BACKGROUND TO INDUSTRY, TRADE AND PRIVATE SECTOR DEVELOPMENT IN MALAWI

Malawi is a landlocked least developed country in the south-east corner of Africa. GDP per capita of just US$ 160 per capita leaves Malawi among some of the countries with the lowest living standards in the world.

While 2005 presented a number of severe challenges, including a major food security crisis where close to half the population required emergency food support, the country looks set to rebound strongly in 2006. A well-managed response to the food crisis by Government and donors saw timely and large-scale imports of maize. 209,000 metric tonnes of maize was imported directly by government, and additional imports by the World Food Programme and local government purchases saw 426,000 metric tonnes of maize distributed for hunger alleviation purposes at a total cost of Mk 23,740 million.

Good rains in the 2005/06 growing season, coupled with improved distribution of subsidised fertilizer resulted in a bumper maize crop and improved yields in almost all major agricultural commodities. Continuing budget discipline and stabilisation of the macro-economy has won Malawi plaudits from the IMF and development partners. The attainment of irreversible debt relief under the Highly Indebted Poor Countries (HIPC) initiative in September 2006 was a landmark event during the year under review.

Much is now being made of so-called “second generation” reforms, and the challenge now for Malawi is to capitalise on progress made in 2006 to ensure that solid foundations are laid for growth and development in the years ahead.  

I: Recent Economic Developments

Real GDP growth is forecast to be 8.4 percent in 2006 and 5.6 percent in 2007. A large component of the 2006 growth figure represents a recovery from the poor performance in 2005 when only 2.1 percent real GDP growth was achieved.  Drought in the 2004/05 growing season saw a 9.3 percent drop in agricultural output, with the smallholder component of Malawi’s agriculture sector contracting 11.7 percent. Hence, a large element of the 2006 strong GDP growth performance reflects recovery as the agricultural sector, and smallholder component in particular bounced back growing at 11.8 and 14.2 percent respectively.

Good rains in the 2005/06 growing season have seen substantially better yields in almost all crops, with strong performances also shown by the construction sector (13.6 percent growth), and mining and quarrying (9.6 percent growth).

Maize production is central to the economy of Malawi and the success or failure of the crop determines the country’s national food security, and has a major impact on overall economic performance. Periodic droughts over Malawi’s recent history have resulted in severe crises. A combination of good rains during 2005/06 and the successful delivery of the Government’s fertilizer subsidy programme saw an impressive 87 percent jump in maize production on the previous year’s output. Total estimated production of 2.35 million metric tonnes was in excess of Malawi’s requirements of 2.18 million metric tonnes for consumption, seed requirements and replenishment of the Strategic Grain Reserve, leaving a net surplus of 250,000 tonnes.

Tobacco is the mainstay of Malawi’s economy and exports of the cash crop account for over 50 percent of foreign exchange earnings. For the same reasons as the maize rebound in 2005/06, tobacco production also recovered strongly with production up 52 percent from 72.5 million kg in the 2004/05 season, to 109.8 million kg in the 2005/06 season.

Sugar has become increasingly important to the economy of Malawi and exports reached USD 46.9 million in 2006. The major determinant for increased export revenues was an increase in Malawi’s quota in the lucrative European Union market. In recent years, Malawi has also managed to make inroads into non-preferential world markets in Kenya, Tanzania and Egypt where prices are barely a quarter of those earned in the EU and US. This demonstrates the competitiveness of growing sugar in Malawi, and indeed the proposed reforms to the EU sugar protocol announced in late 2005 (envisaging a 36 percent drop in the price of sugar within the EU) are unlikely to trouble Malawi’s sugar industry in the same way that other ACP producers will struggle. From 2009/10, the EU sugar market will be tariff and quota free for all LDC producers under the terms of the “Everything But Arms” agreement, and hence there is great potential to increase production and exports of sugar to what will still be a very preferential market.

Production of groundnuts, paddy rice, sorghum, millet, pulses, cassava and sweet potatoes all saw improved yields in 2005/06 of a similar order of magnitude to that seen in the tobacco and maize sub-sectors. Only cotton saw declining output during the year under review.  

Malawi’s manufacturing sector is small and accounts for just 11 percent of GDP, down from a high of 32 percent in 1992. The manufacturing sector is also inward looking as only 14 percent of manufactured output is exported (ICA 2006).

Evidence from the recently completed Investment Climate Assessment (ICA) of Malawi suggests that Malawi possess a comparative advantage in the region in terms of low-cost labour. However when considering total factor productivity, that is taking into account the relative costs and returns to both labour and capital together, Malawi’s cost advantage evaporates. The ICA survey responses suggest that macroeconomic instability is the biggest perceived constraint to private sector performance, followed by access to finance, problems in the supply of electricity, the availability of skilled workers, crime, and then corruption (in that order).

While Malawi is not endowed with mineral resources on the scale that neighbouring countries are, there is significant potential for natural resource extraction to play a meaningful role in the economy.  High transport costs, together with insufficient power capacity have tended to render Malawi’s known deposits unviable for development. However, work on a bankable feasibility study to extract the uranium oxide deposits in Kayelekera in the far north of Malawi is at an advanced stage. Changes in the international environment for nuclear power have driven up uranium prices and mean estimates suggest that once operating at full capacity in 2008, uranium could become Malawi’s second biggest export after tobacco accounting for 20 percent of exports and 5 percent of GDP.

Consumer price inflation is forecast to be 10.9 percent in 2006, down on 15.5 percent inflation in 2005. The 2004/05 food security crisis saw a jump in inflation as Malawi’s (maize dominated) CPI index responded to food shortages. With a much improved crop in 2005/06, inflation has gradually drifted downwards and  is expected to drop below 10 percent by the end of 2006. Consumer price inflation for 2007 is expected to continue on a broad downward trend, forecast at 8.2 percent for the year.

Gross investment as a share of GDP strengthened slightly in 2006 rising to 15 percent of GDP, compared to 14.5 percent in 2005. Malawi continues to be unsustainably reliant on foreign savings to finance net national investment (essentially through international aid flows). Gross capital formation in the public sector continues to outstrip capital formation in the private sector by four to one. Domestic savings improved marginally in 2006 to -8.1 percent of GDP from a low of -10.3 percent in 2005. Economic analyses of very low income countries such as Malawi tend to assume that low savings are a result of poverty. While Africa’s higher poverty certainly does contribute to lower savings than in developing countries in Asia, it is also clear that Malawi has experienced a collapse in private savings and investment for reasons unrelated to poverty. In 1980 Malawi was managing to invest 25 percent of GDP, while savings were running at 17 percent of GDP (World Bank 1981). Raising growth rates to the 6+ percent required year-on-year to achieve meaningful poverty reduction in Malawi will require investment at an intensity, not least in the private sector, much higher than that possible utilising investment funds from foreign donors.

 II: Macroeconomic Policy

The Government of Malawi has attached significant political importance to the restoration of macroeconomic stability, something which eluded Malawi during previous years. Progress since 2004 has been good with fiscal discipline maintained during the 2004/05 and 2005/06 budgets. Such progress was rewarded by the return to PRGF support from the IMF in August 2005, and more recently by the attainment of irreversible debt relief under the HIPC initiative in September 2006. As a result of HIPC and the Multilateral Debt Relief Initiative (MDRI), external debt declined from 229 percent of exports to 32 percent, in end-2005 net present value (NPV) terms.

HIPC debt relief can be seen as a massive vote of confidence in Malawi’s fiscal managementt, but the impact in financial terms is more limited given that the greater part of the country’s greatest debt burden is kwacha denominated domestic debt. In this regard, reduced budget overspending has seen paying down of the domestic debt stock. Having peaked at 25 percent of GDP in 2003/04, domestic debt is estimated to have declined to 20 percent of GDP by end 2005/06, and is projected to fall to 16.5 percent in 2006/07.  Recent progress notwithstanding, domestic debt continues to constitute a large burden on government resources, and political pressures on government spending and the country’s vulnerability to external shocks could easily reverse achievements in bringing domestic debt under control.

The Reserve Bank of Malawi’s base rate was reduced from 25 to 20 percent in November 2006. This is a welcome step in terms of reducing the cost of finance to the private sector, especially given that interest rates were as high as 45 percent in 2004. Import cover improved from an average of 1.8 months in 2005 to 3.2 months in 2006.

The initial indications are that Malawi’s trade performance in 2006 was similar to in 2005. While the trade balance improved slightly, dropping from USD -501.4 million to USD -492.9 million, this was due to the fact that imports fell to a greater degree than exports. Total merchandise exports in 2006 were USD 489.4 million, down from USD 504.5 million. Imports dropped from USD 1,005.9 million in 2005 to USD 982.2 million in 2006.

Malawi’s trade performance has deteriorated significantly over recent years and so the fact that this trend has now been halted might be viewed as a positive sign. However, export performance has remained essentially flat over the last seven years. Sustained export growth in real terms has not been achieved as when the performance of one sector has improved, the performance in other sectors has worsened.