Malawi Public Expenditure Review 2019: Putting Fiscal Policy on a Sustainable Path July 2019 Macroeconomics, Trade & Investment (MTI) Malawi Acknowledgements This Public Expenditure Review (PER) module was prepared by a team comprising Patrick Hettinger (TTL, Senior Economist), Priscilla Kandoole (Country Economist), Bill Battaile (Lead Economist), Moritz Piatti (Senior Economist), Juan Pradelli (consultant), Angela Zeleza (consultant), and Laston Manja (consultant). Trust Chimaliro (Financial Management Specialist), Saidu Goje (Senior Financial Management Specialist), Mike Roscitt (Public Sector Specialist), and Alex Girón Gordillo (consultant) provided additional contributions. The team gratefully acknowledges the overall guidance of Bella Bird (Country Director), Greg Toulmin (Country Manager), Abebe Adugna (Practice Manager MTI), and Yutaka Yoshino (Program Leader). The team also wishes to thank peer reviewers Shireen Mahdi (Senior Economist) and Sebastian Essl (Economist). Tinyade Kumsinda (Team Assistant) provided production support. Irfan Kortschak (consultant) provided editorial support. This report benefitted from fruitful discussions, comments, and information provided by representatives of the Ministry of Finance, Economic Planning and Development; the Department of Human Department of Human Resources Management and Development; the Reserve Bank of Malawi; and the Malawi Revenue Authority. The findings and interpretations expressed here are those of the authors and do not necessarily reflect the views of the World Bank Group, its Executive Directors, or the countries they represent. 1 Table of Contents Executive Summary............................................................................................................................ 3 Chapter 1: Macro-fiscal overview and analysis.................................................................................. 10 1) Introduction ................................................................................................................................... 10 2) Macro-fiscal Context ..................................................................................................................... 10 3) Revenues and Grants Analysis ...................................................................................................... 14 4) Trends and Composition of Public Spending ................................................................................ 17 a. Public Expenditure Trends, Composition, and Efficiency ............................................................ 17 b. Detailed Public Expenditure Composition, Trends, and Efficiency.............................................. 20 c. Wage Bill Analysis ......................................................................................................................... 23 d. Functional Composition of Public Expenditures .......................................................................... 27 e. Budget Execution .......................................................................................................................... 29 f. Fiscal deficits and financing .......................................................................................................... 31 g. Public financial management (PFM) and public investment management issues ..................... 32 5) Conclusions and Recommendations ............................................................................................. 33 Chapter 2: Debt, fiscal risks, and sustainability ................................................................................. 35 1) Introduction ................................................................................................................................... 35 2) Public Finances in Malawi: International Benchmarking and Drivers of Public Debt ................. 35 3) Recent Fiscal Developments ......................................................................................................... 37 4) Fiscal Risks ..................................................................................................................................... 39 5) Baseline, Shocks, and Stronger Reform Scenarios ....................................................................... 46 6) Conclusion and Recommendations .............................................................................................. 54 Annex 1: Historical External and Internal shocks ............................................................................... 57 Annex 2: SOE Financial Information .................................................................................................. 59 Annex 3: Risk Scenarios .................................................................................................................... 60 References ....................................................................................................................................... 66 2 Executive Summary Malawi’s economic growth has historically been undermined by exogenous, climate-induced shocks, as well as economic policies and management that have often exacerbated the impact of shocks. This instability has contributed to Malawi’s having one of the lowest investment rates in Sub-Saharan Africa and limited structural transformation, which have further reinforced the pattern of low growth. These factors have, in turn, constrained poverty reduction, with 51.5 percent of Malawi’s population living in ‘moderate poverty’1 in 2017, only marginally lower than 52.4 percent in FY2004/5. Yet since 2017, Malawi has been enjoying a period of economic stability, with double-digit inflation tamed, and a stable exchange rate for the first time since 2011. The current macroeconomic stability presents an opportunity for the Government to invest in strengthening institutions and fiscal policies to support increased investment, economic diversification, and the development of human capital. A critical component of this is a sustainable fiscal policy, which can plan for expected fiscal shocks. This is the first module of a programmatic Public Expenditure Review (PER). The programmatic PER is intended to support the Government of Malawi to analyze: 1) fiscal risks and sustainability; and 2) the efficiency and equity of public expenditure, particularly in human development sectors. This first module, “Putting Fiscal Policy on a Sustainable Path,” analyzes recent macro-fiscal trends, fiscal risks and sustainability, and the policies required to manage risks and maintain sustainability. Chapter 1: Macro-fiscal overview and analysis Malawi has experienced a challenging macro-fiscal landscape over the last decade. From 2011 to 2017, it experienced macro-economic instability, leading to a depreciating exchange rate and inflation often in excess of 20 percent. High and increasing fiscal deficits contributed to instability. The fiscal deficit increased from an average of 2.5 percent of GDP from FY2008 to FY2013, to 6.5 percent since FY2014, with the deficit being increasingly financed by high-cost domestic borrowing. The withdrawal of most on-budget donor funds in 2013 following the Cashgate scandal diminished grants and external financing. Total revenue and grants declined by about 2.7 percent of GDP, on average, since FY2014 compared to the period from 2008 to FY2013. The key contributing factor to this decline was the withdrawal of budget support and other on-budget donor grants, with grants falling from an average of 7.5 percent of GDP to 2.9 percent between the two periods. Although tax revenues have increased from about 14.8 percent of GDP to 16.8 percent, this increase has only partially offset the decline in the value of grants. With these combined factors, the 2.7 percent of GDP reduction in the resource envelope remains substantial. Despite the reduced funding envelope, total expenditure has increased since 2013, with an increase in recurrent expenditure and a decrease in development expenditure. Recurrent expenditure has increased from an average of 21.1 percent of GDP in the period from FY2008 to FY2013 to about 23.1 percent of GDP since FY2014, a level significantly higher than most of Malawi’s regional peers. Foreign- funded development expenditure has increased slightly between these two periods, from an average of 1 The Government of Malawi has two poverty measures – “moderate poverty” and “ultra-poverty.” Ultra-poverty is calculated with reference to a national poverty line measuring the consumption level needed to satisfy daily calorie requirements. Its value is approximatively US$0.82 in 2011 PPP. The moderate poor are those whose household expenditure per capita is below the total poverty line – a sum of the food and non-food poverty lines— of US$ 1.32 (2011 PPP). 3 3.6 percent of GDP to 4.6 percent. However, domestically funded development expenditure has declined considerably, from an average of 2.4 percent of GDP to 0.9 percent, significantly lower than most of Malawi’s regional peers – the next two lowest are Tanzania (3.9 percent of GDP) and Uganda at (4.4 percent of GDP). The increase in recurrent expenditure has been driven by a substantial increase in domestic interest expenses since 2013 and by a gradual increase in the wage bill. Domestic interest expenses have increased from an average of 1.9 percent of GDP in the period from FY2008 to FY2013, to 3.8 percent of GDP since 2014. Malawi’s average total interest expenditure of 4.1 percent of GDP since FY2014 has been the highest among selected regional peers’, only surpassed in 2018 by Mozambique and Zambia. This very high level of rigid expense decreases the scope for discretionary spending. The cost of employee compensation has gradually increased, from 4.4 percent of GDP in FY2008 to 6.8 percent of GDP in FY2018, with a budgeted level of 7.3 percent of GDP in FY2019. The increase largely reflects increasing numbers of civil servants, rather than average wage increases. This has reached higher levels than that of many peer countries as a share of GDP, which raises concerns if recent growth trends continue. Additionally, pension payments have more than doubled over the past decade, up to a budgeted level of 1.5 percent of GDP in FY2018/19, further reducing the scope for discretionary spending. Expenditure on both goods and services and subsidies and transfers has declined since 2013, although this expenditure remains volatile. In terms of goods and services expenditure, with the withdrawal of significant on-budget donor support since 2013, on-budget expenditure on health and education has declined considerably. Travel expenditure declined over the period, but has been budgeted to increase in FY2019 to the highest level in several years. Expenditure related to maize purchases, associated with the 2015/16 food crisis and with the 2018 ADMARC bailout, has been volatile and has increased. This has been offset by decreased subsidies for the Fertilizer Input Subsidy Program (FISP), which has declined following recent reforms. Arrears clearance has also weighed heavily on fiscal space in recent years, at an average cost of 1.3 percent of GDP since FY2012/13. Actual revenues and grants collections are regularly below budget forecasts . On average, since FY2012, actual revenues and grants have been lower than budget forecasts by 0.9 percent of GDP. Tax revenues have underperformed in three of the past four years, averaging 0.9 percent of GDP below budget for those years. Part of this is due to overly optimistic GDP growth projections, with actual growth being an average of 2.1 percent of GDP below projected growth. Project grants have also regularly under-performed since 2013. Paradoxically, since 2013, projections have been worse at mid-year (with actual revenues averaging 1.3 percent of GDP below revised budget forecasts) than for budget forecasts (with actual revenue averaging 0.9 percent of GDP below budget forecasts). Over-inflated budgets can contribute to expenditure overruns and arrears, while broadly undermining efficient project planning. Malawi’s high levels of recurrent expenditure crowd out room for development expenditure that is needed to increase growth. Moving forward, Malawi needs to re-balance expenditure to ensure sustainability and to increase the development impact of the budget. Maintaining fiscal discipline will be critical for this, with a strong political commitment to remaining within budget. Avoiding unbudgeted increases in expenditure lines is vital to reduce domestic borrowing and interest expenditure. To achieve this, the following additional measures should be considered:  The Government should prudently manage the wage bill and pensions. If recent growth in the expenditure on the wage bill and pensions continues, it could quickly undermine fiscal sustainability. To address this, the Government should improve the efficiency of allocations across and within sectors while containing the growth of the civil service and implementing appropriate inflation adjustments to salaries. 4  Coming off an election year, the Government should ensure that elevated lines of expenditure in FY2018 and FY2019 that resulted from election pressures revert to previous levels from FY2020. This would include expenditure on goods and services, including travel, security, and election-related subsidies and transfers. Together, recent increases on these lines have reached the combined value of more than 1 percent of GDP.  Malawi should make further efforts to improve GDP and revenue forecasting, including at mid- year. Forecasting of both tax revenues and grants needs to improve, especially for mid-year forecasts. Project grants, in particular, are consistently below forecasts. Improved forecasting would improve planning and avoid disruptive funding cuts to budget lines and projects.  The Government should address PFM issues to improve the efficiency of expenditure, to reduce fiscal shocks, and to improve confidence in government systems . Effective commitment controls will be needed to avoid the accumulation of arrears, which have weighed heavily on fiscal space in recent years, with an average cost of 1.3 percent of GDP. This would include a new IFMIS that includes multi-year commitments and by reducing transactions outside of IFMIS. Additionally, it will also be critical to improve procurement processes by increasing the transparency of and competition for Government contracts, which would also result in improved value for money. Stronger PFM systems would further support donor confidence, which could help to increase budget support.  Improving public investment management would further ensure increased efficiency of limited investment funding. Feasibility and cost-benefit analysis should be carried out for all major projects, which could then inform better project prioritization. Additionally, improving project appraisal and maintenance estimates will support improved efficiency of investment expenditure.  The Government should further improve debt management to reduce interest expenditure. Given the high cost of debt service, the Government should strengthen debt management with a careful consideration of interest cost implications of borrowing strategies. Moreover, it should also address the consistent under-estimation of debt service projections.  Revenue mobilization is relatively strong, but further efficiency enhancements could improve collections and support growth. Addressing substantial revenue arrears is one aspect of this, estimated at around 12 percent of the total collected revenue as of June 2018, as well as substantial outstanding taxes from public corporations. Moreover, further efforts to rationalize a high number of incentives, while rebalancing the tax mix and expanding the revenue base, could support growth and investment.  In addition, Malawi needs to continue sectoral reforms, particularly in education, health, and agriculture, to improve the efficiency and equity of expenditure. These reforms are necessary to effectively deliver services and to strengthen human capital within a limited budget envelope. Specific sector issues related to education, health, and social protection will be analyzed deeper in the next module of the PER. Chapter 2: Debt, Fiscal Risks, and Sustainability Public debt has increased rapidly in recent years, driven by persistent budget deficits and macroeconomic shocks. From 2007 to 2018, the stock of public debt increased from 28 to 61 percent of GDP, thus largely wiping out the debt reduction from debt-relief initiatives in 2006. The large increase in the debt-to-GDP ratio was mainly a consequence of large fiscal imbalances (including arrears), and real exchange rate instability, which more than offset the positive effects on debt dynamics of economic growth and low real interest rates on foreign loans. 5 This chapter analyzes fiscal and debt sustainability over the medium term under a baseline scenario, shocks scenarios, and a strong reform scenario. Simulations enable policy-makers to anticipate the impact of fiscal risks and to assess reform priorities. The baseline scenario represents a likely path of key macro and fiscal variables that determine the future path of public debt. The shocks scenarios represent risks to the baseline and are based on actual events which occurred in Malawi’s recent past. They are intended to help develop a sustainable fiscal policy to plan for these known risks. A stronger reform scenario considers how additional reforms to strengthen fiscal consolidation would better enable Malawi to manage fiscal shocks and maintain fiscal sustainability. A baseline scenario The baseline scenario assumes current fiscal policies continue over the medium term, which results in a debt to GDP ratio of around 60 percent. Specific assumptions include GDP growth gradually picking up from 4.5 percent in FY2019 to 6.0 percent by FY2025, with no significant shocks. Revenues and expenditures would continue roughly around historical averages (since 2014), excluding the recent arrears clearance. Under the baseline, fiscal imbalances and high levels of public debt would persist over the medium-term. Overall budget deficits are expected to narrow to around 4.4 percent of GDP from FY2019 onwards, down from the 6.2 percent of GDP observed from FY2015-FY2018. The primary deficit would narrow to 0.5 percent of GDP, down from 2.1 percent from FY2015-FY2018. Under these assumptions, public debt would remain around 60 percent of GDP throughout the medium term, therefore not improving debt sustainability. A shocks scenario There are substantial fiscal risks to the baseline that have detrimental effects on debt sustainability. Malawi faces several fiscal risks: weather shocks and natural disasters; contingent liabilities and financial assistance to SOEs; unrealistic budget forecasts concerning GDP growth and revenues (especially grants); and expenditure overruns (especially in election years) and other risks related to public financial management weaknesses which have contributed to arrears in recent years. Additional uncertainties could result from limited political commitment to fiscal consolidation, and difficulties in securing new financing, either from domestic or external sources. Model simulations under shock scenarios show the detailed impact on debt sustainability. The fiscal sustainability analysis considers the impact of these shocks on public finances (see figures ES.1 and ES.2): 1) Natural disaster. If a natural disaster similar to the latest flooding and drought were to occur in FY2020-FY2021—thereby reducing GDP growth by 3 p.p. of GDP, while Government expenditure picks up to US$50 million per year over two years to support relief and reconstruction—public debt could reach 72 percent of GDP by FY2021. 2) Contingent liabilities. If contingent liabilities and financial assistance to SOEs similar to the FY2017/18 bailout of the Agricultural Development and Marketing Corporation (ADMARC) were required over two years, both in FY2020 and again in FY2021, public debt could reach 63 percent of GDP in FY2021. 3) Low growth. In a lower-than-expected growth scenario, where growth falls 1.8 p.p. of GDP below baseline from FY2020 to FY2025 (similar to the average forecast error in budgeted GDP growth since 2012, and nominal expenditure does not change (reflecting expenditure rigidities), the primary deficits gradually increase from 0.7 percent in FY2020 to 1.8 percent of GDP in FY2025, leading to a surge in public debt to about 70 percent of GDP by FY2025. 6 4) Higher borrowing costs. If the cost of domestic borrowing increased from the recently observed 15 percent to 20 percent, the fiscal deficit is expected to steadily widen throughout the medium term, and public debt would embark on an ever-increasing path. 5) Multiple shock. Adverse shocks feed off each other and are highly likely to be correlated. As such, it is unlikely that any of the shocks above would be the only shock that Malawi experiences by 2025. A “multiple shock” scenario where the above shocks materialize jointly will cause overall deficits to increase to 7.1 percent of GDP by FY2025, setting the public debt on an explosive path of 80 percent of GDP by FY2025. This would clearly represent an unsustainable fiscal situation. Figure ES.1: Fiscal Deficit, All Risk Scenarios Figure ES.2: Public Debt, All Risk Scenarios (% of GDP) (% of GDP) 9 85 Baseline WBG Projections WBG Projections Natural Disaster 8 Contingent Liability 80 Lower Growth 7 Higher Domestic Borrowing Costs 75 Multiple Shocks 6 70 5 4 65 Baseline 3 Natural Disaster 60 Contingent Liability 2 Lower Growth Higher Domestic Borrowing Costs 55 1 Multiple Shocks 0 50 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Source: World Bank Staff calculations based MOF data and Source: World Bank Staff calculations based MOF data and WB WB projections projections A strong reform scenario Lastly, the model was used to consider a stronger reform scenario relative to the baseline. The shock scenarios demonstrate how critical it is for Malawi to plan for potential risks and build fiscal buffers over time, and how continuing current policies (as in the baseline scenario) would not be sufficient to maintain fiscal sustainability. A stronger reform scenario considers one where the Government undertakes an ambitious fiscal consolidation effort to increase the primary surplus to 0.5 percent of GDP from FY2020 from a projected primary deficit of 2 percent in FY2019. Such an effort (in the absence of shocks) would reduce public debt to 53 percent of GDP by FY2025, from 59 percent of GDP under the baseline scenario, significantly improving Malawi’s prospective fiscal and debt performance (see Figures ES.3 and ES.4). 7 Figure ES.3: Fiscal Deficit in Selected Scenarios Figure ES.4: Public Debt in Selected Scenarios w/ w/ and w/o Primary Balance Target (PBT) and w/o PBT Percent of GDP Percent of GDP 9 85 Baseline WBG Projections WBG Projections 8 Lower Growth 80 Multiple Shocks 7 Baseline with PBT 75 Lower Growth with PBT 6 Multiple Shocks with PBT 5 70 4 65 Baseline 3 Lower Growth 60 2 Multiple Shocks Baseline with PBT 55 1 Lower Growth with PBT Multiple Shocks with PBT 0 50 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Source: World Bank Staff calculations based MOF data and Source: World Bank Staff calculations based MOF data and WB projections WB projections While fiscal consolidation required under this scenario is large, it is not impossible to achieve. The strong reform scenario entails a move from a primary deficit of 2.0 percent of GDP in FY2018/19 to a primary surplus of 0.5 percent of GDP in FY2020—an adjustment of 2.5 percent of GDP. While this is difficult, there are various potential expenditure measure the Government can consider. These include measures to reduce election-related goods and services expenditure and transfers after FY2019, which could free up more than 1 percent of GDP. Additional efforts to contain the wage bill and pensions at FY2017 levels (in proportion to GDP) could reduce spending from about 8.8 percent of GDP in FY2019 to 7.4 percent, generating additional savings of 1.4 percent of GDP. Last but not least, ensuring effective commitment controls and strengthening the transparency of procurement could further enhance the efficiency of public expenditure and thereby help generate additional savings. The various scenario analyses above underscore that Malawi needs to implement a comprehensive strategy to manage fiscal risks and ensure fiscal/debt sustainability over the medium term. Several measures are central to such a strategy:  The Government must enforce stronger fiscal discipline. Maintaining current policies alone is unlikely to sustainably reduce debt over the medium term, even if growth gradually increases. This means that stronger reform is needed, which will allow Malawi to build fiscal buffers in good times and draw down in bad times (such as when weather shocks and disasters hit). Targeting a 0.5 percent of GDP primary surplus could provide a fiscal anchor.  The Government should continue developing a framework for effective fiscal risk management. This process began in FY2017/18 and is ongoing. The MoFEPD should continue to actively identify, analyze, and monitor the sources, potential magnitude, and probability of fiscal risks in a fiscal risk statement which should be incorporated into planning and budgeting documents. It should further identify measures to mitigate and manage fiscal risks.  The Government should actively seek to reduce vulnerability to contingent liabilities. Strengthening oversight and financial transparency of SOEs is a critical part of ensuring fiscal sustainability in Malawi, given the substantial value of financial resources under the control of SOEs. 8 The government must enforce financial reporting requirements, require regular and timely audits, and expand the published financial information on SOEs and any associated fiscal risks. Additionally, it should be transparent regarding the creation of potential contingent liabilities, including by establishing appropriate policies for granting guarantees to SOEs, to avoid excessive risk-taking and moral hazard behavior. Moreover, increased transparency and appropriate policies for evaluating and approving public-private partnerships (PPPs) is needed, as the Government is likely to increasingly resort to PPPs to support the development of much-needed infrastructure.  Investing more in addressing weather shocks and promoting resilience will reduce vulnerability to shocks. Over the medium term, direct interventions to improve resilience are critical to reducing shocks to the economy and therefore maintaining fiscal sustainability. Such interventions would include investing in agriculture and irrigation, strengthening flood and drought forecasting, building more effective early warning systems, as well as scaling up social safety nets. Additional steps such as investments in energy and transport, and improvements in the business environment could encourage private investment, making the economy resilient to shocks and helping to diversify fiscal revenues. 9 Chapter 1: Macro-fiscal overview and analysis 1) Introduction 1. This chapter analyzes Malawi’s recent macro-fiscal performance. It begins with an overview of the macro-economic context over the past decade. The chapter then discusses trends in the Government’s revenue, with an analysis of trends for domestic revenues and grants, where governance weaknesses in 2013 led to a substantial reduction of donor grant support. Next it proceeds with an analysis of public expenditure trends, composition, and efficiency. Despite the decrease in revenues, there has been an increase in total spending, driven by recurrent expenditure. This includes a detailed analysis of the wage bill, as well as other drivers of recurrent expenditure. It then concludes with key recommendations. Chapter 2 presents a discussion of debt developments, followed by analysis of the fiscal risks Malawi faces, and how policy-makers can develop a sustainable fiscal policy path that incorporates these risks. 2) Macro-fiscal Context 2. Malawi’s history since independence is characterized by repeated episodes of macroeconomic instability. Growth has generally been low and volatile, with only two periods of high and relatively stable growth, in the periods from 1964-1979 and from 2003-2010 (see Figure 1.1). Its economy has remained heavily dependent on agriculture, with only limited diversification and largely agro-based manufacturing. External and internal shocks have often resulted in low growth. Over the past two decades, Malawi’s real GDP per capita growth rate has averaged 1.5 percent, significantly below the average of 3.1 percent for non-resource-rich Sub-Saharan Africa (SSA) economies. Malawi remains an outlier even compared to its peers that are geographically and demographically similar and that were at a similar stage of development in the mid-90s (see Figure 1.2). 3. Malawi experienced relatively strong growth from 2003 to 2010. The economy proved resilient during this period, even in the context of the 2005 drought that put more than 5 million people at risk of hunger and during the 2007-2008 global financial crisis. Malawi experienced a change of government in 2004, which created a new impetus for the country’s growth and development agenda. For the first time since 1994, public expenditure remained within budget, and donors resumed budget support. Malawi also attained the Highly Indebted Poor Country – Multilateral Debt Relief Initiative (HIPC-MDRI) completion point in 2006, which created additional fiscal space. A combination of good weather during this period (apart from the 2005 drought) and the distribution of subsidized fertilizer resulted in improved yields for both the country’s main staple crop, maize, and its main cash crop, tobacco. The combined effect of reduced fiscal and monetary pressures resulted in lower inflation, which remained in single digits from 2007 to 2011. With these developments, in 2008, Malawi’s GDP per capita returned to the level of 1979, for the first time in almost 30 years, 10 Figure 1.1: Real GDP growth has been volatile Figure 1.2: Malawi’s real GDP per capita has fallen and very low in per capita terms behind peers RGDP growth and RGDP per capita, percent GDP per capita, real USD 2010 terms 15 1200 Malawi Ethiopia Mozambique Rwanda 10 1000 Tanzania Uganda 800 5 600 0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 400 -5 Real GDP growth 200 Real GDP growth per capita 0 -10 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Source: World Bank Global Economic Prospects data Source: World Bank World Development Indicators (WDI) 4. The period of high growth was short-lived and from 2011 the economy experienced declining growth trends due to macroeconomic instability, fiscal indiscipline and climatic shocks. Real GDP growth declined to 3.4 percent from 2011 to 2012, down from an average of 6.4 percent from 2006 to 2010. In June 2011, external budget support was withdrawn when the International Monetary Fund (IMF) program went off-track due to serious policy imbalances. Consequently, Malawi struggled with a severe foreign exchange and fuel shortage that contributed to a marked deceleration in economic activity. Fiscal over- expenditure led to the budget deficit widening from 2.9 percent of GDP in FY2011 to 6.9 percent in FY2012. 5. To avert a crisis, the Government implemented a number of critical reforms mid-2012, with these reforms facilitating a recovery in growth. After the death of the incumbent President in 2012, a new administration implemented a number of key reforms, including a 50 percent devaluation of the Malawi Kwacha (MWK), followed by the adoption of a floating exchange rate regime; the liberalization of foreign exchange markets; and the introduction of an automatic fuel price adjustment mechanism. In the short term, this led to a deceleration in growth from 4.9 percent in 2011 to 1.9 percent in 2012, with an increase in inflation by almost 35 percent by the end of 2012. However, growth accelerated in 2013, reaching 5.2 percent. While the floating of the Kwacha in 2012 supported a gradual accumulation of foreign exchange reserves, it introduced uncertainty surrounding the cost of imports into the budgeting process. The liberalization also facilitated the resumption of budget support from the IMF and other donors. The revelation of the large-scale theft of public funds in 2013, in what became known as the “Cashgate scandal,” led to the withdrawal of budget support by development partners to an estimated value of 4.5 percent of GDP, with an increasing share of ODA being channeled off-budget. 6. While the exchange rate has stabilized and inflation rates have declined since 2017, adverse weather conditions and fiscal indiscipline have continued to derail growth. In particular, floods and droughts in early 2015, followed by another major drought in 2016, had a severely negative impact on agricultural production, energy generation and poverty reduction. With the impact of the weather shocks that ravaged the economy for two consecutive years subsiding, the recovery of the agriculture sector led to a rebound in Malawi’s overall economic growth rate, which went up from 2.5 percent in 2016 to 4.0 percent in 2017. Stronger monetary policies and the buildup of foreign exchange reserves have resulted in a stable exchange rate since 2017, and inflation has declined to single digits. sicn. In addition, since 11 2018, the Reserve Bank of Malawi (RBM) stopped financing Government deficits, thereby supporting macro-economic stability. However, in 2018, dry spells and a fall armyworm infestation resulted in growth decelerating to 3.5 percent. Growth prospects for 2019 are positive, with the growth forecast to reach 4.5 percent, despite the impact of Cyclone Idai. 7. The main proximate reason for Malawi’s low growth rates is the low level of investment, which is amongst the lowest in SSA (see Figure 1.3). The main factor behind low investment has been the high level of macroeconomic instability resulting from the Government’s inability to manage shocks, including a number of policy-induced shocks. This has led to high inflation, which contributed to some of the highest interest rates in the region. Figure 1.3: Malawi’s investment has been amongst the lowest in Sub-Saharan Africa Total Investment, Malawi and Select Countries, 1980–2018, Percent of GDP 100 Malawi Kenya Mozambique Rwanda 80 South Africa Tanzania Uganda Zambia 60 40 20 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Source: IMF, World Economic Outlook, October 2018 8. Malawi’s volatile growth patterns have meant that it has made only limited progress on human development and poverty outcomes. Over the past two decades, Malawi has made significant progress on indicators of maternal and child mortality, as well as primary school enrollment rates. This progress can be largely attributed to donor interventions and the free primary school initiative. However, significant limitations remain on public services coverage, and on access to and quality of services. With Malawi’s very high population growth rate, health and education services have not been able to increase the very low ratios of medical workers and teachers to population, with personal emoluments dominating the budget and squeezing out other recurrent and development funding items. 9. The most recent national poverty estimates show that Malawi’s ultra-poverty rate has declined significantly over recent years. Specifically, in the period from 2010 to 2016, the ultra-poverty rate declined by more than 4 percentage points, going down from 24.5 percent to 20.1 percent. Most of the decrease in ultra-poverty occurred in rural areas, with the decline largely attributable to effective social protection programs and the post-2016 food security response. 10. However, moderate poverty rates remain over 50 percent, with this rate actually increasing slightly in rural areas in recent years. Recurrent natural shocks and bouts of macroeconomic instability have constrained both higher levels of economic growth and poverty reduction. At the national level, the moderate poverty rate declined from 52.4 percent to 50.7 percent over the period from 2004 to 2010, before increasing slightly to 51.5 percent in 2016. In rural areas, the moderate poverty rate has been steadily increasing since 2004, reaching 59.5 percent in 2016. 12 11. External and climate related shocks have contributed to poor growth outcomes. As a small, open economy with an undiversified production and export base and a heavy dependence on aid, Malawi is vulnerable to weather shocks such as droughts and floods, terms-of-trade shocks such as oil and fertilizer price increases and tobacco price declines, and sudden and sharp declines in capital inflows, including external aid. In recent years, Malawi has suffered from weather shocks with increasing frequency, facing five droughts since 1990 that affected more than 20 percent of the population. Weather shocks are invariably accompanied by declines in agricultural output and slowdowns in economic activity linked to agriculture. This in turn leads to declines in government revenue which, accompanied by increased expenditure on relief to the weather-affected poor, have in the past often de-stabilized government budgets. The most common response has been to delay adjustment while awaiting external aid. Figure 1.4: Expenditure has regularly exceeded Figure 1.5: Fiscal deficits have been increasing total revenues and grants and regularly overshoot budget Percent Percent of GDP 35 1 Outturn Budget 0 30 -1 25 -2 -3 20 -4 -5 15 Total revenue & grants -6 10 -7 Total expenditure -8 5 -9 -10 0 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2007/8 2008/9 Source: World Bank staff estimates based on Ministry of Source: World Bank staff based on MoFEPD data Finance, Economic Planning & Development (MoFEPD) data 12. Ongoing vulnerability to adverse weather and policy-induced shocks have led to a deteriorating fiscal performance (see Figures 1.4 and 1.5). Weather shocks generally lead to a decline in agricultural output and an accompanying slow-down in economic activity. In turn, this leads to a decline in Government revenue which, accompanied by increased expenditure on relief to the weather affected poor, often destabilizes Government budgets. While weather shocks are a major factor in explaining Malawi’s macroeconomic instability, poor economic policies have played a critically important role, with the Government maintaining higher expenditure levels despite lower revenues. 13. With financing shortfalls, the Government continues to meet the gap through concessional foreign financing and, increasingly, high-cost domestic borrowing. Not surprisingly, Malawi’s public debt has risen sharply and is now approaching pre-HIPC levels, with debt service costs increasing in proportion to total expenditure. The total value of external debt is estimated to stand at about 31.2 percent of GDP in 2018, while gross domestic debt is estimated at 26.1 percent (see figure 1.34). Most external debt is contracted on highly concessional terms, with the cost of servicing this debt relatively low. Instead, increased debt service costs are due to the increasing level of domestic debt, which has been contracted at relatively high interest rates. 13 Table 1.1: Key Macroeconomic Indicators 2015 - 2018 2015 2016 2017 2018 2019 Proj. GDP growth (percent) 2.8 2.5 4.0 3.5 4.5 Consumer price inflation (annual average) 21.9 21.7 11.5 9.2 8.9 Overall fiscal balance (percent of GDP) -5.7 -6.1 -4.8 -7.8 -5.8 Primary fiscal balance (percent of GDP) -2.4 -1.9 -0.3 -3.8 -2.0 Gross official reserves (US$ million) 670 605 757 790 699 Months of import cover 3.4 2.9 3.2 3.3 3.0 Current account (percent of GDP) -9.2 -14.7 -11.3 -10.9 -10.0 Exchange rate (MWK per US$ average) 499.6 718.0 730.3 732.3 - External debt (public sector, percent of GDP) 33.5 32.0 33.2 31.2 31.4 Domestic public debt (percent of GDP) 20.9 23.6 24.5 26.1 24.8 Total public debt (percent of GDP) 54.4 55.6 57.7 57.3 56.2 International Poverty rate (US$ 1.9 in 2011 PPP terms) 69.4 69.6 69.4 69.1 68.8 Source: World Bank staff calculations based on MFMod, MoFEPD, RBM and IMF data 3) Revenues and Grants Analysis 14. Total revenue and grants have declined considerably since 2013. In the period from FY2008 to FY2013, the average total value of revenue and grants stood at around 24.6 percent of GDP. Since FY2014, this has fallen to 21.9 percent (see Figure 1.6). The key driver for this decline has been the withdrawal of budget support, with grants falling from an average of 7.5 percent of GDP to 2.9 percent between the two periods. While tax revenues have increased from an average of 14.8 percent of GDP to about 16.8 percent, this increase has only partially offset the decline in grants. Fig. 1.6: Revenue and Grants Fig. 1.7: Comparative Tax to GDP ratios, 2007 to Percent of GDP 2017* Tax revenue (Net) Non-Tax Revenue Percent of GDP 30 Grants 25.0 25 2007 2017e 20.0 20 15.0 15 10.0 10 5.0 5 0.0 0 Source: World Bank staff based on MoFEPD data Source: World Bank staff estimates based on IMF and MoFEPD data 14 15. Compared to neighboring countries and relative to its tax potential, Malawi’s tax revenue in proportion to GDP is relatively strong. Tax revenues have gradually risen over the past ten years, reflecting both improvements in domestic resource mobilization and the implementation of tax reforms, including the modernization of tax systems and administration. Relative to neighboring peers, over the past decade, Malawi’s tax-to-revenue ratio has been exceeded only by Mozambique, which has recorded substantial growth over the past decade (see Figure 1.7). Fig. 1.8: Composition of taxes, FY2008 to FY2018 Percent of GDP 25 Individual Corporate Withholding Tax VAT Excise Duties Taxes on Int'l trade Non-Tax Revenue 20 15 10 5 0 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 Source: World Bank staff based on MoFEPD data 16. Over the past decade, Malawi’s improved tax revenue collection performance has been largely attributable to the increased collection of personal income tax (see Figure 1.8). Revenue from this source has increased from about 3.0 percent of GDP in FY2008 to an average of 5.3 percent over the past three years. One factor explaining this has been the expansion of Malawi’s civil service. Withholding tax performance has also improved, with average collections increasing from 0.8 percent of GDP in the period from FY2008 to FY2010, to about 1.5 percent of GDP since then. Since FY2008, value added tax (VAT) has been the single largest contributor to tax revenues, averaging at close to 5.0 percent of GDP over the period. In the past two years, this has increased slightly to about 5.6 percent of GDP, following the expansion of VAT coverage and the elimination of a number of exemptions. The collection of excise duties, on the other hand, has declined somewhat over the past decade, declining from an average of 2.2 percent of GDP in the period from FY2008 to FY2011 to about 1.6 percent of GDP since FY2012. This is largely attributable to a decline in import excise duties. 17. Malawi has made some significant progress to both tax policy and tax administration over the past decade, which has contributed to the increase in tax collections. Improved tax registration and assessment procedures have supported the increase in revenues. However, there is clear room for further improvement, particularly in the area of addressing revenue arrears. As of June 2018, the value of these arrears stood at MWK 114 billion, representing 12 percent of the total value of collected revenue, with most of these arrears outstanding for more than a year (PEFA 2018). Additionally, as noted in the PEFA report, the value of outstanding taxes from public corporations is substantial. Moreover, the cost of doing business is high—tax burden and compliance costs are high for the region, while there are a high number of largely non-transparent and inconsistent incentives that could be rationalized (Kandoole and Le, 2016). Rather than focusing exclusively on increasing revenues, further tax reforms should strive to enhance 15 efficiency and to rebalance the tax mix. The authorities are aware of their high level of dependence on income taxes and are placing increased emphasis on reforms to reduce the growth-retarding taxation of factors of production and shifting toward consumption taxation. 18. In recent years, the substantial decline of on-budget donor funding has constrained the Government’s resource envelope (see Figure 1.9). Prior to the 2013 Cashgate scandal, the Government benefitted from strong on-budget donor support, which took the form of budget support, dedicated grants (for health, the National Aids Commission, agriculture, and education), and project grants. The combined value of this support often reached from 8 to 10 percent of GDP, with the most recent spike in FY2013, following the substantial reforms implemented at the start of Joyce Banda’s administration. However, since 2013, the value of on-budget grants has fallen to about 2.9 percent of GDP. Budget support has never exceeded 0.5 percent of GDP in any given year, while dedicated grants have fallen by more than half, to an average of about 1.2 percent of GDP. Project funding has also declined somewhat, to about 1.5 percent of GDP. Nonetheless, over this period, the total value of the development assistance received by Malawi has increased overall, reaching to close to 24 percent of Gross National Income (GNI) in 2016 and 2017, largely due to the high volumes of humanitarian funding to address the impacts of the floods and droughts (see Figure 1.10). In proportion to GNI, since 2014, Malawi has ranked as the sixth highest recipient of development assistance in the world. This indicates that there has been a substantial shift from on-budget development assistance to off-budget assistance. 2 Fig. 1.9: On-budget grant performance has Fig. 1.10: Overall development assistance has declined increased Pct GDP Net ODA received, percent of GNI Project 30.0 Dedicated grants 12.0 Program/Budget Support 25.0 10.0 20.0 8.0 6.0 15.0 4.0 10.0 2.0 5.0 - 0.0 Source: World Bank staff based on MoFEPD data Source: WDI 19. Actual revenues and grants collections are regularly below budget forecasts (see Figure 1.11). On average, since FY2012, the actual value of revenues and grants has been lower than forecast by 0.9 percent of GDP each year. Tax revenues have underperformed in three of the past four years, averaging 0.9 percent of GDP below budget for those years. Part of this is due to overly optimistic GDP growth projections, with actual growth being on average 2.1 percent of GDP below projected growth. The GDP growth rate was significantly below the budget forecast in FY2016, largely due to the impact of the floods and drought. In this case, additional donor funding helped to fill the gap from reduced tax revenues. 2 On-budget ODA is currently defined as that which is channeled through Government’s own accounting systems, where activities are implemented by Government and where expenditure is approved by Parliament in the annual presentation of financial statements. In contrast ODA which is “off budget” is disbursed and implemented outside of Government systems, such as via non-governmental organizations. 16 Project grants have also regularly under-performed since Cashgate, with programmed budget support failing to materialize in FY2018. Fig. 1.11: Revenue & Grant Performance Deviation from approved budget, percent GDP Tax revenue (Net) Non-Tax Revenue Program Dedicated grants Project grants Total revenue and grants 6 GDP growth chg 4 2 0 -2 -4 -6 -8 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 Source: World Bank staff based on MoFEPD data 20. Tax revenues overperformed significantly in FY2013 and FY2014. To some extent, this can be understood in the context of the budget preparation process for FY2013, when the inflation rate was projected at around 17 percent for the next two years, which would have been integrated into tax projections. However, inflation ended up averaging around 32 percent in the fiscal year (Annual Economic Review, AER, 2012). Similarly, when the budget was prepared for FY2014, average inflation was expected to fall from 25.3 percent in 2013 to 7.4 percent in 2014. However, inflation in 2014 remained in excess of 20 percent, while GDP growth also performed better than expected (AER 2013). Moreover, a surge in VAT and excise taxes in FY2014 (one percentage point of GDP higher than in the previous year) was supported by stronger growth and higher import prices. Otherwise, the impact of Cashgate was clear in FY2014, with donor funds being pulled off-budget, leading to a substantial decline in the value of grants. 21. Since the Cashgate scandal, total revenue and grant forecasts have been consistently worse in revised budgets (which are carried out halfway through fiscal year) than in the approved budgets. Over this period, the total actual value of revenue and grants has been, on average, 0.9 percent of GDP below the level forecast in the approved budget, but 1.3 percent below revised budget forecasts. This suggests a strong need to improve regular revenue monitoring and forecasting capacity. 4) Trends and Composition of Public Spending a. Public Expenditure Trends, Composition, and Efficiency 22. Malawi’s total government expenditure has remained broadly stable and relatively high compared to peer countries over the past decade (see Figure 1.12). Malawi’s total government expenditure has fluctuated between 25 and 31 percent of GDP over this period. While the average ratio has stood at 27.1 percent in non-election years, in election years, this increases to an average of 30.1 percent. Despite the withdrawal of budget support following Cashgate in 2013, total expenditure levels have actually increased since then. Malawi’s total government expenditure in proportion to GDP in recent 17 years is above all peer neighbor countries except Mozambique (see Figure 1.13). Malawi’s recurrent expenditure is relatively high, which has led to relatively low levels of development expenditure which is amongst the lowest in the region (see Figures 1.14 and 1.15). While to some extent this reflects a transition after the withdrawal of budget support, which decreased the fiscal space for development expenditure, overall expenditure has increased, with the increase in recurrent expenditure more than offsetting the decrease in development expenditure. Figure 1.12: Malawi total government Figure 1.13: Government total expenditure is expenditure high in in Malawi Percent GDP, election years shaded Percent GDP, period averages Recurrent expenditure Foreign devex 35 2007/08-13/14 Domestic devex 35 30 2014/15-17/18 30 25 25 20 20 15 15 10 10 5 5 0 0 Source: WB staff estimates based on MoFEPD data Source: IMF WEO, Malawi Ministry of Finance *FY2018/19 figures are revised budget 23. Thus, while recurrent expenditure has increased, development expenditure has declined, particularly domestically-funded development expenditure. On average, Malawi’s recurrent expenditure was 21.1 percent of GDP in the period from FY2008 to FY2013, increasing to 23.1 percent since FY2014. Foreign funded development expenditure increased slightly over these periods, from 3.6 percent of GDP to 4.6 percent. However, domestically funded development expenditure declined considerably between the two periods, from 2.4 to 0.9 percent of GDP, reducing the development impact of the budget. Total development expenditure is the lowest amongst peers, averaging only 5.1 percent of GDP since FY2014 – the next lowest is Zambia at 5.5 percent of GDP, followed by Tanzania at 5.9 percent of GDP. The difference is even more stark considering domestically financed development expenditure. This averaged only 0.9 percent of GDP since FY2014 in Malawi. The next lowest in the region was Tanzania, at 3.9 percent of GDP, and Uganda at 4.4 percent of GDP. 18 Figure 1.14: Malawi’s recurrent expenditure is Figure 1.15: …contributing to very low development very high amongst peers… expenditure Percent GDP, average 2014-18 Percent GDP, average 2014-18 25 14 12 20 10 15 8 10 6 4 5 2 0 0 Source: WB staff estimates based on MoFEPD data Source: WB staff estimates based on IMF WEO, MoFEPD data * Mozambique and Rwanda data is capital expenditure Figure 1.16: Expenditure by economic classification, FY2008 – FY2019 (rev) Pct GDP, election years shaded Employee comp. Interest Goods & services Subsidies & trans. Arrears Exp. Foreign devex Domestic devex Recurrent expenditure 35 30 25 20 15 10 5 0 Source: WB staff estimates based on MoFEPD data * FY2018/19 data is revised budget 24. Expenditure patterns have transitioned over the past decade, especially since the 2013 Cashgate scandal, when substantial donor funding was pulled off-budget (see Figure 1.16). Most notably, substantially higher domestic interest costs and an increasing wage bill have more than offset the decline in expenditure on domestic development, goods and services, and subsidies. Additionally, expenditure on arrears clearance has also weighed on fiscal space. 25. Public expenditure on employee compensation has gradually increased, going up from 4.4 percent of GDP in FY2008 to 6.8 percent in FY2018, with a budgeted level of 7.3 percent in FY2019. The increase largely reflects increasing numbers of civil servants, particularly in the education sector (see wage bill section). This has reached higher levels than in many peer countries, which raises concerns if recent growth trends continue. Additionally, public sector pension contributions have also gradually increased, 19 going from about 0.7 of GDP to 1.5 percent in the period from FY2008 to FY2019, to a high figure for the region (see Figure 1.21). Both of these expenditure lines are highly rigid, with this rigidity reducing the scope for discretionary expenditure. 26. Domestic development expenditure declined substantially in the period up to FY2018. However, in FY2018 and in the revised FY2019 budget, it has begun to accelerate. Moreover, while expenditure on goods and services expenditure has declined, it remains volatile. Expenditure on grants and subsidies have also declined, largely due to reforms to the Farm Input Subsidy Programme (FISP) and to decreased funding for the National Aids Commission. 27. Expenditure also increased significantly before and during election years, in FY2009 and FY2014. In these years, recurrent expenditure increased considerably, from an average of 21.4 percent of GDP in other years to 25.0 percent. The increases were largely attributable to increased expenditure on goods and services and on grants and subsidies. Domestically-funded development expenditure also declined somewhat in election years, from an average of 1.9 of GDP to 1.3 percent. In FY2019, however, although actual full-year expenditure data is not yet available, the revised mid-year budget anticipated total expenditure to be lower than previous years, partially due to the closing out of arrears in FY2018. Nonetheless, the FY2019 budget contains the highest level of expenditure on employee compensation, pension payments, and travel of any budget in recent years. At the same time, it also strives to sustain a higher level of domestic development expenditure. b. Detailed Public Expenditure Composition, Trends, and Efficiency 28. Expenditure on interest has increased significantly since FY2014, with Malawi spending considerably more than its peers (see Figure 1.17). Domestic interest expenses have increased considerably since FY2014, increasing from an average of 1.9 percent of GDP from FY2008 to FY2013 to 3.8 percent since FY2014. This increase is due to the Government’s increased domestic borrowing at high interest rates, particularly since the withdrawal of budget support following Cashgate, which has not been accompanied by a reduction in expenditure. Additionally, the securitization of arrears and the previous recapitalization of the RBM and one public sector bank has contributed to these pressures. While expenditure on foreign interest has also increased over this period, with external borrowing having increased after debt relief in 2006, this expenditure still amounts to only 0.3 percent of GDP. Therefore, since 2014, total interest payments have amounted to an average of 4.1 percent of GDP. This high level of rigid, non-discretionary expenditure limits the Government space for discretionary spending. Malawi’s expenditure on interest payments has been higher, on average, since 2014 than selected regional peers. The next highest are Zambia (3.4 percent), Kenya (3.2 percent), and Mozambique (2.7 percent). Malawi’s expenditure was higher than any of these countries since 2014 until 2018, when Mozambique and Zambia both surpassed Malawi. 20 Fig. 1.17: Total interest expenditure, Malawi and selected peer countries Percent GDP 6 Malawi Mozambique Rwanda Kenya Zambia Uganda 5 Tanzania 4 3 2 1 0 2014 2015 2016 2017 2018 Source: World Bank, Government authorities 29. While expenditure on goods and services has declined considerably since 2013, it remains volatile (see Figure 1.18). With Cashgate leading to the withdrawal of significant on-budget donor support, on-budget health and education expenditure has declined considerably, leading to a decrease in associated expenditure on goods and service. Moreover, while expenditure on “generic goods and services” has been on a declining trend, it remains volatile, with a jump in FY2018 and FY2019 related to election spending. Additionally, expenditure on maize purchases have increased since FY2014 due to the need to restock the Strategic Grain Reserves for maize distribution related to floods and droughts. In FY2018, this expenditure also included the ADMARC bailout for its earlier maize purchase. Figure 1.18: Composition of goods and services Figure 1.19: Travel expenditure expenditure, FY2008 – FY2019 revised Pct GDP Pct GDP Motor Vehicle Running Exp. 6 External Travel 2.0 Internal Travel 5 Subs. & ext. travel allowance 1.5 4 3 1.0 2 0.5 1 0.0 0 Generic Health Education Maize Other goods & Sector Sector purchases services Source: WB staff estimates based on MoFEPD data Source: WB staff estimates based on MoFEPD data 30. Travel expenses comprise a substantial share of expenditure on goods and services. On average, travel expenses have constituted 19 percent of total expenditure on goods and services since FY2014. Although this share has declined somewhat in recent years due to tighter expenditure controls, it is 21 budgeted to increase in FY2019 (see Figure 1.19). Expenditure on travel, including both internal and external travel and vehicle running expenses, has declined substantially, from about 4 to 5 percent of GDP in the period prior to 2010 (PER 2013). More recently, it has gradually declined from about 1.5 percent of GDP in FY2013 to about 0.9 percent of GDP in FY2017. The key reduction to this has been to internal travel. Despite this overall decline, expenditure on daily subsistence and foreign travel allowances has averaged about 0.5 percent of GDP over this period.3 Nonetheless this figure may be under-reported, as there are some anecdotal reports of reporting allowances under other codes in IFMIS. Allowances are widely sought as a supplement to low pay levels in the public service. However, they distort operational efficiency, as they can arbitrarily distort compensation levels for individual civil servants, while they also contribute to numerous off-site events which incur costs and can reduce productivity. In the election year budget, travel spending is expected to increase to 1.4 percent of GDP in FY2019. 31. Expenditure on subsidies and transfers has declined slightly over the last decade, although rigid pension expenditures have increased (see Figure 1.20):  Expenditure on fertilizer subsidies has been highly volatile over this period, although it has declined over the past two years due to reforms to the FISP, which reduced the number of beneficiaries and capped the coupon value, thereby reducing the Government’s price risk.  There has been a substantial reduction in funding to the National Aids Commission (NAC), from a high of 1.8 percent of GDP in FY2008 to an average of only 0.1 percent of GDP over the last four fiscal years. Up until FY2014, the NAC was historically funded largely by donor funds. However, since then, government funding has been considerably lower.  As noted earlier, pensions expenditure has increased considerably, from 0.7 to a budgeted 1.5 percent of GDP between FY2008 and FY2019. This is high for the region – Uganda was at 0.4 percent of GDP (2013), Zambia at 0.9 percent (2012), Kenya at 1.0 percent (2015), Tanzania at 1.1 percent. This raises concerns as it is a rigid expenditure which is difficult to reduce.  Subventions to various institutions amounts to about 1.3 percent of GDP. As of FY2018, the subventions supported 26 institutions, largely in the education sector. In FY2018, 56 percent of this was budgeted for four educational institutions: the University of Malawi (33 percent of the allocation), Lilongwe University of Agriculture and Natural Resources (9 percent), Mzuzu University (8 percent), and the Malawi National Examination Board (6 percent).  While expenditure on elections has declined since FY2009, it continues to weigh on total expenditure in election years, budgeted at 0.6 percent of GDP in FY2019.  “Other grants and subsidies” include funding for the Road Fund Administration (0.5 percent of GDP as of FY2018), the rural electrification program (0.5 percent of GDP), maize seed subsidy (0.1 percent of GDP), and cement and iron sheets subsidy (0.1 percent of GDP). 3 Actual travel expenditure data are available from audited financial statements, which are not yet publicly available for FY2017/18 and after. 22 Fig. 1.20: Composition of Subsidies and Transfers Percent GDP 3.0 2007/8 2008/9 2009/10 2010/11 2.5 2011/12 2012/13 2013/14 2014/15 2.0 2015/16 2016/17 2017/18 2018/19 Rev 1.5 1.0 0.5 - Fertiliser Subventions Pensions Transfers to National Aids Elections Other payments MRA Comm. Source: WB staff estimates based on MoFEPD data 32. Expenditure on arrears clearance has continued to weigh on fiscal policy, amounting to an average of 1.3 percent of GDP each fiscal year since FY2013. In recent years, as part of the IMF ECF program, the Government has implemented measures to close out domestic arrears dating back to FY2013. In early 2018, the Ministry of Finance presented to the Auditor General MWK 316 billion in arrears due to goods and services suppliers and civil works contractors which had accumulated since FY2013. The Auditor General verified arrears worth MWK 199.5 billion (about 4.1 percent of FY2018 GDP). Some of the unverified claims, which may otherwise be written off, have since been contested in court, with rulings for the Government to pay. The settlement of arrears for verified claims has largely been implemented through the issuance of zero coupon promissory notes (ZCPN) with a maturity of up to two years. The arrears largely resulted from weak financial management and spending beyond approved budgets (see PFM section for more discussion). 33. Malawi’s level of development expenditure is low and largely foreign-financed. While in the period from FY2008 to FY2013, about 40 percent of development expenditure was financed domestically, it has since fallen to only about 18 percent. However, in FY2018, domestic development expenditure amounted to 1.6 percent of GDP, more than the previous two years combined. In FY2019, it is budgeted to increase even further, to 2.1 percent of GDP. Domestically-funded public investment faces challenges that reduce the efficiency of spending, including weak cost-benefit analysis of projects, unpredictable funding, weak project management and implementation, and ineffective monitoring, evaluation, and oversight (Public Investment Management Assessment (PIMA) 2018). c. Wage Bill Analysis 34. Over the past decade, the public sector wage bill has increased considerably, largely due to the expansion of the civil service. Expenditure on the wage bill has increased from about 4.4 percent of GDP to 6.8 percent in the period from FY2008 to FY2018, and is expected to increase further to 7.3 percent in FY2019 (see Figure 1.21).4 Expenditure on the wage bill in proportion to domestic revenues is relatively 4 Malawi Government wages and salaries are classified as compensation of employees payable in cash and/or in kind, except for social contributions payable by employers. Wages and salaries exclude amounts connected with 23 high, standing at 34 percent in the period from FY2014 to FY2018, with this figure projected to increase to 38 percent in FY2019. This could raise sustainability concerns, particularly given unreliable donor flows. This increase has been largely due to the increase in the number of employees in the civil service, rather than to wage increases. While it is important to incentivize and motivate the public service to deliver services, the size and overall cost must also be balanced with fiscal sustainability. 35. Compared with selected peer countries, Malawi’s wage bill in proportion to both GDP and revenue is moderately high, and is growing rapidly (see Figure 1.22). In proportion to GDP, Malawi’s wage bill is higher than that of Rwanda, Uganda and Tanzania. While it is lower than that of Mozambique and Zambia, these two countries are recognized to have some of the highest wage bills in Sub-Saharan Africa. In proportion to revenue, it is also moderately high compared to peers, which, if it continues increasing, could raise questions of sustainability (see Figure 1.23). In proportion to recurrent expenditure, however, Malawi’s wage bill appears moderate compared to peers, due to Malawi’s relatively high overall level of expenditure (see Figure 1.24). Figure 1.21: Malawi’s public sector wage bill has Figure 1.22: Public sector wage bill as a share of been increasing across indicators GDP has increased higher than some peers Percent Percent of GDP, period average % of Government Revenue 12 2009-10 - 2012/13 % of Recurrent Expenditure 40% 8% 10 % of GDP (rhs) 2013/14 - 2017/18* 35% 7% 8 30% 6% 6 25% 5% 20% 4% 4 15% 3% 2 10% 2% 5% 1% 0 0% 0% Source: World Bank staff based on various Ministries of Source: World Bank staff estimates, man Resources, Finance, and IMF Management and Development data own-account capital formation. They include amounts withheld from wages and salaries by the employer for administrative convenience or other reasons, such as social contributions, income taxes, and other deductibles, payable by the employee. These deductibles are often paid directly to social insurance schemes, tax authorities, etc., on behalf of the employee (GFS). 24 Figure 1.23: Malawi’s public sector wage bill as a Figure 1.24: Spending on public sector wages as a share of revenue is moderately high share of recurrent expenditure is moderate Percent of GDP, period average Percent of GDP, period average 60 2009/10-2012/13 60 2009/10-2012/13 50 2013/14 - 2016/17 2013/14 - 2016/17 50 40 40 30 30 20 20 10 10 0 0 Source: World Bank staff based on various Ministries of Source: World Bank staff estimates based on various Finance, and IMF Ministries of Finance, and IMF 36. As stated above, Malawi’s increasing wage bill pressures are largely due to the expansion of its public service. The number of public servants has grown rapidly, from around 116,000 employees in FY2010 to about 221,000 in FY2018, an average annual growth rate over 8 percent (see Figure 1.25). This is much higher than Malawi’s population growth rate, which averaged 3.0 percent per year from 2008 to 2018 (NSO 2019). This increase has been particularly high for the education sector, which has recruited around 20,000 teachers over the past two years. As a result, the civil service has increased from 0.8 to 1.3 percent of the population. This is moderately high compared to some countries in the region – Tanzania is at 1.4 percent (2014), Mozambique at 1.2 percent (2015), Uganda was at 1.2 percent (2017), and Rwanda was at 0.8 percent (2010) (ILOSTAT, respective governments). Yet relatively low ratios of teachers to students and healthcare workers as a share of population suggests high employment in administrative roles in Government instead of service delivery. Pupil-to-teacher ratios have remained elevated (over 60 despite some recent declines, compared to Tanzania (around 47), Kenya (around 38), Uganda (around 50), although Mozambique has also been over 60. Malawi also has low numbers of skilled health professionals (which includes physicians, nurses and midwives), positioned at 3.5 professionals out of 10,000 people compared to the regional average of 13. 25 Figure 1.25: Civil servants have increased as a Figure 1.26: Average wage increases have been share of population lumpy and slow to catch up with inflation Civil servants, number and share of population Percent Number 40 Avg wage increase 250,000 1.3 Share of population (rhs) Inflation 35 200,000 1.2 30 1.1 25 150,000 1.0 20 100,000 15 0.9 10 50,000 0.8 5 0 0.7 0 Source: World Bank staff estimates, MoFEPD DHRMD, NSO Source: World Bank staff estimates, MoFEPD DHRMD data data 37. Average wage increases have been lumpy and irregular, with real wages frequently falling below the increased cost of living (see Figure 1.26). Despite often substantial increases to average wages, real wages have often been eroded by inflation, particularly in FY2013, FY2016, and FY2017, when inflation rates were relatively high. Despite the periodic erosion of real wages, on the whole, since FY2010, average wage bill increases have largely been on par with inflation. Over this period, average increases to wage bills have stood at 18.5 percent, compared to an average inflation rate of 17.8 percent.5 Eroding real wages can contribute to the pressure to seek supplemental travel allowances as a supplement to incomes. 38. Expenditure on the wage bill for the education and health sectors constitutes about 60 percent of the public sector wage bill (see Figure 1.27). The education sector accounts for slightly more 40 percent of wages, while health accounts for about 20 percent. The education payroll has increased considerably, from about 2.2 percent of GDP in FY2013 to 2.7 percent in FY2018. The health sector payroll, on the other hand, accounted for about 1.2 percent of GDP in FY2013, before increasing to almost 1.5 percent in FY2015, and then gradually declining again to 1.2 percent in FY2018. Other key sectors include the Malawi Defense Force (6.8 percent of the total wage bill as of FY2018), the Malawi Police Services (7.6 percent), and the Ministry of Agriculture (4.2 percent). 5 This is the average across all grades in the civil service, so that structural changes – such as hiring more employees at higher or lower paybands, or variable wage increases across the payband – may mean this does not apply to a specific payband. For example, in 2014, significant changes in the compensation structure increased wages by the highest amount for professional civil servants (grades A to I), ranging from 71 percent for grade F, to 114 percent for grade C. Additionally, since 2015 employees at Grades H and above (professional levels) stayed for three consecutive years without any wage hike, while the junior levels received an average of between 10 and 15 percent per year. 26 Fig. 1.27: The largest share of spending on wages is in education followed by health Wage bill, percent share by sector 100% 80% 60% 40% 20% 0% 2012/13 2013/14 2014/15 2015/16 16/17 Prel 17/18 Prel Education, Science and Technology Health Malawi Police Services Malawi Defence Forces Agriculture and Food Security Nat. Resources, Energy and Env. Foreign Missions Other Source: World Bank staff, MoFEPD, DHRMD data 39. Since 2014, Malawi’s wage bill has been the largest single component of total Government expenditure. On average, wage levels are modest while the size of the civil service has become moderately high. However, if current growth trends continue, the wage bill will quickly become unsustainable. Malawi’s 3 percent population growth creates a strong need to expand education and health services. At the same time, poorly planned increases in compensation or employment levels could have potentially significant adverse implications for the fiscal balance. Therefore, the Government should make strong efforts to reduce inefficiencies in the administration of the public sector payroll, as these inefficiencies contribute significantly to total costs (CEM, 2017). Widespread allowance seeking to supplement wages also plays a role, with numerous off-site events that pay allowances reducing the efficiency of Government operations, while creating arbitrary disparities in the overall compensation of civil servants. Moreover, Government should strive to improve planning for wage increases and recruitments, as these have derailed a number of budgets in the past. Lumpy wage increases that lag far behind inflation demotivate civil servants. The Government should further strive to strengthen the efficient allocation of civil servants across and within sectors, to ensure improved service delivery. Lastly, the roll out of the planned payroll devolution also needs to be adequately supported—technical and human capacity constraints need to be resolved in order to increase the effectiveness of payroll devolution and ultimately wage bill management. d. Functional Composition of Public Expenditures 40. Malawi’s budget allocations for key sectors highlight the impact that high interest payments have on development spending. Interest expenses account for the third-highest proportion of expenditure, equivalent to around 80 percent of the budgeted expenditure on education and roughly on par with agriculture over the past two years (see Figures 1.28 and 1.29). Interest expenses are also almost 50 percent higher than expenditure on health, and more than double the expenditure on roads. Recent reforms to the agriculture sector have decreased the previous high levels expenditure on that sector, with budgeted expenditure falling from 5.5 percent of GDP to 3.7 percent over the last four years. This is still high compared with some peers: Mozambique spends about 2 percent of GDP on agriculture, while Kenya 27 and Tanzania both spend less than one percent. Malawi’s expenditure on defense and security has increased in FY2018 due to the preparations for the elections. Roads investment has also increased in the period prior to elections. 41. Malawi’s budget demonstrates the Government’s strong commitment to education, with expenditure on the sector constituting the largest proportion of any single sector. 6 This is followed by agriculture, interest payments, and health. Expenditure on education has increased in proportion to GDP in recent years, particularly due to increased teacher recruitment, and close to 80 percent of expenditure goes to salaries, limiting funding for other critical inputs. Malawi’s budgeted expenditure on education, averaging about 4.8 percent of GDP over the past four years, compares favorably with its peers, lower only than Mozambique and roughly on par with Kenya (see Figure 1.30). In terms of per student primary education expenditure, Malawi is below the average regional level, with only Rwanda and Uganda spending less among neighboring countries. Education spending is critical for Malawi’s future development, particularly in the context of its high population growth rate, which calls for a high level of investment to develop the skills of the future population. Figure 1.28: Education has surpassed agriculture Figure 1.29: Education has also seen a pickup in as the top sector in the budget spending as a share of GDP Percent share of revised budget Revised budget, percent of GDP 25 6 2014/15 Revised 2014/15 Revised 2015/16 Revised 5 2015/16 Revised 20 2016/17 Revised 2016/17 Revised 2017/18 Revised 4 2017/18 Revised 15 3 10 2 5 1 - - Source: World Bank staff estimates based on MoFEPD data Source: World Bank staff estimates based on MoFEPD data 42. Malawi’s budgeted health expenditure has averaged about 2.5 percent of GDP over recent years, which is strong compared to its peers. Malawi also performs well in terms of this sector’s share of total expenditure, which stands at about 9.5 percent over the period, with most of Malawi’s peers recording ratios ranging from 6 to 8 percent (see Figure 1.31). However, even after Cashgate, about 13 percent of this amount has come from donor funding over recent years. Including off-budget health expenditure, more than 60 percent of Malawi’s health funding is financed by donors. While general government health expenditure is relatively high in proportion to GDP, its expenditure per capita is relatively low. To some extent, this is due to a lower denominator—Malawi’s per capita GDP is significantly below peers (see Figure 1.2)—while donors funds are included in the numerator. Although per capita 6 The next module of this PER will provide deeper analysis of efficiency and equity issues in education, health, and social protection. 28 expenditure has increased significantly since 2012 (by almost 100 percent), it still ranks lower than all neighboring countries except for Mozambique. Figure 1.30: Education expenditure compares Figure 1.31: Health expenditure is strong relative favorably to peers as a share of GDP to peers as a share of GDP Education expenditure*, percent of GDP, average Health expenditure*, percent of GDP, average 2014-18 (as available) 2014-18 (as available) 8 3.0 7 2.5 6 5 2.0 4 1.5 3 1.0 2 1 0.5 0 0.0 Source: World Bank staff estimates based on MoFEPD data, Source: World Bank staff estimates based on MoFEPD data, Government authorities, WDI Government authorities, WDI * Malawi data is revised budget data * Malawi data is revised budget data e. Budget Execution 43. Malawi’s total government expenditure is consistently over-budget. Since the end of FY2012, expenditure including arrears has been, on average, 7.4 percent (1.8 percent of GDP) over budget (see Figure 1.32). Expenses associated with the clearance of arrears have placed a heavy burden on the budget in recent years. They have averaged 1.5 percent of GDP over budget since FY2015, significantly contributing to deficits and the buildup of domestic borrowing. This underscores the need to ensure continued vigilance over commitment controls. 44. Domestic interest payments have been a major contributor to over-expenditure in recent years. Since FY2012, domestic interest payments have been, on average, 0.9 percent of GDP over budget. Much of this can be attributed to unplanned deficits leading to increased domestic borrowing. 45. Goods and services expenditure has also been regularly over budget, by an average of 0.7 percent of GDP. This is often attributed to “generic goods and services.” In FY2018, expenditure to a value of 0.7 percent of GDP was attributed to increased security spending in preparations for elections. Moreover, maize purchases have also contributed to overruns in recent years, including, in 2018, expenditure associated with the ADMARC bailout. Until FY2016, expenditure on subsidies and transfers were often over-budget, largely due to FISP-related over-expenditure. However, since the recent FISP reforms, this expenditure has been less volatile. 29 Fig. 1.32: Budget execution Deviation from approved budget, percent GDP Wages and salaries Foreign interest Domestic interest Other purchases goods & svcs Subsidies & transfers Dev. Exp. Domestic Dev Exp. Foreign Arrears 5 Total Expenditure 4 3 2 1 0 -1 -2 -3 -4 -5 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 Source: World Bank staff based on MoFEPD data 46. Development expenditure regularly underperforms, by an average of 0.6 and 0.5 percent of GDP for domestically- and foreign-financed, respectively. Domestically-financed development expenditure has been, on average, 35 percent below budget since FY2012. Foreign-financed development expenditure has been, on average, 21 percent below budget over the same period. The consistency with which development expenditure underperforms undermines development impact, with projects being frequently planned, only to be put on hold or under-funded. Forecasting clearly needs to improve. 47. In recent years, expenditure on wages has been somewhat closer to the budgeted level than previously, although this expenditure is still rising. Wages were often over budget in the period up until FY2015, contributing to an increasing un-budgeted wage bill. However, this expenditure was close to or under-budget in FY2016 and FY2017, before again exceeding the budget by 0.2 percent of GDP in FY2018. This indicates that the gradual increase in the wage bill over the past two years has largely been budgeted, which raises the need for budgeting for wages in a sustainable medium-term framework. 48. Budget execution by functional classification has been weak. The composition variance has been considerable in recent years, ranging from 21 to 32 percent from FY2015 to FY2017 (2018 PEFA). While there was 22% over spending on public affairs and safety, social sectors such as health and education were unable to fully execute their budgets by 12 and 16 percent respectively, despite their high reliance on human resources which generally drives their budget performance up. 49. Some economic classifications and votes show consistent over- or under-performance from year to year. This suggests that such budgets are unrealistic or not respected, which fundamentally undermines the strategic allocation of resources. The budget may well be formulated with regard to equity for example, but, if not respected, may have an inequitable turnout. While the implementation of the medium-term budget planning system should support strategic allocation, unreliable annual budget outturns and lack of reconciliation undermine this effort and may lead to a situation where the budget is de-facto reformulated as it is released. Further, not releasing funds when they have been allotted is likely 30 to lead to the accumulation of arrears which undermines the implementation of given systems and leads to operational inefficiencies and fiscal risks. f. Fiscal Deficits and Financing 50. With expenditure consistently outpacing revenues, deficits have been growing, which are increasingly financed with domestic borrowing (see figures 1.4, 1.5, and 1.33). As a result, even though external debt levels, largely contracted on concessional terms, have been fairly level in recent years - estimated at about 31.2 percent of GDP in 2018 - gross domestic debt, incurred at relatively high interest rates, has gradually increased to reach an estimated 26.1 percent of GDP. In addition, while historically much of domestic financing was through RBM, this stopped since early 2018. Continued government financing needs, combined with RBM gradually unwinding their stock of government securities, has led to a substantial increase in government borrowing from commercial banks, which has more than tripled (growing by 275 percent in nominal Kwacha terms) from January 2018 to April 2019, while government borrowing from non-banks increased by 180 percent over the same period. This could raise concerns of crowding out lending to the private sector, although private sector borrowing is also constrained by limited demand. Figure 1.33: Deficit financing Figure 1.34: Public debt Percent of GDP Percent of GDP 8 Foreign financing 60 External debt 7 Domestic financing Domestic public debt Securitization of domestic arrears 50 Total public debt 6 Privatization Proceeds 5 40 4 30 3 2 20 1 10 0 -1 0 FY2007/08 FY2008/09 FY2009/10 FY2010/11 FY2011/12 FY2012/13 FY2013/14 FY2014/15 FY2015/16 FY2016/17 FY2017/18 FY2011/12 FY2012/13 FY2013/14 FY2014/15 FY2015/16 FY2016/17 FY2017/18 Source: World Bank staff estimates based on MoFEPD data Source: World Bank staff estimates based on IMF data 51. The government is planning to improve debt management and deepen the domestic debt market. In line with the IMF’s ECF program, the government plans to continue avoiding non-concessional external borrowing. Moreover, it plans to strengthen cash flow forecasting to improve debt and liquidity coordination. It further expects to lengthen the maturity profile of government borrowing, and to further develop the yield curve. However, while 91-day Treasury Bill interest rates have fallen to around ten percent since early 2019, longer term 3 to 5 year government securities range from 20 to 24 percent. Given the high cost of debt service, it should carefully consider interest cost implications of various borrowing strategies. Moreover, it should also address the consistent under-estimation of debt service projections. 31 g. Public Financial Management (PFM) and Public Investment Management Issues 52. Malawi has undertaken steps to reform PFM systems since the 2013 Cashgate scandal. However, many of these appear to have served form rather than function (World Bank 2016, Bridges and Woolcock 2017). A 2018 Public Expenditure and Financial Accountability (PEFA) Assessment reviewed the national PFM system. The PEFA revealed that 13 of 31 indicators scored D or D+, and another 9 scored only C or C+, which suggests that significant gaps remain. 53. The 2018 PEFA assessed improvements since the 2011 PEFA Assessment including in areas of revenue management, annual budget preparation, bank and advance account reconciliation, and internal audit. Substantial improvements were seen in Parliamentary oversight of budget proposals and scrutiny of audited annual financial statements. Moreover, a separate study indicates how the coverage of the treasury single account (TSA) appears to be quite high, with most of government making use of the TSA thereby reducing opportunity for the accumulation of idle balances. In this respect Malawi scores significantly better than regional peers such as Zambia, Zimbabwe, or Ghana (Hashim and Piatti-Fünfkirchen 2016). 54. However, declining performance was shown in various areas by the PEFA. This includes high variance on the expenditure composition outturn, reflecting frequent re-allocations between votes and economic classifications during the fiscal year. Additionally, deterioration was noted in commitment controls, predictability of funds for commitment, budget documentation which lacks data in a comparable format, and public debt reporting, amongst others. Moreover, weak monitoring of the financial performance of extra-budgetary units and public corporations deteriorated, presenting a clear risk, where deficits may build up and loan guarantees may have been issued. 55. Procurement issues continue to negatively affect the efficiency of both development and recurrent expenditure. A number of assessments indicate the inefficiency of Malawi’s procurement systems. The 2019 Malawi Assessment of the Public Procurement System (MAPS) indicates how the public procurement market is dominated by a few large national firms. The private sector perceives that contract awards are predetermined and preferentially awarded to firms, with no effective appeals mechanism. Non-competitive methods are abused. Although open competition is the default procurement method, 80 percent (by value) of prior reviewed contracts from FY2017 were found to be awarded through a restricted tender process. Procurement oversight is not adequately enforced. Additionally, the 2018 PEFA assessment gives procurement the lowest possible score, further noting how key information is not made available to the public. These weak procurement practices, in combination with the accumulation of arrears that contribute to high financing costs for suppliers, result in increased prices and reduced value- for-money for government procurement processes. 56. The accumulation of arrears, as mentioned above, also likely leads to high financing costs for suppliers and consequently increased prices on government procurement. In the 2018 PEFA, the stock of arrears and capacity of government to manage arrears was rated with a ‘D’. Even though the current Epicor FMIS has sufficient commitment control capabilities in place, these are insufficiently applied, as transactions are frequently routed outside of the system, which makes these prone to the accumulation of arrears (World Bank 2016). Additionally, IFMIS controls do not accommodate multi- year commitments, which could also contribute to expenditure arrears (PEFA 2018). The Government has committed to take steps to avoid the further accumulation of arrears, through tighter commitment controls and stronger monitoring. 57. Strengthening public investment management could also increase the efficiency of development spending. The 2018 PIMA highlights various issues underlying inefficiencies in investment 32 management. The gap between planned and executed investment is higher in Malawi than in neighboring peer countries, and volatility is the highest in the region apart from Zimbabwe. Feasibility studies and cost-benefit analysis – which should help determine which projects are prioritized and funded - are not consistently carried out for major domestic projects. Standard methodologies should be developed for project appraisal and estimating maintenance costs. Additionally, budget ceilings should be communicated earlier in the process to allow line Ministries to prioritize capital projects. This could be extended to costing national and sector strategies within resource envelopes. Moreover, the Public Sector Investment Program (PSIP) should be better linked with the budget. Finally, strengthening fiscal oversight of statutory bodies would also support investment. 5) Conclusions and Recommendations 58. Malawi’s high level of recurrent expenditure crowds out the space for development expenditure that can increase growth. While the withdrawal of much on-budget donor funding since 2013 has reduced overall resources, total expenditure, instead, has increased, with increases in recurrent expenditure more than offsetting the decrease in development expenditure. Expanding deficits have increased the government’s dependence on high-cost domestic borrowing, which further reduces the fiscal space for investment. Malawi’s development expenditure is low compared to regional peers. Only by increasing development expenditure can Malawi exit from a cycle of low growth, which also undermines revenue mobilization. 59. Moving forward, Malawi needs to re-balance expenditure to ensure sustainability and to increase the development impact of the budget. To achieve this, it will be critically important to maintain fiscal discipline, with a strong political commitment to ensure that expenditure remains within budget. It is essential to avoid unbudgeted increases in expenditure lines and thus to reduce domestic borrowing and interest expenditure. Measure to facilitate this include:  The Government should prudently manage expenditure on wages and pensions. If the recent growth trajectory in the wage bill and pensions continues, it could quickly undermine fiscal sustainability. Pensions expenditure is already high for the region. In containing these costs in the medium term, the Government should improve the efficiency of allocations across and within sectors, while at the same time containing the growth of the civil service and implementing appropriate inflation adjustments to salaries. Taking steps to contain the wage bill and pensions at FY2017 levels (in proportion to GDP) could reduce the expenditure on these items from about 8.8 percent of GDP in FY2019 to 7.4 percent, a savings of 1.4 percent of GDP.  After facing election year pressures, the Government should ensure that elevated goods and services, and transfers and subsidy expenditure in FY2019 revert to previous levels from FY2020. This would include expenditure on goods and services, including travel and security spending, as well as election-related subsidies and transfers. Together, these measures could result in savings of more than 1 percent of GDP.  Addressing PFM issues could also help to improve the efficiency of expenditure and reduce fiscal shocks. It will be important to ensure effective commitment controls are implemented to avoid the accumulation of arrears. This would include a new IFMIS that includes multi-year commitments and by reducing transactions outside of IFMIS. If service providers know they will get paid and on time, this would also reduce their cost of selling to the Government. It is also critically important to improve procurement processes by increasing the transparency and competition for Government contracts, which would also result in better value for money. Strict adherence to policies and procedures in line with the PFM Act, including better managerial accountability and 33 application of proper disciplinary measures would also improve efficiency and effectiveness in the use of resources. Stronger PFM systems would further support donor confidence, which could result in increased on-budget support.  Improving public investment management would further ensure increased efficiency of limited investment funding. Feasibility and cost-benefit analysis should be carried out for all major projects, which could then inform better project prioritization. Additionally, improving project appraisal and maintenance estimates will support improved efficiency of investment expenditure.  The authorities should make further efforts to improve GDP and revenue forecasting, including at mid-year. Forecasting of both tax revenues and grants needs to improve, especially for mid-year forecasts. Project grants, in particular, are consistently below budget forecasts. Improvements would facilitate improved planning and project selection and avoid disruptive funding cuts to budget lines and projects.  The government should further improve debt management to reduce interest expenditure. Given the high cost of debt service, the government should strengthen debt management with a careful consideration of interest cost implications of borrowing strategies. Moreover, it should also address the consistent under-estimation of debt service projections.  Revenue mobilization is relatively strong, but further efficiency enhancements could improve collections and support growth. Addressing substantial revenue arrears is one aspect of this, estimated at around 12 percent of the total collected revenue as of June 2018, as well as substantial outstanding taxes from public corporations. Moreover, further efforts to rationalize a high number of incentives, while rebalancing the tax mix and expanding the revenue base, could support growth and investment.  In addition to these reforms, the authorities need to continue sectoral reforms, particularly in education, health, and agriculture, to improve the efficiency and equity of expenditure. This is essential to ensure the effective delivery of services and to build and strengthen human capital more effectively within a limited budget ceiling. Recent reforms to the FISP have cleared up significant fiscal space and should be sustained. The next module of the Malawi PER will focus on education, health, and social protection, which will dive deeper into efficiency and equity issues in these sectors. 34 Chapter 2: Debt, fiscal risks, and sustainability 1) Introduction 60. This chapter analyzes fiscal and debt sustainability over the medium term under a baseline scenario, shocks scenarios, and a strong reforms scenario. In particular, it explores a range of policy options to preserve fiscal sustainability (by reducing both budget imbalances and public debt) and to mitigate a number of major fiscal risks. The chapter is organized as follows. Section 2 benchmarks Malawi’s fiscal deficit and public debt against peer countries and discusses the historical drivers of public debt. Section 3 presents recent policy measures adopted by the Government to contain fiscal imbalances and accomplish commitments made under the MGDS III and ECF. Section 4 identifies key fiscal risks facing the Malawi economy. Section 5 formulates a baseline scenario, which represents a likely path of key macro and fiscal variables that determine the future path of public debt. Then the shocks scenarios represent risks to the baseline and are based on actual events which occurred in Malawi’s recent past. They are intended to help develop a sustainable fiscal policy to plan for these known risks. A stronger reform scenario then considers how additional reforms to strengthen fiscal consolidation would better enable Malawi to manage fiscal shocks and maintain fiscal sustainability. Section 6 offers policy recommendations to strengthen public finances and manage fiscal risks. 2) Public Finances in Malawi: International Benchmarking and Drivers of Public Debt 61. Malawi’s stock of public debt is relatively high compared to peers, with the country having incurred persistent, significant fiscal deficits over the past decade (see Figure 2.1 and 2.2). At the end of 2018, Malawi’s public debt stock amounted to almost 60 percent of GDP. This is a higher proportion than any of Malawi’s structural and aspirational country peers, with the exception of Mozambique. 7 In addition, structural challenges and poor fiscal management have led to persistent budget imbalances. From 2008 to 2017, Malawi ran an average annual budget deficit of 4.4 percent of GDP. Again, this is higher than regional peers, apart from Mozambique. These imbalances have often been aggravated by exogenous shocks (such as adverse weather events) or institutional shocks (such as corruption scandals and weak governance). Over the same timeframe, Malawi recorded lower average real GDP growth rates than any of its peers, with the sole exception of Benin. 7 The pace of indebtedness is also quite rapid in Malawi relative to its peers: between 2008 and 2017, the public debt increased by nearly 31 p.p. of GDP—the highest increase in the debt ratio with the exemption of Mozambique and Benin. 35 Figure 2.1. Public Debt and Fiscal Balance Figure 2.2. Public Debt and Economic Growth Debt-to-GDP in 2017 (%) Change in Debt-to-GDP in 2008-2017 (p.p.) 120 6 Fiscal Deficit in 2008-2017 (% of GDP, annual Real GDP Growth in 2008-2017 (%, annual average, right) 70 12 average, right) 100 5 60 10 80 4 50 8 60 3 40 6 30 40 2 4 20 20 1 2 10 0 0 0 0 Malawi Mozambique Tanzania Uganda Benin Ethiopia Niger Rwanda Burkina Faso Mozambique Tanzania Rwanda Malawi Uganda Benin Ethiopia Niger Burkina Faso Source: World Bank World Development Indicators 62. Recurrent budget deficits and macroeconomic shocks have led to rapid increases in public debt in recent years (see Figure 2.3). In 2006, debt-relief initiatives enabled Malawi to reduce its public debt- to-GDP ratio from more than 100 percent to less than 30 percent, and to regularize access to foreign concessional financing. Since then, however, this ratio has increased steadily, increasing from 28 percent in 2007 to 61 percent by 2018, thus partially wiping out the gains from debt-relief. This increase was mainly a consequence of fiscal mismanagement and real exchange rate instability, with the latter fact largely offsetting the otherwise positive effect of economic growth and low real interest rates on foreign loans. Both the external and domestic components of public debt have increased in the period following the global financial crisis. Foreign loans, which are typically contracted to fund investment projects and which are fully exposed to the valuation effects of currency depreciation, have increased by almost 22 percentage points of GDP since 2011 and reached 34 percent of GDP in 2018. Additionally, frequently recurring budget deficits have led to a heavy reliance on borrowing from local sources and from the Reserve Bank of Malawi (RBM). This has led to a significant accumulation of domestic debt, increasing from 15 percent of GDP in 2012 to 27 percent in 2018. 36 Figure 2.3. Drivers of Debt-to-GDP Ratio (% of GDP and p.p.) 25 70 Primary Deficit (p.p.) Other Funding Needs & Net 20 60 Acquisition of Fin.Assets (p.p.) Valuation Effect Due To 15 50 Depreciation Against USD (p.p.) Real GDP Growth (p.p.) 10 40 Real Interest Rate (p.p.) 5 30 Other Non-Identified Factors (p.p.) 0 20 Change in Public Debt-to-GDP Ratio (p.p.) -5 10 Public Debt (% of GDP, right) Domestic Public Debt (% of -10 0 GDP, right) 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 External Public Debt (% of GDP, right) Source: World Bank staff calculations based on DSA November 2018 data 63. Fiscal and external imbalances drive the dynamics of Government debt (see Figure 2.3). Budget deficits have been largely driven by overruns to recurrent expenditure, with these overruns in turn being driven by high interest payments; the high cost of subsidies (including through the Fertilizer Input Subsidy Program – FISP); transfers to bail out SOEs; and arrears to suppliers and below-the-line transactions, including the securitization of those arrears. With overly optimistic projections and an undiversified revenue base, the Government consistently records lower than expected revenues and grants, which compounds the situation. In the period from 2008 to 2018, the most significant contributors to the increase in the debt-to-GDP ratio were primary deficits (contributing 12 p.p.); below-the-line transactions (37 p.p.); and the valuation effects induced by currency depreciation (33 p.p.) These factors more than offset the positive impact of economic growth and real interest rates—which would by themselves have reduced the debt-to-GDP ratio by 18 p.p. and 32 p.p., respectively. 3) Recent Fiscal Developments 64. Following Cashgate and the significant withdrawal of on-budget donor resources, there has been a surge in government expenditure and a decline in revenues and grants, resulting in a significant deterioration to the fiscal position (see Figure 2.4). The average annual value of revenues and grants decreased from 22.6 percent of GDP in FY2011-FY2014 to 21.9 percent in FY2015-FY2018, representing a decline of 0.7 p.p. of GDP. The most significant contribution was the decline in foreign grants, which decreased by 2.6 p.p. of GDP. This was only partially offset by an increase in tax revenue by 1.8 p.p. of GDP. On the other hand, average annual expenditure increased from 25.8 percent of GDP in in FY2011- FY2014 to 28.1 percent in FY2015-FY2018, representing an increase of 2.3 p.p. of GDP. By and large, the increase in Government expenses was driven by increased expenditure on salaries and wages (which increased by 1.2 p.p of GDP) and interest payments (1.7 p.p). Notably, when arrears are taken into account, recurrent and development expenditure has remained fairly stable as a share of GDP. 8 8 Ostensibly, expenditure in goods and services accelerated in FY2018, reaching 6.9 percent of GDP, on the back of increased spending to ensure integrity of elections, additional maize purchases to provide food security following a poor maize harvest, and the payment of arrears arising from court rulings. Domestic (certified) arrears incurred 37 65. With declining revenue and increasing expenditure, the fiscal gap has widened and public debt has soared, with a disproportionate increase in domestic liabilities (see Figure 2.4). In the period from FY2015 to FY2018, the average annual fiscal deficit stood at 6.2 percent of GDP, significantly higher than 3.2 percent of GDP recorded from FY2011 to FY2014. By and large, the Government has relied on domestic financing to fund increasing budget deficits. Historically, this has involved borrowing from the RBM through ways and means and converting advances to Treasury bills, ultimately monetizing those deficits.9 As domestic securities carry higher interest rates and exhibit shorter maturities, amortization payments have also increased significantly. Overall, the total value of Government debt increased from 50 percent of GDP in FY2014 to 61 percent in FY2018. Figure 2.4. Fiscal Deterioration in FY2015-FY2018 Figure 2.5. Public Debt Structure (Annual Averages, % of GDP) (US$ Million, End-2017) Revenue Expenditure 68 Fiscal Deficit Other Domestic Debts Debt Amortizations Gross Borrowing Requirements 893 Treasury Notes Treasury Bills 347 2015-2018 Bilateral 437 Other Multilat. & PTA 133 78 IFAD 290 2011-2014 ADF 860 IDA 0 5 10 15 20 25 30 224 IMF Source: World Bank staff calculations based on MoFEPD and DSA November 2018 data 66. The greatest proportion of the public debt portfolio consists of external concessional loans and domestic securities held by the RBM and commercial banks (see Figure 2.5). External loans constitute 55 percent of the total public debt, with this figure consisting of loans from multilateral institutions, bilateral creditors, and commercial debt. Domestic public debt constitutes the remaining 45 percent of the total public debt, consisting of Treasury securities and promissory notes. External debt servicing costs are relatively low due to concessionality, but domestic debt servicing costs are significantly higher. For example, in FY2018, expenditure on the repayment of domestic securities and promissory notes amounted to nearly 10 percent of GDP. 67. Overall, the public debt portfolio is moderately exposed to currency fluctuation and interest rate risk. A significant proportion of foreign loans are denominated either in US dollars or in Special Drawing Rights (SDR) (in which the US dollar constitutes an important share of the currency basket). Hence, fluctuations in the MWK /USD exchange rate create currency risk. As most external loans have tenors in excess of 25 years and carry fixed and low interest rates, they are narrowly exposed to interest rate risk. On the other hand, Government securities are denominated in local currency, exhibit shorter maturities, and carry fixed and high interest rates. Treasury bonds (issued with tenors of between two to 10 years) constitute two-thirds of the total value of domestic public debt, while Treasury bills (with less- than-one-year maturity) constitute a quarter. Thus, domestic securities are characterized by a relatively from FY2013 to FY2017, estimated to be around 5 percent of GDP, were securitized as zero-interest promissory notes in FY2018, with scheduled payments in FY2018 and FY2019. 9 However, from early 2018, as part of the IMF ECF program, RBM has stopped financing Government deficits apart from liquidity needs. The passage of the RBM Act in late 2018 also reinforced RBM’s autonomy. 38 higher interest rate risk but a relatively lower currency risk. Rollover risk is limited, as a large proportion of these securities are held by the RBM and commercial banks that have regulatory and liquidity- management incentives to purchase them. 68. Under the third Malawi Growth and Development Strategy (MGDS III) and IMF Extended Credit Facility (ECF), the Government of Malawi is committed to reforms and policies to foster economic growth, to reduce poverty, and to strengthen public finances. MGDS III defines an agenda for growth and reform that is intended to enhance economic productivity, competitiveness, and resilience. The strategy places a strong emphasis on investment in infrastructure, poverty-reducing social expenditure, improved governance, agricultural market reform, and financial-market and business development. Concurrently, the Extended Credit Facility (ECF) recognizes the need to balance policies to consolidate public finances, on the one hand, and to leverage public investment and social spending to support growth and poverty alleviation, on the other. 69. Prudent fiscal and debt policies should be formulated to avoid excessive levels of debt and to preserve sustainability. In the context of the ECF program, Malawi’s authorities have agreed to suspend contracting new non-concessional loans; to complete the securitization of past arrears by FY2018; to avoid the accumulation of excessive new arrears in the future; and to limit domestic borrowings (especially from the RBM). They are also implementing ongoing efforts to formulate a medium-term debt management strategy; to establish sound practices for public investment management; and to enhance oversight of SOEs. 4) Fiscal Risks 70. Malawi’s economy faces various sources of fiscal risks. Over the past three decades, the volatility of Malawi’s growth and fiscal outcomes highlights the country’s large exposure to risks including external (weather- and commodity driven) shocks and internal (policy-driven) shocks. These shocks have had a significant impact on Malawi’s public finances and compromise public-sector resources, resulting in legal, contractual, social, and/or political obligations (liabilities) and associated pressures and requirements for the Government to utilize public funds to meet these obligations. Even without such shocks, the Government must meet statutory expenditures on items such as wages and salaries, debt-service payments and pensions and gratuities, among others. When adverse shocks occur, the Government may be expected to intervene and to utilize public resources to address the financial implications of those unforeseen events. 71. Measures to address fiscal risks may require disruptive fiscal adjustments in the short term, with the potential to severely undermine fiscal sustainability in the long term. Fiscal risks are defined as any substantial deviation in fiscal outturns from budgets or projections that may exert unexpected pressures on public resources through the impact both on cash flows and on the balance sheet.  Impact on cash flows: Downside risks can have an impact on both sides of the Government’s cash flows, leading to higher-than-anticipated outflows (e.g., additional expenses to cope with emergency relief) and/or lower-than-anticipated inflows (e.g., shortfall in revenues due to economic downturn or lower grants in response to corruption scandals). When social and/or investment programs are curtailed due to a decline in revenues or increased expenditures, there may be significant social costs and a weakening of Malawi’s long-term growth potential.  Impact on balance-sheet: Downside risks can also have an impact on both sides of the Government’s balance sheet, leading to higher-than-anticipated levels of public debt (e.g., additional financial obligations when guarantees provided to SOEs are called) or a lower-than- 39 anticipated stock of assets (e.g., physical destruction of public infrastructure during natural disasters or the erosion of value of equity stakes in a SOE facing bankruptcy). Deleterious balance- sheet effects have the potential to undermine the Government’s solvency (creditworthiness) and credit risk ratings. A Fiscal Risk Matrix 72. This section presents a Fiscal Risk Matrix to summarize the major financial obligations facing the Government and to identify contingent liabilities that can be triggered by the materialization of fiscal risks (see Table 2.1). Fiscal risks may originate from a range of sources and take many forms. Thus, the Fiscal Risk Matrix facilitates the identification and categorization of sources of risks to facilitate analysis and disclosure. The matrix is constructed along two axes: with direct/indirect (contingent) liabilities on one axis; and explicit/implicit liabilities on the other.  The explicit/implicit vertical axis: This identifies the basis on which specific liability falls under the Government’s purview. Explicit liabilities are commitments that are based on law or contracts, and thus cannot be avoided by a law-abiding Government. On the other hand, implicit liabilities are those that derive from political or social obligations (often reflecting public concerns and interest-group pressures), and the Government should make a political choice on whether to meet them or not.  The direct-indirect horizontal axis: This distinguishes between obligations that are certain to exist and those that are dependent upon uncertain future events. Direct liabilities imply fiscal obligations in any event, while implicit liabilities are only triggered if a particular uncertain event eventually materializes. Table 2.1. Fiscal Risk Matrix Indirect Liabilities Direct Liabilities (obligation conditional on particular (obligation in any event) events) Explicit Liabilities  Foreign loans and domestic  Guarantees on debts taken by (obligation securities, particularly those SOEs and Statutory Bodies. stemming from denominated in foreign currencies  Arrears to contractors subject to laws, by-laws, and/or with short maturities (i.e., litigation, and any other claims regulations, exposed to currency risk and/or under litigation that may involve contracts, etc.) interest-rate risk). financial compensations.  Securitized arrears to contractors.  Support to the Strategic Maize  Budgetary expenditures, including Reserve. wages, salaries, pensions, and any  Contingent expenses expected to other expense that is legally- be funded with over-estimated binding. revenues at budget planning stage  Expenses expected to be funded (including donors’ grants and with over-estimated revenues at financing). budget-planning stage (including donors’ grants and financing). 40 Implicit Liabilities  Expenses expected to be funded  Transfers to loss-making SOEs and (obligation with over-estimated revenues at Statutory Bodies. stemming from budget-planning stage (including  Support to Subnational Gov’t in the political and social donors’ grants and financing). process of decentralization. expectations,  Long-term operation and ethical reasons,  Support to banks, insurance maintenance of infrastructure etc.) companies, pension funds, and assets. other institutions in case of a  Long-term expenses in health, financial crisis (i.e., bailouts, pensions, and any other social- recapitalizations). security expenses that is not legally-  Interventions in case of natural binding. disasters (e.g., emergency and reconstruction spending). 73. Contingent liabilities may arise from either exogenous shocks or policy choices . Contingent liabilities refer to obligations whose magnitude and timing depend on the occurrence of specific, uncertain future events. These liabilities may be the product of purely exogenous shocks outside the control of the Government (natural disasters or commodity-price volatility) or from deliberate policy choices (guarantees to SOEs or providing bail-outs to SOEs or banks). Contingent liabilities resulting from exogenous shocks may be particularly damaging, since these adverse circumstances may feed off each other and impose a pro-cyclical bias to economic policies. In other words, macroeconomic shocks can be correlated, and this reinforces their negative effects. Thus, prudent macroeconomic policies must be formulated to reduce exposure to those exogenous shocks, through sound fiscal policies reducing borrowing requirements, effective revenue mobilization measures, and development policies favoring diversification of exports and foreign-exchange inflows, among others. Contingent liabilities emerging from policy choices may serve legitimate purposes, such as lowering the cost of financing for SOEs or preserving financial stability. However, they can also result from policy failures, such as the non- transparent administration of resources that undermines credibility and reduces access to donor financing. These failures should be addressed through the appropriate institutional reforms. 74. A brief discussion of some of the key fiscal risks that Malawi has faced in the recent past or which could emerge in the medium term follows (See Annex 1 for a brief elaboration of the materialization of recent internal and external shocks). Natural Disasters 75. Malawi’s agricultural sector faces a significant degree of exposure to natural disasters, including flooding, drought, and infestation, with major implications for the broader economy. Exposure to natural-disaster risks is exacerbated by Malawi’s high poverty rates, its population density, and its predominant cultivation methods. While climate-related shocks have the potential to affect most countries within the region, a number of factors specific to Malawi aggravate the social and economic impact. In particular, Malawi’s poverty levels are significantly higher than those of regional peers, with a 41 large proportion of its population barely able to cover their food needs, even in normal years.10 In addition, Malawi’s high population density implies a low availability of land per capita.11 Agricultural output is undiversified, with a small number of crops being cultivated and with maize accounting for nearly half of output. At the same time, land degradation has gradually reduced soil fertility. Most crops are rain-fed, with irrigation covering just 0.5 percent of crop plots. Therefore, production is particularly vulnerable to changing rainfall patterns. Malawi’s exports are also highly concentrated, in tobacco, tea, and sugar. Thus, its export performance is highly susceptible to natural disasters that may impact the production of any or all of these crops and to volatility in commodity prices in global markets. Figure 2.6: Malawi faces frequent natural disasters, which slow GDP growth Population affected by natural disasters, Real GDP growth, percent, 1979-2019 80 Climatological (Drought, Wildfire) 70 Hydrological (Flood, Landslide) 60 Real GDP growth 50 40 30 20 10 0 -10 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 Source: World Bank staff based on MoFEPD data 76. Over the past few decades, climate-related natural disasters have become increasingly frequent and intense (see Figure 2.6). Since 1990, Malawi has experienced five episodes of drought that affected more than 20 percent of its population in each case, significantly reducing crop production and aggravating food insecurity, particularly in rural areas. On average, flooding and drought reduce GDP by about 1.7 percentage points each year.12 Flooding in the Southern Region in 2015 destroyed 4 percent of Malawi’s arable land, reducing the national maize output by 30 percent and rendering 2.8 million people food-insecure. In the following year, the El-Niño-induced drought rendered an additional 6.7 million people food insecure. The negative impact on economic growth was significant, with the average annual real GDP growth rate dropping to just 2.6 percent in 2015-2016, down from an average of 6.1 percent over the preceding decade.13 Furthermore, in the context of food scarcity and declining export receipts, domestic inflation rose from single digits to an annual average over 20 percent from 2012, before declining steadily to single digits in 2018. 10 Analysis of data from the third Integrated Household Survey found that an estimated 32.5 percent of households in Malawi have very low food security. 11 Malawi presents 238 people/km2 of agricultural land—compared to an average level of 53 people/km2 in neighboring countries (World Bank, 2017). 12 GFDRR, 2009, and MVAC, 2016. 13 A slowdown in actual GDP growth during the flooding and drought may become a persistent phenomenon to the extent that the destruction of arable land and other non-produced assets can deteriorate the potential GDP growth in the long run. 42 77. Natural disasters undermine fiscal performance both by reducing the Government’s revenue and increasing expenditure needs. Domestic revenue is directly affected by the contraction in economic activity caused by climate shocks. In addition, expenditures on emergency and reconstruction measures are required to cope with the social and economic consequences of natural disasters. In particular, policy responses often include subsidies to SOEs to buy and sell maize, and support to the Strategic Maize Reserve, aimed at mitigating food insecurity among the most vulnerable groups. As budget deficits widen, there is generally the expectation that foreign aid will be made available to fund the gap. However, a number of high-profile cases of financial mismanagement, including the Cashgate scandal in 2013, have reduced the willingness of donors to provide on-budget grants. Thus, the Government must often resort to increase domestic borrowing, as was the case following the floods and droughts in 2015-2016. State-Owned Enterprises 78. It is difficult to assess State-Owned Enterprises’ (SOEs) operational and financial performance and their associated fiscal risks due to the lack of publicly-available information on their financial statements and activities.14 Arguably, the lack of information and transparency regarding the financial conditions of major SOEs reinforces concerns about the fiscal risks associated with SOEs, with this lack of transparency in itself being a risk factor. Transparent reporting on SOEs would strengthen their oversight and financial management while also allowing for better assessment of the associated fiscal risks (See Annex 2 for a further discussion of key SOEs’ financial situations).15 79. Most SOEs face serious liquidity shortfalls due to the significant accumulation of receivables in arrears (trade debtors), which erodes working capital. Even those SOEs that record after-tax profits and positive gross profit margins may be characterized by a weak liquidity position. This is the result of wide- spread arrears in receivables, with a large proportion of public institutions, companies, and households failing to pay bills on time (if at all). For instance, the total value of public institutions’ arrears to Electricity Supply Corporation of Malawi Limited (ESCOM) is estimated at MWK 10 billion, while the value of arrears to Blantyre Water Board (BWB) is estimated at MWK 2 billion. With insufficient operational cash inflows, SOEs resort to expensive overdraft facilities extended by commercial banks or loans from other SOEs. Some SOEs, including ESCOM and BWB, even defer the payment of their tax obligations and trade payables (i.e., they incur in arrears with the Government and suppliers).16 By mid-2018, the value of ESCOM’s tax arrears reportedly stood at MWK 1.5 billion and BWB’s at MWK 2 billion, with another three SOEs having a combined total of MWK 9 billion. To put these tax arrears in perspective, it is worth noting that total tax payments made by all SOEs in FY2017 stood around MWK 9.3 billion – less than the value of the tax arrears owed by those five SOEs. 14 There is no regular reporting by SOEs to the MoFEPD on their operational and financial performance, including investment and borrowing activity. This constrains the capacity of MoFEPD to discharge its responsibilities for monitoring and (fiscal) oversight of public companies. 15 Ongoing separate work carried out for the World Bank’s Maximizing Finance for Development (MFD) initiative will provide deeper analysis of SOE issues. 16 Some SOEs do not pay their tax obligations and thus it is unclear whether they comply with the MoFEDP regulation set in FY2017 concerning remittances of dividends to the budget. The regulation establishes that profit- oriented entities pay dividends in an amount equivalent to 40 percent of after-tax profits (if any), and sub-vented entities pay dividends as 100 percent of after-tax profits (if any). Deviations from these standard dividend rates are allowed, but the criteria for granting them are not clearly established. Facing tight liquidity constraints, SOEs are probably reluctant to pay dividends to the budget: In FY2017, total statutory dividends were nearly MWK 17 billion but only around MWK 6 billion were actually paid to the Government. 43 80. Cross debts between SOEs complicate their financial performance and liquidity . SOEs frequently provide goods and services to each other. Often, they cannot meet their mutual payables and receivables. For instance, since ESCOM and the Electricity Generation Company (EGENCO) were unbundled in January 2017, the former built up payables in arrears to a value of MWK 21 billion owed to the latter. While EGENCO was recording pre-tax profits, it still experienced a liquidity squeeze that had to be managed by securing a bank overdraft, with the associated costs. In turn, ESCOM has receivables in arrears from SOEs operating in the water sector. BWB, for example, agreed to settle a backlog of unpaid electricity bills owed to ESCOM by MWK 2 billion per month. Water SOEs also struggle to collect their own receivables. Reportedly, the Lilongwe Water Board (LWB) had MWK 9.5 billion in unpaid bills, of which one-third was owed by public institutions. 81. The poor solvency conditions and liquidity challenges experienced by SOEs lead to the emergence of a number of fiscal risks. In view of the persistent losses and high insolvency risks experienced by major companies such as ESCOM and BWB, the Government may have to further support them by providing budget resources (e.g., above-the-line subsidies or below-the-line on-lending or capital injections). In the case of SOEs that are solvent but holding a tight liquidity position, the Government may have to continue to provide guarantees to facilitate access to bank overdraft facilities or other mechanisms to secure short-term liquidity. 82. The lack of detailed information on the operational and financial performance of most SOEs makes it difficult to quantify the emerging fiscal risks. The size of the costs associated with providing potential support to keep SOEs running, and the likelihood of such support actually taking place, is difficult to assess without detailed and accurate financial statements and business plans. Given the current situation of a number of major SOEs, there is the risk that these liabilities will be absorbed into the Government’s own books, thus becoming Government debt. Overly-optimistic Economic Growth and Revenue Forecasts 83. Budget forecasts of GDP growth and revenue have often been over-optimistic. Macroeconomic and revenue forecasting performance is generally weak in Malawi. This is probably not just a result of optimistic biases, but more fundamentally, a reflection of the underlying economic reality, which is extremely volatile. In this regard, the difficulties inherent to accelerating the pace of economic progress in a country facing frequent shocks have led to a tendency for the Government to systematically overestimate growth and revenue prospects, even in the short term. 84. Forecasting errors related to GDP growth and revenues are significant . Discrepancies between budget forecasts and actual real GDP growth are often large, with an average annual growth forecast error of 1.8 p.p. in the period from FY2012-FY2018 and reaching nearly 4 p.p. in two years, FY2012 and FY2016 (see Figure 2.7). In addition, optimistic economic growth forecasts lead to significant overestimations of domestic revenues. Grant forecasts are also regularly over-estimated. The average annual grant forecast error stood at MWK 30 billion in the period from FY2012 to FY2018, and reaching to almost MWK 150 billion in FY2014 (see Figure 2.8).17 17 Since 1990, external aid declined abruptly in four occasions: In 1992, donors withheld aid to apply pressure for the adoption of a multiparty system; in 2001, 2010, and 2013, donors withheld aid due to loss of confidence in the Government’s ability to manage the economy. 44 Figure 2.7. Real GDP Growth (%, FY) Figure 2.8. Grants (MWK billion, FY) Budget Forecasts and Actuals Baseline Forecasts and Actuals 12 12 Actual Budget Actual Budget 10 10 8 8 6 6 4 4 2 2 0 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: World Bank staff calculations, Malawi Annual Economic Review, MoFEPD data 85. In a context of expenditure rigidities, failing to reliably forecast growth and revenues may further exacerbate fiscal imbalances. Forecasting errors lead to revenue shortfalls and thus an inability to fund expenditure allocations authorized in budgets. In the context of rigidities in expenditure policy, there are often political and institutional factors opposed to the downward adjustment (or at least, rationalization) of public expenses in cases where these revenue shortfalls occur. Thus, revenue shortfalls often lead to higher-than-expected budget deficits (relative to the deficit expected at the budget planning stage).18 Thus, fiscal imbalances are fueled by both overly-optimistic expectations regarding revenues and the inability to adapt expenditures once shortfalls in revenues become apparent. 86. Fiscal risks emerge as a result of poor forecasting of economic growth and revenues. Given sizable revenue shortfalls and the inability to adjust expenditures in order to attain the budgeted fiscal deficit, there is a significant risk that public-finance outcomes will deviate from those envisaged in budget documents. The historical record of revenue forecast errors can help formulate an assessment of the possible magnitudes of revenue shortfalls and their associated probabilities. In the risk scenarios in this section, the average forecast error for real GDP growth (1.8 p.p.) is used to calibrate a reasonable ‘shock’ on expected economic growth that reflects weaknesses in forecasting capacity. Weak public financial management and arrears 87. Weak public financial management (PFM) has also contributed to fiscal indiscipline. The 2013 Cashgate scandal revealed significant shortcomings in PFM systems, in which US$ 50 million was stolen through the national payment system. Since that time, the Government has worked to rebuild confidence in systems, with stronger monitoring and expenditure and commitment controls. Weak expenditure and commitment controls, as well as transactions taking place off of IFMIS, have contributed to over- expenditure and arrears in recent years. Slippages can also result from a shortfall in resources and unplanned expenditures undertaken during the year. Expenditure on arrears clearance has weighed 18 Weaknesses in the Government’s commitment controls and bank reconciliation processes aggravate the management of expenditures. Expenditure overruns when the budget is executed are partly due to the lack of sound controls on commitments and payments. The problems are particularly acute in election years, where the political cycle pushes for additional expenditures. 45 heavily on fiscal policy in recent years, amounting to an average of 1.3 percent of GDP each fiscal year since FY2012/13. Decentralization is increasing. While this could help improve local service delivery, it will also test PFM systems at the local level and creating an attendant risk. Financial sector 88. Shocks within the financial sector can also pose significant fiscal risks. Although less frequent than macroeconomic shocks, shocks within the financial sector can be a major source of risk to public finances. Over the past two decades, the RBM has been recapitalized twice. In 2008, this led to borrowing to a value of 4.3 percent of GDP in FY2007/08. Again following the 2012 exchange rate devaluation, it led to borrowing to a value of 2.3 percent of GDP in FY2013/14. In 2016 two weak commercial banks (Malawi Savings Bank and Indebank) were sold and recapitalized. These expenditures were included in both domestic financing and debt, increasing the debt service burden and reducing space for much-needed infrastructure and social expenditure. Public Private Partnerships (PPPs) 89. While PPPs may play a vital role in developing and financing infrastructure, they can also present fiscal risks. For the Government to achieve its economic growth and development agenda, the development of infrastructure is vital. With the limited availability of public financing, PPPs have been identified as an important means for developing and financing infrastructure. While the number of PPPs that have been implemented so far is limited, there are several large pipeline projects, mainly in the energy, water, and education sectors. PPPs need to be carefully evaluated to ensure that they deliver value for money, including through a proper assessment of associated fiscal costs and contingent liabilities. 5) Baseline, Shocks, and Stronger Reform Scenarios A baseline scenario 90. The baseline scenario for FY2019-FY2025 evaluates the performance of fiscal balances and public debt, assuming current fiscal policies continue (see Table 2.2). The baseline scenario assumes current fiscal policies continue, particularly those defined under the MGDSIII and ECF, and robust growth in the next few years. The underlying macroeconomic forecasts reflect information available at the end of 2018 and are slightly more conservative than those presented in the Debt Sustainability Analysis conducted jointly by the International Monetary Fund (IMF) and the World Bank Group (WBG), published in November 2018. Fiscal forecasts are based on preliminary budget outturns for FY2018. 91. The macroeconomic outlook reflects a strong economic recovery. It projects robust output growth and a steady disinflation over the medium term. Real GDP growth is expected to accelerate from 4.5 percent FY2019 to 6.0 percent by FY2025. Prudent fiscal and monetary policies committed to under the ECF are expected to support domestic disinflation, with GDP deflator inflation projected to decrease from 7.2 percent in FY2019 to 5.2 percent in FY2022 and to hover around this level thereafter. A mild depreciation of the real exchange rate is expected over the medium-term. By FY2020, revenues are expected to recover to the levels recorded prior to the natural disasters of 2015-2016, to reach and remain at around 22.3 percent of GDP (see Table 2.2). Expenditures are expected to decline slightly to 26.5 percent of GDP by FY2020, remaining below 27 percent of GDP in subsequent years. Significant budget 46 imbalances will persist over the medium term, with the average fiscal deficit in FY2019-FY2025 projected to reach 4.4 percent of GDP, down from 6.2 percent in FY2015-FY2018. 92. The public debt-to-GDP ratio will remain high into the medium-term, with current fiscal policies failing to reduce this ratio and to ensure sustainability (see Figure 2.9). In the Baseline Scenario, the lack of significant fiscal adjustment prevents the Government from achieving gains in terms of debt sustainability. The level of public debt will remain at around 60 percent of GDP from FY2019 onwards, with virtually no reduction relative to its current level. Figure 2.9. Baseline Scenario - Public Debt (% of GDP) 10 70 Fiscal Deficit (% of GDP) Public Debt (% of GDP, right) 65 8 WBG projections 60 6 55 4 50 2 45 0 40 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Figure 2.10. Drivers of Debt-to-GDP Ratio (% of GDP and ppts) 5 62 Primary Deficit (p.p.) 4 3 61 Other Funding Needs & Net Acquisition of Fin.Assets (p.p.) 2 Valuation Effect Due To 1 60 Depreciation Against USD (p.p.) 0 Real GDP Growth (p.p.) -1 59 Real Interest Rate (p.p.) -2 -3 58 Other Non-Identified Factors (p.p.) -4 Change in Public Debt-to-GDP -5 57 Ratio (p.p.) Public Debt (% of GDP, right) 2018 2019 2020 2021 2022 2023 2024 2025 Source: MOF and WBG projections 47 Table 2.2. Medium-Term Baseline Scenario for FY2019-FY2025 Figures expressed as percent of GDP, unless otherwise indicated Historical Projections 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 GDP at current prices (MKW billion, fiscal year) 2,877 3,543 4,252 4,889 5,482 6,053 6,629 7,355 8,215 9,151 10,175 GDP at constant prices, annual growth rate (%) 2.9 2.3 4.0 3.5 4.6 4.9 5.2 5.5 5.5 5.7 6.0 GDP deflator, annual growth rate (%) 24.6 20.4 15.4 11.1 7.2 5.3 4.1 5.2 5.9 5.4 4.9 Exchange Rate MKW/USD 499.6 718.0 730.3 732.2 754.7 803.5 849.3 888.3 923.2 957.8 993.7 Real Exchange Rate, Index 2015=100 (1) 100.0 120.8 108.2 99.8 98.2 101.5 105.3 106.9 107.0 107.4 108.4 Revenue 21.2 21.6 23.5 20.8 21.2 22.3 22.3 22.3 22.3 22.3 22.3 Direct Taxes (Tax on Income & Profits) 8.2 8.2 9.1 8.3 8.5 8.9 8.9 8.9 8.9 8.9 8.9 Indirect Taxes (Taxes on G&S and Int'l Trade) 8.2 7.8 9.2 8.9 9.3 9.1 9.1 9.1 9.1 9.1 9.1 Grants (2) 2.8 3.7 3.5 1.4 1.5 2.5 2.5 2.5 2.5 2.5 2.5 Non-Tax Revenue (3) 2.0 1.9 1.8 2.2 1.9 1.9 1.9 1.9 1.9 1.9 1.9 Expenditure 27.5 27.4 28.2 28.5 26.5 26.5 26.5 26.7 26.6 26.7 26.6 Wages and Salaries 6.8 6.4 6.2 6.5 7.0 7.0 7.0 7.0 7.0 7.0 7.0 Goods and Services 5.5 5.7 5.9 6.7 6.5 6.1 6.1 6.1 6.1 6.1 6.1 Subsidies and Transfers 4.8 4.8 3.8 5.1 4.5 4.5 4.5 4.5 4.5 4.5 4.5 Arrears Payments 1.1 2.5 1.4 1.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Interest Payments 4.0 4.0 4.4 3.9 3.3 3.7 3.7 3.9 3.8 3.9 3.8 Development Expenditure (4) 5.3 4.1 6.5 4.7 5.2 5.2 5.2 5.2 5.2 5.2 5.2 Primary Balance -2.4 -1.9 -0.3 -3.8 -2.0 -0.5 -0.5 -0.5 -0.5 -0.5 -0.5 Overall Balance -6.3 -5.8 -4.7 -7.7 -5.3 -4.2 -4.2 -4.4 -4.3 -4.4 -4.3 Gross Borrowing Requirements 7.2 11.9 5.9 17.9 11.3 8.0 8.7 7.1 14.4 10.9 10.2 Overall Balance (+ indicates deficit) 6.3 5.8 4.7 7.7 5.3 4.2 4.2 4.4 4.3 4.4 4.3 Amortizations Payments 0.9 6.1 1.5 10.2 6.0 3.9 4.5 2.7 10.1 6.5 5.9 Other Funding Needs 0.0 0.0 -0.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Net Acquisition of Fin.Assets 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Borrowing Sources 7.2 11.9 5.9 17.9 11.3 8.0 8.7 7.1 14.4 10.9 10.2 Issuance of Domestic Debt (% share) (6) 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 Issuance of External Debt (% share) 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 Public Debt 51.3 60.8 61.0 60.8 60.5 60.9 61.6 61.3 60.3 59.6 59.1 Domestic Debt 25.9 26.5 26.9 27.3 27.8 28.5 27.1 26.8 26.7 External Debt 35.1 34.3 33.6 33.6 33.8 32.7 33.2 32.8 32.4 Notes: (1) Real exchange rate defined as the MKW/USD bilateral exchange rate times the ratio between int'l prices and domestic GDP deflator. (2) Includes program grants, project grants, and other grants. (3) Net of tax refunds and arrears collection. (4) Includes net lending. (5) Excludes net lending. (6) Includes domestic debt issued to rollover maturing short-term liabilities. Source: World Bank projections. Shocks scenarios 93. There are substantial fiscal risks to the baseline that have detrimental effects on debt sustainability. The Baseline Scenario formulated in the previous section pointed to a relatively weak fiscal and debt outlook for the next few years. Under this scenario, budget deficits are expected to remain at around 4.4 percent of GDP, while public debt is expected to remain above 60 percent of GDP, declining only marginally to 59 percent by FY2025. However, the occurrence of shocks associated with the risks described in earlier sections could further deteriorate these prospects, undermining the sustainability of current policies and public debt. 94. To assess the potential impact of these shocks, five alternative scenarios are developed in this section. These scenarios respectively assess 1) the impact of natural disaster events; 2) contingent 48 liabilities; 3) lower economic growth; 4) higher borrowing costs on domestic Government securities; and 5) multiple shocks occurring. These scenarios, with estimates of the potential impacts, are outlined in Table 2.3 and discussed further below. Table 2.3. Risk Scenarios. Assumptions on Size and Timing of Shocks. Timing of Size of Shock Scenario Shock Natural 3 p.p. reduction in annual growth rate of real GDP FY2020 and Disaster 5 p.p. increase in annual growth rate of GDP deflator (as a proxy for FY2021 inflation) 15 p.p. increase in the annual rate of currency depreciation US$50 million emergency relief expenses (recorded in acquisition of goods and services) Contingent 0.3 p.p. of GDP increase in subsidies to SOEs (recorded above-the-line) FY2020 and Liability 0.6 p.p. of GDP (MWK 37 billion) additional funding needs (recorded FY2021 below-the-line and included in the gross borrowing requirements) Lower 1.8 p.p. reduction in annual growth rate of real GDP FY2020 to Growth FY2025 Higher 5 p.p. increase in interest rates charged on medium- to long-term FY2020 to Domestic domestic Government securities and other debts FY2025 Borrowing Costs Multiple 1.8 p.p. reduction in annual growth rate of real GDP in FY2020-25, See Shocks with an additional 1.2 p.p. reduction in FY2020 and FY2021 due to reference in adverse weather each shock 5 p.p. increase in annual growth rate of GDP deflator (as a proxy for inflation) and 15 p.p. increase in the annual rate of currency depreciation in FY2020 and FY2021 5 p.p. increase in interest rates on medium- to long-term domestic Government securities and other debts in FY2020-25 US$50 million emergency relief expenses in FY2020 and FY2021 MWK 37 billion additional funding needs in FY2020 and FY2021 Risk Scenario 1 - Natural Disaster Scenario 95. A natural disaster could result in a significant slowdown to growth and require increased public spending to cope with emergency relief and reconstruction. This scenario assumes a natural disaster occurs in FY2020-FY2021, and impacts economic activity, domestic prices, the exchange rate, and expenditure on goods and services. The size and timing of the corresponding shocks are calibrated to broadly replicate the experience of flooding and drought in 2015-2016, particularly the deviations to growth and inflation relative to their historical trends (see Annex 1). Real GDP declines by 3 p.p. of GDP relative to the baseline for FY2020 and FY2021. This scenario also includes additional emergency relief 49 expenses amounting to US$ 50 million per year in FY2020-FY2021, which would assume the Government takes on a substantial proportion of recovery and reconstruction expenditure. 96. Fiscal and debt performance will weaken as a consequence of this shock (see Figures 2.14 and 2.15). Driven by the additional emergency relief expenses, fiscal deficits increase by about 1.2 p.p. of GDP relative to the Baseline Scenario in FY2020-FY2021. In subsequent years, debt service obligations associated with the additional indebtedness also lead to higher deficits, which exceed those in the Baseline Scenario by 0.2 to 0.4 p.p. of GDP, due to interest payments and additional borrowings Eventually, public debt increases rapidly from 61 percent of GDP in FY2018 to 72 percent by FY2021, declining only to 68 percent by FY2025. Adverse weather can therefore weaken Malawi’s growth potential and prevent current policies from stabilizing Government debt, thus undermining fiscal sustainability. Risk Scenario 2 - Contingent liabilities 97. Contingent liabilities stemming from loss-making SOEs may turn into explicit public debt. A Contingent Liability Scenario introduces a call of guarantees and other financial assistance provided by the Government to SOEs unable to absorb losses or to repay their own obligations. Financial support of this type is assumed to be required in FY2020-FY2021 and to lead to additional subsidies and funding needs (recorded above- and below-the-line, respectively). The cost of the corresponding shocks amounts to MWK 19 billion (or about 0.3 percent of GDP) per year in annual subsidies and MWK 37 billion (0.6 percent of GDP) per year in financial assistance, with this figure reflecting a fairly conservative estimate of the exposure of the Government to major SOEs’ insolvency risk (see Annex 2). As a historical reference, the cost of the bailout of ADMARC amounted to MWK 45 billion in FY2017. This bailout resulted from ADMARC’s difficulties to repay commercial loans for maize purchases—which, in turn, were created as a response to the natural disasters and food shortages. Additionally, this broader risk scenario, totaling around 1.8 percent of GDP, could be considered in light of the recent RBM recapitalization, which led to increased borrowing amounting to 2.3 percent of GDP. 98. The realization of contingent liabilities would lead to a modest deterioration of public debt (see Figures 2.14 and 2.15). Funding support to SOEs would increase fiscal deficits by 0.4 p.p. of GDP in FY2021 and remain 0.2 p.p. of GDP higher through FY2025 due to the interest payments associated with the additional levels of debt. Gross borrowings also increase because of higher deficits and amortization payments. Public debt reaches 63 percent of GDP by FY2021 and exceeds 60 percent of GDP in subsequent years. Contingent liabilities may then weaken the Malawi’s debt position, even under a more robust growth performance than in the Baseline Scenario. Risk Scenario 3 - Lower Growth 99. Lower GDP growth and revenues would aggravate budget imbalances, particularly in the context of expenditure rigidities. A Lower Growth Scenario contemplates a conservative outlook for economic growth and fiscal revenues. Specifically, the real GDP growth rate is assumed to be 1.8 p.p. lower than in the Baseline Scenario from FY2020 to FY2025. Such a significant, persistent loss of growth recognizes the difficulties of accelerating the pace of economic progress in Malawi, and the tendency for the government to consistently overestimate GDP growth and revenues. In addition, the Lower Growth Scenario acknowledges the rigidities of expenditure policy, due to political and institutional factors opposing downward adjustments to, or at least, the rationalization of, public expenses in cases where sizable revenue shortfalls occur. Specifically, this Scenario assumes all primary (i.e., non-interest) expenditures are maintained unchanged in nominal terms relative to the Baseline Scenario, despite the lower growth of GDP and revenues. 50 100. If economic and revenue growth falters and expenditure rigidities prevail, Malawi’s public finances would ostensibly become unsustainable (see Figures 2.14 and 2.15). While a combined slowdown in GDP and revenues maintains the revenue-to-GDP ratio unchanged, expenditure rigidities lead to an increase in the primary expenditure-to-GDP ratio. As a consequence, in the Lower Growth Scenario, fiscal deficits steadily increase throughout the medium term to reach 6.3 percent of GDP by FY2025—which implies an unsustainable path for public finances. Gross borrowing requirements widen, worsening the exposure to rollover risk. Liquidity pressures on local banks and other holders of Government debt would also be a concern in terms of preserving financial stability and avoiding crowding out effects. In turn, public debt is projected to increase steadily, from 61 percent of GDP in FY2018 to nearly 70 percent by FY2025, with no prospect of stabilization due to the growing budget imbalances. Therefore, failing to achieve a robust GDP growth and not adjusting public expenditure in cases where revenue shortfalls occur can undermine fiscal sustainability in the medium-term. Risk Scenario 4 - Higher Domestic Borrowing Costs 101. Domestic borrowing costs can potentially significantly reduce budget resources for priority spending. A Higher Domestic Borrowing Costs Scenario introduces higher-than-expected interest rates on new securities and other debts held by local banks to be issued in FY2020-FY2021 to meet funding needs. This Scenario assumes medium- to long-term domestic liabilities carry an annual, nominal interest rate of 20 percent, compared to the recent rate of 15 percent that is reflected in the Baseline Scenario (see Annex 3). Given the sizable gross borrowing requirements covered with domestic sources of funds, shocks to interest rates can increase the interest bill and thus largely absorb budget resources. 102. Malawi’s public finances will also become unsustainable if domestic borrowing costs exceed their current levels (Figures 2.14 and 2.15). Fiscal deficits and public debt projected in the Higher Domestic Borrowing Costs Scenario resemble those obtained in the Lower Growth Scenario. Driven by an increasing interest bill and total expenditure-to-GDP ratio, the budget imbalances widen steadily and reach nearly 6 percent of GDP by FY2025—ostensibly, a trend at odds with sustainable public finances. Gross borrowing requirements and exposure to rollover risk increase relative to the Baseline Scenario. Public debt is then expected to grow continuously and to reach 65 percent by FY2025, with no prospect of stabilization afterwards either. Malawi’s policy objective of preserving fiscal sustainability cannot be achieved in an environment of expensive costs of domestic borrowing. Risk Scenario 5 - Multiple Shocks 103. An adverse event in which the preceding four shocks feed off each other could be devastating for Malawi’s economy and public finances. A Multiple Shocks Scenario contemplates an extreme event when all shocks discussed earlier occur jointly. This Scenario therefore recognizes the correlations and feedback effects between natural disasters, economic activity, and performance of public finances and SOEs. Thus, in an overall context of low potential growth (as observed in historical experience and reflected in the persistent shock to real GDP growth), the occurrence of a natural disaster will undermine the operational and financial conditions of SOEs (who would require support from the Government, as reflected in the contingent-liability shock) and tighten financial costs of Government debt (represented by a shock to domestic borrowing costs). In view of the recent flooding and drought, the bailout of ADMARC, and the increasing burden of domestic Government debt, it warrants both an assessment of the fiscal effects and a recognition of a possible repetition in the future. 104. The combination of low potential growth, natural disasters, bailout of SOEs, and tighter financial conditions would put Malawi’s public finances on an unsustainable path (see Figures 2.14 and 51 2.15). In the Multiple Shocks Scenario, the annual fiscal deficits significantly widen and average 6.3 percent of GDP in FY2020-FY2025, compared to an average of 4.3 percent of GDP projected in the Baseline Scenario. In turn, public debt is expected to grow explosively and to reach 80 percent of GDP by FY2025, as opposed to the stable debt ratio projected in the Baseline Scenario. Therefore, preserving fiscal sustainability in the medium-term would be impossible if multiple risks occur simultaneously. The plausibility of this scenario is indicated by how these events have actually occurred in recent years. Risk Scenarios – Summary of potential impacts 105. Risk scenarios are presented below to assess the impact of potential shocks on the economy (see Figures 2.11 – 2.12). Public debt could reach 72 percent of GDP by FY2021 if a natural disaster similar to the most recent floods and droughts were to occur in FY2020-FY2021 and the government covers substantial costs. The realization of contingent liabilities and financial assistance to SOEs comparable to the bailout of the Agricultural Development and Marketing Corporation (ADMARC) repeated over two years has a smaller, but sustained impact, with public debt reaching 63 percent of GDP. Even more adverse results would occur if persistently weaker growth in line with the average real GDP growth rate from FY2011-FY2018 occurred, in which case public debt would reach 70 percent of GDP by FY2025. A higher cost of domestic borrowing also has a substantial impact, increasing debt to 65 percent of GDP by FY2025. In these circumstances, the fiscal deficit is expected to steadily widen throughout the medium term, and public debt would embark on an ever-increasing path. The multiple shock scenario assumes that all of the adverse shocks materialize concurrently, with these feeding off each other, and leading to unsustainable public finances – debt would grow explosively, reaching 80 percent of GDP by 2025. These scenarios show that fiscal sustainability is barely maintained under the baseline scenario, and that it could be severely undermined by any shock affecting Malawi’s economy and public finances. Figure 2.11. Fiscal Deficit, All Scenarios Figure 2.12. Public Debt, All Scenarios (% of GDP) (% of GDP) 10 Baseline 90 WBG Projections Baseline WBG Projections Natural Disaster Natural Disaster Contingent Liability 85 Contingent Liability 9 Lower Growth Lower Growth Higher Domestic Borrowing Costs 80 Higher Domestic Borrowing Costs 8 Multiple Shocks Multiple Shocks 75 7 70 6 65 5 60 4 55 3 50 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Source: World Bank Staff calculations based MOF data Source: World Bank Staff calculations based MOF data and and WB projections WB projections A strong reforms scenario 106. The model was used to consider a stronger reform scenario relative to the baseline. While the baseline scenario assumes continuing fiscal policies, stronger fiscal consolidation will be needed to 52 achieve debt sustainability and to mitigate the effects of shocks on public finances. Expected fiscal deficits in the baseline scenario are projected to be lower than in recent years, but they will still not enable the Government to lower public debt to sustainable levels. In addition, as the Shock Scenarios demonstrate, macroeconomic and fiscal shocks – which are likely to occur – have the potential to result in further deterioration to public finances, leading to unsustainable budget imbalances and public debt. In this regard, additional revenue and expenditure measures to improve expected fiscal and debt outcomes during normal times, have the additional effect of mitigating the impacts of shocks if and when they occur. In other words, a budget consolidation may serve not only to restore sustainability, but also to help build resilience to manage fiscal risks. 107. A strong reform scenario considers one where the Government undertakes an ambitious fiscal consolidation effort to increase the primary surplus to 0.5 percent of GDP from FY2020. An explicit primary balance target could help to reduce budget deficits and public debt, if and when the target is achieved. A primary surplus target of 0.5 percent of GDP from FY2020 onwards, if achieved, would help achieve debt sustainability by reducing public debt to 53 percent of GDP by FY2025. Achieving this target would significantly improve performance relative to the Baseline Scenario, with the average fiscal deficit in FY2020-FY2025 falling to 3.1 percent of GDP (compared to 4.3 percent without the fiscal target); and with public debt falling to 53 percent of GDP by FY2025 (while it remains roughly unchanged without the fiscal target) (see Figures 2.13 and 2.14). 108. While fiscal consolidation required under this scenario is large, it is not impossible to achieve. The strong reform scenario entails a move from a projected primary deficit of 2.0 percent of GDP in FY2018/19, to a primary surplus of 0.5 percent of GDP in FY2020—a 2.5 percent of GDP adjustment. While this will be difficult to achieve, there are various potential expenditure measure the Government can consider. These include reducing expenditures related to election-related goods and services and transfers after FY2018/19, particularly travel and security expenditures. These measures alone could free up more than 1 percent of GDP. Additional efforts to contain the wage bill and pensions at FY2016/17 levels could reduce spending from about 8.8 percent of GDP in FY2018/19 to 7.4 percent, an additional saving of 1.4 percent of GDP. Last but not least, ensuring effective commitment controls and strengthening the transparency of procurement could further enhance the efficiency of public expenditure and thereby help generate additional savings. 109. This fiscal consolidation and primary-balance target would support debt sustainability even in the event of large shocks hitting the economy, thereby enabling it to mitigate fiscal risks. For instance, if the additional fiscal consolidation is achieved and a large shock to real GDP growth materializes (as in the Lower Growth Scenario), public debt would stabilize at the same level as the baseline, decreasing slightly to 59 percent of GDP by FY2025. This compares to an increase of up to 70 percent of GDP without the fiscal target (see Figures 2.13 and 2.14). In the event of several shocks occurring (as in the Multiple Shocks Scenario, which includes multiple natural disasters, lower economic activity, and the bailout of SOEs) a small primary balance target would help avoid placing the country on an explosive, unsustainable path. If the fiscal target is achieved and this scenario materializes, the average annual fiscal deficit in FY2020-FY2025 would be maintained at 4.4 percent of percent of GDP—compared to 6.8 percent without the fiscal target. In addition, public debt would increase to only 71 percent of GDP by FY2025, compared to nearly 84 percent of GDP with no fiscal target (see Figure 2.13 and 2.14). Overall, in order for Malawi to preserve fiscal sustainability in the medium term while actively managing fiscal risks similar to those experienced in the recent years, fiscal policy must be recalibrated to achieve a budget consolidation, which could be support by a tight primary surplus target. 53 Figure 2.13. Fiscal Deficit in Selected Scenarios Figure 2.14. Public Debt in Selected Scenarios w/ w/ and w/o Primary Balance Target (PBT) and w/o PBT Percent of GDP Percent of GDP 9 85 WBG Projections Baseline WBG Projections 8 Lower Growth 80 Multiple Shocks 7 Baseline with PBT 75 Lower Growth with PBT 6 Multiple Shocks with PBT 5 70 4 65 Baseline 3 Lower Growth 60 2 Multiple Shocks Baseline with PBT 55 1 Lower Growth with PBT Multiple Shocks with PBT 0 50 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Source: World Bank Staff calculations based MOF data and Source: World Bank Staff calculations based MOF data and WB projections WB projections 6) Conclusion and Recommendations 110. Malawi’s fiscal imbalances and macroeconomic instability have resulted in a significant public debt burden. Over the past decade, public debt has almost doubled and currently exceeds 60 percent of GDP, higher than almost any other peer country. This creates serious vulnerabilities for Malawi. The Government’s financial obligations are sizable and it should make every effort to reduce them going forward. Continued access to concessional credit from official creditors supports debt management. The public debt portfolio is moderately exposed to currency risk due to the predominance of foreign loans, while its domestic securities are exposed to significant rollover and interest rate risks. 111. This chapter analyzed fiscal and debt sustainability over the medium term under a baseline scenario, shocks scenario, and a strong reform scenario. The Baseline Scenario suggests that fiscal imbalances are expected to continue (albeit at slightly lower levels than in recent years), even in a context of rapid growth and disinflation. Under this scenario, public debt would remain at its current level, without improving sustainability. These results suggest that additional measures to generate revenue and control expenditure must be introduced to achieve the Government’s objectives of promoting growth while reducing budget imbalances and avoiding excessive levels of debt. 112. The shocks scenarios highlight substantial risks to the baseline that have detrimental effects on debt sustainability. Economic and fiscal volatility result from recurrent external and domestic shocks, including adverse weather events; contingent liabilities and the necessity to provide financial assistance to SOEs; unrealistic growth and revenue forecasts; and expenditure overruns. The Shocks Scenarios indicate how a range of different shocks have the potential to severely undermine the already suboptimal performance that might be expected if current policies are effectively implemented. With no change in current policies, the occurrence of natural disasters or lower than expected rates of economic growth could result in public debt reaching 70 percent of GDP. The prospects for public finances are even more dire under scenarios that assume simultaneous occurrence of more than one of these shocks, in which case public debt could potentially reach up to 80 percent of GDP and continue to increase on an explosive 54 trajectory. Policy challenges therefore emerge not only from the need to strengthen fiscal sustainability but also from the necessity to manage fiscal risks effectively and reduce exposure to shocks hitting Malawi’s economy and public finances. 113. A stronger reform scenario demonstrated how critical it is for Malawi to plan for potential fiscal risks and build fiscal buffers over time. Continuing current policies (as in the baseline scenario) would not be sufficient to maintain fiscal sustainability. This scenario considered one where the Government undertakes an ambitious fiscal consolidation effort to increase the primary surplus to 0.5 percent of GDP from FY2020 from a projected primary deficit of 2 percent in FY2019. Such an effort (in the absence of shocks) would reduce public debt to 53 percent of GDP by FY2025, from 59 percent of GDP under the baseline scenario, significantly improving Malawi’s prospective fiscal and debt performance. Furthermore, by achieving a primary surplus of 0.5 percent of GDP, the impact of any projected shock on the fiscal deficit and debt would be significantly lower than without this target. 114. While fiscal consolidation required under this scenario is large, it is not impossible to achieve. The strong reform scenario entails a move from a projected primary deficit of 2.0 percent of GDP in FY2018/19, to a primary surplus of 0.5 percent of GDP in FY2020—a 2.5 percent of GDP adjustment. While this will be difficult to achieve, there are various potential expenditure measures the Government can consider. This includes reducing expenditures that were elevated due to election-related pressures after FY2018/19, particularly travel and security expenditures, which could free up more than 1 percent of GDP. Additional efforts to contain the wage bill and pensions at FY2016/17 levels would also present additional saving of 1.4 percent of GDP. Last but not least, implementing effective commitment controls would avoid the accumulation of arrears that could derail fiscal discipline, while increasing transparency related to procurement could also increase the efficiency of expenditure. 115. Building resilience to shocks can pay high returns on investment. Considerable physical and economic costs from natural disasters can adversely impact fiscal and external balances, yet investments in mitigation and/or adaptation are low, and there is limited implementation of resilience and Disaster Risk Management (DRM) strategies. However, in 2019, recent years’ investments in resilience already paid off when measures to adjust water flows from the Kamuzu barrage reduced the impact of flooding. Early warning system can save lives and property through increased preparedness for the pending disaster, while infrastructure that functions during and after a disaster reduces the loss of life and property and reduces the need for reconstruction. 116. The various scenario analyses above underscore that Malawi needs to implement a comprehensive strategy to manage fiscal risks and ensure fiscal/debt sustainability over the medium term. Several measures are central to such a strategy:  The Government must enforce stronger fiscal discipline. Maintaining current policies alone is unlikely to sustainably reduce debt over the medium term, even if growth gradually increases. This means that stronger reform is needed, which will allow Malawi to build fiscal buffers in good times and draw down in bad times (such as when weather shocks and disasters hit). See chapter 1 for specific discussion of measures to consolidate expenditure. One initial key fiscal anchor could be a primary balance surplus target of 0.5 percent of GDP.  The Government should continue developing a framework for effective fiscal risk management. This process began in FY2017/18 and is ongoing. The MoFEPD should continue to actively identify, analyze, and monitor the sources, potential magnitude, and probability of fiscal risks in a fiscal risk statement, which should be incorporated into planning and budgeting documents. MoFEPD should maintain and gradually expand a database of fiscal risks, as well as continually deepen the analysis of these risks. Moreover, it should identify measures to mitigate and manage fiscal risks. 55  The Government should actively seek to reduce vulnerability to contingent liabilities. Strengthening oversight and financial transparency of SOEs is a critical part of ensuring fiscal sustainability. The value of financial resources under the control of SOEs is substantial, as is their capital expenditure, especially in the energy and water sectors. The PFM Act lays out reporting requirements by statutory bodies and associated deadlines, which the government should strictly enforce, as well as regular audits of financial statements. In doing so, it should: o Clarify related roles and responsibilities related to SOE oversight within the MoFEPD (particularly for the Public Enterprise Reform Monitoring Unit (PERMU)), the Office of President and Cabinet (OPC), and related line ministries. Ongoing revisions to the PFM Act can formalize PERMU’s role and the Government should ensure sufficient technical capacity in the unit. o It should also expand the published financial information on SOEs, and any associated potential fiscal risks. The ongoing review of the PFM Act offers an opportunity to require SOEs to publish audited financial statements. In addition to individual SOE reports, the MoFEPD through PERMU should prepare a consolidated annual financial report across SOEs (which can identify key trends and risks) and submit this to Parliament. o The Government should be transparent regarding the creation of potential contingent liabilities, particularly establishing appropriate and transparent policies for granting guarantees to SOEs, to avoid excessive risk-taking and moral hazard behavior. The Government should ensure that guarantees are systematically evaluated for their appropriateness, cost-effectiveness, and potential fiscal impact, and should ensure they are cleared through a centralized authorization point. It could consider capping the size of guarantees to limit the Government’s risk exposure, or also consider applying risk- based guarantee fees, which can help offset adverse selection issues. Moreover, it should maintain a central registry of guarantees, which is regularly reported to Parliament. o Likewise, while PPPs can play a valuable role in delivering services, they may also create significant potential fiscal risks. In a context where the Government is likely to increasingly resort to PPPs to support the development of much-needed infrastructure, increased transparency on public-private partnerships (PPPs) will needed. The Government should ensure centralized control for approving PPPs and subject projects to careful appraisal including value for money checks, feasibility studies, and fully assessing for fiscal risks. It should further ensure it maintains a central registry of PPP commitments.  Investing more in addressing weather shocks and promoting resilience will reduce vulnerability to shocks. Over the medium term, direct interventions to improve resilience are critical to reducing shocks to the economy and therefore maintaining fiscal sustainability. Such interventions would include investing in agriculture and irrigation, strengthening flood and drought forecasting, building more effective early warning and DRM systems, as well as scaling up social safety nets. Additional steps such as investments in energy and transport, and improvements in the business environment could encourage private investment, making the economy resilient to shocks and diversifying the sources of fiscal revenues. 56 Annex 1: Historical External and Internal shocks Table A.1: Malawi’s economy has been affected by numerous external shocks and policy-induced shocks over the past 27 years Year(s) Weather/global External aid shock Policy-induced shock Overall fiscal Inflation Interest rates economic shock balance (% GDP (yoy % (eop, comp. incl. grants) change in 91 day T-bill) CPI) 2018- Tropical Cyclone Idai FY 2017/18 fiscal slippages which included 2017/18: -7.8 2018: 9.2 2018: 11.4 19 2019 ADMARC bailout (1% of GDP); one-off 2018/19*: -5.8 2019*: 8.9 2019: N/A securitization of arrears dating back to FY2013 (1.2% percent of GDP); lower than expected revenue and grants (1% of GDP) 2013- Heavy floods in 2015 Donor grants resumed in Theft of public funds discovered in second 2013/14: -5.5 2013: 28.3 2013: 32.3 16 followed by drought FY2012/13, but the on- half of 2013; FY14/15 fiscal slippages 2% of 2014/15: -5.7 2014: 23.8 2014: 26.8 in 2016 budget share declined GDP; unplanned recruitment of 10,500 2015/16: -6.1 2015: 21.9 2015: 24.2 significantly after teachers, unbudgeted wage increase (1.25% 2016: 23.9 “Cashgate” of GDP) 2010- Significant decline in donor IMF program off track, exchange rate policy 2009/10: 0.2 2010: 7.4 2010: 6.2 12 grants in response to misaligned; significant foreign exchange 2010/11: -2.0 2011: 7.6 2011: 7.7 unsustainable policies: shortages 2011/12: -4.9 2012: 1.3 2012: 20.0 grants declined from 10.3% of GDP in 2009/10 to 3.1% of GDP in 2011/12 2008- ToT shock - fertilizer Elections in May 2009; loosened monetary 2008/09: -4.6 2008: 8.7 2008: 13.4 09 bid prices almost 51 and fiscal policies 2009: 8.4 2009: 7.1 percent higher than budgeted 2001- Drought - maize External budgetary Bad policy decision about sale of entire 2000/01: -4.5 2001: 27.4 2001: 45.7 03 output declined by financing delayed due to reserve stock; expenditure in FY00/01 3.5% 2001/02: -5.6 2002: 14.7 2002: 36.1 1/3 in 2001 - maize policy slippages above programmed; parastatals bailout, civil 2002/03: -6.4 2003: 9.6 2003: 33.1 operation equivalent service wages augmented, increase in low- 2003/04: -4.3 to 3% of GDP in priority spending such as travel and 2002/03 budget representation; during FY02/03-03/04, expenditure in excess of 5% of GDP over 57 Table A.1: Malawi’s economy has been affected by numerous external shocks and policy-induced shocks over the past 27 years Year(s) Weather/global External aid shock Policy-induced shock Overall fiscal Inflation Interest rates economic shock balance (% GDP (yoy % (eop, comp. incl. grants) change in 91 day T-bill) CPI) program; government domestic debt doubled during this period 1997- Spending overruns, teacher recruitment, 1997/98: -5.1 1997: 9.1 1997: 19.2 98 slackened revenue performance; in FY97/98, 1998: 29.8 1998: 42.2 expenditure slippages led to spending of 4.25% of GDP in excess of program; 47% increase in civil service wages 1994 Severe drought in Massive election-related budget overruns in 1993/94: -4.0 34.7 40.6 1993/94 crop season all Ministries in Q1 of FY1994/95; sizable 1994/95: -11.4 unbudgeted expenditure, salaries raised, severe labor unrest; free primary education introduced, 12,000 new teachers hired, overspending financed by Reserve Bank of Malawi 1992 Severe drought in Donors cut back non- Labor unrest due to low increase in minimum 1992/93: -8.5 23.2 20.4 Q1, 67% decline in humanitarian aid by 3.7% wage, still average rise in wages and salaries maize output of GDP from earlier >50% in the economy, monetary compared to projections (asking for accommodation previous year multi-party government) Source: IMF Article IV reports for various years during 1990 to 2018; World Bank Malawi Economic Monitor (MEM) reports (various editions), Country Environmental Analysis (2019). * World Bank staff estimate based on MFMod 58 Annex 2: SOE Financial Information According to the Annual Economic Report, the most problematic of Malawi’s SOEs is the Electricity Supply Commission of Malawi (ESCOM). ESCOM ran significant losses in FY2014 and FY2015 (with an average annual after-tax loss of nearly MWK 40 billion) and tiny profits in FY2016 and FY2017 (averaging just MWK 7 billion). With reduced hydropower generation, the high cost of financing, and lagging tariff adjustments, ESCOM is unlikely to have generated a profit in FY2018. Past losses and recurrent indebtedness have led ESCOM to be highly leveraged, with a debt-to-equity ratio expected to reach 270 percent in this year. Furthermore, insufficient revenue and mounting receivables in arrears are squeezing liquidity, leading to a declining current assets-to-current liabilities ratio. Blantyre Water Board (BWB) has systematically run losses. In the period from FY2014 to FY2017, the average annual pre-tax loss amounted to MWK 5 billion. The proportion of non-revenue water remains at around 40 percent, with this high proportion resulting from technical losses, including old pipes, non- metered connections, and illegal connections. Efforts to contain non-revenue water and two improve water infrastructure are expected to help BWB attain a small profit in FY2018. The company’s leverage peaked in FY2015 (with debt-to-equity ratio above 400 percent) with a steady decline since then, although it remains elevated at around 100 percent in FY2017. Similar to ESCOM, insufficient revenue and significant receivables in arrears are squeezing BWB’s liquidity position. In FY2017, BWB’s current liabilities exceeded current assets by MWK 13 billion. The Agricultural Development and Marketing Corporation (ADMARC) is also in a fragile situation, as the recent bailout demonstrates. ADMARC plays a fundamental role in implementing agricultural policies and market regulation, with a social and political role that heavily influences (and often distorts) its commercial operations. It oversees the Strategic Maize Reserve, which is an arrangement that both mitigates food-insecurity risk and constitutes a fiscal risk in itself. ADMARC ran losses of MWK 22 billion in FY2017, with the Government funding a bailout to a value of MWK 45 billion as a result of the difficulties it was experiencing repaying maize purchase loans. 59 Annex 3: Risk Scenarios Natural Disasters Historical Projections 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 GDP at current prices (MKW billion, fiscal year) 2,877 3,543 4,252 4,889 5,482 6,159 6,868 7,620 8,510 9,480 10,541 GDP at constant prices, annual growth rate (%) 2.9 2.3 4.0 3.5 4.6 1.9 2.2 5.5 5.5 5.7 6.0 GDP deflator, annual growth rate (%) 24.6 20.4 15.4 11.1 7.2 10.3 9.1 5.2 5.9 5.4 4.9 Exchange Rate MKW/USD 499.6 718.0 730.3 732.2 754.7 924.0 1123.2 1174.8 1220.9 1266.7 1314.2 Real Exchange Rate, Index 2015=100 (1) 100.0 120.8 108.2 99.8 98.2 111.5 126.9 128.7 128.9 129.4 130.6 Revenue 21.2 21.6 23.5 20.8 21.2 22.3 22.3 22.3 22.3 22.3 22.3 Direct Taxes (Tax on Income & Profits) 8.2 8.2 9.1 8.3 8.5 8.9 8.9 8.9 8.9 8.9 8.9 Indirect Taxes (Taxes on G&S and Int'l Trade) 8.2 7.8 9.2 8.9 9.3 9.1 9.1 9.1 9.1 9.1 9.1 Grants (2) 2.8 3.7 3.5 1.4 1.5 2.5 2.5 2.5 2.5 2.5 2.5 Non-Tax Revenue (3) 2.0 1.9 1.8 2.2 1.9 1.9 1.9 1.9 1.9 1.9 1.9 Expenditure 27.5 27.4 28.2 28.5 26.5 27.6 27.8 26.9 26.9 27.0 27.0 Wages and Salaries 6.8 6.4 6.2 6.5 7.0 7.0 7.0 7.0 7.0 7.0 7.0 Goods and Services 5.5 5.7 5.9 6.7 6.5 7.3 7.3 6.1 6.1 6.1 6.1 Subsidies and Transfers 4.8 4.8 3.8 5.1 4.5 4.5 4.5 4.5 4.5 4.5 4.5 Arrears Payments 1.1 2.5 1.4 1.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Interest Payments 4.0 4.0 4.4 3.9 3.3 3.7 3.8 4.1 4.1 4.2 4.2 Development Expenditure (4) 5.3 4.1 6.5 4.7 5.2 5.2 5.2 5.2 5.2 5.2 5.2 Primary Balance -2.4 -1.9 -0.3 -3.8 -2.0 -1.7 -1.7 -0.5 -0.5 -0.5 -0.5 Overall Balance -6.3 -5.8 -4.7 -7.7 -5.3 -5.3 -5.5 -4.6 -4.6 -4.7 -4.7 Gross Borrowing Requirements 7.2 11.9 5.9 17.9 11.3 9.2 10.3 7.8 14.9 11.5 11.2 Overall Balance (+ indicates deficit) 6.3 5.8 4.7 7.7 5.3 5.3 5.5 4.6 4.6 4.7 4.7 Amortizations Payments 0.9 6.1 1.5 10.2 6.0 3.9 4.8 3.2 10.3 6.8 6.5 Other Funding Needs 0.0 0.0 -0.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Net Acquisition of Fin.Assets 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Borrowing Sources 7.2 11.9 5.9 17.9 11.3 9.2 10.3 7.8 14.9 11.5 11.2 Issuance of Domestic Debt (% share) (6) 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 Issuance of External Debt (% share) 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 Public Debt 51.3 60.8 61.0 60.8 60.5 65.8 71.9 71.2 69.8 68.7 67.8 Domestic Debt 25.9 26.5 26.9 27.8 29.0 29.9 28.7 28.7 28.7 External Debt 35.1 34.3 33.6 38.0 43.0 41.4 41.1 40.1 39.1 Notes: (1) Real exchange rate defined as the MKW/USD bilateral exchange rate times the ratio between int'l prices and domestic GDP deflator. (2) Includes program grants, project grants, and other grants. (3) Net of tax refunds and arrears collection. (4) Includes net lending. (5) Excludes net lending. (6) Includes domestic debt issued to rollover maturing short-term liabilities. Source: World Bank projections. 60 Contingent Liability Historical Projections 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 GDP at current prices (MKW billion, fiscal year) 2,877 3,543 4,252 4,889 5,482 6,053 6,629 7,355 8,215 9,151 10,175 GDP at constant prices, annual growth rate (%) 2.9 2.3 4.0 3.5 4.6 4.9 5.2 5.5 5.5 5.7 6.0 GDP deflator, annual growth rate (%) 24.6 20.4 15.4 11.1 7.2 5.3 4.1 5.2 5.9 5.4 4.9 Exchange Rate MKW/USD 499.6 718.0 730.3 732.2 754.7 803.5 849.3 888.3 923.2 957.8 993.7 Real Exchange Rate, Index 2015=100 (1) 100.0 120.8 108.2 99.8 98.2 101.5 105.3 106.9 107.0 107.4 108.4 Revenue 21.2 21.6 23.5 20.8 21.2 22.3 22.3 22.3 22.3 22.3 22.3 Direct Taxes (Tax on Income & Profits) 8.2 8.2 9.1 8.3 8.5 8.9 8.9 8.9 8.9 8.9 8.9 Indirect Taxes (Taxes on G&S and Int'l Trade) 8.2 7.8 9.2 8.9 9.3 9.1 9.1 9.1 9.1 9.1 9.1 Grants (2) 2.8 3.7 3.5 1.4 1.5 2.5 2.5 2.5 2.5 2.5 2.5 Non-Tax Revenue (3) 2.0 1.9 1.8 2.2 1.9 1.9 1.9 1.9 1.9 1.9 1.9 Expenditure 27.5 27.4 28.2 28.5 26.5 26.8 26.9 26.8 26.8 26.8 26.8 Wages and Salaries 6.8 6.4 6.2 6.5 7.0 7.0 7.0 7.0 7.0 7.0 7.0 Goods and Services 5.5 5.7 5.9 6.7 6.5 6.1 6.1 6.1 6.1 6.1 6.1 Subsidies and Transfers 4.8 4.8 3.8 5.1 4.5 4.8 4.8 4.5 4.5 4.5 4.5 Arrears Payments 1.1 2.5 1.4 1.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Interest Payments 4.0 4.0 4.4 3.9 3.3 3.7 3.8 4.0 4.0 4.0 4.0 Development Expenditure (4) 5.3 4.1 6.5 4.7 5.2 5.2 5.2 5.2 5.2 5.2 5.2 Primary Balance -2.4 -1.9 -0.3 -3.8 -2.0 -0.8 -0.8 -0.5 -0.5 -0.5 -0.5 Overall Balance -6.3 -5.8 -4.7 -7.7 -5.3 -4.5 -4.6 -4.5 -4.5 -4.5 -4.5 Gross Borrowing Requirements 7.2 11.9 5.9 17.9 11.3 8.9 9.7 7.4 14.8 11.2 10.7 Overall Balance (+ indicates deficit) 6.3 5.8 4.7 7.7 5.3 4.5 4.6 4.5 4.5 4.5 4.5 Amortizations Payments 0.9 6.1 1.5 10.2 6.0 3.9 4.6 2.9 10.3 6.6 6.2 Other Funding Needs 0.0 0.0 -0.3 0.0 0.0 0.6 0.5 0.0 0.0 0.0 0.0 Net Acquisition of Fin.Assets 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Borrowing Sources 7.2 11.9 5.9 17.9 11.3 8.9 9.7 7.4 14.8 11.2 10.7 Issuance of Domestic Debt (% share) (6) 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 Issuance of External Debt (% share) 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 Public Debt 51.3 60.8 61.0 60.8 60.5 61.8 63.3 63.0 62.1 61.4 60.9 Domestic Debt 25.9 26.5 26.9 27.9 29.0 29.7 28.3 28.0 27.8 External Debt 35.1 34.3 33.6 33.8 34.3 33.3 33.8 33.4 33.0 Notes: (1) Real exchange rate defined as the MKW/USD bilateral exchange rate times the ratio between int'l prices and domestic GDP deflator. (2) Includes program grants, project grants, and other grants. (3) Net of tax refunds and arrears collection. (4) Includes net lending. (5) Excludes net lending. (6) Includes domestic debt issued to rollover maturing short-term liabilities. Source: World Bank projections. 61 Lower Growth Historical Projections 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 GDP at current prices (MKW billion, fiscal year) 2,877 3,543 4,252 4,889 5,482 5,949 6,404 6,984 7,667 8,395 9,176 GDP at constant prices, annual growth rate (%) 2.9 2.3 4.0 3.5 4.6 3.1 3.4 3.7 3.7 3.9 4.2 GDP deflator, annual growth rate (%) 24.6 20.4 15.4 11.1 7.2 5.3 4.1 5.2 5.9 5.4 4.9 Exchange Rate MKW/USD 499.6 718.0 730.3 732.2 754.7 803.5 849.3 888.3 923.2 957.8 993.7 Real Exchange Rate, Index 2015=100 (1) 100.0 120.8 108.2 99.8 98.2 101.5 105.3 106.9 107.0 107.4 108.4 Revenue 21.2 21.6 23.5 20.8 21.2 22.3 22.3 22.3 22.3 22.3 22.3 Direct Taxes (Tax on Income & Profits) 8.2 8.2 9.1 8.3 8.5 8.9 8.9 8.9 8.9 8.9 8.9 Indirect Taxes (Taxes on G&S and Int'l Trade) 8.2 7.8 9.2 8.9 9.3 9.1 9.1 9.1 9.1 9.1 9.1 Grants (2) 2.8 3.7 3.5 1.4 1.5 2.5 2.5 2.5 2.5 2.5 2.5 Non-Tax Revenue (3) 2.0 1.9 1.8 2.2 1.9 1.9 1.9 1.9 1.9 1.9 1.9 Expenditure 27.5 27.4 28.2 28.5 26.5 26.7 27.0 27.5 27.8 28.2 28.6 Wages and Salaries 6.8 6.4 6.2 6.5 7.0 7.1 7.2 7.4 7.5 7.6 7.8 Goods and Services 5.5 5.7 5.9 6.7 6.5 6.1 6.1 6.1 6.1 6.1 6.1 Subsidies and Transfers 4.8 4.8 3.8 5.1 4.5 4.6 4.7 4.7 4.8 4.9 5.0 Arrears Payments 1.1 2.5 1.4 1.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Interest Payments 4.0 4.0 4.4 3.9 3.3 3.7 3.8 4.1 4.2 4.4 4.6 Development Expenditure (4) 5.3 4.1 6.5 4.7 5.2 5.2 5.2 5.2 5.2 5.2 5.2 Primary Balance -2.4 -1.9 -0.3 -3.8 -2.0 -0.7 -0.9 -1.1 -1.3 -1.5 -1.8 Overall Balance -6.3 -5.8 -4.7 -7.7 -5.3 -4.4 -4.7 -5.2 -5.5 -6.0 -6.3 Gross Borrowing Requirements 7.2 11.9 5.9 17.9 11.3 8.4 9.5 8.1 16.5 13.3 13.2 Overall Balance (+ indicates deficit) 6.3 5.8 4.7 7.7 5.3 4.4 4.7 5.2 5.5 6.0 6.3 Amortizations Payments 0.9 6.1 1.5 10.2 6.0 3.9 4.7 2.9 11.0 7.3 6.9 Other Funding Needs 0.0 0.0 -0.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Net Acquisition of Fin.Assets 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Borrowing Sources 7.2 11.9 5.9 17.9 11.3 8.4 9.5 8.1 16.5 13.3 13.2 Issuance of Domestic Debt (% share) (6) 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 Issuance of External Debt (% share) 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 Public Debt 51.3 60.8 61.0 60.8 60.5 62.2 64.3 65.7 66.6 68.0 69.8 Domestic Debt 25.9 26.5 26.9 27.9 29.2 30.9 30.5 31.4 32.6 External Debt 35.1 34.3 33.6 34.3 35.1 34.8 36.1 36.6 37.2 Notes: (1) Real exchange rate defined as the MKW/USD bilateral exchange rate times the ratio between int'l prices and domestic GDP deflator. (2) Includes program grants, project grants, and other grants. (3) Net of tax refunds and arrears collection. (4) Includes net lending. (5) Excludes net lending. (6) Includes domestic debt issued to rollover maturing short-term liabilities. Source: World Bank projections. 62 Higher Domestic Borrowing Costs Historical Projections 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 GDP at current prices (MKW billion, fiscal year) 2,877 3,543 4,252 4,889 5,482 6,053 6,629 7,355 8,215 9,151 10,175 GDP at constant prices, annual growth rate (%) 2.9 2.3 4.0 3.5 4.6 4.9 5.2 5.5 5.5 5.7 6.0 GDP deflator, annual growth rate (%) 24.6 20.4 15.4 11.1 7.2 5.3 4.1 5.2 5.9 5.4 4.9 Exchange Rate MKW/USD 499.6 718.0 730.3 732.2 754.7 803.5 849.3 888.3 923.2 957.8 993.7 Real Exchange Rate, Index 2015=100 (1) 100.0 120.8 108.2 99.8 98.2 101.5 105.3 106.9 107.0 107.4 108.4 Revenue 21.2 21.6 23.5 20.8 21.2 22.3 22.3 22.3 22.3 22.3 22.3 Direct Taxes (Tax on Income & Profits) 8.2 8.2 9.1 8.3 8.5 8.9 8.9 8.9 8.9 8.9 8.9 Indirect Taxes (Taxes on G&S and Int'l Trade) 8.2 7.8 9.2 8.9 9.3 9.1 9.1 9.1 9.1 9.1 9.1 Grants (2) 2.8 3.7 3.5 1.4 1.5 2.5 2.5 2.5 2.5 2.5 2.5 Non-Tax Revenue (3) 2.0 1.9 1.8 2.2 1.9 1.9 1.9 1.9 1.9 1.9 1.9 Expenditure 27.5 27.4 28.2 28.5 26.9 27.1 27.4 27.8 27.9 28.1 28.1 Wages and Salaries 6.8 6.4 6.2 6.5 7.0 7.0 7.0 7.0 7.0 7.0 7.0 Goods and Services 5.5 5.7 5.9 6.7 6.5 6.1 6.1 6.1 6.1 6.1 6.1 Subsidies and Transfers 4.8 4.8 3.8 5.1 4.5 4.5 4.5 4.5 4.5 4.5 4.5 Arrears Payments 1.1 2.5 1.4 1.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Interest Payments 4.0 4.0 4.4 3.9 3.7 4.3 4.6 5.0 5.1 5.3 5.3 Development Expenditure (4) 5.3 4.1 6.5 4.7 5.2 5.2 5.2 5.2 5.2 5.2 5.2 Primary Balance -2.4 -1.9 -0.3 -3.8 -2.0 -0.5 -0.5 -0.5 -0.5 -0.5 -0.5 Overall Balance -6.3 -5.8 -4.7 -7.7 -5.7 -4.8 -5.1 -5.5 -5.6 -5.8 -5.9 Gross Borrowing Requirements 7.2 11.9 5.9 17.9 11.7 8.8 9.7 8.3 16.0 12.7 12.3 Overall Balance (+ indicates deficit) 6.3 5.8 4.7 7.7 5.7 4.8 5.1 5.5 5.6 5.8 5.9 Amortizations Payments 0.9 6.1 1.5 10.2 6.0 3.9 4.6 2.9 10.4 7.0 6.5 Other Funding Needs 0.0 0.0 -0.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Net Acquisition of Fin.Assets 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Borrowing Sources 7.2 11.9 5.9 17.9 11.7 8.8 9.7 8.3 16.0 12.7 12.3 Issuance of Domestic Debt (% share) (6) 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 Issuance of External Debt (% share) 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 Public Debt 51.3 60.8 61.0 60.8 60.9 61.9 63.4 64.0 64.1 64.5 65.0 Domestic Debt 25.9 26.5 27.2 28.0 29.1 30.5 29.8 30.2 30.7 External Debt 35.1 34.3 33.7 33.9 34.3 33.6 34.3 34.3 34.3 Notes: (1) Real exchange rate defined as the MKW/USD bilateral exchange rate times the ratio between int'l prices and domestic GDP deflator. (2) Includes program grants, project grants, and other grants. (3) Net of tax refunds and arrears collection. (4) Includes net lending. (5) Excludes net lending. (6) Includes domestic debt issued to rollover maturing short-term liabilities. Source: World Bank projections. 63 Multiple Shocks Historical Projections 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 GDP at current prices (MKW billion, fiscal year) 2,877 3,543 4,252 4,889 5,482 6,159 6,868 7,490 8,222 9,003 9,841 GDP at constant prices, annual growth rate (%) 2.9 2.3 4.0 3.5 4.6 1.9 2.2 3.7 3.7 3.9 4.2 GDP deflator, annual growth rate (%) 24.6 20.4 15.4 11.1 7.2 10.3 9.1 5.2 5.9 5.4 4.9 Exchange Rate MKW/USD 499.6 718.0 730.3 732.2 754.7 924.0 1123.2 1174.8 1220.9 1266.7 1314.2 Real Exchange Rate, Index 2015=100 (1) 100.0 120.8 108.2 99.8 98.2 111.5 126.9 128.7 128.9 129.4 130.6 Revenue 21.2 21.6 23.5 20.8 21.2 22.3 22.3 22.3 22.3 22.3 22.3 Direct Taxes (Tax on Income & Profits) 8.2 8.2 9.1 8.3 8.5 8.9 8.9 8.9 8.9 8.9 8.9 Indirect Taxes (Taxes on G&S and Int'l Trade) 8.2 7.8 9.2 8.9 9.3 9.1 9.1 9.1 9.1 9.1 9.1 Grants (2) 2.8 3.7 3.5 1.4 1.5 2.5 2.5 2.5 2.5 2.5 2.5 Non-Tax Revenue (3) 2.0 1.9 1.8 2.2 1.9 1.9 1.9 1.9 1.9 1.9 1.9 Expenditure 27.5 27.4 28.2 28.5 26.9 28.1 28.3 28.0 28.4 29.0 29.4 Wages and Salaries 6.8 6.4 6.2 6.5 7.0 6.9 6.8 6.9 7.0 7.1 7.2 Goods and Services 5.5 5.7 5.9 6.7 6.5 7.3 7.3 6.1 6.1 6.1 6.1 Subsidies and Transfers 4.8 4.8 3.8 5.1 4.5 4.4 4.3 4.4 4.5 4.6 4.7 Arrears Payments 1.1 2.5 1.4 1.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Interest Payments 4.0 4.0 4.4 3.9 3.7 4.3 4.7 5.4 5.7 6.0 6.2 Development Expenditure (4) 5.3 4.1 6.5 4.7 5.2 5.2 5.2 5.2 5.2 5.2 5.2 Primary Balance -2.4 -1.9 -0.3 -3.8 -2.0 -1.5 -1.3 -0.3 -0.5 -0.7 -0.9 Overall Balance -6.3 -5.8 -4.7 -7.7 -5.7 -5.8 -6.0 -5.7 -6.2 -6.7 -7.1 Gross Borrowing Requirements 7.2 11.9 5.9 17.9 11.7 10.3 11.6 9.2 17.1 14.3 14.9 Overall Balance (+ indicates deficit) 6.3 5.8 4.7 7.7 5.7 5.8 6.0 5.7 6.2 6.7 7.1 Amortizations Payments 0.9 6.1 1.5 10.2 6.0 4.0 4.9 3.5 11.0 7.6 7.8 Other Funding Needs 0.0 0.0 -0.3 0.0 0.0 0.6 0.6 0.0 0.0 0.0 0.0 Net Acquisition of Fin.Assets 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Borrowing Sources 7.2 11.9 5.9 17.9 11.7 10.3 11.6 9.2 17.1 14.3 14.9 Issuance of Domestic Debt (% share) (6) 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 Issuance of External Debt (% share) 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 Public Debt 51.3 60.8 61.0 60.8 60.9 67.2 74.4 75.7 76.7 78.2 80.2 Domestic Debt 25.9 26.5 27.2 28.8 30.7 32.7 32.8 34.2 35.8 External Debt 35.1 34.3 33.7 38.4 43.7 43.1 43.9 44.0 44.4 Notes: (1) Real exchange rate defined as the MKW/USD bilateral exchange rate times the ratio between int'l prices and domestic GDP deflator. (2) Includes program grants, project grants, and other grants. (3) Net of tax refunds and arrears collection. (4) Includes net lending. (5) Excludes net lending. (6) Includes domestic debt issued to rollover maturing short-term liabilities. Source: World Bank projections. 64 Baseline with Primary Balance Target Historical Projections 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 GDP at current prices (MKW billion, fiscal year) 2,877 3,543 4,252 4,889 5,482 6,053 6,629 7,355 8,215 9,151 10,175 GDP at constant prices, annual growth rate (%) 2.9 2.3 4.0 3.5 4.6 4.9 5.2 5.5 5.5 5.7 6.0 GDP deflator, annual growth rate (%) 24.6 20.4 15.4 11.1 7.2 5.3 4.1 5.2 5.9 5.4 4.9 Exchange Rate MKW/USD 499.6 718.0 730.3 732.2 754.7 803.5 849.3 888.3 923.2 957.8 993.7 Real Exchange Rate, Index 2015=100 (1) 100.0 120.8 108.2 99.8 98.2 101.5 105.3 106.9 107.0 107.4 108.4 Revenue 21.2 21.6 23.5 20.8 21.2 22.3 22.3 22.3 22.3 22.3 22.3 Direct Taxes (Tax on Income & Profits) 8.2 8.2 9.1 8.3 8.5 8.9 8.9 8.9 8.9 8.9 8.9 Indirect Taxes (Taxes on G&S and Int'l Trade) 8.2 7.8 9.2 8.9 9.3 9.1 9.1 9.1 9.1 9.1 9.1 Grants (2) 2.8 3.7 3.5 1.4 1.5 2.5 2.5 2.5 2.5 2.5 2.5 Non-Tax Revenue (3) 2.0 1.9 1.8 2.2 1.9 1.9 1.9 1.9 1.9 1.9 1.9 Expenditure 27.5 27.4 28.2 28.5 26.5 25.5 25.4 25.4 25.3 25.3 25.1 Wages and Salaries 6.8 6.4 6.2 6.5 7.0 7.0 7.0 7.0 7.0 7.0 7.0 Goods and Services 5.5 5.7 5.9 6.7 6.5 6.1 6.1 6.1 6.1 6.1 6.1 Subsidies and Transfers 4.8 4.8 3.8 5.1 4.5 3.5 3.5 3.5 3.5 3.5 3.5 Arrears Payments 1.1 2.5 1.4 1.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Interest Payments 4.0 4.0 4.4 3.9 3.3 3.7 3.6 3.7 3.5 3.5 3.3 Development Expenditure (4) 5.3 4.1 6.5 4.7 5.2 5.2 5.2 5.2 5.2 5.2 5.2 Primary Balance -2.4 -1.9 -0.3 -3.8 -2.0 0.5 0.5 0.5 0.5 0.5 0.5 Overall Balance -6.3 -5.8 -4.7 -7.7 -5.3 -3.2 -3.1 -3.2 -3.0 -3.0 -2.8 Gross Borrowing Requirements 7.2 11.9 5.9 17.9 11.3 7.0 7.5 5.6 12.8 9.2 8.1 Overall Balance (+ indicates deficit) 6.3 5.8 4.7 7.7 5.3 3.2 3.1 3.2 3.0 3.0 2.8 Amortizations Payments 0.9 6.1 1.5 10.2 6.0 3.9 4.4 2.4 9.8 6.2 5.2 Other Funding Needs 0.0 0.0 -0.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Net Acquisition of Fin.Assets 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Borrowing Sources 7.2 11.9 5.9 17.9 11.3 7.0 7.5 5.6 12.8 9.2 8.1 Issuance of Domestic Debt (% share) (6) 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 Issuance of External Debt (% share) 25.0 25.0 25.0 25.0 25.0 25.0 25.0 25.0 Public Debt 51.3 60.8 61.0 60.8 60.5 59.9 59.5 58.2 56.2 54.5 52.9 Domestic Debt 25.9 26.5 26.9 26.5 26.3 26.3 24.2 23.3 22.6 External Debt 35.1 34.3 33.6 33.4 33.2 31.9 32.0 31.2 30.4 Notes: (1) Real exchange rate defined as the MKW/USD bilateral exchange rate times the ratio between int'l prices and domestic GDP deflator. (2) Includes program grants, project grants, and other grants. (3) Net of tax refunds and arrears collection. (4) Includes net lending. (5) Excludes net lending. (6) Includes domestic debt issued to rollover maturing short-term liabilities. Source: World Bank projections. 65 References Bridges, Kate, and Michael Woolcock. 2017. “How (Not) to Fix Problems That Matter: Assessing and Responding to Malawi’s History of Institutional Reform.” World Bank Working Paper (8289). De Renzio, Paolo. 2009. Taking Stock-what Do PEFA Assessments Tell Us about PFM Systems Across Countries?: Overseas Development Institute London. Government of Malawi. 2018. Report on the Evaluation of the Public Financial Management System in Malawi. PEFA Assessment 2018. Lilongwe, Malawi. Government of Malawi, Ministry of Finance, Economic Planning, and Economic Development, 2011- 2019, Approved Financial Statements. Various editions. Lilongwe, Malawi. 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