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Cover Art Work Credit: Ellis Singano Cover design, interior design: Piotr Ruczynski, London, United Kingdom Typesetting: Piotr Ruczynski, London, United Kingdom Wojciech Wolocznik, Cambridge, United Kingdom CONTENTS Acknowledgements   7 Abbreviations    8 Overview   9 1 Economic Developments    15 1.1 Global and Regional Contexts    16 Major economies are experiencing a marked economic slowdown, giving rise to worries of a global recession     16 1.2 Recent Economic Developments    19 Malawi’s macroeconomic crisis is worsening, as sustained imbalances are exacerbated by external shocks    19 The ongoing balance-of-payments crisis has led to a sharp contraction of imports     24 Headline inflation has risen to its highest level since June 2013    27 Despite some progress toward fiscal consolidation, budget discipline remains a challenge     29 Malawi’s public debt is in distress, but the Government is restructuring some debt to ensure medium-term sustainability     31 The spread between the official and market exchange rates has widened again, while foreign reserves remain low     34 The rise in the policy rate has not resulted in lower inflation, which remains primarily supply-driven     35 Bolstered by high levels of government borrowing, the banking sector has performed well despite wider macroeconomic challenges     36 1.3 Medium-Term Economic Outlook    38 Policy Options: Reducing macroeconomic imbalances, supporting the recovery of growth and protecting the poor against shocks     39 2 Strengthening Agricultural Commercialization and Rural Labor Markets    42 Improving rural labor market outcomes is key to reducing poverty    43 Rural Malawians engage in a wide range non-farm economic activities both on and off the farm    45 Commercialized smallholder agriculture is an important source of economic growth and job creation     48 Productive alliances play important roles in advancing agricultural commercialization    50 Pathways Forward: Recommendations and considerations for prioritization     52 References    57 BOXES BOX 1.1  Climate change is exacerbating vulnerabilities in BOX 1.5  As MSMEs struggle to grow, financial institutions the Malawian economy    20 are implementing lending programs to support this sector BOX 1.2  The Private Sector Lab: A new approach to with support from the RBM and the World Bank    37 driving agro-industrial transformation in Malawi and BOX 2.1  What is a Commercial Farmer?     44 addressing business concerns     23 BOX 2.2  The importance of adequate finance: the BOX 1.3  What can Malawi do to bolster its reserves?     26 Nsanama Cassava Producers and Marketing Cooperative BOX 1.4  Recent PFM reforms could help improve example     51 management of expenditures and fiscal risk, but will BOX 2.3  The importance of market access: The ACADES require political will for successful implementation     30 Youth Farmer Cooperative example     51 FIGURES FIGURE 1.1  Economic growth prospects have weakened FIGURE 1.21  Debt-servicing costs have been on an substantially...     16 upward trajectory     30 FIGURE 1.2  … while inflation has continued to exceed FIGURE 1.22  Development spending is expected to expectations everywhere    16 increase in FY2022/23    30 FIGURE 1.3  … leading to a global wave of monetary tightening    17 FIGURE 1.23  Malawi’s public debt has grown as fiscal FIGURE 1.4  Different post-pandemic trajectories in deficits have increased     31 Southern Africa     18 FIGURE 1.24  Commercial debt has increased in FIGURE 1.5  Overall economic growth remains weak    19 significance, especially since 2020    31 FIGURE B1.1.1  Losses from climate change can be FIGURE 1.25  Credit to the Government and the private sector    32 mitigated through investments in growth and adaptation    20 FIGURE 1.26  Domestic debt by holder    32 FIGURE 1.6  More than half of all cropland is maize, FIGURE 1.27  Spreads between TT and bureau MWK-US$ groundnuts, and beans…    21 exchange rates continue to widen…    34 FIGURE 1.7  … but soya bean and pigeon pea farmers FIGURE 1.28  …while reserves remain low    34 have seen large gains due to high global prices     21 FIGURE 1.29  The real policy rate has been negative since FIGURE 1.8  The cost of fertilizer subsidies has increased January 2022    35 significantly, but maize production has not     21 FIGURE 1.30  Government borrowing yields have FIGURE 1.9  Rising input costs and foreign exchange increased since March 2022    35 shortages are a strain for businesses     22 FIGURE 1.31  Monetary supply has expanded    35 FIGURE 1.10  Load-shedding has increased the popularity FIGURE 1.32  Financial stability indicators show resilience of solar power systems     23 against economic decline    36 FIGURE 1.11  In the face of severe foreign exchange FIGURE 1.33  Private sector credit is dominated by shortages, imports have declined dramatically    24 personal loans and trading services    36 FIGURE 1.12  The recent import collapse has in particular FIGURE 2.1  Typology of Malawian households    44 impacted non-fuel imports     24 FIGURE 2.2  Medium-sized farms’ share of total crop FIGURE 1.13  Commodity prices are stabilizing at a high level…    25 value in Tanzania increased from 14 to 30 percent in six years    45 FIGURE 1.14  …leading to a decline in Malawi’s terms of trade     25 FIGURE 2.3  Households reporting any member engaged FIGURE 1.15  The long decline in exports    25 in various economic activities or receiving regular income     45 FIGURE 1.16  Outward remittances have increased FIGURE 2.4  Average farming household reported income significantly in the past two years     26 by source     46 FIGURE B1.3.1  In Malawi, aid inflows are still by far the FIGURE 2.5  Types of activities household enterprises are most significant source of foreign exchange    26 engaged in    48 FIGURE 1.17  Inflation has reached the highest levels FIGURE 2.6  Share of household types by IHS wave     49 since 2014     27 FIGURE 2.7  Commercial farming households are heavily FIGURE 1.18  Maize price trends (MWK)    28 concentrated in the North and Central region     50 FIGURE 1.19  Rice price trends (MWK)     28 FIGURE 2.8  AGCOM supported value chains    52 FIGURE 1.20  Changes in poverty rate due to food FIGURE 2.9  Possible pathways for structural inflation of 32 percent    28 transformation in Malawi    53 TABLES TABLE B1.4.1  Government expenditure heatmap     30 TABLE 1.2  Priority policy areas and key actions    40 TABLE 1.1  Fiscal accounts    33 TABLE 2.1  Macroeconomic Indicators    56 7 ACKNOWLEDGEMENTS The Malawi Economic Monitor (MEM) provides an analysis of economic and structural development issues in Malawi. This 16th edition was published in December 2022 and is part of an ongoing series, with future editions to follow twice each year. The publication intends to foster better-informed poli- cy analysis and debate regarding the key challenges that Malawi faces in its endeavor to achieve inclu- sive and sustainable economic growth. This edition of the Malawi Economic Monitor was prepared by Jakob Engel (Senior Country Econo- mist, Task Team Leader), Yumeka Hirano (Economist, co-Task Team Leader), Yalenga Nyirenda (Coun- try Economist), Hayaan Nur (Consultant), Efrem Chilima (Senior Private Sector Specialist), Dipti Thapa (Agriculture Economist), Blessings Botha (Senior Agriculture Economist), and Paavo Eliste (Lead Agri- culture Economist). Chapter 2 benefitted from close collaboration with Todd Benson and Joachim De Weerdt from the International Food Policy Research Institute and draws on the forthcoming Background Paper for the new Malawi Country Economic Memorandum, “Employment options and challenges for rural households in Malawi”. Contributions were also made by William Mwanza (Consultant), Innocent Njati Banda (Consultant), Lina Marcela Cardona (Economist), Nobuo Yoshida (Lead Economist), Besart Avdiu (Economist), Trust Chamukuwa Chimaliro (Senior Financial Management Specialist), Michael Roscitt (Senior Public Sector Specialist), and Paul Welton (Senior Financial Management Specialist). Vivek Suri (Practice Manager, Macroeconomics, Trade and Investment), Hugh Riddell (Country Manag- er, Malawi), Preeti Arora (Operations Manager, Malawi), and Nathan M. Belete (Country Director, Ma- lawi) provided overall guidance. The team wishes to thank Holger Kray (Practice Manger, Agriculture and Food) and William Battaile (Lead Country Economist), as well as the peer reviewers Sashana Whyte (Senior Economist) and Francisco Obreque (Senior Agriculture Specialist) for their constructive inputs. This report benefited from fruitful discussions, comments and information provided by representatives of the Ministry of Finance and Economic Affairs; the Reserve Bank of Malawi; the National Statistical Of- fice; and a number of other Government ministries, departments and agencies. The team would also like to thank representatives of the private sector in Lilongwe and Blantyre for their helpful contributions. Henry Chimbali (External Affairs Officer), Elizabeth Mangani (Team Assistant), and Tinyade Neffie Kumsinda (Team Assistant) provided assistance with external communications, design and additional production support. Peter Kjaer Milne (Consultant) provided editorial support. The findings, interpretations, and conclusions expressed in this publication do not necessarily reflect the views of the World Bank’s Executive Directors or the countries they represent. The report is based on information current as of November 25, 2022. The World Bank team welcomes feedback on the structure and content of the Malawi Economic Mon- itor. Please send comments to Jakob Engel (jengel@wordlbank.org), Yumeka Hirano (yhirano@world- bank.org) or Yalenga Nyirenda (ynyirenda@worldbank.org). 8 ABBREVIATIONS AIP Affordable Input Programme AGCOM Agricultural Commercialization Project DRM Disaster Risk Management ECF Extended Credit Facility EMDEs Emerging Markets and Developing Economies EU European Union FDI Foreign Direct Investment FXB Foreign Exchange Bureau GDP Gross Domestic Product IFC International Finance Corporation IFMIS Integrated Financial Management Information System IFPRI International Food Policy Research Institute IHS Integrated Household Survey IMF International Monetary Fund MEM Malawi Economic Monitor MDA Ministry, Department, and Agency MoFEA Ministry of Finance and Economic Affairs MSME Micro, Small & Medium Enterprises MTDS Medium-Term Debt Strategy NPLs Non-Performing Loans NSO National Statistical Office PDU Presidential Delivery Unit PFM Public Finance Management PFMA Public Finance Management Act POs Producer Organizations RBM Reserve Bank of Malawi ROA Return on Assets ROE Return on Equity TT Telegraphic Transfers US$ United States Dollar VAT Value-Added Tax 9 OVERVIEW Malawi’s macroeconomic crisis is worsening, severely impacting households and the private sector After a tepid rebound in 2021, Malawi’s economy entered another slowdown this year. World Bank estimates suggest that Gross Domestic Product (GDP) growth has slowed to 0.9 percent in 2022, a decline from 2.8 percent in 2021. This constitutes a per-capita GDP contraction of 1.8 percent given annual average population growth of 2.7 percent. External shocks, and in particular the impacts of the Russia- Ukraine war, as well as a worsening balance-of-payments crisis caused by sustained fiscal and external imbalances, are at the core of this recent economic slowdown. Due to adverse weather conditions, agriculture became a drag on growth rather than its principal driver, declining by 1.0 percent relative to 2021. The late onset of the 2021/22 rainy season followed by multiple tropical storms have led to decreased yields for both smallholders and commercial farm- ers. Seasonal production estimates indicate that Malawian farmers harvested 5 percent less maize and 37 percent less tobacco than the average for the three preceding growing seasons. The storms also dam- aged the infrastructure supporting production, including the Kapichira hydroelectrical power plant, which provided about one-third of national capacity and remains offline as of late 2022. Industry in particular has been suffering from pervasive electricity shortages, growing at just 0.9 percent in 2022, while services growth in 2022 is estimated at 1.8 percent. The worsening balance-of-payments crisis has led to an acute foreign exchange shortage, affecting all those producers that import inputs, and causing shortages of fuel and other essential goods. The effects on the retail fuel sector are only the most visible symptom of much wider challenges. The latest World Bank Business Pulse Survey found that, in October 2022, two-thirds of businesses reported a decrease in sales compared with one year earlier and more than three-quarters of businesses consider the unavailabil- ity of foreign exchange as a threat to profitability. In addition, there are reports of organizations that im- port essential commodities, such as the Central Medical Stores Trust, facing shortages of medical supplies. Headline inflation rose to 26.7 percent in October 2022, the highest level since June 2013. The inva- sion of Ukraine by the Russian Federation in February 2022 and the subsequent further rise in global commodity prices contributed to an increase in domestic prices for fuel, fertilizer, cereals and cooking oil. The domestic price of fuel has more than doubled since February 2022, while food inflation soared to 34.5 percent in October 2022. The World Bank’s Macro-Poverty Outlook (October, 2022) estimates that poverty based on the international poverty line of US$2.15/day will increase by 0.5 of a percentage point in 2022, to 71.2 percent. Lower yields and high global and domestic prices are pushing many Malawian families into food insecurity. According to the joint assessment of the IPC Working Group, one in three Malawians is prone to food insecurity and, for the 2022/23 lean season, one in five Malawians will face crisis levels of acute food insecurity. Despite some progress toward fiscal consolidation and debt sustainability, budget discipline remains a challenge Higher government spending during the first half of FY2022/23 widened the fiscal deficit, exert- ing pressure on the Government’s fiscal consolidation plans announced in the FY2022/23 budget. Overview 10 Through the first half of the fiscal year, the fiscal deficit totaled 4.3 percent of GDP, compared to the mid-year target of 3.5 percent of GDP. Despite strong performance on tax collection, revenues overall slightly underperformed the approved target, and together with higher recurrent spending contributed to the widened fiscal deficit. Part of these spending overruns, especially for goods and services, have been caused by external factors such as commodity price increases and the devaluation of the Malawi kwacha, but some are due to a continued lack of budget discipline despite fiscal consolidation efforts. The Government has revised the fiscal deficit for FY2022/23 to 7.0 percent of GDP. If the performance for the first half of the fiscal year is maintained, the fiscal deficit for FY2022/23 is expected to widen fur- ther to 8.6 percent. However, planned expenditure reductions in the mid-year budget could still sig- nificantly narrow the gap between the current fiscal trajectory and the target. Malawi’s public debt is currently assessed to be in distress, but the ongoing implementation of the Government’s debt restructuring strategy means that debt is sustainable on a forward-looking basis. Public debt increased to 64.0 percent of GDP in 2021, up from 54.8 percent of GDP in 2020, and is expected to increase further to 76.6 percent in 2022. Financing of fiscal deficits through domestic resources has led to the accumulation of domestic debt, which increased from 21.9 percent of GDP in 2020 to 31.2 percent of GDP in 2021. A shift in the composition of external debt toward commercial creditors at non-conces- sional terms has increased debt-servicing costs significantly. However, the Government is implement- ing a debt-restructuring strategy with its debt advisors to bring debt onto a sustainable path over the medium term by reducing debt-servicing commitments to commercial creditors. Following a 25 percent devaluation of the Malawi kwacha in May, the spread between the official and market exchange rates has widened once again, while foreign reserves remain low. To align the offi- cial rate with market rates and address foreign exchange shortages, the Reserve Bank of Malawi (RBM) adjusted the official Malawi kwacha-US dollar exchange rate downward by 25 percent in May 2022. However, a divergence between the official rate and foreign exchange bureau cash rates has reemerged and grown to 46 percent by mid-November, surpassing the pre-devaluation level of late May. Gross reserves decreased by more than one-third over the year from US$605 million in August 2021 to US$326 million in October 2022, equivalent to just 1.3 months of import cover. Net reserves have been nega- tive over the past year, and gross reserves have been mainly supported by swaps and medium-term bor- rowing facilities at non-concessional terms. Monetary conditions have been tightened but, in light of the supply-driven nature of inflation, this has not resulted in increased price stability. The RBM raised the policy rate further to 18 percent in October 2022, following an earlier increase from 12 to 14 percent in April 2022. This has contributed to a rise in bank lending rates and monthly average Treasury Bill and Note yields. However, with the real policy rate remaining negative since March, the monetary policy stance has failed to achieve price stability, also reflecting the supply-driven nature of inflation. The banking sector has maintained a strong performance despite the economic challenges facing the country, though this is in part due to its heavy reliance on borrowing by the Government. The main financial stability indicators for the banking sector have mostly been adequate and sufficiently liquid in the first part of 2022. However, especially small and medium enterprises (SMEs) still face sig- nificant constraints in accessing credit and many are unaware of key government support programs. From stabilization to growth: key policy priorities to weather the current crisis and build resilience Amid headwinds in the global economy, Malawi’s economy is projected to show subdued growth and faces considerable downside risks. The economy is projected to grow at 2.2 percent in 2023, an increase relative to 2022 but still significantly lower than its pre-pandemic trajectory. This rate of growth is expected to be driven by a significantly better agricultural season, as well as a gradual recovery in the Overview 11 services and industry sectors. A rapid deterioration of global growth, higher-than-anticipated energy prices, and tighter financing conditions are the primary external risks. Natural disasters and intensi- fying climate-related shocks continue to pose major downside risks to the economic outlook. Other risks include the persistent unavailability of foreign exchange, increasing corporate bankruptcies, ina- bility to access affordable agricultural inputs, and rising poverty and food insecurity in the face of high inflation and weak job creation. The lack of sustained economic growth, along with continued inflationary pressures and recur- rent weather shocks, will make it more difficult to reduce poverty. Meanwhile, any further external shocks and sustained inflation are likely to result in increased poverty and cause rising food insecurity. The increased frequency and severity of shocks related to climate change create additional downside risks and will require a sustained focus on adaptation investments. The World Bank Country Climate Development Report for Malawi finds that climate change shocks could reduce GDP by up to 9 percent by 2030. It could also push another 2 million people into poverty by 2030. However, these impacts can be significantly mitigated by policies and investments supporting adaptation, including in land and for- est restoration and management, in improving the country’s stock of infrastructure to better withstand extreme weather, and by supporting the resilience of households and the private sector. The 16th edition of the Malawi Economic Monitor (MEM) calls for urgent actions to stabilize the econ- omy and enhance growth. As in the previous MEM, this includes addressing three key areas: i) Stabilizing the economy: While some progress is being made, there remains an urgent need for the implementation of the announced macroeconomic reforms, including building foreign reserves, achieving fiscal consolidation goals for the current fiscal year, returning debt to a sustainable path through restructuring, implementing key fiscal governance and public financial manage- ment (PFM) reforms, and continuing the shift toward a more flexible exchange rate regime. ii) Stimulating agricultural export competitiveness and market-driven growth in the economy: In the context of an ongoing macroeconomic crisis, it will be essential to focus on reforms to cata- lyze growth. This includes a sustained emphasis on advancing agricultural commercialization, improving the productivity of firms, and increasing and diversifying exports. It will also be impor- tant to deliver on the planned reform of expensive and poorly targeted subsidies, such as those for the Affordable Input Programme (AIP), and remove distortions that constrain firms’ growth. iii) Protecting the poor and strengthening resilience: As another difficult lean season approaches, includ- ing the heightened risk of extreme weather events, it will be essential to advance implementa- tion of the significantly expanded Social Cash Transfer Program and other assistance programs. In the context of fiscal pressures, it will also be important to continue prioritizing the delivery of essential services to the most vulnerable, while improving the efficiency and effectiveness of social sector expenditure. Strengthening rural labor markets and the scope for agricultural commercialization In light of the current economic difficulties highlighted in Chapter 1, there is an urgent need to sus- tainably increase growth and improve the employment potential of the rural economy. Chapter 2 of this MEM highlights the growing importance of advancing structural transformation in rural areas, in particular through agricultural commercialization. In past years, agriculture has contributed more than 40 percent to overall economic growth. Over three-quarters of all Malawian adults work in agri- culture. The rural economy, which captures the breadth of economic activities through which house- holds in rural areas obtain incomes, accounts for a significant share of employment and output in Malawi. However, the rural economy is characterized by a lack of formal and more remunerative job Overview 12 opportunities. At the same time, high poverty rates show that there are few opportunities to increase rural incomes. Ninety-four percent of all poor households in Malawi are in rural communities and the rural poverty headcount ratio at the national poverty line (57 percent) is almost three times that found in urban areas (19 percent). Even for farming households, own farm income is not the main income source, highlighting the diversity of livelihood strategies that are already a reality in rural Malawi. The median farming house- hold only derives 21 percent of its annual per capita income from own farm income. As a result, even if all farming households were able to reach the agricultural productivity levels of the top 10 percent most productive households, the impact on household incomes and the poverty rate would be limited. According to new analysis in Chapter 2, even such enormous productivity improvements would only reduce the poverty rate by between 1.9 and 9.7 percent, depending on the main crop that a farming household depends on. As such, the current structure of household agricultural production in Malawi offers no pathway to sustained poverty reduction for many, if not most, farming households. This in turn informs the focus on the potential of agricultural commercialization to transform the rural economy. The evolution of the agriculture sector and the rural economy more broadly holds enormous sway over the economy as a whole. Agriculture has many deep links with other sectors, as well as with the overall macroeconomic performance of the country. However, the design of current major agricultural support programs, such as the AIP, not only impacts agriculture directly. Such programs also limit fiscal space and consume a significant share of available foreign exchange, in turn reverberating across the overall economy. Moreover, agricultural support programs have done little to stimulate the agricul- tural transformation process that Malawi urgently needs to generate economic growth and create jobs. Conversely, a vibrant rural economy, stimulated by improved policies and better-targeted investment, could lift the economy as a whole out of its current low-growth equilibrium. The recent announce- ment by President Chakwera of significant reforms to the AIP in particular, provide an opportunity to rethink the direction of agricultural policy toward an increased focus on advancing commercialization and creating rural employment opportunities for smallholders. To assess the potential for increased commercialization, we categorize households into four groups: commercial smallholders, other productive rural households, not economically productive house- holds, and urban households. At 64 percent, other productive rural households comprise the majority of Malawian households, while 16 percent of households are found in urban areas, and not economically productive households comprise 13 percent of households. The remaining 7 percent of households are commercial smallholders and can play a key role in driving the transformation of the agriculture sector.1 Other than farming, rural Malawians are engaged in three types of economic activities: ganyu, com- mercial household enterprises, and longer-term employment. Ganyu — a type of short-term casual employment — is by far the most common type of work, with 70 percent of Malawian households hav- ing at least one member engaged in it. Income from ganyu employment is especially important for poor households, where the income generated through it makes up just over half of total household income. Household enterprises are led by a member of 38 percent of Malawian households. However, household enterprises are predominantly concentrated in low-skilled activities and often do not pay well, even by local standards. The least common type of labor is in longer-term wage employment. Only one in five Malawian households has a member working for a stable wage, with the ratio drop- ping to 15 percent for farming households. For those households that have a member in formal wage employment, the income from this source often contributes a large share to total household income, but such jobs are rare. 1.  Commercializing farmers are defined as those households which sell at least 25 percent of their maize production. While it pre- sents a rather narrow definition of commercializing farmers, it is determined by the limitations of the IHS dataset used in this analysis, it nonetheless serves as a suitable proxy for commercialization. As demonstrated in Chapter 2, commercialization oppor- tunities in Malawi go well beyond maize sub-sector. We therefore consider the above definition of commercializing farmers as a conservative lower bound estimate. Overview 13 Seasonality is a key characteristic of rural labor markets. Farming households face a conundrum: rela- tively remunerative jobs, especially those in longer-term employment, can be an impediment to tending to one’s own farm. Ganyu, too, is most remunerative and sought-after when farming households need to look after their own fields. Nevertheless, farming households are more likely than others to engage in ganyu. Less than one-third of household enterprises operate throughout the year and they are espe- cially attractive to commercial smallholders who can concentrate on their businesses when their farms need less attention. Often these household enterprises process or trade produce from household farms, with non-agricultural trade and food- and drink-related businesses also common. Even with own farm income only delivering a small share of incomes, commercially successful farm- ers are extraordinarily important for the rural economy. The Malawi Vision 2063 identifies agricul- tural commercialization as one of its three pillars to drive the country’s long-term growth. A vibrant commercial smallholder sector would give rise to better non-farm livelihood opportunities, sparking rural economic transformation. Chapter 2 argues for an approach to rural economic transformation that focuses on fostering com- mercially successful smallholders and creating on- and off-farm employment opportunities for smallholders. These can both generate jobs in downstream agro-processing and services sectors and also increase demand for an increasing amount of locally-produced services. This increases the employ- ment opportunities for rural Malawians who, in turn, give up farming to specialize in better paying industry and services sector jobs, eventually freeing up land for the most productive farmers who spe- cialize in commercial agriculture. There is growing evidence from the region that emerging commer- cially-oriented, small- and medium-size farmers can be a significant source of demand for innovation, capital investment, and service provision, which together drive productivity growth and job creation. For example, in Tanzania, medium-scale commercializing farms, which control roughly 20 percent of total farmland, have generated about 13 million labor days per year through local employment. Different forms of agricultural commercialization can be observed in Malawi. Historically, the most traditional pathway for commercialization in Malawi has been through outgrower schemes. In these schemes, an entrepreneur contracts smallholders to produce commodities of high value to be marketed, in turn, by the entrepreneur. The next generation of commercial arrangements between farmers and agribusinesses has been supported through productive alliances. Finally, there are independent com- mercially-oriented farmers. However, widespread rural economic transformation from the dominance of subsistence agriculture has not yet started, as is evidenced by a stagnant and low share of commer- cial smallholders. Nonetheless, pockets of emerging transformation do exist in Malawi. The productive alliances model of agricultural commercialization has been shown to help foster rural economic transformation in Malawi. This model is characterized by strong producer organizations building deep links with commercial off-takers of farm produce. Productive alliances are farmer-led, recognizing their needs, promoting ownership by farmers, and linking farmers to adapted financing solutions. Productive alliances can be particularly beneficial to the most vulnerable population groups, including the poor, women, and the youth. The Malawi Agricultural Commercialization Project (AGCOM) has been supporting agricultural com- mercialization through the productive alliance model. In these productive alliances, smallholder farmers organize themselves into groups or cooperatives, empowered and supported by matching grants to bolster their production, and integrate them into value chains by improving their capacity to finance and execute productivity-enhancing investments and respond to the requirements of buy- ers and off-takers. High and increasing farmer demand to participate in productive alliances supports the approach of the project. A total of 255 productive alliances have been signed, half of which deal in soya or dairy. Examples such as the ACADES Youth Farmer Cooperative and the Nsanama Cassava Producers and Marketing Cooperative show that catalyzing agricultural commercialization at the local level is possible. Overview 14 Three areas of action can enable the more rapid propagation of such pockets of economic transfor- mation, leading to a more robust and vibrant rural economy in general. First, a broad convergence of interests and incentives between agribusiness, commercializing farmers, and smallholders around commercialization objectives should be promoted. Examples above illustrate how this can be successful at the local level and the AGCOM model shows how this can spark wider change. Second, rural popula- tions should be recognized for the diverse constituent groups that they already are. This will improve targeting for commercial opportunities and social safety nets. Lastly, addressing rural economic growth requires holistic, targeted solutions aimed at productive rural communities, which go beyond the nar- row domain of agriculture sector. While commercial smallholders play a critical role in rural econo- mies, there is need for safety nets and non-agricultural livelihood options for those rural households that lack productive capacity or resources. The Government of Malawi can contribute decisively to strengthening rural economies: First, there is a need to strengthen existing commercialization mechanisms, including medium-sized family farms, farmer organizations, and anchor farm models. Regardless of the specific commercializa- tion pathway, support for agricultural commercialization calls for targeted programs for farming house- holds and organizations that can generate significantly more production through increased productivity. Second, Malawian agricultural businesses will benefit from a positive business environment and invest- ment climate. Coordinated business-friendly policy reforms, for example in the legislation of fertilizer, seeds, irrigation, and trade, have the potential to pay off both inside and outside agriculture. Reducing uncertainty should be a key goal of such reforms. Third, investments in productive infrastructure will catalyze rural economic transformation. The Government should focus on high-return investments in public goods that create new economic ac- tivity, such as irrigation schemes, post-harvest facilities, or transport linkages. 1 ECONOMIC DEVELOPMENTS 16 1.1 GLOBAL AND REGIONAL CONTEXTS Major economies are experiencing a marked economic slowdown, giving rise to worries of a global recession Driven by the sustained impacts of the Russia-Ukraine war FIGURE 1.1  Economic growth prospects have weakened and monetary tightening, global economic growth is now substantially... lower than recent estimates had suggested. The October Real GDP growth (%) 2022 International Monetary Fund (IMF) estimates of glob- 8 al annualized Gross Domestic Product (GDP) growth for 2022 6 lag 1.7 percentage points behind those from October 2021 4 Percent (Figure 1.1). Economic growth in the United States, China, 2 and the European Union (EU) has been especially slow, with 0 the United States and China recording 1.0 and 1.6 percent GDP growth, respectively, for the first three quarters of 2022. The −2 EU is among the areas most affected by the war in Ukraine, es- −4 2019 2020 2021 2022 2023 pecially through natural gas shortages. Together, these econo- mies represent about half of total global GDP. In turn, slow eco- SSA 10/2022 Forecast World 10/2022 Forecast nomic growth in these three economies lowers the demand for SSA 10/2021 Forecast World 10/2021 Forecast goods and services produced elsewhere, and can lead to lower Sources: IMF World Economic Outlook 10/2021 and 10/2022. international investment and trade. In addition, other major emerging markets are slowing. In the past, a sharp slowdown FIGURE 1.2  … while inflation has continued to exceed of global growth led by economic distress in major economies expectations everywhere was normally a precursor a global recession2 (Guenette, Kose Consumer price inflation (%) and Sugawara, 2022). 16 14 With inflation exceeding expectations in almost all econo- 12 10 mies, central banks around the world have resorted to rapid Percent 8 monetary tightening. Inflation is accelerating to a global aver- 6 age of 8.8 percent and 14.4 percent in sub-Sahara Africa in 4 2022 (Figure 1.2). This is against an expectation of 3.8 and 8.6 2 percent, respectively, one year ago. The current inflationary 0 2019 2020 2021 2022 2023 wave was initiated by over-extended global supply chains dur- ing the COVID-19 pandemic, which have since eased. However, SSA 10/2022 Forecast World 10/2022 Forecast the Russian Federation’s invasion of Ukraine pushed energy SSA 10/2021 Forecast World 10/2021 Forecast and food prices up further and, over time, price pressures have Sources: IMF World Economic Outlook 10/2021 and 10/2022. 2.  A global recession is an extended period of economic decline synchronized around the world. The IMF dates global recessions based on broad-based weakening of macroeconomic indicators with per capita GDP typically serving as the primary anchor. 1. Economic Developments 17 become increasingly broad-based, signified by price increases in excess of central bank targets for goods other than commodities and those affected by shipping bottlenecks. These developments have sparked fears that more rapid price increases will become entrenched through heightened inflation expecta- tions. Central banks, in turn, have resorted to rapid monetary tightening. Thirty-five out of 38 central banks tracked by the Bank for International Settlements have raised policy rates at some point between January and October 2022 (Figure 1.3). FIGURE 1.3  … leading to a global wave of monetary tightening Number of major central banks changing their respective policy rates 30 25 20 15 10 5 0 −5 −10 −15 −20 −25 −30 Jan-19 Feb-19 Mar-19 Apr-19 May-19 Jun-19 Jul-19 Aug-19 Sep-19 Oct-19 Nov-19 Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Aug-20 Sep-20 Oct-20 Nov-20 Dec-20 Jan-21 Feb-21 Mar-21 Apr-21 May-21 Jun-21 Jul-21 Aug-21 Sep-21 Oct-21 Nov-21 Dec-21 Jan-22 Feb-22 Mar-22 Apr-22 May-22 Jun-22 Jul-22 Aug-22 Sep-22 Rate rises Rate drops Sources: World Bank staff calculations based on Bank for International Settlements data. Aggressive monetary policy responses to increased inflation can become self-reinforcing and have particularly adverse effects on emerging markets and developing economies (EMDEs). Tighter mon- etary policy has a slowing effect on economic activity. In addition, rapid interest rate increases by the U.S. Federal Reserve, resulting in a cumulative 375 basis points increase between March and November 2022, make it more profitable to hold US assets. Together with a “flight to safety”, where investors seek relatively resilient US$-denominated assets, this led to a sharp appreciation of the US dollar by 14 per- cent between January and mid-November 2022 against a set of six other major currencies (the euro, the Swiss franc, the Japanese yen, the Canadian dollar, the British pound, and the Swedish krona). This makes US$-denominated debt more expensive to repay and other central banks may have to raise inter- est rates beyond the point that would be ideal to protect exchange rates. Moreover, the boost to EMDEs’ export competitiveness from their depreciating currencies is often outweighed by the short-term fric- tions caused by exchange rate volatility in the domestic value of US$-denominated trade. Extreme weather events, as well as the war in Ukraine, have led to high global food prices, resulting in widespread food insecurity. Many countries have responded to increasing global food price pressures with trade restrictions which, in turn, have increased price pressures in other countries (World Bank, 2022b). The Global Report on Food Crises estimates the number of people needing urgent humanitar- ian assistance between October 2022 and January 2023 at 205 million, an increase of 30 million from 2021/22 (GNAFC, 2022). Large year-on-year (y-o-y) increases are clustered in sub-Saharan Africa, includ- ing Malawi, as well as some conflict-affected countries such as Yemen. Rising food prices have exacer- bated existing vulnerabilities, including conflict and extreme weather. Several East African countries have been affected by a sustained drought, leading to the risk of a fifth poor harvest in a row. Countries in Malawi’s region are experiencing varied rates of growth and diverse economic chal- lenges. South Africa’s economy was severely impacted by widespread load-shedding, as well as by floods in KwaZulu Natal and the Eastern Cape. Manufacturing was especially badly affected, with a decrease in output of 5.9 percent in the second quarter of 2022 relative to the first quarter. Meanwhile, Zambia 1. Economic Developments 18 has performed better, with growth for 2022 estimated at 3 per- FIGURE 1.4  Different post-pandemic trajectories cent (Figure 1.4). The Government of Zambia’s commitment to in Southern Africa addressing sustained macroeconomic imbalances and a new Real GDP growth (%) US$1.3 billion IMF Extended Credit Facility (ECF) is central to this 6 development. The facility supports what the Government of 4 Zambia calls a “homegrown”3 program of strict fiscal consolida- tion and comprehensive reforms aimed at improving economic 2 governance. Tanzania continues to experience general macro- 0 economic stability and robust economic growth of 4.6 percent Percent in 2022, although this is still slightly below pre-COVID-19 lev- −2 els. It has also recently agreed a new US$1 billion ECF focused on reforms to create fiscal space for social spending and high- −4 yield investments. Mozambique’s economic growth continues −6 to be subdued at 3.7 percent in 2022, despite high natural gas prices. The country faces governance challenges and the ongo- −8 2018 2019 2020 2021* 2022# 2018 2019 2020 2021* 2022# 2018 2019 2020 2021* 2022# 2018 2019 2020 2021* 2022# 2018 2019 2020 2021* 2022# ing fallout from its 2013 hidden debt scandal,4 as well as a con- tinuing insurgency in Cabo Delgado. This is limiting the gains Malawi Mozambique South Africa Tanzania Zambia from its substantial liquified natural gas (LNG) wealth, which Notes: * estimates, # forecasts. represent the world’s 14th largest LNG reserves. Source: World Bank Macro Poverty Outlook (World Bank, 2022c). 3.  As termed by President Hakainde Hichilema (IMF, 2022c). 4.  Transgressions relating to hidden public debt, dubbed the 2013 Tuna Bond Scandal, continue to be uncovered ,with Credit Suisse ordered to pay a US$22.6 million fine in July 2022, following other fines and write-downs related to the scandal amount- ing to US$675 million. However, it is likely that most of the costs of this fraud will remain with the Mozambiquan people. The Center for Public Integrity estimates the economic costs for the Mozambican Government of the Tuna Bond Scandal at US$11 bil- lion (Cortez et al., 2021). 19 1.2 RECENT ECONOMIC DEVELOPMENTS Malawi’s macroeconomic crisis is worsening, as sustained imbalances are exacerbated by external shocks After a tepid rebound in 2021, Malawi’s economy entered another economic slowdown this year. World Bank modeling suggests that GDP growth has slowed to 0.9 percent in 2022, a decline from 2.8 percent in 2021 (Figure 1.5). This constitutes a per-capita GDP contraction of 1.8 percent given popu- lation growth of 2.7 percent. Three factors have driven this development: first, through adverse weath- er conditions and significant problems in the implementation of the Affordable Inputs Programme (AIP) last season, agriculture became a drag on growth rather than its principal driver, declining by 1.0 percent in 2022 com- FIGURE 1.5  Overall economic growth remains weak pared with 5.2 percent growth in 2021. Second, the industry Real GDP growth by sector (%) sector in particular has been suffering from pervasive elec- 8 tricity shortages and is expected to grow at only 0.9 percent in 2022. Third, the services sector achieved modest growth at 1.8 percent. Services continue to benefit from the subsid- 6 ing of COVID-19 effects, in particular benefiting the tourism and retail segments. However, services growth in 2022 has 4 declined relative to 2021 and the sector continues to face low Percent demand, suffering from challenges in the wider macroeco- nomic environment, including foreign exchange shortages 2 and high inflation. Adverse weather events and a balance-of-payments crisis are 0 at the core of the recent economic slowdown. The late on- set of the 2021/22 rainy season followed by multiple tropical storms have led to lower yields for both smallholders and com- −2 2019 2020 2021 2022* 2023# mercial farmers. Crops that are heavily dependent on predict- able weather patterns fared particularly poorly. Seasonal pro- Agriculture Industry Services GDP duction estimates indicate that Malawian farmers harvested Note: * estimates, # forecasts. 5 percent less maize and 37 percent less tobacco than the aver- Source: World Bank Macro Poverty Outlook (2022e). age for the three preceding growing seasons. In addition, trop- ical storms Ana and Gombe in January 2022 have led to direct damage to crops, submerging farmland across many parts of Southern Malawi, and damaging the infrastructure supporting agricultural pro- duction. The Kapichira hydroelectrical power plant, which provides about one-third of national capac- ity, was especially badly hit and will remain offline through the end of the year. The impact of severe weather events and climate-related shocks is likely to increase over time (see Box 1.1). Furthermore, a balance-of-payments crisis has led to widespread foreign exchange shortages, affecting access to fuel, fertilizer and other imported inputs. 1. Economic Developments 20 BOX 1.1  Climate change is exacerbating vulnerabilities in the Malawian economy Malawi’s economic growth continues to be affected by a These priorities will require policy and institutional reforms, series of climate-related shocks, with the frequency and new financing arrangements, and the increased use of digi- severity of these shocks increasing over recent years. In the tal technologies, as well as more private sector investment. past five years, the country has suffered from a prolonged dry However, chronic fiscal imbalances and high levels of external and spell and an armyworm infestation in 2018; floods from heavy public debt will impede Malawi’s ability to invest in climate change rainfall induced by Tropical Cyclone Idai in 2019; dry spells in the adaptation priorities. Thus, optimization of public sector resources southern regions and localized floods in the northern region in and greater access to international public finance, as well as 2020; and flooding in all regions from heavy rainfall caused by increased private sector involvement, will be required to support Tropical Cyclones Ana and Gombe in 2022. Total damage from climate change-resilient and low-carbon growth. Institutional and the latter alone were equivalent to 1.5 to 2.7 percent of GDP, legal frameworks will need to be strengthened to address govern- severely damaging the Kapichira hydroelectricity generation ance challenges that could impede climate change adaptation. plant and reducing the country’s power supply by one-third. Central to this would be passage of the Disaster Risk Management (DRM) Bill, which was introduced in 2018 but has yet to be voted An analysis in the World Bank Country Climate Development on by Parliament. Report (World Bank, 2022d) focusing on Malawi finds that the increased impacts of climate change would reduce GDP by up FIGURE B1.1.1  Losses from climate change can be mitigated to 9 percent in 2030. It would also push another 2 million people through investments in growth and adaptation into poverty by 2030 and 4 million by 2050. As climate change impacts intensify, GDP would further decline by 8 to 16 percent 2 by 2050 (Figure B1.1.1). The analysis considers five climate sce- 0 narios and six types of climate change-related impacts on the economy, including impacts on crop productivity, labor produc- –2 tivity, damage to roads and bridges, and damage to hydropower –4 plants. These impacts vary depending on the climate scenario and the damage channel, with the largest impacts projected to –6 come from damage to roads and bridges. GDP loss (percent) –8 A higher growth path in line with Malawi Vision 2063 would –10 contribute to a significant reduction in annual GDP loss. This would support higher-quality infrastructure and a more diversi- –12 fied economy. The analysis shows that the magnitude and vari- ability of the potential reduction in GDP from impacts of climate –14 change would reduce to 3 – 7 percent by 2030, and then 4 – 7 per- –16 cent by 2050. However, transitioning to a higher-growth economy alone will not be enough and building greater resilience to climate –18 change will require investments in adaptation, which would greatly –20 diminish the likely impact of climate change on the economy. –22 To adapt from climate change impacts, the Government could 2020 2025 2030 2035 2040 2045 2050 focus on three areas that support “resilient development”: (i) halt and reverse widespread land degradation through investments in Business As Usual (mean) Business As Usual (range) land and forest restoration and management; (ii) build, upgrade and Resilient Development (mean) Resilient Development (range) rehabilitate infrastructure (roads and bridges, dams, water and sew- Vision 2063 (mean) Vision 2063 (range) erage networks, urban infrastructure) to withstand climate change Notes: The analysis includes major sector and considers main pathways of climate shocks; and (iii) address climate impacts on households and labor change impact. productivity by protecting people against climate-related damage. Source: World Bank (2022d). Source: World Bank (2022d). Due to rapidly rising prices, farmers are likely to have harvested a higher total value of crops despite generally lower yields. In the 2021/22 agricultural season, Malawian farmers grew field crops on about 4.3 million hectares (ha), slightly less than half its total land area. Reliable production and yield esti- mates exist for nine of the most important crops, representing 73 percent of the planted area (Figure 1.6). According to these estimates, Malawian growers harvested about MWK 2.5 trillion worth of crops at May 2022 market prices. This is an 18-percent increase compared with the MWK 2.1 trillion valued at May 2021 prices but adjusted for overall inflation. Soybeans and pigeon peas saw some of the larg- est increases in volumes and prices. Growers realized higher earnings from soya beans (MWK 303 bil- lion) than from tobacco (MWK 85 billion) and tea (MWK 49 billion) combined. But even for crops such as maize, the 65 percent increase in price more than made up for the drop in yield and headline infla- tion (Figure 1.7). The value of chicken and goat production has increased, as well. 1. Economic Developments 21 FIGURE 1.6  More than half of all cropland is maize, FIGURE 1.7  … but soya bean and pigeon pea farmers groundnuts, and beans… have seen large gains due to high global prices Hectarage allocated to various field crops in the 2021/22 farming season (%) Value of select harvested crops at end-May prices in real 05/2022 (MWK million) 2,500 Other 2,000 27.0% Maize 1,500 MWK, million 39.1% 1,000 0.4% Tea 1.4% Tobacco 5.3% 500 1.6% Soya Beans 2.5% 5.6% 0 7.7% 2021 Value 2022 Value Pigeon Peas 9.3% Rice Maize Rice Sorghum Groundnuts Beans Sorghum Beans Pigeon peas Soya beans Tobacco Tea Groundnuts Sources: Ministry of Agriculture, Irrigation and Water Development, Crop Production Sources: Ministry of Agriculture, Irrigation and Water Development, Crop Production Estimates; Tea Association of Malawi; Tobacco Commission; IFPRI, Maize Market Estimates; Tea Association of Malawi. Reports and Price Bulletin for Selected Legumes, Roots, Tubers, and Other Cereals. In response to persistent challenges, the President of Malawi has announced significant reforms to the AIP, the country’s largest agriculture support program. Key reforms central to a so-called “AIP 2.0” an- nounced in the President’s national address on October 25 include the wider use of a Unified Beneficiary Register to improve efficiencies and targeting across a stream- lined but differentiated package of support, including social FIGURE 1.8  The cost of fertilizer subsidies has increased cash transfers, a scaled-up climate-smart public works pro- significantly, but maize production has not gram for those with limited land, and a scaled up Agricultural Central government spending on fertilizer in percent of GDP and official maize production estimates (million metric tons). Commercialization Project (AGCOM) for more market-ready farmers. He also announced a fixed government contribution 5 2.5 to limit fiscal risk, while reiterating the Government’s commit- ment to the MWK 109 billion budget target during this fiscal 4 2.0 year. The stipulated changes also include market-based pricing Million metric tons Percent of GDP for fertilizer procurement. Fertilizer subsidy schemes, includ- 3 1.5 ing past years’ AIPs, have long been criticized on the grounds of limited efficiency, suboptimal targeting, and a lack of fis- 2 1.0 cal sustainability (see Chapter 2). In 2021/22, adverse weather events also meant that a significant proportion of the subsi- 1 0.5 dized fertilizer that was applied was ineffective, especially in areas where crops were destroyed by flooding. In addition, im- 0 0.0 plementation faced challenges relating to procurement prac- 2017/18 2018/19 2019/20 2020/21 2021/22 tices and execution arrangements, as evidenced by several O icial Maize Production Estimates monitoring reports (ACB, 2022; EU, 2022).5 Consequently, de- Central Government Spending on Fertiliser (RHS) spite increasing budgets, maize yields have not increased com- Sources: Ministry of Agriculture, Irrigation and Water Development; Ministry of Finance mensurately (Figure 1.8). and Economic Development; Integrated Food Security Phase Classification. 5.  Fixing the price that suppliers receive at significantly below commercial prices and limited oversight by the authorities meant that fertilizer was often unavailable and that many clerks demanded extra payments by farmers. Some selling points had intermit- tent network connectivity and often no checks were performed on whether the ID submitted through the network was that of the registered beneficiary, opening opportunities for third parties to redeem subsidized inputs. Evidence also points toward signifi- cant shares of total subsidized fertilizer having been of low quality and diluted with other substances. 1. Economic Developments 22 Lower yields and high global and domestic prices are pushing many Malawian families into food insecurity. Through its chronic food security analysis, the IPC (2022) estimates that one in three Malawians is generally prone to food insecurity. For the 2022/23 lean season, according to the IPC Acute Food Insecurity classification, one in five Malawians will face crisis-level acute food insecurity (IPC, 2022b). This is against the backdrop of rapidly rising prices for staple foods and a lower maize harvest. Food insecurity is concentrated in the Southern Region, where weather shocks have had the most severe impact on livelihoods and food production. The Government has prepared a Food Insecurity Response Plan, currently costed at MWK 76 billion. The plan will coordinate resources from various partners and the Government for the delivery of cash and in-kind food assistance. On the back of economic underperformance, poverty levels are increasing further. The World Bank’s Macro-Poverty Outlook (2022e) estimated that poverty at the international poverty line of US$2.15 in 2017 purchasing power parity (PPP) prices will increase by 0.5 of a percentage point to 71.2 percent in 2022. This is likely to be an underestimate as the economic environment has worsened since these esti- mates were published. Low yields affect farming households, while inflation is increasingly burdening urban households. The Government’s commitment to large-scale commercialized agriculture has not been reflected in recent policy initiatives. The Land Amendment Bill, passed in March 2022, is seen by many producers as introducing additional obstacles to operating a commercial farm, without significantly improving the security of land tenure. This could also impact the Government’s plans to establish “mega farms”, i.e., government-owned but privately-run farms of at least 5,000 ha with a high degree of mechaniza- tion and value addition.6 It is unclear how such farms could assimilate competing customary claims on the land. Other recent developments may hold back existing large, commercialized farms. The recent draft Crops Bill is seen by many as not compatible with promoting agricultural commercialization. It would expand already wide-ranging ministerial powers that many farmers already see as impeding investment and growth in the sector (Duchoslav et al., 2022). Escalating foreign exchange shortages and rising input costs FIGURE 1.9  Rising input costs and foreign exchange shortages put pressure on already strained enterprises. Micro- and small are a strain for businesses enterprises have been especially affected, with few buffers and Share of BPS respondents estimating the effect of increased non-labor input costs and decreased foreign exchange availability since the beginning of 2022 on their limited access to finance to bridge episodes of pressure. The businesses’ net operating profits* World Bank Business Pulse Survey (BPS) interviewed 1,200 100 small enterprises in October 2022 and found that two-thirds of businesses report a decrease in sales compared with a year 80 earlier (World Bank, 2022a). Sales declined by 21 percent on 60 average. Many enterprises are on the brink of financial unvia- Percent bility, with one-quarter reporting existing or imminent arrears 40 and 14 percent insolvent or on the brink of insolvency. Two- thirds of surveyed businesses believe that increased non-la- 20 bor input costs negatively affected their profits, while foreign 0 exchange unavailability is seen as a threat to profitability by Input Costs Forex Availability more than three-quarters (Figure 1.9). Three-quarters also re- Catastrophic decrease No e ect port difficulties in accessing finance, which could be used to Absorbable decrease Increase overcome such impasses. However, small businesses are op- Note: * Catastrophic decrease is defined as a decrease that prompts the timistic about their future, with half of BPS interviewees ex- discontinuation of some business activity. pecting a sales increase during the next year. Source: World Bank BPS (2022a). 6.  While still in its early stages, the Government’s Mega Farm Project aims at facilitating the establishment of large-scale production units that will also anchor willing surrounding smallholder farmers through an out-grower system that will be premised on contract farming arrangements. Through the anchor farm model, mega farms will provide productivity enhancing support to the anchored smallholder farmers. This support will include the provision of extension and advisory services, provision of high-quality inputs (on loan), provision of warehousing facilities, farm equipment hiring services and the implied linkage to markets. 1. Economic Developments 23 Electricity shortages have added further pressure to the FIGURE 1.10  Load-shedding has increased the popularity fuel sector and have become an impediment to businesses. of solar power systems The Malawi Confederation of Chambers of Commerce and Share of BPS respondents taking remedial action to increased blackouts since the beginning of 2022 Industry — a representative body of mostly large enterpris- es — has estimated that frequent load-shedding costs businesses Took action MWK 94 billion annually (Nation Online, 2022). About 17 per- Bought generator cent of small businesses in the BPS survey have taken new re- medial actions in the past year in response to increased black- Increased generator use outs, with the most common response being the purchase of Bought solar solar-powered electricity backup systems, ahead of genera- tor purchases (Figure 1.10). Even critical infrastructure such Increased solar use as hospitals has been affected at times. Running generators Bought inverter is not only significantly more expensive, but also requires im- ported diesel, which is scarce, and further saps revenues from Increased inverter use an underfunded electricity supply system. Reduced services temporarily Foreign exchange shortages have led to the current fuel cri- Reduced services permanently sis. Long queues at fuel stations have become a regular occur- Suspend business temporarily rence in the second half of 2022. The supply of fuel is only in- termittently normalized through credit facilities to support fuel 0 5 10 15 20 imports. Large businesses were among the first to experience Percent shortages with unmet demand reported as far back as 2021. Source: World Bank BPS (2022a). Foreign exchange shortages have also had adverse effects on public services and the wider econo- my. The effects on the retail fuel sector are only the most visible symptom of much wider challenges. In a context where many businesses are unable to access foreign exchange allocations from commer- cial banks, a black market for US dollars and other foreign currencies has emerged. However, organi- zations importing essential commodities, such as the Central Medical Stores Trust, must rely on offi- cial channels. Despite efforts to prioritize these essential imports in foreign exchange allocations, there have been widespread reports of shortages.7 These concerns have also been central to recent discus- sions between the Government and the private sector in the context of the Private Sector Labs organ- ized by the Presidential Delivery Unit (see Box 1.2). BOX 1.2  The Private Sector Lab: A new approach to driving agro-industrial transformation in Malawi and addressing business concerns The absence of structured public-private dialogue for invest- Centre to facilitate investment into key sectors and projects. ment facilitation and the generation of investible opportu- Prior to the Lab, the PDU surveyed 168 private sector firms, nities in Malawi has been widely acknowledged. To address asking respondents to identify key issues impeding private this, the Malawian Government held its first ever Private Sector sector growth in Malawi. These included: Lab from June 17 to 24, 2022, in Lilongwe. The Lab was hosted by the Presidential Delivery Unit (PDU), in collaboration with the • Taxation: Delays in tax refunds and enhancing consistency Ministry of Trade and Industry and the Malawi Investment and and clarity in tax administration. Trade Centre, and with support from the International Finance • Access to Energy: Load-shedding, on-site generation, max- Corporation (IFC). imum demand tariff and independent power producer The focus of the Labs was to resolve issues hindering large- engagement. scale local and international investment. This should help cre- • Forex and Exports: The efficiency of export corridors, export ate a platform to convene high-level exchange between gov- quality standards, efficiency and clarity of export procedures, ernment and private sector to jointly identify and address access to export markets, and access to foreign exchange. bottlenecks impeding the operations and expansion of the pri- vate sector in Malawi. The PDU also invited various investors • Access to Finance: High interest rates, stringent collateral and is continually working with the Malawi Investment and Trade requirements, and onerous documentation requirements. 7.  One striking example of reported shortages is the frequent lack of intravenous drip fluids (VOA, 2022). 1. Economic Developments 24 Ministerial presentations were also made on issues related to President. There have been significant achievements across agriculture, immigration, labor, and land. While these concerns numerous MDAs. This includes implementing a Business also largely mirror binding constraints identified in the recent Development Service unit to support SME investor readiness, World Bank Country Private Sector Diagnostic (IFC, 2021) and launching the Mchinji one-stop border post, sensitizing work- other publications, the focus of these labs was on identifying and shops on business incentives and tax compliance for smaller prioritizing feasible solutions, each assigned to a responsible businesses, and the initiation of a credit referencing system. ministry, department, and agency (MDA) for implementation. The continued focus on delivery across MDAs will be critical to ensure that the process initiated by the Private Sector Labs can The PDU has put in place a tracking mechanism, with quar- further address challenges faced by businesses, and instill a cul- terly progress reports compiled and reported directly to the ture of delivery across MDAs. Source: PDU (2022). The ongoing balance-of-payments crisis has led to a sharp contraction of imports Imports began declining in early 2022 and collapsed in May 2022, reflecting the impact of foreign exchange shortages. Officially reported imports, already slightly below longer-term trends, dropped by 46 percent to 10.0 percent of GDP in May 2022 (Figure 1.11). The trade deficit continued to contract, eventually leading FIGURE 1.11  In the face of severe foreign exchange shortages, to a small trade surplus of MWK 0.1 billion (less than 0.1 per- imports have declined dramatically cent of GDP) in August 2022. There has only been one other Seasonally adjusted trade balance (real 01/2022 MWK billion) month (April 2016) where a trade surplus has been recorded 200 150 since the start of detailed records in 2010. The timing of the 100 contraction suggests that acute foreign exchange shortages, 50 rather than price and exchange rate movements, underlie this 0 −50 MWK, billion trend. The timing also coincides with widespread fuel una- −100 vailability and the Reserve Bank of Malawi’s (RBM) move to −150 −200 become a net buyer of foreign exchange. −250 −300 −350 Protected through RBM-supported credit facilities, fuel im- −400 ports were stable through August but have declined since −450 Jan-19 Apr-18 Jul-20 Jan-18 Jul-18 Apr-19 Jul-19 Jan-20 Apr-20 Jan-21 Jul-21 Apr-21 Jan-22 Jul-22 Oct-18 Oct-19 Apr-22 Oct-20 Oct-21 then. Cumulatively, Malawi imported 192 million liters of fuel in the year through August 2022 . This is only 3 percent less than from January to August 2021 but is likely to have dropped since Real SA Exports Real SA Imports Balance August with fuel shortages proliferating. This stability in im- Note: SA = seasonally adjusted. ports has been achieved through RBM-supported import credit Source: World Bank staff calculations based on NSO data. facilities to the National Oil Company of Malawi (NOCMA). The overall reduction in imports is primarily a result of a decline in FIGURE 1.12  The recent import collapse has in particular imports for goods other than fuel and fertilizer, for example in- impacted non-fuel imports termediate inputs required for producers, or consumer goods Monthly import values (real 01/2022 MWK billion) (Figure 1.12). Currently, the system of foreign exchange alloca- 400 tion prioritizes ad-hoc support for selected essential imports, 350 such as recent interventions in fuel import financing. This un- 300 MWK, billion certainty creates challenges for the private sector, as many firms 250 require imported goods and services as inputs to production. 200 150 In light of declining commodity prices, Malawi’s terms of 100 trade have improved marginally in recent months. Interna- 50 tional oil prices decreased by 13 percent between April and Oc- 0 May-21 Jun-21 May-22 Jan-21 Mar-21 Aug-21 Jun-22 Jul-21 Nov-21 Apr-21 Jan-22 Mar-22 Aug-22 Jul-22 Apr-22 Feb-21 Sep-21 Oct-21 Feb-22 Dec-21 tober 2022, while the price of urea plummeted by 31 percent (Figure 1.13). Combined with relatively stable prices for Mala- wi’s export basket, this price drop in Malawi’s two most com- Fuel Fertiliser Other mon imports means that terms of trade have improved (Fig- Source: World Bank staff calculations based on NSO data. 1. Economic Developments 25 ure 1.14).8 However, Malawi can still buy less than half of its commodity imports with its commodity exports at today’s prices. Fertilizer imports are recovering from a four-month drop through May 2022, which is seasonal but also deeper than those recorded since 2018. FIGURE 1.13  Commodity prices are stabilizing at a high level… FIGURE 1.14  …leading to a decline in Malawi’s terms of trade Select commodity prices, indexed, 01/2019=100 Malawi’s net barter terms of trade and Pink Sheet terms of trade on reported commodities, 2015 = 100 400 140 350 120 300 100 250 80 200 150 60 100 40 50 20 0 0 Jan-19 May-19 Sep-19 Jan-20 May-20 Sep-20 Jan-21 May-21 Sep-21 Jan-22 May-22 Sep-22 Jan-23 May-23 Sep-23 2015 2016 2017 2018 2019 2020 2021 Apr-22 Oct-22 Crude oil Urea Maize Soybeans Tobacco Barter TOT Pink Sheet TOT Source: World Bank Monthly Commodity Prices and World Bank Commodities Market Sources: World Bank Commodity Markets and Data, UNCTAD Handbook of Statistics, Outlook, 10/2022. IMF IFS, National Statistics Office. Tobacco exports have consistently declined, and other leading export sectors have not been able to provide sufficient inflows of foreign exchange. Official tobacco exports in real terms declined by 42 percent between 2016 and 2021 (Figure 1.15). Tobacco exports through August 2022 were only worth MWK 149 billion in nominal terms, compared with MWK 183 billion in the same period in 2021. Although record amounts of soya beans and pigeon peas have been harvested in recent years, rising exports in these goods have not been reflected in official sta- tistics. MWK 312 billion worth of soya beans (303,000 MT) and FIGURE 1.15  The long decline in exports MWK 279 billion worth of pigeon peas (429,000 MT) were har- Annual exports by category (real 01/2022 MWK billion) vested. However, only MWK 28 billion (57,000 MT) in pulses 2,000 between January and August 2022 were officially exported. 1,750 1,500 Remittances are still declining in their relevance as a for- 1,250 MWK, billion eign exchange earner. With recently declining inflows and the 1,000 emergence of high outflows, the net position — the money that 750 remains as foreign exchange that can be used to finance im- 500 ports — has been in a steady decline in recent years (Figure 1.16). 250 Historically, net remittances have been about 8.5 percent of 0 current account credits, covering about the same share of the 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 annualized trade deficit. Incoming personal remittances can also be more reliable than other transfers. Building foreign currency reserves Tea Tobacco Sugar through increasing financial flows including remittances is crit- Pulses Nuts Other ical to managing shocks (see Box 1.3). Source: World Bank staff calculations based on RBM data. 8.  Terms of trade show the relative price of exports versus imports. They are calculated as the percentage change in the price of typi- cal exports over the percentage change in the price of typical imports. The index here is normalized to 2015 being 100. While the terms of trade reported by the World Bank include all trade reported to United Nations Conference on Trade and Development (UNCTAD) that fulfills certain quality standards at actual prices, the Pink Sheet terms of trade are calculated based on a more limited set of prod- ucts, including tea, tobacco, cotton, sugar, soybeans, rice, coffee, oil, urea, and coal, that have the international price of a related com- modity tracked in the World Bank monthly commodity markets data. Thus, both measures are expected to follow the same trend rep- resenting terms of trade, but while Pink Sheet terms of trade are more timely, they are also more volatile. 1. Economic Developments 26 FIGURE 1.16  Outward remittances have increased significantly in the past two years Inward, outward, and net remittances in Malawi (US$ million) 40 35 30 25 US$, million 20 15 10 5 0 May-20 Jul-20 Jun-22 Jan-19 Mar-19 Apr-19 May-19 Jun-19 Jul-19 Aug-19 Nov-19 Jan-20 Mar-20 Apr-20 Jun-20 Aug-20 Nov-20 Jan-21 Mar-21 May-21 Jun-21 Jul-21 Aug-21 Nov-21 May-22 Apr-21 Jan-22 Mar-22 Aug-22 Feb-19 Sep-19 Jul-22 Oct-19 Apr-22 Dec-19 Feb-20 Sep-20 Oct-20 Feb-21 Sep-21 Dec-20 Oct-21 Feb-22 Sep-22 Dec-21 Inward Remittances Outward Remittances Net Remittances Average Monthly Net Remittances (2019, 2020, 2021, 2022) Source: World Bank staff calculations based on RBM data. BOX 1.3  What can Malawi do to bolster its reserves? The current balance-of-payments crisis has shown the impor- There are several policy options for increasing reserves: tance of building foreign reserves to ensure sufficient liquid- • Greater exchange rate flexibility. The misalignment of the ity to meet obligations and manage shocks. Sources of for- real exchange rate can reduce exports and creates uncer- eign reserves include earnings from exports, remittances, foreign tainty for businesses. In addition, greater flexibility in the direct investment (FDI) and foreign assistance, including loans. exchange rate is needed to enable convertibility and increase Key drivers of reserve accumulation include: liquidity in the market. • Enhancing exports. A country could accumulate foreign • Developing the foreign exchange interbank market. This reserves when its earnings from the export of goods and ser- allows for transparent currency exchange, facilitates price dis- vices exceed payments against imports. For example, a key covery, and helps current account adjustments. The manda- driver of successful foreign reserve accumulation in Asian tory retention of export proceeds of 30 percent enforced by economies was through sustained export-led growth, fol- the RBM since August 2021 should be phased out as soon as lowing the large exchange rate depreciation in the region macroeconomic circumstances recover. as a result of the 1997/98 financial crisis. Services exports, • Strengthening the RBM’s reserve management. Key pri- for example through tourism, can also be a major contribu- orities include establishing a reserve management strat- tor of foreign exchange earnings. Malawi’s tourism industry egy, establishing a registry to ensure consolidating records has achieved moderate growth in recent years, despite the of all liabilities and contracted facilities, timely reporting, and impacts of the COVID-19 pandemic (MoFEA, 2021). enhancing transparency and accountability. • Increasing financial flows, especially: • Official development assistance. While aid is the largest FIGURE B1.3.1  In Malawi, aid inflows are still by far the most inflow for Malawi, most of this support, especially from bilat- significant source of foreign exchange eral development partners, is off-budget. Off-budget aid is Financial flows to Malawi (current US$ million) retained by commercial banks and thus does not become part of official reserves. 1,600 1,400 • FDI can increase reserves directly through the inflow of for- 1,200 current US$, million eign capital, without creating any repayment burden. FDI 1,000 can also help earn foreign exchange by increasing export 800 receipts indirectly. FDI to Malawi has been volatile in recent 600 years, driven primarily by individual large investments rather 400 than consistent inflows (IFC, 2021). 200 0 • Remittances are now a greater source of foreign exchange for −200 Malawi than FDI and portfolio investment flows (Figure B1.3.1). 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 Unlike for most developing countries, in Malawi, aid inflows are still by far the most significant source of foreign exchange. On Foreign direct investment, net inflows (BoP) average for developing countries, FDI net inflows are three times Personal remittances, received Portfolio equity, net inflows (BoP) larger than net aid flows in 2020. This indicates that there is a Net o icial development assistance received room for Malawi to enhance private financial flows, especially from FDI and remittances, while gradually reducing aid dependance. Source: World Development Indicators (World Bank, 2022e) Sources: IFC (2021), IMF (2022b), and ECB (2006). 1. Economic Developments 27 A clear strategy by the authorities on how external economy challenges will be overcome is still emerging, though there has been recent progress. In November, the IMF Executive Board approved a US$88 million Rapid Credit Facility and a Staff Monitored Program with Executive Board Involvement. While this is not yet equivalent to an Extended Credit Facility in terms of its overall assessment of the soundness of the country’s macroeconomic situation and its debt sustainability, these funds can be used to bolster foreign currency reserves, support critical imports and contribute to debt servicing, while the authorities work out a more comprehensive plan to address the balance-of-payments crisis under the Staff Monitored Program. The ongoing debt-restructuring process offers a pathway to exter- nal economic stability that would also enable Malawi to transition to a fully-fledged IMF program sup- ported by an Extended Credit Facility. Headline inflation has risen to its highest level since June 2013 Upward inflationary pressures, largely induced by rising commodity prices from the impact of the Russia-Ukraine war and downward adjustment of the Malawi kwacha, have resulted in high and rising headline inflation. Headline inflation started picking up in October 2021, as COVID-19 pandem- ic restrictions were eased and global commodity prices start- ed rising. However, the invasion of Ukraine by the Russian FIGURE 1.17  Inflation has reached the highest levels since 2014 Federation and the resultant supply-related shocks have add- (%, y-o-y) ed an additional strain on commodity prices, which induced a 35 jump in domestic prices. The devaluation of the Malawi kwa- cha and resultant price increases of imported commodities 30 exerted additional upward pressure on prices. Consequently, 25 headline inflation rose and has remained elevated, peaking at 26.7 percent in October 2022 — the highest level since June Percent, y-o-y 20 2013 (Figure 1.17). This has been driven by an upward push on both food and non-food inflation. The impact of the Russia- 15 Ukraine war has had direct effects on oil, fertilizer, cereals and cooking oil prices, which contributed to food inflation soaring 10 to 34.5 percent in October 2022 . Non-food inflation has also risen to 18.6 percent. 5 Global oil prices are moderating, contributing to a decline in 0 0 Feb-18 Jan-18 Mar-18 Apr-18 May-18 Jun-18 Aug-18 Jul-18 Oct-18 Sep-18 Nov-18 Dec-18 Feb-19 Jan-19 Mar-19 Apr-19 Jun-19 May-19 Jul-19 Aug-19 Oct-19 Sep-19 Nov-19 Dec-19 Feb-20 Jan-20 Mar-20 Apr-20 May-20 Jun-20 Aug-20 Jul-20 Oct-20 Sep-20 Nov-20 Dec-20 Feb-21 Jan-21 Apr-21 Mar-21 May-21 Jun-21 Aug-21 Jul-21 Oct-21 Sep-21 Dec-21 Nov-21 Feb-22 Jan-22 Mar-22 Apr-22 May-22 Jun-22 Aug-22 Jul-22 Oct-22 Sep-22 Jan-18 Jan-19 Jul-18 Jul-19 Apr-18 Apr-19 Jan-20 Jul-20 Apr-20 Jan-21 Jul-21 Apr-21 Jan-22 Jul-22 Oct-18 Oct-19 Apr-22 Oct-20 Oct-21 Oct-22 domestic fuel prices, but non-food inflation pressures remain elevated. Crude oil prices (Brent) have declined to US$93 per Headline Food Non-food barrel as of October 2022, from US$120 per barrel in June 2022, and this induced the Government to decrease the domestic Source: World Bank with data from NSO. price of petrol by 10 percent, to a still historically high rate of MWK 1,746 per liter on September 16, 2022. Nonetheless, domestic fuel prices are still high and are contrib- uting to a rise in transportation costs. With the erratic supply of electricity, most companies are relying on diesel-operated generators to supplement their energy requirements, contributing to increased costs of production. The subsequent passthrough to consumers is also contributing to elevated domestic prices. Rising domestic food prices due to lower supply following lower yields is exerting pressure on food inflation. This has induced an upward push on domestic food prices, already strained by high global food prices of certain food products, as well as the higher costs of imported food following the 25 percent devaluation of the Malawi kwacha in May. Prices of maize and rice have increased even during the har- vest period, defying typical seasonality dynamics. Maize prices have more than doubled in 2022, reach- ing MWK 370 per kilogram in October, against MWK 148 per kilogram during the same period in 2021 (Figure 1.18). Increased demand for maize and maize products in all of Malawi’s three regions has also contributed to rising maize prices. The price of rice has also escalated, reaching MWK 1,303 per kilogram in October 2022, compared with MWK 736 per kilogram during the same period in 2021 (Figure 1.19). 1. Economic Developments 28 Domestic food prices of legumes and meat have also increased during the reported period. The survival minimum expenditure basket9 (WFP, 2022) also increased by 3.1 percent in urban areas, 2.0 percent in the rural Northern region, 1.7 percent in rural Central region, and 1.1 percent in rural Southern region in August 2022, over the previous month. Consequently, nearly 22 percent of households are employ- ing severe consumption-based coping strategies (WFP, 2022). FIGURE 1.18  Maize price trends (MWK) FIGURE 1.19  Rice price trends (MWK) 400 1,400 1,350 1,300 350 1,250 1,200 1,150 1,100 300 1,050 1,000 950 250 900 850 800 750 MWK MWK 200 700 650 600 150 550 500 450 400 100 350 300 250 50 200 150 100 50 0 0 May Aug Jan Mar Jun Jul Aug Nov Jan Mar May Jun Jul Nov Apr Apr Feb Feb Sep Sep Dec Dec Oct Oct 5-year average 2022 2021 2020 2019 2020 2021 2022 Source: World Bank, with data from FMPA tool. Source: World Bank, with data from Ministry of Agriculture. Rising food inflation is pushing more people into poverty. New World Bank simulations of the pov- erty impact of rising food prices find that sustained price increases of 32 percent (the rate of food infla- tion in September), in the absence of rising incomes, will push an additional 7 percent of the popu- lation into poverty (Cardona, 2022).10 The magnitude of the effect depends on whether households are net food consum- FIGURE 1.20  Changes in poverty rate due to food inflation ers or net producers.11 The impact of food inflation on poverty of 32 percent differs depending on where people live, with those in the rural 70 +6.2 south hit hardest. However, in relative terms increasing food 60 +7.1 National Poverty rate, percent prices affects people in cities the most (Figure 1.20). 50 +6.7 40 +6.5 The Government has introduced various measures to address 30 62.8 the cost-of-living crisis. This includes the temporary suspen- 50.7 56.7 +6.8 sion of one fuel levy and reductions in three fuel levies. In 20 35.9 addition, the Government reduced the pump price of petrol 10 19.2 by 10 percent on September 16, reflecting lower global prices. 0 However, these measures have not benefited consumers much Total Urban Rural North Rural Centre Rural South amidst fuel scarcity throughout the country. Other measures Baseline High inflation scenario include the removal of value-added tax (VAT) on cooking oil Note: Assumes impacts through affecting food purchases and income from food sales. and bottled water, and maize price interventions. Source: World Bank calculation with data from NSO. 9.  The survival minimum expenditure basket comprises the bare minimum amount required to maintain existence and cover lifesaving needs. 10.  The analysis relies on the following assumptions: (i) households do not change their consumption patterns; (ii) food inflation affects all households equally; (iii) changes in food prices do not affect the share of food produced by families to be consumed in house: (iv) the increase in food prices translates into an equivalent reduction of households’ consumption; and (v) the increase in own farm income translates into an equivalent increase in consumption for producers’ households. 11.  Net consumers refers to households whose net consumption decreases with higher prices as their expenditure on food is higher than their income earned from food sales, while net producers encompasses households whose net consumption increases with higher prices as their income from food sales is higher than their food expenditure. 1. Economic Developments 29 Despite some progress toward fiscal consolidation, budget discipline remains a challenge Higher government spending during the first half of FY2022/23 widened the fiscal deficit, exert- ing pressure on the Government’s fiscal consolidation plans announced in the FY2022/23 budget. The Government expressed its commitment to implement fiscal consolidation during the budget pro- cess of FY2022/23. Through the first half of the fiscal year, from April to September, the fiscal deficit totaled 4.3 percent of GDP, wider than the mid-year target of 3.5 percent of GDP. Revenue collection slightly underperformed the approved target, and together with higher recurrent spending resulted in an above-target fiscal deficit. While some of these spending overruns (especially for goods and ser- vices) have been caused by external factors, including recent increases in commodity prices, others are due to a continued lack of budget discipline. If the performance for the first half is maintained, the fis- cal deficit for FY2022/23 may widen further to 8.6 percent of GDP However, in line with the new IMF Staff Monitoring Program, the Government will further enhance revenue collection and implement expenditure reductions. Taking these into consideration, the Government could still significantly nar- row the gap between the current fiscal trajectory and the target. All major tax categories have performed well, contributing to a good performance of domestic reve- nues by mid-year. Domestic revenues totaled 6.7 percent of GDP, largely driven by a strong performance in international trade taxes, which were supported by rising global commodity prices and their impact on the value of imports, high-value imports for the telecommunication sector, as well as the devalu- ation of the Kwacha. Taxes on income, profits, and capital gains12 performed well and contributed to taxes totaling 6.3 percent of GDP against their mid-year target of 6.2 percent of GDP. Grants totaled 1.1 percent of GDP supported by frontloading of resources for project spending, but still underperformed their mid-year target of 1.5 percent of GDP. An unsatisfactory performance in other revenues, due to lower remittance of dividends, exerted a downward pressure on total revenue. By mid-year, revenue collection totaled to 7.7 percent of GDP, below the target of 8.3 percent of GDP. The Government exceeded spending targets in almost all expense categories during the first half of FY2022/23. Expenditures totaled 12.1 percent of GDP, higher than the mid-year target of 11.8 percent of GDP. Overruns were reported in all expense categories, other than social benefits and other expenses. These categories in particular were impacted by the high rates of inflation and increased global com- modity prices. Use of goods and services totaled 2.1 percent of GDP, largely driven by higher spending on generic goods and services, which totaled 1.3 percent of GDP by mid-year. The Government also spent more on employee compensation, which amounted to 3.2 percent of GDP against a mid-year target of 2.8 percent of GDP. Higher spending was also reported on interest expenses, which totaled 2.2 percent of GDP, missing its mid-year target by 1.7 percent of GDP. This calls for improved expenditure and fiscal risk management by strengthening public finance management (PFM) systems and the management of commitments (see Box 1.4). Spending on social benefits (including the AIP) was mostly in line with plans, with a performance of 0.9 percent of GDP, compared with the mid-year target. Spending on debt servicing had been increasing significantly in recent years, taking up resources for government discretionary fiscal policy. In FY2022/23, debt servicing is projected to take up more than one-third of domestic revenue, increasing by 50 percent relative to FY2021/22 (Figure 1.21). However, ongoing debt-restructuring negotiations are likely to contribute to increased debt sustainability and significantly reduce interest payments, especially for external debt servicing. 12.  This was driven by a strong performance in taxes payable by corporations and other enterprises from higher remittance of provisional taxes, and personal income taxes from gains of the revised PAYE structure. 1. Economic Developments 30 Frontloading of project financing contributed to the strong performance of development spending. Spending under the foreign-financed development component improved due to the frontloading of grant disbursements for on-budget development projects. Nonetheless, by mid-year, the Government had spent 2.1 percent of GDP on foreign-financed development expenditure, below the mid-year target of 2.6 percent of GDP. The Government had less under the domestically financed component, totaling 0.5 percent of GDP by mid-year, below the target of 0.9 percent of GDP. Cumulatively, the Government intends to spend up to 5.2 percent of GDP on development projects (Figure 1.22). FIGURE 1.21  Debt-servicing costs have been FIGURE 1.22  Development spending is expected on an upward trajectory to increase in FY2022/23 Interest as a share of domestic revenue (rhs) and expense as a share of GDP Expenses and development spending as a share of GDP 40 25 30 20 Percent 15 Percent 20 10 10 5 0 0 FY18 FY19 FY20 FY21 FY22* FY23** FY18 FY19 FY20 FY21 FY22* FY23** Interest as a share of domestic revenue Expense as a share of GDP Expense Development spending Note: *Interpolated data to a full fiscal year based on nine months of data for FY21/22. Note: *Interpolated data to a full fiscal year based on nine months of data for FY21/22. **Approved Budget. **Approved Budget. Source: World Bank, with data from MoFEA. Source: World Bank, with data from MoFEA. BOX 1.4  Recent PFM reforms could help improve management of expenditures and fiscal risk, but will require political will for successful implementation Inadequate PFM systems and weak management of commit- The Government has taken an important step to amend the PFMA ments have contributed to the deterioration of Malawi’s fiscal sit- to ensure that public resources are used with due regard to econ- uation, causing budget overruns and posing fiscal risks in Malawi. omy, efficiency, and effectiveness. The PFMA is the principal leg- In FY2021/22, the Government reported large overruns in most islation in the management of public resources. The Government expenditure categories, most notably in compensation for govern- enacted a revised PFMA in March 2022, which provides greater clar- ment employees, social benefits (which include higher-than-targeted ity in terms of responsibilities of controlling and other officers in the spending on fertilizer payments under the AIP), and use of goods and management of public funds. The PFMA emphasizes improved man- services (Table B1.4.1). agement of commitments and arrears. For instance, one of the provi- sions for controlling officers include restrictions against over-expend- TABLE B1.4.1  Government expenditure heatmap iture and over-commitment of funds. (%, actual against approved target) Central to the implementation of the PFMA is the new IFMIS, which was rolled out from July 2020 and is central to supporting FY17/18 FY18/19 FY19/20 FY20/21 FY21/22 budgetary execution. The IFMIS allows the MDAs to commit annual Compensation of employees 2.64 -1.45 -0.93 1.98 10.41 expenditure against approved budgets when contracts are signed, or Use of goods and services 3.37 -10.14 -0.68- -0.62- 12.72 local purchase orders are issued. Annual portions of multiyear con- Interest 13.62 23.49 7.25 -7.37 -9.42 tracts can also be committed as budgeted. Some of the benefits of Grants 30.50 59.87 33.83 0.88 13.40 using IFMIS include: Social benefits 1.09 -0.08 -1.24 -1.54 15.31 • Making expenditure commitments against approved budgets on a Domestic financed projects real-time basis; (Part II) -24.53 -5.53 15.18 -11.60 -34.69 • Managing arrears, as real-time commitments will ensure that arrears are within approved budgets subject to funding; and <-10 >-10<-5 >-5<0 >0<5 >5<10 >10 • Avoiding over-commitment, as reports generation required under Source: World Bank, with data from the Ministry of Finance and Economic Affairs. the Act will be facilitated. While these reforms have generated optimism for improved PFM In turn, the Government has committed to addressing these con- in the country, implementation will be key. There will be a need sistent PFM problems through two major reforms: the amendment for strict application of the provisions of the PFMA to ensure effec- of the Public Finance Management Act (PFMA) 2003 and the imple- tive compliance, including effective deterrence and entrenchment of mentation of a new Integrated Financial Management Information responsibility and integrity. The IFMIS, which has full commitment System (IFMIS).* The objectives of these reforms are: (i) to maintain a control functionality at present, needs to be fully implemented as an sustainable fiscal position; (ii) a more effective allocation of resources; effective tool to address consistent overruns and insufficient budget and (iii) the efficient delivery of public goods and services. discipline. Notes: *IFMIS is a SAP-based software systems to support management of public sector budgetary, financial, and accounting operations and promote better PFM with a centralized registry of public sector revenues and expenditures. Source: World Bank, with data from MoFEA. 1. Economic Developments 31 Malawi’s public debt is in distress, but the Government is restructuring some debt to ensure medium-term sustainability While debt is sustainable on a forward-looking basis, Malawi is assessed to be in debt distress, with both external and public debt considered unsustainable under current polices. The November 2022 Joint IMF-World Bank Debt Sustainability Analysis reports that Malawi’s public debt is unsustainable, with the heaviest burden arising from liquidity ratios against exports. Public debt increased to 64.0 per- cent of GDP by end of 2021, up from 54.8 percent of GDP in 2020. This was largely driven by accumulation of domestic debt from 21.9 percent of GDP in 2020 to 31.2 per- cent of GDP in 2022. The Government has mostly been imple- FIGURE 1.23  Malawi’s public debt has grown menting an expansionary fiscal policy, and related financing as fiscal deficits have increased of fiscal deficits with domestic resources (Figure 1.23) has con- As a share of GDP tributed to the large uptake of domestic debt. External debt 80 0 slightly decreased from 32.9 percent of GDP in 2020 to 32.8 per- cent of GDP in 2021. While the Government has taken meas- 70 ures toward fiscal consolidation, fiscal deficits remain high and −2 60 will contribute to continued accumulation of public debt in the short term. Public debt is estimated to reach 76.6 percent 50 of GDP by end of 2022. −4 Percent Percent 40 The composition of external debt has shifted toward commer- cial creditors at non-concessional terms, increasing debt-ser- −6 30 vicing costs (Figure 1.24). As part of exchange rate manage- ment, the RBM had contracted short-term exchange-rate swaps. 20 However, amid dwindling foreign exchange reserves and thus −8 liquidity challenges, these were converted into medium-term 10 facilities and contributed to the jump in external debt from 25 percent at the end of 2018 to 33 percent at the end of 2020. 0 −10 2014 2015 2016 2017 2018 2019 2020 2021 2022 Some of the medium-term facilities matured in 2021, and exter- nal debt moderated. However, foreign currency liquidity chal- External debt Domestic debt Fiscal Balance (RHS) lenges are still paramount, and public institutions have been Source: World Bank calculations, with data from RBM and MoFEA. contracting foreign exchange facilities for the importation of strategic commodities. This may further strain the country’s FIGURE 1.24  Commercial debt has increased in significance, external debt position, especially if the current shortage of for- especially since 2020 eign exchange in the country persists. As of March 2022, com- As a share of total external debt mercial lenders held 23 percent of external debt (equivalent 90 to 9.8 percent of GDP), while multilateral and bilateral credi- 80 tors held 64 and 13 percent of external debt (equivalent to 27.0 and 5.4 percent of GDP), respectively. Terms of borrowing from 70 commercial creditors are highly non-concessional and exter- 60 nal debt servicing is concentrated on these commercial lend- ers. As of end FY2021/22, debt service to the two major com- 50 Percent mercial lenders (AFREXIM and TDB) comprised 64 percent of the 40 total external debt service. 30 Domestic government debt uptake by the banking sector re- mains high, crowding out resources for private sector invest- 20 ment. With the Government still recording high fiscal defi- 10 cits, uptake of domestic debt to finance the gap is still rising. Domestic debt has increased by 11 percent in FY2022/23 to MWK 0 Jun-17 Jun-18 Jun-19 Jun-20 Dec-20 Jun-21 Mar-22 4.3 trillion (equivalent to 37.4 percent of GDP) as of August 2022, 67 percent of which is held by the banking sector. Broad money Multilateral Bilateral Commercial supply is increasing by 36.3 percent y-o-y as of September 2022, Source: World Bank calculations, with data from MoFEA 1. Economic Developments 32 in turn exerting additional inflationary pressures. At the same time, increased credit to government is eroding resources for private sector investment. As of September 2022, net credit from the banking sector to the private sector had increased by 22.4 percent y-o-y, while net credit to government had in- creased by 66.3 percent over the same period (Figure 1.25). Uptake of government domestic debt by the non-bank13 sector is rising rapidly by 79 percent y-o-y over September 2021. On the other hand, domes- tic debt held by the foreign sector has declined by 21.2 percent y-o-y over the same period (Figure 1.26). FIGURE 1.25  Credit to the Government and the private sector FIGURE 1.26  Domestic debt by holder (MWK million) (MWK billion) 2.0 4,500 1.8 4,000 1.6 3,500 1.4 3,000 MWK, billion 1.2 2,500 MWK, million 2,000 1.0 1,500 0.8 1,000 0.6 500 0.4 0 0.2 Jan-18 Jan-19 Jul-18 Jul-19 Jan-16 Jan-15 Jul-16 Jul-15 Jan-20 Jan-17 Jul-20 Jul-17 Jan-21 Jul-21 Jan-22 Jul-22 0.0 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18 Jan-19 Jul-19 Jan-20 Jul-20 Jan-21 Jul-21 Jan-22 Jul-22 Domestic debt held by commercial banks Domestic debt by RBM Domestic debt held by non-bank sector Net credit to government (NCG, K mn) Credit to private sector Domestic debt held by foreign sector  Source: World Bank, with data from the RBM. Source: World Bank, with data from the RBM. The share of domestic debt held in longer-term instruments reduced slightly relative to FY2021/22, but remains high. In line with the Medium-Term Debt Strategy (MTDS) 2018 – 2022, the Government has shifted its borrowing strategy toward longer-term instruments to address the debt rollover risk asso- ciated with short-term instruments. This has contributed to the share of the Government’s domestic debt held in Treasury notes increasing over the period of implementation of the MTDS, from 66 percent of total domestic debt in June 2017, peaking at 89 percent in March 2022. As of September 2022, the share of domestic debt held in Treasury notes had slightly reduced to 87 percent. Interest rates associ- ated with these longer-term instruments have also been increasing, increasing the debt-servicing bur- den (Figure 1.21). The share of domestic debt held in Treasury bills has slightly increased, from 11 per- cent in March 2022 to 12 percent in September 2022. The Government has taken initial steps to bring debt down to a more sustainable path, both through restricting additional debt and the initiation of PFM reforms. Currently, the Government is engag- ing its external creditors to implement a debt strategy that involves significant restructuring, in par- ticular to reduce debt-servicing costs. PFM reforms may contribute to reduced pressure on public debt from arrears. However, efforts toward fiscal consolidation are being challenged by the current mac- roeconomic environment, including rising domestic prices from the effects of Russia-Ukraine war. 13.  This excludes debt taken up by the foreign sector. 1. Economic Developments 33 TABLE 1.1  Fiscal accounts (% GDP) 2022/23 2018/19 2019/20 2020/21 2021/22   Mid-Year Actual Revised Budget Revenue 14.7 14.6 14.5 14.9 7.7 16.6 Domestic Revenue 13.2 13.1 13.0 13.7 6.7 13.4 Taxes 12.8 12.3 12.2 13.0 6.3 12.7 Taxes on Income, Profits and Capital Gains 6.0 5.8 5.7 5.8 3.0 5.9 Taxes on Goods and Services 5.7 5.5 5.5 6.0 2.7 5.5 Taxes on International Trade and Transactions 1.1 1.0 1.0 1.1 0.7 1.2 Other Taxes 0.0 0.0 0.0 0.0 0.0 0.0 Grants 1.4 1.5 1.5 1.2 1.1 3.1 From Foreign Governments - - - - 0.1 0.2 From International Organizations 1.4 1.5 1.5 1.2 1.0 2.9 Other Revenue 0.5 0.8 0.7 0.8 0.3 0.8 Property Income 0.1 0.3 0.4 0.1 0.1 0.4 Sale of Goods and Services 0.4 0.5 0.3 0.6 0.2 0.3 Fines, Penalties and Forfeits 0.0 0.0 0.1 0.0 0.0 0.0 Expenditure 19.1 20.9 21.7 23.7 12.1 23.5 Expense (with arrears) 15.6 16.6 18.1 19.7 9.5 18.3 Compensation of Employees 5.2 5.5 5.9 6.4 3.2 5.8 Goods and Services 3.4 4.0 3.7 3.9 2.1 3.3 Generic goods and services 2.1 2.5 2.2 2.3 1.3 2.0 Maize purchases 0.1 0.1 0.1 0.2 0.1 0.1 Interest 2.9 3.0 3.7 3.5 2.2 5.3 To non-residents 0.2 0.2 0.2 0.2 0.2 0.3 To residents other than general government 2.7 2.8 3.5 3.3 2.0 5.1 Grants 2.7 2.7 2.0 2.2 1.1 1.9 Social Benefits 1.4 1.4 2.6 3.3 0.9 1.9 Fertilizer payments 0.4 0.3 1.3 2.1 0.3 0.8 Other Expenses 0.1 0.1 0.3 0.4 0.1 0.1 Non-Financial Assets 3.5 4.2 3.6 4.0 2.6 5.2 Foreign financed 2.2 2.4 2.7 2.2 2.1 4.2 Domestically financed 1.4 1.8 1.0 1.8 0.5 1.0 Deficit -4.5 -6.3 -7.2 -8.8 -4.3 -7.0 Primary Balance -1.6 -3.3 -3.5 -5.3 -2.2 -1.6 Net Financing 4.5 5.7 7.1 9.1 2.9 7.0 Foreign Liabilities 0.8 0.8 1.0 0.9 0.6 2.2 Program Borrowing 0.1 0.0 0.3 0.0 0.0 0.8 Project Loans 1.0 1.2 1.2 0.9 1.0 2.6 Amortization -0.4 -0.4 -0.4 0.0 -0.4 -1.3 Domestic Liabilities 3.8 4.9 6.0 8.2 3.7 4.8 * FY2021/22 figures as a percent of GDP represent a nine-month fiscal year, to enable comparison with previous fiscal years. Note: Figures are a share of rebased GDP figures. Source: World Bank calculations, with data from the RBM and MoF 1. Economic Developments 34 The spread between the official and market exchange rates has widened again, while foreign reserves remain low The spread between the official telegraphic transfer rates and cash rates has reemerged after the RBM devalued the official MWK-US$ exchange rate by 25 percent in May 2022. Between July 2021 and May 2022, the official Malawi kwacha exchange rate for telegraphic transfers (TT), through which most foreign exchange transactions are carried out, had only marginally depreciated by 1.4 percent. Meanwhile, foreign exchange bureau (FXB) cash exchange rates depreciated by 25.6 percent, widening the spread against the TT rate to 42 percent (Figure 1.27). To align official rates with market rates and address foreign exchange shortages, the RBM devalued the official Malawi kwacha-US dollar exchange rate by 25 percent. However, the spread between the official TT rates and foreign exchange bureau cash rates now has surpassed the pre-devaluation level. Increases in current money supply in the domestic economy and inflation differentials (i.e., a rise in domestic prices relative to foreign prices) are considered to have a depreciating impact on exchange rate movements. The exchange rate adjustment has had a limited impact in addressing foreign exchange shortages. This comes after a number of measures, including the re-introduction of the mandatory sale of export proceeds in August 2021,14 which did not sufficiently support the foreign exchange supply to eradicate imbalances in the interbank market. The exchange rate adjustment was aimed at improving external sector competitiveness and building up official reserves, aligning the exchange rate with market fun- damentals, as well as improving the circulation of foreign exchange in the market. While imports and other international foreign exchange transactions have declined, banks and other businesses contin- ue to hoard foreign exchange despite the devaluation in May (IMF, 2022b). FIGURE 1.27  Spreads between TT and bureau MWK-US$ FIGURE 1.28  …while reserves remain low exchange rates continue to widen… Official gross and net reserves, months import cover RBM telegraphic transfer (TT) and forex bureau cash MWK/US$ rates and spreads 5 through Nov 17 1,500 500 4 RBM TT and forex bureau cash MK/US$ rates 1,400 400 Months import cover 3 1,300 Med cash sell spread, MK 1,200 300 2 1,100 200 1 1,000 900 0 100 800 −1 700 0 Mar-19 Jun-19 Sep-19 Dec-19 Mar-20 Jun-20 Sep-20 Dec-20 Mar-21 Jun-21 Sep-21 Dec-21 Mar-22 Jun-22 Sep-22 Jan-17 May-17 Jan-18 May-18 Jan-19 May-19 Jan-20 May-20 Jan-21 May-21 May-22 Jan-22 Sep-18 Sep-19 Sep-20 Sep-17 Sep-21 Sep-22 Gross reserves Net reserves O icial TT sell Median cash sell Med cash sell spread (RHS) Notes: Net reserves subtract predetermined short-term drains, such as short-term swaps Source: World Bank staff calculations based on RBM data. Source: World Bank staff calculations based on RBM data. Official foreign exchange reserves remain low, caused by a structural trade deficit and rising debt-ser- vicing payments to external commercial creditors. Gross reserves decreased by more than half, from US$847 million in December 2019 and one-third over the year from US$605 million in August 2021 to US$326 million in October 2022, or around 1.3 months of import cover (Figure 1.28). This is much lower than the recommended adequacy level of 3.9 months of import coverage for a credit-constrained econ- omy (IMF, 2022b). Net reserves have been negative, and gross reserves have been mainly supported by sub- stantial swaps (both new and rollovers) and medium-term borrowing facilities at non-concessional terms. 14.  It requires exporters to liquidate 30 percent of their proceeds held in Foreign Currency Denominated Accounts. The require- ment was supposed to be on a temporary basis but has continued to date. 1. Economic Developments 35 The rise in the policy rate has not resulted in lower inflation, which remains primarily supply-driven Monetary conditions have tightened. Since the policy rate was increased to 14 percent from 12 per- cent in April 2022, the base lending rate and interbank rate have increased in response. The policy rate increase and strong government demand led to a rise in monthly average Treasury bill and note yields across all the tenors (Figure 1.29). For example, the yields of two-year and seven-year Treasury notes increased by 550 and 450 basis points, respectively, between the March and mid-November 2022 posi- tion (Figure 1.30). Furthermore, in October 2022, the Monetary Policy Committee increased its key pol- icy rate to 18 percent from 14 percent to restore price stability, noting that high inflation could frus- trate the country’s economic recovery process and diminish the welfare of households (RBM, 2022). The 6.5 percentage point increase in the policy rate this year is an effort by the RBM to address rising infla- tion by anchoring inflation expectations. FIGURE 1.29  The real policy rate has been negative FIGURE 1.30  Government borrowing yields have increased since January 2022 since March 2022 Interest rate T-bill and T-note interest rates (%) 50 30 800 45 40 700 25 35 600 30 20 25 500 Basis points 20 Percent Percent 15 15 400 10 300 5 10 0 200 −5 5 −10 100 −15 0 0 Jan-16 May-16 Sep-16 Jan-17 May-17 Sep-17 Jan-18 May-18 Sep 18 Jan-19 May-19 Sep-19 Jan-20 May-20 Sep-20 Jan-21 May-21 Sep-21 Jan-22 May-22 Sep-22 91 182 364 2 3 5 7 10 day day day year year year year year Base rate Policy rate Real policy rate 15-Nov-21 31-Mar-22 15-Nov-22 Interbank rate Max lending rate Yield change (RHS) Source: World Bank staff calculations based on RBM data. Source: World Bank staff calculations based on RBM data. However, the real policy rate has been negative amid heightened inflationary pressure. Following the October 2022 rate increase, the real policy rate stands at –8.7 percent, 2022 with headline inflation at 26.7 percent. Despite the recent increase in the policy rate, the monetary policy stance has tended to be accommodative, expanding the money supply to boost the economy during a slowdown and reflect- ing its supply-driven nature (Figure 1.31). FIGURE 1.31  Monetary supply has expanded Currency in circulation (% y-o-y) and inflation (%) 50 40 30 Percent 20 10 0 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 May-18 Jul-18 Sep-18 Nov-18 Jan-19 Mar-19 May-19 Jul-19 Sep-19 Nov-19 Jan-20 Mar-20 May-20 Jul-20 Sep-20 Nov-20 Jan-21 Mar-21 May-21 Jul-21 Sep-21 Nov-21 Jan-22 Mar-22 May-22 Jul-22 Sep-22 Currency in circulation Inflation Source: World Bank staff calculations based on RBM data. 1. Economic Developments 36 Bolstered by high levels of government borrowing, the banking sector has performed well despite wider macroeconomic challenges The banking sector has maintained high profits and a strong overall financial performance, but trends show declining buffers in 2022 compared with the position in 2021. The banking sector’s overall capital adequacy ratio and tier 1 capital adequacy ratio were well above the regulatory thresh- olds of 15 and 10 percent, respectively, as of September 2022 (Figure 1.32). Nonetheless, there has been evidence of slight deterioration in 2022. A similar trend was observed in the liquidity coverage, which stood at 47.3 percent. While this is above the 25 percent regulatory threshold, it is lower than the 55 percent recorded in September 2021. While the sector is still maintaining a healthy asset quality posi- tion, non-performing loans (NPLs) to gross loans and advances deteriorated as compared with the end of 2021, mostly remaining above the prudential limit of 5.0 percent in 2022. The wholesale and retail trade; electricity, gas, water and energy; community, social and personal services sector; and agricul- ture, forestry, fishing and hunting continue to account for a significant proportion of NPLs. On the other hand, the overall profitability for the banking sector is healthy, with return on equity (ROE) and return on assets (ROA) increasing by 22.8 percent (to 30.6 percent) and 17.1 percent (to 3.8 percent), respectively, over the positions at the same period in 2021. Profitability in the sector was a result of increases both in interest and non-interest income, against slower growth in expenses (Figure 1.33). FIGURE 1.32  Financial stability indicators show resilience FIGURE 1.33  Private sector credit is dominated by personal against economic decline loans and trading services 60 30 Monthly share to total lending in selected sectors 50 25 Community, social and personal services 40 20 Wholesale and retail Percent Percent 30 15 trade 20 10 Agriculture, forestry, fishing & hunting 10 5 Manufacturing 0 0 July August September October November December January February March April May June - July - August - September Other 0 5 10 15 20 25 30 35 Tier 1 capital Liquidity ROE Percent NPLs (RHS) ROA (RHS) January April September Source: World Bank staff calculations based on RBM data. Source: World Bank staff calculations based on RBM data. The banking sector is showing resilience, but facing a challenging environment characterized by a slowdown in the economy, rising inflation and a scarcity of foreign exchange. These conditions would typically adversely affect the performance of the banking industry. However, lending to the Government has mitigated such challenges, complemented by lending to low-risk businesses deemed most likely to be capable of servicing loans, explaining the low NPLs. Sentiments from the industry indi- cate that banks are strengthening due diligence procedures and lending to trusted clients only. This performance is also reflected in the performance of shares of major banks, which have outperformed on the Malawi Stock Exchange this year, contributing to the Malawi All Shares Index, which covers 16 stocks, reaching an all-time high in November 2022.15 15.  This, however, is likely to be a function of the shallowness of Malawian financial markets rather than underlying business per- formance. The Pensions Act of 2011 makes it mandatory for businesses and employees to contribute at least 7.5 and 5 percent of pensionable emoluments, respectively, to a pension fund. This leads to rapid growth in assets in a market with few alternatives, government bonds and real estate being among the few notable ones. 1. Economic Developments 37 The pattern of lending to the private sector has not changed much in the year. While growing modest- ly in nominal terms, most lending went to just three sectors, namely community, social and personal services; wholesale and retail trade; and the agriculture, forestry, fishing and hunting sector (Figure 1.33). Collectively, these accounted for 71.9 percent of the total loan portfolio in September 2022, an increase from 67.7 percent in September 2021. Lending to the manufacturing sector remains low at 9.3 percent, down from 13.2 percent in 2021. Analyzing this further, it is notable that most of the lending is direct- ed at activities associated with personal loans, pay day loans, loans associated with state-owned enter- prise activities and mostly for consumption, and for trading and agriculture-related activities. As Micro, Small and Medium Enterprises (MSMEs) struggle to grow with limited access to financing, financial in- stitutions are implementing lending programs to support this sector (see Box 1.5). BOX 1.5  As MSMEs struggle to grow, financial institutions are implementing lending programs to support this sector with support from the RBM and the World Bank The RBM, with support from the World Bank, commissioned an Interventions will be required to increase knowledge and utili- MSME survey, which identified characteristics of micro, small zation of institutions that provide business management, entre- and medium enterprises in Malawi. The survey identified several preneurial skills and access to credit. Most MSMEs are unable to characteristics of the MSMEs and owners, including the following: access formal credit for several reasons, including a failure to meet collateral requirements set by lenders, weak management struc- • Forty-five percent of MSME owners in Malawi are financially illit- tures, and the high cost of credit. These challenges cause MSMEs erate, and they acquired business skills by themselves and mostly to struggle in their efforts to survive and scale up. through trial and error, rather than through a training program. • The majority (71 percent) of business owners did not register with Study findings revealed that most MSMEs were not aware of the Registrar of Companies. Among the minority that did, more the existence of public institutions or bodies that provide sup- than three-quarters (79 percent) had registered as sole proprietors, port for MSME development in Malawi. For example, aware- 11 percent as a private company and 7 percent as partnerships. ness of the Malawi Investment and Trade Centre, Small and • The majority (55 percent) kept records of business finances. Medium Enterprises Development Institute, and the Malawi However, of those who kept records, the majority (82 percent) Confederation of Chambers of Commerce and Industry remains used a standardized manual recording system. low at 24, 29 and 34 percent, respectively, and use of the ser- The survey identified a number of challenges for MSMEs, espe- vices of these three institutions remains at or below 10 percent of cially when it comes to access to finance. With regard to access surveyed firms. to finance, 27 percent of survey respondents indicated access to To help address this challenge, the Government initiated the finance as a major obstacle. The National Economic Empowerment Financial Inclusion and Entrepreneurship Scaling project. Fund Limited is seen as the most popular micro-finance institu- Through this project, which is supported by a US$86 million credit tions for accessing loans (54 percent), followed by FINCA (19 per- from the World Bank, the commercial banks, microfinance institu- cent), and the Microloan Foundation (5 percent). About 74 percent tions and development finance institutions have partnered with the are aware of know-your-customer standards, but only 34 percent RBM to provide low-cost loans to innovative enterprises, support are aware of the credit reference system in Malawi. Digital finan- high-potential start-ups, and establish capable and well-supervised cial uptake is dominated by mobile money accounts (54 percent). investments, while enabling them to adopt digital financial services. 11 percent reported having either a registered debit or credit card, In addition, capacity building programs are being offered to inno- and internet banking is used by only 4 percent. vative MSMEs. Source: Preliminary Report of the Baseline Survey from the Financial Inclusion and Entrepreneurship Scaling project to be published in December, 2022. 38 1.3 MEDIUM-TERM ECONOMIC OUTLOOK Malawi’s economy is projected to post subdued growth over the coming year, with per capita income stagnating. GDP growth is projected to slow to 0.9 percent in 2022. This is driven by a lower-than-antici- pated performance in agriculture, the ongoing balance-of-payments crisis and its impact on production, as well as the cumulative impact of external shocks. The industry and services sectors continue to be impacted by erratic electricity supply. Recovery from the COVID-19 pandemic continues to be hampered by the sustained impacts of cyclones in early 2022, as well as persistent economic imbalances. Economic growth is projected to pick up to 2.2 percent in 2023, driven in particular by a recovery of the agriculture sector. A full recovery of the economy to a pre-COVID-19 growth path is not expected in the near term. Prolonged foreign exchange shortages can have severe and long-lasting effects on the real economy. Businesses have to forego potentially profitable investment opportunities because imported investment items are unavailable, limiting economic growth in the medium term. When a market price is replaced by government interventions, it is often done on a per-good- or per-business-basis. This may deepen the crisis by limiting the capacity of businesses to generate foreign exchange. The poor performance of exports, amid elevated global prices for most key commodities, will result in a further weakened external sector and a high current account deficit. While a more flexible ex- change rate regime has some negative consequences in the short term, such as an increase in the cost of imports, it should gradually help increase export competitiveness and improve the trade balance in the medium term. However, limited diversification and declining global demand for tobacco will con- tribute to sustained difficulties in reducing the current account deficit. As such, increasing exports in identifying new potential export sectors, most notably in agribusiness and mining, will be essential. Inflation is expected to remain high. Malawian businesses and consumers will likely have to expect higher Malawi kwacha prices for imported products, especially fuel, fertilizer and cooking oil. In addi- tion to rising inflation, there is a possibility of energy prices rising, which will increase electricity prices and further strain the costs of production. Pressures on the macroeconomy could create further challenges for the achievement of the Gov- ernment’s fiscal consolidation aims. There is a risk that the FY2022/23 fiscal deficit may widen fur- ther to 8.6 percent of GPD, beyond the revised target of 7.0 percent of GDP in the absence of significant reforms. Despite consolidation efforts planned for this fiscal year, expenditure will likely further rise owing to increased recurrent spending due in part to elevated commodity prices and the recent deval- uation. Due to the scarcity of fuel and erratic availability of electricity and increasing costs of produc- tion from high and rising input costs, several companies are reducing their scale of operations, which could result in reduced mobilization of domestic revenue. These factors could cumulatively result in a higher-than-projected fiscal deficit. As most foreign financing is dedicated or ringfenced to specific spending items, this may result in increased domestic borrowing, which could heighten inflationary pressures and contribute to crowding out resources for private sector investment. 1. Economic Developments 39 In the absence of significant restructuring, public debt is projected to increase further due to high fis- cal deficits financed through high-cost domestic borrowing. Non-concessional external debt incurred to support foreign currency reserves is currently being restructured but remains a concern. In addi- tion, restructuring with bilateral lenders is being sought. Financing assurances from creditors, as well as fiscal, monetary, and exchange rate policies, could bring Malawi to a sustainable debt path needed for a full IMF program supported by an ECF. Such an ECF would in turn engender trust by private inves- tors and crowd in further budget support from development partners. If this process is adequately sup- ported with sustained fiscal consolidation that progressively lowers expenditure, and additional meas- ures to reduce debt vulnerabilities, especially through improved PFM systems, this could give rise to increased investor confidence and private sector investment. The lack of sustained economic growth, along with the continuous inflationary pressures and recur- rent weather shocks, will make it more difficult for Malawi to find a way to reduce poverty. The share of people living with less than US$2.15 per day is projected to remain at 71 percent in 2022 and 2023. However, further external shocks may result in increasing poverty rates and push more people into food insecurity. These economic prospects are subject to considerable uncertainty with several downside risks. Persistent foreign exchange unavailability, a wave of corporate bankruptcies, financial stress, delays in the AIP implementation and reform process, rising poverty and food insecurity, and a worsening of the current cholera outbreak could derail the recovery. A rapid deterioration of global growth, high- er-than-anticipated energy prices, and tighter financing conditions are the primary external risks. Natural disasters and intensifying climate change impacts, especially on agriculture production, con- tinue to pose a major downside risk to the economic outlook. Policy Options: Reducing macroeconomic imbalances, supporting the recovery of growth and protecting the poor against shocks The Government has taken important steps to address the ongoing crisis over the course of 2022. This includes measures to reduce the fiscal and external deficit, including initiating discussions on debt restructuring, the announcement of a less expensive and better targeted “AIP 2.0”, and the ongo- ing implementation of the 2022 PFM Act. In parallel, support to the poorest has been enhanced sig- nificantly through an expansion of cash transfer programs and climate-smart public works. However, the prospects for Malawi’s economy depend on an improvement in external conditions, as well as the materialization of the Government’s plans to improve expenditure management and debt sustainabil- ity. In turn, implementing announced policy reforms and strategies has become more important than ever to overcome the interlinked fiscal, balance of payments, and food security crises, and create the foundations for sustained economic growth. This 16th edition of the Malawi Economic Monitor (MEM) calls for urgent actions to stabilize the economy and enhance growth. As in the previous MEM, this edition includes addressing three key areas: i) Stabilizing the economy: While some progress is being made, there remains an urgent need for the implementation of the announced macroeconomic reforms, including building foreign reserves, achieving fiscal consolidation goals for the current fiscal year, returning debt to a sustainable path through restructuring, implementing key fiscal governance and PFM reforms, and contin- uing the shift toward a more flexible exchange rate regime. ii) Stimulating export competitiveness and overall market-driven growth in the economy: In the con- text of an ongoing macroeconomic crisis, it will be essential to focus on reforms for growth. This includes a sustained emphasis on advancing agricultural commercialization, improving the pro- 1. Economic Developments 40 ductivity of firms, and increasing and diversifying exports. It will also be important to deliver on the planned reform of unaffordable and poorly targeted subsidies, such as those for the Affordable Input Programme (AIP), and remove distortions that constrain firms’ growth. iii) Protecting the poor and strengthening resilience: As another difficult lean season approaches, includ- ing the heightened risk of extreme climatic events, it will be essential to advance implementa- tion of the significantly expanded Social Cash Transfer Program and other assistance programs. In the context of fiscal pressures, it will also be important to continue prioritizing the delivery of essential services to the most vulnerable, while improving the efficiency and effectiveness of social sector expenditure. TABLE 1.2  Priority policy areas and key actions 1. Restoring macroeconomic stability Continue the progression towards a sustainable, well-supported, and market-based exchange rate short regime. Building foreign Gradually increase foreign exchange purchases medium reserves Strengthen the RBM’s reserve management by developing reserve management strategies and prac- tices, including a registry to ensure the consolidation of records of all liabilities and contracted facili- medium ties, timely reporting, and enhancing transparency and accountability. Strengthen fiscal consolidation efforts, in particular by continuing the process of scaling back AIP short expenditures through improved targeting. Addressing fiscal Increase domestic revenue by implementing policies to support private sector growth, improving the medium pressures Government’s tax collection capacity, as well as increasing taxpayer compliance. Strengthen budget planning and prioritize expenditures in a sustainable medium-term fiscal medium framework. Finalize debt restructuring negotiations and proceed with implementation of new debt strategy. short Achieving debt Develop and adhere to an annual borrowing plan to contain the increase in domestic debt and short sustainability non-concessional external borrowing. Enhance public debt transparency by expanding the coverage of public debt reports to include com- short prehensive information on contingent liabilities and outstanding payments. End overspending on budget allocations by implementing commitment controls and a framework for Improving public short cash management that supports more efficient service delivery and increases public trust. finance management and investment Continue improving the prioritization and transparency of the Public Sector Investment Program medium through investments in its technical infrastructure and timely publication of key analyses. 2. Enhancing export competitiveness and market-oriented growth Ensure that any legislation under discussion such as the Crops Bill, and export licensing procedures, Boosting private-sec- short supports implementation of the Control of Goods Act. tor development and trade Implement Malawi’s National Export Strategy, promoting access to key regional and global markets, medium such as the African Continental Free Trade Area. Increase access to reliable power by ensuring the financial sustainability of ESCOM, advancing the real- Improve the efficiency medium ization of the Mpatamanga Hydropower Project, and improving the infrastructure for off-grid systems. and sustainability of infrastructure Build, upgrade and rehabilitate infrastructure to withstand climate change shocks through improved use of medium public sector resources and greater access to international climate finance and private sector investment. Increasing access Promote longer-term and affordable financing options for the private sector, and particularly smaller medium to finance and enterprises. ensuring the stability Strengthen the monitoring of the performance of the banking sector, while slowly phasing out single of the financial sector short exposure limit waivers and reducing lending to the public sector. 1. Economic Developments 41 3. Protecting the poor and strengthening resilience Improve efficiency and effectiveness of public expenditure at the sub-national level to increase access to essential basic ser- short vices among the most vulnerable. Implement emergency cash transfers across both urban and rural areas to help vulnerable households access food and other medium necessities in response to acute food insecurity and price shocks. Expedite national roll-out of climate smart public works programs as a complementary social safety net to cash transfers for the medium poorest and most vulnerable in rural areas. Halt and reverse widespread land degradation through investments in land and forest restoration and management medium Submit to parliament the DRM Bill to provide clarity on the functional mandates of MDAs working on climate and DRM pro- short grams and improve the monitoring and coordination of resource allocation and execution. Initiate Phase out Sustain Strengthen 2 STRENGTHENING AGRICULTURAL COMMERCIALIZATION AND RURAL LABOR MARKETS 2. Strengthening Agricultural Commercialization and Rural Labor Markets 43 Improving rural labor market outcomes is key to reducing poverty A more robust and vibrant rural economy is needed to address Malawi’s economic difficulties. In 2021, over three-quarters of all adults worked in agriculture and the sector contributed 43 percent to the coun- try’s overall economic growth. In addition, agriculture has many deep links with other sectors, and has an important impact on Malawi’s overall macroeconomic performance. As discussed in the previous chapter, the design of current major agricultural support programs, such as the AIP, not only has direct impacts on the agriculture sector, but also limits fiscal space and consumes a significant share of available foreign ex- change, thus reverberating across the overall economy. While the AIP takes up a significant share of scarce agriculture budget resources — around 40 percent on average in recent years — it has done little to stim- ulate the process of agricultural transformation that Malawi desperately needs to generate higher eco- nomic growth and create more jobs. In fact, if anything, it has contributed to the status quo of the current low-return maize-based farming systems that have trapped many rural households in perpetual poverty. Conversely, a vibrant rural economy, stimulated by improved policies and better-targeted investments, could catalyze the economy as a whole, alleviating many of the macro-fiscal imbalances discussed in Chapter 1. As urbanization is progressing slowly, rural labor markets hold the key to sustained poverty reduc- tion in Malawi. Malawi’s population remains mostly rural — the 2018 census classified 84 percent of the population as rural residents (NSO of Malawi, 2019) — and largely pursues small-scale, rainfed agriculture. For most rural residents, farming remains the foundation of their livelihood — over 93 percent of rural workers (aged 15 to 64 years) are employed in the sector and three in four working Malawians are esti- mated to derive their livelihoods from agriculture (IFPRI, 2022). Many people spend most of their lives working in agriculture and there are few signs of labor mobility to other sectors (Baulch et al., 2019). In fact, in Africa more people shifted into farming when the COVID-19 pandemic arrived, with agricul- ture cushioning the economic contraction (Amankwah and Gourlay, 2020). The high level of subsistence farming has been a key factor in Malawi’s persistent poverty, which re- mains predominantly a rural phenomenon. Ninety-four percent of all poor households are found in ru- ral communities, with the rural poverty headcount ratio for Malawi at 57 percent, three times higher than in urban centers, at 19 percent (Caruso and Cardona Sosa, 2022). This is partly related to the low produc- tivity of farming systems in Malawi in terms of crop yields, and partly due to the small average farm size of only 0.7 hectares (ha) in land, which is considerably less than in other countries in the region. For ex- ample, whereas per capita arable land for Malawi’s rural population was 0.19 ha in 2020, this figure was 0.34 ha in Tanzania, 0.37 ha in Zambia and 0.39 in Zimbabwe (World Bank, 2022). Such small landhold- ings, especially when the majority of farming is limited to a single rainfed cropping season, does not of- fer sufficient returns to enable farming households to meet their basic needs.16 According to the most re- cent (2019/20) Integrated Household Survey (IHS), the typical farming household only derived MWK 16,190 (about US$20 in nominal terms) in value per capita annually from their efforts. Meanwhile, the share of rural households with a member engaged in waged employment has steadily dropped to fewer than one in five. While agriculture will remain Malawi’s largest employer for the next decade, farming only provides 21 percent of total income for the typical Malawian farming household. The rest is made up of casual labor, longer-term wage employment, household enterprises and, to a lesser degree, regular income payments such as pensions, as well as social protection and similar transfers. Despite these diversified livelihood strategies that have enabled households to generate incomes from non-farm activities, some 54 percent of farming households are still not able to meet their basic needs. Rural households will increasingly need to turn to other types of employment outside agriculture to avoid or to escape poverty. However, non-farm rural employment does not necessarily provide 16.  Productivity is low, especially for smallholders, due to constraints that range from weather variations (floods and dry spells), limited use of improved agricultural technologies, inputs, and practices, as well as poor access to credit and markets. The scarcity of land and fragmentation of holdings compound these problems. The availability of water is another concern. 2. Strengthening Agricultural Commercialization and Rural Labor Markets 44 sufficiently high incomes to lift households out of poverty and BOX 2.1  What is a Commercial Farmer? many households do not have the resources or skills needed to create or find employment that pays well. New analysis in A commercial farmer is broadly engaged in agricultural pro- duction for the market. These farmers are typically net sellers, Benson and De Weerdt (2023, forthcoming) shows that even if i.e., able to meet food consumption needs while also produc- all farming households were able to reach the agricultural pro- ing a surplus to sell. ductivity levels of the top 10 percent most productive house- For the purposes of this report, households are catego- holds, the impact on household incomes and the poverty rate rized as commercially-oriented if their consumption level is would be limited, ranging from a reduction of 1.9 to 9.7 per- above the food poverty line and they reported selling more centage points, depending on the main crop planted. As such, than one-quarter of their harvested maize annually. Although the current structure of household agricultural production in the total value of crop production that was sold could have been used to define households in this category, maize was Malawi offers no pathway to sustained poverty reduction for used for analytical simplicity. Eighty-eight percent of farming many, if not most, farming households. household in Malawi produce maize and the crop is planted on over 70 percent of the cropland of farming households. In Understanding the full diversity of income-generating ac- addition, gross sales as a share of maize harvested was used, tivities that rural Malawians engage in is crucial to develop- given that information on food crop sales and consumption is not sufficiently harmonized in the IHS to determine annually ing viable strategies that can enhance incomes and reduce whether a household is a net maize seller or a net maize pur- poverty. In contrast to perceptions, which depict rural house- chaser. Information on crop sales is collected on a seasonal holds as a relatively undifferentiated mass, Malawian farming basis, while information on food purchases is based on food households are highly heterogenous. Households across the ru- consumption recall over the previous seven days. ral-urban divide can be categorized into four groups based on economic, residential and demographic characteristics. These are: (i) commercially-oriented smallholder farmers (see Box 2.1); (ii) other productive rural households; (iii) households that are not economically productive; and (iv) productive urban households (Figure 2.1). The analysis in this chapter illustrates how each of these types of households plays a dedicated role in rural economies and how agricultural and non-agricultural labor markets interact. Interaction between local and national economies is also important in shaping rural labor market dynamics, as is the level of skill required for higher returns. To develop viable strategies to boost rural incomes, it is essential to both understand the appropriate policy options to enhance what households reap from farming, and to pay attention to increasing the returns that these households receive from their non-farm work. FIGURE 2.1  Typology of Malawian households Shares calculated as percentage of overall population covered in the 2019/20 IHS 5 survey. Poverty rate defined as the share of households falling under the national per-capita basic needs poverty line. Rural Commercially -Oriented Not Stallholder Other Economically Urban Farmers Productive Productive Households Share of population 7% 64% 13% 16% Poverty rate 27% 40% 100% 12% At least one person with some 48% 33% 18% 57% secondary schooling in household Produces crop 100% 86% 90% 31% Cropland area used 1.07ha 0.60ha 0.54ha 0.17ha Cropland per household member 0.28ha 0.16ha 0.10ha 0.05ha Share renting in some land 20% 9% 7% 6% Crop producers hiring 41% 20% 5% 46% gricultural labour Note: Commercially-Oriented Smallholder Farmers are defined as those households that are not ultra-poor (i.e., consumption below the food poverty line) and that sell more than one- quarter of the maize they harvested. Not Economically Productive Households are ultra-poor and more than half of their members are not working age (aged 15 to 64). Urban Households are residents of urban centers and rural towns. Other Productive Households are rural households that do not fall into the Commercial Smallholder or the Not Economically Productive Household categories. Source: World Bank staff compilation based on Benson and De Weerdt (2023, forthcoming) . 2. Strengthening Agricultural Commercialization and Rural Labor Markets 45 In this context, a move toward commercial livelihood strategies is needed in order to sustainably reduce poverty levels. Successful commercial farming creates demand for labor, thus serving a pivot- al role in rural markets. Commercializing smallholders create local demand for services and labor on their productive plots. FIGURE 2.2  Medium-sized farms’ share of total crop value in This, in turn, stimulates rural off-farm labor markets, which are Tanzania increased from 14 to 30 percent in six years already where most rural economic activity takes place. There Share of total crop value by scale of farms is growing evidence from the region that emerging commer- 90 cially-oriented, small- and medium-size farmers can become 80 a significant source of demand for innovation, capital invest- 70 Percent of total crop value ment, and service provision, which together can drive produc- 60 tivity growth and job creation. For example, such medium-scale 50 commercializing farms (5–100 ha) now control roughly 20 per- 40 cent of total farmland in Kenya, 32 percent in Ghana, 39 per- 30 cent in Tanzania, and over 50 percent in Zambia. In Tanzania, 20 medium-sized farms generate 13 million labor days per year. 10 This trend in most cases reflects increased interest in land by 0 2009 2011 2013 2015 urban-based professionals or influential rural people. About half of these farmers obtained their land later in life, financed < 5 ha 5 – 20 ha 20 – 100 ha by non-farm income. A greater share of savings in urban ar- Linear (< 5 ha) Linear (5 – 20 ha) eas is being re-invested in farming and agribusiness (Jayne et Sources: Tanzania National Bureau of Statistics, National Panel Survey and Wineman, al., 2019) (Figure 2.2). Jayne, Modamba, and Kray (2020). Rural Malawians engage in a wide range non-farm economic activities both on and off the farm Slow structural transformation, accompanied by stagnant per-capita production levels, has left Malawians working in less-productive agricultural jobs, with adverse effects on poverty levels. Services sector employment is growing more slowly in Malawi than among its peers, while the employ- ment share in the industry sector has been decreasing for the past decade. Consequently, Malawi’s pro- gress in addressing poverty and vulnerability has stalled, with the poverty rate virtually unchanged over the past two dec- FIGURE 2.3  Households reporting any member engaged in ades, leading to a significant increase in the absolute number various economic activities or receiving regular income of poor Malawians. At the same time, progress in increasing Percentage of overall population covered in the 2019/20 IHS5 survey in respective household categories non-farm employment in Malawi has been among the slow- 60 est in the region. 50 Rural Malawians engage in a wide range of economic ac- tivities in search of better economic prospects. Particularly 40 Percent due to small cropland holdings of many households, even at 30 much higher levels of productivity, many would not be able to meet their basic needs through farming alone (Figure 2.3). 20 Moreover, the incomes that farming households obtain from 10 the crops that they produce from their small cropland hold- ings are generally too low. Crop prices, particularly for food 0 Commercial Other Productive Not Economically Urban crops, are also volatile from year to year. Consequently, even Smallholders Productive households farming larger cropland holdings cannot be con- fident that they will always be able to generate sufficient in- Longer-Term Employment Household Enterprise come from farming. To meet the basic needs of their mem- Of which: Not Seasonal Of which: Skilled Trade Of which: Employer Regular Income bers, most farming households, whether poor or non-poor, need to pursue additional economic activities to farming, as agriculture alone is insufficient. Source: World Bank staff calculations based on Benson and De Weerdt (2023, forthcoming). 2. Strengthening Agricultural Commercialization and Rural Labor Markets 46 Workers in farming households have three principal options FIGURE 2.4  Average farming household reported income for off-farm employment — (i) casual short-term ganyu em- by source ployment; (ii) more formal longer-term wage employment; In current MWK (’000) per capita per year and (iii) operating commercial household enterprises. The av- 220 erage farming household is heavily dependent on such off-farm 200 180 employment to supplement their farm income (Figure 2.4). 160 MWK, thousand Around two-thirds of the income of farming households comes 140 from off-farm labor. All three types of off-farm employment 120 100 available to workers in farming households come with their 80 own advantages and challenges: 60 40 20 • Ganyu employment and seasonally-operated household 0 enterprises allow workers in farming households to focus Farming Non-Poor Poor Larger Land Smaller Land on farming during the rainy season and then pick up tem- Ganyu Longer-term employment Household enterprise porary work or reengage in a household enterprise after Own farm income Other regular income Social transfers the harvest. However, the income that households can Source: World Bank staff calculations based on Benson and De Weerdt obtain from such unskilled work is uncertain. Demand (2023, forthcoming). for short-term workers in farming communities in the dry season is lower than during the cropping season, while the supply of workers competing for ganyu labor opportunities at that time of year is large, suppressing wages. • The returns to household commercial enterprises depend to a large degree on the nature of the enter- prise — offering relatively more skilled services to other households typically provides a house- hold with a larger income stream than small-scale trading of local agricultural produce. However, many households do not have the capital or skill sets needed to create enterprises that can gener- ate returns to labor that exceed those from subsistence farming. • In contrast, longer-term wage employment can provide a more assured income stream for house- holds. However, such wage employment opportunities are rare. Moreover, if a member of a farm- ing household in successful in finding wage employment, the household then also faces a reduc- tion in the labor that it can call on for farming. Casual short-term or ganyu employment — which typically pays less than one-third of earnings in business or waged employment — is as central to the livelihoods of most farming households as is farming on their own cropland. During the dry season, ganyu labor is the main coping strategy used by poor Malawian households to meet their food security needs (Whiteside, 2000). Ganyu labor is there- fore a necessary component of the annual income stream of growing numbers of farming households in Malawi and acts as a complement to farming activities (Caruso and Cardona, 2022).17 Most ganyu labor is linked directly or indirectly to agriculture, both on-farm and off-farm, such as working on other people’s fields, and engaging in processing and trade, and working in the rural retail sector. Ganyu labor is occupying an increasing share in household incomes, rising from 18 to 37 percent between 2010 and 2019. The share of income from household businesses and wage jobs has also increased, from 3 to 11 per- cent since 2010, although this remains low. Overall, farming households are considerably more likely than non-farming households to have members engaging in ganyu employment — almost three-quarters of farming households in Malawi re- ported a member having engaged in ganyu in the past year, compared with only about half of non-farm- ing households.18 Farming households are more constrained by seasonal factors in their ability either 17.  Trend analysis presented in Benson and de Weerdt (2023, forthcoming) comparing 2010/11 (IHS3) with 2019/20 (IHS5), showed that participation among all Malawian households in ganyu has increased significantly over this period. 18.  The share of all individuals who reported engaging in some ganyu in the past year is much higher among farming house- holds — over one-third, compared with one-quarter of all individuals aged five years and above in non-farming households. 2. Strengthening Agricultural Commercialization and Rural Labor Markets 47 to take on or to find ganyu employment.19 Unlike for many workers in non-farming households, ganyu labor does not appear to be a transitional form of employment for smallholders. Although non-farm- ing households engage in ganyu labor while they seek to secure more remunerative longer-term wage employment, farming households primarily rely on this income source to meet their food security needs, especially during the dry season when there is a labor surplus. As such, ganyu labor is not a way out of poverty. Most of the literature points to the fact that smallholder farmers engaged in ga- nyu might sacrifice productivity on their own farm while working on other people’s fields, because this is when the demand for labor is at its highest. Poor farming households are almost 40 percent more likely to engage in ganyu labor than members of non-poor farming households, while those with smaller landholdings are 20 percent more likely to do so than those with larger cropland holdings. In contrast, relatively few farming households have members in permanent wage employment20 and the overall share of working age individuals with salaried work appears to be declining over time. Only about 10 percent of all those of working age in Malawi receive a salary for their work, which sug- gests that there are significant barriers to expanding formal labor markets across the country. These barriers are particularly challenging for members of farming households — while 24 percent of those of working age in non-farming households have wage employment, only 7 percent of those in farming households do. Surprisingly, despite most agricultural production in Malawi being undertaken at the smallholder farmer level, the most common type of wage employment21 in Malawi is in the agri-food sector, which involves everything from on-farm production to trade, processing and marketing.22 In addition to this, there is an almost limitless supply of potential workers for employers offering wage employment for the sector, resulting in strong downward pressure on rural wage levels. In part because wage employment opportunities are rare, more than one-third of farming households have members that operate at least one commercial enterprise. Meanwhile, 45 percent of non-farming households have some form of household enterprise. Farming households with relatively small cropland holdings are more likely to operate such enterprises, possibly to diversify how their labor is employed to generate sufficient income. The enterprises that members of farming households operate are often only available during the dry season, reflecting the strong seasonality of agricultural production. Less than one-third of household enterprises operate 12 months a year. Moreover, the risk of commercial losses is relatively high, particularly for enterprises involving trade in non-agricultural commodities. Enterprises centered on processing, sales, and trade of agricultural products are the most com- monly reported enterprises (Figure 2.5). Many farming households that have such enterprises simply sell their own production in local markets. While operating such enterprises is certainly an option for households to increase their income and to diversify their income sources, successfully doing so is not assured. Such enterprises generally do not provide sufficient income to cover the basic needs of their households. The more remunerative types of enterprises may need to be located in areas where there is sufficient demand for the products or services (mostly near urban centers), and may not be viable in more remote rural communities with low purchasing power. Other enterprises may require specialized skills or public services to be commercially successful — notably electricity, but also transportation, com- 19.  Those that engaged in ganyu labor in non-farming households reported relying on such work for considerably more days in the previous year than did ganyu laborers in farming households — 106 days on average, compared with 64 days for ganyu laborers in farming households. Moreover, the average number of months in which those in non-farming households reported pursuing such short-term employment was just over seven months, while those in farming households reported doing so for 5.7 months, on average. 20.  While over one-third of non-farming households have a member with wage employment, only 15 percent of farming house- holds do (IHS5 dataset). Farming households with smaller cropland holdings are significantly more likely than those with larger landholdings to have a member with wage employment. However, non-poor farming households are more likely than poor farm- ing households to have a member with wage employment. 21.  Such employment includes agricultural estate managers and employees, tenant farmers on tobacco estates, agricultural extension agents, staff at Agricultural Development and Marketing Corporation depots, and staff of food-processing firms, including local grain mills. 22.  Wage employment in education sector, as well as primary production occupations, including agriculture, is primarily found among members of farming households. 2. Strengthening Agricultural Commercialization and Rural Labor Markets 48 munication, and information services. All household enterpris- FIGURE 2.5  Types of activities household enterprises are es that require significant capital to launch will be constrained engaged in by the poor access that Malawian households have to credit. Percentage share of all household enterprises Transportation The relatively high level of entrepreneurship should prove to be Agricultural processing Charcoal and firewood & trade production an important resource to draw upon as the Malawian economy 4.8% 23.6% 12.3% continues to evolve. Some 38 percent of Malawian households own or engage in some form of commercial enterprise despite the daunting challenges that households face in doing so. This re- flects positively on the entrepreneurial spirit of many Malawians, 17.4% even as it also shows the challenges that they face in terms of lim- Other ited wage employment options and seasonal agricultural produc- tion. Nonetheless, if the process of agricultural transformation 23.3% strengthens and, in parallel, more wage employment opportu- Food and drink 18.6% nities emerge, there will be a need for a large cohort of entrepre- production & sales neurs to exploit new opportunities, respond to new demands, Non-agricultural trade and propel needed adaptations in the structure of the economy. Source: World Bank staff compilation based on Benson and De Weerdt (2023, forthcoming). Commercialized smallholder agriculture is an important source of economic growth and job creation An increasing share of households will either need to commercialize or find more remunerative off- farm employment in order to escape poverty. The relatively low wages that rural workers are likely to obtain if they find secure wage employment in agricultural production, processing, or sales23 reflects oversupply of such unskilled labor. In this regard, increasing household income flows from commercial- ly-oriented farming households through increased agricultural productivity levels could result in greater demand for non-agricultural products and services, including those produced or provided through for- mal/permanent wage employment, in rural communities across Malawi. This increased demand could also help to expand opportunities for off-farm employment. Transitioning from smallholder subsistence farming is imperative to longer-term rural economic development. A vibrant commercial smallholder sector would give rise to better non-farm livelihood opportunities, sparking rural economic transformation. As the productivity of commercial smallholder farmers rises, their farm production expands, and their incomes increase. With increased incomes, they will demand more of the goods and services that their less agriculture-focused neighbors pro- duce. These goods and services are those that are labor-intensive, require limited capital in their pro- duction, and typically are not marketed outside of the local community — construction and building repair services; transport; education, health, and other social services; furniture and handicraft-mak- ing; and food and beverage processing, among others. This consumption linkage spreads many of the economic gains that commercial smallholders make from more productive farming to those other rural households. In the process, local markets are deepened, local economic activities accelerated, and access to food for economically active households in these communities improved, including the poor. Commercialization thereby also has a tremendous employment-generating effect, not just due to growth in terms of increased wage labor employment, but also due to substantial downstream/mul- tiplier effects owing to job generation in sectors beyond on-farm work.24 23.  These are the largest wage employment industry sub-category in terms of number of workers. 24.  This is supported by evidence going back several decades. For example, Mellor (1966) argued that agricultural growth focused on small- and medium-sized farms would generate rapid, equitable, geographically-dispersed growth owing to agriculture’s substantial labor-intensive linkages with the non-farm economy. Bell et al. (1982) highlighted how smallhold- ers spend substantial portions of increased income on employment-intensive, non-tradable goods and services produced by the rural non-farm sector. Hazell and Roell (1983) showed similar indirect income-transfer mechanisms for a comparative analysis of Malaysia and Nigeria. 2. Strengthening Agricultural Commercialization and Rural Labor Markets 49 As this pattern of rural economic development continues, the returns that the less agriculture-fo- cused rural households obtain from their non-farm activities begin surpassing those that they can obtain from their low-productivity farming. Many of the households producing goods and servic- es for the local market will expand their activities to serve wider markets, propelling some special- ization in local rural employment patterns and further increasing their income. In so doing, many will transition from being poor, subsistence-oriented households that engage in some farming to become non-farming households specializing in livelihoods outside farm production. Moreover, po- tentially large shares of the cropland that these less agriculture-focused rural households current- ly use will increasingly be made available for more productive use by commercial smallholder farm- ing households, further accelerating agricultural and rural economic growth. Thus, the structural transformation process involves the movement of labor out of the farming sector and into the non- farm sectors, including downstream segments of food value chains and rural-urban migration for employment in urban areas (Haggblade, Hazell and Reardon, 2007). Accelerating this process and the overall structural transformation in Malawi essentially entails targeting this group and helping it to access other non-farm economic activities, which would include skills development for more remunerative employment opportunities. Commercial farming trends in Malawi have strong spatial and temporal characteristics. While na- tionally the share of commercializing smallholders is low at 7 percent and has not changed significant- ly since FY2004/05 (Figure 2.6), there are significant spatial trends that give hope that commercializa- tion at more localized levels is taking place in Malawi. While similar numbers of rural households live in the rural central region compared with the rural south, at 35 vs. 38 percent, the share in commercially-oriented house- FIGURE 2.6  Share of household types by IHS wave holds in FY2019/20 was almost three times higher in the Central Percentage share of households region than in the Southern region (11.8 vs. 4.6 percent). The 100 share of commercially-oriented farmers is also higher than the national average in the Northern region, at 10.6 percent. 80 More importantly, the share of commercially-oriented farm- ers in the Central region increased steadily from 8.2 percent 60 Percent in FY2004/05 to 11.8 percent in FY2019/20. Similarly, this share increased from 7.5 to 10.6 percent in the Northern region over 40 the same time period (Figure 2.7). However, the share of com- mercializing farmers in the Southern region declined from 20 6.1 to 4.6 percent between FY2004/05 and FY2019/20, and this has been the main reason behind the stagnant national-level 0 2004/05 2010/11 2015/16 2019/20 statistics. These trends highlight that successful rates of ag- ricultural commercialization exist in Malawi at localized lev- els, most likely in areas where farmers have better access to Commercial Smallholders Other Productive land and irrigation, and that are located closer to urban mar- Not Economically Productive Urban kets and major trade and logistics routes. Source: World Bank staff compilation based on Benson and De Weerdt (2022). Different forms of agricultural commercialization can be observed in Malawi. Historically, the most traditional pathway for commercialization in Malawi has been through out-grower schemes. In these schemes, an entrepreneur (e.g., commercial farm or an agribusiness entity) contracts small- holders to produce commodities of high value to be marketed, in turn, by the entrepreneur (tobacco, paprika, cotton, to mention a few crops). The entrepreneur provides smallholders with the necessary technical advice and inputs to produce the agreed product and also provides a guaranteed market out- let for the produce. The next generation of commercial arrangements between farmers and agribusi- nesses has been supported through productive alliances, such as those supported by the Agricultural Commercialization Project (AGCOM) (see next section). Finally, there are independent commercially-ori- ented farmers, similar to the emerging mid-sized farms observed in neighboring countries, who engage directly in the marketing of their produce. While the share of this segment of farmers is still small at the national level, there are significant growth trends at the national level. This provides optimism that 2. Strengthening Agricultural Commercialization and Rural Labor Markets 50 this model of agricultural commercialization is possible in the Malawian context. Demand for servic- es from such commercial farmers would be a critical element in creating off-farm jobs in the future. FIGURE 2.7  Commercial farming households are heavily concentrated in the North and Central region Maps by district and major urban centers of households that fall into rural households a. Commercially oriented farming households b. Other productive rural households c. Not economically productive households Percent Percent Percent less than 5 less than 50 less than 5 5–10 50–70 5–10 10–15 70–80 10–20 more than 15 more than 80 more than 20 7 percent 63.6 percent 13.4 percent of households of households of households nationally fall nationally fall nationally fall in this cotegory in this cotegory in this cotegory Source: Benson and De Weerdt (2023, forthcoming). While structural transformation is not yet happening at scale, there are nonetheless pockets of agri- cultural commercialization in Malawi. Select commercialized farmers produce much of Malawi’s main exports: tobacco, sugar, tea, and soya. This suggests that there are pockets of productive commercial- ized farmers across the country, but they are just still too small to be visible in nationally representa- tive data. Further research in this area is needed to identify the spatial growth centers of agricultural commercialization in order to determine the specific drivers. The anecdotal evidence from AGCOM in the next section provides some hints as to how and where such commercialization trends emerge. It is particularly important to identify the precise policy and business environment that has enabled these enterprises to experience episodes of growth to extract broader lessons for Malawian agriculture at large. Productive alliances play important roles in advancing agricultural commercialization Productive alliances are helping to make markets work for smallholders who operate commercially or are in transition to becoming commercial. This has been shown through the World Bank-financed AGCOM, which has been operational in Malawi for almost five years and has a financing volume of close to US$100 million. Through its “Productive Alliance” model, it has reached over 60,000 farmers oper- ating in more than 20 value chains nationwide. Productive alliances are characterized by strong farmer organizations, links to offtake markets, im- proved access to finance and an enabling environment. The productive alliance model starts with strengthening or building Producer Organizations (POs) to allow smallholders to seize market oppor- 2. Strengthening Agricultural Commercialization and Rural Labor Markets 51 tunities. Forming POs is a way for smallholders to have their voices heard, receive more information, re- duce costs, and reap the rewards that come from selling in volume. Second, productive alliances link POs with off-takers to assure access to markets and partnerships. “Off-takers” — companies that buy pro- duce and refine it, such as commercial-scale oil mills and the dairy industry — are operating at low capac- ity because of inconsistent supplies. If farmer POs orientate their production to meet this demand, this results in a mutually beneficial, commercial relationship be- tween the farmers and the buyers. Third, productive alliances put farmers in the driver’s seat where POs respond to competi- BOX 2.2  The importance of adequate finance: the Nsanama Cassava Producers and Marketing tive calls for proposals. In the case of AGCOM, farmers must con- Cooperative example tribute at least 10 percent cash contributions and 20 percent in- kind contributions before matching grants are awarded. This The Nsanama Cassava Producers and Marketing Cooperative is a women-only group that produces cassava and processes boosts production levels and promotes ownership by the farm- it into high-quality cassava flour and other bakery products. ers. Fourth, productive alliances connect farmers to finance. To achieve the quality standards that its customers, such In the case of AGCOM, this includes a Partial Credit Guarantee as confectionery companies and consumers in Machinga, Facility, which provides access to finance through commercial Zomba, and Blantyre demand, modern processing facilities banks to boost the production capacity of farmer POs. To date, and equipment are necessary. the project has signed 255 sub-projects valued at US$24.6 million, with US$2.5 million own-cash contributions from farmers. Six POs have benefited through a Partial Credit Guarantee Facility, receiving loans of about MWK 125 million to boost the produc- tion operations of their sub-projects. And, lastly, productive al- liances’ efforts to improve the enabling environment, including reforms, land tenure security, standards and certifications, are all geared toward improving agricultural commercialization. Productive alliances can promote greater inclusion, espe- cially for women. The most vulnerable members of the farmer The contribution of MWK 18 million to fund these activities POs are the ones profiting the most from commercial partner- was matched by a grant of MWK 41.5 million (US$55,000) ships with buyers. In AGCOM, the farmer POs are made up of a under the AGCOM project. Through this investment, the diverse mix of men and women, and among them, the youth. Nsanama Cassava Producers and Marketing Cooperative was Based on over 60,000 beneficiaries reached, 54 percent of them able to improve cassava production volumes from 104 to 169 metric tons, with sales increasing by 63 percent within just are women (see Box 2.2). The collaborative partnerships will one year of grant support. New products emerged, including allow women to match and compete on levels of productiv- cassava starch, which boosted income for the cooperative ity with men by providing them with access to inputs, tech- members, while also stimulating increased production of cas- nologies, and markets. The project includes women-only calls sava in the surrounding area by at least 20 percent. and, so far, 25 POs have benefited from the matching grants. Support targeting the youth is gradually increasing, with spe- cial youth-only calls included, in addition to the general calls (see Box 2.3). Currently, 12 youth-only sub-projects have re- BOX 2.3  The importance of market access: The ACADES Youth Farmer Cooperative example ceived support from the project. Conceptualized by graduates from Lilongwe University of Increasing farmer demand for AGCOM shows that pockets Agriculture and Natural Resources, the group with an aver- age age of 27 is already proving to be the leader among the of structural transformation can propagate. The demand youth in agribusiness. ACADES’ substantial investment of for AGCOM sub-projects has greatly increased, from 79 con- nearly MWK 200 million was also supported by the AGCOM cepts received in 2019 to 2,064 in 2022. A total of 255 produc- project. This financed a solar-powered irrigation system and tive alliances are currently signed and financed by the project, water plant, which enabled an increase in sales by 176 per- an increase from 85 in September 2022. Such efforts have in- cent in the first year and a projected 492 percent in the sec- creased the volume and value of sales commercialized with im- ond year. However, investments and production were only made feasible through partnerships with reliable off-takers. proved farmer access to finance and markets. The types of val- These guarantee to purchase agreed volumes and thereby ue chains also spur the hopes for a virtuous cycle of economic secure markets for the produced commodities. Already more transformation: while some value chains are in traditional ex- than 3,000 farmers have benefited through jobs, illustrating port goods, others predominantly serve a local market, creat- the importance of access to profitable markets. ing local economic feedback effects (Figure 2.8). 2. Strengthening Agricultural Commercialization and Rural Labor Markets 52 FIGURE 2.8  AGCOM supported value chains Percentage share of all AGCOM supported value chains 27% 23% 7% 7% 6% 5% 25% Soya Dairy Poultry Rice Honey Horticulture Others Source: World Bank staff calculations. Pathways Forward: Recommendations and considerations for prioritization Commercial smallholder farmers need to be placed at the center of any policies and strategic programs that seek to foster rural economic transformation in Malawi. The Malawi Vision 2063 Development Strategy features agricultural commercialization as one of its three pillars. This subset of farmers is uniquely positioned within rural communities to serve as an engine of local economic growth (Benson, 2021). Viewing all farming households as having a similar role in contributing to the performance of the agriculture sector — something that is enforced by one-size-fits-all agricultural support programs, such as the AIP — is misguided and results in missed opportunities for promoting longer-term rural economic development and for sustainably improving the welfare of rural communities. That said, an opportu- nity exists to capitalize on a reformed AIP, should the political will exist, that would involve segmenta- tion of the beneficiaries according to their needs, such as targeting market-ready farmers to transition toward commercialization opportunities, along with a range of integrated social protection measures for resource-poor farm households.25 Following a rural development strategy based on the expansion of agricultural commercialization opportunities is crucial to create demand and the related service provi- sion. Three major themes emerge from the analysis in this chapter that could lead to a broader rethink- ing toward fostering a thriving commercialized smallholder farming sector in Malawi — one that can stimulate rural economies and expand the participation of farmers in agriculture value chains. These three themes can help guide the design of public support programs for smallholder commercialization. Below, Figure 2.9 presents the possible vision for structural transformation that is driven by agricultural commercialization. First, there is a strong convergence of interests between agribusinesses, commercializing farmers, and more subsistence-oriented smallholders. This is evident in the thriving productive partnership models, discussed above, that could involve both commercially-oriented and other productive rural households. The majority of smallholders in Malawi will not be able to access on their own increasingly sophisticated domestic and international value chains (regardless of their individual or organizational capacity) with- out the support of agribusinesses or off-takers. Agribusiness off-takers are therefore likely to remain the main drivers of growth for agriculture, as well as the main source of credit through various value-chain financing arrangements. However, the comparative advantage of Malawian agri-food value chains will continue to rely on the relatively low production costs of smallholder producers. This has important pol- icy implications in terms of the legal and regulatory framework. Addressing constraints for smallholder commercialization will therefore require actions that benefit smallholders, as well as both agricultural and non-agricultural enterprises in rural areas. This means that the greatest potential for smallholder commercialization lies not so much in addressing smallholder or commodity-specific constraints (as suggested by the draft Crops Bill currently being drafted by the Ministry of Agriculture), but in overall increases in the efficiency of value chains arising from the removal of economy- and sector-wide con- straints, together with the strengthening of institutional mechanisms by which key stakeholders and their service providers can effectively link to each other by forming partnerships and alliances. 25.  This vision has been reflected in President Chakwera’s national address on October 2022. 2. Strengthening Agricultural Commercialization and Rural Labor Markets 53 FIGURE 2.9  Possible pathways for structural transformation in Malawi Policies: 10% Non-farm 16% Urban households Inclusive economic growth Infrastructure R&D Not economically 13% Education productive Post-secondary Successful 70% non-farm 90% Farming Other productive 64% Policies: rural households R&D / extension services Land access Finance Infrastructure and investments Successful along value chain 30% farming Irrigation Roads 7% Commercially oriented smallholder farmers Electricity Source: Figure adapted from Thomas Jayne (2018) using data from Malawi (2019/20 IHS5) on farm/non-farm population shares and farmer typology in this chapter. Second, there is a pronounced variation among smallholders in Malawi in terms of the potential for commercialization that requires different targeting strategies. This heterogeneity of smallholder households with different potential, already demonstrated in this chapter, also has implications for the design and targeting of government support programs. It is most likely that farmers already involved in commercial activity — those located closer to urban or trade logistics centers, and who already possess necessary productive and social assets, such as land and labor, human capital (education and health), social capital (e.g., functioning farmer organizations), and access to financial assets — will be the van- guard of commercialization efforts. Most of these smallholder households are still relatively poor, so there is potential for poverty reduction in the short term, as demonstrated by the success of produc- tive partnerships under AGCOM. In the longer term, with new investments in transport, communication infrastructure, and irrigation, some poor rural households in what are currently considered remote or lower potential areas might benefit from agricultural commercialization. Third, addressing the issues of rural poverty, and household risks and vulnerabilities, including man- aging the risks to household food insecurity are the largest hurdles to overcome to accelerate agri- cultural growth in Malawi, and requires holistic solutions that go beyond the agriculture sector. Overcoming these hurdles will require making markets more reliable for both sellers and buyers, par- ticularly through efforts to reduce price volatility, including through increased crop productivity and expanded trade. It would also require a consideration of social safety nets to support those seeking to obtain their livelihoods outside of subsistence farming. If farming households perceive that they can- not rely on the market to supply adequate food for their families, low-productivity subsistence farming will continue to be dominant in smallholder farming systems across Malawi. Therefore the risk of food insecurity at the household level is what makes commercial agricultural development particularly chal- lenging in Malawi. Yet as discussed in this chapter, commercialization of smallholder agriculture still has the potential to create local economic development linkages that can benefit non-commercializing 2. Strengthening Agricultural Commercialization and Rural Labor Markets 54 smallholders in their communities. Smallholder agricultural production systems will continue to remain important from a household food-security perspective, especially for those smallholders that do not have commercial potential. However, there will still be a need for safety nets as well as off-farm and non-agri- cultural livelihood options for more vulnerable groups. This will require more realistic expectations about the short- and medium-term potential of moving smallholders to higher levels of commercialization. For commercialization to take place, agricultural support programs should simultaneously address both smallholder-specific and broader sector-wide issues that limit development of agri-food value chains, as opposed to direct commodity-specific interventions. There is a need for flexible investment approaches to accommodate changes in demand-side factors and to support the development of emerging-market opportunities. It is also equally important to recognize that many of the key constraints for smallholder commercialization are multi-sectoral in nature, and lie largely outside the domain of agriculture sector. The opportunities for the Government to support smallholder commercialization in Malawi can be organized around the following three pillars: Pillar 1: Strengthen Existing Commercialization Mechanisms. A range of agricultural commercialization path- ways exist in Malawi. These could include: (i) medium-sized family farms, as evidenced in neighboring coun- tries; (ii) the development of appropriate farmer organizations and strengthening their access to markets through productive partnership models, such as those supported under the AGCOM project; or (iii) through the development of anchor farm models where large commercial farms will partner with smallholders to provide them with access to agricultural inputs, training and markets. Regardless of the specific commer- cialization pathway, support for agricultural commercialization would call for targeted support programs for those farming households and their organizations that can generate significantly more production through increased productivity. These include farmers with relatively larger cropland holdings concentrated in the mid-altitude plateau areas of the Central and Northern regions, those living in the vicinity of large irriga- tion and anchor farm schemes, particularly in the Southern region, or those aiming to achieve economies of scale by joining farmer organizations. Specific recommendations under this pillar include the following: • Increase farm-level productivity by encouraging the adoption of innovative farming technol- ogies and skills that have been seen to work in Malawian farming systems. Here, the particular focus should be on those technologies and practices that, in parallel to enhancing productivity, also improve resilience against climate-related shocks, and related risk management practices. Realignment of public extension programs to support technology transfer, adoption and skills development could go long way toward supporting agricultural commercialization in Malawi. • Develop functional farmer organizations to overcome constraints facing the development of more dynamic crop or livestock sub-sectors through productive partnership arrangements. Supporting development of strong farmers’ organizations is critical for the emergence of vibrant productive partnership arrangements as it makes smallholders more attractive business partners for agri-busi- nesses and off-takers. Support programs could include facilitation of business development services to viable and commercially-oriented farmers’ organizations addressing group formation, group gov- ernance skills, farm planning skills, market intelligence training, and business skills and training on contracts and understanding contractual obligations. • Support local economic development through anchor farms. While the analysis in this chap- ter provides little direct insight on the anchor farm (or megafarm) commercialization model, it is nevertheless an important element of the Government’s agricultural strategy. Anchor farms con- trol a significant share of cropland in Malawi and thus have an important role in the development of the sector. The constraints that anchor farms face are not so different from those of commer- cializing farming households. The conceptual framework of commercialization presented in the chapter suggests that the anchor farm model could energize local economic activity if its design is based on close engagement with nearby communities. Agricultural support programs here could help to build stronger linkages between the larger farms, nearby farmers and local communities. 2. Strengthening Agricultural Commercialization and Rural Labor Markets 55 Pillar 2: Reform and Strengthen the Implementation of Sectoral, Multi-sectoral and Macro Policies. Many issues that are critical for smallholder commercialization are part and parcel of broader “investment climate” issues, which could be addressed through coordinated policy reforms. Opportunities exist for sectoral policy interventions that are relatively low cost and have potentially significant impacts and high returns. Sectoral policies for agri-food systems need to reflect a strong growth orientation, with attention also focused on food security and safety-net issues. This includes the following priorities: • Carry out policy reforms that improve the business-enabling environment, especially as these relate to weaknesses in legal and judiciary systems in Malawi, and that enhance the sustainabil- ity of commercialization pathways. These include: (i) enactment of the Fertilizer Bill; (ii) imple- mentation of the Seed Act, including the drafting of related regulations; and (iii) approving the pending Irrigation Bill. • Take actions to reduce the uncertainty of the government policy-making process, which has a negative impact on developing private sector-led markets and appropriate market institutions. The Government’s commitment to the full implementation of the Control of Goods Act would go a long way toward this end, along with a careful review and revision of the draft Crops Bill and the Land Amendment Bill. This would help to conserve the recent achievements of agribusiness investments in agricultural commercialization and improve the relative cost-competitiveness of smallholder production systems in Malawi. • Improve the efficiency and effectiveness of agricultural public expenditure programs. Increasing debt levels and shrinking fiscal space mean that public agricultural expenditure programs need to be able to deliver more and better results with less. This means better rationalization of the budget allocations for input subsidy programs, such as the AIP, which currently absorbs almost 40 percent of agriculture budget, and rebalancing scarce public resources toward genuine growth and job-enhancing investments, such as extension for better farm management skills. In order to improve the targeting of these programs by differentiated farmer typology, there is a need to develop a robust (i.e., biometric) farmers’ registry. Pillar 3: Investments in Productive Infrastructure. This strategy would focus on investments in public goods that have the potential to generate new economic opportunities, improve accessibility, and facil- itate forward and backward linkages to other sectors in the economy. There is a need to support the development of new approaches and partnerships for the delivery of productive infrastructure assets (i.e. irrigation infrastructure, and storage and post-harvesting facilities, among others) to improve the competitiveness of value chains. Priorities in this regard include: • Invest in sustainable irrigation development. Irrigated farming is key for intensifying farming systems and generating employment opportunities. In addition to significantly expanding farm- ers’ access to irrigation infrastructure, there is also a need to improve water management to trans- form farming practices. There is a need for support programs and approaches that enhance prof- itability of small-scale irrigated farming, such as farmer-led irrigation development approaches. • Develop more efficient logistics and trade corridors to bring produce to regional and global mar- kets. Access in terms of road and rail linkages would enable commercialization of agriculture in both directions: farmers can be reached through the local network and their produce can access regional/international markets through regional corridors, especially using cheaper long-term modes of rail and inland waters. • Prioritize investments in productive rural infrastructure through geographically targeted approaches. The strategic focus should be on those rural areas that have the highest potential for agricultural growth. 2. Strengthening Agricultural Commercialization and Rural Labor Markets 56 TABLE 2.1  Macroeconomic Indicators 2018 2019 2020 2021 (Est.) 2022 (Proj.) 2023 (Proj.) National Accounts and Prices GDP at constant market prices (% change) 4.4 5.4 0.8 2.8 0.9 2.2 Agriculture 0.3 5.9 3.4 5.2 -1.0 1.1 Industry 7.2 7.7 1.2 1.9 0.9 2.6 Services 4.5 5.5 -0.5 2.0 1.8 2.5 Consumer prices (annual average) 9.2 9.4 8.6 9.3 22.5 22.7 Central Government (FY % of GDP) Revenue and grants 14.6 14.7 14.6 14.5 14.9 16.6 Domestic revenue (tax and non-tax) 13.6 13.2 13.1 13.0 13.7 13.4 Grants 1.0 1.4 1.5 1.5 1.2 3.1 Expenditure and net lending 19.0 19.1 20.9 21.7 23.7 23.5 Overall balance (excluding grants) -5.4 -5.9 -7.8 -8.7 -10.0 -10.1 Overall balance (including grants) -4.4 -4.5 -6.3 -7.2 -8.8 -7.0 Foreign financing 1.8 0.8 0.8 1.0 0.9 2.2 Domestic financing 3.0 3.8 4.9 6.0 8.2 4.8 Money and Credit Money and quasi-money (% change) 11.2 10.2 16.7 30.0 27.5 23.5 Credit to the private sector (% change) 10.6 27.3 16.1 17.8 27.9 14.7 External Sector (US$ millions) Exports (goods and services) 1112 1238 1202 1262 1294 1421 Imports (goods and services) 2927 3031 3088 3255 3406 3173 Gross official reserves 750.1 815 566 429 172 409 (months of imports) 3.6 3.9 2.1 0.3 0.6 1.5 Current account (percent of GDP) -17 -13.8 -11.7 -14.6 -16.4 -13.6 Exchange rate (MWK per US$ average) 732.3 745.9 780.8 827.0 -- -- Debt Stock External debt (public sector, % of GDP) 25.0 27.8 32.9 32.8 38.9 37.1 Domestic public debt (percentage of GDP) 18.9 17.5 21.9 31.2 37.7 37.5 Total public debt (percentage of GDP) 43.9 45.3 54.8 64.0 76.6 74.6 Poverty Poverty rate (US$ 2.15 in 2017 PPP terms) 70.1 70.7 70.7 71.2 71.1 Poverty rate (US$ 3.65 in 2017 PPP terms) 89.1 89.4 89.4 89.5 89.5 Poverty rate (US$ 6.85 in 2017 PPP terms)   97.3 97.4 97.4 97.4 97.4 Sources: World Bank staff calculations based on MFMod, MoF, RBM and IMF data. 57 REFERENCES ACB (Anti-Corruption Bureau). 2022. 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