Ihe Government reognizes the importance of introducing more competition into thesystem. Based on work under ITPAC, the Banking Act was revised in December 1989, with aview to establishing the regulatory framework fDr more cmpeon, including provision for

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Improved supevision, eny into the banking setor, and new insrumn by both bank and no-bank financial sitns to gneat reurces. Recly other non-ban financial

imdaes, particlarly the Leasing and Finance Company, have provided a source ofcmpetition fr commerci bank deposits and, to some extent, for apects of their lendingbusness. Th two commercal banis have been prompted to give serious conideraon toadditional areas of banking business, lustatig the financial deepenig potential that can resnutfrom increased baking ompetiion In Malawi.

104. EDDRP is supportig measures whih ens open entry into the banking system byboth foreign and domesdc financial isttutions and by both bank and on-bank financWiintermedIaIes. The Reserve Bank fiely makes available foms for applicatio for bankinglicenes under the Banking Act. To corm an open and trnsparent process In the considerationof banking applications, the Govenment reviewed with the Bank the results of bank applicationsreceived through Jamuay 1992, assessed aginst the Reserve Bank of Ma1awis policy. Inaddition to approval for the two commercial banks active before the refonr program, a number ofother financial titus have been licemed under the Act to engae in various bankingactivities, including deposit takndg, leasing and merchant baning activities. Rejection of anyapplicatons has been in line with the provisions of that Act. The Govement wil coninue toactively seek applcations from sound regional and intrational banks.

105. Another fici ins ion which wil be important to increased bank competition isthe Post Office Savings Bank (POSB). ts link with the postal system was aimed at attractsmall savers; the lending mandate of the POSB is to generate resources exclusively for theGovernment and fcal defick fnancing. Day-to-day operations hae been hampered by a bacikogOf unecorded and unaccounted-for oprations; this is being cueny rectified but up-odateaccouns are not avaiable. Deposi up to MK 125,000 are granted tax-exempt status, which hasatracted a sigf icant share of corporate savers, estmated at one point at 70 percat of totaldeposits. This did not rest in a net loss of tax revenue as long as the POSB was acquiingGovernment paper at lower interest rates reflecting fuo tax beefi, but the tax provision is notencouraging small savers as intended. Small savers generally are not paying income taxes; anexemptin on withholding tax for interest below a ceran amount served the purpose ealy well.ather, the tax benefit is accruing to large corporate de trs, frequenly In multiple accwunts.

The Govement has sharply reduced its needs to issue new secrities becase of its negative netdomesdc credit financig requrement, Which has created an investment dilemma for the POSBand has led to a decision to review the basic role and fucdons of the insitudon. The outine ofthe scope of work to restructure the POSB was prepared and reviewed In January 1992 under theFcial Sector and Enteprise Development Credit. As a condiion of second tranche release ofEDDRP, the Govenm will bave ta major steps to initiate the restuctg of POSB as aviable finac institution. Thee include its legal sepation from the Post Office, publication ofpoate accounts, abolition of the tax-exempt status for POSB deposit terest, and expansion in

the range of authrzed uses of funds to include finacial insments other ta local regiedstock

3. CiItal Mf =

106. With the Capita Markets Act of 1990 In place, the Gam= plans tp newOa"ital mtket activity. IFC has been ivolved In advng the Government in his area and bexected to play a role In genatg incsed private sector capital market acdvit. This Creditwill address rdated tax policy iss. To ensure efent pomoton, the Goverment plans to

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connu to mreiew the tax teamet of dividends and capitl gai. Specifically, in the 1993/94budget, taation of inter-firm dividends wil be elimia and the dividend gsossingyup sytemfor indivds wil be adjusted. Capial gains are not currently taxed; the Governm plas tomaintain this feature at least for publicly traded company shares to encourage their use. Itehousing market wll be an Impott component of capital market developmn_t in Maawi. Amajor mpe to the development of a housing market has been Govaernm control ofhouing for its civi servants, and, with the support of Bank sector and project work, theGovenm will be iepmtg policy changes in this area. The Goverment also will reviewalterative mehanims to faciitate home ownerhip in an equitable manner. I this regard, underEDDRP, the Goverm eliminae in the 1991192 budget the mortge Iterest deductibility forpersond Income tax purpos, which f tose in high-incom brackets, and will replace theta-free deposit of the New Building Society MM, where less than half of the portolio is forowe-occupied housing.

E. Access to Hmn Cata

107. The laO of h ca* ta=n fbroad U&MOU of thep Iatjm gmja11s k j4 abnsnz. Despite improvement shie Independence, socialindicators are among the worst in Sub-Saharan Afica Given the discipline of the Mdawianlabor force, the ingredient needed to encourage greater investment in labor-intensive exportproduction is a wide labor pool with basic educadon and health. In agricture, the capability toadapt and nvate is closely rdated to access to education. Dampenng population growth is alsoesential to ensure ta the gains from the adjustment process are susainable. The ability ofwomen, in particular, to contrte to the adjustment process and egae in new acdvities hasbeen limited by time consaints due to chfld-beaing, child-reaing and other household taskiluding water collecdon. The critical policy areas supported by the Credit are reorientation ofpublic expedures in andem with widening of the tax base for sustinable finning ofstrengthened social services, and improved functioning of labor market to utilize manpowerrources. While the impact of these chages is expected to come largely In the medium to longterm, the policy adjusments must begin immediately to ensure the sustainability of the policydcanges supporting labor-Itensive growh.

1. Public &MWhM Reorientation

108. The Government tdoally gave the economic sector higher priority the socialsectors in budget allocato because of th perception that only these sectors contribute directly togrowth. Recently the share of the budget for education in Malawi has increased from about 11percent to 12 pcet in the 1990191 reisd budget and 15 pct in the 1991192 approvedbudget, still less than In oter sub-Saharan African counties and stll inadequate to meetaerollment and qualty objectives. The kshre of health also incsed sligty from about 7percent to 8 percent in 1991192; its shae of the Revenue Budget remained at slighty over 7percen Despite the inoduction of a numbr of preventve programs, the share allocated toprimary heath care ismed to be a small fraction of the total, with a systematic bias againstsuch services under existing e control procedres.

109. MM Wm mi _ modmum o f bWgS= reorces tO education andWriMarv hed1h over the next two budget cycles, namely, 1992193 and 1993194. To more firmly

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cement its commtme to educaion, the Govem anllocated at les 15 percent of totalrecuant and deovlo epment in the 1992/93 approved budget to education, includingthe Mintry of Education and Cutr and other sattory bodies such as the Examons Board.A condition of seond tnch release will be that the budget submission for 1993/94 allocate atleat 15.5 peent of total expenditures to education. These levels ensure adequate recurrentexpenditures In line wit an improved teachr/pupfil aio of 1:50 and desk and texook provisionoutlined as part of the quaty bpwvement suorted by the Education Sector II Credit. Theyalso ensure adequate budgetary resurces for im plementing the development program forincreaing enrollment by 4-5 percent per year based on original projections. However, tialocadon will continw to constain the progress that can be made in primary educaton. Inpaicular, it cannot omm the ptoposed phased reduction i primary school fees which iscridcal for enling more low-Icome households to paticipate; it does not accommodate anyunanticipated cost of the expanded teacher training program. Hence, to the extent possible, theGovernment will make additional resources available to the sector beyond the minimum shares towhich it is committed under EDDRP.

110. For primary health care, the Governmt is committed to strengthening the delivery ofservices at the perpheral level, Icdimg the identfication and protection of related expenditures.e is introducing a systm for resurce mgement at the district level with the maitnac ofseparate accounts for c on peripheral activities. A significant component wil be anicreased supply of key paramedic cadres and community-based health workers. In the 1992/93budget, the shwe of the Ministry of Health (MOH) Revenue Budget for peripheral level servicesincreased by at least 2 percentage points above the percentage share established by a detailed baseline svey carried out for 1990/91. As a condition of second tranche release, the Government'sbudget subnmssion for 1993194 will allosate at least a fiurer 2 percentage points above the shareof the 1992/93 budget, for a cmuave total increase ir t5 share of about 30 percent. To enosurethat the overall share allocated to health is adequae, the hei& budget share of the RevenueBudget was at least 8 percent in 1992193 and, as a second tt .che release condition, wi bemained at 8 percent again in 1993/94.

111. Less than 40 percent of the rural popWulaon have access to clean water. TheGovernment currently does not have a sysematic plan for the development of rura water InMalawi. The deveopment progm is based on rehabilitation and miscelaneus requestssubmited to the Ministry of Works, including those by agencies suppordng the refugeecommunity and sectoral ministries. Under EDDRP, the Government is developing a plan for theexpansion of the rural wr'-, supply which will be completed by third quarter 1992. Governmentthen wll introduce a consu uction program, seek donor assistance, and allocate sufficientbudgetary resources for this purpse.

112. Under previous adjustment credits, a three-year rolling Public Sector lvestmentProgram (PSIP) has been developed and regulary subdtted for IDA review. The 1992/93-1994/95 PSIP was reviewed by IDA during its preparon, and on a final basis in March 1992.The review of the 1993194-1995196 PSIP and confirmaton of an emphasis on social sectorpriorities is a condition for second tranche release of EDDRP. To facilitate the reorientation ofdonors' aid programs in line with the Govenment's priorites, donors have been emphasing theimportance of the Govenment sbaring the PSIP with dons. To this end, the drafts of the1991/92-1993/94 and 1992193-1994/95 PSIPs were shared and discussed with individual donrs inthe course of preparat. The fial version of the 1992/93-1994/95 PSIP was disuted andds_ssed wh the donor _mmnity at the May 992 CG. In addton, in MaL.Il 1991, the

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Governme began Imp_i on of its Soca Program Support Fund, which supports pioteffrt to assess the effectivems of targeed povery reduction progrms, and includes NMOs as away to widea participation in the provision of soi services and to complement a constrainedpublic sector.

2. MU

113. The _Maboj_ tx zm gMU desiged under SAL m and supported under1PAC was aimed at efficlency and sustnabity. This requires a lowering of tax rates wbh areamong the highest in the world. Tte prgram has made significant progress in expading the taxbase, h partua wi lthe introduction of the surtax credit system similar to a VAT in 1989190,with a base su rate of 35 perent and additonal luxury surtax rates of 55 percent, 85 percent,and 100 percent Also, excise taxes were shifted ftom a specific to an ad valorem basis in1987188A988189. Other major steps were the introduction of a current payments system forbusine income tax in 1988/89, strengthened collection of income taxes, and extension oftaation of fringe benefits in 1990/91. At t'he sam time, the Govenment began the lowering oftax raes, with a decre in the highest marginal corporate and individual income tax rate in1989/90 from 50 pet to 45 percent without jeopardizing the revenue base. Revenues as asxare of GDP iniilly increased and now have stabilized at aound 19 percent of GDP in1991192.

114. Further expansion of the tax base will be supported by EDDRP. Ihis is necesary tosupport expanded in the socia sectors whie at the same tme furer reducing taxrates both income tax and base srta rates, to stimulate domestic production The lowering oftax te is critica for faciitating investment, as noted in the FLAS diagnostic study (para. 83).In 1991/92 the Government combined a reduction in the base surtax rate from 35 percent to 30percent with a widening of the base, namely, expanding to electricit and telephone as wel ascrtain other services. As a condition of second tranche release, in the 1993/94 budget theGoverment wil have icreased the surx rate on those services to at least 10 percent andreviewed te expansion of the base to further sevices. The Government is considering furtherreducdons of income tax rates to a levethat balances revene geraion requiements with theneed to lower effecdve tax rates to suppt increased investmet

3. ENungtL of Labor Markets

115. Stable and compettive labor market conditions are essential for both the desredinvestme response in labor-intnsive acvities and employment generation in line with humancapital ansformaion. The largest employment sector in Maawi is the smalUholder sector whereself-employnt predomnae. Unlike mny other counties, the largest employer within theformal sector is the estm sib-seor. Real formal sector wage levels are low in Matawi and hvebeen declining over the last two decades, for bot wage employees as a whole and employees onthe estates. For the decade 1978, real wages fel on average 5 percent and 3 percent,respectively, per yea; for estates, the real wage decline was 6 percent and 4 percent,repectively. This reflects the significant part of the burden of adjustment borne by labor as welas increaing population pressres unmatched by productivity improvement

116. A nmbr weagknGM contie to exist in gme formal labor markets particularly Inrual Malawi which employs the vast mgjorit of unskilled labor: fi, bargaiing power Is

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highly unequal. Local people may hve litde choice but to work for a single large estate, sogiving it monopsony power. Because of the cost of tansport and lack of ifomaon, localeatates ofe havo monopsony power over migratory labor as well, and migratory workers oftencannot afford transport once they arrive in a siation with unforseen low wages and conditions.Estate workers do no h&ve any orgaized forum for bargining in contrast to the variousassociations of estate employers; S9g, estate wages frequently have fallen below dficient andequitable levels. Despite excessively high rates of labor tunver and low nutrition levels whichreduce producdvity, estate owners and managers have nt tended to take the Initiative in raisingwages to secure productivity gains; and k, income distribution has been skewed. The aim hasbeen to increase wages only up to the point where labor demand and, hence, employment remainby and lage inact. To ade these irmpefections, the Governmen's policy has been to setstauory minium wages (city, muncip Ay, and rural) at levels equivalent to those that wouldexist under more perfect markets. One problem has been the infrequency of minimum wagereviin. Another is that the legal minimum wage has been viewed by many employers as amaximum ceiling, based on earlier moral suasion by Government to keep wages down. (Fortobacco tenuts, the Ministry of Agricae continues to issue guidelines on maximum rather thanminimm prices to be paid.) Hence, whenever minimum wage changes have been delayed,employers have had difficulties attractn labor, as was the case in the late 1980s uni theminimum wage revision of 1989. Large eventual changes then prove diruptive. The 1989adjustment was, by and large, of the apprpriate magnitude, The Government carried out a studyof employment and minimum wages based on the 1989 adjustment which suggests hat the level inta year, for the nura sector, was not detimental for employment and may proximate a marketsolution; for casual labor in the urban sectors, resulted in some loss of employment for casalabor and may be sligbhly above the market solution; and for formal labor in the urban sectors,rewulted in litde impact on the wage bil and employment because employees were receiving wellabove the minimum wage.

117. Itis crtcato inrvthe fim niggof labor markets in Malawi. indudingbarginiag environment, information flows, labor manafement on estates, and the lins to thenow-formal se as well as to examine aspects of minimum wage policy that need revision.These will become particularly importat as the growth stategy incraingly emphasizes labor-inbensity and human capital development. Under EDDRP, the Government is committed to arevizw of these issues. The teams of reference for this review have been agreed with theGovernent. Dung that review, the Government wil analyze the appropriateness of minimumwage policy in the face of imperfections, in particular, disnguisin betwen rural and urbanareas where markets function quite differy. Ihe Government wiU also evaluate options toimprove the underlying functoning of labor markets, including measures to address imbalances inbargahinng power, improve informaon flows and promote competiive labor force developmentIn paralel, the Government is carrying out studies in 1992/93 in collaboration with USAID with aparticular focus on tobacco tenancy, inuding labor market dimensions, which wll form the basisfor specific policy changes, including in pricing and contracts. As a condition of second trancherelase, the Government will Identify an action plan to improve overall functioning of labormarkets and revise minimum wage policy as necessy.

118. In the interim, it is important to ensure that minimum wage policy meets the objective ofacdng as a proxy for a market solution. Under EDDRP, to avoid unnecessrily abruptadjustmen, the Government has adopted a trigger rule for minimum wage review, namely, acumuaive price increase of 20 percet The Regulation of Minmum Wages and Conditons ofEmployment (Amendme) Act, 1992 includes a revision to the authorization of the Minister of

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Labor to set the minimum wage, nmly, mandating a reguar review of minimum wage levestriggered by a 20 percent cmuative change in prices since the last minimum wage adjustment,and at a miniumm every two years. TIs minimum wage rview would Id.ntify any factors thatwould suggest a shift in the level of the red market wage, either labor market or macroeoonomicoonsideratos, as well as propose adjusatment in the nominal minimum wage level in lin withanalysis of the appropriate real minimum wage level. Given that the last revision was In 1989,steps tO initia the net review ane being take with a view to adjustng minimum wage levelsearly in 1992193. Imple on of the mrinium wage adjustment called for by the review is acondition of second tanche release.

PART IIL T =MDROUT RIQRXiFB PROGRAM

Domestic Cerea Aygaiilt and SharSs

119. Based on May 1992 estmates, Malawi will have to import 656,000 MT of maize tooffset the drought-reated production shortf i 1992/92 (Table 2). Assuming draw-dow fromexsting stocks of 214,000 MT-nduding 114,000 MT out of ADMARC sorage and 100,000 MTfrom the Stegic Grain Reseve (SGR)-and total productn thi year aund 660,000 MT,domestic availability of maize in Malawi is expected to be about 870,000 MT. With a 1992populaion of about 9 million and a per caput consumption of maize of 170 kg per annum, theaggegate maize requireme for the Malawi populaon is estimated at 1.53 million MT, leaving amaize import need of 656,000 MT. Against his requiemet, the Govermnent is planning tocommercially import up to 50,000 MT; using own scarce foreign exchange resources, theremaining 606,000 MT will need tD be covered by food aid or baance-ofpayments supporLtiPart of this food aid wil have to be spplied by donors for free disbuton, but larger quaniswil also be required for monetizaon dhough the commerci maketing network In addiin,150,000 MT of food aid in ceals will also be needed In 1992f93 for almot 1 mMionMozambicn refugees. The requied food aid for refugees is ewxected to be coveed throughbilateral humaniaian aid in line with the practice in previous years. The food situation inMalawi is currendy so grave tat the Goverment has already started maize distribution from itown scks in critcally affected areas. The Government's intention is to commercia thelocally-procured white maize (which is preferred by Malawian consume) as much as possible,while leaving yellow maize obtaned from overseas sources for free disbution.

Cmmcia Food -and Needs

120. Governmentes stategy in the commial sector is to maintain food supplies to mitgateas much as possible inflaionary presures on food prices and reduce recourse to free fooddisbution. In addtion to the commercdial imports of 50,000 MT financed fhm theGovernment's own resources, program food aid of at least 350,000 MT for commercial sales

11 Total exrnal financing reqiemen for maize comprise the foreign exchange needsfor 606,000 MT of maize imports (US$218 million), plus the foreign exchange needsfor govenment commercial imports of 50,000 Mr (US$18 milion).

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would be eeal to avoid a major breakdown In food supply. However, oommercial impors,food for subsidized sales and supplmay feeding programs cannot reach all tose at risk. Atargeted free distution prom Is also needed to mainain a minimum level of nutrition unSthe mxt harvesting season. It is esmated that, of the total maize aid requirement of 606,000MT, about 250,000 MT of maize (plus 5,000 MT of pulses In the most critical areas) are neededas free emergency food aid for a seioudy affected population of 4.7 milion based upon a dalyration of 300 grams of maize and 20 grams of pulses). Ihe distrbtion pei wil varyacourding to th. severty of the drought In a given area, but is expected to average six mont in

Tabl 2: MALAWk DROUGfr-RELATED EXTERNAL FINANCING REQUIREMENW

1 - ~~~ ~ ~~~~~~~~~~~~~~~~QYYM VALUE

2.UDlUeCMN 6U0.0

REDUCTON l IS 214.0_

OF V40M- ADMARC 1~~~~~~~~~~~~~~~~~14.0

SIAE G.D RID 0.

PLBDGED CI&D WYl AJD 23S.0 843

INCWDING: US, EC, S.C.F.

BLME OP SPOt 40.0 146

DIBCLUDD10: UKR, GERMN, TAIWAN __

lDQECaNIS ~~~~~~~~~~~~~~~~~~603

ABCDMPW , __ 103

2: . B1 anX CIg Me_ _als *pof 9M 360 hlpet Mr._{ t

Ii[I t

[I

ii

II

I

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most areas. to World Food Programme (WFP) wil be responsible for overall coordination ofdelivenes of emergey food aid, with NMOs (notably the Malawi Red Cross Society) assistng mthe final dWsbution to benefiiaries. The selection citeria for targeted free dtbution ofemergency food aid will be: those who suffered total crop loss; those with land holdings of lessthan 0.7 ha in reas which harvested les than 70 percent of the averags crop; those fmae-headed houseolds with no source of income; and others who are considered destiue. WFP hasalso projected a need to extend its edsting progms of nutidonal support to vulnerable groups,a wel ast heutic feeding in hospitals and nutriton reabitation units, to a total of some855,000 beneficdai, including 575,000 chfldren under five and 280,000 pregnant-lactaingwonmen

NonFo Ned

121. Lga tanpr s. In addition to the maize import needs, it is esdmated that Malawiwould need about MK 100 milion to cover local costs for distrion and handling of maize.The Govenment will cover these costs from revenue of commercial maize sales and out ofbudgetary provisions for drought-reled expenditures.

122. tudgdMt 1M. Some 20% of the 940,000 drought-afected farm families cultivatehybrid maize, while the rest cultit local maize varieties. As a result of drougt-induced cropfailures, these small-scale farmers no longer have the means to purchase agricltural inputs (seedand fertilizer) for the next agriculural season. Extena assistamce is thus required to providesome 24,000 MT of fertlizer and 2,400 MT of maize seed for half a hectare each to 188,000dtiute farming families. The selection criteria for the targeted distribution of seed and fertilizer(thwough the Ministry of Agiculture) would be: frms who sffered a total crop loss;smaliholders cultivating less than 0.7 ha in areas where the harvest was less tha 25 perct of theaverage; and female-headed households with no other consistent source of income.

123. W= j yg abI1aig The are also major drougt-reated needs emerging in thewater sector. To allevate the problems of shortage of water supply, boti groundwater andsurface waer sources will need to be developed. The rehabilitation of existng water sources,especially boreholes, will be given top priority. It is assumed tiat all of the existing boreholescan be made opationl; an addikona 1,000 boreholes will need to be sunk. In addition,existig shallow wells will be deepened and some 2,000 new wells sunk to provide a servicecoverage of no more than 350 people per shallow well. Nine existi piped water schemes in thesouth, which have been badly afected by the drastic reduction in river water flows, will also needupgrading. Domestic costs for water supply rehabilaion are esmated at about MK 33 million.The major share of these costs wil be covered by modifying and advancing disbursemeschedules of eistg projects in the sector.

124. Short-em healtiprgma. Finally, if food supplies faUl well short of the total need,massnive increases in mantrition and morbdity and mortity from infecto des are likely;while reduced access to safe water supplies wil also hinrease diarrhoeal diseases, eye and skininctions, and cases of cholera, measles, meingiti and uberclosis. Urgent assistance is thusrequired to srengthen existg health programs to be able to provide basic services mainly at theprimary health care level. A basic range of essential drugs is needed to complement nadonalso and enable the effective treatme of anticipated outbreaks of infectious diseases. Domesticcost of abou MK 33 million will mainly be provided out of existing health sector projects whichwPil be modified t commodate the immedit needs of the drougt.

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bWImUna and Lo4 g

125. Malawi has created and maintained a good road network throughout the counry. Thetiming of deliveries must filly utiz the tsport frstructure caaciy. Although the reliefprogram wil not become opeaional in most aras befbre AugutSepmbr, deliveri will needto start as soon as possible to reduce congestion In the last qr of 1992. Both for logtics andfood secrity reasons, as much food as possible will need to be positioned in rura disticts fordistibution. A Drought Technical Sub-Committee bas been established under the Governmen'sDisaster Preparedness Committee, with a number of tecical sub-commite on food assessmentand monitoring, health and nutition, water supply, tranort, and sourcing and procementThis will be the main coordinating body for the relief operation. The recently establishedEmergency Management Unit will execute the directives of the Technical Sub-Committee andmonitor food movem and stock throughout the country. Ihe regional and distictadmiistrins will identify the areas most at risk, with distributon to beneficiaries beingmanaged largely by NGOs.

126. One problem that could jeopadize food security in the coming year, however, arisesfrom logistic conamints impeding the distribution of imported food, with port handling capacitiessteted by unprecedentedly large cere imports. In addition, the ongoing food aid reqiemenfor refugees will have to compete with drought-related emergency needs for both fod anddistrbon facilies. Based upon the detailed data provided by the Miistry of Transport andADMARC, the operational internal storage and transport capacity of the country was assed bya recent WFP mission at approximately 600,000 tons annually. ADMARC is well equipped witha stoge capacity of 180,000 tons in the SOR and an addional 350,000 tons storage space in themain regional warehouses. The port/overland supply routes are through South Africa,Mozambique and possibly Tanzania, with corresponding adequa rail/trucking trasport fciities,for delivery to four primary Extnded Delivery Poits (EDPs) at the distict level in LflongweKaneno), Liwonde, Blantyre (Limbe) and Luchenza. Recognizg its limited food aid

distribution capi, the Goverment has requested additional NGO asistance in strengtheningthe commodity dibuion network at the district level. Donors would need to provide thenecessary cash fuding for these operations. Govemment plns to dedsgate a Diaster ReliefCommissioner to act as a central focal point and ensure efficient and timely food ditrbutio totargeted affected popuation on a regular basis.

127. proughtrala exal f iftr :ements. In the short run, Malawi's externalfinancing requirements are dominated by the need to import maize in order to preent widespreadstarvation due to the severe impact of the drought. Ihe total fimmcing rirement for drought-related maie import iS estmated at US$237 million 2/-. Indcato of donor assistancereceived so far include about 235,000 MT of maize (many from the US and EC), plus balaeof payments support from various countries (including UK, Germany,. and Taiwan) that coudenable the promuemt of an additional 40,000 MT. This, however, adds up to less than half themininmm required food aid for Malawi (estimated at 606,000 MI). Ihe existg commments

21 Based on c.l.f. Malawi cost of US$360 per MT and including forign eagerequirements for commercial maize imports.

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acn for about US$100 millon. Expected cnmet clude the _ of tie Fund'sESAF arageme and US$50 m (equial to abot 140,000 MT of maize) under theproposed EDDRP, Ibe remaining f_mcing p of US$78 miion s expected to be closed byAfDB o of tho EDDRP and fhrIer pledges from bilateral donors. If fil dwutfinancing does not marize and WM has to reo to commrda browing or coamp onof other imports, the adJustment prom could be throwm off-track and ftu growth prostsedousy theatend.

PART IV. PROD CREDrr

A. ObI nfi Rof de for IM A & cmig

128. Malawi has contned to face difficult extenal durg the maionof a c Preen ve reorm progM to ense e adjustment in the conte of economicgrow and povery reduction objecis. The objecdve of the proposed Credit is twofold:

3 rks, support the I of the next phase of the program desribed in An5 and 6 ich aim at removing remaiig obstades to a response in theinvestment enviroment and access to financi and human capital. Ihe Credit wilprovie additiona foreip san to complement domestc savings in ficing theInvtme evisaged under the Credit and wM poi sort to the bacef-paymen during the tasl-lon to a viable eal posion created by the proposed

measures formag outwa sented and labor-ntensive, lnvestmen deepningfiad _at, and tas=ng hma qp* &ad

* ~md. provide supoeto to alleviate the burden of thdrought on Malawv's extenal position. WIt regad to this objectve, II)A sWppot-thrugh the prpose Credit-l be the fat and most efective way tO assis thecouny in recovery from the drougbL Ihe mgitude of the proposed IDA upport is(I In line with Il)As aIistan i other drought-affcted counties in the region, and(-i) jusied in order to mantin the viability of th entire adjustmet program. IThCredit wM c toward mniing the impact of the drought on economicdevelopment In gena, and on the exte posin particular.

129. IDA's involvement m the proposed Creit evlved during the dose collaboton betweenthe Govenment and the Bank in foruating policies for adjustmt as refiected in the Country

c MI m -- II (Report No. 8140-MM) and Financial SecoDr Study Repot No. 9009-Mm). ITe proposed Credit ie a vehicle by which IMA would cntn to play aneffective role in (i) aistig Maawi to bmulate and implement ap e policies andstategies as needed t ain gowh nd reduce poverty; () mobiizing external resourcesnecesary to faofsupoliciesandsttegies;m ad (l)fsti feffetvecoordination of donor within a coheren atey.

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B. F in

130. A total of US$134 million is efpected to be provided under th proposed Credit. Tbisamount would omprise US$120 mfllion equivalent from IDA and US$14 million equivalent fromco-ftimacn under the Special Program of Assistance fiom the African Development Bk.

131. J line with the rade librlizaon progm, the Credit would reimburse 100 percent ofthe foreign exchae cost of eigible morts on the basis of a negative list and 100 prcet of thecost of consultancy services, esimated at SDR 0.4 million (US$0.5 million), fbr short-termstac assistance in policy dedgn and implementation. Ithe negative list would cowmprise goodsand services financed from other sources, acoholic beverage, tobacco, military equipmnt, andluxury consumer goods. Ibe local currency generated by the sale of the Credit proceeds toiporters would be credited to the Govemmet's acount, including for use in repaying theReserve Bank for increased flows to the prnvate sector and supporting the process of reorientingpublic eq toward the social sectors.

C. Ioarement DimsbrsmmnL AC unts. ad Audit

132. Except for consultancy serCvieS, the prposed Credit would prvide quick-disbursingfud in spport of the balncof-payments. Procurement procedum hwe been deignd topermit rapid use of the funds while ensuring efficiency ad accountability. Private, parasta,and public sector impots of goods and services woud be eligible for financing under the Credit.Contracts exceeding US$1 million would be subject to ineaona competitive bidding inaccordance with simplified procedus. For mouns below US$1 million: (a) the public sectorwould follow Malawi G erm t prworement procedues which are acceptable except In minorrespects which the Goverment has agreed to modify (under the ongoig IDA-financed PublicProcurement Code Rvision Study) to make the proede fully aceptable to IDA; and (b)private sector purchases would foliow established commercial practices, including competiivebidding wherever approiate, which have worked well in Mlawi. Wherever possible, quotationsfrom eligible suppliers from at least two counties would be sought. Direct contmacting (singlesource purchase) would be used only for proprietary equipment or where compatibility withexistng equipmen requires tndadized equipment and spare parts. Certain commonly tradedcmmodities may be purchased through price quotations from organized Intenational commoditymarkets. Procurement would be Umited to goods from Bank member countries, Switzerland, andTaiwan. Pre-ipment inspection of quality and quantty, as well as al relevant Import

won, will be carried out by an ndeent Inection Agency accetable to IDA.Given that verification of imports has been currently limited to physical inspections by Customsand, hence, the Goverment needs to retain such an agency, presiipment ispection would bewaived for those goods to be fianced retroactively. Regardess of the procurem megtodsused, no more than US$15 mitlion would be used to finance imports in any single trade goup orsubgroup. Exempted from the US$15 million ceiling is the portion of the Credit which providesbaacof-payments assistance for drought-related food imports (US$50 million under the firsttranche). Consudtancy services woud be provided accor to Bank Guideines for the use ofconltmt.

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133. Except for coutany sices, the proposed Credit would be disbursed In two tranches.Ibo fit tranche of SDR 57 milion (Including SDR 35.6 million for drought-related paymentssuport) would be made avalle upo Credit effectivenes and the second tranche of SDR 28millon about a year laesr. SDR 0.4 million would be iwailable for cosltancy services inconnecton wh studies on labor maket, government proment and pre,shlpment inspection,expediting the land-lease process and other activities for investment promotion, carrying out theresructurndg of POS and tax reform program, and implemeng ficial sector deveopment asoutlned above. Ds t of the second te would be conditonal on satisfactoryimpleme of the overall policy reform program outlined in the Government's Letter ofDevelopment Policy (Annex V), avaiability of sufficient exena fancing to sustain thead4ustment prom, and on the actin specf:ied in (para. 137). To facilitate disbursement, aSpecial Account would be established with a commercia bank of the Governments choice, underterms and cond s satsfctory to IDA. The init deposit would be US$15 million, whichrrsents about 3 monts of the expected exenditures under the Credit; the account would bereplenished regularly up to the imit of the ini deposit. Replenshmns would be made on thebasis of fully doc_uented reimbursen applications, except for expenditures under $250,000which would be reimbursed on the basis of Staments of Expendiu (SOEs). The SOEs wouldshow the nature and origin of the goods, the name of the importer, and the payment date. Thesupporting documents for SOEs (invoice8, csom dedarato, bills of lading and evidence ofpayment) would be retained by the RBM and made available for review by Bank supervisionmissions. Exp s for goods covered by contracts of less than US$10,000 equivalent wouldnot be eligible for financing. Withd applications would be consolidated in amounts of atleast US$50,000. Reroactve finacing of up to SDR 7 milion (US$ 9.8 million) will beallowed. Ihe closinqg date of the proposed Credit is June 30, 1994.

Accut and Aft

134. Ihe RBM would be responsible for maint Credit a s and preparing andsubmitting witdrawal applications. In addition, RBM woud be responsible for aa,n annualaudit of Credit acouns, including the specia acount and SOEs, by indepndent auditorsacceptable to IDA. The audit reports, including specific comments on SOEs, would be submittedto IDA wivhi nine months of the end of RBM's fiscal year. RBM is adequately staffed toundertake these dudes and has discharged them effectively under previous adjustment operations.

D. Monitd and Tanche Releam

135. IDA will review the imple of the overall adjustment program as well as specificactions outlined in the Goveranent's Letter of Development Policy and Agenda for Policy Actionsthrough regular supwvion missions and exchange of views with the Government. In view of thecritical need to ensure that the macroeonomic framework remains conducive to adjusment, IDAwill monitor the progress in attaining key mc objectives oudined in the PolicyFramwork Paper. To this end, IMA will coordinate its supervision work closely with the IMP inrviewing key c r oeconomic policies and indicators, particularly dtose regaring exchange ratemanagemet, fiscal deeit tagets, and credit and interest rate management. The following arespecific condions of Board presa and second tranch. release.

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136. CondiUofoard iat The Gaovement has taken the fowing acto prito Board Preseation :

Invesmt E

(a) Issac of mv Polcy aceptable toD thw Dank

(O) of buiness regstrto an incorporaion of copaies by redcin tDo nestop with th Restra of Compae;

(c) elimination of idurl licening, wit the aception of a short negative list eptble toIDA;

(d) streaminig of lnd lme aval prces by enatin obligton to submit ndusaand commercial ppliclations to MlIT and by requrng the COmmi of Lands toapprove/is leasea withn 90 days of applicato;

(e) enc em of leasing by DLV wihout sericing and development of idusra,commercil and resientia estaes by private deveopers;

(1) _ o of objedve, plmed time frame and quattative targets of tariff and tradetax reform progrm;

() elimnaton of surax empion for domestcally produced goods; consolidation ofprotece efct of exemption ino taiff system; and limiting r ting consoldaed tarffrat to madimum of 75 perct

Acess to Fiani CaIa:

) ablishment of Capital Mak Det at RBM which is adequately stafdandcarying out peiodic aucti of RBM bils;

(i) dematon of dire credit controls;

() expgdiou and p decision on bank application as of January 31, 1992aessed agai specific eemet of the RBUMs policy as laid out in the Bankig Act;

(k) ema"tion of motge interestducton.

Acce to Hum Cil:

() alocaton to educato of at least 15 per of ttal _in appoved budget1992/93; ea in peiphal svices' share of health Revenue Budge in 1992193 byat least 2 percentge points; ad alocatio to helth of at leas 8 percet of ta RevenueBudget 1992/93;

(m) review of PSIP 1992/93-1995/96 wth IDA,

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(n) exakson of surtax base to deticity, telepho and oth sevis; and reduction ofbue surtax e to 30 percent;

(o) reiom of glation, mandat r wprocess fo mimm wagw lev, tged by20 prcea amuve e Incre and at a minimum evry two yes.

137. eim of n e Qn& . would be dndkkDi opon ( s cyA *pi a of teoveralladjustment prorm describedin te Letter of DeveopmentPolicy(Ane V) aad Agenda for Plicy Acdow (Anex VI) and (II suffici en ternalD fiang tosustain the adjusmen progm Second tcanche relas condiom would fcus on further tradereform steps necesay for the apopriate hnvestment environment (with other invene tepshaig aready been taken beore Board ), ndued progre on fandal secorresIru g, contned evien of budgetary and labor pocy reortioen to aceleat humancapita deveopment, and adequate finaCINg to sustain theI w seicaydte condidons are

-nvste" nti

(a) in of major taiff sede rviin 1993/94 budget and outlin offuther steps to reach targets for 1995196.

A~c's to Finandal Capita:

(b) afiple of maj;or steps i iniion of restucing of the POSB, Iuluding lega=pfidn from the Post Office, pubicaton Of upt-daef accounts, rsion of ta-

emPt StaW" for POSB deposit nerest, and epnsn in the rapge of au ized uses offud to Indlude finaal other tha local regiteed stock;

Access to Human Capital:

(c) allocation in pproved budget 1993194 of at least 15.5 peacent Of ttltoeducon; ae In peripheral services' dae of heat Re Budgot 1993/94 by atles 2 pe e points; and allocation in approved budget 1993/94 of at least 8 peetof Revens Budget e _peadim to hefth;

(d) satsctoy review of PSIP 1993/94-1995/96 with 3DA;

(e) increase in ax rat on ectcity and telephoe sevices to at least 10 percent;

(f) review of labor markt Impefctoand policy opto inug minmum wage policy,ad formulaion of acton plan agreed with IDA; and ImApiof minimum wagadjust caRed for by review;

Framwork:

(g) mobizain of fudn reqired to sustain carrn out of th prog

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E. Imac on Growlh

138. lTe proposed Credit Is expected to remove obstacles that have ben blockiag privatesector e p and responsivens so as to lead th economy toward sto eteralpedr_fan The proposed reform measur wiSl bave a positi impact on economic growth bysmulaig investm ranging from lr to micro actvities, exanding the flow of fanciresources into new productive acdvities, and increasing the supply and sklls of manpower. In theshort-run, the proposed Credit will alleviate the negadve impact of the drought on overalleconomic performance.

139. Gross foxed capial fomation, which iaed from 13 percen of GDP in 1987 to 16percet itn 1989 under ffPAC, is expected to cea furher to 18 percent of GDP in 1992 inresponse to the policy changes supported by EDDIP. The investmen policy changes will signaltie encouagement of investment from new grups of en er within the busnesscommunity and wfll release previously blocked en talent. Investment and expandedproduton also will be facilitated by the fina ser dorms. Protected market shares undercedit controls and lack of bankig competition already are being d t , and financialInstitutions will have to develop other business chamnels, enhace domestc resource mobilization,and eand access to crediL Con _ting fisa discipline and strong externa support will ensuread te financia resource avaiability to the private sector. lhe external policies, both trade andexchange rate, will ensure an orientation ofthe ep an investme toward export markets andefficient iport subsution.

140. In addition to growth In the medium- and largele formal sector, the program willsupport h in off-farm actvities and employment opportitimes particuarly given theincetves created by the enabling envomet for small-scale enises, broader reah offcial Insitton , and impred education, health, and water services. Dicreased invtment Inhealth, population, and waer gradually will release time consaints facing many rural womenand allow them to reallocate labor resources to other producdve activities and employment.

141. The program eues greater investnent in human capital. While much of the impact ofthis investment on growth will not be felt immediately, the picy shift in fvor of expandingskills and capabilities throughout the population is a preequiit to restrucring sources ofgrowth in the medium- and lOngerm

F. bJrc on ucion

142. Simultaneously, these growth mes will conut to povety reduction over themedium-term. As oudined in the Country Economic M, the poor are praeomiatyru and conservatVy enoMps about half of the population, including orionatenumbers of women and cildren The major cause of poverty are liited employmentoporui ties, complicated by labor consa for female-headed households, low agriculurayields, and limited human resoures. IEDDRP is aime at stimulating labor-intensive growthwhich benft the poor who generily have inwufficint land resour and requie otheremployment opportnties. In a country such as lawi which is labor abundant, theentrerene_ si being unblodced by EDDRP wM stimulate employmenL Policy measure whih

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Utdsmall ad micro-o , development wl drely pvide grea off-fmemployment o. Tr rform and resting port-orented ac es w be athesoure of demaud for unskilled labor, an area of competive advantage for Malwi. Improvemnin the minimum wag and other labor policies for estawt workers wi en stable employment

143. Expanded aoess to financial makes wil rest In more resours flowing Into satorsothr thn the naow fom sector in which the participation of the poor has been limited. IhePOSS trfoMS wiU ImprVoe that In8su s ability toX se mall saVerS and rua cMUMUnities.

144. Impwe education, helth, and water seicas wil ensure tha the poor can takadvanage, of this employmet and financil developmt as well as other oppotunes In theagricultul sectr. RIentatin of public to primay educaton and perpheahealth care servioes suppted by EDDRP would orient these more toward the poor ta otherservices. Expaded nrual water supply is an Important elemnt in releasng time for women,par y in female-eaded households, to purse other income- ating acvies. Wihthe struct refom msures pported by the Credt, growth n the Malawian eoommy wadbe lied. Extnal balance oud be ataned at the xpne of povety reductin

145. The Credit would provide for a signfficant proporion of the drougtrelated fiancingreuire s, thus helping to reduce widespad srvation and food IWurity. The mainbeneiciaries of the droughtlated Credit component ae the ru and urban poor, iudinglaIle labor and food deficit smaholders.

G.

146. A poetial risk I the potcal reitae loosenn conol and weig economicparticiion t is al for any fther progress under the adjustme progm However, theGovernmen I covined of th importne of easing constraints, on lactit inorder to create a positive i_nem cimate. The Govenment has confied fits commitment bytaking a number of politically difficut meaes prior to Board presntatin, with cetn othrsas conditon of th second trache.

147. Another major ris is the possible failure of the Goverment to meet the conces ofbiate donors, expressed at the recent Consutatve Group (CG) meeting, regardg the need toimprove govenance, especaly basic fieedoms and hum rgs. Biateral donors are sedingtangible and irreversle evidence of a basic in the way Maawi approce thesematus, so ta there is a sidft In the way human righs in Malawi ae viewed.

148. Tho proposed Credit is eealy a hodg operaon desid to provide continuity inexternl sppo and to keep the adjustment program on track while the Govermnt rolves thecontoversy with bial donors. Ihe ger bala bofayments support under the firstranche of th Credit wll sustain Gosvrmetes adjustmet program for th remader of1992. Additon blatera balance-of-ayments support from 1993 onwd wil depend onreaching agreem wit bilatrl donors. Govemen's failur to resolve the goveance Issueswith bilteral donors by end-1992 would result in postoning the second tranche release untiadffonl external fminc is seced to sustain the Govermnmes program from1993 onwad.

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149. An additional-hough smaller-cisk I the Goverenent's falure to secure eterafinacing in order to flly mt the drought-related Import requiements, many maie. This riskshld be minimized following the rece CG meetiag where all donors emphasized thathumnitan and drought-rdated aid would not be affected by the controversy over goverance.Several door idicatdt pledgs on drougt reief wre fotthcoming as they wee finlzing

eir respective regonal drou relid strategies.

PAR1 V. RECO0ENMMENDAT

150. I am satisfied that e proposed IDA Credit would comply with the Ardtles of Agreemeof the Asociaon and reommend tat the Exewuive Directos appowve the proposed Credit.

Lewis T. PrestonPreddent

Wasigon, D.C.May 1992

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SOCW lodkakn stDovd0pus" M* ~ANNEX IA

Malawi Page 1 of 2

2540 ~ ~ 5 15_ ~ -t *F°t Ncr8wv qy SdAu Low- m

ws~~~~~~~~~~~~~~~~~~~~~~soHUM"RE4 aRCSk% pvww1b a new .dpqeIMU 48

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FaIuus Pr too meJm

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dwLp* 56 5. 46? 29.8 30.0Syaeq~pwam . z49 * .. .. 5.

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Tolt b z94 m3.4t 194 1.371 26

44.? 413 37 35.9 302

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Sy_S_.. .. n . ~ . - .. ..-sal.~~. - .. .. ..

NAUMAL33OU1CAm - 118 11U 118 23066 36,97 21083

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ANNEXPage 2 of 2

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1ww %d .. 1* 2.1 __.

-1_~~~~~~~~~9

b*kd b edlTA_d_ _. 1X 1 .

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OWd*=bLynWJ s4o Sd_ 2.. 1 . .d45>| _ A _ S S

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-50 -

KEY MACROECONOMIC INDICATORS, 19M7-"91987 A:kCTUA I e l I 199 1995M-

LMW. I~~~~~-RmU ~P

w - . ~ ~ ~ ~ ~~ ~~~~~~~~~~~~.6 . .W-T --- ; . U

ODY Gow&b 40.5 3.7 6.0 2.9 7.8 5.2 9.8 6.2 6.1ODYgv.plwGRau -3.9 03 2.W -0.4 4.1 4.5 6.0 2.5 1.5CoawOM ParoqlssGwtRdl 11 4.7 -14 5.3 -. 4 7.5 -119 64 2.4 0.0

Ddut Seiuv OIMof US$)21 162.8 167. 117.9 104.1 108.6 11S.7 102.2 105.3 1113Of wi: ha" 40.7 46.4 39.7 412 384 39.0 39.4 40.4 39.6

DONSebt u/ 1 o o_a f G & S 54.1 51.9 39.5 22.8 0.3 20.8 16.9 16.1 15.8D*t Soviku (u , Dsbt 53.9 37.6 33A 22.8 20.3 20.8 16.9 16.1 IS.8DEM SawekOdoP 13.8 12.5 74 5.6 5.0 5.7 4.6 4.5 4.4

Gase mnveODp 15.4 18.7 20.2 19.1 19.0 1t.8 19. 19.5 19.5Pdvab Find TwamsutGDP3/ 7.7 9.7 10.7 10.8 10.6 12.9 13.9 13.9 13.9GoywnmuglFid Jwvaui(GDP S. 5. 5.1 5.3 5.1 4.9 44 4. 4.4

1.9 34 4.3 3.0 33 1.9 1.0 1.0 1.0_q a Toconwatf(m 13.5 15.3 15.9 16.2 16.9 17.8 18.5 18.5 18.5

DomjS vwi*NIDP4f 134 12. 11.3 15.1 13.1 15.6 15.6 16.0 16.9Ngloed bwbWGDP 10.3 9.7 6.9 10.6 93 11.5 11.9 12.5 13.5

GswG=wSaDVlwm"P -5.0 -2.3 -23 -1.3 -1.1 42.0 -1.1 4.4 0.0Puvas Sag~ 15.3 110 91 11.9 10 13.5 13.1 12.9 13.6

bht&m Dnoagh SavlqiRa 0.31 0.10 0.07 0.40 0.03 0.43 0.16 0.19 0.26bu3&e Naloi Savhg Ra. 0.31 0.08 0.03 0.35 0.03 036 0.15 0.18 0.25

Gw-.nbe. 51oD?sI 20.7 21.3 21. 19.6 18.7 2Q0 20.0 20.2 20.2omwa wziDowa 51 l 30.4 28.7 29.5 25.7 24.1 27.3 25.4 25.1 24.7rm1 Ddkb/=P 51 -9.7 -74 -7.7 -6.2 -5.4 -73 -53 *4.9 *4.5

ftm Votum.Grwda4b6eamn))6/ -0.9 -2.7 -14.1 50.1 7.5 7.5 3.3 3.0 2.6BoWeDtP 23.5 22.0 169 22A 22.6 254 25.0 25.8 25.8ispasVokm Gusthaebeod)7/ -13 25.0 7.8 8.9 19.2 .4.5 8.0 7.0 4.5

Ipas/D? 24.6 27.2 25.0 26.0 29.1 29.1 28.3 28. 27.9

Owmt ALccss OM= of US$)9/ M403 -121.1 -212.5 -1583 -236.1 -4.5 2293 -164.7 -150.7Cmat A UsoumG SW -5.1 -9.1 -13A4 8.5 -10.8 -17.0 -103 -7.1 .6.0OeWAftauWbobtGuuaufGDP9l -2.5 -2.2 487 .4.2 -7.5 -9.5 *63 -43 -3.2

Com" MAtoum_ es. otUS 81101 .603 -121.1 -212.5 -1583 -236.I -1664 -169.7 -164.7 -150.7CsmsA_osseIG?81101 -5.1 -9.1 -134 48.5 -108 48.2 -7.6 -7.1 46.0

Imelb m oQ siofUUSt 44.4 1454 97.8 130.8 140.6 159.4 189.9 201.9 237.0JaMoihaofNcMafi 1.8 48 3.0 3.2 2.7 3.3 3.6 3.6 4.0

2/ biooak debt u h e.dlgdes.bouoa niossoadlag atanosdastem4 dobt

4/ SsvIqy.hde.eueqeasymua ai VdS- relatd vto lasmbwWWsum

BUOOM'.Isvepupam6 =au a~.d1Wuea lNoshm=ThaspasCsaior h*daT mia6/FIue. is 1990.9 ms afbuoad by uslbaddskhab coare ovew as *oand of1989 sacd la a heis sexam as lb e.d o 1990.

7/ ftsf=sbab =mreybImostrt. hwldas peus. Juadlagpuhm eota. aispmabyAir alawi in 1991 (US$ 25.7 =Muhs.

101 ft*hdftfromVl sbfted lwouimid&*u*As rh

- 5 1 -

MUAWI-EXTERNAL FINANCING REQURMENlM

NON-DROUGHT RELATED, 1W-95

1987 I£ psa n 9. iIM AM USSI

Cumua Mocum 1/ .603 -121.1 411.6 -.S13 .6.1 .16.4 .109.7 164.7 .150.7Aaawtitoa (Ptbl S-e) V -5.I -741A 4.0 472 4.1 -50A 41.1 .51.0 54.0cQhp in An" (lnoem +) -12.5 -. 8 0.0 0.0 0.0 0.0 0.0 0.0 0.0Chang in Own OlYou Rms(Mo" .) -24.1 101.0 47.6 -33.0 .9.8 -11.8 30.5 -12.0 .35.1

5W _wcls -30.0 -26.1 -24.4 -187 -Ms .18.5 -S. -5.4 4.7Chop in Wa" Rouv BankLialh*ti 9.2 2.S .25.1 9.0 643 3.1 -1.7 -3J 4.2

NotOtsi"jlminsi 30.1 91.7 74.5 1.1 731 79.5 33.7 29.1 17.8Ofwt: SAL - roltOdma G 83 D9 17.9 30.7 7.5 32.4 0.0 0.0 0.0

Dowlogby gwmubll Sootw 123.1 134.9 110.6 14.9 193.6 100.4 93.3 63.2 36.1BUktmal Cm4Ito 26.4 41.5 6.7 29.7 SU.0 19.0 13.8 8.8 4.9Of wicb: o tu ml 23 3.1 0.0 25.0 12 0A 0. 0.0 0.0

m-uI"al Codus 95.9 89.0 943 114.7 137.7 93 78.7 54.1 31.2Of whioh: AdMjuuma ew I 36.3 323 49. 473 41 10.5 11.7 0.0 0.0Of which: Wadd Bank SS.0 73.2 . 81.4 100.9 96.7 67.7 51.1 25.9 10.6

Pdvta CudIo 0.8 4.4 9.6 13 3.9 2.1 O.8 0.3 0.0DFl (Smby PUraes) 0.0 12.4 0.0 0.0 0.0 0. 0.0 0.0 0.0MMQCe4 0.0 12.5 23.8 252 20.4 7.8 0.0 0.0 0.00w Caphl (n= Si 19.1 493 51.0 -3.9 213 5.7 6.2 6.5 7.0

N Olud" T ts 0.0 0.0 0.0 0.0 0.0 0o.0 287 36.0 S.70twbiob SAL - llsd Ota 0.0 0O 0.0 0.0 0.0 0.0 tO 10.0 10.0

sngwiqbyg do iic Sn QO0.0 0.0 0.0 0. 0. 482 94. 103.6 136.0Iia Crdlm 0.0 0. 0.0 0.0 0.0 1O.4 21.0 31.0 40AOf wb:i- AdjuanmLal 0.0 0.0 0.0 0.0 O OA.0 10.0 10. 0.0

blulbilatal Croditm 0.0 0. 0.0 0.0 0.0 57.8 73.6 72.6 95.1Of wlhWb: A4Us.tLam tl 0.0 0.0 0.0 0.0 0.0 36.7 S3,4 385 45.00f-whch: WS & Book 0.0 0.0 0.0 0.0 0.0 30.0 48. 60.4 74.8

MvWaacteCdiocs 0.0 0.0 0. 0.0 0.0 0.0 0.0 0.0 0.0

Dok Rech.do"ng 0* 24 17.6 0.0 0.0 0.0 0.0 0.0 0.0

Samo: Da piMi&d by U. Miei-dtoWesd-Isa nd piadom

3/ DIbtmmemmat orn e tmgauiUaaI as o May 19924VMA M= & inMMM iar6 do busibt__r MM a_aL5/ holudaa Mtr priat easi bormowint ahectamai omit and auand onao

IiS I [ tI 1 I' 1I it i 11 I

1~~~~~~~~~~~~~~~~~~ I

lil ~ ~~ . : i . t i 1 ll1 l

. . }~ . . . . . . . .. I . I N x

. *- . . . .. .... . , , 1~I

- 53-

MAU BALNC O PA8SE PRWECTDOW

O"g "W 9 3 . MS 2 4 403. SWJ 5M $O G" A h.fa *it V 41. .3 J9.7 .W3 -M0 'M44 41004 <4 .".2 nu M I

_."d #L. 4f tf -=. -W M %S -U -. 44.1 4%65 NaSI 4ST.tCUl_ tISM 4374 *5| -W 1B 5L4t .1 -ISA *2* i s4.9 .24t.D_Jaob m *- *- .. I -... ... ...

s_ri d7 TAN" 4tJ 4 4 3 .s 5 4U 4S4 45 473 .103 .11tAIfat- ai 403 42S -12 *Itt eX I104 .IIJ 41ta -U? .13.7 -14r8

_p* = 2J 299 3S.? 42 4 W 47.3 46 33 f7.4 41.IP 49 -as -* - 49T -- 4d 4.1 dlit¢ .n1.1 -76X

_ad -M9 43J2 40.9 .t?.t 46 44 tJ 42 JOJ aiS3 4_esi 33 94 10Z5 93 7.1 7.6 9A U33 14.1 14A IU4

Fp_0 41O -3.4 -WA4 6.4 43i J9.1 413 J34 44.7 -*A -1AOrvbbsb toQ5 4 42A 0 X 45 41 t3 -W 39 4 JQ -a 39.6 CAL AS.$

NoPA% S _o 19.7 14.4 -=I 41.1 47.1 40-3 Jtt. 4tJ J339 46.S 4.39

1 _." 99.0 MA|. 13t9 IVA 3244 30SA =42 1$74 t944 tsO.A 1619.ot,-CllUll_ 30 t 9t.1 745 $1.1 1732 1519 U.9 65.t 69Si 6A 6t.9

aw_tmia 03 5t bS-1VJ IIIS- U; a; $I6 ;co IA i:id Ul.4 ptt t.l23A4t 120 127l SU m ".4

PA _owd 4.1 ttA t¢0 35.9 04 25.4 333 33.9 95 X3 41.1=n&21 UA I7 DS UJ74 3" 394 41-7 44.9 483 M

D" 4A~t. 4.9 4i 4 -72 4.7 43 -73 4.4 -10.1 -10.9KOO etle 1.0u IS tOJ IU 7 6.1 5.7 6. 65 7A 7A S4

Sb* lmdUd 9 tUs 47.0 412 4t.S U2 0.0 u 04 W 0.0 OA 04

Is*S -13A. 393 -tTJ4a * 379.9 .4.9 4& 44.0 4tS. 43

IbtNGP__fAlm4 O D 0 tOQ -17i J9 J oao 4L 44D 41t. 443

_WOIIIMR~(-I 1c -MA. 47A 43. 4a -Sa3 4S tlOA J5.1 1A -17.2tN Ftwsw OD -19 u 0.4O 44 44S -<. 40 a 13.U -17.1

ChopiZ_ -12 _5 O.0 0.0 0.0_;§ o oi QO 0.0D bt" J 1iL4 t7A 0.00. 0.0 0.004 00 OA 0.0

GJ.L_*%s eteit 4X0 3" =a JKO 4WJ 41.0 39.0 370 3SA 33n0 31D0Imaro P I _ .7 33 a 7Wi NJ1~... .... ...

coJ_ ff. 4.4A 1a4A 9 uoLa 14&1 IDA. MS9 010t. 237D 523S 2meate _m IJI1 43 3J0 32 2.J Si 3A 34 4D0 3J 3.9

- 54 -ANNERX IE

FOREIGN EXCHANGE REQUIRMENTAND DEBT SERVICE ASSUMONS

1987M95

UMTUATw.R 318.4 412.4 421.4.. TUAL 231.$ 298.0 184.6PtIVATE 135.9 34.5 137.5IMP 48.7 53.4 0.0TOrAL 7343 79.3 743.5

N"T DISWSEM EFUMTLATgRt&L 212.4 348.7 305.9BLATUAL 142.7 233.6 128.3RVATE 91.2 11.3 129.9

SWP -32.5 -4.9 .19.9TOTAL 413. u 544.2

PRINCIPALMULTLUATAL 106.0 63.7 115.5RUTUVAL 88.8 64.4 56.3PVATE 44.7 23.2 7.6AF $l.2 58.3 19.9

TOTAL 32* 2S.5 1993

MULTIATUAL 69.3 60.4 80.73UATRAIL 25.1 28.4 27.2PRIATE 16.0 14.6 9.7OIP 15.9 14.9 1.6TOTAL 1263 1U1 119.2

MULTU.ATUAL 1753 124.1 196.2AILATUAL 113.9 92. 8.5

PRIVWAT 60.7 37.7 17.3up 97.1 73n 21.5TOTAL 44M* 317* 318Si

ILNo.K 3_;Z_

55 -

SA TI1_ 05229 at 06.3i.49

Stso Of aft 4Sp agratlw In ISWhIPMM - ws_y Stateomt Of Loom aid MA Credits(UKO ts of 4 92 * Nis d a of OV22UMl)

Cwaitryt ~ ~ ~ ~ ~ ~ ~ { ISLAIIIeV ~ ~ ~ ~ ~ ~ ~ ~ ( Cam"tt"

Anoit fn tS rdillionCtm ttelations)

Laon or Fiscat Widis- ClosingCredit No. YeU sIrree ppob * IDA based Coto..... .................................. ...... ........ _.. .. .. ... .... . .... ........ .......

Credits

41 Credits(s) closed So

C1S260S 1965 l I_ I 15.00 6.24 06//2()C15490-4AL 1965 MMMIIt AI US. 23.80 13.08 10/31/92(3)C16264.AL 1966 ALMiAI WT. PUIING 11.60 3.96 02/28/93(3)C17420-AL. 1987 MWI LItLOI TER CMUT 20.00 1.59 06,30/9C176704AL 1967 WLA 0. SECT Wtt 1 27.00 5.32 .12/15/93C176S0-t 198 WALIZ WALYI/P.II 11.00 .55 03/Ci=SIONAL 195s FiLI AIlLiUMI CllDlt 5.90 1.10 06,30196C18790-A 195 UM1 TPANOWT I 13.60 4.95 06,30/94C-,1-PAL 195 KWA ASIJWASTIN & Of 18.30 13.2? 06,30/C19900MAL 199 UM1 URGT I 46.70 32.96 12/31/94C203604ML 1989 NAIAMI INSTIT.OH. 11.30 5.81 12/31/94C690-N.L 1990 KMl INFUTRUCTIM t 28.80 1T.9? 12/31/9C-030-NL 1990 PALMII =1C.UC.II 3690 30.56 06/3/96C21210-IlCS) 190 UM AS}I OrCTO 70.00 1.13 121/9A2(R)CIU l. 1991 KU PoI SECT CR IT 553.0 49.19 06,30/97CZ222O1UL 1S99 "KLM! FINANCI & TPt 32.00 27.40 OVUMC22=504AL t991 A FtISNIES OEV. 6.81 8.13 06/30/9

TOTAL Mtur Credit-e 1? 436.00 223.20

9 Lows(s) closed 98.51

L26460-HAL 195 SHIM 1S. * ASIC. CR. 7.80 1.38 06/30/

TOTAL mwur Low a i TAG 138

TAL" 106.31 1,00O.57of *6fch rpaid 38.12 20.26

tOTAL hetd by 8t a IDA 4l9 964.31FUIt soldotmuh* ldof which repad

TOTAL udiebAse 224.57

mts:...... ........ ...

N Not yet effetiveNot wt siwdTotal Appved, AR_,s mi *A.OWng balmc*e *m th bb tiv ad ctiat Lows ad wC redts.

(R) fndicts famlY revisd Closing Ots.CS) IncHset h/CSEAL Loa ad Credits.

Tie Not 4provd wd 8a R_a)nnt wr historical walw, Oll othe eSe whet cltw.

Thb Si1wng, Iffctivw, ad Ctloig des are based em hF Low epat offlfa dts wd ae not tdsfrm the Tak Budget ffle.

- 56 -

ULSn

Statemant of IFC Imvestmentsas of March 31, 1992

Invest Type ofNauer Fn Obligor euines Loan Equity Total

s 9 * * - -*-- - USS Milion .-

326*-AI 1976618-AI 1962 0 Ihitthed & San Textiles 10.8 10.8

362NAI 77/8tJ/S Duangwa Sugpr Corp Suger 11.3 11.3

434-PAI 1979 IMDESAIl 0evwt finance 0.6 0.6

SQ2.MAI 19t0/8$ alavi Notels Ltd Tourfsm 2.t 2.1

543-MAI 1961614*NAt 1982 Ethanol Co Ltd Chem/Petrochem 2.3 0.2 2.5

832- AI 1986 Leasing & Finnce Co Money/Cap Market 0.7 0.2 0.9

741 -NAl 1985

872-NAI 1987 Viphy Plywood Plywood 3.9 0.5 4.4

Total Gros Cmitment 31.1 1.3 32.6

Less: Cancellatifns, termdnftiens,ecag adjusmets, repubt* _

write-offs, and ales 23.8 0.0 23.8

Total coMitente held by IfC 7.3 1.5 8.8

Tot lUndiabnsad 0.0 0.0 0.0

TotAl Disbursed 7.3 1.5 8.8

-57 -Pagp Iof 4

URHPDEVELOPbMEN AND DROUGUT RBCOVEtY PROGRAMP#It Std Aeuka_ Op0o

SAL I (2'Y]I SAL n S4\ IA. M aM

WDas=G IUSS3A FINANCING f l EANCING usIDA 45.0 DA 55.0 0A 3.0

African Facilit 40.0Finacing

99.0

MAIN O S MAN OECTI M OECTI

1. Diverfy upt bm& 1. Diversty 0pt b_1. 1. Divesty eport ban.2. Encourage fflait impo 2. Ecour dficietipo 2. Promt expot.

substio. substiuton. 3. Strnthen Govt.'s policy-3. Ensure aopapie l nd 3. Esur adequat imnives. akingcapabilities.

iflOoS policy. 4. Iaprovm public sectos 4. Impve pft*omnc of4. IWove publi ses financial finacia pe an Developumet Isi ons.

performace. 5. Stren6he policy-mingS. stregten Qovermates capabiliie

economic plAninganmoitoing capaility.

MAIN ACrIOS TAK MAIN ACTINNS T M AOTE

Adjod periodicy. Co _iud to be adud Contiud to be adiusted.periodicy, ad Kwci wa tied toa bakt of cunecis

A&dWA

t. Smalodeor produeW pic 1. S nuolde prod prc 1. Sn_ dodr prices contiueinead ualy, nOay incre a,in Bak to be adjus*d UAn Bakfor Mai^, usng metodology methodolog. methodology.desiged by the Ban 3. ADMARC's financl inne 2. Agreement neahd Witht th

m eatcapability strengthd. Bank to postpo eiinatof futiliur wbid to 1989/90.

3. Divetur of ADMARC'sinetet ineate to

-S wa n itialb&

1. Reucton (by 41) of iWM 1. Eimindo of items subjecsuject to puc otroL to pM conrol aot

p-, b baf.fawas,m sugr andraw osapm pads

1. Preparton of an export

2. E _adlIsme of exportf- &clity.

Page 2 of 4

- - '-' - Resources Mr bilization andMangum_ m Mansgumenu

1. Expansion of the tax bm ad 1. Improved buoyacy of tax 1. Further tax increases oninreasing tax rates. systems selected items.

2. Steghening Govment 2. Inreased non-tax revenues 2. Adjustment of the tax system tocabilit for -- -c from higher fes nd levies, improve efficiency andand sectoral plnning, and 3. Preparton of 3-yer Public incentives.pubhic debt moioing and Secto investment Pwram. 3. Preaation of a 3-year Publicn _nagene. 4. Further strentening of the Sector Investment Program.

3. ncrased recurt budget Govenmet paing capability 4. Steghening policy-makingallocation for agriculture and with emphasis on formuton of capacity and ecoonomicother key economic ad social medium-term stg, project anyses capability.sectos. identificaion, evaluation d S. Introduction of a programmatic

mitorins. budget systemS. Inreasing of recuret budget to

key onomic and social sectors.

_ Edoienev ~~~~Parffictllg ImdwPnU Efficiency

1. Improved financil struct 1. ADMARC (see above under 1. ADMARC (see above underof Malawi Dewelpme Agriculture). Agdculture).Cooaion (MDC); and Prs 2. Furter finaal rstuctur- 2. Futher restuctuing of MDCHoldinp Ltd. (PL). ing of MDC and PHL and PHL.

2. Inc d triffs for public 3. Fufrter adjustment of triffsfacilities, for Malwi Aiwa for public utdides.and Malawi Housing

IMpor Ubainito Itniort Libauizdo hmort LibeaWizstion

montSary MME2_ M agemuenwt kSQnetw Metnent

1. Iet rats adjused 1. Inest rates a4ut 1. Iest rates adjustedperiodicly, peiodicaly. periodically.

_59 _ kNNBXmPage 3 of 4

MA SUPIM AMs L Rn AGRICLTURE SE=rOF - E=POIC ADJUSTMRT &IM=ENTCRBEDIrt

CREDrr MuES8 (Ff0

}5NAS=aNG FINA*s NC:ING (USStM} FINANCIAL (USS*M)

African FacilitY 10.0 IDA 79.0 IDA 79.0

Special Joint Japan 25.0 UK 25.0

Financing 30.0 EEC 15.0 Nethnds 10.6

USAID Lfl ADF 17.2 Gemany 95S.0 USAID 35.2 123.6

Gmay 10.2Nethrlad I.9

186.5

MAIN OBJECTIVES ,fAIN OBJECTVES MAIN OBJECTIVES

1. Expand role of privt sitor t. Improve policy ewvront fbr 1. Inreas efficiency and imrovein marketing of smaliholder the manfcturing sectw to incomes of smaMholders,

CVOPs icra dfScecy of particlarly smalbolder ones.

2. Impov final prforma rsoue use includig Wpot 2. In¢ce officiency of land use

and opeaiona efficiecy of .ad expad exports. and protect environment.

ADMARC. 3. Improve macneconomic

3. Strengthen Food SocuritY envioent through frter

plng capbility. import liberdizton andpublic expendiue restucturing.

M{AIN A=T=ONS TAKEN MAIN ACrIONS TAKEN MAIN ACTIONS TAXEN

Exbm W*e.Exm

Further adjusted. Frhrajd Continued monitoring.i * ~~hXtlad jm

Intra-regional differentatd 1. Bee price decontrolled 1. Snilole pries cod

producer aod consumer main adjustmentL Two-payment price

prices implemted to a nd sysem for smailoder tobacco

the ole of private sector in intoduced.marketing smlihode cp 2 othe agents alowed to marketexcept bacco and cott, fertlizer. Impwoved cash flow

2. Govenment took over from mangmen for SFFRFM. Ford-

ADMARC the finacing of lir econoc subsidy reduced.

strategic A: reserv 3. RatonaHntion and Govement

3. Divaeti of ADMARC finncing of ADMARC develW

investmet uesated to ment fuctions.maketing tivities was 4. Smallhe llowed to grow

accelerated. burly tobacco.S. mim re shifted to devel-

op high-yielding flint vareties.6. EstatU land ts a4justed more

frequedy. Rent raised in1990i91 an d agai in 1992/93 toreal 198S lovel. Tander of landfrom Astomy es to estateshalted except in low populatondensity areas. Enforemen ofwoodlot envronmet covenantsstrengthened

-60 - Page 4 of 4

1. Reduction of scopes ofindustrial icesing

_ 9adelimination of authityto grant exclusive productfights.

ExDot EPtIoo Expor E19111tioa xp Promotion

1. Reduction of te scope ofexport liceing-

2. Revision of duty drew back.3. Inroduction of wrta credit

Reon BSW obil"m tid Resougoe MobilizMion adB p o nMaysfteme maaem_

1. Reduction of f_incia deficit. 1. Prpation of 3-year roiling2. Prepaation of a 3-year roling PSIP, and maintenance of

Public Sector. atsfatory fiscal deficit.3. Expnsio of excise ta bm and

Mov to ad valorem rate.4. Itoductioa of current payment

sysm for corpoat inmom t

P _ EfEcine Prso Ef

1. ADMARC (se Above under 1. ADMARC (see above -nderAgricuItu@). A4diculture).

lmLauizatdoa Impor Libqizgo ore LibeWaiiond

1. Remova of r_qurmt for 1. Final removal of prior foreippW loction by th excIa control except forRosene sBank for 65% of all smal ngtve list.

Monetav MjONON Monda cLr-mmb mam

1. n ras adjusd 1. Revision of Resve Bak Act.peiodically. 2. Revision of Banking AeL

61-

secton I: nMetae of Kea Evet

(a) TL # takcen to prepare Credit: 26 moao(b) Responsibility for Credit prqmxkmxo Govanet/Bank(c) First Baik missiow. lauaxy 1990(d) Appraisa mission departur: June 1990(e) Post-Wappris msion depue: July 199(t) Planned date of effectiveness: June 1998

SgW= 1 S eW Bn IMDl=UeaX Acdm

None

SgWo : Sneioi Codido

(a) Conditions of Negodtiaons: see M.D.(b) Conditions of Board Presentation: see M.D.(c) Conditons of Effectivenes: None(d) Conditions of Release of Second Tanche: see ILD.

.

ANNEX V-62 - Page I of 17

April 3, 1992

Mr. Lewis T. PrestonPresidentIntetioal Development Association1818 H Street, N.W.Washington, D.C. 20433U.S.A.

Dear Mr. President:

RE: ENTREPRENEURSHIP DEVELOPMENT AND DROUGHT RECOVERY PROGRAMLETTER OF D_VELOPMENT POLICY

1. I am writing this leter to request on behalf of the Malawi Government a credit of

US$70 million equivalent from the International Development Association (IDA) in support of our

program of structural adjustment. The strucmural program and improvements in short-term

macroeconomic management to date have created a stable macroeconomic environment, but the

structural change in response to those measures continues to be dampened and requires fiuther

policy actions. These actions would be supported by the proposed Credit. In addition, the Credit

would provide needed financing in light of the continuing external difficulties facing Malawi, in

particular, the disruption to traditional rail routes. As outined in the Policy Framework Paper of

1991 and supported by the Government's Statement of Development Policies In 1988, the

Goverr - vit "iews these additional actions as central to its medium-term development and poverty

reduction strategy.

ANNEX V-63- Page 2 of 17

2. During the 1960s and 1970s the Malawi economy grew smngly, led by an

expansion In the agricultural estate secor. Redl GDP per capita increased on average by 3

percent in 1964-79. Beginning in the early 1980s, the economy was subject to a number of

advse exogenous shocks, including a deterioration of the external terms of trade, droughts, and

the onset of external on problems stemming from regional unrest. To address these

difficulties, the Government of Malawi implemented a broad-based adjustment program supported

by three Structural Adjustment Loans and a series of Inernational Monetary Fund arrangements,

and considerable gains were made. However, the adjustment effort was impeded by a new round

of unfavorable developments starting in the mid-1980s, foremost among these the complete

closure of the main extern trade routes combined with a substantial influx of displaced persons

and further worsening of the terms of trade. Ihe resulting imbalances were compounded by the

emergence of a substanidal fiscal deficit and the itroduction of direct controls on imports. In

these circumstances, the Government strengthened its program of demand management and

structural reforms, supported by the Fund's Enhanced Structurl Adjustment Facility and the

Bank's Industrial and Trade Policy Adjustment Credit. This resulted in a return to positive per

capita GDP growth in 1989.

3. Earlier adjustment operations achieved much in macroeconomic stability and more

liberalized product markets, but the Goverment recognized that structur weaknesses remain.

Improved marketing, pricing, and agricultural services have led to improved performance for the

large smallholders but not reached most smatlholders. In response, the Government lauched a

comprehensive policy reform program in the agricutural sector supported by the Agricultura

Sector Adjustment Credit fousing on increased productivity of a broader range of smatlholders

and improved land use. Odt Impediments to a supply response remain to be addressed in the

-64 -AMIEX VPage 3 of 17

capital and labor markets. Whle investent -has begun to recover, dynamic new setors of the

economy have been slow to emerge, Impeded by narrow financa markets, lack of a prmotdng

environment for invtment and small-scal actvity, and hsfflcient inv n in human

resources. Malawi has a low per capita naonal income and th design of smructural refrm has

to ensure at the poor benefitm the adjusm proces while being procted from any

negatve ImpSac.

Ihe Gomovrmets Medh==en Polig ftraMe*

4. To ensure a supply response, e Govenunent remains commied to a statgy of

macroeconomic stabiizaton and s8tuctura refr, with an increased emphasi on stmulating and

filitatig priate sector production am ctvity. is stty wil address the

concerns for reducing poverty in Malawi. The Govrnmens program alms at attaining a GDP

growth rate of 4.5-5 percent in 1992-94. his would be in the contet of domestic price stabiliy,

with inflation falling to about 5 percen per annum, and hiproved external perfomance, with a

projected current account deficit of 8.3 perct of GDP in 1992 failing to 6.9 pecet by 1994.

S. The Goveent wil contnue to purse m poes aimed at

maintainin ex a and iral balance, including fiscal disciplHne, remained monetay and

credtk poliies, and a lization of the btade and payments systm.im vemlew in the public

finances adhiewd in recuet years will be consolidatd and extended and the fiscal deficit is

expected to sIabilize at about 5.56 percent of GDP. Develdpment prioriies will be reflected

within stricdy contined expenditr leves; tax effots aimed at broadening the base wi

cone. More specific expenditre and tax stuctr refms are desied below (para 28-31).

Monetary and credit policy wil onu to be gared towward saing low iflaon and

provkding resources to the pdvate sector. Ovrall monetay growth i targeted In 1992/93 in He

- 65 - * ANNIE VPage 4 of 17

wlth nftatlon objectives and contied netive net domesdc credit fnaing by the Govermnt

Ibis wil be combined with structural refms In the fiancial sector aimed at strenghening

monetary control, enhancing domestic saig, and imroving allocative efficiency, described in

more detai below (par 24-27).. Extna sector polic will aim at enhning Internati

ompetitives and promoting diersification. The projected ivement in the crre accou

will stem from sharper growth In eports combined with a tapeing off of import growth.

International reserve levels would be mintned at an appropriate level, equivalent to about four

months of imports. Spefic trde and exchage rate policy measures are outlined below (par

19-23).

6. The Govnment's program aims to stegthen perform in the productio sects

rough increased investment and employment. Ihe Goverment will improve the policy

nwironmet for both lar- and small-scale private sector activity, with secific reforms outlined

below (pam 9-18) and Improve the functioning of tLe labor markets (para. 32-33). As noted

above, the Govemt has lud a omprehensie new progr for ithe agiule sector

with a focus on expanded frtilizer use, enhanced productivity among food deficit and female-

headed households, improved efficiency of resource use in the estate secr, and contied

encouragement of private sector marketing activity and provision of adequae smallholder price

inceni. In infaructure, te Govenm wl cotine to provide services that enhamce

productive advity. It wfll seek ways to Improve the extea transport situation, nluding

contnuaio of the Northern TransPort Corrdor Project and work on the reopening of the Naala

rail route md Wi continue its prom of man*ff and rehabilitation of the road and war

networks.

7. Social indicaor in Mall reman a maer of concen, pardculaly with regard to

nutiom school enrollment, lieay, and Infant and m l mortay leves. Ihe Govnet

-66- ANNEX VPage 5 of 17

will continue to implement a comprehensive program to strengthen education and health services.

To complement its program of maternal and child health care, the Government is actively

developing other policies to tackle the problem of rapid population growth. Specific measures in

social sector expenditures are oudined below (para. 28-29). The Goverment's program also

includes measures to protect the environment and Improve natural resource management.

8. A major objective of the Government's program is the reduction of poverty in

Malawi. The Government's major approaches to poverty reduction are captured in the strategy

for economic growth. First, the Government seeks to increase employment opportunities and

labor productivity, given that the poor have limited access to resources other than their own labor.

Second, the Government aims to increase the productivity of smaller farmers in particlar. Third,

the Government will give increasing attention to human resource development. These will be

complemented with expansion of targeted programs and support for greater non-govenment

nvolvement in poverty reduction.

Stutua eforns for E=ternMKMUOip Develop metad Drougbt lteco Emn

A. Imvestent En ironment

9. Imestment Policy. The Government is strongly committed to supPorting the private

sector and strengthening the policy environment for domestic and foreign investment in Malawi.

Given this commitment, the Government has been concened with the weak investment response

to date and has taken a critical look at the investment climate in Malawi. Considerable delays

were being experienced in decisions which impede the flow of investment. The Government

recognized that decisive action was necessary to stimulate investment, and the Government has

-67 - ANNEX VPage 6 of 17

taken a number of measures to this end. These are complementd by other measures in the

financial sector (para. M27) and tax policy (para. 31).

10. To outline the general thrust of changes in Government policy in these nd other

areas, the Government issued an Investment Policy Statement. Ihe legislative famework for

investment promotion was established through the Ilvestment Promotion Act, 1991. Schedules to

this Act include the Investment Policy Statement and its supplement, the Investors Guide which

outlines the specific laws and regulations conducive to Investment. The Government has given to

the policy statement and accompanying guide the widest distribution and highest visibility.

11. In order to establish a focal point for Government-private sector dialogue and give a

clear signal of Government's commitment the Government has established the Malawi Inves_tm

Promotion Agency under the Investment Promotion Act and has empowered it to ensure that

commitments of the Government in Malawi are met, including authority to investigate and solve

any problems that may arise during the investment process. The Goverment has staffed the

agency appropriately.

12. One major area is to expedite business registration and incorporation of co,mpi,

which has been revised to a single step with the regstrar as outlined in the Investment Promoton

Act. To send investors a strong and necessay signal of an improved enviroment and to ensur

that unnecessary barriers to investment are removed, industi licensing has been eliminated, with

the exception of only a short list of environmentally hazardous activities, through the repeal of the

Industrial Development Act and its replacement with the Industrial Licensing Act, 1991. Other

health, safety and environmental standards will be addressed by the relevant authorties in a timely

manner.

-68 - ANNEX VPage 7 of 17

13. Me stegthening of lad policy is critical to the approprite use of this valuable

resource and to the growth of Malawi. The Government is strengthening land rent collecon and

has increased agricultural land rents in 1992 to an average level at lea equa in real terms to the

1985 level. To expedite the process of land lease approvals, the Government has streained the

procedures for issuance of land leases and requires the Commissioner of Lands to issue leases and

consent to lease transfers and subleases so as to reduce thime from date of application to date

of lease offer and to date of lease transfer and sublease consent to within 90 days. The procedure

of DLV submitting applications for industrial plots to Ministry of Trade and Industry (MTI) is no

longer applicable given the repeal of the Industrial Development Act, with the exception of those

applicants who indicate that the proposed land use is one of the industrial activities requiring

licensing.

14. The Government permis and encourages leasing large tracts to private investors,

encourgn g the private sector to develop industrial, commercial and resienal estates and offer

serviced plots for sublease within a reasonable tme period as oulined in the Inv1tment

Protion Act. As long as expeditious development takes place, the Government will, with the

exception of leases on customary land, offer leases long enough to allow the developer to offer

leases of 99 years. The DLV bas been encouraged to lease without servicing to enable private

development of industrial, commercial and residential serviced facilities as long as the relevant

standards are met.

15. _ = ector. The Govenme also iends to improve the

investment and operating environment for small and very small busies of all types in the

country, which have a large role in the futre growth of employment and income, ad in rural

and utban poverty alleviation. Credit, technical assistance and training directed at these

enterprises is already being expanded and strengthened through a number of ongoing and

ANNEX v-69 - Page 8 of 17

forthcoming development projects. Ihis will be complemented by policy measures to ensure an

environment conducive to credit expansion for this sector (ara. 24-25).

16. Tnese entepris Aso require a supportive zoning and land use environment. Along

these lines, the Govnment has modified selected aspects of its zoning and land use policies in

the revised Town and Country Planning Act which came into force in 1991. The Goverman

will contnue to emablish and expand, as needed, business areas in traditional housing areas and in

high-density modern residential developments. The Government has applied flexible standards to

allow for small commercisa and industrial plots in certaint estate developments and plans to expand

this practice.

17. Furhermore, the Government wil attempt to increase the impact of relar

procurement of stores by Government and parastts on local producers, particulady the small

enterprises. To this end, the Govermnment will initiate by August 1992 a thorough study of its

pocurement policies, practices and procedures, and will commence implementation by April 1993

in line with recommendations of the study that adapt those policies, practices and procedures to

the potenW of local producers and provide guidance to these producers on how they can improve

their chances of obtaining Government orders. The study will include a review of the features of

the current tax system which discriminate against the purchase of domesticaly produced goods

and evalute the option for duty-drawback and rebate of surtax on government and Intnational

agencies direct local purchases.

18. A critical constraint in the development of the small and micro-ent se sector in

Malawi is access to credit. The Govenm Intends to review the policies of financial IstituXtions

serving the small and medium scale sector, especially thoe of SEDOM and INDEFUND. The

Governmet will encourage mese institutions to mobilize additional resources and move towards a

-70 ANNEX VPage 9 of 17

mote market oriented interest rate policy. The Government also plans to strengthen the

insimtions through appropriate tning and review of structure of services to enable the

institations to reach a broad client base.

19. &na Trde and Excage Raim Following the series of externaJ shocks to

the economy in the mid-1980s, the Government itroduced exchange conbtols on impots. Since

1988 these have been removed gradually, and the Government completed the final stage of

eliminaion of exchange controls on imports except for a short negative list in January 1991. TIhs

program has been successful in stimulating economic activity and increasing competitive forces.

20. Reduced domestic protection is essena for ensuring that investment is orented

toward labor-intensive and export-oriented activities. As part of its comprehensive tax reform

program, the Government further reduced protection in 1988/89 by merging part of the import tax

with the domestic surtax and establishing a maximum tariff of 45 percent. The next stage of trade

liberalization is the completion of the program of tariff and trade tax rationalization. In 1991/92

the Government increased the minimum rate on imported inputs. Based on the Malawi Protection

Study undertaken in 1991 and subsequent updating exercises the Government is formulating a

phased program to fiuther reduce the levels and dispersion of protection across sub-sectors. The

targets of the program, to be reached in a period of no more than four years startng with the

1992/93 budget and ending with the 1995/96 budget, are a cascaded tariff structure with Oi an

average taM collection rate of no more than 15 percent on non-government imports in line with

esdmates of the current tariff collection rate; (ii) a maximum import tariff rate of no more than 35

percent in line with the targets of other successfully reforming countries; and (ii) a mini_mm

import tariff rate of 10 percent (except for a short list of tariff exempted goods, such as

phamacetcals and medical supplies). Given the investment enhancing measures to be

implemented under this program, the Governmen intends to have eliminated the industri rebate

-71 - ANNEX VPage 10 of 17

option by t'he end of the program. In the interim, the industrial rebate option will continue to be

graned on a very selecdve and temporary basis. In the contet of the 1992/93 budget, the

Government has announced the objective, the planned time frame, and the quantitative tariff

targets of the tariff and trade tax reform program. Specific measures which are being

implemented in the 1992193 budget include (1) elimination of the urtax exemption for

domestically produced goods; (ii) consolidation of -the protective effect of domesdc surtax

exemption into the existng tariff system; and (iii) limiting the resulting consolidated tariff rates to

a maximum of 75 percent. By June 1992, the Government will assemble and begin to analyze

detailed data on imports, tariff and tax revenues for 1990, and other data deemed necessary.

Based on this and complementary analysis, the Government will implement major triff schedule

rvisions in the 1993/94 budget and will outline the further steps of the tariff and trade tax reform

to be taken toward reaching the targets for 1995/96.

21. In addition, the Government is currently reviewing and will implement appropriate

measures to strengthen customs administration, increase tariff compliance, and increase customs

revenues. Based on a study to be conducted in 1992/93, the (iovemment will exend pre

shipment inspection to all imports should the study confirm the need for such action.

22. The Government recognizes, however, that in designing the tariff and trade

tax reform program, pressure from competing imports to ensure efficiency of the existing

industrial base needs to be balanced with adequate transitional measures to prevent shuttig down

of activities that may be viable in the long-mn. Provision of any transitional measures Is intended

to allow the involved frms to restructure with a view to attaining medium-run fiancial viabiity

and economic efficiency and competing effectively in domestic and export markets. Tbe

Goverment will not gram any transitional assistance unless the following steps have been te.

First, the respective sub-sector, a firm or group of firms on behalf of the sub-sector would have

-72- AN VPage II of 17

submitted to Government a detailed proposal including a detailed identfication of the exsting

problems due to pressure from competing Imports as substantad by audited accounts; details and

dming of a restructming plan with a view to ataining medium-term objectives; and details and

timing on the proposed tempor and unsparent relief mesr which woul4 exclude

quantitative restrictions. Second, the Government would consult with IDA prior to consideration

of graing any transitional relief. In this regard, the Govemment is cuntly reviewing policies

which affect the textile sector. Based on this review, Govem expects to adopt a policy which

will ensure continijn, access of low-income consumers to affordable clothing while smating

small-scale tailoring activity and garment production. I is Govenment's plan to address the issue

of second hand clothing in the context of this broader review.

23. In March 1990 the Malawi Kwacha was devalued by 7 percent against a basket of

currencies. The Governmen remains cmmitted to closely monitoring the exchange rate on a

cntinuous basis with particular atention paid to the need for export diversification and

acievement of eternal objectives and wiU make adjustment whene necessary to Improve

competitiveness, also in the light of trade liberalization and other developments.

B. Finanial MarketDepming

24. Mlna Control and Jnterest Bi gmet. In recognition of the important

role that the financial sector can play in mobilizng rea domestic resources and allocadng them

in support of struct chage, the Govenment and Reserve Bank of Malawi have been

implementng a comprehensive financial reform program. The monetary authorities are

committed to a movement towards more indiret, market-oriented monetary contol, as reected

in the revised Rese Bank of Malawi Act of 1989. The Reserve Bank has established a Capital

Market Departme to flitat tding of montary and serities. It is conducting

-73 ANNE VPage 12 of 17

periodic auctions for the issuance of ROM bills and intends to increase the frequency of issuance

and range of maturities, with varying amiuts and yields based on monetary policy

consideraions. Direct regulations of commercial bank credit have been discontinued. As

reflected in interest rate adjustmes made by the commercial banis, bans and other fincan

institutions will contn to dermine their intere rate structure. The strengthening of indirect

monetary control wfll encourage positive real intest rates.

25. Bankin. The Government has put into place a new rWgulatory

framework, laid out in the revised Banking Act of 1989, to improve competition in the highly

segmented financial market and promote investment. To ensure expeditious and transparent

decisions on applications for entry, the Reserve Bank of Malawi freely mkes available forms for

application for banking licenses under the provisions of section 6 of that Act. In addon to

approval for the two commercial banks active before the reform progrm, six other financial

institions have been licensed under the Act to engage in various banking actvities, incuding

deposit taking, leasing, and merchant banking activities. A number of other applicadons also

have been processed expeditiously and in line with the provisions of that Act The Government

will conue to actively seek applications from sound regonal and international ban. In an

atempt to reduce fagmeion in the financial system as well as increase competition, every

encouragement will continue to be given to both banks and non-bank financial is to

widen the range of financial activities in which they ae curreny Involved and consistent with

prudentdal supenrision.

26. To enable the Post Office Savings Bank (POSB) to play a more effective role in

mobilizing resources of small savers, the Government has prepared an oudine of the scope of

work to restucture tie POSB. Based on this restructug progrm, during the course of 1992M93

the Government intends to take major steps in the iniation of the restructuring of the POSB

_74 - ANNEX VPage 13 of 17

including the publicaion of up-to-date accounts, legal separation from the Post Office, a revision

of the tax-eempt status for POSB deposit ie and epansion in the range of authorized uses

of fMnds to include fincial inume other than local registered stock.

27. Ca"l Market De m . Another element of the fnancial reform program is

the encouragement of new capital market activity, based on the Capital Market Development Act,

1990. 'he Reserve Bank of Malawi will review expeditiously any applications for such activities.

To ensure promotion of capital market activity, the Government will continue to review taX

treatment of dividends and capital gains, including the dividend grossing up system and interfirm

dividends. At this stage of development, the housing market will be important. The Government

intends to adjust its policy towards provision of housing for civil sevan as well as review

alternative mechanisms that will facilitate home ownership in a more equitable manner. In

1991/92 the mortge interest deduction was eliminated, and the Government will review the

eliimiaion of tax-exempt interest on the tax-free deposits of the New Building Society.

C. Access to Human Cgita

28. Public E d%ure R The Government has recognized the critical role

that social sector expenditures play in both generating growth and reducing poverty in Malawi.

The 1991/92 budget reflects this recognition with an increased share of total expenditures to

education to 15 percent. Ithe Government is committed to maintning strong budgetary support

to education. It has allocated not less than 15 percen in the 1992/93 budget and will allocate at

least 15.5 percent in the 1993194 budget.

29. In health, primary health care is the Government's basic philosophy behind service

delivery. Despite this, reurrent expenditures allocaed to peripheral health care services have

-75 - AN= VPage 14 of 17

been nequate. Tbe Government has developed a system for strening budgetary allocation

and control whin disrict health budget. It has incsed the share allocated to periphea

services in the 1992/93 budget by not less than two pecena poits above the level prvailing in

1990/91 and wIl irease the share by at least a further two percentage poiuts in the 1993/94

budget. The Governmen also will maitn the health share of expenditures. ithe

importnce of rura wat to not only health but also the burden on women's tme, the

Govenmet will develop a plan for the systematic easion of safe rura waw and to acdvely

seek donor assistance for the construction program, In addition to current rehabilitation activities.

30. For other expenditures, to ensure that they reflect development priorities, the

Goverent will continue to prepare a three-year roiling Public Sector lnvestment Program

(PSIP) and review it annualy with IDA. In particular, the PSIP will emphasize the priorty of

soca sectors and other programs for alleviaing poverty. The Govemment will sare the PSW

with other donors, including consultations during its preparadon, to filate the reorienton of

donors' aid programs in line with the Goveenm's expte priries. To implement Is

growdt and poverty reduction strategy, the Goverment supports wider participation of non-

governmel o ions (NGOs), boh domestic and interonal, in development acdvities

and specifically has included NGOs in the Implementation of its SocW Program Support Fund as

part of the Social Dimensions of Adjustmet initiative.

31. T . Since 1987, the Goverment has been Implementng a corehensive tax

program aimed at efficiency, equiy, and Imprved administion. A key objective of the

program is to widen the tax base so as to allow a reduction in tax rates and to ensu sustainabe

fnacing of core public ependi progms. The Government further wiened the surt bas

in 1991/92 with the expamion to electricy, telepone, and certai other services. Ihe

Govnment will consolidte this exaion by Wpoving administatve capacity, Ica the

-76 - ANN VPage 15 of 17

sutx rates on telephone and electricity services, and revewing t feasibility of expg tho

uMrt to other Services. Reduction In tax rates enabled by tax ba wideng is a crical deen

In Governments pro-invesm Iniave. In light of the widening of the tax base the

Goveent reduced the base surtax rate from 35 percent to 30 percent in 1991192. in to czuwse

of 1992193, the Government plans to idenify the target bas sur rate oward which it is

moving in line with base expansion. I has rviewed fiuther reductn in the coporae and

individua income tax rate for 1992193 to ensure that such rates are reduced as quicldy as

possible, albek in light of the fiscal situation.

32. FunctioningofJLaborMarkets. Stable a' competive labor market cond s ;re

essent for both the desired investment response in labor-intensive actvities and employment

generation in line with human capit tanm on. Given impfections In the funtion of

labor marets and the desire to raise efficiency of wokers snd addre Iances in bargain

power, statutory minimum wags have been in existe for some time, wIth the intention of

seting them at levels consistent with a properly functioig labor maket However, up to now,

revIew of the mInimum wage has been sporadic. Ihe Govenmet has revised minimum wage

leation mandating a regular review process for the minimum wag% fiiggered by a cumulative

change In the relevat price Index since the last minium wage adjustment, and at a nImum

every two years. he rwiew would oudine rDS based on economic analysis of

shifts in the appropriate real wage, if any, due to labor market conditons nd

facors. During such reviews, the Govemn ll ensure that appropra coladon betwee

employer and worker organizations have taken place and wfll take action on any minimum wag

adjustmen called for by the review. Given hat e lastr eision was in 1989, steps to lnts die

nex review wll be taken Immediately with a view to adjustig minimum wage levels shrdy

therefer.

7N1-M VPage 16 of 17

33. A parallel effort of the Govenmem is to Improe the fictioning of labor markets.

During ta review, the Govermt will analyze the appropr s of minimum wage policy in

the face of ImpfecDons, d t between rural and urb eas where markets funtion

quite diffirently. The Government lso will evauate in that review options to imprve the

underlying fnctioning of labor markets including meas to stengthen the bargainin and

consulton process between employr., and workers, improve information flows, and develop a

competiive labour force. Based on the recommendations of this review, the Govenment will

fonmlate an action plan for improving labor maret policies. In parallel, the Government is

carying out studies in 1992/93 in collaboration with USAID on tobacco tenacy, including labour

market dimensions. These studies will form the basis for specfic policy dcanges appriate for

tenancy arrangements, including pricing and contracts.

Conclusion

34. In the recen past the Malawi Govemen has undetaken a major program of

reforms aimed at adjusting the economy and attaining sustainable growth and believes that the

frther actions outlined in this letter will contribte to a sharp improvement in the supply response

of the econmy, in particular, from the private sector. The Govermen views IDA support as an

important input to this effort.

35. I would like to reconfirm that the Malawi Government Is committed to implement

the Entrepreneurship Development and Drought Recovery Progm. It is the itton of the

Govermnent to expedite the progm and take whater other complementry measures are

necessary to ensure Its success.

ANNEX V

- 7 - Page 17 of 17

* Yours sincerely,

Louis 1. Chinmago, M.P.

Miister of Fnanc

Enclosure

ANME VI_Page I of 11

AGEDA OF POUCY ACllONS

MALAWI

ENTREPRENE_RSHIP AND CAPITAL MARKET ADJUSTIM CREDIT

to= mm RE= ACnON1S TAKE ANDFRHt AnN OH AE MNIMPUkI1FOR ElRtAC

DDI LDl I ONE: To uppon a Imrod wonmt f activity and ne s n labor-intensIe ataIvaes.

3. Inv_caS

To prmote domeste and fri a) Athive mn Pein. Mm G o Issuance of hvestmet Policy Board Cond_ion

investnt in new, effici has sed its policy to be suppotivo of Stement acepte to IDA, wdh

tivies tog a) actv peiva seor activity. wide dtb n and hig vsibty.

promol n policy ad b)_mIAto of barr io entry. 1 fe dF Wmb of

wmes promoton center.

b) Rawyl of Bw : Under ITPAC, Revisin of policy dies so that Board COd_tlodo Gow_nmt redud t scope of business registration and incoationIndustrial ieeming and deimia the of compa_n consist of only on stepmathorky to gr edclve poductio wih te Registra Geea.rgt. Recogniz i fttier actions areneed to reduce delays in Ivestme Replaement of lndustr Delme Board Condiionpoedue, the Govenme has produced Act with Industri Licasg Act so asI met GWidelInes widt the assisanac of to diminate indusrial licensing processFIAS whih oudmon the necssary legislative for invesm, with e exception ofand _ st eps. a short list.

c) Land Pol): Under ASAC, the Govnment Issuance of policy directive requiring Board Conditionagreed to increase the freq y with which the Commissioner of Lans to issue

ANX VIPage 2 of 11

land ens can be adjued. Land prcedures leases and grAnt approvals andare subject to conserable ddea which conents of leases and subleases so asimpede nvesum in comerce, industy, to educe the tiake requW to completead agiule. me Goveme agred to procss fiom date of application toincre agutoul lnd reM in 1992 to the date of lease offe, tanse, oral Wd praiing in 1985. sublease consent to wIt 90 days.

Isuce of policy direct Board Conditionencuran DLV to leas wutsevking so as to encora th- secto delopment ofhinuvial, comm_ eial, anid reidentWestat on condkion ta plzsmitted by private deopen ofinustral co_merca ad resideteses prior to coucto confirmthd rdee sevking stand willbe nout

8

Page 3 of 11

2. Smdl Lmd Miam

To pomote avities bi gnall a) Zoig. Land d Govenmen iiad r 0ub mdiri bs policies to anwgaa) mig and Ind woa policE, b) qwwm fo r 1uhh so

cedt policy ad c) Wnmet cs.ev m in ial, _cEl, adIuial areas It cniu to estalshbusnm am in aional housig areaand higb4dnsity modern resientiWsUd"_ Ina idubt alw(

d" _cmld and hdW plot.

b) m .: Actions are needed to expand Encourgement of SEDOM andavalbity of mmercil crodk for INDEFUND to move towads a moresma _ca aiviies and strn rdevat marke orieted inest rat policy.

IStrengening of SME instionshrough ropate tai andreiew of sructe of ices toenabl the instituios to reach a broadcliet base

c) M A : Actio is neded to Increase Identificatin and comm ong of August 1992aces to Govwrmn procremet. Ile conrutncy services to cry out aGovenmets tax ream proam Inialy stWdy on goement proumntcalled for Intouctin of a tax-inclusive policy including optin for duty-budget which was rejected due to drawback and rebate of swax on

administrative concemns, goverment d intera nal agendirect local purchses.

Co n nt of imple ionof April 1993policy changes in lin wihrecommendations of the study.

ANNEX VIPage 4 of 11

3. Exnr

To e ad 1_ hmalm in labor- a) Trade LlWbeiati:Impor and expont A _ enl of objective, planned Board Condiionntve sactvies hrou gb a) trade licensing ha been sharply reduced. Under time frane and quantiaive tarifflIrizaion, and b) e ITPAC mnd ASAC, the Gormet has targs of tsaiff and trade tu reform

w tte _o m. completed Ohe phased removal or prior program to be implemented overapproval of breign exchange for all imports, period of no more Ihan O iur yearsexcept for a dht list of hems satsfactory to from 1992I93 budget thgh 1995196IDA, and has improved te duty dawback budget, which wil aim at a cascadedsystem for exps. m ta reform pacage tariff struct.-e wtkh average tariffhas begun the unificatio of the import and collection rate of no more than ISdomeic s rte sysms. Fuer percent on non-govaement impors,actions are needed to duce and rationalize maximum unpont tariff ate of no moemtade poecto and to complete he sua than 35 percent, and minimum importunificion. taiff nate of at lea 10 pen.

Elnination of srtax exemption for Bond Conddomestically prduced goods;

soliation of proteve eff ofdomestic su exemption intoexiing aiff system; and limiigresultg comolad ariff maes tomaximm of 75 percen.

Assembly md shaing with IDA of June 1992data on Imrs, tariff and turevenues for 1990 and applicable tariffand tu schedules.

Implemeatio of major iff Second Tranchescdle revisions in 199394 budget Conditonbased on detiled alysis, and oudineof fiurter steps of the tariff and trade

X~i ,TIIIII 1 5.|tX',

IL~~

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LIX-..I

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ANNEX VIPage 6 of e1

adjusted f _equentl and reeny beenliberlized and curar y ae posiive ia real

S.

To promote greer access to a) FB io lBanking Aeti f: lh Banlking Expeitiou and tasae decisins Board Conditionfi al resoures uth Act esltabishd thegulatoy famework on applications ousanding a ofa) ikare_d openess of entry ito Inced cmpetition. A nuber of bank Januay 31 1992 to egage In bankingbanking acttie and b) Impoved and nonank financil instituais have and financial actviies and review ofacess for small save applied fr enty. their s ame against RBM's

policy as laid out in Baking Act.

Continuing to acvdy seekapplications fron sound inatinaland regional banks.

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ANNEX VIPage 9 of 11

b) Primary Health Cre: The Government has Intoduction of budgetary system forintoduced several prevemive care programs separating allocation and conrl ofincluding child spacing, and a Family, individual district and peripheral healthWelfare Council has been set up. Furtier care services in Miiy of Healthactions are noeded to strengthen budgetary Revene Budgetsupport to PHC.

lncrease in peiphera services' share Board Conditionof health Revenme Budget in 1992193budget by at least 2 percetage poinsabove die pcetage share of walestablished by the 1990191 base linesurvey.

lncrease in peiheral services' share Second Tranch.of bealth Revenue Budget in 1993/94 Conditionbudget by at least 2 perenta poiursabove the percentage share of total inthe 1992/93 budget.

Maintenance of total health budget at Board Conditionat least 8 percet of total RevemeBudget expeaditres in t992193.

Maintenae of total health budget at Second Trancheat least 8 percent of total Revenue ConditionBudget expendiure in 1993194.

c) Rwi Water: The Goerment has a Development of a plan for expansion June 1992

program to rehabilitate exisig boreholes, of rural water supply.the majority of which are not functioning.Futdher actom are needed to prpar and Introduction of construction programimplement a plan for rural water expamion. to increase rural water facilities in

addition to rehabilitation.

ANNEX VIPage 10 of IlI

d) Ta: Action is neded to Implemnation of Social Pogram March 1991intmduce pilot program to assess effective Support Fund, including NGOprograms, induding tanusfer programs. participation.

e) OHb dtes: Under previo Review of PSIP 1992/93-1995196 with Board Conditionadjusuenrovdb, dke Gov t has IDA to ens emphasis on sociad

prpaied a hree-year rolling ubic Sector seo ad odwer priorities.I_esmnt Pgram (PSIP) for IDA review.

Review of PSIP 19934-1996197 with Second TrancheIDA to amar emphasis on social Condktionsector and other priorities.

8. Tax Policy

To generae domesic resources for a) Surta: Under Governmnt's tax reform Expansion of the surtax base to Board Conditionpubic expenditure finandng while program supported by ITPAC, the elecuricity and tdephone as well aslowering tax rames by broadening Govenmt ntoduced a surtax credit cerain other services.the tax bae induding an extension system and began to broaden the tax base. aof the surax. To increas the Actions are needed to broaden th base Increase In the surtax rate on Second Tranchoefficiency of the tu ysem firher. eectricy and telephone svices to Conditionrdati to utade txs a financial not less than 10 percent.axation (0!!ch hv bee coveredearlier). Idenifiction of taget base su rate, Aprl 1993

review of incra in surtax rae onservices already axed to that rte, andreview of epanion of surtax base tofihe serve.

Reducton of base surtax rate to 30 Board Condiion*perenL

AM=S VI

Page II of II

b) noMaIax: lhe highest marginal tax ate Review of further decreases in Apri 1992for corporae and personal Income was corpoate ad personlm income uxlowered in 1990/91 to 45 percent. rates.

9. L1dLukK

To develop labor makets for a) Labo Market ERKIWftg Review of labor mak imperfetions Seoond Tranchegeratio in lin and policy options including minimum Condion

wih bman capital development wage policy, and formulation of actonthogh a) mprved labor make plan agreed wit IDA.funonng and b) minimm wIp

mi.

b) Minin Nsg Review: Actbn are Revision of Minimum Wage legislation Board Condtinneeded to ensre employment-oriented mandating review process forpolicy, minimum wage levels, triggered by a

20 perce cumulative price ieae <0and at a minimum every two yeas.

Gov Impl O of Second Trancdeminimum wage adjustment, if any, Conhditincalled for by the rview.

c: 30,do1992pMuc 30, 1992