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Cover design, interior design and typesetting: Piotr Ruczynski, London, United Kingdom CONTENTS Acknowledgements 7 Abbreviations 8 Overview 9 1 Economic Developments 18 1.1 Global and Regional Context 19 Global growth remains steady as inflation moderates, but low-income countries are facing new policy challenges 19 1.2 Recent Economic Developments 22 Malawi’s economic growth has fallen following the impacts of Cyclone Freddy and an ongoing debt and balance of payments crisis 22 The balance of payments crisis has resulted in continued foreign exchange shortages, while the policy response remains inadequate 28 Supply-side constraints and money supply growth are pushing inflation upwards 31 Despite strong performance on revenues, higher spending across budget categories led to a worsening fiscal position for FY2022/23 32 Government projects that the budget deficit will improve in FY2023/24, but fiscal room remains highly constrained 34 Government debt is still in distress and unsustainable, but ongoing external debt restructuring negotiations, if successful, will help ease the burden 36 The Malawi kwacha has experienced a sharp depreciation, as foreign exchange shortages remain severe 38 The RBM has further increased the policy rate to 22 percent, but so far monetary policy has had limited impact on containing inflation 39 The banking sector remains well capitalized, highly profitable and has ample liquidity, though NPLs are on the rise 40 1.3 Medium-Term Economic Outlook 43 Policy Options: Restoring macroeconomic stability, supporting the recovery of growth, and protecting the poor against shocks 44 2 Powering up: How Malawi can rapidly increase electricity access 46 Enhancing access to energy is critical to achieving economic development and the aims of Malawi 2063 47 Malawi’s rate of electricity access is among the lowest in the world 47 Malawi has set ambitious policy goals, but implementation has often lagged behind 48 Implementation results of the electrification policy has been mixed 49 Key lessons learned from Malawi’s Power Access Programs 51 Malawi has an opportunity to rapidly increase electricity access 53 How can Malawi achieve the electrification target set in Malawi 2063? 54 The pathway to universal access requires leadership, partnership, and reforms 56 References 62 BOXES BOX 1.1 Lessons from Malawi’s recent cholera outbreak 23 BOX 1.5 The Lilongwe-Salima water project raises BOX 1.2 A balance between private sector leadership and transparency and debt sustainability concerns 37 public facilitation will determine the success of the Mega BOX 1.6 Consecutive shocks have pushed many Farms Programme 24 Malawian households to borrow money, relying primarily BOX 1.3 What potential does the mining sector hold for on informal sources 42 Malawi? 29 BOX 2.1 Overview of the key electricity access programs BOX 1.4 Fiscal risks emanating from poor performing in Malawi 49 SOEs are increasing 35 BOX 2.2 Electrifying public institutions 59 FIGURES FIGURE O.1 A snapshot of Malawi’s economic situation 11 FIGURE 1.18 Fertilizer and oil have been getting cheaper FIGURE O.2 Malawi lags behind other East African recently while Malawi’s main exports have maintained countries in increasing energy access 13 their value 30 FIGURE O.3 Business as usual will only increase FIGURE 1.19 After a long decline, Malawi’s terms of trade Malawi’s access rate to 30 percent by 2030 15 are looking up 30 FIGURE 1.1 Global growth is steady while inflation is likely FIGURE 1.20 Increasing money supply is inducing to have peaked in 2022 19 pressure on inflation 31 FIGURE 1.2 Above target inflation has prompted most FIGURE 1.21 Maize prices have seen the sharpest year- central banks to tighten interest rates 19 on-year increase in over 15 years 31 FIGURE 1.3 Trade openness has declined following a FIGURE 1.22 Increased expenditure is contributing to steady increase from 1990 until the Global Financial Crisis 20 worsened fiscal deficits 32 FIGURE 1.4 Trade and investment restrictions have been FIGURE 1.23 Fiscal deficits continue to miss their on the rise, especially since 2018 20 approved targets 32 FIGURE 1.5 Economic fortunes in the region are diverging 21 FIGURE 1.24 Interest expense has mostly missed FY targets contributing to expenditure overruns 33 FIGURE 1.6 Not the post-COVID recovery Malawians had hoped for 22 FIGURE 1.25 Allocation for interest expense is eclipsing sectoral allocations 35 FIGURE 1.7 Cyclones are becoming more frequent and destructive 22 FIGURE 1.26 Public debt is still increasing rapidly 36 FIGURE 1.8 Cyclone Freddy’s impacts affected highland FIGURE 1.27 Composition of public debt by holder 37 districts more than previous storms 23 FIGURE 1.28 Increased interest expense has been driven FIGURE 1.9 Yields of maize and pulses 24 by higher debt held in high-cost treasury notes 37 FIGURE 1.11 Shortages loom when the fuel price exceeds FIGURE 1.29 As reserves decline, the spreads between the economic costs of fuel 25 TT and bureau MWK – US$ exchange rates continue FIGURE 1.10 Announced minimum farmgate prices are to widen 38 often too high to make trading financially viable 25 FIGURE 1.30 Swap rollovers have been increasingly used FIGURE 1.12 Malawi is falling behind on energy supply 26 as sources of foreign exchanges 39 FIGURE 1.13 Employment levels are trending down since FIGURE 1.31 While the real policy rate remains negative, early 2022 27 the base lending rate and interbank rate have increased 40 FIGURE 1.14 The COVID-induced return to farming has FIGURE 1.32 The yield of 364-day bills climbed over been reversed but family businesses are not absorbing the year 40 workers 27 FIGURE 1.33 Bank resilience is reflected in financial FIGURE 1.15 The labor market for the educated stability indicators 40 has recovered 27 FIGURE 1.34 Bank lending is predominant in three sectors 41 FIGURE 1.16 Without access to foreign exchange, imports FIGURE B1.6.1 Almost half of Malawian households have dwindled, closing the trade deficit 28 attempted to borrow money 42 FIGURE 1.17 Fuel and fertilizer have been largely FIGURE 2.1 Malawi lags other East African countries in protected from the fallout that affected other imports 28 increasing energy access 47 FIGURE 2.2 Malawi has one of the largest electricity FIGURE 2.7 Malawi’s existing MV network 54 access deficits, with over 80 percent of the population not FIGURE 2.8 Business-as-usual will only get Malawi to a connected to power 48 30 percent access rate by 2030 55 FIGURE 2.3 ESCOM increased connections from 2012 to FIGURE 2.9 Achieving the electrification target set in 2021, but on-grid access rate stalled 50 Vision 2063 55 FIGURE 2.4 Malawi has a dynamic off-grid market FIGURE 2.10 Malawi’s pathway to achieve 50 percent connecting over 5 percent of population 50 electricity access rate by 2030 58 FIGURE 2.5 Malawi is among the countries with highest FIGURE B2.2.1 Various financing initiatives and options share of access to solar 50 to support healthcare facility electrification in Malawi 60 FIGURE 2.6 Off-grid solar is driving the electricity access rate increase while on-grid connections stalled 51 TABLES TABLE 1.1 Fiscal accounts 33 TABLE 2.1 Macroeconomic indicators 61 TABLE 1.2 Priority policy areas and key actions 45 7 ACKNOWLEDGEMENTS The Malawi Economic Monitor (MEM) provides an analysis of economic and structural development issues in Malawi. This 17th edition was published in July 2023 and is part of an ongoing series pub- lished twice each year. The publication intends to foster better-informed policy analysis and debate regarding the key challenges that Malawi faces in its endeavor to achieve inclusive and sustainable economic growth. This edition of the Malawi Economic Monitor was prepared by Jakob Engel (Senior Country Economist, Task Team Leader), Yumeka Hirano (Economist, co-Task Team Leader), Yalenga Nyirenda (Country Economist, co-Task Team Leader), Hayaan Nur (Consultant), Efrem Chilima (Senior Private Sector Specialist), Innocent Njati Banda (ET Consultant), Zhengjia Meng (Senior Infrastructure Finance Specialist), Michael Chipalaule Gondwe (Senior Energy Specialist), and Federico Hinrichs (Consultant). Contributions were also made by Javier Aguilar (Senior Mining Specialist), Grain Malunga (Consultant), Lina Marcela Cardona (Economist), William Mwanza (ET Consultant), Svitlana Orekhova (Program Officer), Chiho Suzuki (Senior Health Specialist), and Collins Zamawe (Health Specialist). Abha Prasad (Practice Manager, Macroeconomics, Trade and Investment), Julia Fraser (Practice Manager, Energy), Hugh Riddell (Country Manager, Malawi), Preeti Arora (Operations Manager, Malawi), and Nathan M. Belete (Country Director, Malawi) provided overall guidance. The team wishes to thank William Battaile (Lead Country Economist) and Arun Sanghvi (Consultant), as well as the peer review- ers Fiseha Haile (Senior Economist) and Dana Rysankova (Lead Energy Specialist) for their construc- tive inputs. This report benefited from fruitful discussions, comments and information provided by representatives of the Ministry of Finance and Economic Affairs; the Reserve Bank of Malawi; the Ministry of Energy, the National Statistical Office; and a number of other Government ministries, departments and agen- cies. The team would also like to thank representatives of the private sector and civil society organiza- tions in Lilongwe and Blantyre for their helpful contributions. Henry Chimbali (External Affairs Officer), Keziah Muthembwa (External Affairs Officer), Elizabeth Mangani (Team Assistant), Thokozile Chiwaya (Team Assistant), and Tinyade Neffie Kumsinda (Team Assistant) provided assistance with external communications, design and additional production sup- port. Peter Kjaer Milne and Ella Hoffman provided editorial support. The findings, interpretations, and conclusions expressed in this publication do not necessarily reflect the views of the World Bank’s Executive Directors or the countries they represent. The report is based on information current as of June 30, 2023. The World Bank team welcomes feedback on the structure and content of the Malawi Economic Monitor. Please send comments to Jakob Engel (jengel@wordlbank.org), Yumeka Hirano (yhirano@ worldbank.org) or Yalenga Nyirenda (ynyirenda@worldbank.org). 8 ABBREVIATIONS AIP Affordable Inputs Programme MRA Malawi Revenue Authority BAU Business as Usual MW Megawatt BOP Balance of Payments MWK Malawi Kwacha DRM Disaster Risk Management NEP National Energy Policy DSA Debt Sustainability Analysis NES National Electrification Strategy ECF Extended Credit Facility NLB Net Lending and Borrowing EDF Export Development Fund NNNF Ngwee Ngwee Ngwee Fund EMDEs Emerging Markets and Developing Economies NPL Non-Performing Loan ESCOM Electricity Supply Corporation of Malawi NSO National Statistics Office FY Fiscal Year PAYE Pay-As-You-Earn GDP Gross Domestic Product PAYG Pay-As-You-Go GoM Government of Malawi PDNA Post Disaster Needs Assessment HFPS High-Frequency Phone Survey PFM Public Financial Management IDA International Development Association PPG Public and publicly guaranteed IFI International Financial Institution PPP Purchasing Power Parity IFMIS Integrated Financial Management Information PSF Price Stabilization Fund System RBF Result-based Financing IMF International Monetary Fund RBM Reserve Bank of Malawi LIC Low Income Country ROA Return on Assets LV Low Voltage ROE Return on Equity MAIIC Malawi Agricultural and Industrial Investment SDG Sustainable Development Goals Corporation SHS Solar Home System MAREP Malawi Rural Electrification Program SOE State Owned Enterprise MTDS Medium-Term Debt Strategy SSA Sub-Saharan Africa MEAP Malawi Energy Access Program TA Technical Assistance MEM Malawi Economic Monitor TT Telegraphic Transfer MIS Management Information System USAID United States Agency for International MoE Ministry of Energy Development MoFEA Ministry of Finance and Economic Affairs VAT Value Added Tax MPC Monetary Policy Committee Y-o-Y Year-on-Year 9 OVERVIEW Malawi’s economy continues to struggle amidst a devastating cyclone, rising inflation and a protracted macro-fiscal crisis Weak growth performance in 2022 was driven by longstanding macroeconomic imbalances cul- minating in a protracted balance of payments (BOP) crisis and was exacerbated by numerous exter- nal shocks. The economy was weakened by foreign exchange shortages that constrained the importa- tion of essential commodities and production inputs, a generally unfavorable external environment, and continued challenges in advancing key macroeconomic and governance policy reforms. This con- strained growth for 2022 to just 0.9 percent, equating to a per capita output reduction of 1.8 percent. The widespread destruction caused by Cyclone Freddy and the persistence of external balance chal- lenges in early 2023 already weighed down economic performance for the current year. Cyclone Freddy was the most destructive in a series of increasingly frequent extreme weather events affecting Malawi, causing US$505 million material loss and damage, as well as production losses equivalent to a real gross domestic product (GDP) loss of 0.5 percent for 2023. The effects of the cyclone have particu- larly impacted the outlook for the agriculture sector in the coming season, with potentially grave con- sequences for the poorest. Higher domestic food prices due to disappointing harvests and high agricultural input prices con- tinue to exert pressure on household incomes, pushing many into poverty. The proportion of peo- ple living on less than US$2.15 Purchasing Power Parity (PPP) per capita a day (approximately Malawi kwacha (MWK) 1,220 as of April 2023) increased to 71.3 percent in 2022. High fertilizer prices as well as the increased growth potential of other crops has caused many households to shift away from maize towards legumes, oilseeds, and nuts. While this could result in reduced supply of staples and conse- quently upward pressure on domestic food prices, it could also result in increased agricultural export potential and diversification. The Government’s efforts to support commercialization and diversifica- tion through the “Mega Farms Programme” could further accelerate this favorable dynamic if imple- mented in a way that incentivizes private sector participation. The industrial sector has been particularly impacted by foreign exchange, fuel, and electricity short- ages. While the fuel allocation mechanism is not public, industry often is first affected by rationing. Industry is reliant on adequate electricity supply, which was intermittent throughout 2022 and the start of 2023. In recent years Malawi has often struggled to meet the country’s energy supply require- ments. The partial restoration of the Kapichira hydroelectric power station is a first step towards the alleviation of energy supply challenges. Larger plans to increase generation capacity both through the expansion of solar power generation and the Mpatamanga hydropower plant could further address energy needs, but this will take time. Industry is also reliant on accessing capital and production inputs, but Malawi’s imports continue to be constrained by the foreign exchange shortages. Inputs are often not accessible in the domestic market and the ensuing BOP crisis makes their importation difficult. Official real imports in the year to April 2023 are at a level approximately 65 percent below their 5-year average through 2021, though this likely overstates the actual decline in imports given the significant volumes of informal trade. However, a robust start to the tobacco marketing season promises some alleviation this year, while the growth of new non-traditional agricultural exports, and increased investor interest in the mining sector, could generate new sources of foreign exchange over the medium term. Overview 10 The FY2023/24 budget signals a shift towards consolidation, but successful implementation depends on improved fiscal governance Driven by expenditure overruns, the planned fiscal deficit for FY2022/23 was exceeded by over 4 per- cent of GDP. Supported by good performance in taxes and grants, revenue surpassed the FY2022/23 target. However, Government overspent in compensation of employees and acquisition of non-financial assets (previously development expenditure) resulting in significant expenditure overruns and consequently offsetting the good performance in revenue collection. The fiscal deficit worsened to 10.9 percent of GDP, exceeding the revised mid-year target of 6.4 percent of GDP. This lack of budget discipline has been a consistent feature over recent years, with the fiscal deficit largely financed by domestic borrowing. Government projects that the fiscal deficit will reduce in FY2023/24, but fiscal room remains highly constrained. Although the fiscal deficit is projected to narrow, it will remain high at 7.7 percent of GDP in FY2023/24. Revenue is projected to improve to 16.0 percent of GDP, while expenditure is projected to decline to 23.8 percent of GDP. Amidst rising domestic interest rates and high domestic debt lev- els, interest payments are projected to increase to 5.7 percent of GDP in FY2023/24 from 4.8 percent of GDP in FY2022/23, leaving little room for much-needed investment, and constraining the government’s ability to respond to shocks. In this context, doing more with less will be essential, including making further progress on ongoing fiscal governance reforms. The Government is making some strides in implementing public financial management (PFM) reforms to improve expenditure management and advance the fiscal consolidation process. Since the beginning of FY2023/24, the Government is piloting quarterly budgetary allotments and requiring Ministries, Departments, and Agencies to commit up to the amount allotted within the Integrated Financial Management Information System (IFMIS). If properly implemented, this will help address overcommitments, which have resulted in the growth of spending arrears. Government debt is still in distress and unsustainable, but ongoing debt restructuring negotia- tions, if successful, will help ease the burden. Weak performance of the external sector and the dete- riorating fiscal deficit have contributed to worsened debt vulnerabilities, already pressured by rising debt and debt servicing costs. The joint World Bank-IMF November 2022 Debt Sustainability Analysis reported that public debt is in distress under current policies, but achieving progress in the ongoing debt restructuring negotiations with commercial and bilateral creditors would bring debt on a down- ward trajectory over the medium term. The Malawi kwacha has experienced a sharp depreciation, as foreign exchange shortages remain se- vere. The Malawi kwacha continued to weaken, with spreads exceeding 50 percent between telegraph- ic transfer (TT) and bureau MWK – US$ exchange rates. Gross foreign exchange reserves remain at around 0.8 months of import cover. Net reserves have been negative for over one year, and gross reserves have been mainly supported by swaps as well as World Bank International Development Association (IDA) project disbursements and the International Monetary Fund (IMF) Rapid Credit Facility approved in November 2022. Various measures to rebuild foreign reserves, including conducting foreign exchange auctions, have had limited impact on foreign exchange accumulation so far, as foreign exchange sales by the Reserve Bank of Malawi (RBM) have continued. However, the introduction of foreign exchange auctions is contributing to the facilitation of price discovery and addressing the growing exchange rate misalignment. The tightening of monetary conditions has been insufficient to contain inflationary pressures — in large part due to the continued increase in the money supply. The Monetary Policy Committee (MPC) increased the policy rate from 18 to 22 percent in April 2023. This policy rate increase and strong Government demand led to a rise in monthly average treasury bill and note yields. Despite some ef- forts by the RBM to address rising inflation, the real policy rate has been negative, reaching –7.2 per- cent and the money supply has continued to expand. Overview 11 FIGURE O.1  A snapshot of Malawi’s economic situation a. Shortage of foreign reserves has constrained imports and exports, contributing to an b. The exchange rate remains overvalued, despite the continued decline of foreign improved trade balance exchange reserves 150 1,800 4.0 RBM TT and forex bureau cash MK/US$ rates 100 3.5 50 1,600 0 3.0 Months import cover −50 1,400 MWK, billion 2.5 −100 −150 1,200 2.0 −200 1.5 −250 1,000 −300 1.0 −350 800 0.5 −400 01/2018 04/2018 07/2018 10/2018 01/2019 04/2019 07/2019 10/2019 01/2020 04/2020 07/2020 10/2020 01/2021 04/2021 07/2021 10/2021 01/2022 04/2022 07/2022 10/2022 01/2023 04/2023 600 0.0 01/2020 03/2020 05/2020 07/2020 09/2020 11/2020 01/2021 03/2021 05/2021 07/2021 09/2021 09/2021 11/2021 11/2021 01/2022 01/2022 03/2022 03/2022 05/2022 05/2022 07/2022 07/2022 09/2022 09/2022 11/2022 11/2022 01/2023 01/2023 03/2023 03/2023 05/2023 05/2023 Seasonally Adjusted Real Exports Seasonally Adjusted Real Imports Seasonally Adjusted Real Trade Balance O icial TT sell Median cash sell Gross reserves (RHS) c. Inflation has been rising, with pressures from the increased money supply mounting d. The RBM has adjusted the policy rate to address rising inflation, but the real policy rate is still negative 40 50 35 40 30 30 25 20 Percent Percent 20 10 15 0 10 −10 5 −20 01/2016 05/2016 09/2016 01/2017 05/2017 09/2017 01/2018 05/2018 09/2018 01/2019 05/2019 09/2019 01/2020 05/2020 09/2020 01/2021 05/2021 09/2021 01/2022 05/2022 09/2022 01/2023 05/2023 0 01/2017 05/2017 09/2017 01/2018 05/2018 09/2018 01/2019 05/2019 09/2019 01/2020 05/2020 09/2020 01/2021 05/2021 09/2021 01/2022 05/2022 09/2022 01/2023 05/2023 Policy rate Base rate Interbank rate Inflation Broad money growth 364-day treasury bill Max lending rate Real policy rate e. Spending overruns continue to drive the fiscal deficit beyond budgeted levels f. Deficits are largely financed through domestic borrowing, and the issuance of high-cost treasury notes 0 5,500 −2 5,000 4,500 −4 4,000 3,500 Percent MK, billion −6 3,000 2,500 −8 2,000 1,500 −10 1,000 500 −12 0 2010/11 2018/19 2011/12 2012/13 2013/14 2019/20 2023/24 2014/15 2017/18 2015/16 2016/17 2020/21 2021/22 2022/23 01/2015 08/2015 03/2016 10/2016 05/2017 12/2017 07/2018 02/2019 09/2019 04/2020 11/2020 06/2021 01/2022 08/2022 03/2023 Budgeted deficit Actual deficit Treasury bills Treasury notes Others Sources: a. World Bank staff calculations based on National Statistics Office Trade Bulletin data and RBM Consumer Price Index data; b. World Bank staff calculations based on RBM data; c. World Bank with data from RBM and NSO; d. World Bank staff calculations based on RBM data; e. World Bank with data from Ministry of Finance and Economic Affairs. ; f. World Bank staff calculations based on RBM data. Overview 12 Getting Malawi back on track will require significant reforms to increase macro-stability, growth, and resilience The growth of Malawi’s economy is projected to slightly pick up in 2023, followed by higher rates of growth in the subsequent years. Economic growth is expected to increase to 1.4 percent in 2023, driven by a partial recovery of the agriculture sector, which was impacted by Cyclone Freddy, and the resumption of electricity generation at the Kapichira hydropower plant. However, this is still a decline in output in per-capita terms. Lingering effects of the cyclones that occurred in 2022 and 2023 may delay the economy’s full recovery to the pre-COVID-19 growth trajectory and further external shocks may result in increasing poverty and food insecurity. Over the medium term, economic growth is pro- jected to increase moderately, underpinned by gradual macroeconomic stabilization and a recovery across all sectors. Elevated inflationary pressures may constrain headline inflation from reaching its target in the near term. The projected decline of global commodity prices is expected to ease inflationary pressures from 2023. However, food prices are still rising and additional pressure from anticipated lower agricultural output could further increase food inflation. Persistent current account pressures are expected to further strain foreign reserves, leading to con- tinued forex shortages. While agricultural exports are expected to improve, albeit moderately, imports are also projected to slightly pick up in 2023. These periods of foreign exchange shortages inflict severe and enduring impacts on the economy. Due to the unavailability of imported inputs, businesses are forced to forgo lucrative investment opportunities, thereby worsening the medium-term economic growth outlook. Despite efforts towards fiscal consolidation, the fiscal deficit is likely to remain persistently high due to continued high expenditure pressures. Interest expenditures will continue to rise and absorb a higher proportion of the resource envelope, in turn continuing to constrain fiscal space, especially for needed investment to spur growth. Financing assurances from these creditors, supported by sup- portive fiscal, monetary, and exchange rate policies, could pave the way towards a sustainable debt path and enable the country to qualify for an IMF Extended Credit Facility (ECF). However, debt vulnerabil- ities will remain elevated, even if successful external debt restructuring with commercial and bilateral creditors is achieved due to the growing domestic debt burden. Key to addressing these vulnerabili- ties is sustained fiscal consolidation, which progressively lowers expenditure, and additional measures to reduce debt vulnerabilities, particularly through improved PFM systems, in turn, engendering trust from private investors and development partners. The financial sector is expected to remain resilient though access to credit remains highly constrained amidst the continued rise in Government borrow- ing from commercial banks. There is a significant degree of uncertainty surrounding these economic prospects, with both down- side risks and potential for higher growth. Downside risks include prolonged foreign exchange short- ages, setbacks in the ongoing negotiations for external debt restructuring, financial stress, delays in the Affordable Inputs Programme (AIP) reform process, intensifying climate change impacts, and a renewed cholera outbreak. However, if the economy is able to bounce back quickly from the impacts of the recent cyclone and the Government is able to advance on its reform agenda, the coming year could also exceed current expectations. The path towards achieving the goals of Malawi 2063 is nar- row but still feasible and will require a sustained focus on implementing tough but necessary reforms. This 17th edition of the Malawi Economic Monitor (MEM) calls for urgent actions to stabilize the econ- omy and enhance growth. As in the previous MEMs, this edition includes addressing three key areas: i) Restoring macroeconomic stability: Despite the recognition within Government that macro-stabi- lization is a prerequisite for achieving broader development aims, stepped-up reforms are needed Overview 13 to rebuild foreign reserves, instill budget discipline, improve public financial management, and achieve debt sustainability. ii) Increasing production and exports: Malawi’s private sector has been hit hard by the instabil- ity and shocks of the past years. To achieve growth, reforms that support private invest- ment and the enhancement of productive capacity in firms will be needed to boost exports, strengthen agricultural diversification and commercialization initiatives, and bring in more foreign investment. iii) Building resilience and protecting the poor: Given the growing frequency and severity of climate-re- lated shocks, it will be essential to step up efforts to support the most vulnerable. This includes moving forward with the implementation of the Disaster Risk Management (DRM) Act, expend- ing the roll-out, coordination, and scaling up of key social protection programs and improving disease surveillance and response in the case of a new disease outbreak, such as cholera. Special Topic on “Powering Malawi’s Growth” Enhancing access to energy is critical to achieving economic development and the aims of Malawi 2063 Given the challenges highlighted in Chapter 1 of this MEM, it will be important to create the con- ditions and enabling environment for growth. Increasing access to energy, the focus of Chapter 2 of this MEM, is essential for economic development, and its impact on a nation’s GDP can be substantial. In Malawi, energy access is a key element for the achievement of Malawi 2063 of transforming the coun- try into a more industrialized and prosperous nation. As such, investment in energy access is a top pri- ority to advance the country’s economic development and wealth creation aims. In households, energy access can significantly improve living conditions by providing access to mod- ern technologies, lighting, and cooking. This directly translates to improved living standards, and bet- ter economic opportunities, particularly benefiting poor and rural households. Moreover, energy access plays a crucial role FIGURE O.2  Malawi lags behind other East African countries in in the delivery of essential public services such as health and increasing energy access education, ultimately contributing to human development Progress in electrification in Malawi and other East African Countries from 2000 – 2020 and annual growth rates and poverty reduction. In the past decade, several Sub-Saharan African (SSA) coun- Malawi 5.5% p.a. tries have made strides in accelerating electrification ef- forts. Countries in East Africa, including Malawi’s neighbors Mozambique 8.0% p.a. Mozambique and Tanzania, significantly increased access rates, having started from electricity access rates below 10 percent in 2000 like Malawi. These countries now have access rates over Rwanda 10.1% p.a. 30 percent, while Malawi still lags, with access below 20 per- cent (Figure O.2). They offer valuable lessons, highlighting the Tanzania 7.4% p.a. need for comprehensive, long-term electrification efforts that build nationwide and sector-wide electrification platforms, lev- eraging both grid and off-grid electrification, and mobilizing Kenya 7.7% p.a. public and private sector resources in a coordinated manner. The success of these countries has been attributed to political 0 10 20 30 40 50 60 70 80 90 commitment, a conducive enabling environment, a long-term Percent electrification strategy, least-cost planning, and a commitment 2000 2010 2020 to adopting adaptive approaches that fine-tune implementa- tion based on lessons learned. Source: World Bank Global Electrification Database. Overview 14 Malawi’s rate of electricity access is among the lowest in the world, but important lessons have emerged from past electrification programs Malawi has one of the lowest electricity access rates in the world. In 2023, the electricity access rate is estimated at 19 percent with severe disparities between urban (42 percent) and rural areas (5 per- cent). The inequity among the rich and poor is also stark — access among the richest 20 percent of the population is about 30 times higher than the poorest 20 percent. The annual population growth rate of 2.8 percent is outstripping the pace of electrification. World Bank data shows that Malawi had the fourth-lowest energy access rate in Africa in 2022, just ahead of South Sudan, Chad, and Burundi. Malawi’s government has set an ambitious policy goal to achieve universal energy access by 2030. Through the publication of the revised National Energy Policy (NEP) in 2018 and other framework documents, the Government set a strong foundation for progress. Despite a robust strategic and pol- icy framework, electrification program implementation over the past five years yielded mixed results. While the rate of access has climbed from 11 percent in 2018 to 19 percent in 2023, owing to the expan- sion of the private sector-led off-grid solar home system (SHS) development1, the share of the popula- tion linked to the grid has remained stagnant at about 12 percent. As a result, overall progress remains below expectations. A significant grid connection backlog of over 50,000 households2 demonstrates program execution issues. The COVID-19 pandemic compounded implementation challenges and slowed electrification efforts significantly. Here are some key lessons learned from past electrification programs: • Increasing energy access requires political support and government ownership. • Solving energy access deficit requires a value chain approach. • Improving the operational efficiency of Electricity Supply Corporation of Malawi (ESCOM) is key to its success. • Attracting private sector capital and expertise can leverage new technology and business models. Malawi has the potential to achieve rapid electrification in the coming years if lessons from previ- ous electrification programs are effectively implemented and essential changes are initiated. Malawi can break the pattern of slow progress, thanks to the country’s advantage of high population density and the emergence of off-grid technology and innovative business models. However, it is critical that ESCOM reforms are implemented quickly and successfully to achieve the promise of rapid electrification. How can Malawi rapidly its increase energy access rate? Business as usual will not move the country above the 30 percent access rate by 2030. Assuming the same number of ESCOM connections per year as in the past (about 35,000 per year), new grid connec- tions will be offset by population growth, resulting in only marginal contributions to the overall elec- trification rate increase. The off-grid solar market will continue to grow, but due to affordability chal- lenges, it will be increasingly difficult to achieve annual growth rates much higher than 15 percent and for the country to achieve an overall electricity access rate of more than 30 percent (Figure O.3). Crucial policy and reform measures will be required to reach 50 percent access rate by 2030. A joint effort from the Government3 and private sector is needed with both ESCOM and off-grid solar 1. Fueled by supportive government policies, such as value added tax (VAT) and duty exemptions, the SHS market has grown expo- nentially with 400,000 SHS sold as of 2022 2.  Estimated at the beginning of 2023. 3.  The Ministry of Energy and Ministry of Finance and Economic Affairs started the reform in 2023 through the resolution and implementation of long-standing legacy issues (e.g., single buyer governance and sector arrears). Overview 15 companies having a shared responsibility to connect about FIGURE O.3  Business as usual will only increase Malawi’s a quarter of the population each in the next 7 years. ESCOM access rate to 30 percent by 2030 needs to triple its annual connection rate to 100,000 house- Thousands of customers connected to on-grid and off-grid connections holds, prioritizing grid densification to achieve both speed 1,800 30 and efficiency. The off-grid solar companies need to grow 1,600 at 25 percent annually, which requires supportive govern- 25 1,400 ment policy, new financing mechanisms and business mod- Customers, Thousand 1,200 20 el innovations. 1,000 Percent 15 Universal access by 2030 remains an ambitious target that 800 Malawi should strive for. Crucial reforms must be achieved 600 10 in the power sector, but financing and sector coordination 400 5 are also key. It is estimated that connecting all people to the 200 grid will cost US$2 – 3 billion, most of which will be borne 0 0 2012 2013 2018 2019 2014 2016 2020 2024f 2015 2017 2021 2023e 2026f 2022e 2028f 2025f 2029f 2030f 2027f by the Government, donors, or existing ESCOM custom- ers. Achieving universal access also requires a concerted ef- fort from the Government and private sector to make best On-grid O -grid Power Access Rate use of scarce public finance resources and to avoid dupli- Source: ESCOM, World Bank team estimate. cated efforts. Note: e indicates estimates and f forecasts. The pathway to universal access requires leadership, reforms, and partnership Leadership: Government leadership and clear policy goals will be central to progress 1. The Government should establish institutional arrangements and regularly update the gen- eration and transmission master plans to ensure adequate supply and transmission capacity. Updating and implementing generation and transmission least cost plans are important for con- nections, as this will facilitate new connections and better serve existing customers. The least cost plans have not been updated and implemented in the past five years, making them ineffec- tive tools to guide sector development. To address this issue, the Ministry of Energy (MoE) has hired international consultants to update these plans, with technical support from ESCOM. The updated generation and transmission plans are expected to be published by the end of 2023. The MoE should also ensure the timely execution of these least cost plans. 2. The MoE can take a stronger coordination role in balancing the roll-out plans for on-grid and off-grid connections. This can be achieved by working closely with ESCOM and the private sec- tor to ensure that resources are allocated appropriately to both on-grid and off-grid electrifica- tion projects. While the private sector has been driving off-grid deployment, there have been limitations in the ability of the MoE to monitor progress and coordinate between ESCOM and off-grid players, as not all data has been collected. Addressing these monitoring issues is crucial to ensure that the progress towards increased access to electricity is effectively tracked. As the country faces significant affordability challenges, it will become increasingly important for the Government to play a driving policy role in facilitating financing and providing targeted subsi- dies to solar companies and end users respectively to support electrification efforts. 3. The MoE is encouraged to update the NEP 2018 to ensure its alignment with current challeng- es. While the NEP 2018 provides a good framework for energy sector development, certain as- pects of the policy need to be reviewed, considering the increasing threat of climate change im- pacts and the current progress towards universal energy access. An updated NEP will provide policy guidance on incorporating climate risks in energy sector planning and set an ambitious yet achievable energy access target for 2030. Overview 16 4. The Government should formally adopt the draft Guidelines for Implementation of the National Electrification Program, which outlines the connection and connection fee policy. The formalization will remove any financial uncertainties for potential customers and the im- plementing agency, thereby facilitating scale-up. Reform: Government needs to reform ESCOM to improve its operational efficiency and financial sustainability 1. The Government needs to foster a culture of accountability and continuous improvement within ESCOM. The operational efficiency of the connection team should be measured against clear targets in a systematic manner. Such approaches, when combined with a comprehensive training program and human resource development policies, can dramatically boost connec- tion speed. 2. ESCOM should improve its procurement processes. Exploring options to further standardize con- nection design and procurement documents can streamline the availability of materials and re- sources, reducing the possibility of procurement delays and ensuring cost competitive contracts. 3. ESCOM needs to fully operationalize its Management Information System (MIS). Currently the under-utilization of the MIS leads to manual work and human errors that significantly slow down the roll-out of connections. The ESCOM management team need to execute a comprehensive change management program to maximize the utilization of the advanced MIS4 already in place. 4. The Government needs to work with ESCOM to achieve financial sustainability. Improving ESCOM’s financial position is vital for increasing access rates. Previously, ESCOM was discouraged from expanding its connection program, in part because of perceived risks of increasing losses. A financially stable ESCOM will have adequate resources for routine maintenance and customer service, reducing losses and line faults. Additionally, it will also be able to access more medium- and long-term capital without the need for a sovereign guarantee, which can be used to fund el- igible consumer connections. A recent World Bank study identified critical areas where ESCOM and the Government should collaborate to improve ESCOM’s financials, including revenue man- agement, loss reduction, tariff adjustment mechanisms, balance sheet optimization, and sector arrears elimination. Partnership: The Government needs to work with the private sector to sustain the growth momentum in the off-grid solar market 1. The Government is encouraged to continue supportive policies, such as a value added tax (VAT) and duty exemptions, to stimulate additional private sector investment. These incentives have proven effective in attracting investment and driving growth in the sector. Additionally, the gov- ernment can explore other incentives, such as result-based financing (RBF) comparable to USAID’s “Kickstarter” program and the World Bank-financed Malawi Energy Access Program (MEAP), to entice more enterprises to join the Malawian market. Increased competition will not only drive down prices but also spur innovation and the development of new technologies, enhancing the efficiency and efficacy of off-grid solar systems. 2. The Government is encouraged to facilitate more local currency financing5 for off-grid com- panies. Financing has been a major barrier to the growth of local off-grid solar companies. The ongoing macroeconomic crisis and issues of currency inconvertibility have exacerbated the chal- lenge. International off-grid solar companies that rely on hard currency loans face substantial 4. The MIS implementation was not fully successful, and many modules of the system remain underutilized. 5. As an example, the “Ngwee Ngwee Ngwee Fund” under the MoE is providing local currency financing to Malawi-based solar companies. Overview 17 foreign exchange risks due to a currency mismatch between funding and revenue currencies. By facilitating local currency loans, the government can create funding opportunities and reduce risks associated with hard currency financing. This will enable solar companies to expand their business and cut their price, leading to market growth. 3. Targeted end-user subsidies can be introduced to further reduce the price of off-grid solar products for those who need them most. An affordability analysis suggests that increasing ac- cess beyond business-as-usual projections will require additional price reductions, particular- ly for low-income users. The Government can work with its development partners to create fi- nancial instrument that enable targeted end-user subsidies. Currently development partners like EnDev and the World Bank are piloting end-user subsidies, with the goal of testing design and paving the way for future scale-up. 4. The Government is encouraged, in consultation with off-grid solar companies, to set market standards for mini-grid and SHS to ensure quality products and services. Implementing prov- en standards and best practices, which have been locally adapted and successfully implemented in other countries such as Bangladesh, Kenya, and Rwanda, will enhance consumer confidence and drive increased demand in the off-grid solar market. 1 ECONOMIC DEVELOPMENTS 1. Economic Developments 19 1.1 GLOBAL AND REGIONAL CONTEXT Global growth remains steady as inflation moderates, but low-income countries are facing new policy challenges Despite continued shocks, global growth conditions remain stable. Global real economic growth in 2022 is now estimated at 3.1 percent in the most recent World Bank Global Economic Prospects (June 2023) — slightly lower than the forecast of 3.2 percent in the 16th edition of the Malawi Economic Monitor in December 2022 (Figure 1.1). Several major forces that slowed growth in early 2022, including vola- tile commodity prices, the economic fallout from Russia’s invasion of Ukraine, and the impacts of the COVID-19 pandemic continue to play a role but have moderated. With inflation stubbornly high, central banks are increasingly walking a tightrope between tam- ing inflation and risking financial instability and output losses. After peaking at 8.7 percent in 2022 (Figure 1.1), inflation has recently started declining, largely driven by a fall in fuel and energy prices. Nonetheless, it remains far above historical averages and central bank targets in most countries. In re- sponse, central banks around the world to continue to tighten monetary policy (Figure 1.2). Central bankers must balance a commitment to inflation targets with the risk of significantly dampening eco- nomic growth. Tighter monetary policy also ends a period of abundant, low-cost liquidity. Resulting pressure on the balance sheets of many firms and financial institutions led to the failure of some banks, such as Credit Suisse, Silicon Valley Bank and First Republic Bank, but contagion was avoided through proactive policy. FIGURE 1.1  Global growth is steady while inflation is likely to FIGURE 1.2  Above target inflation has prompted most central have peaked in 2022 banks to tighten interest rates Real GDP growth (in bars) and consumer price inflation (lines) Number of major central banks changing their respective policy rates 16 30 20 12 10 8 0 Percent 4 −10 −20 0 −30 −4 2020 2021 2022e 2023f 2024f −40 01/01/2019 01/04/2019 01/07/2019 01/10/2019 01/01/2020 01/04/2020 01/07/2020 01/10/2020 01/01/2021 01/04/2021 01/07/2021 01/10/2021 01/01/2022 01/04/2022 01/07/2022 01/10/2022 01/01/2023 01/04/2023 Real GDP growth: World EMDEs SSA Consumer price inflation: World EMDEs SSA Sources: World Bank Global Economic Prospects (growth) and IMF World Economic Rate rises Rate drops Outlook 06/2023 (inflation). Note: e indicates estimates and f forecasts. Source: World Bank staff calculations based on Bank for International Settlements data. 1. Economic Developments 20 Global trade openness has declined amidst increased economic nationalism. Following disruptions due to the COVID-19 pandemic and rising trade tensions, many high-income countries are increasingly “re-shoring” and “friend-shoring” production (IMF, 2023).6 This comes on top of a longstanding decline in trade openness, which has steadily fallen since 2008, when global trade as a share of GDP was at 61 percent (Figure 1.3). The speed at which new trade and investment restrictions are being announced also greatly outweighs the number of new liberalizing reforms (Figure 1.4). New World Bank analysis shows that a worldwide shift towards reshoring could drive an additional 52 million people into pov- erty, most of them in Sub-Sahara Africa (Brenton, Ferrantino, and Maliszewska, 2022). New supply chain due-diligence laws, which aim to protect labor rights in producer countries, may also have the unintended consequence of hurting commodity exporters (Felbermayr et al., 2021).7 FIGURE 1.3  Trade openness has declined following a steady FIGURE 1.4  Trade and investment restrictions have been on increase from 1990 until the Global Financial Crisis the rise, especially since 2018 Trade as a share of GDP globally and in selected regions Liberalizing reforms and restrictions harmful to international trade 70 400 60 200 0 50 Number of measures −200 40 Percent −400 30 −600 20 −800 10 −1000 0 −1200 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 World SSA China United States Liberalizing: Goods Services Investment Harmful: Goods Services Investment Source: World Bank national accounts data, and OECD National Accounts data files.04/2023. Source: Global Trade Alert as of 31/03/2023. More than half of low-income countries (LICs) are at high risk of debt distress or in debt distress, including Malawi, holding back growth in these countries. According to World Bank-IMF Debt Sustainability Analyses (DSA), the number of low-income countries in “debt distress”8 has grown to elev- en as of the end of May 2023. Debt burdens have increased and non-Paris Club9 bilateral and commer- cial creditors account for a larger share of creditors than in previous episodes of widespread debt dis- tress. The new composition of creditors significantly increases the complexity of debt workouts, and the need to ensure increased debt transparency. 6. The term “reshoring” refers to a country’s transfer of (part of the) supply chain back to its origin “Friend-shoring” limits sup- ply-chain networks and the sourcing of inputs to countries allied with the home country and trusted partners. 7. A German law that came into force at the start of 2023 raised the standard on the enforcement of human rights across global supply chains. It makes larger companies liable for any human rights violations across their entire supply-chain, with offences punishable with fines of up to two percent of average annual turnover. A similar law is being developed at the EU level. Research by the Kiel Institute for the World Economy shows such laws include could result in producers in middle- and low-income coun- tries being cut out of profitable global value chains (Felbermayr et al. 2021). This is because it can often be cheaper for companies to switch to suppliers from high-income countries where less intensive compliance processes are needed. This has also impacted Malawi: US legislation to prevent child labor resulted a suspension of all tobacco imports from Malawi to the US in 2019 following allegations that some Malawian producers were in violation of these rules. 8. DSAs include an assessment of the risk of external and overall debt distress based on four categories: low risk; moderate risk; high risk, and in debt distress (i.e., when a distress event, like arrears or a restructuring, has occurred or is considered imminent). See IMF (2018) for details. 9. The Paris Club is a group of official creditors whose role is to find coordinated and sustainable solutions to the payment diffi- culties experienced by debtor countries. The Paris Club has 22 permanent members, all of which are high-income countries (Paris Club, 2023). 1. Economic Developments 21 Zambia, the first country to default on its debt after the onset of the COVID-19 pandemic, has final- ly achieved a breakthrough in its debt restructuring negotiations. After the disbursement of over US$460 million under an IMF Extended Credit Facility and World Bank budget support for an ambi- tious reform program10, further support is conditional on the restructuring of bilateral debt under the G20 Common Framework for Debt Treatments to facilitate Zambia’s return to debt sustainability and increased growth. In June 2023, the country reached a debt restructuring deal with its key creditors, with lenders led by China agreeing to restructure US$6.3 billion in loans. Growth in the Southern African region is being bolstered FIGURE 1.5  Economic fortunes in the region are diverging by Mozambique and Tanzania, while South Africa’s econo- Real GDP growth my continues to falter.11 High global commodity prices and a fully flexible exchange rate have supported South Africa’s Malawi fiscal and external balances. However, mining production fell while manufacturing stagnated, as load-shedding and Mozambique transport bottlenecks intensified leading to just two percent real economic growth in 2022 (Figure 1.5). High global de- mand for its key exports — coal and aluminum — also shored South Africa up Mozambique’s economy, which grew by 4.1 percent in 2022. However, Mozambique was the second-most impacted coun- Tanzania try by Cyclone Freddy (after Malawi), with 1.1 million impacted people and 183 deaths, dampening the economic growth out- Zambia look for 2023. Tanzania’s post-pandemic recovery, with 4.6 per- cent growth in 2022, has been broad-based as all subsectors −7 −6 −5 −4 −3 −2 −1 0 1 2 3 4 5 6 7 8 9 surpassed their pre-pandemic production levels by the third Percent quarter of 2022. However, despite a generally robust economy, the decline in the Bank of Tanzania’s official liquid reserves 2020 2021 2022e 2023f 2024f amidst increased import bills from higher food and fuel pric- Source: World Bank Macro Poverty Outlook (World Bank 2023a). es is a cause for concern. Note: e indicates estimates and f indicates forecasts. 10. Key components of Zambia’s reform program uunderpinned by the ECF and the World Bank Development Policy Financing series included (i) restoring fiscal and debt sustainability through a fiscal adjustment and debt restructuring; (ii) creating fiscal space for social spending to cushion the burden of adjustment; and (iii) strengthening governance and reducing corruption vul- nerabilities, including by improving public financial management (PFM). 11. Analysis of economic developments in Southern African region is based on the April 2023 World Bank Macro Poverty Outlook (World Bank 2023a). 1. Economic Developments 22 1.2 RECENT ECONOMIC DEVELOPMENTS Malawi’s economic growth has fallen following the impacts of Cyclone Freddy and an ongoing debt and balance of payments crisis Following the weak growth performance in 2022, the impact of Cyclone Freddy paired with con- tinued macroeconomic imbalances has resulted in a difficult start to 2023 for Malawi’s economy. In 2022, the economy was weakened by foreign exchange shortages that constrained the importation of essential commodities and production inputs, a generally unfavorable external environment, and con- tinued challenges in advancing key macroeconomic and governance policy reforms. Additionally, the damages caused by Cyclone Ana impacted crop production and further worsened an already erratic electricity supply situation. This constrained real economic growth to just 0.9 percent, equating to a per capita output reduction of 1.8 percent (Figure 1.6). The widespread destruction caused by Cyclone Freddy and a persistence of external economy challenges in early 2023 already dampen economic per- formance for the current year. Cyclone Freddy was the most destructive in a series of increasingly frequent extreme weather events affecting Malawi. Between March 12th and March 14th, 2023, some areas in Malawi experi- enced more rainfall than their average annual amount. These heavy rains led to multiple floods and landslides. The Post Disaster Needs Assessment (PDNA, Government of Malawi 2023) estimates more than 2.5 million Malawians were affected and over 1,400 died as a result of the cyclone (Figure 1.7). FIGURE 1.6  Not the post-COVID recovery Malawians had FIGURE 1.7  Cyclones are becoming more frequent and hoped for destructive Real GDP growth by sector Loss and Damage (in constant 2023 US$, left axis), deaths in number of deceased directly attributable to the weather event (people affected, right axis) 6 1,400 3.5 1,200 3.0 4 1,000 2.5 800 2.0 Percent Million 2 600 1.5 400 1.0 0 200 0.5 0 0.0 −2 2015 Cyclone 2019 Cyclone 2022 Cyclone 2023 Cyclone 2020 2021 2022e 2023f 2024f Chedza Idai Ana* Freddy Agriculture Industry Services Real GDP Growth Loss and Damage Deaths People A ected (RHS) Source: World Bank Macro Poverty Outlook (World Bank 2023a). Source: World Bank staff calculations based on PDNA (Government of Malawi 2023). Note: e indicates estimates and f forecasts. Note: * Range of estimates based on Global Rapid Damage Estimation (World Bank 2022d). 1. Economic Developments 23 Additionally, the storm is estimated to have caused US$505 FIGURE 1.8  Cyclone Freddy’s impacts affected highland million in material loss and damage. While destruction districts more than previous storms from previous storms was concentrated in low-laying are- Total loss and damage across affected councils as, Cyclone Freddy affected the Southern highlands, with Phalombe and Mulanje most affected and Nsanje, Chikwawa, and the city of Blantyre also reporting significant damage (Figure 1.8). The economic impacts from Cyclone Freddy led to a down- ward revision of economic growth expectations in 2023. The cyclone is estimated to have caused production losses equivalent to US$36.4 million, which translate to a real GDP loss of 0.5 percent for 2023. These impacts further call at- tention to Malawi’s vulnerability to climate change high- lighted in the recent Country Climate and Development Report (World Bank, 2022e), which shows that without significant US$, millions investments in adaptation, the impacts of climate change <20 will lead to GDP losses of 3 to 9 percent by the end of the 20–40 decade. It will also be important, in the aftermath of the cy- 40–60 clone, to ensure that a renewed outbreak of cholera, as was 60–80 >80 the case following Tropical Storm Ana and Tropical Cyclone Gombe in 2022, can be avoided (Box 1.1). Source: PDNA (Government of Malawi 2023). BOX 1.1  Lessons from Malawi’s recent cholera outbreak The 2022/23 cholera outbreak was the worst in Malawi’s Several factors complicated the cholera outbreak response. recent history. The severity of the outbreak was driven in These factors include: (i) COVID-19 and its impact on the economy part by Tropical Storms Ana and Gombe in early 2022, which and the public health system, which was already under stress; caused substantial flooding, accelerated displacement of pop- (ii) Russia’s invasion of Ukraine, which exacerbated Malawi’s forex ulations from affected districts, and reduced access to safe crisis, contributing to a worsening of chronic and severe short- water, sanitation, and hygiene — which all contributed to an ages of essential medicines; (iii) measles and polio outbreaks in increased risk of a cholera outbreak and its eventual spread. late 2021 and early 2022 and the subsequent vaccination cam- On March 3, 2022, Malawi declared a cholera outbreak after a paigns that followed, which further strained the health systems; case reported to Machinga District Hospital was confirmed. By (iv) a global supply shortage of oral cholera vaccines; and (v) inad- mid-August 2022, the surge in cases reached previously unaf- equate availability of staff at cholera treatment centers. fected districts in the north of Malawi, and by late 2022 all dis- Avoiding future severe cholera outbreaks will require learning tricts had reported cases of cholera. By late February 2023, the from lessons from the 2022/23 outbreak. In the short term it is number of new cases each day reached nearly 500. Since then, critical to build on the experiences gained through the COVID-19 the number of new cases each day has gradually declined. response and the ongoing cholera response, and (i) further Over the course of this outbreak, 58,000 cases and slightly strengthen integrated disease surveillance and response to detect more than 1,700 total deaths have been confirmed across the and contain outbreaks promptly, and (ii) improve awareness of country, and the cumulative case fatality rate has been approxi- safe water and hygiene practices. Longer-term measures involve mately three percent. increasing resources for the health sector to both strengthen Following the declaration by President Chakwera of a “public health emergency preparedness and increase access to and qual- health emergency” in December 2022, the “National Cholera ity of essential health services (including routine immunizations), Response Plan” was updated in December 2022. In turn, a mul- especially among socially and economically vulnerable popu- ti-sectoral emergency response mechanism building on the lations. It will also be important to ensure better access to safe COVID-19 Presidential Task Force was activated. Following a water and sanitation facilities. Furthermore, future investments in stepped-up response by Government, and significant develop- health, water, and energy infrastructures need to be climate-resil- ment partner support, case numbers gradually declined in the ient to ensure that impacts from future climate-related shocks on early months of 2023. the ability to respond to disease outbreaks is minimized. The impacts of Cyclone Freddy have dampened the performance of the agriculture sector in the com- ing season. About 47 percent of total production losses were located in the agriculture sector, and pre- dominantly through crop loss. Acute crisis level food insecurity is expected to persist after the harvest in parts of Southern Malawi, where many households have limited food and income from their own 1. Economic Developments 24 crops (FEWS NET, 2023). While most camps for flood victims have been closed, many affected households still reside in temporary shelters within their villages. Higher domestic food prices due to below-trend harvests have continued to exert pressure on household incomes, pushing many into poverty. The pro- portion of people living on less than US$2.15 Purchasing Power Parity (PPP) per capita a day (approxi- mately MWK 1,220 as of April 2023) has increased to 71.3 percent in 2022. High fertilizer prices have contributed to a shift among FIGURE 1.9  Yields of maize and pulses many farming households away from maize to other crops. 20 Aggregate yields of maize and pulses are set to decline or stag- 15 nate in 2023 according to the second of three rounds of official 10 agricultural production estimates (Figure 1.9). This has been driven by the impacts of Cyclone Freddy, high agricultural in- 5 Percent put prices, and the limited availability of inputs, while the ex- 0 pansion of irrigation has been advancing slowly. Farmers have −5 responded to these challenges by planting 10.4 percent more −10 land with soya and 4.7 with groundnuts in 2022/23 compared −15 to 2021/22, while cereal hectarage is estimated to have grown −20 by less than one percent. Whether the Government’s efforts 2020 2021 2022 2023* to support productivity, commercialization, and diversifica- Smallholder Maize Yield Changes Estate Maize Yield Changes tion through the “Mega Farms Programme” can turn this dy- Smallholder Pulses Yield Changes Estate Pulses Yield Changes namic around depends on its design and implementation, and Source: World Bank Staff Calculations based on Ministry of Agriculture third round in particular the extent to which it incentivizes private sector Agricultural Production Estimates. participation (Box 1.2). Note: * APES Round 2 estimates. BOX 1.2  A balance between private sector leadership and public facilitation will determine the success of the Mega Farms Programme The Government’s Mega Farms Programme intends to develop government-led agriculture in the 1970’s morphed into a policy anchor farms to provide production support services to small- of granting estates in the 1980s (Deininger and Xia, 2018). From and medium-scale farmers in surrounding areas. Mega Farms the late 1990s, the Government shifted its focus to smallholder are expected to use more capital-intensive and technically agriculture with programs like the Starter Pack program, which advanced farming techniques on larger tracts of land than tradi- later became Farm Input Support Programme, and eventually the tional farms. Working with the Greenbelt Authority, the Ministry of Affordable Inputs Programme. A renewed focus on larger Mega Agriculture’s private sector arm, Mega Farms should also process Farms signifies a continued transition in policy priority towards on site for exports, thereby boosting Malawi’s trade balance. larger, commercialized farms, though these would continue to rely on smallholder production. A clear financial vision for the Programme has yet to emerge. The stated intention is to primarily rely on existing financing Malawian and international experience show that the suc- mechanisms. Support from the budget is intended to especially cess of large-scale farming initiatives depends on private sec- target government and parastatal entities and suffers from lim- tor involvement and a conducive enabling environment. While ited financial capacity. This leaves the Export Development Fund Joseph, Dijk, and Krisztin (2023) find that large-scale farms can (EDF) and the Malawi Agricultural and Industrial Investment have positive spillovers, previous research shows that Malawi’s Corporation (MAAIC) as primary financing vehicles for the pri- existing large-scale farms tend to be less productive than their vate sector. With EDF disbursements of MWK 2 billion in 2022 smallholding peers (Deininger and Xia, 2018). Most importantly, and a total loan book of MWK 4 billion for MAAIC, financing likely operations and management of Mega Farms are best led by the would have to grow significantly to meet the ambitions for capi- private sector, with the Government providing a conducive envi- ronment for investors. The Government’s plans for the Mega tal-intensive production. An Agriculture Development Bank is yet Farms Program discusses “leverage[ing] the private sector par- to be established and would require capitalisation. These have ticipation in the agricultural sector” through PPP arrangements, also often been unprofitable and reliant on subsidies in other However, to date the Government has established two Mega country contexts (Seibel 2000). Farms led by the Malawi Prison Services and the Malawi Defense Mega Farms represent an evolution from the Government’s Force (Chikoti 2023), respectively, indicating that this ambition is longstanding smallholder focus. An emphasis on not yet reflected in policy. The Ministry of Agriculture’s new minimum farmgate prices for this season may make it difficult for Malawian producers and products to be internationally competitive. Aggregating, grading, and transporting agricultural produce is costly. Thus market-based farmgate prices are generally lower than 1. Economic Developments 25 market prices. The minimum farmgate prices announced for the FIGURE 1.10  Announced minimum farmgate prices are often 2022/23 agricultural season, however, are in many cases higher too high to make trading financially viable than international prices, with regional prices for locally pro- Minimum farmgate prices and international commodity prices as of end-March 2023 at official and foreign exchange bureau median mid-market rates duced commodities often even lower (Figure 1.10). Enforcing such high minimum farmgate prices encourages imports 2,800 and favors those traders who are inclined to ignore Ministry- 2,400 mandated minimum prices. Setting minimum farmgate pric- 2,000 es too high can also counter the Government’s policy goals of supporting smallholder farmers and promoting local value ad- 1,600 MWK dition. For example, high soybean minimum farmgate prices 1,200 encourage the importation of cooking oil from neighboring 800 countries, leaving local value-adding oil mills without business. 400 The industrial sector has been particularly impacted by for- 0 eign exchange, fuel, and electricity shortages. Industry is re- Maize Rice Soyabeans Groundnuts liant on adequate electricity supply, which was intermittent International price at o icial rate International price at parallel rate throughout 2022 and the start of 2023. Many companies in- Minimum farmgate price vested in energy back-up systems to supplement their supply. Source: Staff calculations based on Ministry of Agriculture data, World Bank The World Bank’s Business Pulse Survey from October 2022 Commodity Markets data, and Reserve Bank of Malawi exchange rate data. showed that between January and October 2022 alone, 17 per- cent of firms acted in response to frequent load-shedding, with 7 percent of firms purchasing a solar backup system. However, many larger electricity backup generator systems are diesel-powered, which has also often been in short supply. While the fuel allocation mechanism is not public, industry often is affected first by rationing. These shortages are primarily a function of administered prices direct- ly in the fuel market and in the market for foreign exchange. Fuel becomes scarce when prices are not reflective of economic costs (see Figure 1.11). Available resources in the Price Stabilization Fund (PSF) and the incurrence of arrears by importers can only cushion the market for short periods. Additionally, industry is also reliant on accessing capital and production inputs. Both have closely circumscribed availability in the domestic market and the ensuing balance of payments (BOP) crisis makes their im- portation difficult. The Business Pulse Survey shows foreign exchange shortages weighed down on the profitability of more than three quarters of firms, highlighting the need for policy reforms to address distortions in the foreign exchange market. FIGURE 1.11  Shortages loom when the fuel price exceeds the economic costs of fuel MERA-regulated ruling pump price and shadow price of fuel 2,400 MERA/NOCMA arrears and shortages 2,000 1,600 MWK per liter 1,200 800 400 PSF accrues consumer funds 0 07/2018 09/2018 11/2018 01/2019 03/2019 05/2019 07/2019 09/2019 11/2019 01/2020 03/2020 05/2020 07/2020 09/2020 11/2020 01/2021 03/2021 05/2021 07/2021 09/2021 11/2021 01/2022 03/2022 05/2022 07/2022 09/2022 11/2022 01/2023 03/2023 05/2023 Average Shadow Price Average Actual Price Source: World Bank staff calculations based on MERA data and State of New York Transportation Fuels Spot Prices data. Notes: Averages are taken between diesel and petrol. The Shadow Price is calculated as international landed costs of fuel at the median Foreign Exchange Bureau selling rate plus the proportional taxes calculated based on the international landed costs plus the fixed taxes and levies contained in the official price build-up. It does not contain financing levies or levies for the Price Stabilisation Fund. 1. Economic Developments 26 The restoration of the Kapichira hydroelectric power station is a first step towards the alleviation of energy supply challenges. The partial restoration of Kapichira’s capacity in May 2023, which consti- tuted a third of Malawi’s total power generation capacity before the station was damaged by Tropical Storm Ana in January 2022, restored stability in Malawi’s en- ergy supply. Full rehabilitation of Kapichira is planned to be FIGURE 1.12  Malawi is falling behind on energy supply completed in the second half of 2023. However, this was a Requirements, projections, and actual installed national grid electricity-generating capacity temporary reprieve, considering the changing seasonality of 1,400 power demand and the fact that, for Malawi, the actual and unmet or suppressed demand for power still outstrips the 1,200 available supply. Plans to further increase generation capacity through various supply options are under consideration, inl- 1,000 cuding solar power and hydropower, such as the Mpatamanga hydropower plant. These could address energy needs, and in 800 Megawatt turn economic growth, but they will take time. Since 2018 in- stalled capacity has largely stagnated — and temporarily even 600 declined following the damages to Kapichira in 2022 — while supply needs have continued to increase (Figure 1.12). Cyclone 400 Freddy caused some losses and damages to the energy sec- 200 tor (US$13.4 million) but did not critically impact the nation- al grid for an extended period, as temporary measures were 0 put in place while awaiting arrangements for permanent re- 2017 2018 2019 2020 2021 2022 2023 pairs to the damaged sections of the grid. A World Bank study 2017 IRP Demand Forecast 2017 IRP Capacity Projection based on the 2014 Enterprise Survey showed that load shed- Installed Capacity* ding costs the Malawian economy more than 3 percent of GDP (Rentschler et al., 2019). This was the second highest share Source: World Bank staff calculations based on the 2017 Integrated Resource Plan (IRP, Government of Malawi, 2017) and MERA installed capacity data (2022). among 137 low- and middle-income countries. Considering Note: * Excludes capacity for the damaged Kapichira hydroelectric power station for 2022. increased blackouts since this time, the economic benefits from meeting electricity demand are now likely to be even higher. Chapter 2 focuses in more depth on the how electricity access can be rapidly and sustainably increased if the Government implements the appropriate reforms. The tourism recovery in Malawi from the pandemic has been among the slowest in the region. Before 2020 and the COVID-19 pandemic, Malawi received 4.3 percent of its export earnings from international tourism. Travel and tourism also represented 7.3 percent of GDP and employed over 500,000 Malawians. While the number of available airplane seats to Malawi had reverted to pre-pandemic levels of around 6,000 per week in early 2023, similar to the trend seen across the continent, estimated aviation passen- ger arrivals have recovered to just about half their 2019 levels (World Bank, 2023b). Aside from Namibia, this is the slowest recovery on the continent. While global factors play a role, the domestic environ- ment for tourism enterprises has not supported a more rapid rebound. In the 2021 World Economic Forum Travel and Tourism Development Index, Malawi ranks only 109th out of 117 evaluated coun- tries. Malawi’s new “National Tourism Investment Masterplan 2022 – 2042” makes some advances by focusing on the creation of an enabling environment for subsectors where Malawi has a competitive advantage, including eco-tourism, hiking, and the numerous lakeside tourist hubs. The employment rebound from the COVID shock has been highly varied, with non-farming family businesses struggling. The Malawi High-Frequency Phone Survey (HFPS) implemented by the Malawi National Statistical Office (NSO), in collaboration with the World Bank’s Living Standards Measurement Study program, shows that the post-pandemic employment rebound was varied and uneven (Figure 1.13). While a higher share of the urban population was working than their rural peers in early 2020, this re- lationship has meanwhile reversed. A challenging business environment also means that Malawians are pursuing different activities to make a living (Figure 1.14). Farming continues to occupy a larger share of Malawians than before COVID. Family businesses used to be the main source of livelihood for one in three Malawians before COVID, but by 2022 this has been reduced to one in six. 1. Economic Developments 27 FIGURE 1.13  Employment levels are trending down since FIGURE 1.14  The COVID-induced return to farming has been early 2022 reversed but family businesses are not absorbing workers Share of respondents having worked in the past week Share of respondents by type of job currently worked 95 100 90 80 85 60 Percent Percent 80 40 75 70 20 65 0 02/2020 04/2020 06/2020 08/2020 10/2020 12/2020 02/2021 04/2021 06/2021 08/2021 10/2021 12/2021 02/2022 04/2022 06/2022 08/2022 10/2022 12/2022 02/2023 03/2020 02/2021 02/2022 03/2023 Not Working Family Farming Employee for someone else National Urban Rural Own business Other Employment Source: National Statistics Office and World Bank High Frequency Phone Survey. Source: National Statistics Office and World Bank High Frequency Phone Survey. Increasing skilled employment will require improvements in human capital. An analysis of data from Malawi’s largest jobs website, MyJobo, which has over 100,000 subscribers, shows that the skilled seg- ment, which the website focuses on, has recovered since the pandemic, driven by the increased posting of public sector jobs (Figure 1.15). As an online platform, MyJobo is biased towards higher-skilled jobs, with the majority of jobs advertised in 2022 requiring at least a tertiary education degree.12 However, in order to support the country’s long-term growth, increased investments in human capital are needed. While Malawi has made significant gains in improving its human capital in recent years, according to the World Bank’s Human Capital Index,13 a child born today will only be 41 percent as productive when she grows up as she could have been be if she enjoyed complete education and was fully healthy (up from 36 percent 10 years ago). FIGURE 1.15  The labor market for the educated has recovered Number of jobs advertised on the MyJobo online platform and shares of minimum required educational qualification in 2022 job advertisements 700 PhD Certificate or lower 600 Master's degree 22% 500 12% 1% 400 300 22% 200 Diploma 100 0 44% 01/2019 03/2019 05/2019 07/2019 09/2019 11/2019 01/2020 03/2020 05/2020 07/2020 09/2020 11/2020 01/2021 03/2021 05/2021 07/2021 09/2021 11/2021 01/2022 03/2022 05/2022 07/2022 09/2022 11/2022 01/2023 03/2023 Degree Source: World Bank staff calculations based on data provided by MyJobo. 12. With 5,096 vacancies posted in 2022, the jobs advertised on MyJobo can cover a large share of the graduates of Malawi’s public higher education institutions. While higher education has expanded rapidly, participation remains one of the lowest in the world with just 56,000 students enrolled (Ministry of Education, 2022). 13. The World Bank’s Human Capital Index combines metrics for child survival, schooling, and health. It is associated with the knowledge and skills of a population, which is a critical component of economic development. Last measured in 2020, Malawi scores beyond what would be expected based on its income, and on par with much wealthier countries like Iraq and Botswana. 1. Economic Developments 28 The learning loss caused by school closures in response to the COVID pandemic has created addi- tional challenges for the education system and the labor market. Recent World Bank analysis shows that students lost approximately 1.6 years’ learning in 2020 – 21 (Asim, Bashir, and Gera 2023). Losses were most severe in English and Maths. Girls had more severe direct learning losses while boys found it more challenging to revert to their already slower pre-pandemic learning pace. Recent climate-related disasters disrupted education, with approximately a million students out of school following Cyclone Freddy as over 400 schools were either not functional or used to house displaced families. This exac- erbates already low learning outcomes where, for example, only 22 percent of Grade 4 students can read and comprehend a short passage in Chichewa. The balance of payments crisis has resulted in continued foreign exchange shortages, while the policy response remains inadequate Malawi has entered the second year of an acute BOP crisis. Double-digit current account imbalances (in terms of percentage of GDP) between 2013 and 2021 have led to the accumulation of substantial external liabilities. With Malawi entering debt distress in 2022 and net official reserves negative, Malawi expe- rienced a dramatic import compression caused by an acute foreign exchange shortage, which even a 25 percent devaluation of the kwacha was not able to alleviate. With these issues unresolved halfway through 2023, Malawi is entering a second year of an acute BoP crisis. Malawi’s imports continue to be constrained by the shortage of foreign exchange. Official real imports in the year to April 2023 are approximately 65 percent below their 5-year average through 2021 (Figure 1.16). While fuel and fertilizer continue to be largely protected from this shock through prioritized access to official financing, the contraction is severe across all other major imports (Figure 1.17). Other arguably essential imports, such as medical supplies and pharmaceutical imports, have been 78 percent below their 2020 – 21 average while goods that primarily serve production purposes, such as machin- ery, have also declined by 74 percent. FIGURE 1.16  Without access to foreign exchange, imports have FIGURE 1.17  Fuel and fertilizer have been largely protected dwindled, closing the trade deficit from the fallout that affected other imports Seasonally adjusted merchandise imports, exports, and trade balance in 01/2022 in MWK Merchandise imports by component in 01/2022 in MWK 150 360 100 320 50 280 0 −50 240 MWK, billion −100 MWK, billion 200 −150 160 −200 −250 120 −300 80 −350 40 −400 01/2018 04/2018 07/2018 10/2018 01/2019 04/2019 07/2019 10/2019 01/2020 04/2020 07/2020 10/2020 01/2021 04/2021 07/2021 10/2021 01/2022 04/2022 07/2022 10/2022 01/2023 04/2023 0 12/2020 02/2021 04/2021 06/2021 08/2021 10/2021 12/2021 02/2022 04/2022 06/2022 08/2022 10/2022 12/2022 02/2023 Seasonally Adjusted Real Exports Seasonally Adjusted Real Imports Seasonally Adjusted Real Trade Balance Fuel Fertiliser Other Source: World Bank staff calculations based on National Statistics Office Trade Bulletin Source: World Bank staff calculations based on National Statistics Office Trade Bulletin data and Reserve Bank of Malawi Consumer Price Index data. data and Reserve Bank of Malawi Consumer Price Index data. 1. Economic Developments 29 Official exports are constrained by a weakness in some of Malawi’s core export commodities and an adverse policy environment. Tobacco continues to be predominantly officially exported. However, the global tobacco market continues to face long-term challenges of weakening global demand. The last exporting season through April 2023 yielded only 72 percent of the preceding 5-year average in real MWK. Prospects for the current exporting season, however, look promising with tobacco sales up by over 60 percent in volume by June 16th compared to the same time a year earlier, incentivized by a 11 percent higher price in nominal US$. For other export crops, the incentives to export unofficially continue to grow with an increasing exchange rate spread, continued mandatory conversions of export proceeds, and other burdensome regulatory interventions. Official foreign exchange inflows increasingly come from international financial institution (IFI) disbursements rather than exports or foreign investment. While tobacco exports have been de- clining and other merchandise exports have not been able to fully make up for this, the external fi- nancing gap has increasingly been filled by World Bank International Development Association (IDA) and IMF financing. In the year to June 2022, IDA disbursed US$371 million while tobacco contributed US$363 million. The IMF additionally disbursed US$177 million during the same period, more than the second-largest category of merchandise exports, nuts, which contributed US$112 million. The emergence of new non-tra- BOX 1.3  What potential does the mining sector hold ditional agricultural exports, and especially mining, could for Malawi? generate new sources of foreign exchange over the medium Malawi’s mining sector can play a key role in driving term (Box 1.3). growth and addressing fiscal and foreign exchange con- straints. This is recognized in Malawi 2063, which sees min- Malawi’s terms of trade have improved after declining for ing as central driver of industrialization, especially if appropri- more than two years through June 2022. The prices of many ate investments in domestic value addition can be achieved. of the key commodities that Malawi imports such as petrole- However, currently the sector still plays a relatively small role, accounting for less than 1 percent of the GDP. um fuel have decreased in recent months while the prices of Malawi’s core export commodities have stabilized at a high level Currently, seven larger projects are moving ahead and (Figure 1.18). This is reflected in improved terms of trade since may begin production before the end of the decade, with many of these likely to produce so-called “green miner- the second half of 2022 (Figure 1.19). The prices of Malawi’s als” necessary to support the energy transition. However, commodity exports relative to its commodity imports are ap- past mining projects in Malawi and elsewhere in the region proximately at the level they were in late 2021, before the re- have often failed to deliver on their promise. While projec- cent commodity price shock, and similar to mid- 2019, before tions from mining firms indicate that the sector could play a the onset of pandemic-induced disruptions. significant role in the economy, these projections need to be treated with caution at this stage given the many variables that could influence the materialization of these benefits. Amidst a thriving parallel market, the official exchange rate Moving ahead it will be important to ensure that these is increasingly only used for a limited number of transac- assets, which belong to the country, are not squandered. tions. While officially a managed float regime, the Reserve Production delays are common and price fluctuations can Bank of Malawi (RBM) has attempted to enforce a peg to the create significant uncertainty around likely revenue and US$. A small section of strategic imports and government pay- export outcomes. The ongoing debt crisis in Ghana, was the ments are supported directly through the RBM and most for- result of, among others, heavy borrowing following the dis- covery of oil and poor public investment decisions. This eign exchange is allocated through Authorized Dealer Banks, means both incentivizing investment and ensuring that the which have to record transactions at the official rate. With the Government maximizes the fiscal gains from these resources de-facto value of foreign currency significantly higher than the over many years, and spends these resources effectively to exchange rate set by the RBM, sellers of foreign exchange are benefit the population. This will require a stable (but not nec- becoming increasingly creative in ensuring they receive fair essarily low tax) fiscal regime, as well as careful assessments of the potential impact of different incentives. value. This is a phenomenon seen across countries with an overvalued exchange rate, such as in Ethiopia and (until re- The government is currently reforming the legal and insti- cently) Nigeria (World Bank, 2022a). Sellers may charge fees tutional structure to support the sector. In this context, it will be important to ensure that expertise is sought to support or demand other benefits equivalent to the parallel market negotiations and that all contracts are made public. Malawi’s rates in actual trades. The primary exception are mandatory participation in the Extractives Industry Transparency conversions instituted by the RBM in 2021, the enforcement of Initiative creates an important institutional framework to sup- which have been stepped up recently, as well as transfers from port this. development partners. 30 percent of official export proceeds 1. Economic Developments 30 have to be converted into Malawi kwacha immediately upon receipt. At the current 54 percent spread between official exchange rate and parallel market rate, this translates into an effective tax of approx- imately 10 percent on exports. FIGURE 1.18  Fertilizer and oil have been getting cheaper FIGURE 1.19  After a long decline, Malawi’s terms of trade are recently while Malawi’s main exports have maintained their looking up value Commodity terms of trade, rolling weights by ratio of net exports to total commodity trade Price indices for select commodities (01/2022 = 1) (01/2022 = 1) 1.6 1.6 1.4 1.5 1.2 1.4 1.0 1.3 0.8 1.2 0.6 0.4 1.1 0.2 1.0 0.0 0.9 01/2019 04/2019 07/2019 10/2019 01/2020 04/2020 07/2020 10/2020 01/2021 04/2021 07/2021 10/2021 01/2022 04/2022 07/2022 10/2022 01/2023 04/2023 07/2023 10/2023 01/2024 04/2024 07/2024 10/2024 0.8 01/2019 04/2019 07/2019 10/2019 01/2020 04/2020 07/2020 10/2020 01/2021 04/2021 07/2021 10/2021 01/2022 04/2022 07/2022 10/2022 01/2023 Crude oil Urea Maize Soybeans Sugar Tobacco Source: World Bank staff calculations based on World Bank Commodity Markets data. Source: World Bank staff calculations based on IMF Commodity Terms of Trade data. Barter trade arrangements are unlikely to address the fact that Malawi exports too little of value to support its imports. Plans for a commodity barter scheme to import fertilizer drew criticism from experts and have reportedly been cancelled in response to concerns (The Investigator Magazine 2023). The pricing structure was questioned, as were the amounts of commodities pledged by the Ministry of Agriculture, which constitute very large shares of official national production estimates (54.4 percent on average across the eight mentioned commodities,) and, except for sugar, exceeding 2022 total exports at least three-fold. Typically, countries resort to bartering when they are restricted from the international financial system or when they are highly indebted and commodities have superior credit enforcement properties (Marin and Schnitzer 2002). However, it is unlikely that Malawi would gain from barter rel- ative to currency-based exchange, as money introduces advantages of transparency (an easily compre- hensible unit of account), removes the requirement of coincidence of wants (that both trading parties have something on offer of value for the other party), removes some of the incentive to deliver low-qual- ity goods (a common problem in barter arrangements) and tends to be a better store of value (mon- ey can easily be transferred and invested while goods often lose value when not needed immediately). Recent trade and industrial policy predominantly attempts to contend with the symptoms of these imbalances, rather than addressing their underlying causes. This is exemplified by the introduction of Malawi Revenue Authority (MRA) export warehouses in the FY2023/24 budget that all official exports must pass through. Implementation on this measure started in May with the revocation of all export licenses, requiring all exporters to reapply. The measure adds another cost and potential delays for exporters. Malawi’s capital account is already one of the more restrictive in the world (as measured by the Chinn-Ito Index), but this is likely to increase further following the gazetting of exchange control regulations in May 2022. While the justification of the exchange control regulations is to “increase the circulation of scarce foreign currency resources in the Malawi economy” and strengthened controls introduced with the budget are “in order to curb smuggling”, such enforcement can have unintended consequences, including deterring foreign investors and incentivizing smuggling. 1. Economic Developments 31 Supply-side constraints and money supply growth are pushing inflation upwards Headline inflation continues on an upward trajectory driven by rising food prices. Upward pressures on prices have contributed to headline inflation increasing to 29.2 percent in May 2023. Additional sup- ply-related constraints to maize and other commodities on the domestic market induced inflation- ary pressures, contributing to food inflation rising to 38.8 percent in May 2023. While food inflation remains the primary driver of headline inflation, non-food inflation has gained momentum in recent months, increasing 18.4 percent, year-on-year (y-o-y), in May 2023. This is the highest since February 2016. Transportation is among the key drivers of non-food inflation, increasing by 26 percent year-on- year in May 2023. Moreover, electricity supply was still erratic at the beginning of the year and the addi- tional cost of production from reliance on diesel-run generators to supplement power exerted pres- sure on non-food inflation. Money supply growth remains persistently high, further contributing to elevated inflation. Annual growth of money supply has continued to increase since late 2019, following the onset of the COVID-19 pandemic (Figure 1.20). Induced by higher government borrowing to finance fiscal policy, especially through monetization of the fiscal deficit, money supply increased by 35.9 percent (year-on-year) in April 2023. The additional demand for goods and services emanating from this, amidst constrained output growth, is intensifying inflationary pressures. Domestic food prices remain elevated even after the harvest for the new agriculture season has com- menced, with the impacts of Cyclone Freddy exerting additional pressure on prices. Global food mar- kets moderated during the first half of 2023. While this contributes to pressure easing on food prices, rising informal exports to the region have contributed to maize prices remaining on an upward trajec- tory, increasing from MWK 185.0 per kilogram in March 2022 and peaking at MWK 696.5 per kilogram in March 2023 (the highest annual increase in over 15 years) before declining to MWK473.5 per kilogram in May 2023 (Figure 1.21). Further, the damage to crops and livestock by Cyclone Freddy and expected lowered agriculture output will likely result in food prices remaining elevated. Prices of other staple products have also remained high throughout this period. FIGURE 1.20  Increasing money supply is inducing pressure FIGURE 1.21  Maize prices have seen the sharpest year-on-year on inflation increase in over 15 years Currency in circulation (y-o-y) and inflation Percentage change 40 300 35 250 30 200 25 150 Percent Percent, y-o-y 20 100 15 10 50 5 0 0 −50 01/2017 05/2017 09/2017 01/2018 05/2018 09/2018 01/2019 05/2019 09/2019 01/2020 05/2020 09/2020 01/2021 05/2021 09/2021 01/2022 05/2022 09/2022 01/2023 05/2023 −100 05/2008 03/2009 01/2010 11/2010 09/2011 07/2012 05/2013 03/2014 01/2015 11/2015 09/2016 07/2017 05/2018 03/2019 01/2020 11/2020 09/2021 07/2022 05/2023 Inflation Broad money growth Source: World Bank with data from RBM and NSO. Source: World Bank with data from FAO FPMA Tool. While global pressures that contributed to rising non-food inflation have eased, domestic prices are still increasing. Tariffs for electricity have not been adjusted yet, but erratic supply has increased the de- mand for charcoal and firewood, consequently pushing their prices upwards. Further planned tariff in- creases in electricity as well as water will exert additional pressure on non-food inflation. Consequently, housing, water and electricity inflation increased by 18 percent in May 2023, year-on-year. 1. Economic Developments 32 Despite strong performance on revenues, higher spending across budget categories led to a worsening fiscal position for FY2022/23 Government overspent by over 4 percent of GDP relative to the revised FY2022/23 fiscal deficit. Sup- ported by good performance in taxes and grants, revenue surpassed the FY2022/23 target. However, overspending in compensation of employees and acquisition of non-financial assets (previously devel- opment expenditure) resulted in substantial expenditure overruns, and offset the good performance in revenue collection (Figure 1.22). Consequently, this exerted pressure on the fiscal deficit, reaching 10.9 percent and exceeding the revised target of 6.4 percent of GDP. This lack of budget discipline has been a consistent feature in recent years (Figure 1.23). FIGURE 1.22  Increased expenditure is contributing to FIGURE 1.23  Fiscal deficits continue to miss their approved worsened fiscal deficits targets As a share of GDP As a share of GDP 30 0 0 25 −2 −2 20 −4 −4 Percent Percent Percent 15 −6 −6 10 −8 −8 5 −10 −10 0 −12 −12 2010/11 2018/19 2011/12 2012/13 2013/14 2019/20 2023/24 2014/15 2017/18 2015/16 2016/17 2020/21 2021/22 2022/23 2010/11 2011/12 2012/13 2013/14 2018/19 2019/20 2023/24 2014/15 2017/18 2015/16 2016/17 2020/21 2021/22 2022/23 Revenue Expenditure Deficit Budgeted deficit Actual deficit Source: World Bank with data from Ministry of Finance and Economic Affairs. Source: World Bank with data from Ministry of Finance and Economic Affairs. While tax intake declined slightly, government exceeded its target contributing to a reasonably strong performance in domestic revenue, totaling 12.6 percent of GDP. In FY2022/23, all categories of tax revenue, except “other taxes”, surpassed their fiscal year targets. Taxes on income, profits and capital gains totaled 5.7 percent of GDP against a target of 5.4 percent of GDP, boosted by strong perfor- mance in PAYE following the revision of the middle tax bracket. Due to intermittent electricity supply, most businesses sought alternative energy sources which increased their operational costs. This, com- pounded by forex and fuel shortages during the second quarter of the fiscal year, resulted in lower than anticipated corporate tax collection. The impact of these challenges extended to taxes on goods and services. Nonetheless, taxes on goods and services still marginally surpassed their FY target, totaling 5.2 percent of GDP against their fiscal year target of 5.1 percent of GDP. This performance was supported by a good performance of excise taxes. Taxes on international trade and transactions also performed well (1.1 percent of GDP), supported by the implementation of the advance income tax. Remittance of para- statal dividends was lower than anticipated, an indicator of the struggling performance of most para- statals. Consequently, this contributed to “other revenue” totaling to 0.6 percent of GDP, below the fis- cal year target of 0.7 percent of GDP. Owing to frontloading of project resources, as well as increased disbursements for cholera and cy- clone response, grants surpassed their fiscal year target. Anticipating the recent trend to continue, the Government projected a total of 2.4 percent to be disbursed as grants for budget and project sup- port. However, frontloading of project resources in the first half of the FY resulted in increased dis- bursements for the fiscal year and as a result, grants reached 3.2 percent of GDP, exceeding the revised target of 2.9 percent of GDP. 1. Economic Developments 33 Statutory expenditures, including salaries and wages, as well as interest expenses, continue to increase. These two components of statutory expenditure alone absorbed 67 percent of revenue in FY2022/23 (84 percent of domestic revenue), eroding fiscal room for other expenditures. The government over- spent on employee compensation, reaching 5.9 percent of GDP and higher than the revised fiscal year target of 5.3 percent of GDP. This was driven by a higher than budgeted adjustment in wages and salaries. Interest expense FIGURE 1.24  Interest expense has mostly missed FY targets reached 4.8 percent of GDP (Figure 1.24), which was within the contributing to expenditure overruns fiscal year target of 4.9 percent of GDP. 5 The performance of statutory expenditure, compounded by 4 higher than targeted spending in other expenditure catego- Percent of GDP ries, resulted in significant overruns in FY2022/23. Spending 3 on goods and services reached 3.2 percent of GDP, exceeding the revised target of 3.0 percent of GDP. This was mainly driv- 2 en by overspending in generic goods and services which to- 1 taled 2.0 percent of GDP, higher than the revised target of 1.8 percent of GDP. Spending pressures on the Affordable Input 0 Programme (AIP) also contributed to overruns in social bene- 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19 2019/20 2020/21 2021/22 2022/23 fits which reached 2.0 percent of GDP, compared to a revised target of 1.7 percent of GDP. Acquisition of non-financial as- Budget Actual sets (previously development spending) totaled 7.3 percent of GDP, exceeding the targeted 4.8 percent of GDP. This was driv- Source: World Bank with data from Ministry of Finance and Economic Affairs. en by overruns in both foreign financed components, support- ed by frontloading of project resources, and domestically financed expenditure. Cumulatively, total ex- penditure for FY2022/23 amounted to 26.814 percent of GDP, exceeding the target of 21.6 percent of GDP. Given constraints to foreign non-concessional borrowing, the Government continued to finance the fiscal deficit using domestic borrowing. In FY2022/23, 4.0 percent of GDP15 was borrowed from the do- mestic market, and especially the banking sector. This increased borrowing is contributing to increased money supply, which is inflationary, and crowds out resources for private sector investment. In addition, interest rates are high and still increasing. This will further push public debt service charges upwards. TABLE 1.1  Fiscal accounts Percent of GDP   2022/23 2023/24   2019/20 2020/21 2021/22 Act Rev App App Revenue 14.6 14.3 14.1 15.9 15.2 14.9 16.0 Domestic Revenue 13.1 12.8 13.0 12.6 12.4 12.4 14.1 Taxes 12.4 12.0 12.3 12.1 11.6 11.7 13.3 Taxes on Income, Profits and Capital Gains 5.8 5.6 5.5 5.7 5.4 5.6 6.2 Taxes on Goods and Services 5.5 5.4 5.7 5.2 5.1 5.1 5.6 Taxes on International Trade and Transactions 1.0 1.0 1.1 1.1 1.1 1.0 1.5 Other Taxes 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Grants 1.5 1.5 1.1 3.2 2.9 2.4 2.0 From Foreign Governments — — — 0.2 0.2 — 0.1 From International Organizations 1.5 1.5 1.1 3.1 2.7 2.4 1.9 14. This includes capital transfers for RBM recapitalization. 15. This figure is still missing February and March 2023. 1. Economic Developments 34   2022/23 2023/24   2019/20 2020/21 2021/22 Act Rev App App Other Revenue 0.8 0.7 0.7 0.6 0.7 0.8 0.7 Property Income 0.3 0.4 0.1 0.1 0.4 0.5 0.3 Sale of Goods and Services 0.5 0.3 0.6 0.4 0.3 0.3 0.4 Fines, Penalties and Forfeits 0.0 0.1 0.0 0.0 0.0 0.0 0.0 Expenditure 20.9 21.4 22.5 26.8 21.6 21.5 23.8 Expense 16.7 17.8 18.7 19.5 16.9 15.3 18.5 Compensation of Employees 5.5 5.8 6.1 5.9 5.3 5.2 5.8 Goods and Services 4.0 3.6 3.7 3.2 3.0 2.7 3.4 Generic goods and services 2.5 2.2 2.2 2.0 1.8 — 2.1 Interest 3.0 3.6 3.3 4.8 4.9 4.0 5.7 To non-residents 0.2 0.2 0.2 0.3 0.3 0.1 0.2 To residents other than general government 2.8 3.4 3.2 4.5 4.6 3.8 5.5 Grants 2.7 1.9 2.1 3.4 1.8 1.6 1.9 Social Benefits 1.4 2.5 3.1 2.0 1.7 1.6 1.6 Fertilizer payments 0.3 1.3 2.0 1.1 0.7 0.7 0.6 Other Expenses 0.1 0.3 0.4 0.1 0.1 0.1 0.1 Acquisition of Non-Financial Assets 4.3 3.6 3.8 7.3 4.8 6.2 5.2 Foreign financed 2.4 2.6 2.0 5.6 3.9 4.4 3.8 Domestically financed 1.8 1.0 1.7 1.7 0.9 1.8 1.4 Net borrowing -6.3 -7.1 -8.4 -10.9 -6.4 -6.7 -7.7 Primary Balance -3.3 -3.5 -5.0 -6.1 -1.5 -2.7 -2.0 Net incurrence of liabilities 5.7 6.9 8.6 7.2 6.4 6.7 7.7 Foreign Liabilities 0.8 1.0 0.9 1.9 2.0 1.7 0.8 Programme Borrowing 0.0 0.3 - - 0.7 0.3 - Project Loans 1.2 1.1 0.9 2.6 2.4 2.0 1.8 Amortization -0.4 -0.4 0.0 -0.7 -1.2 -0.5) -1.0 Domestic Liabilities 4.9 5.9 7.7 5.3 4.4 5.0 6.9 Source: World Bank calculations, with data from the RBM and MoFEA. Government projects that the budget deficit will improve in FY2023/24, but fiscal room remains highly constrained Supported by an expected improvement in revenue collection, the fiscal deficit is projected to slightly narrow in FY2023/24. Revenue is projected to increase to 16.0 percent of GDP. This is expected to keep the deficit at 7.7 percent of GDP in FY2023/24, considering increased expenditure. Higher tax collection is expected to drive the improvement in revenue. All major tax categories are projected to increase over FY2022/23 collections, reaching 13.3 percent of GDP, supported by implemen- tation of new tax measures and efficiency-improving administrative reforms. The government intro- duced a 40 percent tax on banks that are making profits beyond K10 billion. While these charges are likely to increase government revenues, they will probably also be passed on to consumers, potentially further reducing access to credit. Across budget components, the main drivers of expected increases in tax revenue are taxes on income, profits, and capital gains as well as taxes on goods and services, which are projected to reach 6.2 and 5.6 percent of GDP, respectively. Other revenues are projected to slightly improve to 0.7 percent of GDP but poor performing State-Owned Enterprises (SOEs) may make it diffi- cult to reach targets on the remittance of parastatal dividends (Box 1.4). Contrary to anticipated good performance in taxes, disbursements of grants are projected to decline to 2.0 percent of GDP. 1. Economic Developments 35 BOX 1.4  Fiscal risks emanating from poor performing SOEs are increasing Performance of SOEs has deteriorated in recent years, pos- in 2018 to 9 percent in 2021, driven by the performance of the ing significant fiscal risks. In Malawi, SOEs are grouped into Malawi Communications Regulatory Authority. Service providers three categories — commercial (those that are market oriented); had an ROA of -23 percent in 2021. semi-subvented (relying on partial funding from the government); and fully subvented (those relying solely on government funding). Return on equity for the commercial SOEs also dwindled. An assessment of 28 commercial SOEs categorized into trading Driven by poor performing SOEs in the communication and (14), regulatory (9) and service providers (5) revealed that 46 per- water sectors, return on equity dwindled for trading entities, from cent incurred losses in 2021 — an increase from 23 percent in 2018. 9 percent in 2019 to -8 percent in 2021. A similar trend was also This was driven by trading SOEs, with 71 percent reporting losses reported for service providers, with their ROE dwindling to -3 in 2021, an increase from 21 percent in 2018, and especially in the percent in 2021, down from -1 percent in 2019. This was driven by water and energy SOEs due to the persistence of non-cost reflec- poor performing SOEs in the governance sector. Regulators con- tive tariffs. The proportion for regulators reporting losses remained tinued to report good ROEs, albeit at a declining rate, to 18 per- the same, and others registered surpluses but at a declining rate. cent in 2021 from 25 percent in 2019, thus maintaining their per- formance above the international threshold of 15 percent. Overall, commercial SOEs have a high-risk position in terms of their return to assets (ROA). About 90 percent of the total assets Most SOEs were still heavily indebted taking into account are in the trading sector. However, the return to assets for this trade receivables. Though significant, the interest-bearing debt category was consistently below the international threshold of 5 was still low but needs to be kept in check as it has a bearing on percent and has been negative since 2021. The main driver of this the budget. There was a steady increase in the portions of the performance were SOEs in the communication sector, reporting cash flow of trading SOEs that was used for debt service from a ROA of -20 percent in 2021. SOEs in the energy and water sec- 2017 to 2020. This proportion increased in 2021 to 4.5 percent tors reported a ROA of 2 percent. While regulatory SOEs con- from 0.11 percent in 2019 indicating that institutions were facing tinue to register a strong ROA, the ratio declined from 21 percent challenges in meeting interest payments. Source: MoFEA (forthcoming) Driven mainly by compensation of employees and interest expense, expenditure is projected to in- crease to 23.8 percent of GDP in FY2023/24. The Government has adjusted wages and salaries for the civ- il service by 8 percent, significantly below the rate of inflation of 17.9 percent as well as the requested 35 percent by civil service trade union. Nonetheless, this has contributed to higher allocation for compen- sation of employees, reaching 5.8 percent in FY2023/24. This amount also includes an allocation of MWK 36 billion for transport allowance for the civil service. Amidst rising domestic interest rates in light of high domestic debt levels, interest payments are projected to increase to 5.7 percent of GDP in FY2023/24 from 4.8 percent of GDP in FY2022/23. Consequently, statutory expenditures will absorb 94.7 percent of the total domestic revenue (or 99.8 percent of taxes), thereby further constraining fiscal room for dis- cretionary policy as well as the ability to respond to shocks. Government is reforming the AIP and has reduced its allocation to K102 billion, which implies a real decline in the size of the program. However, based on the outturn performance in the previous two fiscal years, there is a significant risk that this target could be exceeded. In addition, poor performing SOEs (Box 1.4) pose an additional fiscal risk to implementation of FIGURE 1.25  Allocation for interest expense is eclipsing the budget and the fiscal consolidation process. Acquisition sectoral allocations of non-financial assets (development spending) is also project- Percent of total budget ed to increase, reaching 5.2 percent of GDP in FY2023/24, sup- 202 Public Debt Interest 3/2 ported by projected growth in both domestically and foreign 4 Education financed components. 24% Agriculture 29% 18% Health Sectoral allocation has not changed significantly, and spend- 28% 2022 Transport and /2 ICT Infrastructure ing on social and productive sectors is increasingly being 3 Energy, Industry, crowded out by interest expense. Education continues to be 16% and Tourism 2% Governance the largest sector, representing 15.6 percent of the total budget, 2% and Rule of Law followed by agriculture, representing 11.8 percent of the total 3% 8% 16% Other/Unspecified budget. In addition to the reduction on AIP, the agricultural 1% 10% 16% 6% sector will receive a lower share of the budget in 2023/24 than in 2022/23. Like last FY, interest expenditure will eclipse all 9% 12% other sectors, with an allocation of MWK 914 billion compared to MWK 603 for education (Figure 1.25). Source: World Bank with data from Ministry of Finance and Economic Affairs. 1. Economic Developments 36 Government continues to finance the deficit using mainly domestic resources. The projected net borrowing of 7.7 percent of GDP in FY2023/24 will be financed by 0.9 percent of GDP foreign borrowing and 6.9 percent of GDP domestic borrowing. If the trend of financing the deficit using borrowing from the RBM is maintained in FY2023/24, this will likely induce additional inflationary pressures. The Government is advancing implementation of public finance management (PFM) reforms to sup- port expenditure management and the fiscal consolidation process. Since the beginning of FY2023/24, the Government is piloting quarterly budgetary allotments and requiring Ministries, Departments and Agencies to commit up to the amount allotted within the Integrated Financial Management Information System (IFMIS). This will help address overcommitments, which has resulted in growth of spending arrears. To this effect, the Government communicated to ministries, departments and agencies through a circular to adhere to this requirement. In addition, to support this directive, the Government communicated to sup- pliers that delivery of goods and services should be supported by an IFMIS-generated Local Purchase Order. Government debt is still in distress and unsustainable, but ongoing external debt restructuring negotiations, if successful, will help ease the burden Rising total public debt and debt servicing costs pushed public debt into distress. Weak performance of the external sector and insufficient revenue mobilization over many years have contributed to worsened debt vulnerabilities, already pressured by rising debt and debt servicing costs. The joint World Bank-IMF November 2022 Debt Sustainability Analysis reported that public debt is in distress under current policies but ongoing external debt restructuring negotiations with commercial and bilateral creditors will help bring debt on a downward trajectory over the medium term. The negotiations remain ongoing and focus on inter- est rate deductions, repayment moratoria, as well as extending the maturity profile of both commercial and bilateral external debt to reduce refinancing risk and thus contribute to easing the pressure on forex reserves. Government’s public debt is high and still rising. The worsening fiscal deficit continues to push public debt on an upward trajectory. Public debt increased to 75.2 percent of GDP in December 2022, up from 61.5 percent of GDP in December 2021 (Figure 1.26). This jump was driven by both domestic and external debt. The Government’s recourse to mainly finance high fiscal deficits with high-cost domestic borrowing contributed to do- FIGURE 1.26  Public debt is still increasing rapidly mestic debt reaching to 40.8 percent of GDP in 2022, up from 90 30.0 percent in 2021. External debt also increased to 34.4 per- 80 cent in 2022, from 31.5 percent of GDP in 2021. This was driven 70 by conversion of short-term swaps, which were contracted for 60 increasing liquidity, into medium-term swaps. Percent of GDP 50 Monetization of the fiscal deficit is shifting public debt to- 40 wards the monetary sector, with inflationary impacts. The 30 share of domestic debt in total public debt increased to 57 per- 20 cent in 2022, up from 53 percent in 2021. Within this subsec- 10 tor, the composition of public debt by holder, is shifting to- 0 wards the RBM, exerting upward pressure on already high levels 2018 2012 2013 2019 2014 2016 2020 2015 2017 2021 2023 2022 of money supply and thereby increasing risks of further in- External Debt Domestic Debt flation. By December 2022, total public debt held by the RBM had increased to 21 percent of total debt, up from 15 percent Source: World Bank with data from Ministry of Finance and Economic Affairs. in December 2021 (Figure 1.27). For external debt, multilateral organizations remain the largest creditors, holding 32 percent of total public debt (74 percent of pub- lic and publicly guaranteed (PPG) external debt) in 2022 compared to 68 percent of PPG external debt in 2021. However, debt held by bilateral and commercial lenders declined to 5 and 6 percent of total public debt in 2022 from 6 and 9 percent, respectively, in 2021. The non-concessional form of the lat- ter has increased the external debt burden, especially from debt servicing. 1. Economic Developments 37 Domestic debt continues to move towards long-term treas- FIGURE 1.27  Composition of public debt by holder ury notes, in line with the Government’s Medium-Term Debt Strategy (MTDS). The new MTDS for 2023 to 2026 maintains the 202 Monetary 2 Depository option of financing using long-term instruments, to contain the Corporations 21% refinancing risk from a high share of short-term debt. However, Non-Bank 15% debt held in treasury bills had increased to 12.3 percent of total 32% Commercial 32% 202 debt by December 2022, compared to 9.9 percent in December 1 Bilateral 2021 (Figure 1.28). Consequently, debt held in treasury notes Multilateral declined, from 87.8 percent of total debt in 2021 to 82.2 per- 24% cent in 2022. Recapitalization of the RBM’s loss from the 25 per- 6% 22% cent devaluation in May 2022 pushed debt held in other instru- 5% 9% ments upwards, from 2.4 percent in 2021 to 5.5 percent in 2022. 15% 6% High and rising cost of domestic debt instruments have con- 14% tributed to rising debt servicing costs. While multilaterals are the highest holder, the concessional nature of their debt con- Source: World Bank with data from MoFEA. tributes to lower external debt servicing costs. In FY2022/23, ex- ternal interest expense increased slightly to 0.3 percent of GDP FIGURE 1.28  Increased interest expense has been driven by from 0.2 percent in in FY2021/22, driven by increased interest higher debt held in high-cost treasury notes payments towards commercial external debt. Higher domes- 5,500 tic debt held in treasury notes, given the high-cost nature of 5,000 these instruments, has resulted in significant increase of do- 4,500 mestic debt servicing costs. 4,000 3,500 MK, billion To effectively ease the debt burden, on-going debt restructur- 3,000 ing negotiations need to be supported by fiscal consolidation 2,500 and prudent monetary policy. To attain this, the Government 2,000 needs to ensure that borrowing to support implementation of 1,500 fiscal and monetary policy, especially medium to long-term 1,000 500 debt, adheres to a non-concessional borrowing limit. Projects 0 that the government is implementing with borrowed funds, 01/2015 08/2015 03/2016 10/2016 05/2017 12/2017 07/2018 02/2019 09/2019 04/2020 11/2020 06/2021 01/2022 08/2022 03/2023 such as the Lilongwe-Salima water project (Box 1.5), should be cost-effective and ably generate resources for debt repay- Treasury bills Treasury notes Others ment. Otherwise these risk adding pressures to the country’s debt vulnerability. Source: World Bank with data from RBM. BOX 1.5  The Lilongwe-Salima water project raises transparency and debt sustainability concerns The Government of Malawi is planning on commencing imple- conditions for the loan were not provided to parliament for vet- mentation of the Lilongwe-Salima Water Project. The project ting, nor was the loan included in the budget for FY2023/24. will abstract and treat water in Lifuwu in Salima and transport This understates the fiscal deficit and domestic borrowing for the treated water to Lilongwe. The project was initiated in 2015 the fiscal year. but implementation was delayed due to challenges in accessing In line with other large-scale investment projects, it will be private sector funding. important to conduct a cost-benefit analysis to ensure that In the FY2023/24 budget, the Government allocated MWK500 the project is cost-effective, especially given the high-cost million to the secretariat of Special Purpose Vehicles for the nature of domestic debt and the consequent debt vulnerabil- project. These resources were allocated to facilitate financ- ities that would result from this. Moreover, this project is ener- ing agreements, preparatory works and documentation, among gy-intensive considering the amount of energy required to pump others. Towards the end of the parliamentary sitting ending in water from Salima to Lilongwe, which is 600 meters above the April 2023, the Government submitted to parliament a bill to lake. This will crowd out already limited energy supply (see chap- authorize National Bank of Malawi and NBS banks to source ter 2) to other productive sectors. Further, to ensure that there is private resources of MWK105 billion which would be injected transparency and accountability in implementation of the pro- into the project as equity for the government. However, trans- ject, the Government should submit relevant information, includ- parency on the project remains a problem. Information on the ing on project financing, to parliament. 1. Economic Developments 38 The Malawi kwacha has experienced a sharp depreciation, as foreign exchange shortages remain severe The Malawi kwacha continued to weaken in the first half of 2023, with widening spreads between telegraphic transfer (TT) and bureau MWK – US$ exchange rates. Despite the official kwacha-US dollar exchange rate being adjusted downward by 25 percent in May 2022, the spread between the official rate and the less strictly controlled rates on cash purchases at foreign exchange bureaus at times exceeded 54 percent in June 2023 (Figure 1.29). This spread has surpassed the pre-devaluation level of late May 2022. While the official exchange rate remains at MWK1,064 per US$ since May 2022, the median bureau rate reached MWK1,592.5 in mid-June 2023, the highest in recent years. The forex shortage remains acute. Gross reserves decreased by half from US$388 million in May 2022 to US$195 million in May 2023, equivalent to around 0.8 months of import cover (Figure 1.29). This is much lower than the recommended adequacy level of 3.9 months of import cover for a credit-con- strained economy (IMF, 2022b). The May 2022 exchange rate adjustment had only limited impact to support the build-up of official reserves. Net reserves have been negative, and gross reserves have been mainly supported by substantial rollover swaps.16 The disbursements of IDA projects and the IMF Rapid Credit Facility also eased pressures in late 2022 and early 2023. FIGURE 1.29  As reserves decline, the spreads between TT and bureau MWK – US$ exchange rates continue to widen RBM telegraphic transfer (TT) and forex bureau (FXB) cash MWK/US$ rates and spreads through June 28 and official gross reserves, months import cover 1,800 4.0 RBM TT and forex bureau cash MK/US$ rates 3.5 1,600 3.0 Months import cover 1,400 2.5 1,200 2.0 1.5 1,000 1.0 800 0.5 600 0.0 01/2020 01/2020 02/2020 02/2020 03/2020 03/2020 04/2020 04/2020 05/2020 05/2020 06/2020 06/2020 07/2020 07/2020 08/2020 08/2020 09/2020 09/2020 10/2020 10/2020 11/2020 11/2020 12/2020 12/2020 01/2021 01/2021 02/2021 02/2021 03/2021 03/2021 04/2021 04/2021 05/2021 05/2021 06/2021 06/2021 07/2021 07/2021 08/2021 08/2021 09/2021 09/2021 10/2021 10/2021 11/2021 11/2021 12/2021 12/2021 01/2022 01/2022 02/2022 02/2022 03/2022 03/2022 04/2022 04/2022 05/2022 05/2022 06/2022 06/2022 07/2022 07/2022 08/2022 08/2022 09/2022 09/2022 10/2022 10/2022 11/2022 11/2022 12/2022 12/2022 01/2023 01/2023 02/2023 02/2023 03/2023 03/2023 04/2023 04/2023 05/2023 05/2023 06/2023 06/2023 O icial TT sell Median cash sell Gross reserves (RHS) Source: World Bank staff calculations based on RBM data. Various measures have been taken to rebuild foreign reserves, albeit challenges remain. Given con- straints on non-concessional external borrowing, short-term swap rollovers remain a key source of re- serves, though the RBM has begun to wind down new foreign exchange swaps with non-residents in re- cent months (Figure 1.30). The RBM plans to increase purchases of foreign exchange from the market and conduct foreign exchange auction with market-determined rates, but these plans are only proceeding slowly. The pilot auction in January 2023 was cancelled due to insufficient interest by authorized deal- er banks. A further auction held in June 2023 saw the participation of all Authorized Dealer Banks and resulted in the new market selling price increasing to MWK1,063.86 per US$. While this marks the first rate increase since May 2022, the spread between TT and bureau MWK – US$ exchange rates remains large. The new “Foreign Exchange Act” being proposed by Government aims to address some of these issues but may also have unintended consequences on investment. The draft legislation puts more 16.  Net reserves subtract predetermined short-term liabilities, such as swaps with maturity of one year or less. 1. Economic Developments 39 restrictive capital controls and transfer restrictions on multinational companies and places restric- tions on domestic firms’ access to foreign exchange. These measures could have an adverse impact on attracting new foreign investment and potentially undermine the competitiveness of the domes- tic private sector that may not be able to import critical inputs for production or services they provide. In finalizing this legislation, it will be important to find a balance between bringing stronger controls into the foreign exchange market and ensuring that this does not create additional barriers for much- needed investment. FIGURE 1.30  Swap rollovers have been increasingly used as sources of foreign exchanges RBM source of foreign exchange by type 600 500 400 US$, million 300 200 100 0 01/2015 03/2015 05/2015 07/2015 09/2015 11/2015 01/2016 03/2016 05/2016 07/2016 09/2016 11/2016 01/2017 03/2017 05/2017 07/2017 09/2017 11/2017 01/2018 03/2018 05/2018 07/2018 09/2018 11/2018 01/2019 03/2019 05/2019 07/2019 09/2019 11/2019 01/2020 03/2020 05/2020 07/2020 09/2020 11/2020 01/2021 03/2021 05/2021 07/2021 09/2021 11/2021 01/2022 03/2022 05/2022 07/2022 09/2022 11/2022 01/2023 03/2023 05/2023 Purchases of Foreign Exchange New Swaps Others Total Project Funds Balance of Payments Grants Balance of Payments Loans Swap Rollovers Source: World Bank staff calculations based on RBM data. The RBM has further increased the policy rate to 22 percent, but so far monetary policy has had limited impact on containing inflation With rising inflationary pressure in early 2023, the Monetary Policy Rate was increased by four per- cent in April 2023. The Monetary Policy Committee (MPC) increased the policy rate from 18 to 22 percent in April 2023 after noting that the inflation outlook had worsened since the last MPC meeting in February 2023. Inflationary pressures have increased since early 2023 induced by domestic shocks, including the impact of the Cyclone Freddy. In addition, the need to rehabilitate the infrastructure damaged by the cyclone may amplify aggregate demand and further fuel inflation (RBM 2023). The MPC also adjusted the Liquidity Reserve Requirement upwards to 5.75 percent to contain the growth in money supply. To date, the tightening of monetary conditions has been insufficient to contain inflationary pres- sures — in large part due to the continued increase in the money supply primarily through moneti- zation of fiscal deficits. In response to the policy rate increases, the base lending rate and interbank rate have increased (Figure 1.31). The policy rate increase and strong government demand led to a rise in monthly average Treasury bill and note yields across all the tenors (Figure 1.32). Yields on 364-day bill increased by 269 basis points since the beginning of the fiscal year. This exerts additional pressure on an already difficult domestic public debt situation by increasing interest payments. Despite some efforts by the RBM to address rising inflation, the real policy rate has been negative, reaching –7.24 per- cent in May 2023 and the money supply continue to expand (Figure 1.31).17 17. There was an uptake of Treasury bills by RBM in 2022, while the commercial banks remain the largest holder. 1. Economic Developments 40 FIGURE 1.31  While the real policy rate remains negative, the FIGURE 1.32  The yield of 364-day bills climbed over the year base lending rate and interbank rate have increased Treasury bill and Treasury note interest rates Rates 35 300 50 45 30 250 40 35 25 30 200 25 20 Percent Basis points 20 Percent 150 15 15 10 5 100 0 10 −5 50 −10 5 −15 2016-01-01 2016-05-01 2016-09-01 2017-01-01 2017-05-01 2017-09-01 2018-01-01 2018-05-01 2018-09-01 2019-01-01 2019-05-01 2019-09-01 2020-01-01 2020-05-01 2020-09-01 2021-01-01 2021-05-01 2021-09-01 2022-01-01 2022-05-01 2022-09-01 2023-01-01 2023-05-01 0 0 91 182 364 2 3 5 7 10 day day day year year year year year Policy rate Base rate Interbank rate 15/06/2022 31/03/2023 15/06/2023 364-day Treasury bill Max lending rate Real policy rate Yield change (RHS) Source: World Bank staff calculations based on RBM data. Source: World Bank staff calculations based on RBM data. The banking sector remains well capitalized, highly profitable and has ample liquidity, though NPLs are on the rise The Malawian banking sector has maintained a solid capital and liquidity position despite eco- nomic challenges facing the country. As of May 2023, the total capital ratio and tier 1 capital ratio was at 21.6 percent and 24.8 percent, respectively, compared to regulatory minimum levels at 10.0 per- cent and 15.0 percent (Figure 1.33). This is higher than in May 2022 when the ratios reached 18.9 percent and 22.3 percent. FIGURE 1.33  Bank resilience is reflected in financial stability The liquidity coverage ratio increased to 58.4 percent from indicators 47.4 percent in May 2022. Financial stability indicators 70 30 By April 2023, the level of non-performing loans (NPLs) had 60 increased by 20.7 percent per year over the same period in 25 2022. NPL as a ratio of gross loans increased to 7.4 percent in 50 20 April 2023, compared to 6.1 in April 2022 and 6.6 in January 40 2023, representing faster growth in 2022 and the first quar- Percent Percent 15 ter of 2023. As at the beginning of 2023, the wholesale and re- 30 tail sector accounted for 29.2 percent of total NPLs, followed 10 20 by the restaurants and hotels sector at 23.0 percent and the community, personal and social services sector at 19.4 percent. 10 5 Although lending to the restaurants and hotels sector account- 0 0 ed for 3.8 percent of the total private sector credit, the NPLs for 08/2022 09/2022 10/2022 11/2022 12/2022 01/2023 02/2023 03/2023 04/2023 this sector account for 23.0 percent of NPLs, reflecting a poten- tial impact of lagged returns from capital investments to cov- Tier 1 capital Liquidity ROE er loan obligations. Provisioning for NPLs has remained high, NPLs (RHS) ROA (RHS) at 31 percent in April 2023, implying that banks are comforta- bly covered for the cost of NPLs. Source: World Bank staff calculations based on RBM data. 1. Economic Developments 41 Malawian banks reported higher profit levels in December 2022 compared to the previous year. The sector’s profit after tax increased by 54.5 percent compared to the same period in 2021. This can be attrib- uted to a large increase in gross income by 124.1 percent, and a slightly lower increase in expenses of 114.5 percent. The growth in gross income was mainly due to an increase of 41 percent in net interest income, 89.5 percent in foreign exchange income and 27.7 percent in other non-interest income. As of April 2023, return on equity and return on assets increased by 39.2 and 5.2 percent, respectively. While the econ- omy is struggling, banks have been able to increase their profits by lending to Government and other low-risk clients with strong willingness and capability to repay, leveraging the resources of their clients efficiently, and earning significant foreign exchange revenues amid acute foreign exchange shortages. There has been an increase in bank lending to the private sector, notably for consumption. In to- tal, MWK 960 billion of loans were outstanding as of March 2023 a slight decrease from MWK 980 bil- lion in December 2022 primarily directed at three sectors: the community, social, and personal servic- es sector, the wholesale and retail trade sector, and the agriculture, forestry, fishing, and hunting sector (Figure 1.34). In total, MWK 1.1 trillion of loans were outstanding as of December 2022 from MWK 868.6 billion in December 2021 primarily directed at three sectors: the community, social, and personal ser- vices sector, the wholesale and retail trade sector, and the agriculture, forestry, fishing, and hunting sector. Combined, these three sectors accounted for 70.3 percent of the total loan portfolio. Specifically, loans to community, social, and personal services accounted for 37.2 percent in April 2023. These loans are typically used to finance consumption. A similar trend was observed in the recent survey on access to finance from informal sources (Box 1.6). Although banks are supporting economic growth through lending, total exposure of just 30 percent in December 2022 going to agriculture (14.5 percent), manu- facturing (11.7 percent) and restaurants and hotels (3.8 percent), reflects a need for more focused com- mitment to these sectors as they have more impact on economic growth, generation of export reve- nues and creation of jobs. FIGURE 1.34  Bank lending is predominant in three sectors Monthly share to total lending in selected sectors Community, social and personal services Wholesale and retail trade Agriculture, forestry, fishing and hunting Manufacturing Transport, storage and communications Electricity, gas, water and energy Construction Restaurants and hotels Financial services Real estate Mining and quarying 0 5 10 15 20 25 30 35 40 Percent 12/2021 03/2022 06/2022 09/2022 12/2022 03/2023 Source: World Bank staff calculations based on RBM data. The other subsectors of the financial sector are resilient, albeit with increasing challenges. The micro- finance sector remained stable, resilient, and profitable. The total assets of the sector have continued to grow, and total capital and liquidity ratios are adequate and above the regulatory minimum. A strong growth in assets and positive investment returns was recorded in the pension sector in the second 1. Economic Developments 42 half of 2022. This was primarily due to the new members who were enrolled in the national pension scheme. In December 2022, the capital to total assets ratio of the Life Insurance sector increased to 7.1 percent from 6.6 percent in June 2022. Over the period, the industry’s aggregate core capital increased by 19.9 percent. With two life insurers accounting for 87.5 percent of gross premiums, market concen- tration risk has remained high in the sector. The capital and solvency position of General Insurance was adequate, albeit marginally. However, amid rising need for credit, most Malawian households bor- row through informal channels (Box 1.6). BOX 1.6  Consecutive shocks have pushed many Malawian households to borrow money, relying primarily on informal sources The High-Frequency Phone Survey (HFPS)* shows that dur- mainly to buy working inputs (52 percent), while food purchases ing COVID-19 and the most recent period of rising inflation, were reported by 20 percent of the households, a share that was the share of households with outstanding loans has increased slightly below the 25 percent observed before the pandemic. in the country. The proportion of indebted households grew Providing timely access to finance in the presence of eco- from 15 percent in 2020 to 63 percent in 2022. While most house- nomic shocks is critical. Financial inclusion is very limited, and holds (84 percent) attempted to borrow during the pandemic, it has been stalled in the last few years, while saving groups and about 50 percent of households asked for a loan between 2021 village associations have gained importance over time. For many and 2022, which is still higher than the pre-Covid level (30 per- households, already out of the scope of the formal financial sec- cent) observed in the 2019/20 Household Survey (Figure B1.6.1). tor, joining saving groups could be a starting point for formal Economic shocks in the form of job losses of the main earner, the lending to access to resources in a timely and accessible manner. reduction in the price of the selling output, as well as adults not eating for a whole day, are closely related to the likelihood of try- FIGURE B1.6.1  Almost half of Malawian households ing to borrow (between 50 and 70 percent) in the subsequent attempted to borrow money months following the shock. Share of households attempting to borrow Access to finance for households comes mainly through friends and relatives, a trend that has increased in 2022. 90 Personal ties have been the main source of finance for house- 80 holds even before the COVID-19 pandemic. Nevertheless, the share of households reporting such loans has grown from 28 70 percent during the pandemic to 45 percent in 2022. Similarly, saving groups, which consist of a group of people pooling their 60 money into a fund to be able to borrow from it, also gained 50 Percent importance during 2022 with 30 percent of households report- ing it as the main source of finance, in contrast to the 23 percent 40 of households relying on savings groups during the pandemic. Instead, only 3 percent of households reported credits with com- 30 mercial banks in 2022, just above the 2 percent reported during 20 COVID-19 and the 1 percent before it. Use of other credit institu- tions was reported by 9 percent of households in 2022. 10 The share of households who borrowed to buy food increased, 0 similar to the trend observed in the formal banking sec- During COVID-19 Post COVID-19 tor, reflecting rising the cost of living faced by households. August, 2020 May, 2022 During the food price increase of 2022, households borrowed to Aattempting to borrow With successful borrowing requests buy food (35 percent) followed by purchases of working capi- With other outstanding loans Attempting to borrow Pre COVID-19 tal inputs (30 percent) and to cover education expenses (15 per- cent). In comparison, during the COVID-19 pandemic, loans were Source: World Bank (2023). * The High Frequency Phone Survey has been conducted in Malawi since the COVID-19 outbreak. Households have been interviewed monthly or bi-monthly since May 2020, and these are ongoing. The HFPS has aimed to monitor the living conditions of households during the COVID-19 pandemic and more recently after the different external shocks hit the country. In August 2020 and May 2022, the survey included two financial modules. 1. Economic Developments 43 1.3 MEDIUM-TERM ECONOMIC OUTLOOK Malawi’s economy is projected to slightly improve in 2023, followed by moderate growth in the sub- sequent years.18 Economic growth is expected to increase to 1.4 percent in 2023, driven by a partial re- covery in the agriculture sector, which was impacted by Cyclone Freddy, and the resumption of elec- tricity generation at the Kapichira hydropower plant, which will support the manufacturing sector. However, this is still a decline in output in per-capita terms. Over the medium term, economic growth is forecast to increase moderately, underpinned by gradual macroeconomic stabilization and a recov- ery across all sectors. Lingering effects of the cyclones that occurred in 2022 and 2023 and the ongo- ing economic crisis could constrain the economy’s full recovery to the pre-COVID-19 growth trajectory. The persistent deterioration of the current account deficit is expected to further weaken foreign re- serves, leading to continued forex shortages. While agricultural exports are expected to improve, al- beit moderately, imports are projected to significantly pick up in 2023. Consequently, the current ac- count deficit is projected to widen further to 11.3 percent of GDP in 2023, assuming foreign exchange constraints can at least in part be addressed. Persistent challenges, including limited diversification and declining global demand for tobacco, are expected in counter efforts to reduce the current account deficit. Promoting new potential export sectors, particularly in agribusiness and mining, and boost- ing exports will be crucial going forward. Extended periods of foreign exchange shortages may inflict severe and enduring impacts on the real economy. Due to the unavailability of imported investment items, businesses are forced to forgo lucrative investment opportunities, thereby restricting the me- dium-term economic growth. Elevated inflationary pressures may constrain headline inflation from reaching its target in the near term. The projected decline of global commodity prices is expected to ease inflationary pressures from 2023. However, food prices are still rising and additional pressure from anticipated lower agricultur- al output could further increase food inflation. Furthermore, the possibility of upward adjustments in energy prices may result in higher electricity costs and exacerbate production expenses, compound- ing the effects of rising inflation. Malawi’s elevated inflation is attributed to both external shocks and a lack of coordinated measures among trade, exchange rate, monetary, and fiscal policies. A combina- tion of these factors will likely constrain inflation from reaching the RBM’s near term target of 5 percent. Despite efforts towards fiscal consolidation, the fiscal deficit is likely to persist due to continued high expenditure pressures. The gradual recovery and expansion of business operations, facilitated by the resumption of the Kapichira hydropower plant, could potentially bolster domestic revenue. However, fiscal consolidation efforts are challenged by continued spending pressures, especially the high share of statutory expenditures. Interest expense will continue to rise and absorb a higher proportion of the resource envelope, given increased domestic financing of the fiscal deficit using high-cost domestic in- struments. This will continue to constrain fiscal space, especially for needed investment to spur growth. 18. Forecasts in this MEM draw on the World Bank Macro-Poverty Outlook published in April 2023. 1. Economic Developments 44 Debt vulnerabilities will remain elevated, though they could be mitigated by successful debt restruc- turing negotiation. Currently, the Government is engaging commercial and bilateral creditors to re- structure external debt. Financing assurances from these creditors, supported by credible fiscal, mone- tary, and exchange rate policies, could pave the way for a sustainable debt path and enable the country to qualify for a full IMF program supported by an ECF. The key to achieving this lies in sustained fiscal consolidation, which progressively lowers expenditure, and additional measures to reduce debt vulner- abilities, particularly through improved PFM systems. This, in turn, engenders trust from private inves- tors and crowd-in further budget support from development partners. The financial sector is expect- ed to remain resilient though access to credit remains highly constrained amidst the continued rise in government borrowing from commercial banks. The absence of sustained economic growth, coupled with persistent inflationary pressures and re- curring weather shocks, is likely to pose significant challenges for Malawi in its efforts to alleviate poverty. The share of people living on less than US$2.15 per day is projected to increase to 72 percent in 2022 and 2023. Further external shocks may result in increasing poverty rates and push more peo- ple into food insecurity. There is a significant degree of uncertainty surrounding the country’s economic prospects, with numerous potential downside risks. Several factors, including prolonged foreign exchange shortages, setbacks in the ongoing negotiations for external debt restructuring, the materialization of rollover risk from short-term swaps, a surge in corporate bankruptcies, financial stress, delays in the AIP imple- mentation and reform process, and the recurrence of a cholera outbreak could potentially impede a recovery of the economy and exacerbate poverty. Prolonged effects from Cyclone Freddy, and gener- ally intensifying climate change impacts, especially on agriculture production, continue to pose a major downside risk to the economic outlook. However, if the economy can bounce back quickly from the impacts of the cyclone and the Government is able to make progress on its reform agenda, the coming year could also exceed current expec- tations. The diversification and commercialization of the agricultural sector is proceeding and could mean that new viable export sectors are able to emerge and grow, reducing the reliance on tobacco as the main foreign exchange earner. Implementing difficult but much-needed fiscal consolidation meas- ures and PFM reforms, as well as successful debt restructuring can create the necessary space to invest in growth-enhancing projects. Addressing the root causes of persistent fuel and power shortages could greatly improve the ability of firms to succeed. However, this will require a sustained focus on imple- menting tough but necessary reforms. Policy Options: Restoring macroeconomic stability, supporting the recovery of growth, and protecting the poor against shocks The Government has initiated several steps to curb the ongoing economic crisis. Notably, the RBM has introduced foreign exchange auctions to facilitate price discovery. Progress has been made with Malawi’s largest bilateral and commercial creditors towards an agreement that restores debt sustain- ability. The Government has also put forth substantial reforms in key structural policy areas. These include enhancing State-Owned Enterprises’ transparency for improved performance and strengthen- ing PFM systems. Efforts to reform the AIP are in progress, though clear plans have not been announced yet. A breakthrough in disaster response capabilities has been realized with the passage of the Disaster Risk Management (DRM) Bill, though it will be important to proceed urgently with its implementa- tion. Lastly, debt management has been bolstered through a new Medium-Term Debt Strategy and an Annual Borrowing Plan in alignment with the PFM Act of 2022. The 17th edition of the Malawi Economic Monitor (MEM) outlines urgent actions required to sta- bilize the economy, enhance growth, and protect the most vulnerable. It specifically recommends: 1. Economic Developments 45 1. Restoring macroeconomic stability: Despite the recognition within Government that macro-stabi- lization is a prerequisite for achieving broader development aims, stepped-up reforms are needed to rebuild foreign reserves, instill budget discipline, improve public financial management, and achieve debt sustainability. While many technical details remain to be elaborated, these reforms are necessary ingredients to stabilize the economy. 2. Increasing production and exports: Malawi’s private sector has been hit hard by the instability and shocks of the past years. To achieve growth, reforms that enhance production capacity and pri- vate investment will be needed to boost firms’ ability to export, strengthen agricultural diversi- fication and commercialization initiatives, and bring in more foreign investment. 3. Building resilience and protecting the poor: Given the growing frequency and severity of climate-re- lated shocks, it will be essential to step up efforts to support the most vulnerable. This includes moving forward with the implementation of the DRM Act, expending the roll-out, coordina- tion, and scaling up of key social protection programs and improving disease surveillance and response in the case of a new disease outbreak, such as cholera. TABLE 1.2  Priority policy areas and key actions 1. Restoring macroeconomic stability Building foreign Continue the progression towards a market-based exchange rate regime by increasing Short reserves foreign exchange auctions. Balancing Implement announced fiscal consolidation measures in line with the targets under the Short the budget Staff Monitored Program agreed with the IMF. Improving public financial Adhere and commit to quarterly allotment ceiling in IFMIS to reduce growing spending Medium management arrears that arise from overspending and committing outside the system. Achieving debt Finalize the restructuring of external debt and contain domestic debt and reduce costs. Short sustainability 2. Increasing production and exports Simplifying access to Review planned legislation and processes such as the Foreign Exchange Bill and Medium regional and global markets export licensing procedures to ensure these incentivize investment and exports. Increase access to reliable power by ensuring the financial sustainability of ESCOM, Increasing electricity bringing additional generating capacity online and accelerating the connection of Medium generation households to the grid. Stimulating agricultural Sustain momentum in the agricultural commercialization agenda by announcing and Medium growth implementing AIP reform plans and rolling out AGCOM 2.0. 3. Building resilience and protecting the poor Finalizing Universal Improve the delivery of social support services through the Universal Beneficiary Medium Beneficiary Registry reforms Registry. Preparing for the next Implement the DRM Bill and PDNA lessons to ensure rapid disaster recovery and Short disaster continued human capital increases. Responding Further strengthen integrated disease surveillance and response to detect and contain Short to health threats outbreaks promptly, while improving awareness of safe water and hygiene practices. Initiate Strengthen Sustain Phase out 2 POWERING UP: HOW MALAWI CAN RAPIDLY INCREASE ELECTRICITY ACCESS 2. Powering up: How Malawi can rapidly increase electricity access 47 Enhancing access to energy is critical to achieving economic development and the aims of Malawi 2063 Expanding access to energy is a critical component of economic development, and its impact on a nation’s GDP can be substantial. In Malawi, energy access is an essential element for the achieve- ment of Malawi 2063 of transforming the country into a more industrialized and prosperous nation. As such, investment in energy access is a top priority to advance the country’s economic development and wealth creation aims. In households, energy access can significantly improve living conditions by providing access to mod- ern technologies, lighting, and cooking. This directly translates to increased productivity, improved living standards, and better economic opportunities, particularly benefiting the poor and rural house- holds. Moreover, energy access plays a crucial role in the delivery of essential public services such as health and education, ultimately contributing to human development and poverty reduction. Despite the recognized benefits of energy access, Sub-Saharan Africa (SSA) still faces significant elec- trification challenges. According to the 2022 Tracking Sustainable Development Goal (SDG) 7 report,19 nearly half of SSA’s population (568 million people) currently lacks access to electricity. Malawi has one of the lowest electricity access rates in SSA at below 20 percent. FIGURE 2.1  Malawi lags other East African countries in In the past decade, several countries in the region have made increasing energy access strides in accelerating electrification efforts, and some are Progress in electrification in Malawi and other East African Countries from 2000 – 2020 and annual growth rates now on the path towards achieving universal electricity ac- cess. Countries in East Africa, including Malawi’s neighbors Malawi 5.5% p.a. Mozambique and Tanzania, significantly increased the ac- cess rate, having started from below 10 percent electricity ac- Mozambique 8.0% p.a. cess rate in 2000, and now have over 30 percent access, while Malawi, which started at a similar point in 2000, still lags be- Rwanda 10.1% p.a. hind (Figure 2.1). These countries offer valuable lessons, high- lighting the need for comprehensive, long-term electrification Tanzania 7.4% p.a. efforts that build nationwide and sector-wide electrification platforms, leveraging both grid and off-grid electrification, and Kenya 7.7% p.a. mobilizing public and private sector resources in a coordinat- ed manner. The success of these countries has been attributed 0 10 20 30 40 50 60 70 80 90 to political commitment, a conducive enabling environment, Percent a long-term electrification strategy, least-cost planning, and 2000 2010 2020 adopting adaptive approaches that fine-tune implementation based on lessons learned. Source: World Bank Global Electrification Database. Malawi’s rate of electricity access is among the lowest in the world Malawi has one of the lowest electricity access rates in the world. The electricity access rate for 2023 is estimated at 19 percent with severe disparities between urban (42 percent) and rural areas (5 percent). The inequity among the rich and poor is stark — access among the richest 20 percent of the population was about 30 times higher than the poorest 20 percent. The annual population growth rate of 2.8 per- cent has been outstripping the pace of electrification in recent years. World Bank data shows that in 2022 Malawi had the fourth-lowest energy access rate in Africa, just ahead of South Sudan, Chad and Burundi (Figure 2.2). Over 16 million Malawians currently lack access to electricity (World Bank, 2022c). 19. See https://trackingsdg7.esmap.org/. SDG7 aims to achieve access to affordable, reliable, sustainable and modern energy for all by 2030. 2. Powering up: How Malawi can rapidly increase electricity access 48 FIGURE 2.2  Malawi has one of the largest electricity access deficits, with over 80 percent of the population not connected to power Share of population without access to electricity and total population without access 100 South Sudan: 10 million Chad: 15 million Burundi: 10 million 90 Malawi: 16 million Burkina Faso: 17 million Share of population without access to electricity, Percent 80 Democratic Republic of the Congo: 72 million Niger: 20 million 70 Mozambique: 22 million Madagascar: 18 million Tanzania: 36 million 60 Uganda: 26 million Angola: 17 million 50 Ethiopia: 56 million Democratic People's Republic of Korea: 12 million 40 Nigeria: 92 million Democratic People's Republic of Korea Sudan: 20 million Democratic Republic of the Congo Myanmar: 16 million 30 Kenya: 15 million Pakistan: 54 million 20 India: 14 million Rest of world: 173 million Burkina Faso Mozambique South Sudan Madagascar 10 Myanmar Tanzania Pakistan Ethiopia Burundi Uganda Nigeria Malawi Angola Sudan Kenya India Niger Rest of world Chad 0 0 31 60 91 121 152 182 213 244 274 305 335 366 397 425 456 486 517 547 578 609 639 670 700 731 Population without access, Million Low-income Lower-middle-income Rest of world Source: World Bank (2022). Malawi has set ambitious policy goals, but implementation has often lagged behind The Government of Malawi set a goal to achieve universal energy access by 2030. In 2018, the Government published a revised National Energy Policy (NEP 2018), which serves as the main guid- ing document for the sector. The NEP 2018 set the target of universal access by 2030, in line with the Government’s commitment to achieve Sustainable Development Goal 7. This builds on the experi- ences of longstanding programs to increase electricity access and also incorporates recent programs, such as the USAID-funded “Kick-Starter Program” and the World Bank-funded “Malawi Energy Access Program (MEAP)” (Box 2.1). In 2019, the Ministry of Energy (MoE) prepared a National Electrification Strategy (NES) in line with policies in the NEP 2018. The NES proposes a framework through which the Government will guide accelerated access to households and businesses at acceptable quality and levels of service that is an- chored in the priority policies presented in the NEP 2018. The strategic elements of the NES are organ- ized in four thematic pillars — institutional, policy and regulatory, technical and planning, and finan- cial20 — that taken together define the means and processes by which electrification expansion will be implemented. Elements of the NES are very similar to those of electrification strategies being suc- cessfully implemented by governments in other countries in the region, including Ethiopia, Kenya, Mozambique, Niger, and Rwanda. 20. The institutional pillar includes defining the roles and responsibilities of electrification agencies and developing capacity building programs. The policy and regulatory pillar include defining minimum service levels, adopting quality standards for off- grid electrification, and scaling up mini-grid and standalone off-grid systems. The technical and planning pillar involves identify- ing power supply shortfalls, establishing a least-cost planning framework, and evaluating low-cost electrification design standards. The financial pillar includes promoting affordable access to electricity and developing a financing plan to support expansion goals. 2. Powering up: How Malawi can rapidly increase electricity access 49 BOX 2.1  Overview of the key electricity access programs in Malawi Malawi Rural Electrification Program (MAREP) MEAP’s on-grid component focuses on on-grid densification. The MAREP started in 1980 with ESCOM as the implementing MEAP off-grid component facilitates eligible Solar Home System agency, supported both through its own financing and donor (SHS) companies to expand services by issuing working capital funds. The Government of Malawi took over implementation of loans and result-based-financing (RBF). Under this component, the Program in 1995 and the Department of Energy, now Ministry the MoE established the “Ngwee Ngwee Ngwee Fund” (NNNF), of Energy (MoE), was appointed lead implementing agency. which manages financing through US$14 million in loans and US$6 million of grants, as well as technical assistance (TA). MAREP is funded by the Rural Electrification Fund sourced from a The RBF window (up to US$5.5 million) provides end-user sub- 4.5 percent levy on all energy sales as stipulated in Section 25 (2) sidies to close the affordability gap of customers that cannot Energy Regulation Act, and Rural Electrification Act Section 12 (b). afford solar home systems. The remaining US$0.5 million will be The Rural Electrification Management Committee with the Board of used to support market-based innovative solutions to scale up Directors chaired by the Principal Secretary of Ministry of Energy energy access. oversee the implementation of MAREP. The Rural Electrification In addition, through the MEAP TA component, the MoE is launch- Unit in the Ministry of Energy executes the activities of MAREP. ing consumer awareness campaigns, supporting efficient finan- Since MAREP’s inception, eight phases of the program have been cial management, establishing national off-grid solar product implemented. This involved extending power distribution lines standards, and conducting mini-grid feasibility studies. to district administration centers, major trading centers, tobacco growing areas and the development of the 4.5 megawatt (MW) Kick-Starter Program Wovwe Hydroelectric Power Plant. Since Phase IV, MAREP has Under USAID’s Southern Africa Energy Program, the “Kick-Starter electrified over 1,100 sites, including popular trading centers. Program” in Malawi was a three-year initiative, launched in 2019, to incentivize market entry and scale-up of SHS companies Malawi Energy Access Program (MEAP) through RBF, operational support and access to working capital. MEAP is an ongoing energy access program financed by the Four companies were awarded RBF grants: Solar Works!, Vitalite, World Bank which includes on-grid, off-grid and technical assis- Yellow Solar and Zuwa Energy. A wide range of partners sup- tance components. The on-grid and off-grid components are ported the program, including local banks and lending institu- implemented by ESCOM and MoE, respectively. MEAP aims to tions (FDH Bank, Kuwa Capital, National Bank of Malawi and connect 170,000 households to the grid and 200,000 to off-grid Standard Bank), international financiers (Lion’s Head Global solutions by the end of 2024. Progress has been slow. As of May Partners and SunFunder), industry associations (EnDev), and 2022, only about 10,000 connections were made by ESCOM. awareness-raising institutions (Maeve). In 2021, the MoE also prepared the draft Guidelines for Implementation of the National Electrification Program, which include connection charge policies, provision of government financing, and roles and responsibilities of government implementation agencies. According to the guidelines, low-income families meeting certain criteria will be eligible for free connections or a soft loan with zero interest to finance connections. The Electricity Supply Corporation of Malawi (ESCOM) is also planning to intro- duce a cross subsidy within the domestic customer category by allowing the first 50 units consumed per month to be charged at a lower rate to support the basic social needs of low-income households. Implementation results of the electrification policy has been mixed Despite the existence of a strong strategic and policy framework for energy access, the implementation of these policies has been slow and inadequate. This is partly due to lack of consistent political commitment, limited financial resources, weak institutional capacity, bureaucratic procedures, and governance issues. On-Grid Electrification has traditionally been driven by the expansion of the grid connections, funded by the Government and implemented by ESCOM. Malawi has made progress in the past decade towards ex- panding access to electricity. For example, ESCOM connected over half a million residential, commercial and industrial customers to the grid since 2012, increasing its customer base by over 8 percent on an annualized basis (Figure 2.3). This translates to an average of over 34,000 new connections every year. Despite these achievements, the national electrification rate has remained stagnant since 2016, with the grid connection rate only increasing by 0.2 percent between 2016 – 2021. While ESCOM has made 2. Powering up: How Malawi can rapidly increase electricity access 50 new connections, these have been mostly offset by the impact FIGURE 2.3  ESCOM increased connections from 2012 to 2021, of the country’s rapidly growing population, which is increas- but on-grid access rate stalled ing at a rate of 2.8 percent annually. As a result, the electricity 600 12 access rate has been effectively flat in recent years, highlighting 500 11 the need for further action to accelerate electrification efforts Customers, Thousand 400 10 and bring sustainable and reliable power. The on-grid connec- Percent tions have mostly been supported by MAREP and MEAP. 300 9 200 8 100 7 Off-Grid 0 6 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Off-grid electrification, dominated by solar home systems Customers Grid-connection rate (RHS) (SHS)21, is growing rapidly and plays a significant role in the Government’s electrification plans. Off-grid electrifi- Source: ESCOM. cation is led by the private sector, incentivized by favorable Government regulations and fiscal incentives. Malawi is con- FIGURE 2.4  Malawi has a dynamic off-grid market connecting sidered an emerging off-grid solar market characterized by both over 5 percent of population fast growing sales and a large remaining electricity access gap 500 6 (World Bank 2022b). Private-sector operators like Yellow Solar, 5 Customers, Thousand 400 Vitalite, Solarworks!, and Zuwa, among others, have increased 4 sales of high-quality SHS of tier 1 and above22 through the in- 300 Percent 3 troduction of Pay-As-You-Go (PAYG) contracts. 200 2 100 1 About 400,000 SHS have been sold in Malawi as of 2022. About two thirds of these (260,000) are estimated23 to be actively 0 0 2016 2017 2018 2019 2020 2021 2022 serving off-grid households, thus contributing about 6 percent (Figure 2.4) to the electricity access rate. This makes Malawi Cumulative sales Active o -grid SHS O -grid electrification rate (RHS) one of the top 20 countries (Figure 2.5) in the world by the share of population with access to solar.24 Source: GOGLA sales data, own analysis based on interviews with market players. FIGURE 2.5  Malawi is among the countries with highest share of access to solar Share of population using solar lights 100 80 60 Percent 40 20 0 Vanuatu Seychelles Mauritius Kenya Fiji Samoa Rwanda Uganda Somalia Senegal Burkina Faso Papua New Guinea Jordan Ethiopia India Zambia Malawi Cameroon São Tomé and Príncipe Sierra Leone Source: IRENA 2021. 21. A Solar Home System (SHS) is a small-scale electricity generation system that uses solar photovoltaic technology to generate electricity from sunlight. It typically includes a solar panel or panels, a battery, and other components such as charge controllers and inverters, and can be used to power lights, appliances, and other electrical devices in homes, businesses, and other settings. 22. Tier 1 and above per the Multi-Tier framework developed by ESMAP. Unlike solar lanterns, the government counts these SHS of tier 1 and above as connections and, thus, they contribute to the electrification rate. 23. Estimates based on a default rate of 10% (meaning SHS sold are inactive or repossessed), average active life of 3 years, and the assumption that 20% of SHS are installed as back-up in grid-connected households and thus do not contribute to the access rate. 24. Source: IRENA 2021 data cited in the World Bank: Tracking SDG7 report 2022, page 37. Accessed on April 22, 2023: https://www. esmap.org/mtf_multi-tier_framework_for_energy_access.” 2. Powering up: How Malawi can rapidly increase electricity access 51 The off-grid market in Malawi has taken off due to several factors. First, there has been a strong increase in the availability of affordable off-grid systems, coupled with the use of the Pay-As-You-Go (PAYG) business model. This has made it easier for households in remote areas to access electricity and enjoy the benefits that come with it. Second, development partners and private sector investors have shown a keen interest in investing in this market, recognizing its potential for growth and profitability. Third, the Government has taken important steps to support the off-grid sector, including streamlining the licensing process and providing import duty and value added tax (VAT) exemptions for solar home systems. These measures have made it more attractive for investors to enter the market and expand their operations. Lastly, the slow progress of on-grid electrification and unreliable electricity supply has created a market gap for off-grid solutions, which has further spurred the growth of this sector. The impact of mini-grids on increasing the country’s access rate has been negligible so far. 25 While some mini-grids have been developed through donor funding, there are few commercially viable mod- els for scaling these up. There are several challenges associated with mini-grid development, including high upfront capital costs, operational costs, and difficulties in accessing finance. Additionally, there is a need for robust policies and regulations to support mini-grid development, including clear tariff structures and standardization of technical standard and installation practices. Overall FIGURE 2.6  Off-grid solar is driving the electricity access rate increase while on-grid connections stalled The fast-growing sales of SHS has driven the increase in elec- 1,000 20 tricity access between 2020 and 2023, with on-grid connec- tions remaining stagnant at around 12 percent (Figure 2.6). 800 16 Customers, Thousand There is a significant backlog of over 50,000 households wait- 600 12 Percent ing for grid connections. Addressing this backlog will require Government and ESCOM working together to establish clear 400 8 targets informed by integrated energy planning, streamline 200 4 the connection process and improve overall efficiency in order to clear this backlog and provide access to future applicants. 0 0 2012 2013 2018 2019 2014 2016 2020 2015 2017 2021 2023e 2022e It is also important to continue supporting the growth of off- grid solutions such as SHS26, which can help to bridge the gap until grid connections can be made. Overall, while progress On-grid O -grid Power Access Rate (RHS) has been made, a lot more needs to be done to accelerate elec- Source: ESCOM, World Bank team estimate. trification, especially for grid connections. Note: e indicates estimates and f indicates forecasts. Key lessons learned from Malawi’s Power Access Programs Malawi still lags behind its neighboring countries in increasing the electricity access rate. This is despite the fact that it has a clear sector policy since 2018, sufficient financing since the approval of the MEAP in 2019, and dedicated implementation agencies such as the Rural Electrification Unit in the Ministry of Energy and the Project Implementation Unit in ESCOM. While government policies and investments have set a strong foundation for progress, there are still significant challenges that need 25. Mini-grids are power generation and distribution systems designed to provide electricity in areas that the main grid has not yet reached, or where the cost of a grid-based connection is too high. While there is no universally accepted definition of mini grids, they are typically used to supply electricity to local communities, covering a range of needs including domestic, commercial, and industrial demand. These systems can operate on a range of power sources, including solar, wind, hydro, and diesel genera- tors. Mini-grids can play a crucial role in expanding access to electricity in rural areas, where the cost of grid extension is prohibi- tively expensive or logistically challenging. 26. The off-grid connection numbers presented here are based on reported company sales, estimated active PAYG contracts, and the number of grid customers using SHS as a backup service. These numbers may not reflect the actual situation, and a more accurate report is expected to be obtained from the Multi-tier Energy Expenditure Survey that will be conducted by the Malawi Bureau of Statistics in 2023. 2. Powering up: How Malawi can rapidly increase electricity access 52 to be overcome, such as inefficient and slow implementation processes, lack of coordination between agencies, and limited capacity in both the public and private sectors. Additionally, the COVID-19 pan- demic has further compounded these challenges and led to delays in the electrification efforts. Some of the key lessons learned in the past five years include the following. 1. Increasing energy access requires political support and government ownership The Government’s and ESCOM’s ownership and prioritization of the access agenda are key to its suc- cess. Unfortunately, both lacked the urgency to implement MEAP and MAREP during a difficult peri- od marked by multiple crises including COVID-19, the depreciation of the kwacha, dollar shortages, and natural disasters affecting the power sector. ESCOM lacked a permanent CEO in 2021, creating a void of strong leadership and focus. ESCOM’s failure to prioritize energy access during this tough period has hampered progress, and neither the Ministry of Energy nor the Ministry of Finance and Economic Affairs has been able to drive the necessary reforms. As a result, the energy access agen- da has trailed behind other government initiatives, and access has slowed. All stakeholders must take ownership and prioritize energy access to accelerate progress toward universal energy access. 2. Reforming governance of MAREP and increasing transparency The reputation of the Government’s main electrification program, the Malawi Rural Electrifi- cation Program (MAREP), is mixed due to governance concerns. The MAREP initiative has previ- ously been a subject of perceived corruption. Transparent and fair procurement processes are essential not only for fostering public confidence but also for attracting potential investors and encouraging healthy competition among suppliers and contractors. By addressing the percep- tion of corruption associated with the MAREP initiative, the Government can demonstrate its commitment to effectiveness and accountability. Financially while MAREP has a robust funding mechanism in place — a 4.5 percent levy on fuels and energy sales, which generates about $10mil- lion funding per year —  it has failed to achieve the rapid electrification goals. The Government is re-designing the MAREP procurement methodology as a step towards achieving better govern- ance and financial management.27 3. Solving the energy access deficit requires a value chain approach There needs to be sufficient energy generation and transmission infrastructure to support connec- tions. Malawi has been struggling with severe supply shortages for most years since 2017. From 2017 to 2020, due to low water flow, the dominated generation system dominated by hydro power could not meet demand. The supply shortage led to the installation of emergency diesel-based power sup- ply. While the river flow improved, in 2022 Malawi lost supply from Kapichira Power Plant, the larg- est hydro plant in the system, because of damages caused by Tropical Storm Ana, leading to frequent and extended load shedding for existing electricity users. The load shedding and unreliable power supply compelled many consumers to seek alternative sources of electricity, such as off-grid diesel generators and SHS. ESCOM’s ability to make new connections was severely hindered by its inability to meet the demand of existing customers, disincentivizing ESCOM from expanding its customer base. Additionally, insufficient transmission capacity from the southern hydro power base to the north- ern region has also posed a challenge for ESCOM. Therefore implementation of least cost plans and the construction of more generation and transmission capacity to allow rapid growth of power con- nections is urgent. The Mpatamanga Hydro Plant (361 MW capacity), which is expected to generate power in 2029 – 2030 will be a critical step to ensure sufficient generation capacity to achieve univer- sal access for Malawi. This will increase the current installed capacity (536 MW) by almost 70 percent. 27.  Detailed measures include: 1. Streamlining the procurement process; 2. Robust evaluation and selection criteria; 3. Staffing the MAREP department with qualified projects managers and engineers; 4. Enhanced disclosure and reporting; and 5. Capacity building and training. 2. Powering up: How Malawi can rapidly increase electricity access 53 4. Improving ESCOM’s operational efficiency is key to the success of the electrification program ESCOM’s performance under MEAP has been a cause for concern, with progress falling far short of expectations. As of April 2023, ESCOM had only managed to make connections to approximately 10,000 customers. This slow progress can be attributed to a range of factors, including ESCOM’s overly bureaucratic procurement and hiring practices, as well as ineffective management in mo- tivating staff performance. The utility company has also struggled to incorporate large amounts of new connections into its customer management systems. ESCOM’s operational challenges have been further compounded by a lack of necessary equipment, including vehicles and machinery. With construction works being carried out by its own staff, these additional bottlenecks have significantly slowed progress. It is clear that Malawi’s electrification efforts will not move for- ward as quickly as desired unless ESCOM’s operational performance is improved. ESCOM, with the support of MoE and MoFEA, has started to implement critical reforms to address these issues. 5. Leverage new technology and business models by attracting private sector capital and expertise The use of solar home systems and the PAYG business model has rapidly grown, which has been the driving force behind electricity access gains in both urban and rural areas. Private sector com- panies offering these solutions have demonstrated that the business model and technology28 are viable in Malawi. These solutions have proved to be particularly successful in remote and under- served areas where grid connections are not feasible or cost-effective. The success of these off- grid models underscores the importance of leveraging new technology and innovative business models in addressing energy access challenges. The declining cost of SHS is another key driver of the off-grid success, resulting from not only economies of scale but also more efficient operations. Malawi’s leading SHS companies have cre- ated highly efficient sales and distribution networks and adopted modern customer management systems, in contrast to ESCOM’s inefficiencies in these areas. Malawi has an opportunity to rapidly increase electricity access If energy sector reforms are restarted, Malawi is poised to finally achieve rapid electrification in the years ahead. This means it will need to continue its commitment to market-friendly policies and sig- nificantly improve the implementation capacity of government and ESCOM. Several factors combined present the Government an opportunity to rapidly increase the electricity access rate. As a densely populated country, Malawi can achieve universal access at lower costs than some larger countries, such as its neighbors Mozambique and Tanzania. Malawi is a densely populated country with an existing medium voltage grid network of broad reach. It is estimated that about 95 percent of the population live within 10 km of the existing network. Even more promising, a high percentage of people already live within 5 km of existing ESCOM network infrastructure (Figure 2.7). This means that there are a large number of potential connections in the range of existing transformers and can be reached with little to no additional medium voltage lines in the near term. Specifically, if these house- holds were to be connected to the grid, it would bring the national access rate to over 30 percent. There is strong demand for electricity connections despite macro-fiscal challenges, as evidenced by the overwhelming number of applications submitted to ESCOM. Unfortunately, ESCOM’s capacity to make these connections is lagging, resulting in a backlog of over 50,000 households. On average, these house- holds have been waiting for more than a year after making their application fee payment of MWK 92,000. 28. This includes key enabling technologies including remoting monitoring and mobile payment. 2. Powering up: How Malawi can rapidly increase electricity access 54 ESCOM has reported that the demand for grid connection is FIGURE 2.7  Malawi’s existing MV network even higher than what has been seen through the applica- tion process. This is evidenced by marketing and consultation meetings with district councils. According to the Ministry of Energy’s estimate, there are over 200 MW of suppressed de- mand (the total installed capacity of Malawi is 536 MW) that has not been met by the existing supply. For households that are not yet connected to the power grid, the cost of energy-related expenditure is significant. A recent study conducted by SE4All in 2022 found that current levels of energy expenditure in areas close to grid infrastructure, would translate to a monthly electricity consumption well above 50 kilowatt-hours29 for 50 percent of households. The high cost of energy-related expenditure for households not yet connect- ed to the power grid is a significant concern but also an oppor- tunity for ESCOM. By addressing this issue, ESCOM can simulta- neously improve the quality of life for its customers, increase its revenue base and achieve economies of scale. The rapid advancement of technology in recent years has led to the emergence of innovative solutions to the long- standing challenge of expanding energy access in Malawi. The difficulties of consumer financing and complexities to collect payment from relatively poor residential users have long been obstacles for private sector solar companies to de- Source: ESCOM. velop viable business models and expand their business. The recently emerged PAYG business model has proved to be a game changer, as it allows consumers to pur- chase small-scale solar systems on a payment plan, making solar power more affordable and accessi- ble to those who might otherwise be unable to afford it. Additionally, off-grid solar systems have be- come increasingly affordable and effective thanks to economies of scale, providing a viable alternative to grid infrastructure. In Malawi, PAYG payment terms are typically structured as monthly payments over a period of ranging from 12 to 36 months depending on the product and the company. An up- front payment, roughly equivalent to two monthly payments, is required from customers. Customer payments are typically made via mobile money, in exchange for a code (token) that keeps the device activated. Devices are otherwise locked, in case of delayed payment. After meeting all PAYG payments, customers own the product. In case of defaults, repossessions are the last-resort option for suppliers. How can Malawi achieve the electrification target set in Malawi 2063? Business-as-usual will not go beyond 30 percent The Government of Malawi is targeting universal access by 2030, however in a business-as-usual (BAU) scenario for Malawi’s electrification, the access rate will fall far behind the target, reaching about 30 per- cent, with ESCOM and off-grid each connecting about 15 percent of population. Sales of off-grid solar systems are expected to continue to grow at 15 percent in the BAU scenario. More international companies are entering the market, increasing competition, which is expected to reduce prices and the expansion of distribution networks into underserved parts of the country. As a 29. The 50 kilowatt hours per month per household equates to tier-3 access per the Multi-tier Framework for energy access. It is also the tariff threshold for ESCOM 1-phase pre-paid customers. 2. Powering up: How Malawi can rapidly increase electricity access 55 result, off-grid solar is projected to serve 860,000 off-grid customers by 203030, increasing the popu- lation served by off-grid technology from 6 percent today to 15.3 percent. On the other hand, the country will continue to rely on ESCOM FIGURE 2.8  Business-as-usual will only get Malawi to a 30 to connect additional customers to the grid. Without reforms, percent access rate by 2030 ESCOM will struggle to install connections in line with popula- 1,800 30 tion growth. Assuming the same average number of connec- 1,600 tions per year as in the past (approximately 35,000 connections 25 1,400 annually), grid connections will not significantly contribute to Customers, Thousand the increase of the electrification rate. 1,200 20 1,000 Percent Under the BAU scenario, Malawi is expected to achieve a 30 15 800 percent electrification rate by 2030, primarily through off- 600 10 grid solar installations. However, with the increasing num- ber of off-grid installations, affordability is becoming a major 400 5 challenge. A 2019 World Bank survey suggests that afforda- 200 bility may not be a major barrier until the 30 percent target is 0 0 2012 2013 2018 2019 2014 2016 2020 2024f 2015 2017 2021 2023e 2026f 2022e 2028f 2025f 2029f 2030f 2027f reached. Nevertheless, every additional connection thereafter will pose a challenge. Therefore, it is difficult to expect the off- grid sector to achieve a growth rate much higher than 15 per- On-grid O -grid Power Access Rate (RHS) cent by 2030, and for the country to achieve an overall elec- Source: ESCOM, World Bank team estimate. tricity access rate over 30 percent (Figure 2.8).31 Note: e indicates estimates and f indicates forecasts. Crucial changes needed to achieve 50 percent electricity access target in Malawi 2063 An electricity access rate of 50 percent by 2030 is achievable but requires a joint effort from the Government and private sector. Under the “50 percent by 2030” scenario, both ESCOM and off-grid solar companies have equal responsibility to each connect about a quarter of the population (Figure 2.9). FIGURE 2.9  Achieving the electrification target set in Vision 2063 ESCOM needs to triple its annual connection rate from the 3,200 60 current average of 35,000 households to at least 100,000 2,800 households, prioritizing grid densification to achieve both 50 2,400 Customers, Thousand speed and efficiency. The financing requirement for these 40 2,000 connections would also be relatively modest. However, as a Percent key lesson learned in the past five years, this target cannot be 1,600 30 achieved without significant improvements in ESCOM’s oper- 1,200 20 ational efficiency and financial sustainability, which should be 800 10 addressed through key reforms. 400 0 0 2012 2013 2018 2019 2014 2016 2020 2024f 2015 2017 2021 2023e 2026f 2022e 2028f 2025f 2029f 2030f 2027f On the other hand, the off-grid market needs to continue its growth. In comparison to 15 percent sales growth in the BAU, this scenario calls for 25 percent growth, which requires On-grid O -grid Power Access Rate (RHS) new financing mechanisms and business model innovation. Source: ESCOM, World Bank team estimate. Otherwise, the growth will slow down when the relatively Note: e indicates estimates and f indicates forecasts. 30. 15 percent year-on-year growth is based on 2022 sales growth of 15 percent in Malawi and the average growth of the off-grid solar industry globally, at 10 percent. Assumptions on how sales translate into active off-grid customers include a 10 percent default rate, 3-year useful life of SHS, and 30 percent of sales going to grid-connected households or recurrent off-grid customers, and thus not contributing to access. 31. An assessment of the World Bank of 2019 suggests that 60 percent of off-grid households cannot afford to spend more than US$4 per month on electricity, while the current PAYG is priced at about US$5 a month. The affordability issue will become a signif- icant barrier with as SHS penetration approaches 30 percent. 2. Powering up: How Malawi can rapidly increase electricity access 56 wealthier market segment is saturated. The Government’s recent launch of the NNNF, providing local currency financing to off-grid solar companies, is a good start for catalyzing the market through the supply of capital while mitigating foreign exchange risks. It is essential to continue the partnership be- tween the MoE and the private sector to sustain the off-grid market growth. Raising the bar: striving for universal access by 2030 Universal access by 2030 remains an ambitious target. Crucial reforms must be accomplished in the power sector to break away from the past pattern of slow progress, and financing and sector coordina- tion need to improve to deliver this higher access rate by 2030. Expanding the grid is essential to achieve universal access. In the 50 percent access scenario, the focus is on-grid densification, utilizing existing medium and low voltage (LV) lines. In the universal access sce- nario, grid expansion is necessary. The SE4All Integrated Energy Plan study estimates that connecting the remaining 50 percent of the population to the ESCOM grid will require a significant investment of US$2 – 3 billion. Most of these costs will need to be borne by the government, donors, or existing ESCOM customers. As such, financing will be a critical challenge that needs to be addressed. Universal access by 2030 would require an annual connection target of close to 500,000 per annum. This is over 15 times faster than the current speed and calls for a complete overhaul of the implemen- tation model of ESCOM and MAREP, requiring streamlined and transparent processes, efficient contrac- tors, and a larger and dedicated delivery unit. Universal access will also need fast growth of the off-grid solar market in addition to grid expan- sion. In addition to SHS market, a significant scale up of mini-grid connections may be needed.32 The scale up of mini-grid, SHS and on-grid connections requires a concerted effort from the Government and private sector to make best use of scarce public finance resources and to avoid duplicated efforts. The pathway to universal access requires leadership, partnership, and reforms Leadership: the Government can demonstrate sector leadership and set clear policy goals 1. The Government should establish institutional arrangements and regularly update the gen- eration and transmission master plans to ensure adequate supply and transmission capacity. Updating and implementing generation and transmission least cost plans are important for con- nections, as this will facilitate new connections and better serve existing customers. The least cost plans have not been updated and implemented in the past five years, making them ineffec- tive in guiding sector development. To address this issue, the MoE has hired international con- sultants to update these plans, with technical support from the System Operator (ESCOM). The updated generation and transmission plans are expected to be published by the end of 2023. MoE should also ensure the timely execution of the least cost plans. 2. The MoE can take a stronger coordination role in managing the roll-out plans for on-grid and off-grid connections. This can be achieved by working closely with ESCOM and the private sector to ensure that resources are allocated appropriately to both on-grid and off-grid electrifi- cation projects. While the private sector has been driving off-grid deployment, there have been limitations in the ability of MoE to monitor progress and coordinate between ESCOM and off- 32. According to SE4All’s Integrated Energy Plan, best connection technology for over 300,000 households will be mini gird where the grid expansion costs are over US1,300 per household. 2. Powering up: How Malawi can rapidly increase electricity access 57 grid players, as not all data has been collected. Addressing these monitoring issues is crucial to ensure that the progress towards increased electricity is effectively tracked. As the country faces significant affordability challenges, it will become increasingly important for the Government to play a policy role in facilitating financing and providing targeted subsidies to solar companies and end users, respectively, to support electrification efforts. 3. The MoE is encouraged to update the NEP 2018 to ensure its alignment with current challenges. While the NEP 2018 provides a good framework for energy sector development, certain aspects of the policy need to be reviewed, considering the increasing threat of climate change impact and the progress towards universal energy access. An updated NEP will provide policy guidance on incorporating climate risks in the energy sector planning and set an ambitious yet achieva- ble energy access target for 2030. 4. It is recommended that the government formally adopt the draft Guidelines for Implemen- tation of the National Electrification Program, which outlines the connection and connec- tion fee policy. The formalization will remove any financial uncertainties for potential custom- ers and the implementation agency, thereby facilitating scale-up. Reform: Government needs to reform ESCOM to improve its operational efficiency and financial sustainability 1. The Government, through governance reforms, needs to foster a culture of accountability and continuous improvement within ESCOM. The operational efficiency of the connection team should be measured against clear targets in a systematic manner. Such approaches, when com- bined with a comprehensive training program and appropriate human resources policies, can dramatically boost connection speed. 2. ESCOM should focus on improving its procurement processes to tackle a major bottleneck of electrification. Exploring options to further standardize connection design and procurement documents can streamline the availability of materials and resources, reducing the possibility of procurement delays and ensuring cost competitive contracts. 3. ESCOM needs to fully operationalize its Management Information System (MIS). Currently the under-utilization of MIS leads to manual work and human errors that significantly slow down the roll-out of connections. The ESCOM management team need to execute a comprehensive change management program to maximize the utilization of the advanced MIS already in place.33 4. The Government needs to work with ESCOM to achieve its financial sustainability. Improving ESCOM’s financial position is vital for increasing access rates. Previously, a loss-making ESCOM was discouraged from expanding its connection program, in part because of perceived risks of increasing technical and financial losses. A financially stable ESCOM will have adequate resourc- es for routine maintenance and customer service, reducing losses and line faults. Additionally, it will also be able to access far more medium to long-term capital without the need for a sover- eign guarantee, which can be used to fund eligible consumer connections. A recent World Bank study identified critical areas where ESCOM and the Government should collaborate to improve ESCOM’s financials, including revenue management, loss reduction, tariff adjustment mecha- nisms, balance sheet optimization, and sector arrears elimination. 33. The MIS implementation was not fully successful, and many modules of the system remain underutilized. 2. Powering up: How Malawi can rapidly increase electricity access 58 Partnership: Government needs to work with the private sector to sustain the growth momentum in the off-gird solar market 1. The Government is encouraged to continue supportive policies, such as VAT and duty exemp- tions, to stimulate additional private sector investment. These incentives have proven effective in attracting investment and driving growth in the sector. Additionally, the government can ex- plore other incentives, such as RBF similar to USAID’s “Kickstarter Project” and the World Bank’s MEAP, to incentivize more enterprises to enter the Malawian market. Increased competition will not only drive down prices but also spur innovation and the development of new technologies, enhancing the efficiency and efficacy of off-grid solar systems. 2. The Government is encouraged to facilitate more local currency financing34 for off-grid com- panies. Financing has been a major barrier to the growth of local off-grid solar companies. The ongoing macroeconomic crisis and issues of currency inconvertibility have exacerbated the chal- lenge. International off-grid solar companies that rely on hard currency loans, face substantial foreign exchange risks due to currency mismatch between funding and revenue currencies. By facilitating local currency loans, the government can create funding opportunities and reduce risks associated with hard currency financing. This will enable solar companies to expand their business and cut their price, leading to market growth. 3. Targeted end-user subsidies can be introduced to further reduce the price of off-grid solar products for those who need them most. Affordability analysis suggests that increasing access beyond the business-as-usual projections will require additional price reductions, particularly for the lowest-income facilities. The Government can work with its development partners to cre- ate financial instruments that enable targeted end-user subsidies. Currently development part- ners like EnDev and the World Bank are piloting end-user subsidies, with the goal of testing de- sign and paving the way for a future scale-up. 4. The Government is encouraged, in consultation with off-grid solar companies, to set market standards for mini-grid and SHS to ensure quality products and services. Implementing prov- en standards and best practices, which have been locally adapted and successfully implemented in other countries such as Bangladesh, Kenya, and Rwanda, will enhance consumer confidence and drive increased demand in the off-grid solar market FIGURE 2.10  Malawi’s pathway to achieve 50 percent electricity access rate by 2030 GoM to establish institutional MoE to take a stronger GoM to formalize Leadership arrangements and update coordination role to balance MoE to update NEP 2018 connection fees policy sector plans on -grid and o -grid and guidance Reform GoM to improve ESCOM ESCOM to improve its ESCOM to achieve ESCOM to operationalize MIS governance procurement e iciency financial sustainability GoM to continue Partnership GoM to facilitate more local GoM to introduce targeted GoM to set market standard supportive policies incl. currency financing end user subsidies incl. mini-grid and SHS VAT and duty exemption Source: World Bank. Note: GoM — Government of Malawi. 34. As an example, NNNF under MoE is providing local currency financing to Malawi based solar companies. 2. Powering up: How Malawi can rapidly increase electricity access 59 BOX 2.2  Electrifying public institutions Access to reliable and affordable electricity is critical for the and waste management as an integral part of budget plan- provision of essential health and education services. However, ning for health-care facility electrification; only 59 percent of health facilities in Malawi have regular elec- iii. Funding procedures and disbursement time frames of gov- tricity from the grid, including 36 percent of health centers and ernments and development partners should be adapted to 25 percent of clinics.a Many schools and some 12 – 15 percent of cover these long-term maintenance costs; and health facilities in Sub-Saharan Africa have no electricity whatso- ever. Rural schools in Malawi often serve as the only community iv. Functionality of installed energy systems in the medium and infrastructure and their electrification provides a resource that is long term should be monitored (including through remote enjoyed by the many villages that these public institutions serve. monitoring), and accountability mechanisms should be put On one hand, electrification of schools can provide numerous in place. benefits, such as improved learning outcomes, increased access Electrification of health facilities is essential to enable Malawi to digital technology and resources, and improved teacher reten- to reach its healthcare policy goals outlined in the Health tion. On the other hand, unreliable electricity translates into Sector Strategic Plan II (2017 – 2022). Electricity is essential shorter light hours suitable for studying and community activities to power lighting system prolonging service hours, in particu- and limited ability of individuals to use digital solutions hinder- lar for medical emergencies and child birth; to facilitate criti- ing digitalization drive and development of Malawi’s STEM pro- cal communications and to assure adequate water supply; to gram. Given the central role that schools often play as commu- maintain refrigeration of cold-chains for vaccine deployment; to nity centers, school electrification can improve learning, catalyze power medical devices and equipment, and to improve medical teacher training and engagement, and enable community activi- records systems. ties that can support youth and adult training. Increased and more efficient financing will be critical. A new Malawi faces significant challenges in ensuring that pub- 2023 joint report by the World Bank, IRENA, SE4All and WHO, lic institutions have access to electricity, particularly in rural states that solutions for electrification of health facilities in low areas. Despite the main grid running mostly along the main income countries are readily available and rapidly deployable. roads, the grid connection fees remain prohibitively high for hos- Their implementation requires better cooperation between the pitals located just 1 – 2 km away from these roads. Even if the energy and health sectors. Ministries of Health and Energy and health facilities can afford the connection fees, the time it takes for other relevant stakeholders at all levels must be involved, from connection is exceptionally long. Even grid-connected healthcare strategy and planning to policies, budgeting, procurement and facilities often still require diesel or solar-based additions to sup- implementation. Strong collaboration between public, private plement grid power due to grid unreliability and load-shedding. and nongovernmental institutions need to be facilitated to lever- For this reason, off-grid electrification via solar photovoltaic age synergies and unlock resources. Donors and development systems became the main choice for providing electricity to partners need to increase dialogue and collaboration at country rural clinics in Malawi. Solar panels, typically installed on roof- level, to maximize impact and avoid duplication of efforts. tops, collect energy from the sun which is then stored in batter- Currently, publicly owned clinic and hospital electricity con- ies and can be used to power various applications, ranging from nection and usage are funded through national budget allo- task lighting to delivering supplemental oxygen. However, cur- cations, concessional finance, and grants. However, these rent off-grid approach to electrifying essential public institutions sources are insufficient to meet the country’s future energy in Malawi does not place an adequate focus on long-term oper- capacity needs. To triple its generation capacity by 2030 and ations and maintenance, which is imperative for sustainable ser- meet the growing population’s energy needs, Malawi requires vice. Most grant-based donor interventions in Malawi, similar to significant investment in connecting these healthcare facilities to those in other Sub-Saharan African countries, have focused on power. The absence of investors in the country due to an under- the procurement of power generating assets for public institu- developed market and small investment opportunities is a chal- tions, following a traditional grant-based donor-funded model, a lenge. Innovative business models could be introduced to attract so-called “install and forget” approach to decentralized electrifi- international investors. cation. To ensure sustainable electricity supply to public institu- tions, there is a need for a shift towards a more comprehensive The initial investment outlay can be provided by the exist- and sustainable approachb that includes long-term operations ing energy financing initiatives present in the country. Other and maintenance of solar systems, including: financing options, such as commercial loans and national fund- ing sources, can be used to lower the cost of capital and make i. Long-term operation and maintenance of energy systems, this investment affordable to the country and people. Risk mitiga- along with replacement of batteries and spare parts; tion instruments, such as payment guarantees and guarantees, ii. Funding for long-term operation and maintenance of a facil- insurance, and hedging, can facilitate investment decisions and ity’s energy systems, including costs of battery replacement bridge the bankability gap (Figure B2.1.1) 2. Powering up: How Malawi can rapidly increase electricity access 60 FIGURE B2.2.1  Various financing initiatives and options to support healthcare facility electrification in Malawi DFIs/IFIs Donors Concessional Guarantees/First capital loss capital Technical assistance grants Energy payments Donors PPP Fund/Platform TA facility Grants Repayment Loan on debt Energy Technical Pooled fund payments Energy service providers assistance TA provider Financial contribution PPA/SLA/F4S Energy Energy contract payments provision SaH facilities and other end users? MoH (households, SMEs) Source: UNDP 2019. Notes: DFIs — development finance institutions; F4S — finance for sustainability; IFIs — international financial institutions; MoH — Ministry of Health; PPA — power purchase agreement; PPP — public–private partnership; S4H — Solar for Health; SLA — solar license agreement; SMEs — small and medium enterprises; TA — technical assistance. a. UNDP’s “Solar for Health (S4H) Innovative Financing Feasibility Study”, Country Report for Malawi, July8, 2019 b. “Energizing health: accelerating electricity access in health-care facilities”, the World Health Organization, the World Bank, the International Renewable Energy Agency, and Sustainable Energy for All, January 2023 2. Powering up: How Malawi can rapidly increase electricity access 61 TABLE 2.1  Macroeconomic indicators 2019 2020 2021 2022e 2023p 2024p National Accounts and Prices GDP at constant market prices (% change) 5.4 0.8 2.8 0.9 1.4 2.4 Agriculture 5.9 3.4 5.2 -1.0 0.5 2.4 Industry 7.7 1.2 1.9 0.9 1.3 2.4 Services 5.5 -0.5 2.0 1.8 1.8 2.5 Consumer prices (annual average) 9.4 8.6 9.3 21.8 25.7 20.8 Central Government (FY % of GDP) Revenue and grants 14.7 14.6 14.3 14.1 15.9 16.0 Domestic revenue (tax and non-tax) 13.2 13.1 12.8 13.0 12.6 14.1 Grants 1.4 1.5 1.5 1.1 3.2 2.0 Expenditure and net lending 19.1 20.9 21.4 22.5 26.8 23.8 Overall balance (excluding grants) -5.9 -7.8 -8.6 -9.5 -10.9 -9.7 Overall balance (including grants) -4.5 -6.3 -7.1 -8.4 -7.7 -7.7 Foreign financing 0.8 0.8 1.0 0.9 1.9 0.8 Domestic financing 3.8 4.9 5.9 7.7 5.3 6.9 Money and Credit Money and quasi-money (% change) 10.2 16.7 30.0 38.5 25.0 20.2 Credit to the private sector (% change) 27.3 16.1 17.8 23.2 14.7 10.9 External Sector (US$ millions) Exports (goods and services) 1238 1202 1266 1216 1417 1487 Imports (goods and services) 3031 3088 3250 2707 2941 3077 Gross official reserves 815 566 429 110 379 513 (months of imports) 3.9 2.1 1.6 0.4 1.5 1.9 Current account (percent of GDP) -11.6 -13.8 -14.3 -3.2 -11.3 -11.3 Exchange rate (MWK per US$ average) 745.5 749.5 805.9 949.0 ­— — Debt Stock External debt (public sector, % of GDP) 27.8 32.9 31.5 34.7 37.6 36.0 Domestic public debt (percentage of GDP) 17.5 21.9 30.0 40.8 42.9 44.3 Total public debt (percentage of GDP) 45.3 54.8 61.5 75.5 80.5 80.3 Poverty Poverty rate (US$1.90 in 2017 PPP terms) 73.5 74.3 74.3 74.4 74 73.4 Poverty rate (US$3.20 in 2017 PPP terms) 90.4 90.7 90.7 90.8 90.5 90.3 Poverty rate (US$5.50 in 2017 PPP terms) 97.1 97.2 97.2 97.2 97.1 97.1 Sources: World Bank staff calculations based on MFMod, MoFEA, RBM and IMF data. 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