MALAWI AT A CROSSROADS WITH IMF

UNCLAS SECTION 01 OF 02 LILONGWE 000768

SIPDIS

TREASURY FOR LUKAS KOHLER
STATE FOR EB/IFD/OMA FRANCES CHISHOLM
STATE FOR EB/IFC/ODF MARLENE BREEN

E.O. 12958: N/A
TAGS: EFIN ECON EINV PREL MI
SUBJECT: MALAWI AT A CROSSROADS WITH IMF

REF: A. LILONGWE 719


B. LILONGWE 728

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SUMMARY
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1. (SBU) At last week's outbriefing to donor countries, the
IMF's Article IV assessment team said Malawi's new government
is going in the right economic direction and that the IMF
team would recommend a Staff Monitoring Program for the
2004/05 fiscal year. They assessed the GOM's draft budget as
realistic and workable, though tight, and expressed
confidence that the GOM would succeed in establishing
budgetary discipline. The new government is showing signs of
the political will needed to achieve macroeconomic stability.
If the new government succeeds in sticking to its budget
over the next several months, donors will have to act quickly
to avoid a balance of payments crisis late in the calendar
year. END SUMMARY.


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IMF ENCOURAGED, READY WITH MONITORING PROGRAM
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2. (U) At the end of a two-week Article IV assessment, a team
from the International Monetary Fund (IMF) described
themselves as "not at the end of a mission, but at the
beginning of a new relationship." They said that the new
government is going in the right direction, based on

- the team's review of June results, where targets were
achieved "by a wide margin,"

- the draft budget for the July-June fiscal year just begun,
and

- a review of achieved and proposed structural reforms.

The team characterized the budget as tight but workable, and
perhaps most importantly, as inclusive of all forseeable
expenditures. Team leader John Green said the team saw good
confidence in the economy, such that if the GOM sticks to its
budget, economic conditions, particularly interest rates,
should improve. Green said his team would recommend a
12-month Staff Monitoring Program, starting with July 2004,
with reviews in September and December. The earliest
recommendation for a new Poverty Relief and Growth Facility
(PRGF) would be in December.


3. (U) In addition to the sanguine assessment of financial
indicators, the team took note of the new government's
behavioral shift from the previous administration. The GOM
has recently said no to extra funding requests, moved the
President and Cabinet to Lilongwe to save travel costs,
reduced the size of the Cabinet, and resolved to close five
to seven embassies. (NOTE: The IMF team also mentioned the
government's refusal to give Parliament a large pay increase,
but unconfirmed media reports have since said GOM has agreed
to an even larger pay package. END NOTE.) GOM officials
have also said they are close to announcing a civil service
wage reform package, designed to raise salaries, especially
at the bottom of the scale, and reduce the numerous tax-free
allowances for high-ranking civil servants. The team noted
that its financial targets would allow for government grain
purchases for this hunger season (late 2004 - early 2005) and
for fertilizer subsidies for the 2004/5 growing season,
provided the GOM can keep recurring costs within the new
budget.


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GONDWE: IT'S POSSIBLE, BUT NOT EASY
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4. (U) Responding to the IMF's briefing, Finance Minister
Goodall Gondwe, a retired IMF official, said he welcomes the
IMF's involvement as an opportunity for the GOM to get its
financial house in order. He said he would be surprised if
the needed reforms are not done in six months. That said,
Gondwe noted two factors working against GOM's fiscal reform:
a possible food shortage late this year, and a need to build
grain stocks in advance of a crisis, and a continuing need
for fertilizer subsidies for the 65 percent of the population
below the poverty line. He added to this an urgent need for
civil service wage reforms. All of these will require
relatively heavy government spending before the end of
October and thus before donor assistance starts. In order to
avoid another round of inflationary spending, he said, the
Combined Approach to Budgetary Support (CABS) group of donors
(which provide direct budgetary support) and the World Bank
must release funds as early as possible.


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COMMENT: SPENDING DISCIPLINE, THEN QUICK DONOR REACTION
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5. (SBU) Whether Malawi falls into an inflationary spiral
between now and the end of the calendar year depends on two
things: the political will to reduce government spending, and
the donors' ability to respond quickly should the GOM
succeed. While it is still too early to judge the political
will, the signs thus far are encouraging. The Mutharika
government has shown signs of independence from the United
Democratic Front (UDF) old guard (former president Muluzi's
allies) in several ways, including its resistance to requests
for off-budget funding, its replacing the director of public
prosecution, a declared intent to prosecute former ministers
for corruption, and a halt to privatizations pending
investigation of financial irregularities. Mutharika's
ability to change the GOM's spending behavior depends on his
ability to garner support outside of established UDF/Muluzi
circles, and in defiance of many entrenched political
interests. Whether he can do so remains to be seen.


6. (SBU) If Mutharika succeeds in taming government
profligacy, at least one hazard remains: the timing of
foreign currency revenues at the end of the tobacco buying
season. With the CABS donors and World Bank holding
disbursements until the GOM has established its fiscal
responsibility more firmly, a balance of payments crisis is a
real possibility. These groups appear to want a clear signal
from the IMF September review, a position we believe is
prudent. This means that if the GOM performs well, donors
will have to move quickly to avoid a devaluation of the
currency at precisely the time that the economy is most
susceptible to inflation. Mixed signals from the GOM on
fiscal discipline or on the political stability needed to
maintain that discipline will make a timely decision
difficult.


RASPOLIC