The Malawi Economic Monitor (MEM) provides an analysis of economic and structural development issues in Malawi. This edition of the MEM was published in October 2016. It follows on from the three previous editions of the MEM, and is part of an ongoing series, with future editions to follow twice per year.

The aim of the publication is to foster better-informed policy analysis and debate regarding the key challenges that Malawi faces in its endeavors to achieve high rates of stable, inclusive and sustainable economic growth. The MEM consists of two parts: Part one presents a review of recent economic developments and a macroeconomic outlook. Part two focuses in greater depth on a special, selected topic relevant to Malawi’s development prospects.

In this edition of the MEM, the focus of the special topic is on poverty and vulnerability. At a time when Malawi is experiencing a second successive year of food insecurity, the special topic focuses on the key factors that have led to persistently high poverty rates in rural areas, with these factors contributing significantly to vulnerability to the impact of climate shocks. The special topic also identifies and describes potential pathways and reforms that could help Malawi improve its level of resilience to better manage the impact of future shocks.

Economic Developments

In 2016, with Malawi facing drought and subsequently poor harvests for a second consecutive year, it is expected to record a GDP growth rate of 2.5 percent. The severe droughts have affected agricultural production, with these droughts following both flooding and drought in the previous year. The start of the 2015/16 agricultural season was delayed, with the advent of the season being followed by erratic and below average rains, with prolonged dry spells resulting in severe crop failures, particularly in the Southern Region and parts of the Central Region. The production of maize, the key food crop, fell by 14.7 percent. This follows the decline of 30.2 percent recorded in the previous year. Thus, growth in the agricultural sector is expected to decline for a second consecutive year, with the rate of decline standing at 2.3 percent in 2016. The rate of growth for industry is expected to stand at 2.4 percent, while the rate for services is expected to stand at 4.4 percent.

Malawi is particularly vulnerable to weather shocks. The impact of shocks has intensified over the years and is likely to continue to worsen with climate change. Over the past four decades, droughts have become more frequent, widespread, and intense. The effects have been compounded by a number of other factors, including Melawi’s high rate of population growth and environmental degradation. On average, these shocks have caused annual losses to a value equivalent to 1 percent of GDP. Most drought episodes have occurred in El Niño years, during which Malawi experiences rainfall deficits.

The humanitarian impact of the drought will be significant, with around 40 percent of Malawi’s population likely to experience food insecurity. Estimates indicate that at least 6.5 million people in Malawi’s 24 drought-affected districts will not be able to meet their food requirements during the 2016/17 consumption period. The total annual maize deficit is projected to reach 768,687 metric tons, compared to the deficit of 233,000 metric tons recorded in the previous year.

With the GDP growth rate lower than the population growth rate for a second consecutive year, average living standards will fall in 2016. Given Malawi’s relatively high population growth rate of 3.1 percent, Malawi’s economy needs to expand at a faster rate than is the case for many comparable countries to ensure improvements in average living standards over time.

Malawi’s Government has limited fiscal space available to respond to the crisis. Large fiscal deficits over the past three years and high levels of debt mean that the Government has limited scope to respond to the humanitarian crisis unless it receives significant support from development partners. Following a major public financial management scandal in 2013, the level of on-budget development assistance provided by development partners to Malawi has fallen dramatically. Following this withdrawal of support, the Government has run large fiscal deficits over successive years. The Government has come under pressure to increase expenditure as a result of increasing debt service costs; rising public sector wage demands; costly subsidy schemes; and the need to settle outstanding arrears.

To finance fiscal deficits, the authorities have borrowed heavily from domestic sources. This has exerted an upward pressure on inflation and lending rates, crowding out private sector investment. More importantly, the Government has not been able to establish the necessary fiscal buffers that would enable a more robust domestic response to external weather shocks.

The Government’s recent efforts to consolidate public expenditure have produced some positive results, but these efforts will be hard to sustain in the context of the current humanitarian crisis. Efforts to consolidate expenditure; to improve budget execution; and to exercise stronger central oversight over public expenditure have enabled greater month-on-month control over spending commitments by ministries, departments and agencies. As a result of these efforts, despite the fact that the value of collected revenues stood at 3.0 percent below targeted levels by the end of the fiscal year in June 2016, the Government was able to contain expenditure growth. However, at the end of the year, domestic borrowing was still in excess of targeted levels, largely because the Government began to purchase maize towards the end of the fiscal year to prepare to implement its humanitarian response.

The FY 2016/17 budget emphasizes the allocation of resources for food purchases and for investments to increase agricultural resilience. Key elements of the budget include reforms to the contentious Farm Input Subsidy Program (FISP), with these reforms including a sizable budget cut; a reduction in the number of beneficiaries; and the significantly increased involvement of the private sector in importation and retailing. Health and education budgets have been ring-fenced, with the allocations for almost all other budget lines being reduced in real terms.

The fiscal deficit for FY 2016/17 is projected to reach a value equivalent to 4.1 percent of GDP, a decline from the figure of 4.3 percent recorded in FY 2015/16. This gap is expected to be met mostly through concessional foreign financing, the value of which is estimated to reach the equivalent of 2.6 percent of GDP, and through domestic borrowing, at 1.4 percent of GDP. However, significant additional resources will be required to meet the food deficit requirement. Unless these resources are provided by development partners, the Government will struggle to remain below its targeted domestic borrowing limit.

While the rate of inflation declined in the period up until April, it accelerated in June and July, mostly due to increased food prices, before stabilizing again. In September 2016, the year-on-year headline inflation rate stood at 21.2 percent, representing a 1.6 percentage point decrease from the previous month. The figure at this point in 2016 compares to that of 24.1 percent recorded at the same point last year. Malawi is a net energy importer, so the decline in global oil prices has provided some respite, exerting downward pressure on non-food inflation and resulting in improved terms of trade. Prices are expected to remain under upward pressure until the next harvest in early 2017. Thus, in 2016, the overall annual rate is expected to stand at 22.5 percent.

The Reserve Bank of Malawi’s tight monetary stance has constrained the pace of credit growth. Active market interventions by the authorities through the issuance of Reserve Bank of Malawi (RBM) securities have helped to mop up liquidity and to ensure continuous positive real interest rates. The RBM continues to maintain its policy rate at 27.0 percent.

A second year of drought conditions and weak economic growth has weighed on business confidence. The agricultural sector dominates Malawi’s economy, directly accounting for around a third of GDP. This share is even higher if the contribution of agricultural manufacturing and services is taken into account. However, even before the impact of recent weather shocks, Malawi’s private sector was struggling to cope with an extended period of macroeconomic instability. High interest rates and inflation rates have undermined the returns on private investments, as demonstrated by the increasing share of nonperforming bank loans. Increasingly frequent power and water supply outages in Malawi’s key economic hubs, Lilongwe and Blantyre, and the instability of the exchange rate have also sapped investor confidence.

An economic recovery is possible in 2017, although its achievement would require the implementation of a number of politically challenging reforms. In particular, the Government faces the challenge of managing the humanitarian response effectively while at the same time continuing with efforts to restore fiscal balances and to control inflation. The simultaneous achievement of these goals is not impossible, but it will certainly require prudent management and careful prioritization of expenditure. In 2017, a higher rate of growth could be driven by increased agricultural output. However, growth recovery is dependent on the implementation of a well-managed humanitarian response and careful macroeconomic management to avoid further instability.

A strong El Niño effect in Southern Africa is typically followed by a similarly strong La Niña effect, resulting in higher than average rainfalls in Malawi. This could help support a recovery in the production of key crops, including maize, and the restoration of the water resources upon which Malawi is currently dependent for electricity generation. However, there is also a risk that a La Niña effect could trigger localized flooding that would place already strained disaster response mechanisms under further pressure.

In the medium-term, improved economic performance is dependent on Malawi building its level of resilience to enable it to better withstand the impact of both internal and external shocks. It is highly likely that Malawi will continue to face weather shocks on a recurring basis. Key steps to lay the foundations for a growth recovery include the following:

• Policy reforms to reduce distortions and to ensure that agricultural markets function more effectively: Malawi’s agricultural sector continues to be dominated by smallholders oriented towards subsistence farming, with only a limited degree of commercialization. The prices for agricultural commodities in Malawi are amongst the most volatile in the region. In many instances, the impact of climate-induced shocks has been amplified by policy-induced distortions that result in market failure.

• Measures to maintain economic stability and to improve fiscal discipline: Improved levels of macroeconomic stability and fiscal discipline are essential to the achievement of a mediumterm growth recovery in Malawi. Only by breaking the current vicious cycle, characterized by large deficits, over-borrowing and the crowding-out of the private sector, can Malawi effectively control inflation and restore the basic macroeconomic conditions necessary for higher levels of investment and job creation. The Government should also implement measures to increase fiscal buffers to enable the budget to better withstand the impact of external shocks. Improved systems of public financial management and governance could result in increases to ODA flows to onbudget execution, reversing the trend of these flows to off-budget execution.

• Investments to build resilience to mitigate against climate-induced weather shocks and to diversify Malawi’s economy: These investments should include measures to develop agricultural infrastructure and extension services to facilitate a higher level of crop diversification, to improve yields, and to build resilience through the development of irrigation, market information systems and improved farmer organization.