Report No. 22440 MAI Malawi Public Expenditures Issues and Options September 2001 Africa Region Macroeconomics 1 Document of the World Bank CURRENCY EQUIVALENTS (Exchange Rate Effective September 28, 2001) Currency Unit = Malawi Kwacha (MK) MK1 = US$0.0163 US$1 = MK61 SDR 1 = US$1.26 MEASURES Metric System FISCAL YEAR July I to June 30 (As of July 1998) Vice President Callisto E. Madavo Country Director Darius Mans Sector Manager Philippe H. Le Houerou Task Team Leader Hassan Zaman MALAWI PUBLIC EXPENDITURES: ISSUES AND OPTIONS TABLE OF CONTENTS EXECUTIVE SUMMARY ....................................................... I 1. MACROECONOMIC OVERVIEW ........................................................1 INTRODUCTION ........................................................1 MACROECONOMIC TRENDS ....................................................... 1 DOMESTIC REVENUE TRENDS ....................................................... 3 EXPENDITURE TRENDS ....................................................... 4 THE MEDIUM TERM FRAMEWORK ....................................................... 8 2. INSTITUTIONAL ANALYSIS OF PUBLIC EXPENDITURE MANAGEMENT ....................................................... 13 INTRODUCTION ....................................................... 13 BUDGETARY AND ADMINISTRATIVE REFORMS IN MALAWI: 1995-PRESENT .......... .............. 13 THE BUDGET PROCESS ....................................................... 14 UNDERSTANDING MALAWI'S BUDGETARY REFORM EXPERIENCE ....................................... 17 AN APPROACH TO SEQUENCING BUDGETARY REFORMS ..................................................... 22 3. EDUCATION ....................................................... 26 INTRODUCTION ....................................................... 26 KEY SECTOR ISSUES ....................................................... 26 TRENDS IN EDUCATION EXPENDITURE ................ ....................................... 28 POLICY PRIORITIES ....................................................... 3 3 4. HEALTH ....................................................... 36 INTRODUCTION ........................................................ 36 KEY SECTOR ISSUES ....................................................... 36 TRENDS IN PUBLIC HEALTH EXPENDITURE ....................................................... 37 POLICY PRIORITIES ........................................................ 39 5. AGRICULTURE ....................................................... 43 INTRODUCTION ....................................................... 43 KEY SECTOR ISSUES ....................................................... 43 TRENDS IN AGRICULTURE EXPENDITURE .................. ..................................... 44 POLICY PRIORITIES ....................................................... 48 6. ROADS ....................................................... 50 INTRODUCTION ....................................................... 50 KEY SECTOR ISSUES ........................................... 50 PUBLIC EXPENDITURE TRENDS ........................................... 51 POLICY PRIORITIES ........................................... 52 7. PENSIONS ........................................ 54 INTRODUCTION ........................................ 54 TRENDS IN PENSIONS AND GRATUITIES EXPENDITURE ....................... .................... 54 PROBLEMS WITH THE CURRENT SYSTEM ........................................... 54 MOVING TO A FUNDED SYSTEM: BENEFITS AND RISKS ........................................... 57 8. PARASTATALS ...................................... 59 INTRODUCTION ........................................... 59 CURRENT PERFORMANCE OF PARASTATALS ........................................... 59 RECOMMENDATIONS ........................................... 62 ANNEXI ........................................... 66 ANNEX II ........................................ 69 REFERENCES ........................................ 73 LIST OF TABLES Table 1.1: Basic Macroeconomic Indicators .................................................................52 Table 1.2: Central Govenmment Operations, 1994/95 to 2000/01 ....................................................4 Table 1.3: Functional Classification of Expenditure (Percent of GDP) . ..........................................7 Table 1.4: Macroeconomic Framework, 1999-02................................................................. Table 3.1: Incidence of Recurrent Education Expenditure by Income Quintile 1 Table 4.1: Health Expenditures and Performance: Regional Comparison ...................................... 37 Table 4.2: Health Expenditures by Facility Level.3 8....................................................................... 32 Table 5.1: Recurrent and Development Expenditures on Agriculture ............................................ 46 Table 5.2: Maize Subsidy ................................................................. 47 Table 6.1: Road Sector Expenditures, 1994/95 to 200 ............................................................20 0 152 LIST OF BOXES Box 1.1: Prioritizing the Development Budget.5 ........... ................................................................4 Box 1.2: Variations Between Budgeted and Actual Expenditures ....................................................8 Box 1.3: Saving Public Money by Reducing Fraud and Corruption ........................12 Box 2. 1: Debt Management in Malawi.............................................. 18 Box 2.2: Tanzania's Performance Improvement Fund: Providing Incentives for the Reorientation of Line Agencies.............................................2 1 Box 2.3: Public Expenditure Tracking Surveys in Uganda's Education Sector................22 Box 3. 1: The Budgetary Process in Education .........................................30 Box 3.2: Moving Towards Decentralization in Education ................................33 Box 4. 1: Moving Towards Decentralization In Health ...............................39 Box 5. 1: The Budget Process in the Ministry of Agriculture..............................47 Box 6. 1: The National Roads Authority and the Road Fund..............................5 1 Box 8.1: Lease Contract Leads to Improved Performance in Guinea Water Facility .......... ........... 64 Box 8.2: Multisectoral vs Industry Specific Regulatory Agencies ................................................. 65 LIST OF CHARTS Chart 1.1: Share in Total Recurrent Expenditure by Economic Classification .................................5 Chart 2.1: Wage Structure within the Civil Service, 1999 ............................................................ 19 Chart 2.2: An Approach to Sequencing of Budgetary reforms ....................................................... 24 Chart 3.1: Recurrent Education Expenditure by Program ............................................................ 29 Chart 7.1: Total Pension and Gratuity Expenditure .................................... ........................ 5 5 Chart 7.2: A Breakdown of Pension Expenditures ................................. ........................... 55 Chart 8.1: Financial Performance of Parastatals, 1996/97-1999/00 ........................... .................... 60 Chart 8.2: Arrears to Water Boards ............................................................ 61 Chart 8.3: Arrears to Water Boards: Relative Importance of Government Defaulters .......... ........ 61 ACRONYMS ABB Activity Based Budget ADD Agricultural Development Division ADMARC Agricultural Development and Marketing Corporation APIP Agricultural Productivity Investment Progran ASP Agricultural Services Project BHA Better Health for Africa BWB Blantyre Water Board CCA Credit Ceiling Authority CCS Commitment Control System CDSS Community Day Secondary Schools CHAM Christian Health Association of Malawi CIDA Canadian International Development Agency CMS Central Medical Stores COMESA Common market for Eastern and Southern Africa CDSS Community Day Secondary Schools CSS Conventional Secondary Schools DFID Department for International Development DANIDA Danish International Development Assistance DPP Director of Public Prosecution EPA Extension Planning Area ESCOM Electricity Supply Commission of Malawi EU European Union FAO Food and Agriculture Organization of the United Nations FEWS Famine Early Warning System GDP Gross Domestic Product HIPC Heavily Indebted Poor Countries IDA International Development Association IFAD International Fund for Agricultural Development IFMIS Integrated Financial Management Information System JCE Junior Certificate of Education JEG Job Evaluation and Grading MACRA Malawi Communications Regulatory Authority MANEB Malawi National Examination Board MASAF Malawi Social Action Fund MASIP Malawi Agriculture Sector Investment Program MDC Malawi Development Corporation MHC Malawi Housing Corporation MIE Malawi Institute of Education MITTEP Malawi Integrated In-service Teacher Education Program MIPA Malawi Investment Promotion Agency MoAI Ministry of Agriculture and Irrigation MOFEP Ministry of Finance and Economic Planning MOHP Ministry of Health and Population MPC Malawi Posts Commission MPTC Malawi Posts and Telecommunications Corporation MRA Malawi Revenue Authority MRFC Malawi Rural Finance Company MSCE Malawi Secondary Certificate of Education MTEF Medium Term Expenditure Framework MTL Malawi Telecommunications Ltd. NEC National Economic Commission NFRA National Food Reserve Agency NGO Non-Governmental Organization NHP National Health Plan NRA National Roads Authority NRC Natural Resources College NSO National Statistical Office OPC Office of the President and Cabinet PAC Parliamentary Accounts Committee PCC Petroleum Control Commission PEM Public Expenditure Management PIF Policy Investment Framework PRSP Poverty Reduction Strategy Paper PSLCE Primary School Leaving Certificate Examination RBM Reserve Bank of Malawi RDP Rural Development Project SADC Southern Africa Development Community SFFRFM Smallholder Farmers' Fertilizer Revolving Fund of Malawi SFSP Smallholder Food Security Project SGR Strategic Grain Reserve SPC Secretary to the President and Cabinet SPS Starter Pack Scheme ST Secretary to the Treasury TAMA Tobacco Association of Malawi TCC Tobacco Control Commission TTC Teacher Training Colleges UNESCO United Nations Education Social and Cultural Organization USAID United States Agency for International Development VLPA Village Level Participatory Approach ACKNOWLEDGEMENTS This report is part of a public expenditure review process that was launched in conjunction with the Government of Malawi in November 1999. The first stage of this process consisted of the World Bank providing technical assistance to a Government team led by Maxwell Mkwezelamba (Ministry of Finance) in producing a Public Expenditure Review (PER). The report was finalized in late 2000 and its preliminary findings were included in the 2000/01 Budget. This report 'Public Expenditures in Malawi: Issues and Options' is based on this work and takes the dialogue forward by summarizing areas covered within the 2000 PER, updating the macro framework and introducing certain new topics relevant to the public expenditure discussion in Malawi. A joint Government of Malawi-World Bank workshop was held in August 2001 where both the 2000 PER and the green cover 'Public Expenditures: Issues and Options' were discussed. The task manager and main author of this report is Hassan Zaman. The peer reviewers were Vinaya Swaroop, Anand Rajaram and Jeffrey Hammer. Lalita Moorty provided substantive input to various parts of the report. The technical assistance part of the PER process was initiated by Ahmad Ahsan and Sudhir Chitale provided excellent comments and inputs throughout the process. Background papers for the chapters in this report were prepared by Navin Girishankar (Institutional Analysis), Oscar Picazo (Health), Peter Moll and Jorge Munoz (Agriculture), Stephen Brushett (Roads), Aline Coudouel (Pensions), Syed Mahmood, Lalita Moorty and Donald Mphande (Parastatals). This report has also benefited from the comments of Darius Mans Philippe Le Houerou, Robert Liebenthal, Sudhir Shetty, Peter Moll, Fahrettin Yagci, Jose Leandro, Demissie Habte, Mmantsetsa Marope, Keiichi Ogawa, Gaiv Tata, Catherine Revels, Paivi Koljonen, Taziona Chaponda, Stanley Hiwa, Francis Mbuka, Steven Banda, Alfred Kammer, Thomas Baunsgaard, Samer Al-Samarrai, Naomi Hossain and Marie-Jo Cortijo. Rose Thunyani provided excellent assistance in document preparation. EXECUTIVE SUMMARY 1. This report argues that public expenditure outcomes in Malawi can be improved in the next few years if (i) additional spending on priority items is balanced by expenditure cut-backs in low priority areas in order for public expenditures to remain within the fiscal parameters necessary to restore macro-economic stability (ii) the incentives for improving the budget process are strengthened (iii) intra-sectoral allocations in key sectors such as education, health, agriculture and roads are focused on key public goods and measures to improve the effectiveness of this spending is taken (iv) areas such as pensions and parastatals are monitored and restructured appropriately in order to reduce their fiscal burden for future generations. 2. Balancing additional spending on priority areas with the macro framework: Malawi underwent extended periods of macroeconomic instability in recent years and fiscal deficits have been part of the problem. This report argues that in order to reduce inflation from its present level of 30 percent to single digits within two years, the overall budget deficit after grants needs to fall from -1.3 percent in 2000/01 to 1.1 percent in 2002/03. This will limit the between and within year swings in domestic financing that have contributed to hardening inflationary expectations. Given the limited scope for expanding the domestic revenue base the fiscal adjustment will need to be borne by low-priority domestic expenditures. Domestic non-interest expenditures excluding IPC resources will need to fall from 17.8 percent of GDP in 1999/00 to 16.2 percent of GDP in 2002/03. If this expenditure restructuring is done by limiting non-essential spending and by reducing corruption, Malawi can reduce its overall deficit, achieve its macro targets and have HIPC debt relief finance additional spending on priority items. Domestic non-interest expenditures with HIPC relief can then rise from 17.8 percent in 1999/00 to 19.4 percent in 2002/03. 3. As part of this expenditure restructuring strategy, this report recommends that there ought to be a shift in expenditures towards the following areas: * Social sectors: Total education expenditures have fallen from 5.5 percent of GDP in 1997/98 to 3.7 percent in 1999/00. Total expenditures in the health sector have remained fairly constant averaging around 2.2 percent of GDP in this period. The allocation for education and health needs to be raised given the pressing needs in primary education and preventative health care and in order to accommodate a higher wage bill required to improve incentives for front-line workers. * HIVIAIDS: The report recommends that the Government act as a catalyst to the implementation of the National Strategic Plan for HIV/AIDS by making a direct budgetary subvention to the National Aids Control Program (NACP) funding its administration costs and financing areas of the National Plan that are not currently being financed by donors. - ii - * Roads: Analysis of road sector expenditures suggest that receipts from the fuel levy and other road user charges are insufficient to meet the annual minimum requirements for road maintenance. Hence, a combination of measures to raise road sector resources needs to be undertaken: an increase in the fuel levy, an increase in road user charges and the use of HIPC resources towards rural roads. * Governance: Increasing domestic and donor pressures for improvements in governance imply a strengthening and hence a greater budgetary allocation to the Anti-Corruption Bureau, Office of the Ombudsman, Law Commission, Auditor-General's office and the Judiciary. In 1999/00 and 2000/01 these bodies combined were allocated around 0.2 percent of GDP. * Natural disasters: Malawi experiences natural disasters almost on a yearly basis. It is recommended that the budget includes an 'emergency' expenditure reserve of around 0.2 percent of GDP with strict criteria for the use of these funds. 6. The main areas for expenditure cuts are in the General Administration budget and in ad- hoc expenditures. In particular savings can be generated by: * Reducing ad-hoc expenditures such as maize price stabilization interventions that have cost the Government 1.8 percent of GDP as recently as 1998/99. - Reducing the allocation for the Ministry of Foreign Affairs, State Residences foreign travel and allowances and funeral expenses. - In light of the recent Public Accounts Committee and Auditor-General's reports, curbing waste, fraud and corruption can be a major source of expenditure savings. 7. Improving budget management: Since 1995, the Government of Malawi has undertaken a variety of initiatives to improve the budget process, most notably with the attempted introduction of the Medium Term Expenditure Framework. While progress has been made in certain areas, these budgetary and administrative reform efforts have had a decidedly modest impact on public expenditure outcomes. Budget estimates continue to differ significantly from budget outturns undermining aggregate fiscal discipline. Strategic prioritization is undermined by poor forecasting of macroeconomic parameters, sharp fluctuations in monthly allocations and virement away from budgeted activities. Weaknesses in the budgetary process are also reflected in poor front-line service delivery indicators. Formal rules governing formulation, execution, and reporting are not adequately enforced and the poor quality and lack of timely access to fiscal and macroeconomic data is a serious constraint to budget monitoring. The key factors underlying the current shortcomings of the budgetary process are the lack of high level political commitment behind these reforms, the lack of a sequencing strategy and the lack of focus on improving front- line performance through wage and line-agency reform. 8. This report proposes the following sequencing strategy for improving budget management. The recommended emphasis in the short run is a cluster of mutually-reinforcing activities designed to improve budget execution and monitoring. The first step is to use the newly introduced performance contract scheme to enforce financial management practices as the key performance benchmark for top cadres, particularly for Principal Secretaries. It is essential that the senior political leadership support the strict enforcement of performance agreements, particularly the emphasis on financial management practices. In this regard it will be important to bolster the bodies that safeguard the professionalism of civil servants enabling them to implement expenditure control even in the face of political pressures. The second element of this short run strategy should be to develop the necessary information systems and coordination arrangements - iii - between Government and donors, between various agencies of Government and within line ministries to improve the quality and timeliness of fiscal data. The third element of a short term sequencing strategy revolves around strengthening checks and balances such as auditing practices and the Anti-Corruption Bureau. Building on a foundation of improved budget execution and monitoring, the Government will be in a better position to pursue medium term efforts to improve the enabling environment necessary to promote frontline performance. The dual thrust of a medium term strategy should include (i) a pay policy that enhances incentives along with a program for role restructuring for line agencies and (ii) efforts to broaden parliamentary and civil society involvement in budget formulation, standards-setting, monitoring and program evaluation. 9. Improving the effectiveness of sectoral expenditures: This report reviews expenditures in four key sectors: education, health, agriculture and roads. The criteria by which public expenditures will be assessed in these sectors revolve around two main themes. The first relates to the extent that public spending improves economic efficiency by intervening in areas where there are significant market failures. The second broad theme by which public expenditures will be judged is the extent that they promote equity. The poor will require essential services that they may not be able to access if left to the market and hence there is a legitimate role of the State in meeting its poverty alleviation objectives. The nature of the efficiency and equity arguments for public spending will also determine the type of Government activities in these sectors in terms of whether public provision, financing or regulation are the appropriate means to achieve desired outcomes. 10. Malawi has made substantial gains in the provision of primary education over the last decade but access to secondary and tertiary education remains limited, the quality of education is poor and HIV/AIDS is having an impact on the sector through a variety of channels. Malawi's health indicators are worse than several neighboring countries even though their health expenditures are similar to Malawi. This suggests that the effectiveness of health expenditures is poor in Malawi and service delivery surveys indicate that shortages of medical personnel and drugs in rural areas are the two biggest problems in the sector. In agriculture resources are excessively concentrated at the Ministry headquarters and front line operations face a shortage of critical ORT resources. Moreover extension and research are not demand-driven and have not kept up with the times. Expenditures on irrigation and livestock have risen in recent years. In roads, while the overall network is similar to regional averages the rural road network is below average. A Road Fund financed by the fuel levy was set up in 1998 and while this has contributed to an increase in road maintenance expenditures, these expenditures are still short of requirements. 11. This report highlights two basic channels by which service delivery in these key sectors can be improved - intra-sectoral allocation shifts and efficiency improvements. The main recommended intra-sectoral shifts in education, health, agriculture and roads are: * Increase share of qualitative inputs in primary, teacher training and day secondary education. This can be accommodated by reducing the share of the University of Malawi in the education budget and reducing the boarding subsidy in secondary education. * Increase allocations for preventative health programs such as HIV/AIDS, malaria, tuberculosis, diarrhoea control and immunization. * In agriculture the direct subvention to Rural Development Programs (RDP) should be raised to fully fund the ORT expenses required for extension activities with a corresponding decline in headquarters resources. - iv - * Increase resources allocated to rural feeder roads as currently the focus is on the 'core' network defined according to traffic volumes. Fully fund routine and backlog maintenance. Cross-cutting recommendations to improve the efficiency of expenditures in the sectors are: * Shift resources from headquarters cost centers to regional/district cost centers in order to reduce the share of administration, provide more resources for front-line work and pave the way for decentralizing services. * Focus on implementing staff recruitment, training, retention and deplovment strategies in order to mitigate the serious human resource constraint to quality service delivery, particularly in health care. * Address the impact of HIV/AIDS by introducing life skills as a separate subject in the school curriculum, through teacher training programs and by introducing a provision for funeral costs, particularly for the Ministries such as education, health and agriculture who employ the largest field-based staff contingent. 12. Monitoring and restructuring pensions and parastatals: The pensions and gratuities burden on the Budget is steadily increasing while that of parastatals is more ad-hoc and varies significantly from year to year. However, both areas could cause serious fiscal pressures in the future and hence they need to be adequately monitored and restructured. 13. The payment of public pensions is made directly from the budget with no contributions from civil servants. The sustainability of this present arrangement is in question given that the share of pensions and gratuities doubled from 0.8 percent of GDP in 1994/95 to 1.7 percent of GDP in 1999/00 (2.5 percent of recurrent expenditure in 1994/95 to 9.3 percent in 1999/00). Moreover pension management is characterized by poor administrative capacity and incentives resulting in processing delays, ineligible claimants etc. 14. It is important to ensure the separation of the pension fund from the general budget and switching to a funded system is likely to improve the key problems with the current system. There are several options on how the transition to a funded system can take place and the contribution rates and fund capitalization vary according to the one selected. In the short term it is recommended that a high-level pension reform committee be set up within Government in order to discuss these transition options and for ensuring that the appropriate regulatory framework is set up to address some of the risks of moving to a new pension system. 15. Information on parastatal finances is weak making a comprehensive assessment difficult. However, there exists enough evidence to show that the general financial performance of the parastatal sector is poor and the government needs to take swift action to reverse the build-up of parastatal borrowing and arrears. Poor performance is due to low tariffs, operational inefficiency and failure to collect dues. These problems have had an impact on the Budget as central Government has intervened to absorb parastatal debts (e.g. NFRA in 2001), convert debt into equity (ESCOM 1999) and other similar bailouts. In order to limit the future burden on the Budget the Government needs to proceed on four fronts. First it must systematically collect information from parastatals and produce regular updates on their financial performance. Second, measures to improve operational efficiency are essential. In particular, parastatal boards need to be staffed by qualified professionals and support must be extended to parastatals who suspend services to clients who are in arrears. Third, annual audited accounts of the Privatization Revenue Account need to be published on a timely basis. Fourth, the process for greater private sector participation, from full privatization to lease contracts, needs to be accelerated particularly in power and water. - v - Summary of recommended reform measures Area/Objective Reform Measure Timetable Fiscal stability Exercise fiscal restraint on Reduce budget deficit before grants from 12.9 percent in 2001-03 non-priority items in order 2000/01 to 9.8 percent by 2002/03 to accommodate additional HIPC expenditures in an Reduce the domestic non-interest expenditure excluding anti-inflationary macro debt relief from 17.7 percent in 2000/01 to 16.2 percent framework. in 2002/03. Suggested areas for savings are by eliminating maize interventions, reducing general administration costs, foreign travel, controlling funeral costs and reducing wastage and fraud. If fiscal restraint is exercised as above debt relief can be used to increase outlays on education, health, HIV/AIDS, wages for rural health workers and teachers, institutions related to governance and a disaster relief fund. Pensions: Improve the Establish high-level pension reform committee to 2001 predictability and evaluate reform options and transition steps sustainability of pension payments Move to a funded pension system, which is separate from 2002-03 the general budget. Parastatals: Minimize the Improve parastatal monitoring by adequately staffing the 2001 budgetary burden of Parastatal Monitoring Unit and generating parastatals and improve comprehensive, regular reports. their efficiency Implement a program of identifying and eliminating 2001-02 arrears between parastatals, the Government and private sector Provide timely annual audited accounts of Privatization 2001-02 Revenue Account. Take steps to accelerate the privatization program in 2001-02 water and power. Approve power sector policy and select privatization mode from on-going privatization option study in water sector. Appoint experienced professionals on parastatal boards 2001-02 and clarifying responsibilities of the Government, boards and senior management in parastatal operations. Budgetary/ Administrative Reforms Strengthen the budget Link the perfornance contract for Principal Secretaries to 2001 process through a good financial management practices. sequenced strategy that improves the necessary Improve coordination between Ministry of Finance, 2001-03 information flows, Reserve Bank and donors to improve revenue forecasts, strengthens checks and expenditure planning and debt management. balances, implements pay reform along with Improve comprehensiveness of the budget by including a 2001-03 restructuring of line greater share of off-budget donor aid. Develop a debt agencies. management strategy on the basis of this information. - vi - Area/Objective Reform Measure Timetable Strictly enforce the Credit Ceiling Authority for all 2001-03 Government ministries and agencies. Prohibit extra-budgetary requests from being discussed in 2001 Cabinet except in genuine emergencies Update macro data regularly in order to adjust within 2001-02 year expenditure targets. Strengthen internal and external auditing through 2001-03 capacity building initiatives, strengthening quality control and reporting arrangements. Introduce Public Expenditure Tracking Survey to identify 2001-03 sources of leakage and operational inefficiencies in service delivery. Widely disseminate survey results in order to promote accountability of public resources. Insulate civil servants from political pressure by 2001-03 clarifymig the relationship between the Minister and PS and strengthening the role of the Civil Service Commission Develop affordable, medium-term wage policy within 2002 macroeconomic targets, identifying salary targets for specific job classes Finalize functional reviews 2002 Develop instrument for linking wage enhancements to re- 2003-04 structuring of line agencies. Sectoral Expenditure Programs Education Increase budgetary allocations to primary schools for 2001-03 teaching and learning materials, inspection and school maintenance. Increase the deployment of teachers to lower grades, 2001-03 outlays for teacher training, and introduce an allowance to attract teachers to rural areas. Improve efficiency by restructuring exams and 2001-03 reorienting secondary school allocations from boarding schools to day secondary schools. Increase cost sharing by raising secondary school and 2001-02 university fees while increasing the size of the bursary fund to protect poor students. Address the impact of HIV/AIDS by introducing life 2001-03 skills as a separate subject in the school curriculum, through teacher training programs and by preventing funeral costs from cutting into teaching expenditures. Health Reallocate expenditures from Ministry Headquarters, and 2001 - vii - Area/Objective Reform Measure Timetable facility construction towards preventative health care programs (e.g. malaria and HIV/AIDS control). Re- prioritize National Health Plan. Expand public financing-private provision arrangements 2001-02 by increasing government subventions to CHAM. Introduce cost recovery at tertiary hospitals, and facilitate 2001-03 the creation of autonomous hospital Boards. Reform Central Medical Stores (CMS) by taking the 2001-03 necessary steps for granting institutional autonomy to CMS and introducing measures such as reviewing the Essential Drug List and cost-sharing for drugs. Create a pay and incentives package to recruit, train and 2001-03 deploy health personnel to rural areas. Agriculture Shift a greater share of expenditures from headquarters 2001-03 and ADDs to Rural Development Programmes. Improve efficiency of extension system by contracting 2001-03 out to farmers associations Contract out agricultural research fully and ensure that it 2001-03 is demand-driven Limit Ministry's role in livestock to disease surveillance 2001-03 and registering veterinary drugs. Focus Government role in irrigation to water-related 2001-03 regulation and information. Progressively transfer irrigation schemes to beneficiary groups. Roads Increase outlays for road sector through a combination of 2001-03 a higher fuel levy, other user charges and through HIPC resources. Amend Road Act to permit concessioning to private 2001-02 sector. Fully fund routine and backlog maintenance 2001-03 Integrate District Assemblies, MASAF and NRA road 2001-03 programs in order rationally plan the rural roads program. 1. MACROECONOMIC OVERVIEW INTRODUCTION 1.1 This chapter shows that Malawi underwent extended periods of macroeconomic instability in recent years and that fiscal deficits were part of the problem. It reviews recent revenue and expenditure trends and argues that the amount of expenditure reduction required for stabilization purposes can be achieved by limiting ad-hoc expenditures, non-essential administrative spending and by reducing corruption. If restraint is exercised in these areas, HIPC debt relief can be used to finance additional spending on priority items. 1.2 The chapter begins by outlining the extent of macroeconomic instability in Malawi in recent years. Subsequent sections provide an overview of recent revenue and expenditure trends. The final part of the chapter proposes a medium term expenditure re-structuring strategy embedded in a macro-economic framework designed to reduce inflation. MACROECONOMIC TRENDS 1.3 Sustained growth has clearly been elusive in Malawi (see Table 1). Real growth went from negative 10 percent in 1994 to 8.2 percent in 1996, averaging an impressive 8 percent per year during the period 1995-97. This reflected a broad-based expansion of agricultural output, led by the smallholder burley tobacco sector, and recovery from the 1994 drought. However, growth has only averaged 2.6 percent between 1998 and 2000. Around 5.5 percent growth is required if the numbers below the poverty line (65 percent) are to decline (World Bank 1997). 1.4 Malawi's current account deficit (averaging at 14.4 percent of GDP excluding grants between 1997-00) is large and has been financed through substantial inflows of grant and loan financing. Tobacco receipts have a significant impact on Malawi's external balance, as they constitute about 60 percent of export revenues. Malawi's dependence on a single crop, coupled with a secular decline in terms of trade, underscores the need for rapid diversification. 1.5 The nominal exchange rate has seen periods of relative stability interspersed with two sharp devaluations in 1995 and 1998. A more market-based approach led to the Kwacha slide - from an average of 44 to the dollar in 1999 to 80 in late 2000, reflecting poor tobacco prospects, a correction of an overvalued real exchange rate and minimal interventions from the Central Bank. 1.6 Interest rates remain high in Malawi (see Table 1.1) with the lending rate hovering between 50-55 percent during 1999/00. The main macro factors that keep an upward pressure on interest rates are high inflation, depreciation of the currency, lack of policy consistency and a narrow economic base.' 1 Concerns about the Government's ability to restrain inflation reduce the period for which people will invest and raises interest rates as lenders wish to protect their loans. Moreover, the lack of clarity and coordination between monetary and fiscal policy, as exemplified by recent volatile shifts in Treasury bill - 2 - 1.7 Monetary policy in recent years has been inconsistent. The actions in the last three months of 2000 are illustrative of the recent 'stop-and-go' policies undertaken by the monetary authorities. Expansionary policy in October and November, fuelled by a sharp rise in net credit to Government was followed by a 20 percent contraction in reserve money resulting in a 30 percent increase in the three-month Treasury bill rate.2 Table 1.1: Basic macroeconomic indicators 1994 1995 1996 1997 1998 1999 2000 GDP growth rate -10.2 9.6 8.2 4.9 2.0 4.0 1.7 Inflation rate (averae, percet) 34.7 83.1 37.7 9.1 29.8 44.8 29.6 Domestic savings / GDP (percent) -3.0 -0.3 3.0 0.9 6.0 3.1 3.1 hivestment/GDP (percent) 29.1 17.0 11.6 12.2 13.3 14.8 15.9 Interest rate (lending rate, percent) 31.0 47.3 45.3 28.3 37.7 53.6 53.6 Current account deficit / GDP (incl grants, percent) -13.4 -1.7 -7.7 -10.5 -2.5 -8.3 -4.9 Exchangerate(MK/US$,average) 8.7 15.3 15.3 16.4 31.1 44.1 59.5 Extemal debt/ GDP (percent) 150.6 139.1 88.6 90.8 142.7 144.0 150.3 Sowuce: IMF 1.8 Malawi's Central Government fiscal deficit before grants has fluctuated from 26.1 per cent in 1994/95 down to 7.6 per cent in 1996/97 rising again to around 12 percent of GDP between 1997-2000 (Table 1.2). The central government deficit provides a narrow definition of Malawi's fiscal position, as it does not include the full public sector impact of parastatal activities. As such, chapter seven takes a closer look at parastatal activities and argues the case for a wider coverage of the Budget. The remainder of this chapter will continue to discuss the Central Government deficit because of its current operational relevance in Malawi. 1.9 The deficit after grants rose to 8.2 percent of GDP4 in 1997/98 but has progressively declined to around 5.5 percent in 1998-00 and an estimated 1.3 percent in 2000/01. As Table 1.2 indicates, while domestic revenues have been relatively stable, (between 15-18 percent of GDP) variations in total expenditure have determined the size of the fiscal deficit. Total expenditures progressively declined from 42 percent of GDP in 1994/95 to 24 percent in 1996/97. It has subsequently increased to an estimated 31 percent in 2000/01. 1.10 The financing composition of the deficit shows that foreign grants are an increasingly important part of the Government budget having risen from 3.5 percent of GDP in 1997/98 to 11.4 percent in 2000/01 (Table 1.2). Since 1997/98, foreign program and project loans have had a larger share of financing the deficit after grants compared to domestic borrowing. However, these figures also mask sharp intra-year variations. For instance, domestic financing in the first half of 2000/01 amounted to 1.6 percent of GDP while in the second half of the fiscal year it is around -3.8 percent. The high level of domestic borrowing in the first half of 2000/01 was partly a result of delays in donor balance of payments support as well as due to expenditure over-runs. These slippages in fiscal policy, leading to higher than expected domestic borrowing, lead to higher interest rates and a hardening of inflationary expectations. rates, creates investor uncertainty. Malawi's narrow economic base also keeps upward pressure on interest rates due to the risk of a macro shock and its impact on inflation and exchange rate expectations. 2 The three-month Treasury bill rate rose from 37 percent in end-November to 67 percent in December. 3 The deficit includes direct transfers to parastatals and parastatal debt absorbed by Central Government. However it does not include contingent liabilities. The most comprehensive definition of fiscal deficit includes deficits incurred by public enterprises, extra-budgetary funds, and quasi-fiscal activities performed by the Central Bank. For more details, see World Bank, 1998. 4 This is due to expenditure overruns of approximately 2.2 percent more than budgeted levels and shortfalls in expected tax revenue of around 1 percent of GDP. - 3 - 1.11 Inflation is another pressing macroeconomic problem in Malawi. Average inflation declined from 83 percent in 1995 to 9 percent in 1997. However, a large depreciation of the Kwacha in late 1998, combined with inadequate monetary and fiscal adjustment, contributed to average inflation rising to 45 percent at the start of 1999, with estimates for 2000 at 30 percent. 1.12 A reduction in inflation and interest rates in Malawi is a necessary condition for growth to revive in Malawi. For this is to occur, monetary and fiscal policy measures must be pursued in a consistent and coordinated fashion. Otherwise, a continuation of stop-and-go adjustment policies or the exclusive reliance on one set of policy responses can result in heavy costs in terms of foregone growth. DOMESTIC REVENUE TRENDS 1.13 Domestic revenues have remained between 15-18 percent of GDP5 between 1994/95 and 1999/00 (see Table 1.2) while the structure of revenues has undergone important changes. The largest share of domestic revenues is derived from taxes on individual and corporate incomes (7.5 percent of GDP in 2000/01), closely followed by taxes on goods and services (7 percent of GDP). Trade-related taxes (2 percent) and non-tax revenue (1.5 percent) make up the remainder. It is unlikely that significant 'fiscal space' can be generated through domestic revenues. 1.14 A comprehensive reform of taxes and surtaxes was launched in 1996/97 resulting in a simplification of the tariff structure and reduction in rates. The maximum import tariff has steadily declined from 45 percent in 1996/97 to 25 percent in 1998/99. Combined with exchange rate depreciations and regional trade agreement obligations, the decline in tariffs has led to a steady decline in revenues from trade taxes (from 4.4 percent in 1995/96 to an estimated 1.5 percent in 2000/01). 1.15 Revenue losses from trade have been compensated by increased revenue from income and corporate tax and from taxes on goods and services. This reflects improvements in tax administration, facilitated by the recent establishment of the Malawi Revenue Authority (MRA),6 and a widening of the tax net. 1.16 The Government is reforming the surtax system and extending its base. It intends to extend the 20 percent surtax from manufacturing to wholesale and retail with exemptions for merit goods and other items7 in late 2001. 1.17 Non-tax revenues contribute a relatively small share to domestic revenues. One of its components, the fuel levy, is discussed in more depth in the chapter in roads. In order to raise the incentive to charge and collect fees for their services, the Government is now allowing Ministries to retain up to 80 percent of the revenue they collect, offset against their budgetary allocation. However, it is suggested that the Ministry of Finance commissions an independent assessment of 5 Domestic revenues as a percent of GDP are slightly higher in neighboring countries: Zambia (18-22), Zimbabwe (24-28). 6 However, the experience of the first year of the MRA suggests that the institution needs to be further strengthened. This can be done by raising the proportion of revenue collection that it can retain; currently, the MRA, receives 1.7 percent of collections, with an additional 3 percent of the difference between actual and targeted collections, subject to a maximum of 2.3 percent. 7 Medicines, condoms, fertilizer, maize flour, paraffin, petroleum products, certain vehicles, fertilizers, pesticides, mechanical pumps, and for purchases by the President and Vice-President. - 4 - the extent of revenues that line agencies generate from these fees as the experience of neighboring Mozambique suggests that there may be significant under-reporting. 1.18 While the simplification of the tax structure, reductions in rates and improvements in administration have undoubtedly led to efficiency gains, it is less clear what the equity implications of these reforms have been. The concerns are primarily due to the extension of the surtax and the increase in surtax rates on items such as sugar (from 12 percent to 20 percent in 1998/99). A tax incidence analysis needs to be carried out to ensure that the poor are not adversely affected by these changes. Tablel.2 Malawi: Central Government Operations, 1994/95 - 2000/01 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01 Actual Actual Actual Actual Actual Actual Proj. Prel (In percent of GDP; unless otherwise specified) Total revenue and grants 26.7 25.5 21.0 18.4 24.0 24.4 29.8 Total revenue 15.9 17.6 16.3 14.9 17.7 17.5 18.2 Total expenditure 42.0 31.2 23.9 26.6 29.5 30.1 31.0 Currentexpendittre 34.0 24.3 18.4 21.1 18.1 19.5 20.9 Wages and salaries 7.3 6.6 4.9 5.6 4.8 4.8 5.3 Goods and services 1/ 20.8 10.6 8.1 11.4 10.8 7.8 7.4 Transfers (incl. separation benefits) 2/ 1.2 1.0 1.0 1.2 1.5 1.9 2.5 Interest 5.1 6.6 5.2 3.2 3.8 3.8 4.9 Domestic 3.1 4.3 4.1 2.1 2.1 2.3 3.0 External 2.0 2.2 1.1 1.1 1.7 1.5 1.9 HIPC expenditire 0.4 Development expenditure 7.6 6.5 4.8 5.1 8.6 10.6 10.0 Domestic 2.5 1.4 1.5 1.3 2.2 2.1 1.6 Foreign-financed projects 3/ 5.1 5.1 3.3 3.9 6.5 8.5 8.4 Overall balance (excluding grants) -26.1 -13.6 -7.6 -11.7 -11.9 -12.6 -12.9 Overall balance (including grants) -15.3 -5.7 -2.9 -8.2 -5.5 -5.7 -1.3 Total financing 17.0 5.7 3.0 8.0 5.5 6.9 1.6 Foreign (net) 7.5 2.0 4.9 3.0 10.3 4.8 3.8 Domestic (net) 9.5 3.7 -1.9 4.9 -4.8 2.1 -2.2 Discrepancy 1.3 0.4 Sources: Malawian authorities; and Fund staff estimates and projections. 1/ In 1998/99, includes nonrecurrent outlays for elections, census, and the MRA. 2/ In 1998/99 and 1999/00, includes an average transfers of 0.5 percent of GDP to NRA, and average transfers of 0.3 percent of GDP to MRA. Also includes past NFRA interest in arrears and new local registered stock issued in January 2001 to retire NFRA debt amounting to 0.2 percent of GDP in 1999/00 and 0.9 percent of GDP in 2000/01. 3/ Starting in 1998/99, previously off-budget development expenditure are increasingly included in the budget. EXPENDITURE TRENDS 1.19 Overall: * Total expenditures declined from 42 percent of GDP in 1994/95 to 23.9 percent in 1996/97 but have since risen to 30 percent in 1999/00. * Recurrent expenditures peaked at 34 percent in 1994/95 but have averaged around 19 percent of GDP in recent years, except for 21 percent in 1997/98 that resulted from a serious loss of fiscal discipline. Development expenditures fell from 7.6 percent in 1994/95 to an average of 5 percent between 1996-98 rising again to 10.6 percent in 1999/00. However the recent rise in development spending is largely due to greater recording of previously off-budget aid projects (see Box 1.1). Box 1.1: Prioritizing the development budget The current separation of the recurrent and development budgets inhibits budgetary planning and priority setting. At times the same item is funded in both budgets, medical drugs being a classic example, distorting the resource allocation process. A concerted effort to identify major items (e.g. drugs and teaching materials) which are being financed in both the recurrent and development budgets needs to be made as a step towards integrating the two budgets. Recently, steps towards the prioritization of the development budget have been taken in Malawi. A comprehensive database is being established within the Ministry of Finance of all aid-financed projects and the 2000/01 Budget included a list of projects that had been dropped as part of a prioritization process. A systematic exercise of reviewing each project according to their relevance to the sectoral strategy, age of project, implementation difficulties, recurrent cost implications etc needs to be conducted in order for a 'core development budget' to be implemented in Malawi. Expenditure by Economic Classification 1.20 Wages and salaries: As Chart 1.1 illustrates, the share of wages and salaries have remained broadly constant as a share of recurrent expenditures, but they have Chart 1.1 Shwe of total recurrent expenditure by declined as a share of GDP economic cldsificatio, 1994195to 19990 from 7.3 percent in 1994/95 50 to 4.8 percent in 1999/00 in line with the reduction in 40 recurrent expenditures. 30 1.21 A major cause of 2 poor morale and performance A. A-Z problems has been the 10 deterioration in civil service salaries in real terms, 0_ ,_ ,_,___, especially at the higher managerial, professional, and 94/ 959 9W97 98 99 for mid-level employees. In an attempt to redress the |- Saies and wages -- Gxs aind savKm A. totest pEynuts incentives issue a performance contract scheme has been introduced in the 2000/01 Budget for senior civil servants. This scheme makes its participants eligible for a two-to-three fold increase in their base salaries in exchange for migrating to a system of three-year contracts. The estimated impact on the wage bill is 0.5 percent of GDP. 1.22 Goods and services: As Chart 1.1 illustrates the share of goods and services have remained around 45 percent of the recurrent budget since 1996/97. However, despite this respectable share of expenditures, subsequent chapters will highlight the critical shortage of essential goods and services expenditures in key sectors. This suggests that re-allocations - 6 - amongst goods and services expenditures as well as improving the efficiency of these expenditures is critical. For instance, the goods and services category includes maize purchases, arrears and other ad-hoc expenditures that have consistently contributed to budgetary over-runs. A sizeable component of this category is interventions in the maize market which peaked at 6.6 percent of GDP during the drought year of 1994/95 but were significant (1.8 percent of GDP) even in non-drought years such as 1998/99. This category also includes extra-budgetary expenditures such as vehicle purchases in 1998/99 (0.7 percent of GDP) as well as payments financed by arrears (up to 0.5 percent of GDP in 1998/99). 1.23 Interest expenditure. Interest payments peaked in 1995/96 at 6.6 percent of GDP but have gradually declined to around 3.8 percent of GDP in 1999/00. Interest on domestic debt has been consistently under-budgeted in Malawi. For instance, while the approved allocation for domestic interest payments in 2000/01 was 1.1 percent of GDP for domestic interest payments, the estimated expenditure on this item will be around 3.0 percent of GDP (Box 1.2 on expenditure over-runs). 1.24 Transfers: Transfer payments have risen gradually from 1 percent of GDP in 1995/96 to 1.9 percent in 1999/00. The main component of this category, pensions and gratuities is increasing partly due to the impact of the HIV/AIDS epidemic and the consequent early retirement and death in the civil service (see chapter 7 for a more detailed discussion of pensions and gratuities in Malawi). Transfers from the Budget to the National Roads Authority (NRA) and the MRA are also included in this category. Expenditure by Functional Classification 1.25 Table 1.3 provides a breakdown of expenditures from 1995/96 to 1999/00 by functional classification. Appendix 1 has a more detailed breakdown as a share of recurrent, development and total expenditure. The main theme that emerges is that expenditure on education has declined as a share of the budget in the last two fiscal years, in favor of spending on agriculture and roads while spending on health has remained broadly constant. 1.26 The General Administration budget is sizeable at 6.3 percent of GDP in 1999/00. The ministries that comprise the largest share of this category are the Ministry of Finance (2.5 percent of GDP),8 Ministry of Foreign Affairs (0.7 percent of GDP), and Ministry of Defense (0.6 percent of GDP). It has to be noted that defense expenditures are significantly lower than the African average and that of its neighboring countries.9 1.27 Total education expenditures have fallen from 5.5 percent of GDP in 1997/98 (20 percent of total expenditures) to 3.7 percent in 1999/00 (13 percent of total expenditures). Education expenditures peaked at 20 percent of total expenditures in 1997/98 and have since declined to around 13 percent in 1999/00. The share of education in the development budget declined significantly perceptibly from 22.6 percent in 1995/96, following the classroom construction boom associated with free primary education, to 9 percent in 1999/00. 8 A significant part of the allocation was for 'Special Activities' (2.4 percent of GDP in 99/00), which in the 2000/01 Budget is a separate voted expenditure. Special activities include 1.5 percent of GDP for payment for commitments (fertilizer, local government elections, arrears), 0.9 percent for transfers to other ministries for salaries. 9 The average spending on defense (1985-95) for Malawi is 1.6 percent of GNP while the African average is 3 percent. Neighboring countries, during this same period, spent as follows: Zimbabwe (5.5 percent), South Africa (3.5 percent), and Zambia (2.2 percent). 1.28 Total expenditures in the health sector has fluctuated less markedly (1.9 percent to 2.6 percent of GDP) and in 1999/00 averaged around 2.2 percent of GDP. However, the share of health expenditures in the development budget fluctuated sharply on a yearly basis, as donor disbursements were typically far short of projected amounts (see Box 1.2). 1.29 The share of agriculture rose from 3.1 percent of total expenditures in 1995/96 (0.9 percent of GDP) to around 9.2 percent in 1998/99, falling to around 6.5 percent in 1999/00 (1.5 percent of GDP). Expenditure on roads has risen during this period from 0.9 percent of GDP in 1995/96 to 1.9 percent in 1999/00; part of this increase is due to previously off-budget road sector capital expenditure being included in the development budget. Table 1.3: Functional classification of expenditure (Percent of GDP) 1995/96 1996/97 1997/98 1998/99 1999/00 Recurrent expenditure General Administration 5.2 4.8 8.4 5.3 4.1 Education 4.0 3.5 4.7 2.5 2.8 Health 1.5 1.7 1.9 1.1 1.6 Agriculture 0.6 0.7 0.6 0.6 Roads 0.1 0.2 0.2 0.5 0.4 Recurrent expenditure 24.3 18.4 21.1 18.1 19.5 Development expediture General Administration 1.0 1.9 0.6 0.8 2.2 Education 1.5 0.4 0.8 1.2 0.9 Health 1.1 0.2 0.3 1.4 0.6 Agriculture 0.3 0.4 1.3 0.9 Roads 0.8 0.9 0.8 0.6 1.5 Development expenditure 6.5 4.8 5.1 8.6 10.6 Total expenditure General Administration 6.3 6.7 9.0 6.1 6.3 Education 5.4 3.9 5.5 3.7 3.7 Health 2.6 1.9 2.2 2.6 2.2 Agriculture 0.9 1.1 1.9 1.5 Roads 0.9 1.1 1.0 1.1 1.9 Other 12.2 8.2 3.4 10.7 10.3 Of which: Public debt service 6.6 5.2 3.2 3.8 3.5 Pensions and gratuities 1.0 1.0 1.3 1.0 1.7 Total expenditure 31.2 23.9 26.6 29.5 30.1 Source: Economic reports, various issues and IMF. - 8 - Box 1.2: Variations Between Budgeted and Actual Expenditure A comparison of budgeted and actual expenditure in Annex 1-3 shows that, a) there is a marked difference between budget estimates and actual expenditure in Malawi and b) the recurrent budget appears to consistently overshoot its budgeted amount in contrast to the development budget which in most years has under-spent relative to its budget allocation. Total budnet: The overall actual expenditures have been greater than budgeted expenditures by around 2- 3 percent of GDP since 1995/96. A key determinant of over-spending in the recurrent budget is the higher than anticipated interest payments on debt. For instance in 1995/96 interest on debt absorbed more than twice its budgeted share of the recurrent budget. In 1997/98 and 1998/99, the actual interest on debt was higher than the approved amount by 0.7 percent and 1.3 percent of GDP respectively. Recurrent budget: An encouraging sign is that the magnitude of over-spending in the education sector has declined in recent years. In 1994/95 and 1995/96, following the decision to introduce free primary education, actual recurrent education expenditures were around 1.4 percent of GDP more than the budgeted amount. In 1994/95 twice as much ORT expenditure was spent in primary education than budgeted and 1.7 times higher personal emoluments for primary education in 1995/96 compared to the budgeted amount. However in 1998/99 and 1999/00 the discrepancy between actual and budgeted expenditures in education had narrowed to 0.4 percent and 0.2 percent of GDP respectively. The narrowing gap between budgeted and actual expenditures in education is mirrored by the shrinking gap between overall budgeted and actual recurrent expenditure. In 1994/95 and 1995/96 this 'gap' was 7.0 percent and 2.7 percent respectively while in 1999/00, it is estimated to be around 1.9 percent of GDP. Development budget: Delays in project implementation are the key factor behind the consistent over- estimation of development budget out-turns between 1995/96 and 1998/99. These over-estimates are particularly striking in the health sector. In 1996/97, the budgeted development expenditure on health was 20.7 percent of the development budget (1 percent of GDP) whereas the actual out-turn was 3.6 percent of the development budget (0.2 percent of GDP). Similarly in 1997/98 and 1999/00 the budgeted amounts for health development expenditure is nearly three times than that of the out-turn. On the other hand, in the transport sector significant development expenditure overruns took place in 1997/98 (1 percent of GDP) and 1999/00 (1.1 percent of GDP). Greater recording of previously off-budget development expenditure in the roads sector has contributed to the unprecedented overall development budget over-run for 1999/00. THE MEDIUM TERM FRAMEWORK 1.30 Against the backdrop of the trends in revenue and expenditures, this section discusses the expenditure restructuring necessary to achieve macroeconomic stabilization and accommodate debt relief. Table 1.4 provides the macroeconomic framework that targets a fall in inflation from 29.6 at end-2000 to 7.5 percent in 2002. This reduction in inflation will be achieved by using broad money as the nominal anchor, along with reserve money targets. Broad money will be reduced by cutting back on the growth of net domestic assets and net foreign assets. 1.31 In order to contribute to an inflation-reduction strategy over the next few years, net repayments by Central Government to the banking sector are envisaged and the fiscal balance after grants is programmed to be 1.1 percent of GDP by 2002/03. On the other hand, debt relief granted through the HIPC Initiative is expected to be used to increase outlays in priority sectors. Table 1.4 shows that the Government of Malawi can achieve these two objectives (i.e. a reduction in the deficit along with increased expenditures on priority items) if it creates the necessary fiscal space by reducing domestic non-interest expenditures'° by 1.6 percent of GDP over the 2001-03 10 Domestic non-interest expenditures excluding debt relief is defined as total expenditures minus interest on debt, foreign financed development expenditures and debt relief -9- period. In view of the limited scope for increasing domestic revenues, policies to reduce administrative expenditure, non-essential spending, corruption, waste and fraud are recommended as the main avenue for this fiscal adjustment. If this takes place then additional resources released due to HIPC can be used as truly additional expenditure on priority items in the spirit of the debt relief initiative that seeks to create the fiscal space for anti-poverty expenditures within a coherent macro framework. Table 1.4: Macro Framework, 1999-2002 1999 2000 2001 2002 GDP at constant prices (annual change, percent) 4.0 1.7 2.7 4.0 CPI (annual average change, percent) 44.8 29.6 20.2 7.5 Exchange rate (average, MK/$] 44.1 59.5 78.2 82.6 Change over previous year Money and quasi-money (percent of GDP) 3.6 4.8 1.8 2.5 Net foreign assets (percent of GDP) 1.2 5.3 3.9 3.5 Net domestic assets (percent of GDP) 2.4 -0.5 -2.1 -1.0 Credit to government (percent of GDP) -0.3 0.8 -3.4 -1.8 Credit to rest of the economy (percent of GDP) 2.7 -1.3 1.3 0.8 Central govemment 1/ Revenue (excluding grants, percent of GDP) 17.5 18.2 18.2 18.2 Total expenditure (percent of GDP) 30.1 31.0 31.8 28.0 Foreign financed development expenditure 8.5 8.4 6.9 5.4 Interest expenditure 3.8 4.9 4.9 3.2 Debt relief 0.0 0.4 3.1 3.2 Domestic non-interest expenditure including debt relief 17.8 17.7 20.0 19.4 Domestic non-interest expenditure excluding debt relief 17.8 17.3 16.9 16.2 Overall balance (excluding grants) -12.6 -12.8 -13.6 -9.8 Overall balance (including grants) -5.7 -1.3 -1.9 1.1 Overall financing: Foreign financing 4.8 3.8 3.3 1.0 Domestic financing 2.1 -2.2 -1.4 -2.0 Discrepancy 1.3 0.4 Source: Derived from IMF staff estimates 1/ Fiscal year Inter-sectoral allocations within the medium term framework 1.32 In order for fiscal policy to play an important role in macroeconomic stabilization as well as stimulating growth and reducing poverty in Malawi, a strategy for expenditure restructuring and improving the efficiency of expenditures is required. Subsequent chapters will address the issue of intra-sectoral re-allocations in four key sectors - education, health, agriculture and roads. 1.33 The inter-sectoral allocations need to be made in the context of the following upward pressures on expenditures. These upward pressures are partly in the Government's own control and others which are due to exogenous forces. -10- Areas Where Expenditures Will Need to Increase * lHIV/AIDS: The fiscal impact will be felt with a rise in pensions and gratuities payments due to early retirements and death."' Second, expenses for recruitment and training to replace civil servants need to be factored in, particularly by the largest ministries such as education, health and agriculture. Third, the Government at a minimum will have to meet the wage costs of an expanding Aids Control secretariat as well as decide on its contribution to the National Strategic Plan for HIV/AIDS. * Social sectors: The triggers for Malawi to reach the 'completion point' for the HIPC process specify minimum floors for expenditures on social sectors. The share of education as a percent of discretionary recurrent expenditures has been set at 23 percent and that of health at 13 percent. In 1999/00 the respective shares were 21.8 percent and 12.7 percent. Hence, these targets will require a relatively minor upward adjustment in social expenditures in order to meet the minimum requirements. However, in addition to these minimum floors, the HIPC triggers imply greater outlays on wages and salaries to meet the requirements for increased recruitment and deployment of medical personnel and teachers. * Governance improvements: Increasing domestic and donor pressures for improvements in governance imply a strengthening and hence a greater budgetary allocation to the Anti-Corruption Bureau, Office of the Ombudsman, Law Commission, Auditor-General's office and the Judiciary. In 1999/00 and 2000/01 these bodies combined were allocated around 0.2 percent of GDP. It is recommended that this be increased to around 0.4 percent of GDP in 2001/02, focusing on agencies such as the ACB, the Judiciary and the Auditor-General's office who are most pressed for resources. * Cushion against natural disasters: Malawi experiences natural disasters (flooding or drought) almost on a yearly basis. The budget needs to retain an 'emergency' expenditure cushion as opposed to diverting expenditures from other items on an ad-hoc basis. Areas Where Expenditure Savings Will be Required 1.34 Recent decisive action to curb non-essential spending12 is an encouraging development. However, further savings can be generated by cutting back on maize interventions, general administration, lowering the stock of domestic debt, reducing spending on specific items such as foreign travel, vehicles and funeral expenses and by cutting back on ad-hoc expenditures, waste, fraud and corruption. 1.35 Maize market interventions have cost the Government up to 6.6 percent of GDP (1994- 95) and averaged 1.7 percent of GDP between 1997-99 (Table 5.2). Significant expenditure savings can be generated by curbing these interventions that cannot be justified on economic efficiency grounds and are difficult to argue from an equity standpoint given the large number of relatively well-off urban consumers who benefit from such subsidies. " Due primarily to death gratuities although there will also be a reduction in pension payments due to death. 12 In April 2001, Cabinet approved a set of expenditure cutting measures in non-priority areas in order to keep overall fiscal targets on track. - 11 - 1.36 The General Administration share of the Budget provides ample scope for cutbacks, though across the board uniforn reductions are not recommended. It is essential that providers of critical public goods, such as those related to improving governance, are protected while streamlining functions that are not priority public goods or could be contracted out to the private sector. * One component of the General Administration category where savings can be generated is the Ministry of Foreign Affairs, which in 1999/00 was allocated 3.7 percent of recurrent expenditure or 0.7 percent of GDP.'3 A thorough review of the value-added of maintaining nineteen embassies is essential given Malawi's budgetary constraints. Efforts at lowering rental expenses, scaling down operations and reducing waste (see Box 1.3) need to be pursued. An action plan for scaling back foreign representation is required. Implementing this plan will incur short-term costs (relocation, retrenchment etc) and steps to finance these costs will then have to be taken either within the Budget or through donor resources. * Significant savings could be generated by merging all Government functions in one capital as opposed to spreading them across Lilongwe, Blantyre and Zomba. The financial cost of travel and the decision-making delays caused by the dispersion of Government officials can be redressed by relocating all central government activities in one city, with Lilongwe being the most feasible venue. Foreign travel and travel allowances is another area where obvious savings could be generated. In 1999/00, actual expenditures were 0.4 percent of GDP, twice the budgeted amount. The size of foreign delegations needs to be curtailed in order to generate significant savings. * Funeral costs: In a high-AIDS environment, Government needs to review its policy of financing funeral expenses for civil servants and family members. Chapter 3 discusses how essential spending in line ministries is diverted towards meeting these expenses. A more restrained policy on subsidizing funeral expenses will also reduce absenteeism. * Reducing waste, fraud and corruption. As chapters 3-6 will show, the scope for improving the efficiency of public resources is significant. The most recent Auditor-General's report and the Public Accounts Committee report (Government of Malawi, 2000d) highlight many instances where public expenditures have been misspent (see Box 1.3). 13 In 1998/99, actual expenditures at 0.7 percent of GDP were 75 percent more than the budgeted amount. The allocation for 2000/01 is 0.6 percent of GDP. Headquarters expenses absorb around 22 percent of the Ministry's costs with the remainder split between nineteen embassies worldwide. Rent is the largest expenditure item within the embassies accounting for more than 50 percent of costs in certain cities. - 12 - Box 1.3: Saving Public Money By Reducing Fraud And Corruption Poor procurement practices: The Public Accounts Committee (Government of Malawi, 2000d) reports widespread violations of legal procurement directives where '...government ministries have for some reasons opted wholly to purchase stores from dubious briefcase suppliers as well as its own employees at very exorbitant prices. '(pg 9) Many Government officials operate private businesses giving rise to serious conflict of interest issues and opportunities for corruption (The Chronicle, March 19, 2001). Education: One of the most high profile corruption cases of recent years, the Auditor General's office and the Public Accounts Committee exposed around 187 million Kwacha (0.4 percent of GDP) worth of illegal and inflated contracts for unfinished projects. A former Minister of Finance is implicated and accused of making direct payments from Treasury. Foreign Affairs: The PAC report and the latest Auditor General's report (Government of Malawi, 1999) documents abuses by Malawian diplomats in terms of payments for the use of educational and medical services abroad, excessive telephone and fuel bills and arrears for excess baggage charges. Tax fraud: Nine customs officials were arrested in early 2000 on charges of falsifying the valuation of import shipments - approximately 141 million kwacha (0.2 percent GDP in 1999/00) are due to be recovered by the Malawi Revenue Authority. Fuels coupons/rental payments/cheque books: The Auditor General's report (Government of Malawi, 1999) documents an array of examples where internal controls have not been enforced. Examples are the unrecorded purchase of 3.1 million Kwacha worth of fuel by the State Residences, over 6 million kwacha in questionable rental payments by the Ministry of Lands and numerous examples of unauthorized use of cheque books. 1.37 This chapter provided an overview of recent public expenditure trends and outlined a possible expenditure restructuring strategy over the next two years. The next chapter assesses the effectiveness of the budget process and proposes a sequencing strategy for budgetary reform. Chapters three to six assesses the use of public resources in the four largest sectors education, health, agriculture and roads. The final two chapters discuss two key areas, pensions and parastatals, which have the potential to contribute to fiscal imbalances and offers suggestions on how such risks can be minimized. 1.38 The criteria by which public expenditures will be assessed in the four sectoral chapters revolve around two main themes. The first relates to the extent that public spending improves economic efficiency by intervening in areas where there are significant market failures. The most extreme case of market failure takes the form of a pure public good, one which private markets cannot charge a price as they are non-excludable (people cannot be prevented from using the product even if they do not pay) and non-rival (an additional person using the product does not affect the utility of other users). Externalities are a more common form of market failure as these are goods that the market supplies, but are either under-supplied (e.g. sanitation) or over-supplied (e.g. pollution) compared to socially optimal requirements. The second broad theme by which public expenditures will be judged is the extent that they promote equity. The poor will require essential services that they may not be able to access if left to the market and hence there is a legitimate role for the State in meeting its poverty alleviation objectives. The nature of the efficiency and equity arguments for public spending will also determine the nature of Government activities in these sectors in terms of whether public provision, financing or regulation are the appropriate means of achieving desired outcomes. - 13 - 2. INSTITUTIONAL ANALYSIS OF PUBLIC EXPENDITURE MANAGEMENT INTRODUCTION 2.1 Since 1995, the Government of Malawi has undertaken a variety of initiatives to improve the budget process. While progress has been made in certain areas, these budgetary and administrative reform efforts have had a decidedly modest impact on public expenditure outcomes. Chapter I noted that budgetary estimates continue to differ significantly from budget outtums undermining aggregate fiscal discipline (Box 1.2). Other chapters illustrated numerous instances where strategic prioritization between and within key sectors was undermined by poor forecasting of macroeconomic parameters, sharp fluctuations in monthly allocations and virement away from budgeted activities. Weaknesses in the budgetary process are also reflected in poor front-line service delivery indicators. 2.2 This chapter analyzes the institutional underpinnings of budgetary performance in Malawi during the 1995-2000 period. It provides an overview of the recent budgetary and administrative reform experience, and the lessons for the design of future reforms. Particular attention is given to a short to medium-run sequencing strategy that would improve the commitment to budgetary procedures and rules, integrate budgetary reforms with other public sector initiatives such as civil service reform, and deepen the impact of reforms on budgetary outcomes. BUDGETARY AND ADMINISTRATIVE REFORMS IN MALAWI: 1995-PRESENT 2.3 Malawi has undertaken a variety of initiatives to improve public expenditure management over the past five years. Specifically, the Medium-Term Expenditure Framework (MTEF), which was introduced progressively since 1995, sought to develop a strategic approach to budgeting over the medium-term, to improve resource allocations in accordance with emerging poverty reduction priorities, and to integrate the investment and recurrent sides of the dual budget. It also introduced logical frameworks to assist line agencies in defining their mission, goals, and program objectives, and Activity-Based Budgets (ABB) to enhance program costing and classification in budget presentation. 2.4 Recent reviews of the 1995-99 phase of the MTEF (MTEF-Phase One) indicate that the effort was neither adequately resourced nor appropriately focused on (i) the incentives of political principals and senior bureaucrats to commit to medium-term expenditure targets; (ii) the robustness of budget planning and execution systems; and (iii) the clarification of reporting relationships and accountability (Government of Malawi, 2000a). Moreover, Malawi's monthly cash budget system, first introduced in 1996 to reduce budgetary over-runs, magnified problems of budgetary uncertainty, thereby weakening the credibility of medium-term strategic planning. 2.5 The shortcomings in the MTEF-Phase One exercise have been partly addressed by more recent efforts to strengthen procedures and systems for budget execution. In May 2000, the Government updated the monthly cash allocation system with a Credit Ceiling Authority (CCA) and a new Commitment Control System (CCS) designed to prevent the build-up of new domestic arrears and improve monitoring of old arrears. Finally, ongoing efforts to pilot an Integrated Financial Management Information System (IFMIS) in four ministries aims to improve overall quality and timeliness of the Government's fiscal data by facilitating day-to-day reporting and - 14 - accounting of government transactions, and automating cash management, commitment control, receipting and payment. 2.6 In parallel to the budget reforms described above, the Government has sought to review its civil service system with an eye towards more far-reaching improvements in the incentive framework of the public service. These include reviews of pay and grading systems and functional reviews of line agency roles and structures. While these exercises have helped identify some of the incentive problems in the public sector, the Government's approach has remained largely incrementalist. Such initiatives have included the abolition of the common services model, hiring of accounting professionals on contract, as well as outsourcing activities previously undertaken by industrial class workers. 2.7 The most significant of these administrative reform initiatives involves the introduction of a performance-contracting scheme for top cadres.14 The contracting scheme, originally introduced in August 2000, provides for the voluntary migration of top cadres (P4/S4 and above) to renewable three-year contracts at more favorable levels of remuneration. A more thorough review and revision of job classes, grading, and salary structures as well as role restructuring of line agencies remains part of Malawi's largely unfinished civil service reform agenda. THE BUDGET PROCESS 2.8 Despite the numerous initiatives described above, progress in achieving the fundamental objectives of a well-functioning MTEF such as fiscal discipline, or allocative and operational efficiency has been mixed. Comprehensiveness is improving as a greater share of donor financing is being recorded in the development budget. The MTEF exercises within line ministries facilitated the introduction of program classification, a necessary but not sufficient condition for an effective MTEF. Also, line ministries are more effectively complying with the requirements of the cash budget system with more timely submission of expenditure returns. Yet, public expenditure management in Malawi is still characterized by an annual, one-year fiscal framework and a dual budget. A range of structural or institutional deficiencies and poor capacity continue to weaken virtually all stages of the budget cycle. Formal rules and procedures governing budget formulation, execution and reporting are not regularly enforced. Mechanisms to deal with macroeconomic volatility and unpredictable cash flows are absent, thereby magnifying problems of non-compliance. Moreover, the poor quality and lack of timely access to fiscal and macroeconomic data is a serious constraint on budget monitoring. Budget planning and formulation 2.9 Poor coordination between key agencies undermines forecasting: Rules for generating and sharing economic data between and within core agencies such as the MOFEP, RBM and NSO are lacking. Problems of inconsistent-often conflicting-economic data used in forecasting have been exacerbated by poor lines of communication between units of the MOFEP, notably the Economic Affairs, Debt Management, Budget Divisions as well as the Accountant General's Office. Such coordination problems are also apparent in Government-donor relations, an increasingly important part of fiscal management given Malawi's growing aid dependency 14 The Government also introduced a new housing allowance scheme, in July 2000 This monetized allowance-specific to job classes and grades-is provided to civil servants, who previously were fully housed at the Government's expense. For the remaining civil servants, who were not housed, the scheme increases their housing allowance from 15 percent to 25 percent of base salaries. While inequalities between previously housed and non-housed staff within the same grade, the scheme does introduce greater transparency in the compensation for Malawian civil servants. - 15 - (para. 1.10). Box 2.1. discusses both external and domestic debt management issues in more depth. 2.10 Lack of budget comprehensiveness: The budget presented to Parliament has typically omitted the detailed operations of sub-vented organizations, treasury funds, and commercial parastatals. In addition, substantial amounts of donor financing as well as the contingent liabilities generated by parastatals are not captured. Recent efforts to include off-budget donor aid in the development budget-most notably EU projects-should improve comprehensiveness. Efforts by the MOF to compile a database of all development projects is also encouraging. 2.11 Separation of recurrent and development budgets: The budget cycle for the recurrent and development budgets continue to operate in parallel without adequate integration. Even though Budget Coordination Committees were established in line ministries to promote better coordination between recurrent and development expenditure proposals, the impact has been limited. In other ministries, budget planning is further fragmented by the separation of the Ministry from other critical public institutions in the sector. For example, in the education sector, the Ministry of Education and the University of Malawi budgets are planned and executed separately with little coordination. 2.12 Late issuance of ceilings: Delays in issuance of ceilings by the Ministry of Finance lead to sector ministries replacing the Activity Based Budgets, that were produced for the original budget estimates, with line item budgeting as budgetary revisions are made. Budget Execution 2.13 Extra-budgetary requests are common: Intended as a contingency measure to cope with genuine crises, extra-budgetary requests have become a standard part of the budget process in Malawi. This trend has a perverse effect on the budget process as some ministries propose secondary priorities during the normal budget formulation exercise, while saving real priorities such as utility bills for extra-budgetary requests. 2.14 Macroeconomic volatility undermines budget execution: Execution of the planned budget is further complicated by high inflation, exchange rate volatility, and fluctuations in donor assistance. Delays in donor disbursements have led to high intra-year domestic borrowing and higher than forecast interest payments on domestic debt (Box 2.1). In addition, exchange rate volatility affects programs that are heavily dependent on imports. For instance, the 2000/01 allocation for medical drugs expenditure was close to the Better Health for Africa target of $1.25 per capita. However, a sharp Kwacha depreciation during the course of the fiscal year resulted in a significant reduction in resources available for this item. 2.15 Poor compliance and information flows undermine cash budgeting: As noted above, the CCA represents the maximum amount of cash expenditure that an agency can incur. These ceilings are issued by the Accountant General for each agency, and then communicated to the RBM and commercial banks where agencies have accounts. According to the cash budget system, the RBM is supposed to reimburse commercial banks for checks presented for payment by agencies. Checks in excess of CCAs are not to be honored by commercial banks. Nor should these banks be reimbursed by the RBM for transactions in excess of ceilings. 2.16 In practice some commercial banks continue to honor checks presented in excess of ceilings. In the absence of sanctions such as requiring banks to meet interest payments for transactions in excess of the ceilings, the practice will likely continue. Moreover, poor information flows to the central bank on CCAs and supplementary CCAs have at times led to - 16- inadvertent RBM reimbursement of commercial banks for overpayments. Differences between the RBM and MOFEP in terms of supplementary CCA amounts is also undermining the system. Ongoing initiatives such as the deployment of IFMIS across Government should eliminate the delays in communicating ceilings to the Accountant General's Department, RBM, and line agencies. This should also facilitate the monthly reconciliation of reimbursement records from RBM with the CCA and supplementary CCAs. As with all automated systems, there will be need for senior-level support to ensure the integrity of inputted data, regular reconciliation of records, and vigorous follow-up in cases where discrepancies are identified. 2.17 Recurring claims from line agencies that exceed CCAs are indicative of deeper compliance and control problems, specifically, the relationship between ministers and the controlling officers of line agencies, Principal Secretaries (PSs). The extent to which ministers should be entrusted with the executive role in line agencies continues to be source of much debate, including competing interpretations of the Constitution. From the point of view of Malawi's Public Service Act, PSs are the administrative chiefs of line agencies and therefore responsible for ensuring agency-level compliance with financial and procurement regulations including the CCA and CCS systems. In an effort to clearly communicate high-level commitment to these rules, the Secretary to the Treasury (ST) is in the process of formally communicating Core Expectations for Departmental Financial Management to all controlling officers across government. Integrating these expectations as criteria in the perforrnance agreements of controlling officers on contract is also being considered as a way of generating senior-level support good financial management practices. 2.18 Given widespread concerns among civil servants about political interference, and its implications for problems of virement, there is an emerging consensus instituting additional measures to protect the neutrality of administrative cadres. While the Secretary to President and Cabinet (SPC), as Head of the Civil Service, is ultimately responsible for managing disputes between senior civil servants and their political principals, proposals to reconstitute and expand the mandate of the Civil Service Commission-in line with its counterparts in other African countries-are being discussed. Budget monitoring 2.19 Deficiencies in timeliness, coverage, and quality of in-year fiscal data: Effective use of the CCA and other aspects of the cash budgeting system depend on the timeliness and comprehensiveness of fiscal data. Recent reviews of quality of bookkeeping and accounting, annual financial statements, the MOF's monthly fiscal reports, and line agencies' monitoring reports indicate conflicting information, poor coverage, and delays in preparation. 2.20 Preparation of the annual financial statements have been completed and audited only up to 1997-98. This lag is due to delays accumulated within line ministries, the Accountant General's Department and the Auditor General's Office. In addition, coverage of the audited financial statements tends to fall short of recommended modern public sector accounting practices; specifically, they fail to disclose commitment and arrears, selected assets and liabilities, as well as contingent liabilities (IMF, 2001). 2.21 Bank reconciliation is ad hoc, lacks quality control: Although it is fundamental to accurate in-year fiscal reporting, bank reconciliation in Malawi lacks consistency or comprehensiveness. Certain accounts in line agencies are not reconciled at all while others, though reconciled, are replete with clerical and procedural errors. At times, certain items that are found to be irreconcilable are not investigated, rather simply carried forward. - 17- 2.22 Sanctions have enhanced timely reporting but data quality remains poor: Recent efforts to enforce the reporting requirements of the new CCS have met with success in part because the Minister of Finance's strong leadership, including his willingness to withhold cash releases to ministries that failed to submit CCS returns in a timely manner. The variable quality of submissions remains a problem in part because of the failure of staff to understand the intent of CCS forms. 2.23 Internal and external audit quality needs strengthening. Sustaining these reporting relationships is in part the function of internal auditors, who provide the first check on the quality of fiscal data. Their involvement in supervising the maintenance of commitment registers and capturing commitments information is one of a range of activities that require the internal audit function to be adequately staffed, funded, and appropriately supervised. The capacity of Auditor General's Office is also critical to verifying data generated by line agencies, undertaking regular and up-to-date financial and operational audits, and preparing meaningful annual reports to the Public Accounts Committee in order to appropriately inform the legislative oversight function. UNDERSTANDING MALAWI'S BUDGETARY REFORM EXPERIENCE 2.24 Three key factors explain the decidedly modest impact to date of the MTEF and other reform initiatives on Malawi's budget system and its ability to consistently generate desirable development outcomes. These include a lack of sustained political support for the fundamental objectives of a budget system; the absence of a sequencing strategy for complex budgetary reforms; and inadequate linkages to program implementation, and specifically front-line service delivery performance. 2.25 Lack of sustained political support for MTEF and related budgetary reforms. Weak political commitment to the objectives of budgetary reforms is fundamental to problems of budget discipline and financial accountability. In the absence of sustained buy-in from political principals and senior bureaucrats, even well designed technocratic initiatives such as efforts to improve fiscal forecasting, establishment of the CCS or the development of IFMIS are not likely to succeed. Despite laudable efforts by the Minister of Finance to refocus and re-energize the budget reform effort, with a particular focus on execution, reporting, and accountability, problems of weak political buy-in have a structural dimension. Specifically, the executive role of ministers in certain line agencies fundamentally distorts incentives to abide by medium-term budget targets and follow sound financial management practices. Prospects for success on a range of initiatives such as the CCS and the performance contracting scheme for top cadres depends on the Government's willingness to place both the authority and accountability administer line ministries in the hands of PSs, as indicated in the Public Service Act and financial regulations. - 18- Box 2.1: Debt Management in Malawi It is clear from the discussion in Chapter I that sharp intra-year variations in the composition of deficit financing and large under-estimates of interest payments are partly a result of weak debt management in Malawi. Sound debt management requires an institutional structure that provides clear accountability and responsibility for managing debt with clear reporting lines and coordination of information flows among the various units, and a well-trained and adequately compensated staff with the necessary skills to carry out their responsibilities. It also requires strong support from senior management at the highest levels; i.e., the Minister of Finance and Cabinet. Malawi has made a good start on these aspects by creating the Debt and Aid Management Division (DAD), completing a functional review of its purposes, functions and staffing requirements, and proposing a Debt Coordination Committee and Debt Operations Committee for reviewing and recommending debt policies. However, much still needs to be done. The DAD is far from being operational: it is understaffed, domestic debt management is being carried out by the Reserve Bank of Malawi, and there is inadequate coordination of information flows between DAD, Budget Division, Economic Affairs Unit, and RBM. Malawi lacks a debt management policy and strategy that is implemented in the government's borrowing program. A longer term borrowing program needs to be developed, which takes into account available sources of finance as well as the cost and risk implications for the total debt portfolio. Line ministries and parastatals are particularly lax in providing timely information on disbursements and repayments. This has led to problems in debt recording, servicing, forecasting of financing requirements, and cash flow management. The specific recommendations to improve debt management are: Recruit staffto fully operationalize the Debt and Aid Management Department. Train staff in debt negotiating skills. Since Malawi will continue to rely of donor funding in the short to medium term, it is necessary that its staff be fully trained to handle negotiations with donor institutions. As part of this process the knowledge and monitoring of conditionalities needs to improve in order to forecast donor cash flows. Develop clear funding strategy for external and internal borrowing, as well as for grant negotiation, within the context of a portfolio management framework. Develop a comprehensive database of terms and conditions of all concessional project loans available to the government to permit an accurate assessment of their relative concessionality. Integrate debt recording, domestic and foreign, on one system and install shared network link between MoF and RBM Improve coordination between MoF and RBM in the area of cash forecasting and liquidity management. As part of this develop a formal process for agreeing the quantity of Treasury bills offered. Source: Malawi: Sovereign Debt Management, Cash Management and Domestic Market Development, MEMFI, The World Bank - 19- 2.26 Absence of a sequencing strategy for budgetary reforms. There is a growing consensus among countries undertaking budgetary reforms that sequencing matters not only in terms of the sustainability of specific interventions, but also the overall credibility of the budget as an instrument for collective decision-making. In Malawi, the Government attempted to introduce an elaborate medium-term planning framework under MTEF-Phase in a budgetary environment characterized by soft budget constraints, poor information, and weak compliance with basic financial regulations. Without reliable fiscal forecasts or any guarantee of proper in-year budget execution, sector ministries had relatively little incentive to contribute and commit to medium- term targets and plans. As a result, the MTEF exercise lacked the necessary credibility to be mainstreamed as the primary budgeting instrument. 2.27 Inadequate linkages to program implementation andfront-line delivery: Ultimately, the development impact of budgetary reform efforts depends on efficient program implementation and front-line delivery performance, particularly in priority sectors such as health and education. There is a broad consensus in Malawi that operational Chart 2.1: Wage structure within the civil service, 1999 efficiency and improvements in 180000 output performance require 160000 Job grades 48-2 include primnary enhancements in civil service 140000 teachers, technialleachers, nursing sitmnuming ffrrcers, poilireN pay and incentives, role . 120000 umenadam and O.unaiptolbendn\ restructuring of line agencies, o .00000 o , - and stronger safeguards = 80000 - against corruption and 60000 i - resource leakage. Equally 40000 - - important is the need for these 20000 - - initiatives to be implemented in O an integrated and mutually 1.0 11.0 21.0 31.0 41.0 51.0 61.0 71.0 reinforcing manner. Grades assigned to positions 2.28 A robust pay and incentive framework is critical to motivate public sector staff, particularly those on the front lines of service delivery. The current wage structure in the Malawi public service is currently compromised in four ways. First, a comprehensive job evaluation and grading exercise (JEG), undertaken in 1999, found that civil servants occupying middle-level, technical posts-ranked as grade-levels 46 through 62 in Chart 2.1-faced a significantly less favorable reward structure compared to more senior cadres.'5 Civil servants in these grades mainly comprise primary teachers, nursing staff, police inspectors etc, all of whom are directly involved in service delivery (Bryher Partnership, 1999). The recommended strategy for improving productivity therefore is to "smooth" the salary structure by raising the relative wages of these workers (circled in Chart 2.1) vis-a-vis those in higher grades. The recently introduced performance-contracting scheme increases the compensation of staff that P4/S4-level and above (grades 64 and above in the chart); the implication is that internal relativities between technical workers and managerial staff has further widened. 2.29 Second, several labor market comparator surveys have also indicated that Malawi civil servants are significantly underpaid vis-A-vis their private sector counterparts. Preliminary comparisons suggest wage differentials in 1999 were especially pronounced for cadres occupying mid-level, technical posts as well as for those in senior management. Specifically, based on extrapolations of the 1999 market comparator data, managerial staff in the public sector (grades 64 and above) earned base salaries (i.e., not including allowances and benefits) that were approximately 3.5 times lower than private sector counterparts. Civil servants in those mid-level 15 The grade-level used in Chart 2.1 was assigned to all positions for purposes of the JEG exercise. - 20 - grades identified for "smoothing" under the JEG exercise (grades 46-62), on average, could receive a three- to four-fold increase in base salaries if employed in jobs requiring comparable responsibility and skill in the private sector. 2.30 Third, Malawi's pay and employment system currently tolerates horizontal inequities between civil servants within the same job class. For instance, certain civil servants within a given grade were historically housed by Government, while others were simply given a monetized allowance as a percentage of their base salary; the latter represented a lower percentage of a civil servant's total income. In addition to equity concerns, differential benefits for staff with comparable responsibilities can undermine the transparency of Malawi's existing pay and employment system. 2.31 A fourth constraint on the incentive framework within the Malawian civil services is related to payroll administration. The Ministry of Finance funds the personal emolument bill based on a central payroll database in the Department of Human Resources and Management. However information on civil service attrition and new hiring is not updated on a timely basis in the payroll system due to lags in updating this information on the part of sector ministries as well as delays in reconciling and entering the data centrally. 2.32 In addition to competitive wages, the roles, functions, and structures of line agencies also need to be improved to strengthen service delivery. The functional reviews undertaken in twenty ministries were essentially designed to identify more optimal structures for line agencies to improve output performance. However, in light of the imminent decentralization of service delivery responsibilities and personnel to local assemblies, the functional reviews will need to be updated and adequately integrated with JEG findings. 2.33 The Government has made little progress in restructuring in part because it has not defined a credible change management process by which line agencies are given an incentive to do so. It is widely acknowledged that frontline performance gains will materialize only when wage enhancements are tightly linked to the structural reform of line agencies. One option, currently being used in Tanzania, is to provide wage enhancements and access to capacity building resources in exchange for agreed role restructuring for line agencies as well as development of service standards (Box 2.2). - 21 - Box 2.2: Tanzania's Performance Improvement Fund: Providing Incentives for the Reorientation of Line Agencies Since 1993, Tanzania has sought to transform a bloated, hierarchical and inefficient bureaucracy into a more efficient, client-oriented public sector. The early phases of reform focused on reducing public employment and decompressing civil service salaries. The current phase of Tanzania's reforms turn on its Performance Improvement Management (PIM) program, which focuses on role restructuring and performance enhancement of central agencies as service delivery responsibilities are shifted to local authorities and the private sector. The program envisages a central government that plays a "steering" or policy and regulatory role. To ensure that central ministries actually undergo strategic reorientation and restructuring, the Tanzanians have developed "a process-oriented change management model" that gives ministries, departments and agencies (MDAs) access to capacity building funds, and more flexible salary and budgetary rules- available through a Performance Improvement Fund (PIF)- in order to successfully complete the PIM program. The PIF supports MDA reorientation in two stages: * Access rules first require that each MDA develop a strategic, operational, and performance improvement plan for restructuring. Each agency is also required to publish a social pact or charter that sets out service standards that the public can expect. Resource requirements to meet these standards need to be delineated, along with a commitment to review progress at least twice a year. * Following the adoption of a strategic plan, the PIF supports capacity building activities needed for effective implementation, including training, salary enhancements within the medium-term fiscal framework, and recruitment of specialized professionals on contract terms. Nearly fifty MDAs have responded to this incentive mechanism and are currently participating in the PIM. Growing demand is fuelled not only by the financial incentives provided by the PIF, but also the "peer pressure" generated by participating MDAs and the political credibility that this change management model enjoys in Tanzania. 2.34 The third element required to give Malawi's budget reforms a front-line focus involves safeguards against resource leakage including corruption and fraud. Since its transition to multi-party democratic, Malawi has made progress in developing new mechanisms, most notably the Anti-Corruption Bureau (ACB), for fighting and controlling corruption. The ACB, established under the Corrupt Practices Act, is given broad powers for investigating complaints of alleged corrupt practices and prosecuting, subject to the direction of the Director of Public Prosecutions (DPP). The Act also grants the Bureau authority to investigate the conduct of any public officer that may be connected with corrupt practices. Since its establishment, the ACB has proven to be an increasingly credible mechanism for raising public awareness about the costs of corruption, and more important, investigating suspected corrupt practices by high officials. However, the Bureau has had only modest success in prosecuting cases in part because of insufficient evidence, capacity constraints within the Bureau and a perceived reluctance on the part of DPP to move forward with certain cases. 2.35 More broadly, there is urgent need to generate accurate and timely information on levels of resource leakage-due to either financial and procurement irregularities or excessive administrative overhead-between cost centers and facilities. Experience with expenditure tracking in other African countries such as Uganda suggests that such information-when disseminated broadly-can help empower communities to hold government institutions accountable, and thereby reduce levels of leakage (Box 2.3). - 22 - Box 2.3: Public Expenditure Tracking Surveys in Uganda's Education Sector In the absence of well-functioning public accounting information and management information systems, governments in several developing countries have increasingly used public expenditure tracking surveys (PETS) to identify sources of leakage and operational inefficiency on the frontlines of service delivery. When appropriately disseminated to the concerned public, information generated through PETS can provide a cost-efficient alternative for checking the misuse of public resources. The PETS was first pioneered in Uganda's education sector in 1996. Findings indicated that non-wage primary education spending was captured by district-level bureaucrats. As a result, only 20 per cent of allocated resources intended for schools actually reached their destination. In response, the central government launched an information campaign both nationally and at the district and school level to sensitize parents and public officials about incidence of leakage and its consequences for school performance and student achievement. PETS data-specifically the amounts of resources that actually reached individual headmasters-were posted in public venues and disseminated through the media. Parents and community members responded by holding district and schools officials responsible when schools received less than allocated amounts. As a result, a repeat survey in 1999 indicated that leakage had been reduced. Nearly 90 per cent of non-wage education spending was reaching schools, albeit with some delays. The key is that reductions in leakage resulted from a strategy of disseminating information broadly, and thereby empowering communities to hold public actors accountable. AN APPROACH TO SEQUENCING BUDGETARY REFORMS 2.36 Malawi's reform prospects in the future depend on the Government's ability to refocus ongoing efforts based on lessons learned during the 1995-2000 period. Of particular importance is the need to develop a sequencing strategy that can evoke renewed political commitment and enhance the credibility of the budget. A careful review of the lessons from the recent past suggests that a viable sequencing strategy over the short- to medium-run can revolve around three elements: information flows and systems, a motivated staff, and checks and balances on non- compliance (Chart 2.2). A Short-Run Focus on Budget Implementation 2.37 In order to develop a viable MTEF, Malawi needs to begins with an intensive, short-term effort to improve budget execution, reporting, and accountability. Chart 2.2 identifies three mutually reinforcing initiatives that would rapidly improve these elements of the budget process by developing the capability and strengthening the incentives of public actors to generate high quality and timely fiscal data. 2.38 Enforcement of good financial management as criteria in contracting scheme. The first element involves the immediate introduction and enforcement of good financial management practices as criteria in the new contracting scheme for top cadres. Efforts to strengthen the chain of information that runs through the budget process should begin with Controlling Officers or PSs, who are ultimately responsible for ensuring agency-level compliance with core financial management regulations. Designating these as criteria in the annual performance agreements of Controlling Officers on contract implies that renewal of employment contracts will be based on an agency's in-year financial reporting, submission rates for CCS returns, reduction in the build- up of arrears, timely completion of accounts, minimal use of extra-budgetary requests, sound asset management and prompt action on audit queries and findings. An additional performance criteria should be the level of extra-budgetary requests made in a given budget year to ensure that Controlling Officers budget all essential items during the formal Parliamentary approval process. - 23 - 2.39 It will also be important for the political leadership, as well as senior officials such as the ST and SPC, to support vigorous enforcement of performance agreements that are pinned on financial management responsibilities. As senior civil servants are increasingly held to account for their ministries' financial management practices, there will be need to better insulate them from widely-acknowledged political pressures to breach financial regulations and divert money from on line item to another. While the SPC has typically played the role of arbiter in cases of administrative grievance, additional measures may be required so senior civil servants are protected from continued political pressures while on contract. Unlike other several other African countries, Malawi's Civil Service Commission, though a constitutional body, has a fairly restricted role in practice, chiefly comprising the recruitment and appointment of junior- and middle-level staff to established positions across government. Civil servants with grievances have increasingly sought redress by appealing to the Ombudsman, which is designed to ensure the accountability of public institutions to citizens broadly. Consistent with the principle of accountability, there is need to review the CSC's role, consider expanding its mandate, develop stronger mechanisms of recourse and redress for top cadres on contract, as well as additional provisions for ensuring the integrity and professionalism of the civil service. 2.40 Better coordination of information flows and deployment of modern systems. The second element of a short-term sequencing strategy involves better coordination of information flows and deployment of modem systems in order to improve the quality and timeliness of fiscal data. Improving Government-donor coordination is essential to 'smooth' the flow of external financing. This can be done by encouraging donor commitment to the Government's budget calendar, scheduling of Consultative Group meetings in line with the revenue forecasting process, and staggering donor disbursements during the year. In addition, coordination of information flows between the Reserve Bank and MOFEP is essential, along with a coherent debt management strategy, and recruitment and training of appropriate staff in the Debt and Aid Management Unit of MOFEP. Also, Budget Coordination Committees within sector ministries need to be strengthened in order to improve the allocation of resources within and between the recurrent and development budgets. It is essential that the MOF communicates budget ceilings to sector ministries early in the budget planning cycle and also regularly updates budgetary projections in line with changing macroeconomic parameters. 2.41 Concerted efforts by the MOFEP and line agencies to rapidly pilot and roll-out modern information systems such as IFMIS will also reduce the processing time for recording and reporting government financial transactions. The automated system will also improve the coverage and accuracy of fiscal data. The IFMIS rollout not only requires continued senior-level support but also continued attention to change management issues such as data management, capacity building, and IT maintenance. - 24 - Chart 2.2: An Approach to Sequencing of Budgetary Reforms SHORT-RUN Informition ows I = Establish financial management as criteria in and systems perfornance contracts 2 = Improving coordination and deploying systems to improve quality of fiscal data 3 = Strengthening intemal and extemal audit staff -{- A balances MEDIUM-TERM 4(a) = Implement pay reform and role restructuring of line agencies in integrated manner 4(b) = Deepen accountability including parliamentary and civil society involvement in budget process, including M&E and standards-setting 2.42 Strengthening the quality control and audit function. The third element entails an investment in the quality control and audit function to ensure the integrity of fiscal data. It is widely recognized that Malawi's internal audit function has weakened in recent years. There is need not only to build the capacity of internal auditors (including preparing them for the roll-out of IFMIS), but also to strengthen reporting arrangements back to the Accountant General in order to provide a measure of quality control over the generation of fiscal data including accounting, bookkeeping, maintenance of CCS, submission of various financial reports, etc. Parallel efforts are needed to build the Auditor General's capacity to carry out timely financial audits, verification studies of arrears, and value-for-money audits, and then make meaningful and accessible reports on the findings to the Parliamentary Accounts Committee. Yet another check and balance mechanism that can be further strengthened in the short-run is the ACB. Proposals to increase budgetary allocations to the Bureau, to lower the burden of proof required in corruption cases, and to establish fast-track courts for high profile cases are currently being considered. A Medium-Run Focus on Front-line Performance and Accountability 2.43 Taken together, the above-mentioned activities provide the basis for a three-pronged strategy to improve execution, monitoring and accountability in the short-run. Effective budget implementation provides a sound basis for a medium-run strategy aimed at (i) relieving public management constraints on front-line performance, and (ii) deepening accountability through broader legislative and civil society involvement in all aspects of the budget process. 2.44 Performance improvement through wage enhancements and role restructuring. Frontline performance improvements require an enabling environment in which civil servants are paid adequate wages and organized in agencies that are structured to encourage efficient, client- oriented government operations. This requires a human resource policy based on an affordable medium-term wage policy-consistent with macroeconomic targets-that inter alia improves the conditions of work for technical and frontline staff, as well as a strategy to limit the deleterious impact of the WHV/AIDS epidemic on Malawi's public service. It is envisaged that the Government will develop medium-term wage policy that integrates these three concerns by end- March 2002. The public sector pay policy proposal would be costed within medium-term macroeconomic projections, and include a revision of grading and salary structures. In addition, - 25 - the policy is expected to identify salary "targets" for specific classes of civil servants, to be implemented in a phased manner, subject to resource constraints. 2.45 Even as it develops a more comprehensive proposal for the structural reform of civil service wages, more modest wage increases for front-line staff can be introduced with HIPC resources in priority sectors (Chapter 1). In the interim, the Government should also seek to improve the efficiency of the existing system. This includes eliminating inefficiencies in payroll management, strengthening personnel audit, and developing an open appraisal system. 2.46 Part and parcel of a strategy to improve operational efficiency is the need to reorient central agencies to move towards a policymaking and regulatory role as service delivery responsibilities are shifted to local government. A process change instrument, along the lines of the Tanzania Performance Improvement Fund (Box 2.2) that links wage enhancements to role restructuring of agencies would be required to generate the incentives required to support the re- ordering of state institutions and intergovernmental relationships. To be complete, role restructuring should be completed by a strategy to define and harmonize administrative structures at the local level, define intergovernmental fiscal relations, and develop systems for fair and transparent management of frontline cadres by local assemblies. 2.47 Greater legislative and civil society involvement in budget process. Deepening the accountability of Malawi's public institutions will require greater involvement of the legislature and civil society in all aspects of the budget process. Success in improving the quality of fiscal data in the short-run should enable legislators, think-tanks, citizens' groups, and other civil society institutions to enhance their substantive involvement in budget formulation as well as program monitoring. The highly consultative nature of the 2001/02 Budget formulation process is an important step in this direction; however this ought to be followed by greater engagement in Budget monitoring by civil society. Building the necessary capacity for this to occur is essential in improving accountability. As central government reorients towards a policy and regulatory role, there will also be scope for involving civil society to set service standards in priority sectors. 2.48 In addition, as the decentralization agenda proceeds, there will be need for significant efforts to empower communities to systematically track and monitor the use of public resources and the performance of public institutions against service standards. Several countries with weak control systems are using periodic expenditure tracking surveys to gauge the degree of resource leakage between cost centers and facilities. For example, the dissemination of results from tracking surveys in Uganda's education sector has systematically reduced leakage of resource in local government (Box 2.3). In addition to disseminating information on leakage, beneficiaries should have recourse or appeals mechanisms (for example, citizen oversight committees such as health management committees or parent-teachers associations) by which demand accountability in financial management and service standards. Finally, the accessibility of government institutions to public scrutiny is the bedrock of an accountable state. This implies the need to re- institute the practice of annual reporting on performance by public bodies, expanding the scope of Freedom of Information legislation, strengthening of the Office of the Ombudsman, and improving relations between the media and government agencies. - 26 - 3. EDUCATION INTRODUCTION 3.1 Malawi has made substantial gains in the provision of primary education over the last decade but access to secondary and tertiary education remains limited, the quality of education is poor and HIV/AIDS is having an impact on the sector through a variety of channels. 3.2 The public sector is the main provider of primary education as only 2 percent of primary schools are 1rivate.16 In the secondary sector on the other hand, around one-third of the schools are private.' Government secondary schools are divided into boarding schools (16 percent) and day schools (84 percent). There are two universities, the University of Malawi composed of five colleges and Mzuzu University, both in the public sector. 3.3 This chapter reviews the main trends in access, performance and public expenditures in the Malawian education system since the mid-i 990s and concludes by suggesting policy priorities in the sector. KEY SECTOR ISSUES Access to Education 3.4 Primary school enrolment increased after the abolition offees in 1994: Primary school enrolment increased from 1.9 million in 1993-94 to 2.9 million children in 1999/00 following the introduction of free primary education in 1994 (see Annex II Table 1). The large difference between the gross enrollment rate at primary (117 percent) and the net enrollment rate (76 percent) is largely due to over-age enrollment (see Annex II Table 2). 3.5 However dropout and repetition rates remain high: The largest dropout occurs between standard one and two where approximately 30 percent of students dropout. Overall repetition rates in primary were around 14 percent in 1999. While survival rates have increased between 1995-1999, they still remain remarkably low with only 30 percent of students completing the cycle (Annex II Table 1). 3.6 The dropout rate is particularly high for girls: The dropout rate is even higher for girls; despite equal numbers of girls and boys starting primary, girls represent only 42 percent of students in standard 8. A recent household survey suggests that the primary reasons for female dropout are pregnancies and early marriages (Tsoka, 2000). 16 There are around 4500 primary schools in Malawi. 70 percent of schools belong to religious agencies, but are treated as public schools because of government's financial support introduced after introducing free primary education. Private schools currently account for less than 2 percent of the total. After eight primary school standards, students are selected for secondary schools on the basis of their primary school leaving certificate (PSLCE) exam results. "7 The secondary school sector is composed of 99 conventional secondary schools (CSS) and 521 Community day secondary schools (CDSS) in the public sector, and approximately 350 day and boarding institutions in the private sector. Distance Education Centres (formerly significant providers of secondary schooling, have been undergoing conversion into CDSSs since 1998. There are 4 years of secondary education, which is sub-divided into junior and senior levels. - 27 - 3.7 Significant geographic differences in access to primary schooling: Net enrolment rates are highest in the Northern region than in both the Southern and the Central regions (84 percent versus 75 percent). Enrolment rates are consistently higher in urban than in rural areas, where households are poorer and where physical access to schools is more difficult. 3.8 Free primary education led to greater access to education for poorer groups in rural areas: The gross enrollment rate for the poorest quintile increased from 58 percent to 110 percent between 1990/91 and 1997/98, while that for the richest quintile only increased from 110 percent to 119 percent. (Annex II Table 3) However, dropout rates are still higher arnong the poorer income groups18 and gender gaps in enrolment ratios have persisted. 3.9 Secondary enrolment is low despite increasing steadily since 1993/94: There has been steady annual growth in secondary enrolment between 1993/4 and 1999/00 (Annex II Table 4) but the 1997/98 household survey still found a net enrolment rate of only 7 percent. 3.10 Secondary education remains the preserve of the rich: The gross enrolment rate of children from the richest income quintile was over four times that of those in the poorest quintile and twice that of the next richest quintile, indicating the strong relationship between welfare and enrolment. As with primary, secondary enrolment ratios are highest in the northern region and highly skewed towards urban areas. Moreover, as was the case in primary education, a comparison of enrolment ratios in 1990/91 and 1997/98 shows that poorer groups have increased secondary enrolment faster than richer groups. 3.11 Teacher training enrolment is inadequate:'9 Due to the rapid expansion of primary enrolments around half the current teaching force are not fully trained (many have received in- service training).20 Malawi's six teacher training colleges are not currently producing enough teachers to even replace the 5000 or so teachers lost annually due to AIDS and regular attrition. 3.12 Enrolment at university is low by regional standards: There are only around 3500 students enrolled, which is low even by Sub-Saharan African standards.2' Women represent less than a third of the students. Quality of Education 3.13 Teaching inputs have not kept pace with enrolment surge: A recent survey of over eight hundred school children (Tsoka, 2000) suggests that the main constraints to quality education are "s Although officially free, primary education effectively incurs a range of costs for parents and communities. Fees are not charged at primary level, but parents generally contribute in various ways (Kadzamira et al, 1999). There is evidence that schools raise substantial amounts through general-purpose funds in addition to official fees. '9 The total capacity of primary teacher-training colleges was around 3500 in 1999. Secondary teachers are also trained at the education faculty of the University of Malawi, the University of Mzuzu, the Polytechnic and Bunda College of Agriculture, and the African Bible College (the only private provider). 20 This prompted the introduction of a high volume crash program of primary teacher training - the Malawi Integrated In-service Teacher Education Program (MIITEP). This 2-year training course combines formal training and field based experience (three cohorts per year of approximately 2,500 are in college facilities, while another three cohorts are field-based). 21 In 1995, Malawi recorded 76 tertiary students for every 100,000, while the figures were 241 in Zambia and 679 in Zimbabwe. - 28 - insufficient teaching materials, followed by insufficient teachers, poor sanitation, poor teaching and inadequate classrooms. Pupil textbook ratios are around 1:1.4 and while student teacher ratios are around 62: 1, student to qualifed teacher ratios are around 120:1 in primary. 3.14 In secondary, sharp quality differences are reflected in exam performance. Overall pass rates for the final secondary exam has declined from 48 percent in 1994 to 20 percent in 2001. Explanations for this decline relate to the effect of the recent conversion of Distance Education Centers into day secondary schools and a tightening of marking due to extensive cheating. The 1999 pass rate for this exam was 26 percentage points lower in Government day schools than in boarding schools. Pass rates between the state boarding schools and the private schools are comparable. 3.15 Education pays clear dividends in urban areas but less in rural areas. As is the case in most countries, the most recent household survey shows that completing secondary education is closely associated with moving out of poverty in urban areas.22 In rural areas the correlation between higher education and income levels are far less strong (National Economic Council, 2000). 3.16 HIV/AIDS is having a serious impact on the sector. Teacher attrition is around 10 percent and a significant share is due to AIDS related illness and death. HIV/AIDS also impacts on the quality of education due to morbidity and funeral attendance. Moreover, the current Government policy of subsidizing funerals for staff and relatives results in virement away from essential items such as teaching materials. (Kadzamira et al, 2001). 3.17 Education is a key part of the fight a2ainst WIV/AIDS. There is a strong correlation between lack of education and HIV infection.I HIV/AIDS education is dealt with in both the primary and secondary curriculum though the impact on behavior change is partially limited by inadequate teacher training and AIDS related teaching material (Kadzamira et al, 2001). TRENDS IN EDUCATION EXPENDITURE 3.18 Public education spending has recently declined: Total education expenditure24 averaged around 5.5 percent of GDP between 1994-98 but has declined to around 3.7 percent of GDP between 1998-00, lower than the sub-Saharan African average of approximately 5 percent of GDP. As a share of the total budget, education spending rose from 13 percent in 1994/95 to 20 percent in 1997/98 but has declined back to 13 percent in 1999/00. 3.19 Government increased the share of education in the national recurrent budget from 10.5 percent in 1994/95 to 21 percent in 1997/98 but this has since declined to and estimated 16 percent in 1999/00 by 1999/00. As a share of the development budget education has declined from around 28 percent in 1994/95 to 9 percent in 1999/00 though this share has fluctuated significantly in line with lumpy donor disbursements. 22 Only 16 percent of urban poor households finished secondary school compared to 40 percent of non-poor urban households. 23 The 2000 Malawi Demographic and Health Survey shows that 50 percent of women with secondary education used a condom with a non-cohabiting partner while only 9 percent of women with no education did. 24 The sector includes primary, secondary, teacher training, university and technical education, MANEB, MIE, NLS, National Commission for UNESCO, administration, and other tertiary institutions. - 29 - 3.20 Shift towards primary education: The share of recurrent resources going to primary has risen from approximately 50 percent in 1993/94 to around 60 percent in 1999/00. The shares of secondary (around 10 percent) and tertiary education (around 18 percent) have changed little but significant declines in the share of teacher training and administration have taken place during this period (Chart 3.1). Chart 3.1 Recurrent Education expenditure by program 70 60 50 193901900 40 j 30 20 10 Primary Secondary Teacher training Administration Tertiary Other 3.21 The distribution of public primary and secondary recurrent expenditures has become more pro-poor. Table 3.1 presents the incidence of benefits from recurrent education spending across income quintiles (Al-Samarrai and Zaman, 2000). During the 1990s, the distribution of primary education expenditure across income quintiles has been reversed. The richest income quintile received 24 percent of the primary subsidy in 1990, and only 16 percent in 1997/98. The poorest 20 percent of the population, on the other hand, saw their share increase from 15 percent to 22 percent during this period. Similarly, the distribution of secondary spending has become more equal, benefiting the poorest groups more by the end of the decade, than at the beginning. However, over half of public secondary education expenditure still goes to the richest 40 percent and overall, public education expenditure is still benefiting the rich disproportionately.25 25 This is even more pronounced once the larger size of poorer households is taken into account. -30 - Box 3.1: The Budgetary Process in Education Budget preparation and execution One of the strengths of the budget preparation process in Malawi is that activity based budgeting has been institutionalized at the district level with each cost center producing their own budgets according to local priorities. This augurs well for the decentralization process. However, the numerous weaknesses overshadow this point: * Initial activity based estimates are typically in excess of the final ceiling, and they are not scaled down in order to fit the final ceiling. Budget revisions are done by line item and hence the link between the activity based budget and the line item budget which is derived from the final ceiling is broken. * Revision of budgetary estimates, following the submission of final ceilings, is often done in a very short span of time. As a result a transparent process of consulting within the Ministry, to re-prioritize activities is often not done. * Another key problem is the relative apathy within Ministry headquarters to produce activity based budgets as cost center managers believe there is little link with the actual budget they will receive during the year. Resources for headquarters are nominally allocated to cost centers but in practice managed centrally and used for the most urgent perceived need at the time. * Another serious problem in budget preparation is the separation of the recurrent and development budget compounded by an ineffective Budget Coordination Committee. * A key problem within education is that budget preparations are conducted separately by the Ministry of Education (primary, secondary and teacher education), the University of Malawi and other recipients of education subventions. In other words, strategic prioritization within the education sector as a whole does not take place. * Personal emoluments estimates are incorrect for two reasons. First, they are under-budgeted, because the budget system only permits posts that are already filled to be listed. Hence, vacancies that are filled during the year are not budgeted for. Secondly, there are significant lags between the Divisions sending an updated number of teachers and the payroll system recording these changes. Since the Ministry of Finance releases monthly cash allocations to the Education Divisions for teacher salaries based on the central payroll system the personal emoluments bill is inflated by this discrepancy. Budget monitoring: Education expenditure data needs to be reported on a monthly basis to the Ministry of Finance. While this is done on a timely basis, the quality of the returns are somewhat suspect as the ministry systems lack the checks and balances normally found in an accounting package. Secondly, these returns are produced on the basis of cost centers making it difficult to analyze expenditures by program. - 31 - Table 3.1 Incidence of Recurrent Education Expenditure by Income Quintile Household income quintile Poorest 20 2nd 3rd 4th Richest 20 percent percent 1997/98 All 16 19 19 20 26 Primary 23 22 21 19 16 Secondary 12 17 15 22 33 1990/91 All 10 13 16 24 38 Primary 15 18 20 23 24 Secondary 7 11 14 28 41 Sources: Al-Samarrai and Zainan Table 10 authors' calculations from IHS 1997/98 and MoE (1998), all other data from Castro-Leal (1996). Notes: All education data for 1997/98 refers to primary, secondary and university public education spending only. All education data for 1990/01 also includes other tertiary education (primary teacher education and technical training). 3.22 Share ofpersonal emoluments is highest in primary: Personal emoluments account for 86 percent of the primary budget on average, in contrast to secondary and teacher education (44 percent and 30 percent, respectively). Average salaries, at about four times GDP per capita, are close to regional norms.26 However, a frequent complaint is that teachers' pay and conditions of service are poorer than those in similar grades in the civil service (Government of Malawi, 2000b). 3.23 Teacher deployment patterns are inefficient: The qualified teacher-pupil ratio in primary ranges from 1:92 to 1:135 across the six education divisions. (Annex II Table 5). There are significant rural urban gaps in teacher deployment with female teachers predominantly found in urban areas (83 percent) compared to rural areas (33 percent). In secondary education, pupil teacher ratios are far lower in boarding and private schools than in Government day schools. Pupil-teacher ratios are 41 percent higher in Government day schools and most are untrained teachers. 3.24 Wide regional variations in public education expenditure and efficiency ratios at the primary level across the six education divisions, suggests there is scope for improved efficiency by re-allocating resources, particularly qualified teachers, across regions. Appendix Table 5 shows, for instance, that the Northern region achieves lower pupils/teacher ratios and lower number of pupils per classroom than the South Western region despite lower recurrent expenditure per pupil in primary. Similar disparities are found in secondary education (Appendix Table 6). 3.25 Unit costs at primary are comparatively low: Primary students receive far lower resource allocations per student than their counterparts at higher education levels. Even though there has been a relative shift towards primary spending in the recurrent budget, a secondary student in 26 The mean for a sample of 40 African countries between 1970 and 1990 was 3.2 (from UNESCO yearbooks). - 32 - 1999/00 was still eight times - and a university student 202 times - as expensive as a primary student. These ratios are much higher than regional norms.27 3.26 Primary pupils account for over 90 percent of total enrolment, but the share of ORT going to primary schools averages just 34 percent of total ORT expenditure. On average, over 1993-1999, government contribution for teaching and learning materials in primary was only $1 per student. Spending on primary school rehabilitation is also very low, with the highest recorded unit expenditure US$1.10 in 1999, or below the recommended annual maintenance norm of 2 percent of construction cost. 3.27 Expenditure on boarding itemns crowd out teaching and learning materials in the secondary sector: The proportion of government secondary school spending on salaries fell from 60 percent to 40 percent between 1993 and 1999. However, the other recurrent expenditures have not been redirected towards quality-enhancing components. Boarding has increased its share from 5 percent to 18 percent, while teaching and learning materials declined from 6 percent to 3 percent of the secondary budget during this period. Administrative expenses, utilities and other items account for 38 percent of the total in 1999. 3.28 Inequalities persist between public funding for conventional and community schools: Around three-fourths of day secondary schools received little or no non-salary public funding between 1998-00. In 2000/01 resources were allocated to inspection for day secondary schools. 3.29 Student-staff ratios are grossly inefficient at tertiary. Over half of the University of Malawi budget is spent on boarding and administration, around 35 percent on personal emoluments and the remainder on teaching and learning materials and maintenance. Student staff ratios are inefficient, with the student staff ratio at the College of Medicine of 1:1, being an extreme case. 3.30 Cost recovery through fees at secondary and university levels has been extremely low: While the higher public benefits from primary education are recognized, tertiary and secondary education - with their higher private returns - are heavily subsidized. The amount collected in boarding schools and university constituted a mere 1 percent of public expenditure at these levels. Official tuition, boarding and exam fees have not changed since 1997, although a secondary textbook fee was introduced in 2000. Moreover, the collection rate for fees is alarmingly low, at only 18 percent of expected revenue. 3.31 Recent changes are designed to improve cost recovery. As of January 2000, instructional materials for secondary levels are financed outside the budget through the textbook revolving fund. By contrast, collection of the newly introduced textbook fee - which is retained at school level - appears to be very high, possibly because the benefits of such fees are more readily apparent. Fees at the University of Malawi were raised sharply from MK1500 per student to 25,000; student protests succeeded in bringing it down from MK46000. Development Expenditure 3.32 Assessing project spending by only focusing on the development budget can be misleading. For instance, until 1998/99 primary education received the largest share of the development budget (around 85 percent) mainly for school construction. However, estimates for 27 In 1992/93, Kenya had primary: secondary: university ratios of 1: 3: 41, while Guinea had 1: 2: 58 in 1994/95 (Castro-Leal, 1996). - 33 - 1999/00 and 2000/01 indicate that secondary education expenditure has dramatically increased to over 60 percent of funds, compared to the 30 percent share now going to primary. 3.33 However off-budget aid still focuses on primary education. The education sector has a significant proportion of projects that are off budget although this proportion is gradually declining. The five main bilateral donors28 - whose expenditure are not recorded in the development budget - provided the equivalent of about 60 percent of the public development budget in 1999-00 and 54 percent in 2000-01. Bilateral donor funds are focused on primary and teacher education, so that despite the new emphasis on secondary education in the development budget, the primary program still receives the bulk of sector development expenditure (Annex II Table 7). The problem of off-budget donor expenditure is discussed in the context of other shortcomings with the budgetary process in education in Box 3.1. 3.34 Construction accounted on average for 58 percent of total development expenditure (over 70 percent in 1998). The second largest item, personal emoluments for project staff has fallen from a high of 33 percent in 1996-97 to 6 percent in 1999/00. After the introduction of free primary education, teaching and learning materials have averaged over 11 percent of development funds although provision has been erratic. Box 3.2: Moving towards decentralization in education Another major government theme is the decentralization of services and financing. It is envisaged that in education both recurrent and development expenditures will be channeled directly to as many education service providers as possible. In the long term, schools will become responsible for strategic management of public, donor and private funds, allowing head-teachers to adapt educational expenditure to the needs of their school. To ensure improvements in the effectiveness of public expenditure, transparent expenditure monitoring systems are needed at all levels of the education system. Administration has been deconcentrated: The Ministry of Education is structured with a headquarters, six education divisions, each responsible for six districts, within each of which there are nine zones. A Primary Education Advisor (PEA) attached to each zone is accountable for approximately 14 primary schools. At the secondary level, schools are now organized into clusters of ten. Funding goes directly from the treasury to the divisions. The universities, examination board, the curriculum development center, the national library service and the National Commission for UNESCO are also subvented directly. POLICY PRIORITIES 3.35 This section recommends policy priorities, in line with the Government's Policy Investment Framework (PIF) for education, to address the main issues emerging from the previous sections. These changes are split into three main groups (i) improving quality and efficiency of primary, day secondary and tertiary education (ii) increasing access at secondary and tertiary (iii) developing a strategy to mitigate the impact of HIV/AIDS in education. Improving Quality and Efficiency 3.36 The quality of education is constrained by a lack of trained teachers and by inadequate teaching and learning materials at primary and in day secondary schools. As such it is recommended that a larger share of resources go to primary education, teacher training and day 28 CIDA, DANIDA, DFID, KFW and USAID. - 34 - secondary schools. This would be achieved by a reduction in the share of secondary boarding schools, university education and administration. Improvements in the quality of education can be achieved by: * Increase teaching and learning materials allocation at primary targeting the UNESCO recommended norm of $5 per student. * Increase inspection visits to at least once a year. * Increase allocation for maintenance to recommended norm of 2 percent of construction cost every five years. * Increase the proportion of qualified teachers by instituting a teacher education and professional development program, that teacher training colleges are equipped with relevant instructional materials and providing upgrading opportunities for teachers without final secondary school certificates. 3.37 The efficiency of expenditures can be improved by: * Double-shifting with different teachers in each shift should be encouraged to reduce the pupil-classroom ratio and/or increase the number of pupils. The administrator-student ratio should be reduced at University level, to release resources for more direct learning activities. * Restructuring exams: The secondary examination system is expensive and ineffective. In 1999, the JCE exam costs MK226 per candidate, most pass, and it is assumed to be little more than a certificate of attendance. The MSCE, on the other hand, is very difficult to pass and costs MK645 per candidate. Replacing the JCE with an internal certificate, and reducing the number of subjects offered at MSCE would release resources without compromising the quality of assessment. Repetition is highest at standard eight, mainly because selection for secondary school is based on performance in the Primary School Leaving Certificate Exam (PSLCE). At present, this qualification has little value on the job market. One suggestion for reform is for secondary school clusters to develop their own aptitude test for entry into that cluster. * Improving teacher allocation and incentives: Wide variations in pupil-teacher ratios between standards, regions and different types of school mean that public resources are not being used efficiently or equitably. The most qualified primary teachers, also best equipped to handle large classes, should be assigned to the lower standards. At secondary level, there is an urgent need to upgrade the skills of the primary teachers who teach in the day secondary schools. The posting of teachers also needs to be decentralized, as poor information often leads to a mismatch between school requirements and teacher skills. In order to redress the urban bias in teacher postings, a 'rural allowance' can be introduced as part of the next salary review. It is estimated that this would add around 2 percent to the recurrent budget in primary education and is consistent with the suggested expenditure restructuring strategy in Table 1.5 (Government of Malawi, 2000c). * Reallocate resources from boarding schools to day secondary: The discrepancies in learning outcomes are affected by a bias against day secondary schools with regards to financial resources and teacher deployment. - 35 - Improving access to secondary and higher education 3.38 Increased access to higher education can be achieved by: * Promoting double-shifting in day secondary schools * Reducing drop-out at primary, restructuring PSLCE exams (see above) * Use of distance education programs at university. * Promoting the development of private higher education. * Introducing a bursary scheme for poor students. These measures can befinanced by: * Raise secondary fees to cover full boarding costs and 50 percent of non-salary expenditure. * 70 percent of students to pay fees at university (20 percent full fees and 50 percent subsidized fees). * Further privatization of services and income generating activities (consultancies, training, workshops). Mitigating the impact of HIV/AIDS in education 3.39 The policy recommendations to mitigate the impact of HIV/AIDS are: a Introduce life skills as a separate subject in the core curriculum into both primary and secondary education. This subject should be taught early, even at first grade in primary. Peer education programs, effective in other countries, are recommended. * Teacher training programs should mainstream HIV/AIDS issues in the curriculum. * School-community links need to be strengthened to reduce sexuality-related taboos. * Teacher absenteeism needs to be countered with a supply of flexible teaching covers such as voluntary teachers and teaching assistants. Tighter rules on funeral attendance need to be enacted and enforced. * Funeral benefits need to be scaled down so that expenditure on teaching inputs is not adversely affected. It is recommended that coffins and transport are only provided for Ministry employees and that a revolving fund be set up for funeral expenses for employees. Funeral costs can also be reduced by granting teachers who are ill permission to be transferred to their home districts. The current decentralization programs presents an opportunity for this to occur as District Education Offices will have responsibility for teacher recruitment. 3.40 In short, significant improvements in education in Malawi can be made through reallocating existing resources, dealing decisively with the impact of HIV/AIDS and by cost sharing with students, the community and the private sector. Targets will need to be adjusted depending on the extent of the resource reallocations, cost sharing and the availability of Government and donor financing. - 36 - 4. HEALTH INTRODUCTION 4.1 Malawi's general health indicators continue to be bleak, despite recent modest improvements.29 HIV/AIDS prevalence is now estimated to be 16 percent, and has become the leading cause of death for the working age group; half the children under-five are chronically malnourished; and nearly one-fourth of infants do not reach the age of five. Malaria is the main cause of death for children and second only to HIV/AIDS for adults. These poor indicators cannot be blamed entirely on low levels of spending as health expenditures have remained between 2-3 percent of GDP since 1994/95. Neighboring countries with similar per capita expenditures exhibit better health indicators (Table 1). The low correlation between health expenditures and outcomes is not unique to Malawi (Filmer et al, 2000) and is related to the poor effectiveness of health expenditures. 4.2 The chapter starts by providing the context behind Malawi's poor health outcomes. It then discusses the allocation and effectiveness of public expenditure in the health sector. The chapter concludes by suggesting a shift in priorities, based on basic principles of efficiency and equity of public expenditures combined with measures to improve human resources and access to drugs. KEY SECTOR ISSUES 4.3 The Ministry and Christian Health Association of Malawi (CIHAM) dominate the sector: The Ministry of Health and Population (MOHP) provides around 60 percent of health services and the remainder is largely provided by CHAM mission facilities. Other NGOs and private facilities provide around 3 percent of services. 4.4 Staffshortages, particularly in rural areas, are a major concern: A critical factor behind Malawi's poor health indicators is the serious shortage of medical, nursing, and related personnel, particularly in rural areas. For instance, the 2000 DHS shows that medically assisted deliveries are far higher in urban areas. Vacancy rates for these positions range from 33 percent to as much as 80 percent resulting in extremely high ratios of population to health personnel (Table 4.1). 30 Most districts lack a doctor, and even nurses are in extremely short supply. Around 90 percent of public health workers fall within the age range with the highest HIV/AIDS infection rate; hence attrition due to the disease is a serious problem. 4.5 Access to drugs, particularly in rural areas, is another key problem: Results from a recent household survey (Tsoka, 2000) indicate that the lack of drugs was the most important source of frustration by health-care seekers. Respondents stated that drug shortages were particularly acute in rural health centers, followed by district hospitals while they are generally available in hospitals. 29 The preliminary figures of the 2000 Demographic and Health Survey show that maternal and infant mortality rates have declined in the past five years. 30 A recent report on human resources in the health sector in Malawi illustrates the depth of the crisis: '..a 250 bed district hospital operating 3 eight hour shifts, 365 days of the year, needs a minimum nursing contingent of 150 nurses. No district hospital has more than twenty' (Government of Malawi, 2000f) - 37 - 4.6 Referral bypass, due to poor service delivery, is pervasive: The poor quality of primary care programs encourage patients to bypass local facilities in favor of central hospitals, making per capita outpatient attendance high, by regional standards.3' It is estimated that as much as 85 percent of central hospital admissions and an overwhelming number of outpatients could be treated at lower-level facilities. 4.7 Poor management and weak supervision contribute to poor quality of care: Poor patient management in hospitals and the lack of supervision of remote facilities accentuate the lack of human resources and medical supplies leading to overall poor service delivery. 4.8 The burden of disease is heavier on the poor: Loss of productivity and income due to morbidity and mortality has a greater impact on the poor. Moreover, household expenditures on malaria prevention and treatment are estimated to be around four times greater as a share of total expenditures for the poorest households compared to the 'average-income' household (World Bank, 1999). Table 4.1: Health Expenditures and Performance: a Regional Comparison ___________________________________________ |Malawi Kenya Tanzania Zambia Health expenditure as percent of GDP 2.2 0.8 2.0 Population per physician 45,737 21,970 n.a. 10,917 Life expectancy at birth in years 42.3 51 47 43 Infant mortality rate (per 1,000 live births) 104 76 85 113 Mortality rate under 5 (per 1,000 live births) 189 124 136 192 Source: World Development Indicators, World Bank. TRENDS IN PUBLIC HEALTH EXPENDITURE 4.9 Health spending has fluctuated little: Total health spending has averaged around 2.2 percent of GDP even though actual health spending in the development budget has consistently fallen significantly short of budgeted amounts (see Box 1.2). Slow donor disbursements are due to shortages in counterpart funds, weak administrative capacity within the Ministry and cumbersome donor procedures. 4.10 The budget breakdown by economic classification illustrates that goods and services occupy a larger share of the recurrent budget (75 percent in 2000/01) than in recent years (62 percent in 1998/99). On the surface, this appears to be a welcome development since the problem in most sub-Saharan countries has traditionally been the large wage bill crowding out expenditures for goods and services. However, the Malawi situation is largely due to the high attrition rates and the difficulties in filling posts in the health sector, which seriously constrain the government health system's ability to deliver services. 4.11 Expenditure breakdown by facility level understates the actual amount going to tertiary care: Budgetary data presented in table 4.2.disaggregates expenditures by facility level but the sizeable allocation for drugs is shown as 'headquarters expenditures'. As discussed earlier drugs are by and large only found in tertiary facilities so the extent of public subsidy towards tertiary care is understated in Table 4.2. The overall share of recurrent spending on primary health services is 18 percent of the recurrent health budget in 2000/01. The breakdown of development expenditures only partially captures total aid inflows to the health sector as a significant portion is 1 Average government hospital outpatient department attendance is two visits per year compared with only 0.9 per year in Tanzania (HERA, 1999). - 38 - off budget. However, this partial breakdown suggests that donor spending is increasingly being directed at the district level. 4.12 Drugs now occupy a sizeable part of the budget: The Government has steadily raised its contribution to drug expenditures and the per capita drug budget for 2000/01 is greater than the US$1.25 recommended for sub-Saharan African countries after including HIPC and donor funds. Table 4.2: Health Expenditures by Facility Level 1998/99 1999/00 2000/01 Percent of recurrent health expenditure Ministry headquarters and regional offices 56.6 37.7 51.8 Of which: Drugs 35.7 28.1 29.9 Additional HIPC resources on drugs 13.5 Preventive health service 9.1 0.9 0.6 Tertiary 1/ 17.8 13.9 12.8 District 25.5 48.3 35.4 Of which: Primary 3.9 26.0 18.4 Secondary 21.6 22.4 17.0 Percent of development health exnenditure Ministry headquarters and regional offices 51.1 32.8 Of which: Drugs 24.4 6.3 Preventive health service 4.0 6.9 Tertiary 1/ 21.3 9.8 District 27.6 57.4 Of which: Primary 5.9 13.1 Secondary 21.7 44.3 Memo item: Per capita expenditure on drugs (dollars) 2/ 1.1 1.3 Source: Budget, Various years. 1/ Includes Queen Elizabeth Hospital, Zomba Central Hospital, Zomba Mental Hospital, Lilongwe Central Hospital, Mzuzu Central Hospital 2/ Includes HIPC expenditure on drugs - 39 - Box 4.1: Moving Towards Decentralization In Health The decentralization process for the health sector will ultimately result in the transfer of responsibility for staffing decisions, the management of primary health facilities and communicable disease programs from the Ministry of Health to local authorities. The Ministry will remain as an oversight, supervisory and regulatory body. The timing of the transition from devolution to full decentralization of health services will depend crucially on building the requisite financial and technical capacity at the district assembly level. Various steps have been taken to facilitate the transition process. Regional Health Offices were abolished in 1999/00 and cost centers at the district level were established. However, the flow of funds is highly variable. Resources reaching district health offices vary significantly on a monthly basis, largely due to variations in Central Government cash flow. Monthly data on 'other recurrent transactions' releases from Treasury to four district health offices reveal striking variations - for instance, the allocation to Blantyre district tripled between September and October 1999 but dropped by 25 percent from March to April 2000. This lack of resource predictability is a serious constraint to budget execution. A District Implementation Planning process is underway, where districts are preparing to tailor activities according to their local priorities. This is part of the preparation of the 2001/02 budget submissions for each district. It is recommended that the 2001/02 budgetary allocations to district health offices are in part given according to the quality of the district plan. This will create the appropriate incentives so that the district planning process is viewed as an integral part of the transition to decentralization. Analysis of the 2000/01 district budgetary allocations suggests that poorer districts receive higher per capita allocation of public health funding (Boex et al, 2000). However, multivariate analysis also suggests that populous districts receive smaller allocations per capita and that the number of children in a district is not correlated with district allocations. Hence, the formula for district allocations may need to be refined during the forthcoming decentralization process to explicitly take into account population size and child health needs. POLICY PRIORITIES 4.13 The focus of Government expenditures on health should be based on redressing market failures by focusing on the provision of public goods and on areas with large externalities. Accordingly, priority should be given to key public health programs: immunization, safe motherhood, nutrition, prevention and control of H1V/AIDS; malaria, tuberculosis, diarrheal diseases. In many of these areas there are certain interventions that can be justified on both efficiency and equity grounds and others which merit public subsidies on one of these grounds. Malaria control is a good example. 4.14 Malaria control includes activities for which large externalities clearly exist (e.g. draining swamps) and hence public intervention is essential. On the other hand, the case for public subsidies for insecticide-treated mosquito nets (ITMN) and anti-malarial drugs is less clear as these are private goods. However, given the higher burden of disease among the poor and the fact that ITM coverage is particularly low among the poor (DHS, 2000), public subsidies on these items can be justified on equity grounds. - 40 - 4.15 Another essential role of the State is to promote good hygiene and sanitation practices due to their close association with health status. Hence collaboration between the Ministries of Health, Education and Water is crucial to improve health outcomes. 4.16 Aside from focusing on the right programs, the Government can improve the effectiveness of health expenditures by taking a number of short and medium term actions. These include re-prioritizing the National Health Plan, improving the efficiency of drug expenditures, making greater use of CHAM as a provider of health services, implementing cost recovery measures and undertaking measures to improve the availability of health personnel in rural areas. Reprioritize National Health Plan 4.17 An analysis of Malawi's National Health Plan (NHP) for 1999-2004 reveals a number of problems: Over-ambitious outcome targets: Given the five-year timeframe and available resources, the Plan's service coverage and program targets (e.g., halving the maternal mortality ratio, 50 percent reduction in HIV prevalence, and 50 percent reduction in childhood malnutrition) are clearly not feasible. Unrealistic costing and resource estimates: The NHP's projected resource envelope for the health sector is seriously over-estimated (see Government of Malawi 2000 for details). Using more realistic resource envelope estimates yield a funding gap of between $256 - $316 million over five years. * Inconsistent output targets: While the NHP's stated objective is to improve primary health care, its facility targets are biased towards hospitals. The NHP's excessive focus on capital investments is made worse by the fact that staffing and other recurrent expenditure estimates were prepared independent of new facility projections. 4.18 For the above reasons, the NHP needs to be re-prioritized and properly costed before it can become the basis for a sector investment program. Moreover, it is also essential that the quality of program classification is improved in order to be able to assess whether health expenditures are focused on the above mentioned priority programmes. Strengthen Drug Policy, Procurement and Distribution 4.19 The financial allocation to drugs in the budget, particularly when donor contributions are included, is not far short of best practice standards (see Table 4.2). Yet, access to drugs in government facilities, especially rural health centers, is a serious problem, as discussed in section II. The effectiveness of drug expenditures is seriously constrained by weaknesses in drug procurement, storage and distribution by the Central Medical Stores and pilfering and inappropriate usage by public health providers. Any increases in government drug expenditures need to be planned in line with donor drug expenditures and with the reform of the Central Medical Stores (CMS). - 41 - 4.20 The CMS restructuring process aims to establish CMS as an autonomous Trust engaged in need-based drug procurement and a strong management information system that ensures equitable and timely distribution. This will require revision and adherence to an Essential Drug List, adoption of a cash-limited system to ensure payment, reduction of overruns in hospital drug budgets by imposing tighter cost controls. Cost sharing for drugs needs to be expanded in light of the positive experience with the 1200 community-based drug revolving funds in Malawi. Implement cost sharing measures 4.21 Discussions about cost-sharing programs have been ongoing since the 1980s, but Malawi has yet to develop a comprehensive, national cost-sharing policy that has strong political support. Currently, tertiary hospitals and a few district hospitals are the only facilities charging fees but fee structures and health services that are charged are determined on an ad-hoc basis. For example, at Queen Elizabeth Central Hospital, cost sharing revenues only constitute 5 percent of total hospital expenditure (Gausi et al, 1999), compared to around 15 percent in Kenya and Tanzania. Few are covered by health insurance and hence many who use hospital services cannot pay the entire cost of specialized services. However there are services that can operate on a full cost recovery basis such as the use of private rooms while the poor are likely to self-select themselves into general wards. 4.22 CHAM facilities already generate as much as a third of their revenues from fees, and the success of community-based drug revolving funds illustrates the willingness to pay for quality services (see Franco-Miller 1995). The poor can be protected through fee exemptions for specific services (such as maternal and child health), through demographic targeting, or through community waiver programs organized along community health or other social funds. 4.23 Increased cost recovery in higher-level health facilities should be accompanied by greater autonomy. The National Health Plan has committed to granting autonomy to two of Malawi's tertiary hospitals.32 Decisions on which services to provide and the required skill mix, the appointment of hospital boards and legislative action to formalize this decision are essential next steps. Public funding-private provision: the case for expanding the role of CRAM 4.24 After the Ministry of Health, CHAM is the other major provider of health services in Malawi. A subvention from the Government pays for the salary costs of CHAM health workers. This subvention has increased from 0.7 percent of health recurrent spending in 1997 to 5.2 percent in 2000. All CHAM facilities charge fees that are set at the local level by independent committees. 4.25 Cost effectiveness of CHIAM is higher than Governmentfacilities. A household survey on user satisfaction suggests that the quality of care in CHAM is more effective and faster than those provided by equivalent Govemment hospitals (Tsoka, 2000), notwithstanding the fact that CHAM facilities also suffer from shortages of medical personnel and drugs (Nkhoma, et al, 2000). Moreover, since the unit costs of health care services in CHAM facilities are similar to Government facilities (KPMG, 1999), CHAM facilities appear to be more cost-effective. 32 Queen Elizabeth Central Hospital and Lilongwe Central Hospital - 42 - 4.26 In view of this the Government should consider (a) increasing the subvention to CHAM (b) introducing explicit service contracts with CHAM (c) formally designating CHAM facilities as district hospitals in areas where there are no such government hospitals, and (d) closely coordinating policy decisions, including health facility construction, with CHAM. Alleviate Human Resource Shortages 4.27 The shortage of critical health personnel, particularly in rural areas, is a key factor in poor service delivery and health outcomes. Hence the two problems that need to be addressed are the absolute numbers of medical personnel and their deployment. This is arguably the most difficult challenge the Government faces. 4.28 A key factor behind difficulties in recruiting and deploying medical personnel is low pay. Extending the Government's performance contracting scheme to health personnel would be an important step towards improving pay and incentives in the health sector once appropriate appraisal systems and safeguards have been developed (see Chapter 2). Additional incentives are required to deploy health workers in remote, rural areas. Accordingly, the Ministry of Health ought to make provisions for housing and additional allowances for rural postings. It is recommended that a clear deployment policy that takes into account the phased decentralization of health services is developed in order to improve the availability of health personnel in rural areas. 4.29 A human resources strategy has been developed to improve the output, retention and deployment of critical health personnel. The Ministry of Health can begin implementation of the strategy from its own resources by using expenditure savings generated from reducing nonessential programs and staff. Donor financing could supplement the financing once clear Government commitment is shown towards this strategy. In view of the fact that one of the HIPC completion point triggers calls for an increase in the numbers of nurses, medical assistants and radiography technicians, the Ministry of Health would be justified in using additional resources freed up due to HIPC debt relief for recruiting additional staff and offering appropriate incentives to retain them. 43 - 5. AGRICULTURE INTRODUCTION 5.1 The agricultural sector in Malawi is the mainstay of the economy accounting for about 37 percent of GDP, 90 percent of exports and 85 percent of employment. Maize is the major staple food crop, grown on around 60 percent of the total cropped area, with tobacco the main export crop. 5.2 Agriculture in Malawi is characterized by subsistence farming on small land holdings33 along with an estate sector where around half a million households work. The sector suffers from low productivity, declining soil fertility and shortages of key agricultural inputs for resource-poor farmers. 5.3 This chapter focuses on the activities of the Ministry of Agriculture and Irrigation as well as the dominant parastatal,34 the Agricultural Development and Marketing Corporation (ADMARC). It starts by discussing key sector issues, moves onto examining expenditure trends and concludes by discussing policy priorities. KEY SECTOR ISSUES 5.4 The Ministry operates through eight Agricultural Development Divisions (ADDs) covering the whole country. These are subdivided into 30 Rural Development Projects (RDPs) and 146 Extension Planning Areas (EPAs). Agricultural research is conducted at 10 stations. 5.5 ADMARC is actively engaged in the marketing and storage of most crops though its share of the market has declined in recent years. ADMARC has had an important role in the sector through maize price interventions, although its safety net function has now been transferred to the National Food Reserve Agency (NFRA). 5.6 Liberalization of input and output markets took place in mid 1990s: The market for seeds and fertilizer was progressively liberalized and restrictions on smallholder production of burley tobacco lifted in the mid-1990s. This resulted in a five-fold increase in smallholder output between 1995 and 1999. 5.7 Maize production andfertilizer use is correlated with poverty status: Household survey results show that the poorest households concentrate on local maize cultivation in contrast to wealthier rural households who produce hybrid maize along with other crops.35 The main reason 33 There are three categories of land resources in Malawi: (i) Approximately 2 million smallholder households live on about 6 million hectares of customary land allocated to them by village headmen and traditional authorities. About 60 percent of these households cultivate less than one hectare of land. (ii) Over half a million people work on 1.2 million hectares of land under estate tenure (either leasehold or freehold) and (iii), there are about 1.8 million hectares of public land are reserved for parks, urban areas and other purposes. 34 The NFRA, the Smallholder Farmers' Fertiliser Revolving Fund of Malawi (SFFRFM) and various Crop Authorities (tobacco, tea, coffee, sugar) are also part of the agricultural sector. 35 Only 26 percent of the poorest rural quintile cultivates hybrid maize whilst 42 percent of the richest rural quintile does (National Economic Council, 2000). - 44 - for this sharp difference is the high cost of fertilizer that results from high transport and freight costs and the small size of import orders. 5.8 Public intervention in input markets persists: The Government launched a program of universal free distribution of seeds and fertilizer for two years between 1998-00 known as the 'Starter Pack' program.36 A key reason for donor support to this program was on the grounds that it would promote crop diversification and partially redress the trend in declining soil fertility. 5.9 Evaluation reports indicate that the benefits of the Starter Pack was about 50 percent greater than the input costs, but the main drawback was that as a universal program over half of the transfers went to the non-poor. A more targeted scaled down version was implemented in 2000/01. 5.10 Food security concerns result in intervention also in output markets. In response to food security concerns, the NFRA was created in 1999 as an autonomous body, to act as a strategic grain reserve. The Government has recently amended the Trust Deed of the NFRA to narrow its mandate from one of being engaged in stabilization of maize prices to being exclusively engaged in disaster and relief operations. 5.11 Access to creditfor smallholders remains a major problem: Commercial banks view rural lending as largely unprofitable and the non-banking sector led by the Malawi Rural Finance Company has a limited outreach. The sharp decline in the Kwacha has also adversely affected loan recovery as much of the loans went to finance fertilizer inputs. TRENDS IN AGRICULTURE EXPENDITURE 5.12 Table 5.1 shows that the share of total agricultural expenditure in GDP rose from 0.9 percent of GDP in 1995/96 to a revised estimate of 1.8 percent in 1999/00. This is due to a rise in development expenditure from 0.3 percent of GDP in 1995/96 to 1.3 percent in 1999/00, partly to finance the Starter Pack and partly due to the greater recording of off-budget aid. 5.13 Administration occupies a signif icant share of the Budget and in recent years has raised its share during the course of a year. For instance in 1999/00 the budgeted share of Administration in the total budget was 53 percent while the revised estimate share rose up to 70 percent. 5.14 The share of Headquarters expenditure is high but projected to fall: In 1999/00, both the budgeted and estimated recurrent expenditures at Headquarters was 44 percent of recurrent expenditures but the budgeted allocation for 2000/01 fell to 32 percent. The centralized nature of the Ministries operations leads to a high share of ORT expenditures going to internal travel due to meetings at headquarters and supervision visits from headquarters. 5.15 However donor financing is mainly channeled through headquarters: The development budget is primarily donor financed and most projects funds go through headquarters. The development budget finances many recurrent costs; for instance an examination of the Dedza Hills RDP accounts reveals that 19 out of 28 line items are financed both in the recurrent and development accounts (Deloitte and Touche, 2000). 36 The Starter Pack Scheme in 1998 and 1999 consisted of free distribution of a pack of 10 kg of fertilizer and 10 kg of (mostly maize) seed, to some 2.8 million households in all areas of the country. - 45 - 5.16 Direct subventions to lower tiers of the Ministry have increased in the recurrent budget: The share of the thirty RDPs has increased from 11 percent in 1999/00 to 35 percent of the recurrent budget in 2000/01. The higher share is at the expense of the eight ADDs, whose share of the recurrent budget fell from 45 percent in 1999/00 to 20 percent in 2000/01, and a smaller share for headquarters. 5.17 Share of wage bill is declining: The wage bill averaged around 70 percent of recurrent expenditures between 1991/92-1996/97 but is progressively falling. In 1997/98 the wage bill was 56 percent of recurrent expenditures and in 2000/01 the budgeted amount for wages was 47 percent of budgeted recurrent spending. This decline is primarily a result of staff attrition, accelerated by HIV/AIDS. Public salaries are low; NGOs pay their extension agents about three times the government level. 5.18 Share of research has declined in the agriculture budget: Public spending on agricultural research in Malawi averaged around 0.1 percent of GDP between 1995-00, well below international norms (around 0.5 percent of GDP in low-income countries). However, Malawi is in a position to adapt research findings from its neighbors, whose soil and meteorological conditions are similar. 5.19 Research typically has a strong case for being considered a public good, particularly in the case of low-value domestic crops as the incentive for private sector investment in this research is inefficiently low. In high-value or export-oriented crops, private research is taking place in Malawi, e.g. for tobacco and tea.37 Around 40 percent of publicly funded research is contracted out and several research stations have shut down recently. However, the research program is generally still not considered demand driven and hence not responsive to farmer needs. Thus far annual meetings which select research projects have had limited success in transmitting priorities identified by extension staff into the research agenda (World Bank 2000). 5.20 Spending on extension services by the Government has declined significantly (from around 0.6 percent of GDP in 1995/96 to 0.3 percent in 2000/01), particularly due to cutbacks in the recurrent budget. Part of the explanation in the decline in extension spending over the last two years is related to the implementation of the nationwide Starter Pack scheme in which extension agents played a key role. 5.21 The quality of extension is constrained by several factors: (i) Shortage of fuel and maintenance funds for transport and the lack of demonstration materials, though donor financing of these recurrent costs is common. (ii) Extension agents lack the technical skills for delivering messages effectively. Outdated methods of technology transfer are being applied by field staff who have not had the opportunity for in-service training and skill upgrading. (iii) Low staff incentives due to low salaries, lack of resources and poor performance monitoring has contributed to the poor quality of service delivery. Poor morale is also the result of headquarters staff taking a disproportionate allocation of training opportunities and operating expenses (World Bank, 2000). 37 Research on high-value cash crops, particularly export crops, by contrast, is a private good because associations of producers are already organized and can cheaply impose levies to fund research efforts. There is no problem of "nonexcludability". Private research is conducted by the Agricultural Research and Extension Trust for tobacco and by the Tea Research Foundation of Central Africa. - 46 - Table 5.1 Recurrent and development expenditure on agriculture (Percent of GDP) 1995/96 1997/98 1999/00 2000/01 Recurrent 0.62 0.75 0.55 0.56 Research 0.08 0.08 0.06 0.05 Extension 0.38 0.45 0.06 0.14 Livestock 0.07 0.08 0.06 0.06 Irrigation 0.02 0.03 0.02 0.02 Administation and general 0.07 0.11 0.35 0.28 Of which: starter pack 0.00 0.00 0.04 0.16 Development 0.3 0.4 1.3 0.9 Research 0.03 0.05 0.04 0.00 Extension 0.17 0.16 0.10 0.11 Livestock 0.02 0.00 0.06 0.06 Irrigation 0.03 0.06 0.13 0.09 Administation and general 0.08 0.09 0.92 0.65 Of which: starter pack 0.00 0.00 0.21 0.00 Total 0.9 1.1 1.8 1.5 Research 0.11 0.13 0.10 0.05 Extension 0.55 0.61 0.17 0.25 Livestock 0.09 0.08 0.12 0.13 Irrigation 0.05 0.09 0.15 0.11 Administation and general 0.16 0.20 1.27 0.93 5.22 Research and extension partnerships with NGO 's have worked: During the 1 990s Malawi experienced a root crop revolution as the output of cassava and sweet potato increased by 519 percent and 1,670 percent respectively. This was to a large extent the result of strong linkages between researchers, multiplication stations, NGOs, and farmers. The benefits of increased productivity have been widely spread; cultivation of these crops does not require fertilizer so even the poorest farmers are able to benefit. 5.23 The irrigation program has benefited from a sharp rise in public spending: Between 1995/96 and 1999/00, total spending on irrigation tripled from 0.05 percent of GDP to 0.15 percent. This is justified by the fact that only around 15-20 percent of Malawi's farming land is covered by irrigation, mainly in the estate sector and the high risk nature of rain-fed farming results in an unmet demand for irrigation. The customary land tenure system is a key constraint to private investments in irrigation due to the lack of security to land access. 5.24 Spending on the livestock sector has remained broadly constant: As a share of GDP total spending on the livestock sector has remained around 0.1 percent of GDP. The main public good role of the Ministry is disease surveillance and control, regulating livestock import and exports and registering veterinary drugs. These functions are around 60 percent of the livestock budget. - 47 - Other activities, such as artificial insemination, clinical diagnosis and treatment and drug production are largely private goods. Table 5.2: Maize subsidy, 1994/95 to 1999/00 (percent of GDP) 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 I Maize subsidy 6.6 1.2 0.0 1.6 1.8 0.3 Source: IMF 5.1 The Budget pays a significant price for maize price subsidies: The lower-than-market consumer price subsidy for maize and the cost of purchasing maize for emergency reserves was 1.8 percent of GDP in 1998/99 and 0.3 percent of GDP in 1999/00. The Government has recently agreed to refrain from costly maize price stabilization activities and instead channel resources through a more cost-effective national safety net program. Box 5.1: The Budget Process in the Ministry of Agriculture The Ministry has been active in restructuring its financial system. Until 1997/98, recurrent budget payments were made from Treasury to the Ministry, which then distributed them to the ADDs and other programs at its discretion. In order to limit the leakage and permit greater rationality in funding, Treasury decided from 1998/99 to make recurrent account payments to the ADDs as a line item. In 1999/2000 it extended this to include RDPs. A recent review of the budgeting process within the Ministry has identified the following weaknesses: Budget formulation: (i) Late ceilings from Treasury leads to RDPs being excluded from the process of producing revised budgetary submission; (ii) unrealistic estimates of budget ceilings lead to significant differences between approved budget and original estimates; (iii) the Ministry's activities do not take into account agricultural activities of parastatals and NGOs; Budget execution: (i) Budget approval is often given after the fiscal year begins which is when RDPs typically become aware of significant reductions in their original estimates (ii) Treasury funding is not based on submitted projected cash flows which take into account seasonality in agriculture; (iii) RDPs have little control over the funds allocated to them by ADDs; (iv) expected donor reimbursements are often processed very slowly, leading to delays in work plan implementation. - 48 - POLICY PRIORITIES 5.25 The State can play an important role in stimulating agricultural development by focusing its role on areas where large externalities exist. The Ministry of Agriculture and Irrigation should therefore focus on enforcing regulations, disseminating relevant information and ensuring that the relevant infrastructure for private sector development exists. The Ministry also needs to accelerate the pace at which the provision of extension services, research and irrigation is transferred from the Ministry to community groups, farmers and the private sector. As part of a more focused role of the State, ADMARC needs to be privatized. The decentralization process is also a major opportunity to improve service delivery. These changes are explored in more depth in this section. 5.26 Using decentralization as an opportunity to improve service delivery: As the Ministry moves from deconcentration to decentralization, the main change will be in the role of the eight ADDs as they represent an intermediary role between Central Government and district assemblies. The technical specialists who currently work in the ADDs could leave the Ministry and work as private providers of their services or move to the District Assemblies. The headquarters and ADD's role in financial management also need to be transferred to the District Assemblies though clarity on salary levels and functional responsibilities is needed. (NIBR / University of Malawi, 2000). Since these decisions and detailed implementation arrangements will take time it is recommended that Treasury raise the share of resources going directly to RDPs by reducing the share of headquarters and ADDs. This will immediately contribute to improving the financial constraints to improved service delivery and reduce the donor share of recurrent expenditures. 5.27 Introduce a pluralistic extension system relying on (i) private funding and delivery (e.g. through agribusiness and farmer associations) in the case of "excludable" services, and (ii) public funding where there are market failures, with private subcontracted provision in order to raise service standards. As part of this the Ministry should accelerate the use of demand-driven approaches, increased farmer-to-farmer contact and the application of cost-recovery for large- scale tobacco growers to increase extension effectiveness. The 'root crop revolution' shows that successful research and extension efforts result when strong linkages are built between farmers, extension officers, NGOs, and scientists. 5.28 Increase the dissemination of marketing information through extension agents. Currently extension messages are 'production focused' and there is little discussion on how to access markets. However, market information should also be demand driven on the basis of a partnership between Government and the private sector and it is recommended that the collection of crop production data be contracted out in order to focus the role of extension agents. 5.29 Improving agricultural research: The main recommendation for agricultural research is that the budgetary allocation ought to remain unchanged but that the proportion of research contracted out should increase from the current 40 percent to 100 percent. However, the effectiveness of research needs to be improved by developing a demand-driven research agenda, focusing on low value domestic crops where the incentives for private sector driven research are low. Complementary programs of multiplication and distribution of seed material with NGO and private sector assistance are also critical to improving the effectiveness of research expenditures. 5.30 Refocusing the Ministry's role in irrigation: The role of the State in irrigatior should be in providing the necessary infrastructure (electricity and roads) for private provision as well as the - 49 - necessary water-related regulation38 and irrigation information. The Government can improve the performance of irrigation schemes through a variety of measures, including transfer of existing schemes to beneficiaries, decentralizing irrigation activities to RDP's and contracting out to NGOs and producer organizations. 5.31 Limiting the Ministry's role in livestock: The Ministry must focus entirely on disease surveillance and control, regulating livestock import and exports, registering veterinary drugs and other pure public good functions. It should contract out activities such as artificial insemination, clinical diagnosis and treatment and drug production to the private sector. 5.32 ADAMRC privatization: In order to implement the Government's policy of encouraging private markets it is important that all profitable operations of ADMARC be privatized. In rural areas where both the private sector and ADMARC find it unprofitable to operate, the Government can consider providing special incentives to promote the operation of markets. However in order for ADMARC privatization to move from rhetoric to reality a process of consultation and discussion with key stakeholders needs to be conducted so as to generate the requisite political momentum for change. 5.33 Policy consistency: This is particularly important in strengthening the role of the private sector in input supply. The partial reversal of the liberalization policies of the early 1990s discourages private suppliers from making the long-term investments required to reduce the cost of inputs. 33 Regulation would need to be done by a combination of the Ministry of the Agriculture and Irrigation, the Ministry of Water Development, the Department of Environmental Affairs and the Water Resources Board. - 50 - 6. ROADS INTRODUCTION 6.1 Malawi's overall road network is broadly in line with regional norms, at 127 km per 1000 square km. However its rural network is below the regional average. Malawi's rural network is around 47 percent of its total network while the Southern Africa Development Community (SADC) average is 58 percent. 6.2 Malawi continues to have one of the worst road safety records in the world with an estimated 220 deaths per 10000 vehicles, around eight times more than the regional average. Investment in road maintenance is one of the most cost-effective ways of reducing transport costs39 and improving road safety. 6.3 The establishment of the Road Fund under the auspices of a newly created National Roads Authority (NRA) in 1998 was designed to restore adequate resources to road maintenance. This chapter describes the current state of the road sector in Malawi, assesses public expenditure trends, describes the transition to the NRA and suggests policy priorities. KEY SECTOR ISSUES 6.4 Road maintenance was neglected in the early 1990s: The percentage of paved roads has increased over time from 15 percent in 1980 to around 21 percent currently. However, the conditions of the road network have deteriorated in the 1990s, as maintenance did not keep pace with the increasing average age of the network and regulations on axle loads were not enforced. Latest estimates suggest that the percentage of all roads in good, fair and poor conditions is approximately 10 percent, 65 percent and 25 percent respectively. 6.5 The NRA was set up to restore adequate maintenance levels: The NRA Act (1997) provides the legislative framework behind the creation of the NRA. The NRA was made operational in July 1998 and funded a limited routine maintenance program, taking over from the Ministry of Works and Supplies. 6.6 The Road Fund finances routine maintenance: A Road Fund was set up with the objectives of financing the cost of maintaining public roads, sharing in the cost of maintaining other roads, contributing to the cost of donor-funded rehabilitation or development programs and administering the NRA (See Box 6.1 for more details on the NRA and the Road Fund). The main resource for the Road Fund is the fuel levy through which routine maintenance is funded. Periodic maintenance, rehabilitation and new construction are funded mainly by donors. 6.7 Road maintenance has been contracted out to the private sector since 1995/96 on a road- by-road yearly contract basis. However, no roads have been concessioned to the private sector for 39Estimates suggest that a hypothetical 10 percent increase in fuel price (from an increase in fuel levy) would increase operating costs of cars by 1.5 percent and of light commercial vehicles by 2.2 percent, but as the increment is to be ploughed into maintenance this would reduce overall vehicle operating costs respectively by 5.4 percent and 9 percent (i.e. 3: 1 benefit: cost ratio). - 51 - long-term maintenance and operation, in contrast to Zambia, which has around 200-300 km of roads on a long-term maintenance contract. Box 6.1: The National Roads Authority and the Road Fund Earlier examples of road funds ('first generation road funds') were discredited for poor financial management practices, mis-use of resources and the allocative inefficiency associated with 'earmarking' (i.e. using general tax revenue to 'ring-fence' the road sector). In the 1990's Road Funds have been established in several countries incorporating the lessons from earlier mistakes. Malawi's Road Fund has most of the features of 'second generation' road funds namely (i) more than half its board represent road users and the business community (ii) only road user charges are used for financing maintenance activities (iii) charges are adjusted regularly to meet agreed expenditure targets. The NRA main board has thirteen members comprising of representatives of road users, farming interests, the business community, Local Govermnent and the National Road Safety Council, the Ministries of Transport and Public Works. This public-private partnership has a sub-committee that manages the Road Fund. The primary resource of the Road Fund is the fuel levy collected by the Petroleum Control Commission (PCC). The only other source of funding identified for backlog maintenance is a one-off contribution from the European Union. Overall, the NRA has benefited from clear, speedy procedures for crediting revenues into the Road Fund account and finds have been credited within 45 days of receipt by PCC. The levy has become an element of the wholesale fuel price structure. Initially set in line with the estimated cost of damage to the road network caused by different vehicles, the levy has been revised upwards several times; in November 2000 it was raised to 3.75 kwacha per liter ($0.5 cents). PUBLIC EXPENDITURE TRENDS 6.8 Actual spending on maintenance less than budgeted amounts: Total road sector expenditures rose from 0.9 percent of GDP in 1996/97 to 1.9 percent of GDP in 1999/00 (Table 6.1). Routine maintenance expenditures have increased from an average of 0.2 percent of GDP between 1994-97 to around 0.5 percent of GDP since the formation of the NRA in 1998. However as table 6.1 shows despite these improvements, actual expenditure on routine maintenance over the past two years has still fallen short of budgeted amounts. Clearly, current Road Fund revenues are insufficient even from the minimum amount of routine maintenance required. 6.9 There is now a better balance between routine maintenance, periodic maintenance, rehabilitation and construction: New road construction takes up about 40 percent of total road sector expenditures while routine maintenance is around 35 percent of the total. Around 19 percent of the road budget is spent on periodic maintenance and 6 percent on rehabilitation. The ratio of capital to maintenance spending has come down from 6.4 in 1995/96 to 3.7 in 1999/00. 6.10 Even routine maintenance has a significant donor funded component: While the Road Fund is meant to finance recurrent expenditures in the road sector, in 1999/00 the European Union financed almost half of these costs, primarily for backlog maintenance. The 2000/01 NRA Budget estimates that the fuel levy and road user charges combined will contribute almost three- fourths of NRA revenues for routine maintenance. - 52 - 6.11 Emergency repairs occupy a sizeable share of the budget: In 1999/00, 17 percent of the NRA budget was kept for 'washaways' to be used in the immediate aftermath of a flood and around 6 percent of the budget was spent for this purpose. Other non-budgeted 'VIP' works occupied around 3 percent of the NRA recurrent budget and they were the most expensive contracts per kilometer of work completed. 6.12 Expenditure on rural roads is inadequate: Road projects focus on the core network to the detriment of rural roads. For instance even though 23 percent of all roads are district roads, only 14 percent of the roads maintained in 1999/2000 are district roads. The traffic volume based formula used for prioritizing road sector expenditures leads to a rural bias where traffic volumes are high. Table 6.1: Road sector expenditures, 1994/95 to 2000/01 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01 Millions of Kwacha Recurrent 27 32 87 84.1 331 375 780 Development 477 205 320 337 430 1400 1900 Total 504 237 407 421 761 1775 2680 Percent of GDP Recurrent 0.19 0.13 0.24 0.19 0.49 0.41 0.68 Development 3.41 0.81 0.88 0.76 0.64 1.53 1.67 Total 3.60 0.94 1.12 0.95 1.14 1.94 2.35 Source: IMF and budget books I. Figures for 2000/01 are budgeted. 2. In 1999/00, actual recurrent expenditure was K375 million compared to budget estimates of K420 million. 3. In 1997/98, actual recurrent expenditure was K84 million compared to budget estimates of K140 million. 4. In 1996/97, actual recurrent expenditure was K87.4 million compared to budget estimates of K140 million. POLICY PRIORITIES 6.13 The NRA has developed a medium term program designed to improve access to the road network, reduce overall transport costs and improve road safety. To fulfill these objectives, the NRA needs to focus on the following key areas: 6.14 Clear backlog maintenance using available donor funds: There is a significant backlog of routine and periodic maintenance on the core network and donor funds have been earmarked to clearing this backlog. NRA ought to focus on completing these projects in order to restore the network to its 'steady state.' 6.15 Fully fund routine maintenance for the core network40 by 2001/02 and the full public road network by 2003/04. Minimum targets for Road Fund revenues and hence routine maintenance expenditures have also been set4' on the basis of these objectives. 6.16 Increase the domestic contribution to road sector expenditures: As shown by table 6.1, the volume of resources for the road sector has increased sharply in recent years, but it still 40 The core network in Malawi is defined as that carrying more than 30 vehicles/day and is 7,200 km. 41 Annual targets of 9.5, 12.0, 12.9, 13.8 and 15.3 million dollars between 1999/00 and 2003/2004. - 53 - remains well below the level required to meet sector targets.42 In order to reduce this funding gap the Government has the following options: (a) Raise the fuel levy in order to ensure that the 2001/02 Road Fund target of $12.8 million dollars is met. (b) (ii) Raise other road users charges (e.g. vehicle service licenses, transit tolls, parking charges) and ensure a timely flow of funds to the Road Fund. (c) (iii) Use HIPC resources on road maintenance and on increasing the domestic contribution to the rehabilitation and construction of rural feeder roads. 6.17 Introduce multi-criteria analysis in order to improve rural access: The core network43 definition is currently biased against rural networks and needs to be revised to take into account socio-economic factors. The more broad-based formula ought to include accessibility to markets, schools and health centers the economic prospects of the area as well as traditional traffic volume criteria. 6.18 Develop rural feeder roads program jointly with MASAF and District Assemblies: NRA needs to transfer the responsibility for rural road planning and management to the District Assemblies. These District Assemblies will need to closely integrate MASAF and the community in jointly prioritizing rural roads. The PRSP process is currently setting targets for the number of feeder roads that need to be developed and its associated costs. 6.19 Stimulate greater private sector participation by taking steps towards road concessioning: In order to provide the appropriate legal framework for private sector participation the Government should amend the Road Act as part of which a concession agreed during a term of office would not subsequently be revoked with a change in regime. Discussions with potential concessionaires should begin after NRA identifies a list of the roads to be concessioned. 42 Projected development expenditure over the next five years will be sufficient neither to complete the rehabilitation of the network and nor to fully finance upgrading. In order to meet the goal of 50 percent of all roads in good condition and 30 percent in fair condition by 2005, about 6000 kilometers of road would need to be periodically maintained and about 1500 kilometers of road would need to be subject to rehabilitation. 43 This is currently defined as roads carrying more than 30 vehicles per day. Many rural roads fall below this threshold but actually have a much higher volume of person-journeys using the infrastructure i.e. higher usage of public transport, higher number ofjourneys by foot or by non-motorized transport. - 54 - 7. PENSIONS INTRODUCTION 7.1 The payment of public pensions is made directly from the budget (see Table 1.3) with no contributions from civil servants and none from the Government towards a pension fund. The current system is one of defined benefits; i.e. the benefits that will accrue to employees are defined in advance, following rules set out in the Service Regulations. The present system provides for pensions (monthly installments), gratuities upon retirement (part of the pension commuted to a lump sum payment) and death gratuities.4 7.2 This chapter builds on the discussion in Chapter 1 on the growing fiscal burden of pensions and gratuities and discusses various options for reform. TRENDS IN PENSIONS AND GRATUITIES EXPENDITURE 7.3 Overall, expenditures on pensions and gratuities have increased sharply in relation to GDP, the overall recurrent budget, and to expenditure on wages and salaries. As shown in Chart 7.1, the share of pensions and gratuities doubled from 0.8 percent of GDP in 1994/95 to 1.7 percent of GDP in 1999/00.45 Accordingly, their weight in the recurrent budget increased almost fourfold, from 2.5 percent in 1994/95 to 9.3 percent in 1999/00. Pensions and gratuities increased from 11.6 percent of the total wage and salary bill in 1994/95 to 35.5 percent in 1999/00. 7.4 The relative share of the various components of pension and gratuity payments varies sharply over the years (See Chart 7.2). For instance, gratuities represented 75 percent of the total pension expenditure in 1994/95 while its share in 1995/96 was about 42 percent. These changes, may in part, reflect ad-hoc adjustments in line with budget fluctuations or civil service reforms. Overall, the share of death gratuities has increased, from 12-13 percent over 1991-1994 up to 21 percent in 1998/99. PROBLEMS WITH THE CURRENT SYSTEM 7.5 The current system is facing problems related to (i) budget estimation and variability, (ii) arrears, (iii) overall sustainability of the current scheme, (iv) management, and (v) predictability. 44 Other pension schemes for the private sector and some institutions such as the Malawi Institute of Management exist, which function on the basis of contributions for employers and employees and of capitalization of members' contribution. 45 This number is high by international standards (in a sample of 25 sub-Saharan African countries, only two countries - Mauritius and Senegal - had pensions at or above I percent of GDP). - 55 - Chart 7.1: Total Pension and Gratuity Expenditure 45 Er pensions as percentage of total current ependiture (left scale) 1.7 _ pensions as percentage oftotal wages and salaries (leftscale) 1.6 40 -4- pensions as percentage of GDP (rght scale) 1.3 5. 1.4 35-- 1.2 30 0.9 1.0~~~~~~~~~~~. 25 0.8 0 22.7 20.5 0.8 20 18.4 15 13.2 0.6 11.6 10 9.3 0.4 4.9 ~~~6.1 5 5 25 3.8 0.2 0 0.0 approwd actual actual actu actual reAsed 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 Chart 7.2: A Breakdown of Pension Expenditures o pensions 70 -68 gratuities 66 6 death gratuities 49 - a transfened pensions and redundancy 50 - ~ 49 49 42 40- 4033 1 1 3132 2 1~~~~~~~~~2 2 - 1 L L2i21o 1 1 1 0 3 9 10 5 4 0 0 1991/92 1992/93 1993/94 1994/95 1995696 1199/97 1997/98 1998/99 1999/00 actual actual actual approxed actual actual actual act_al estimate * Data for pensions include transferred pensions and data for gratuities include death gratuities for 1999/00. - 56 - 7.6 Budget variability: The estimated pensions budget does not appear to be based on detailed actuarial calculations.46 Although the pension roll is computerized, systematic reconciliation with the payroll does not seem to take place, preventing the accurate forecasting of future pensions. Overall, actual spending was above the approved level over 1992-1997 (with a sharp jump in 1994/95 when actual expenditure amounted to 340 percent of approved expenditure) before falling to 85-88 percent of the approved level in 1997/98 and 1998/99. A breakdown of the various components, shows that death gratuities have been far below their planned levels in 1997/98 and 1998/99, possibly reflecting delays in payment of the gratuity, while pension payments have been higher than planned expenditure. 7.7 The Government does not have formal pensions arrears since pensions are part of the statutory expenditure and have priority over other recurrent expenditures. Hence, payments to pensioners already in the system are made regularly. The only flexibility in times of budget shortfalls comes from new entrants to the pension roll. Arrears towards new entrants are built up in the form of delays in (a) getting on the rolls for new retirees (delay around 6 months currently) and (b) getting death benefits (upon application) (delay of around 9 months currently). 7.8 Sustainability: The overall sustainability of the scheme is undermined by various factors. First, the system has accumulated liabilities towards those currently employed, for which no provisions have been made (since current revenues are used to finance current pensions and gratuities). The total existing liabilities for past service were estimated to amount to MK 9.6 billion as of May 2000 (10.5 percent of GDP in 1999/00). 7.9 In addition, changes in demographic trends will likely generate additional pressure on the pension scheme. Trends in demographics suggest that H1V/AIDS could result in a decrease in the working population, in tax revenue, and therefore in resources for payment of pensions while increasing the needs for pensions and death gratuities. In the longer term, an aging population will increase the dependency ratio, with a smaller work force facing a larger pensionable age cohort.47 Overall, it is likely that the burden on the pension system will increase, relative to resources. This increased pressure is already reflected in the increasing size of pensions and gratuities expenditure. Finally, the structure of civil service employment is changing, with the introduction of a performance contract scheme. This will have important consequences for the system, since gratuities are negotiated separately. 7.10 Management: The local press has recently reported on a series of problems with the administration of deceased members estates, delays in the processing of cases, irregular distribution of death benefits to ineligible claimants and cases of "ghost" pensioners. As chapter 2 has discussed, low pay and incentives combined with poor administrative capacity and oversight contribute to these cases of poor management. 7.11 Predictability: Despite existing rules, employees do not appear to know what they can expect when they retire or die. In addition, the current system contains a strong disincentive for employees to leave before they have completed 20 years of employment or have reached the age 46 Such calculations would take into account the structure of employee and its changes (age, length of service, wage level) and demographic patterns and trends (in particular linked to HIV/AIDS prevalence). 47 The proportion of the population over the age of 60 is expected to increase from 4.2 percent to 6.2 percent between 2020 and 2040. This would result in estimated 10.7 working age adults per pensioner in 2020 and 8.6 in 2040. - 57 - of 55. This structure is an impediment to labor force mobility and a factor preventing adequate civil service reform. MOVING TO A FUNDED SYSTEM: BENEFITS AND RISKS 7.12 There is no clear blueprint to solve these problems. However, switching to a funded system48 is likely to improve a number of the current problems with the pension system. A pension fund does not necessarily have to take the form of a separate institution. The main recommendation is to ensure the separation of the pension fund from the general budget in terms of accounting, reporting and management. The benefits are: * Improve sustainability, by building assets for future payments and earning a return on these to allow for inflation. * Lead to better management, with detailed rolls of pensioners and contributors, and their characteristics. * Ensure a predictable cost to the Budget * Improve the timeliness of the payment of pensions and gratuities. * Promote the development of capital markets. 7.13 There are also risks to bear in mind when moving to a funded system: T heir financial sustainability is often jeopardized by the failure of Government to pay its contributions. In addition, poor management linked to low administrative capacity often result in delays in payment of contributions and/or benefits, and a mismatch between benefits and contributions due to lack of precise actuarial valuations. Civil service reforms can also endanger the financial stability of pension schemes by changing the rules for eligibility for pensions. For instance, Governments often offer their dismissed employees eligibility for retirement irrespective of their age or length of employment in order to facilitate their retrenchment. This increases in an unexpected manner the liability of pension schemes, while reducing the contributions the scheme was expecting from these workers. A system where benefits are defined and guaranteed ex-ante (i.e. where the level of pensions and gratuities are set before retirement or death) presents the danger that the contributions made will not be able to cover the benefits guaranteed. This is likely to be the case, for instance, when death rates are different from those forecast, or when the employment structure changes. A solution to this risk would be to adopt a 'defined contribution' scheme in which contributions for each employee are accumulated with interest in a specific account for that person, and these funds are used upon retirement to purchase a pension for the 48 Where provision is made every year for the payment of future pensions of current employees and these funds are invested on financial markets. - 58 - employee or are given to the employee as a lump sum (in such systems, the employer usually contributes additional funds to cover death benefits). 7.14 The transition from the current system to a fund is a difficult exercise requiring important financial, political and administrative investments. There are four options to consider: * The first option consists of creating a funded scheme for new entrants only (possibly for those who recently joined the civil service), while keeping existing members under the old regime. Under this alternative, new entrants would have to pay a contribution, while some mechanism could be put in place to reduce the variability of pension payments for the old scheme (through an automatic price indexation for instance). * A second option consists of transferring all members (current and new) to a funded scheme at the same time. In such a case, there is a need to 'capitalize' the fund with assets to cover liabilities accumulated in the past. There might also be a need for a salary increase, to compensate for the new contributions employees have to make. A third option consists of transferring to a new fund only those benefits accruing after the date of transfer for all members (existing liabilities would continue to be paid out of the budget for all members). - A fourth option would be to transfer members (all of them, only the new entrants, or some of the young members) to an existing pension scheme that is already found in the private sector. 7.15 Estimates have been made of the contribution rates necessary under the different assumptions. If the first option were chosen, the contribution rates for those under the funded scheme would vary from 17 percent (if members under 30 years of age are switched) to 18.7 (switch for those under 40) of pensionable salaries. In the second option, if the pension scheme held enough assets to cover the past service liabilities, the contribution rate that would be required was estimated at 22.4 percent. Finally, if the third option were chosen, the rate would also be 22.4 percent9. 7.16 In summary, the current situation in Malawi is characterized by problems of high budget variability, arrears, overall sustainability, and management. While there are potential pitfalls in moving to a funded system, the benefits are likely to outweigh the risks and hence the transition options discussed above need to be considered carefully. In the short term it is recommended that a high-level pension reform committee be set up within Government in order to discuss these transition options and for ensuring that the appropriate regulatory framework is set up to address some of the risks of moving to a new pension system. 49 Alexander Forbes (2000), 'Final Report on the Actuarial Investigation into the Possible Conversion of the Malawi Civil Service Pension Scheme to a Funded Arrangement as at May 31, 2000' - 59 - 8. PARASTATALS INTRODUCTION 8.1 This chapter reviews the operations of the main commercial parastatals in Malawi in order to take a more comprehensive view of Malawi's fiscal stance and flag areas of potential future fiscal risk.50 8.2 There are currently two types of parastatals in Malawi: subvented and commercial. Subvented parastatals fulfill various 'social' functions, such as the University of Malawi and receive annual budgetary subventions. While it is important that these 'social parastatals' are rationalized (see Chapter 3 for a discussion on the University of Malawi) this section focuses on the commercial parastatals that have a more ad-hoc fiscal impact. These include the power company, Electricity Supply Corporation of Malawi Ltd. (ESCOM), five water boards, the Malawi Posts Corporation (MPC) and Malawi Telecommunications Ltd. (MTL), Air Malawi, the Petroleum Control Commission (PCC), Malawi Housing Corporation (MHC), Agricultural Development and Marketing Corporation (ADMARC), and Malawi Development Corporation (MDC). 8.3 Information on parastatal finances in Malawi is weak and varies in terms of quality, coverage, and timeliness making it difficult to carry out a comprehensive, up-to-date analysis of the parastatal sector. Hence a comprehensive picture of the whole parastatal sector cannot be presented due to these data limitations. However, this chapter pieces together evidence from various parastatals in order to flag areas of potential future risk. CURRENT PERFORMANCE OF PARASTATALS 8.4 There is wide variation in the financial performance of the parastatals but on average their performance is poor. Financial performance of parastatals varies widely both among enterprises as well as over time in the same enterprise. Overall, however, the performance is poor (see Figure 8.1). The profit figures should be interpreted with care. Since the accounts are presented on an accrual basis, and many parastatals do not adequately write off un-collectable accounts, profits are often a misleading indicator of financial viability. Profits may also be misleading when operating costs are low not because of high efficiency but because necessary expenditures, such as maintenance, are not carried out. This is the case with the Water Boards, for example. 8.5 Inadequate tariffs are partly responsible for poor financial performance. While the severity of the problem varies, many parastatals in Malawi are unable to charge cost-recovering tariffs (there are regulatory entities or tariff boards for each parastatal and in some cases such as PCC the price adjustment is automatic). For instance, stamp prices charged by MPC barely cover 20 percent of costs of printing stamps and distributing mail. While the rationale for maintaining low tariffs for utilities is normally based on the likely impact of raising tariffs on poorer segments of the population, it is unclear why this approach is adopted in Malawi where the utility sector largely serves small better-off customer bases in urban areas. 5O The widest definition of the fiscal deficit includes the balance of central government, local and provincial governments, pension funds, public enterprises, extra budgetary funds (these together constitute the non- financial public sector deficit), and deficit of the Central Bank that is unrelated to financing of the non- financial public sector deficit. For more details, see World Bank, 1998. - 60 - Chart 8.1: Financial performance of parastatals, 1996197 to 1999100 c0 __ __50.0_- Z0. 150.0 - CL4) Parastatals 101996/97 * 1997/98 01998/99 01999/00 E~~~~~~~~~~~~~~~~~~ 8.6 Poor performance is also due to poor management and operational inefficiency. Parastatals in Malawi are beleaguered by inefficiencies and part of the blame resides with poor management and governance of the parastatals. -- For example, one of several technical audits recently carried out by ESCOM revealed that 17 percent of the consumers have not been metered for several ytears and that significant portions of meters were faulty.51 - MPG currently has about 2000 employees but estimates that at least a quarter of them can be declared redundant. * Overstaffing also is a problem in ESCOM, which has a consumer to staff ratio of 37 compared to 68 and 80 in Zimbabwe and Uganda respectively. 8.7 The Board of Governors of many parastatals are largely unable to redress these inefficiencies due to poor Board composition and the abuse of privileges by some Board members. The Department of Statutory Corporations issued a 'code of conduct' for parastatal directors in 1999 in light of these issues but it appears to have had little impact on redressing these problems. In August 2001, the Ministry of Statutory Corporations announced that most parastatal boards were to be dissolved and new members appointed. 51 During FY99J00, ESCOM has installed 1500 pre-paid meters and had plans to install a further 2500 meters with the help of a grant it has received from the government. The Bank has urged ESCOM to act on the findings of the technicalis aus and further expand on the measures already initiated. However, ESCOM's track record with regard to initiating efficiency-enhancing measures has been poor. The Aide Memoire of the May 2000 supervision mission for the Fifth Power Project stated: "Over the years, Bank missions have urged ESCOM to institute plans of action to cut down waste and inefficiencies and measures to enhance cash flow. Independent studies were recommended for a thorough review of ESCOM's operational practices and financial management. The recommended studies never took place. Although some measures have been taken by ESCOM, comprehensive efficiency improvement action plans have never been instituted. Network losses have increased and cash collection performance has gradually deteriorated over recent years". - 61 - 8.8 Failure to collect dues compounds these problems: A poor record of collecting dues and build up of arrears compounds the parastatals' cash flow problem. A large part of the arrears, especially those of the utilities, is due from government agencies. * In ESCOM total receivables stood at MK 501 million (0.6 percent of GDP) at the end of FY99/00; of this 36 percent is overdue. The government accounted for 12 percent of receivables and 24 percent of overdue. * In the water boards, mounting arrears have diluted the benefits of recent tariff increases. Arrears owed to the water boards remain a serious problem despite some recent efforts to improve collections and are preventing the water boards from achieving financial viability. As of end-March 2000, arrears owed to all the water boards together amounted to MK446 million (0.5 percent of GDP)-double the amount owed to them a year earlier (Chart 8.2).52 Government agencies are major culprits; 41 percent of Water Boards arrears are owed by government institutions. Among government institutions, the army and the police are the major defaulters accounting for more than two-thirds of the defaults (Chart 8.3). 8.9 Poor cash flow is preventing parastatals from meeting their financial obligations and funding critical investment, maintenance and restructuring expenditures. Chart 8.2: Trends in arrears to Water Boards: Comprehensive data needs to be collected 1999-00 on loan obligations and loan repayment performance of parastatals. These data should permit a rigorous analysis of the i2MO likely impact of poor parastatal cash flow on X 3_ -___ the government budget. However, evidence X Z_ already gathered indicates serious potential 1=0 problems. Some examples of how = parastatals in Malawi are failing to meet A g-, financial obligations due to poor cash flows are: Chart 8.3: Arrears to water boards: relative importance of different government * At the end of FY99/00, ESCOM defaulters: June 2000 had an overdue debt service State Other Govt. obligation to external lenders of Parliament 3% T 12% MK354 million (0.39 percent of 0% Army GDP) and unmet debt service Labor 36% obligations of MK322 million to 0% the government. ESCOM's Prisonsl unpaid surtax liabilities to Government increased Health Police considerably in FY99/00, from 9% Education 24% MK41 to MKI41 million. 11% * The Water Boards are being forced to borrow on overdraft facilities at very high rates of interest (70 to 90 percent) 52 The bulk of the arrears are owed to two water boards, the Blantyre and Lilongwe Water Boards (MK260 mil. and MKI07 mil. respectively). - 62 - and have more or less exhausted their lines of credit. There are concerns that they may not be able to pay ongoing operating costs and they are already deferring essential maintenance. The effects of borrowing at high interest rates will be reflected in the income statements beginning with FY2001." * MPC is now able to pay only salaries to its employees; it has delayed payments to suppliers and has built up arrears in its debt service obligations to government organizations. At the time of the split of its parent enterprise MPTC, MPC inherited debts of over MK162 million (0.2 percent of GDP), the bulk of it (MK102) owed to the Malawi Savings Bank representing customer deposits that should have been remitted to the Bank. 8.10 The poor cash flows of the parastatals and their consequent failure to meet financial obligations have had substantial impact on government finances. The impact occurs in two ways: a) government forgiving its own dues from parastatals; b) government making payments on behalf of parastatals. Some of the government waivers are mere accounting exercises as they simply cancel out the governments own obligations to the parastatals. As discussed at the outset, data limitations prevent us from providing an aggregate 'impact on the budget.' However the following examples illustrate the type of fiscal burden that is likely to recur in the years ahead: The Government converted MK71O million of ESCOM's debt to equity in mid- 1999 after netting out government arrears due to ESCOM. * -In January 2001, the Government took over NFRA's commercial debt of MK600 million and paid off related interest arrears. It paid off NFRA's debt by issuing a local registered bond at 37 percent interest rate with a 3-year maturity. * MPC has also asked Government to pay off all of the Corporation's debts incurred before the establishment of MPC (about MK193 million) as well as provide it with at least MK30 million to pay for the retrenchment of 500 staff. RECOMMENDATIONS Parastatal Finances 8.11 This partial analysis of parastatal finances in Malawi points to an unsatisfactory situation, which if not addressed promptly and adequately, may create a significant future fiscal burden. Poor parastatal cash flows and build up of arrears is problematic for at least two reasons: the creation of a vicious cycle and the loss of transparency. Poor cash flows lead to inadequate resources to fund investment, maintenance and restructuring, such as labor retrenchment. This, in turn, tends to increase operational costs and/or lower revenues; in either case, accentuating the cash flow problem. Moreover, a pervasive regime of cross-arrears dilutes the transparency of financial management, especially when rigorous estimates of cross-arrears do not exist. Defaulting parties then find it easy to get away with excuses not to pay simply by alluding to arrears due to them. The short term recommendations to address these issues are: 53 In prior years the Treasury was providing guarantees for overdraft borrowing and the interest rates were more reasonable. - 63 - 8.12 Collect and analyze data: The activities of the Public Enterprises Reform and Monitoring Unit in the Ministry of Finance need to be strengthened. In particular, the Unit needs to systematically collect data on cash flow situation of the parastatals, new financial obligations incurred by the enterprises and build-up in arrears to and from the enterprises. To be useful, the data need to be comprehensive, up-to-date and comparable across enterprises. Based on the data, the Unit should carry out periodic forecasts of the likely trends of these variables. 8.13 A comprehensive analysis of the arrears situation within the parastatal sector and between parastatals, and government and other creditors, should be carried out. The comprehensive approach is essential given the inter-locking nature of the arrears. Based on this comprehensive analysis of the arrears situation, a time-bound plan to eliminate the stock of arrears should be developed and implemented. This should be complemented by a plan to help prevent the build-up of such arrears in the future. 8.14 Review tariffs: The issue of parastatal tariffs also needs to be addressed in a holistic manner. Low parastatal tariffs are usually rationalized on social welfare grounds, and Malawi is no exception. However, it is necessary to revisit the rationale. Cross-country experience, especially in developing countries, increasingly reveals the perverse effect of low-tariffs on low- income groups. This is because low tariffs leading to poor financial performance, and consequently low investment and maintenance expenditure, lowers access of the poor to basic services. Tariff issues are currently being reviewed for some individual parastatals, e.g. ESCOM and the water boards. However, this exercise needs to be informed by a general policy on parastatal tariffs, grounded in a solid analysis of the determinants of the access to goods and services by the poor. When the poor has little access to services, low tariffs benefit the rich who have access while undermining expansion of coverage. Tariff reforms are thus often required to expand access for the poor. 8.15 Increase efficiency by enforcing collections and improving corporate governance: While an increase in tariffs and a reduction in the stock of arrears are likely to improve the cash flow of parastatals, these are not substitutes for measures that increase operational efficiency. These could include measures that reduce non-technical losses, such as in power distribution, by strengthening technical audits of meters, stricter disconnection policy and credit control to improve collection and minimize bad debts, and retrenchment of surplus staff. It is particularly important that the Government does not stand in the way of parastatals enforcing collection, especially vis-a-vis other government agencies. 8.16 The decision to dissolve parastatal boards in August 2001 demonstrates the Government's commitment to improve the management of parastatals. It is now critical that qualified individuals who have experience in the relevant sectors are appointed and that the roles of the Government, Board and parastatal management are clearly defined. Appointing a qualified and experienced chairperson for each Board is crucial in this process of strengthening parastatal governance. Privatization 8.17 While there is some scope for improving performance of parastatals through the kind of measures described above, in the medium to long run the most effective means of improving performance on a sustained basis is privatization. The Government of Malawi has embarked on a privatization program that started with the manufacturing sector but is now being expanded to include utilities and infrastructure. Solid progress is being made on telecommunications. It is important the implementation of the program remains on schedule. In many countries, inordinate - 64 - delays in completing the final stages of privatization have reduced the effectiveness of the privatization programs. Private participation in power and water needs to be accelerated: 8.18 Power. Reform efforts in the power sector have fallen behind schedule. A revised power sector policy was to have been approved by now. However, it has only recently been submitted to the Cabinet Committee on the Economy. This policy needs to be approved as soon as possible and further actions, such as revisions to the Electricity Bill of 1998, needed to implement power sector reform should not be unduly delayed. 8.19 Water: In the water sector, the Government has begun a study on options for private participation for Blantyre and Lilongwe Water Boards. It is important that this study is completed according to the revised schedule and that steps are taken to introduce private participation into the sector. The most common mode of private participation in this sector in other countries has been management contracts and leases, which do not involve the sale of assets. As in telecommunications, cross-country experience reveals significant gains in efficiency and service levels from such reforms. (See Box 8.1). Box 8.1: Lease Contract Leads to Improved Performance in Guinea Water Utility Until the late 1980s Guinea had one of the least developed urban water supply sectors in West Africa. Barely 40 percent of urban dwellers had access to piped water through either connections or standpipes. Service interruptions were common and water treatment inadequate. To improve this situation, the government of Guinea in 1989 entered into a lease arrangement for private sector operation of water services in the capital city, Conakry, and sixteen other cities and towns. Two organizations are central to the lease arrangement: a state-owned national water authority, Societe Nationale des Eaux de Guinde (SONEG), and a water management company, Societe d'Exploitation des Eaux de Guinee (SEEG). SONEG owns the water supply facilities in the cities and towns covered by the lease. It is responsible for sector development, including planning and implementing new investments, and for servicing sector debt. SONEG also has responsibility for setting tariffs. SEEG is jointly owned by the state (49 percent) and a foreign private consortium (51 percent). SEEG holds a ten-year lease contract with SONEG under which it is responsible for operating and maintaining urban water supply facilities, billing customers, and collecting charges. The private partner provides management services to SEEG through a separate management contract. At the start of the lease the consumer tariff was raised from US$0.12 to US$0.25 per cubic meter. This tariff was still too low to cover operating and debt servicing costs, so in the initial years of the lease the difference between tariff revenues and costs was funded by an International Development Association (IDA) credit. This subsidy has declined stepwise as tariffs have increased. By 1996 connections had increased from about 12,000 to more than 23,000. Metering has increased from about 5 percent to 98 percent for private customers and to 100 percent for government customers. Investments in new supply capacity (external to the lease), combined with rehabilitation and maintenance have brought about a substantial increase in the population with access to safe water, from 38 percent in 1989 to 47 percent in 1996. And with progressive tariff increases, the average tariff (US$0.83 per cubic meter in 1997) now more than covers costs. SEEG's water revenues (excluding the subsidy) rose tenfold between 1989 and 1996. In an environment in which earlier attempts to secure reliable access to safe water had foundered, and in which financial sustainability had seemed unreachable, these achievements are truly impressive. Despite these gains, two broad concerns arise about the performnance of Guinea's lease contract. First, the water supply system, particularly in Conakry, has not improved and expanded asfast as had been hoped. Unaccounted-for water remains high, at about 47 percent. New connections to the system have been added slowly-though the lease did not specify targets. Second, the relationship between SONEG and SEEG has not been smooth, lessening the efficacy of SONEG's monitoring and Regulation. Source: Penelope Brook Cowen: Lessons From The Guinea Water Lease, Viewpoint No. 78 - 65 - postal sectors. There are other regulatory agencies for individual sectors, such as the Electricity Council for the power sector. International good practice suggests that regulatory agencies should be adequately staffed and independent, i.e. decision-making should be insulated from political pressure. Among other things, this would require adequate budgets for the agencies. An issue the Government needs to address is the choice between multi-sectoral regulatory agencies and industry-specific regulatory agencies. Each approach has its pros and cons. However, for a country like Malawi where the resources and manpower required for effective regulation is limited, there is a strong case for a multi-sectoral regulatory agency (see Box 8.2). The Government and the World Bank are undertaking a study that is expected to provide guidance on this important issue by December 2001. 8.21 Making optimum use of privatization revenues. An important policy issue, specially, when privatization of large utilities is involved, is the appropriate use of privatization revenues. A good practice is to use privatization proceeds to pay off public debt; this ensures that the net worth of the government is maintained (privatization implies a reduction in the asset side; this is offset by a reduction on the debt side. Privatization revenues in Malawi are deposited - per the Privatization Act, 1996 - into a separate Privatization Account. It is recommended that a close review of the use of privatization proceeds be carried out as per the Auditor General's regular audits and as part of future public expenditure reviews. Box 8.2: Multi-sectoral vs. Industry-specific Regulatory Agencies Utility regulators can be organized on three main lines. In the industry-specific approach, there is a separate agency for each industry; in the sector-wide model, there is an agency for each more broadly defined sector, such as the energy regulator in Colombia and the transport regulator in Canada (or MACRA in Malawi); and in the multisectoral approach, there is a single agency for all or most utility regulators, such as the state-level regulators in Brazil and the US, and the national regulators in Costa Rica and Jamaica. There are several potential advantages of multi-industry (sectoral or multisectoral) agencies. These include: a) sharing of resources; particularly important in countries where regulatory expertise is scarce; b) facilitating learning across industries; while utility industries have unique features, the main issues in their economic regulation are substantially the same-hence, having a single agency helps the transfer of insights and experience between industries; c) reducing the risk of industry capture; the broader responsibilities of a multi- industry agency helps reduce the risks that the regulated industry and the regulator will develop too close a relationship; d) reducing the risk of political capture; the broader constituency of a multisectoral regulator agency makes it easier for the agency to develop greater independence from sectoral ministries; e) reducing the risk of economic distortions; having a single agency makes it easier to adopt consistent approaches in dealing with issues common to all industries. Proponents of industry-specific agencies argue that multi-sectoral agencies may have several weaknesses such as lack of sufficient industry-specific expertise or focus, enhancing the risk of failure by "putting all eggs in one basket" and reducing or eliminating the options of experimenting with different approaches. However, these potential problems can be dealt with in multi-sectoral agencies, e.g., by creating industry-specific departments within the agency but with a cross-sectoral decision-making body and by allowing industry-specific experiments in the multi-sectoral agency. Source: Warrick Smith, "Utility Regulators---Roles and Responsibilities", Public Policy for the Private Sector Viewpoint Note, No. 128, October 1997. - 66 - ANNEX I Recurrent Expenditure by Functional Classification ( percent of recurrent and percent GDP) 1993/94 - 1999/00 1994/95 1994/95 1995/96 1995/96 1996/97 1996/97 1997/98 1997/98 1998/99 1998/99 1999/00 1999/00 Approved Actual Approved Actual Approved Actual Approved Actual Approved Actual Approved estimate Percent of recurrent expenditures General Administration 56.1 34.0 30.6 21.5 23.8 26.3 34.3 37.4 28.8 28.9 37.7 23.1 General Public Services 51.1 23.7 22.7 12.3 15.8 15.5 25.9 27.5 20.3 21.6 29.6 15.0 Defense 2.2 3.3 4.5 2.8 3.7 5.1 3.9 4.8 3.9 3.6 3.7 3.8 Public Order and safety 2.8 6.9 3.4 6.5 4.3 5.7 4.5 5.1 4.6 3.7 4.4 4.3 Social Services 15.2 32.5 20.5 30.6 34.0 35.2 36.3 45.5 38.0 27.4 39.6 35.3 Education 8.3 10.5 11.9 16.3 15.0 19.0 17.8 20.8 19.0 13.6 16.2 15.6 Health 6.0 8.3 7.8 6.2 9.6 9.2 8.2 8.5 8.0 6.2 10.2 8.7 Social Security and welfare 0.0 13.8 0.0 8.1 6.6 7.0 8.6 12.7 7.7 6.2 11.3 9.7 services Community and Social 0.9 0.0 0.8 0.0 2.8 0.0 1.7 3.4 3.3 1.3 1.9 1.3 Development* Economic Services 14.5 11.9 36.6 12.1 17.0 7.7 8.6 9.3 6.9 5.5 11.1 6.9 Agriculture and Natural 6.9 7.1 8.8 9.0 10.0 5.1 3.3 5.4 5.1 4.2 8.3 4.9 Resources Energy and Mining Services 0.0 0.0 0.0 0.0 0.2 0.0 0.3 0.0 0.1 0.0 0.1 0.0 Tourism Affairs and Services 0.0 0.0 0.0 0.0 0.2 0.0 0.2 0.2 0.1 0.0 0.1 0.2 Physical Planning and 0.0 0.0 0.0 0.0 0.3 0.0 0.3 0.3 0.0 0.1 0.0 0.2 Development Transport 1.3 3.2 1.1 1.5 4.8 1.4 3.0 1.8 0.9 0.5 1.0 0.6 Industry and Commerce 0.0 0.0 0.0 0.0 1.0 0.0 1.0 1.1 0.5 0.4 1.0 0.5 LaborRelationsand 0.0 0.0 0.0 0.0 0.3 0.0 0.2 0.2 0.0 0.1 0.2 0.1 Employment Services Environmental Protection and 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 conservation Scientific and technological 0.0 0.0 0.0 0.0 0.1 0.0 0.2 0.1 0.1 0.1 0.2 0.1 services Other Economic Services 6.3 1.5 26.7 1.5 0.1 1.2 0.1 0.1 0.1 0.0 0.1 0.1 Unallocable Services 14.2 27.8 12.2 37.4 25.2 35.4 20.8 33.0 26.4 33.2 11.6 29.2 Public debtservice 10.9 15.1 10.4 27.0 3.5 28.1 12.5 14.2 15.8 20.6 0.0 19.9 Pensions and gratuities 3.1 3.5 1.3 4.0 3.5 5.6 7.4 5.7 7.1 5.3 0.0 9.3 Other 0.3 9.2 0.5 6.5 1.6 1.7 0.9 6.6 3.4 7.3 0.0 0.0 Adjustment 0.0 -6.2 0.0 -1.6 0.0 -4.6 0.0 -25.2 0.0 5.0 0.0 5.4 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Percent of GDP General Administration 15.12 11.54 6.61 5.24 4.54 4.83 6.99 8.44 4.49 5.32 6.00 4.12 General Public Services 13.78 8.06 4.90 2.99 3.01 2.85 5.28 6.20 3.16 3.98 4.71 2.68 Defense 0.59 1.14 0.97 0.68 0.71 0.93 0.80 1.08 0.61 0.66 0.59 0.68 Public Order and safety 0.76 2.34 0.74 1.57 0.82 1.04 0.92 1.15 0.72 0.68 0.70 0.76 Social Services 4.11 11.07 4.44 7.44 6.48 6.47 7.40 10.25 5.92 5.05 6.30 6.30 Education 2.24 3.55 2.58 3.95 2.86 3.49 3.63 4.70 2.95 2.51 2.58 2.79 Health 1.63 2.81 1.69 1.50 1.83 1.69 1.68 1.92 1.25 1.14 1.63 1.55 Social Security andwelfare 0.00 4.71 0.00 1.98 1.26 1.29 1.75 2.86 1.20 1.15 1.79 1.73 services Community and Social 0.24 0.00 0.17 0.00 0.53 0.00 0.34 0.77 0.51 0.25 0.31 0.24 Development* Economic Services 3.90 4.03 7.91 2.93 3.25 1.41 1.76 2.09 1.07 1.01 1.77 1.23 Agriculture and Natural 1.86 2.42 1.89 2.19 1.91 0.94 0.67 1.22 0.79 0.77 1.31 0.87 Resources Energy and Mining Services 0.00 0.00 0.00 0.00 0.03 0.00 0.07 0.00 0.02 0.00 0.01 0.00 Tourism Affairs and Services 0.00 0.00 0.00 0.00 0.03 0.00 0.04 0.04 0.01 0.01 0.02 0.03 Physical Planning and 0.00 0.00 0.00 0.00 0.07 0.00 0.07 0.07 0.00 0.02 0.00 0.04 Development Transport 0.36 1.09 0.24 0.38 0.91 0.25 0.61 0.41 0.14 0.09 0.17 0.11 Industry and Commerce 0.00 0.00 0.00 0.00 0.19 0.00 0.21 0.25 0.08 0.08 0.17 0.10 Labor Relations and 0.00 0.00 0.00 0.00 0.05 0.00 0.04 0.05 0.00 0.02 0.03 0.02 Employment Services Environmental Protection and 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.02 conservation Scientific and technological 0.00 0.00 0.00 0.00 0.03 0.00 0.04 0.03 0.01 0.01 0.03 0.03 services OtherEconomicServices 1.69 0.52 5.78 0.37 0.01 0.22 0.02 0.01 0.01 0.01 0.02 0.01 UnllocableServices 3.84 9.46 2.64 9.10 4.81 6.50 4.23 7.45 4.11 6.11 1.84 5.21 Publicdebtservice 2.93 5.12 2.26 6.56 0.66 5.17 2.54 3.19 2.47 3.79 0.00 3.55 Pensionsandgratuities 0.84 1.21 0.28 0.96 0.66 1.03 1.51 1.28 1.11 0.98 0.00 1.66 Other 0.07 3.14 0.10 1.58 0.30 0.31 0.18 1.50 0.53 1.34 0.00 0.00 Total Memo item: 7.0 2.7 -0.7 2.2 2.8 1.9 Recurrent expenditure/ 27.0 34.0 21.6 24.3 19.1 18.4 20.4 22.6 15.6 18.4 15.9 17.8 GDP ( percent) *Includes Housing and Community Amenity Services; Recreational, Cultural and Other Social Services; and Broadcasting and Publishing Services Source: Econonic Report (Various Issues), Public Finance Tables - 67 - Development Expenditure by Functional Classification ( percent of development and percent of GDP) 1993/94 - 1999/00 1994/95 1994/95 1995/96 1995/96 1996/97 1996/97 1997/98 1997/98 1998/99 1998/99 1999/00 1999/00 Approved Actual Approved Actual Approved Actual Approved Actual Approved Actual Approved estimate General Administration 0.00 28.04 0.00 15.90 18.73 39.76 30.23 11.45 13.19 9.32 18.69 21.13 General Public Services 0.00 27.32 0.00 15.48 17.26 38.46 28.04 9.11 11.22 8.90 15.15 18.43 Defense 0.00 -0.01 0.00 0.03 0.58 0.83 0.64 0.98 0.25 0.13 1.12 0.77 PublicOrderandsafety 0.00 0.73 0.00 0.39 0.89 0.47 1.55 1.36 1.72 0.30 2.41 1.92 Social Services 24.04 50.93 24.02 53.95 62.55 28.72 51.92 35.80 44.64 53.74 44.85 35.65 Education 10.30 27.94 10.18 22.60 22.57 8.43 16.12 15.29 8.13 13.35 14.34 8.74 Health 11.54 0.45 11.43 16.21 20.71 3.63 15.31 5.89 19.16 16.45 13.78 5.78 Social Security and Welfare 0.00 0.07 0.00 0.06 0.00 0.71 0.77 0.22 1.45 1.53 0.07 1.01 Services Community and Social 2.21 22.47 2.40 15.08 19.27 15.95 19.73 14.40 15.89 22.41 16.66 20.12 Development* Economic Services 15.60 15.12 51.28 24.21 16.12 16.23 14.92 32.20 41.99 25.17 36.26 39.54 Agriculture and Natural 13.62 14.06 13.31 10.40 12.16 10.35 11.61 10.47 24.56 10.49 15.46 13.14 Resources Energy and Mining Services 0.00 0.13 0.00 0.06 0.03 0.02 0.03 0.03 0.01 0.02 0.00 0.00 Tourism Affairs and Services 0.00 0.00 0.00 0.00 0.00 0.08 0.03 0.78 0.07 0.00 0.04 0.02 Physical Planning and 0.00 0.10 0.00 0.19 0.49 0.09 0.47 0.00 0.22 0.14 0.07 0.07 Development Transport 1.98 0.67 2.48 13.04 2.59 5.50 0.65 20.21 14.10 13.58 16.69 25.21 Industry andCommerce 0.00 0.01 0.00 0.27 0.60 0.15 0.34 0.15 0.17 0.66 1.01 0.89 LaborRelationsand 0.00 0.14 0.00 0.00 0.00 0.00 0.00 0.15 0.15 0.00 0.00 0.00 Employment Services Environmental Protection and 0.00 0.00 0.00 0.00 0.24 0.03 0.46 0.00 1.09 0.28 1.73 0.18 conservation Scientific and technological 0.00 0.00 0.23 0.25 0.00 0.00 1.33 0.40 1.61 0.00 1.25 0.03 services Other Economic Services 0.00 0.00 35.25 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Unallocable Services 60.36 0.00 24.70 6.00 2.61 15.29 2.93 2.56 0.19 3.80 0.32 0.00 Adjustment 0.00 5.91 0.00 -0.06 0.00 -0.01 0.00 17.98 0.00 7.97 0.00 3.67 Total 100.00 100.00 100.00 100.00 100.01 100.00 100.00 100.00 100.00 100.00 100.12 100.00 General Administration 0.00 2.13 0.00 1.03 0.92 1.90 1.53 0.59 1.23 0.81 1.74 2.21 General Public Services 0.00 2.08 0.00 1.01 0.85 1.83 1.42 0.47 1.05 0.77 1.41 1.93 Defense 0.00 0.00 0.00 0.00 0.03 0.04 0.03 0.05 0.02 0.01 0.10 0.08 PublicOrderandsafety 0.00 0.06 0.00 0.03 0.04 0.02 0.08 0.07 0.16 0.03 0.22 0.20 Social Services 1.65 3.88 1.67 3.51 3.08 1.37 2.63 1.84 4.18 4.65 4.18 3.73 Education 0.71 2.13 0.71 1.47 1.11 0.40 0.82 0.79 0.76 1.15 1.34 0.92 Health 0.79 0.03 0.80 1.05 1.02 0.17 0.77 0.30 1.79 1.42 1.28 0.60 Social Security and Welfare 0.00 0.01 0.00 0.00 0.00 0.03 0.04 0.01 0.14 0.13 0.01 0.11 Services Community and Social 0.15 1.71 0.17 0.98 0.95 0.76 1.00 0.74 1.49 1.94 1.55 2.11 Development* Economic Services 1.07 1.15 3.57 1.57 0.79 0.77 0.75 1.66 3.93 2.18 3.38 4.14 Agriculture and Natural 0.93 1.07 0.93 0.68 0.60 0.49 0.59 0.54 2.30 0.91 1.44 1.38 Resources Energy and Mining Services 0.00 0.01 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Tourism Affairs and Services 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.04 0.01 0.00 0.00 0.00 Physical Planning and 0.00 0.01 0.00 0.01 0.02 0.00 0.02 0.00 0.02 0.01 0.01 0.01 Development Transport 0.14 0.05 0.17 0.85 0.13 0.26 0.03 1.04 1.32 1.17 1.55 2.64 Industry and Commerce 0.00 0.00 0.00 0.02 0.03 0.01 0.02 0.01 0.02 0.06 0.09 0.09 Labor Relations and 0.00 0.01 0.00 0.00 0.00 0.00 0.00 0.01 0.01 0.00 0.00 0.00 Employment Services Environmental Protection and 0.00 0.00 0.00 0.00 0.01 0.00 0.02 0.00 0.10 0.02 0.16 0.02 conservation Scientific and technological 0.00 0.00 0.02 0.02 0.00 0.00 0.07 0.02 0.15 0.00 0.12 0.00 services Other Economic Services 0.00 0.00 2.45 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Unallocable Services 4.13 0.00 1.72 0.39 0.13 0.73 0.15 0.13 0.02 0.33 0.03 0.00 Memo item: Developmentexpenditure/ 6.8 7.6 7.0 6.5 4.9 4.8 5.1 5.1 9.4 8.6 9.3 10.5 GDP ( percent) - 68 - Total Expenditure by Functional Classification ( percent of Total GDP) 1994/95 - 1999/00 1994/95 1994/95 1995/96 1995/96 1996/97 1996/97 1997/98 1997/98 1998/99 1998/99 1999/00 1999/00 Approved Actual Approved Actual Approved Actual Approved Actual Approved Actual Approved estimate Percentage of total expenditure General Administration 44.71 32.87 23.15 20.34 22.77 29.04 33.50 32.59 22.93 22.63 30.68 22.38 General Public Services 40.73 24.38 17.16 12.96 16.09 20.25 26.33 24.09 16.87 17.54 24.27 16.30 Defense 1.73 2.73 3.40 2.21 3.09 4.20 3.25 4.10 2.53 2.47 2.76 2.69 Public Order and safety 2.25 5.76 2.59 5.18 3.59 4.59 3.91 4.40 3.53 2.62 3.65 3.39 Social Services 17.02 35.91 21.39 35.50 39.82 33.89 39.41 43.66 40.46 35.83 41.56 35.46 Education 8.70 13.65 11.51 17.59 16.52 16.81 17.46 19.80 14.90 13.54 15.51 13.09 Health 7.16 6.82 8.70 8.29 11.88 8.05 9.64 8.04 12.20 9.47 11.54 7.62 Social Security and Welfare 0.00 11.33 0.00 6.44 5.24 5.73 7.02 10.37 5.35 4.73 7.14 6.48 Services Community and Social 1.16 4.11 1.18 3.18 6.17 3.29 5.28 5.45 8.01 8.08 7.37 8.28 Development* Economic Services 14.69 12.46 40.18 14.62 16.82 9.46 9.88 13.54 20.04 11.79 20.40 18.98 Agriculture and Natural 8.25 8.40 9.86 9.28 10.46 6.18 4.93 6.35 12.37 6.21 10.92 7.94 Resources Energy andMining Services 0.00 0.02 0.00 0.01 0.15 0.00 0.27 0.01 0.07 0.01 0.06 0.00 Tourism Affairs and Services 0.00 0.00 0.00 0.00 0.12 0.02 0.16 0.30 0.08 0.03 0.11 0.10 Physical Planning and 0.00 0.02 0.00 0.04 0.37 0.02 0.36 0.25 0.08 0.14 0.03 0.18 Development Transport 1.46 2.73 1.44 3.97 4.33 2.23 2.54 5.23 5.87 4.69 6.82 9.73 Industry and Commerce 0.00 0.00 0.00 0.06 0.93 0.03 0.88 0.93 0.38 0.49 1.03 0.67 Labor Relations and 0.00 0.03 0.00 0.00 0.22 0.00 0.16 0.22 0.07 0.06 0.11 0.08 Employment Services Environmental Protection and 0.00 0.00 0.00 0.00 0.06 0.01 0.10 0.01 0.42 0.10 0.66 0.14 conservation Scientific and technological 0.00 0.00 0.06 0.05 0.12 0.00 0.41 0.19 0.65 0.04 0.57 0.10 services Other Economic Services 4.99 1.26 28.82 1.20 0.06 0.96 0.06 0.05 0.04 0.03 0.09 0.03 Unallocable Services 23.58 22.74 15.27 30.78 20.59 31.25 17.21 27.38 16.57 23.79 7.41 18.41 Percent of GDP General Administration 15.12 13.68 6.61 6.27 5.47 6.72 8.52 9.03 5.72 6.12 7.74 6.33 General Public Services 13.78 10.14 4.90 3.99 3.86 4.69 6.70 6.67 4.21 4.75 6.12 4.61 Defense 0.59 1.14 0.97 0.68 0.74 0.97 0.83 1.13 0.63 0.67 0.70 0.76 Public Order and safety 0.76 2.40 0.74 1.60 0.86 1.06 1.00 1.22 0.88 0.71 0.92 0.96 Social Services 5.75 14.94 6.11 10.95 9.56 7.84 10.02 12.09 10.09 9.69 10.48 10.04 Education 2.94 5.68 3.29 5.42 3.97 3.89 4.44 5.48 3.72 3.66 3.91 3.70 Health 2.42 2.84 2.48 2.56 2.85 1.86 2.45 2.23 3.04 2.56 2.91 2.16 Social Security and Welfare 0.00 4.71 0.00 1.98 1.26 1.33 1.79 2.87 1.33 1.28 1.80 1.83 Services Community and Social 0.39 1.71 0.34 0.98 1.48 0.76 1.34 1.51 2.00 2.19 1.86 2.34 Development* Economic Services 4.97 5.19 11.47 4.51 4.04 2.19 2.51 3.75 5.00 3.19 5.15 5.37 Agriculture and Natural 2.79 3.49 2.82 2.86 2.51 1.43 1.25 1.76 3.09 1.68 2.75 2.25 Resources Energy and Mining Services 0.00 0.01 0.00 0.00 0.04 0.00 0.07 0.00 0.02 0.00 0.01 0.00 Tourism Affairs and Services 0.00 0.00 0.00 0.00 0.03 0.00 0.04 0.08 0.02 0.01 0.03 0.03 Physical Planning and 0.00 0.01 0.00 0.01 0.09 0.00 0.09 0.07 0.02 0.04 0.01 0.05 Development Transport 0.49 1.14 0.41 1.22 1.04 0.52 0.65 1.45 1.46 1.27 1.72 2.75 Industry and Commerce 0.00 0.00 0.00 0.02 0.22 0.01 0.23 0.26 0.09 0.13 0.26 0.19 Labor Relations and 0.00 0.01 0.00 0.00 0.05 0.00 0.04 0.06 0.02 0.02 0.03 0.02 Employment Services Environmental Protection and 0.00 0.00 0.00 0.00 0.02 0.00 0.03 0.00 0.10 0.03 0.17 0.04 conservation Scientific and technological 0.00 0.00 0.02 0.02 0.03 0.00 0.11 0.05 0.16 0.01 0.14 0.03 services Other Economic Services 1.69 0.52 8.23 0.37 0.01 0.22 0.02 0.01 0.01 0.01 0.02 0.01 Unallocable Services 7.98 9.46 4.36 9.49 4.94 7.23 4.38 7.58 4.13 6.44 1.87 5.21 Memo item: Total/GDP ( percent) 33.8 41.6 28.6 30.8 24.0 23.1 25.4 27.7 24.9 27.0 25.2 28.3 - 69 - ANNEX II Table 1: Public Primary School Enrolment Year 1993-94 1994-95 1995-96 1997 1998 1999 Enrolment (STD 1-8) 1,895,423 2,860,819 2,887,107 2,905,950 2,797,047 2,896,280 %, Female 48% 47% 47% 48% 48% 48% %growth 6% 51% 1% 1% -4% 4% Enrolment (STD 1) 631,948 1,006,194 881,425 817,512 769,497 751,002 %Female 51% 49% 49% 49% 50% 50% % growth 13% 59% -12% -7% -6% -2% Enrolment (STD 8) 81,137 142,790 143,693 144,919 134,724 151,879 % Female 37% 39% 39% 40% 40% 42% % growth -32% 76% 1% 1% -7% 13% Repeaters (STD 1-8) 313,650 513,282 434,827 445,464 410,305 404,754 % Female 47% 49% 48% 49% 49% 48% % growth -5% 64% -15% 2% -8% -1% Rate 17% 27% 15% 15% 14% 14% Drop-outs (STD 1-7) -514,477 682,206 559,254 659,096 416,829 485,777 % growth -18% 18% -37% 17% Rate -27% 24% 19% 23% 15% 17% Notes: a) Repetition rate is calculated as the number of recorded repeaters in year x / total enrolment in year x-l b) Dropouts (Std 1-7) = (enrolment std 1-7) year x - (total enrolment - new enrolment std I - std 8 repeaters) year x+ I c) The school year changed in 1997 from a September to August cycle to a calendar year cycle. Table 2: Public Primary School Enrolment by Region 1997/98 Gross Enrolment Ratio (GER) Net Enrolment Ratio (NER) Rural Urban Total Rural Urban Total Total 117 117 117 75 82 76 Male 123 121 123 75 84 76 Female 112 114 112 76 80 76 North 132 127 131 84 88 85 Male 140 128 139 84 88 84 Female 123 125 123 85 89 85 Centre 116 117 116 74 87 75 Male 121 122 121 73 91 75 Female 111 112 111 75 84 76 South 116 117 116 75 78 75 Male 121 119 121 74 80 75 Female 111 114 112 75 76 75 Source: Al-Samarrai and Zaman (2000) - 70 - Table 3: Gross Enrolment by Quintile and Gender Consumption per adult equivalent quintile Poorest 20% 2nd 3rd 4th Richest 20% Total populatior 1990/91 Total 58 76 86 97 110 81 Male 65 83 88 104 113 86 Female 51 69 83 89 106 75 1997/98 Total 110 118 120 122 119 117 Male 115 125 124 127 124 123 Female 106 111 116 117 115 112 Notes and Sources: The official starting age for primary school in Malawi is six and the primary level lasts for eight years. The gross enrolment rate is total enrolment in primary divided by the primary school age population (6-13) Source: 1990/91 data from Castro-Leal 1996, 1997/98 data from IHS (1997/98) Table 4: Enrolment in Secondary Education Year 1993-94 1994-95 1995-96 1997* 1998* 1999* Total Secondary 88,752 105,841 136,386 174,487 222,244 270,000 % female 36% 36% 36% 39% % growth 23% 19% 29% 28% 27% 21% Boarding 32,551 32,887 37,595 43,929 51,965 60,000 % female 36% 37% 35% 39% % growth 1% 1% 14% 17% 18% 15% Private 13,893 15,473 17,217 21,712 40,856 60,000 % female 47% 45% 52% 38% % growth 221% 11% 11% 26% 88% 47% Day schools 42,308 57,481 81,574 108,846 129,423 150,000 % female 33% 33% 33% 40% % growth 18% 36% 42% 33% 19% 16% * All secondary data after 1997 are estimates. 1999 figures were taken from the 2000 report into private education in Malawi (reference footnote 6). 1998 enrolment was computed as the mean of 1997 and 1999 enrolments. Source: EMIS, University of Malawi office, Mzuzu University - 71 - Table 5: Efficiency Ratios for Primary (1998/99) Division North C.E C.W. S.E. S.W. Shire PE per student 346 270 335 418 423 257 ORT per student 26 20 32 21 34 27 Total per student 372 290 367 439 457 284 Pupils per teacher 59 66 58 72 61 71 Qualified teacher per pupil 92 135 122 143 100 134 Pupils per stream 57 73 74 80 79 73 Pupils per school 464 573 729 694 751 830 Pupils per classroom 67 97 110 103 105 105 Teachers per stream 0.98 1.11 1.27 1.21 1.30 1.02 Teachers per school 7.9 8.7 12.6 9.6 12.3 11.6 Teachers per classroom 1.1 1.5 1.9 1.4 1.7 1.5 Streams per school 8.1 7.8 9.9 8.7 9.5 11.3 Classrooms per school 6.9 5.9 6.6 6.7 7.2 7.9 Pupils not in classrooms 15% 25% 33% 23% 25% 30% Notes: *Urban= Blantyre, Mzuzu, Lilongwe and Zomba cities Source: Government of Malawi (2000e) Table 6: Efficiency Ratios for Secondary (1999 sample) Division North C.E C.W. S.E. S.W. Shire Urban Rural Pupil: Teacher 29 34 52 39 33 36 28 36 Pupil: Qualified Teacher 45 45 67 56 49 49 59 131 Pupils per school 209 279 324 346 341 337 407 277 Teachersperschool 7 8 6 9 10 9 15 8 Source: Government of Malawi (2000e) - 72 - Table 7: Decomposition of 1999/00 and 2000/01 Education Sector Development Expenditure by Source Programme Part 1: Loans % of Dev. Part II: GoM % of Development %of Bilateral % of Total % of Bud. Dev Budget Total (Estimate) Total Total Bud 1999/00 Education Sector Development Expenditure Total 516.234.000 89% 65127.000 11% 581.361.000 35% 1,065.360,000 65% 1.646.721.000 100% Primary 146,814,000 80% 35,650,000 20% 182,464,000 26% 506,620,000 74% 689,084,000 42% Secondary 324,023,000 92% 28,636,000 8% 352,659,000 60% 238,000,000 40% 590,659,000 36% T. Ed 19,096,000 99% 105,000 1% 19,201,000 6% 313,740,000 94% 332,941,000 20% Admin. 26,301,000 97% 736,000 3% 27,037,000 79% 7,000,000 21% 34,037,000 2% 2000/01 Education Sector Development Expenditure Total 51.506.00 78% 233.432.000 22% 1.084.938.000 46% 1.295.235.000 54% 2.380.173,000 100% Primary 199,744,000 68% 92,331,000 32% 292,075,000 30% 691,451,000 70% 983,526,000 41% Secondary 592,677,000 95% 28,660,000 5% 621,337,000 75% 204,490,000 25% 825,827,000 35% T. Ed 25,930,000 100% 0 0% 25,930,000 10% 234,016,000 90% 259,946,000 11% Tertiary - 104,000,000 104,000,000 - 104,000,000 4% Other Ed Orgs 7,600,000 Admin. 33,155,000 98% 841,000 2% 33,996,000 17% 165,278,000 83% 199,274,000 8% Source: Government of Malawi (2000e) - 73 - REFERENCES Al-Samarrai, S. and H. Zaman, (2000). "The Distribution of Public Education Expenditure in Malawi: An Update," Mimeo, World Bank, Washington DC. Barbone L. and B. Luis-Alvaro Sanches, (1999). 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