Introduction and Background:

Massive fiscal policy slippages and other governance concerns marred Malawi's recent past. The country's macro-economic program with the International Monetary Fund (IMF) had effectively lapsed, resulting in a three-year hiatus. However, since the May 2004 elections, the new Government of Malawi (GOM) administration has pledged commitment to restoring economic stability and to addressing related governance issues, including a crackdown on corruption. The GOM is committed to control expenditure and improve economic management in order to reduce huge domestic borrowing, inflation and interest rates, and stabilize the exchange rate as necessary conditions to accelerate the growth potential of the country. The GOM entered an IMF staff-monitored program (SMP) in July 2004, aimed at monitoring its FY 2004/05 MK89.9 billion (US$825.1 million) budget, which Parliament passed on September 23, 2004. Thus, the first quarter marked the beginning of an era full of hope for improved economic management.

Summary:

GOM's cash budget operations depict some improvement in fiscal prudence, with the monthly fiscal gap slowly closing up. However, consistent with the new administration's desire to transform the country from a consuming and importing economy to a producing and exporting one, more needs to be done to establish conditions for accelerating Malawi's growth potential. The government needs to accord the private sector its rightful role as the engine for growth by further controlling expenditures and reducing domestic borrowing in order to ease continuing pressures on money supply growth, inflation, interest and exchange rates. Pressures on the latter continued to mount despite some rise in gross foreign reserves during the quarter. Prospects for improved economic performance during the second quarter are high to ensure successful negotiations for a new PRGF between the GOM and IMF.

Budget performance by government:

Analysis based on GOM cash budgetary operations shows that fiscal imbalance during the quarter improved by 85% from a deficit of MK7,702.4 million (US$70.7 million) the previous quarter to a deficit of MK1,136.7 million (US$10.4 million) this quarter. The improvement was mainly due to reduction in expenditures as total expenditures reduced by 20% from MK22,192.5 million (US$203.8 million) the previous quarter to MK17,812.8 million (US$163.5 million) this quarter. Expenditure on interest payments, however, increased by 17% from MK4,824.5 million (US$44.3 million) the previous quarter to MK5,649.8 million (US$51.9 million) this quarter. The increase in interest payments was due to a 21% increase in domestic interest payments, while foreign interest payments reduced by 6%, from MK631.3 million (US$5.8 million) the previous quarter to MK590.4 million (US$5.4 million) this quarter. Revenue performance improved by 15%, from MK14,490.1 million (US$133.1 million) the previous quarter to MK16,676.1 million (US$153.1 million) this quarter. The impetus to the rise in total revenues came from improvements in both grants and domestic revenue collection. The former rose by 36%, from MK2,139.7 million (US$19.6 million) the previous quarter to MK2,920 million (US$26.8 million) this quarter. The latter rose by 11%, from MK12,350.4 million (US$113.4 million) the previous quarter to MK13,756.1 million (US$126.3 million) this quarter.

Analysis of GOM's budget expenditure data relative to IMF targets shows that the Other Recurrent Transaction (ORT) budget expenditure at MK4,344.4 million was on track by 16% below an IMF benchmark for the quarter at MK5,176 million. The domestically funded development budget expenditure was 20% below the budget ceiling for the quarter.

Domestic borrowing:

Total net domestic credit by the banking sector rose by 3%, from a monthly average of MK34,794.3 million (US$319.5 million) the previous quarter to an average of MK35,774.1 million (US$328.3 million) this quarter. Monthly average net domestic credit to government kept almost constant at MK24,778 million (US$227.5 million) the previous quarter and MK24,783.1 million (US$227.4 million) this quarter. As GOM's monthly average share of domestic credit reduced by 3%, from a monthly average of 71% the previous quarter to an average of 69% this quarter, monthly average net domestic credit to private sector rose by 11%, from an average of MK10,475.2 million (US$96.2 million) the previous quarter to an average of MK11,594.0 million (106.4 million) this quarter. Consequently, share of credit to private sector rose by 8%, from a monthly average of 30% the previous quarter to an average of 32% this quarter. Although Malawi's nominal debt stock is primarily external, as noted above, debt-servicing costs emanate mainly from domestic debt -- a true reflection of GOM's domestic debt overhang. Thus, more efforts are needed to reduce domestic debt and channel resources to the private sector.

Foreign Reserves:

Compared to the previous quarter, gross reserves rose by 8%, from US$517.3 million the previous quarter to US$557.4 million this quarter. The increase was due to an 18% increase in official reserves, from US$284.4 million the previous quarter to US$336.2 million this quarter. Commercial bank reserves, however, declined by 5%, from US$232.9 million the previous quarter to US$221.2 million this quarter.

Money supply and prices:

Growth in money supply reduced from an average of 36% (year-on-year) per month the previous quarter to an average of 26% per month this quarter. Inflation increased from an average of 10% (year-on-year) per month the previous quarter to an average of 11% per month this quarter. The Malawi Kwacha per one United States Dollar nominal exchange rate depreciated at a slower pace, from an average of 20% per month the previous quarter to an average of 5% per month this quarter. The lower nominal depreciation resulted from the official desire to manage the exchange rate. Consequently, the local currency became overvalued by 6% and 13% against the US$ and South African Rand, respectively, since July 2004.