MALAWI CABINET'S INTERNAL ECONOMIC DEBATE

C O N F I D E N T I A L SECTION 01 OF 02 LILONGWE 000037

SIPDIS

SIPDIS

STATE FOR AF/S G. MALLORY
TREASURY FOR INTERNATIONAL AFFAIRS/AFRICA/BEN CUSHMAN
STATE FOR EB/IFD/ODF LINDA SPECHT AND ELAINE JONES
STATE PLEASE PASS TO MCC FOR KEVIN SABA
PARIS FOR D'ELIA
JOHANNESBURG FOR FCS

E.O. 12958: DECL: 01/13/2016
TAGS: EFIN EINV ETRD ECON MI
SUBJECT: MALAWI CABINET'S INTERNAL ECONOMIC DEBATE

REF: A. LILONGWE 0019

B. LILONGWE 0020

Classified By: Econoff W. Taliaferro,for reasons 1.4 b/d


1. (C) In a round of New Year courtesy calls on the finance
minister and the governor of the central bank, Embassy has
gained some new insights on cabinet-level thinking on
economic issues. Among these are:

-- Recognition that subsidizing low maize prices has been a
mistake
-- An upcoming devaluation of the kwacha in the very near
future
-- Disagreement within the cabinet about controlling the
exchange rate
-- Expectations that GOM will exceed the IMF targets for last
quarter

While there are no major revelations here, we have learned
that the GOM is dancing to the finance minister's tune on
economic policy, but there is a lively debate behind the
scenes. The IMF mission in February is an opportunity for
some outside encouragement for greater independence of the
central bank. End summary.


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GONDWE: HIGHER GRAIN PRICES, LOWER INTEREST RATES
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2. (C) In a courtesy call on 11 January, the Ambassdor was
prepared to debate Finance Minister Goodall Gondwe on the
GOM's continuing price subsidies on maize (ref A). Instead,
he opened the topic with an admission that the government had
made a "fatal mistake" in maintaining a price that is roughly
half the market rate. He said the government had "tried to
compete with the previous government for popularity" by
keeping food prices low, and that it was costing them dearly.
The GOM had budgeted to supply the parastatal ADMARC with
10,000 metric tons of grain per month, but "infinite demand"
(caused by the Malawi government's continuing half-price sale
on maize through ADMARC) had forced them to up the allocation
to 20,000, with almost no effect on stocks. One of the
ramifications of supplying the infinite demand for cheap food
has been that the GOM has diverted some grain from its
commitments to the humanitarian flow, which could result in a
humanitarian shortfall by March. Gondwe owned up to this as
the GOM's problem, and said it has a "moral commitment" to
make good on its obligation.


3. (C) Despite the budget hit from buying more maize than
anticipated, Gondwe expects fiscal performance for the
quarter just completed to be good, beating IMF targets. The
main impact of higher food expenditures will be smaller
principal payments on domestic debt, but that would still
leave him ahead of the IMF domestic debt target. He
anticipates a clean bill of fiscal health from the IMF's
February mission and HIPC completion by June. (The February
mission will provide a strong indication of Malawi's
prospects for a June completion point.) Gondwe went on to
say he expects to devalue the kwacha within the next month,
without commenting on the current controversy over the
Reserve Bank of Malawi's tactics for limiting forex
remittances (ref B and below). He also said he will likely
argue for lowering interest rates early in 2006, once HIPC
completion becomes certain and the rainy season has run its
course. (This is probably based on an internal GOM
discussion about the inflation rate, in which some argue that
monetary policy should look more to non-food inflation rather
than the food-heavy top-line inflation figures, particularly
in this drought year.)


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A RUEFUL CENTRAL BANKER
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4. (C) A conversation the next day with Reserve Bank Governor
Victor Mbewe confirmed the existence of fault lines between

LILONGWE 00000037 002 OF 002


the government and the RBM. In a classic exercise of careful
phrasing, Mbewe tacitly acknowledged that his bank has been
slow-balling applications for foreign currency and thus
effectively discouraging imports. He is clearly
uncomfortable with this policy and attributed it to "an
unfortunate tradition regarding the relationship between
various institutions." Read: the finance ministry, and
possibly the President, is forcing the RBM to break the rules
of its IMF agreement. (As Trade Minister Martin Kansichi
pointed out to us recently, the practice breaks not only the
IMF's rules, but the WTO's as well.) As Mbewe ruefully put
it, "This bank has become essentially the government's bank."
Mbewe went on to say that the RBM is actively discussing the
exchange rate issue with the government, and that it is near
resolution--but that depends on some fairly challengin "issue
management," namely, how to reconcile a devalued kwacha with
the President's inaugural statement that he would "never"
allow the kwacha to slip.


5. (SBU) Mbewe appeared to be less confident about interest
rates than Gondwe. Whereas Gondwe had indicated clearly that
rates could come down early in 2006, Mbewe could not identify
a time frame for this to happen, saying that it would be
difficult to do with the amount of liquidity left in the
system. (One of the decisive factors in this debate may be
the government's official measure of GDP. Gondwe told us his
ministry is considering a revision to take into account the
huge informal sector. He believes the current GDP figures
are understated by about 60 percent--a conservative figure by
most estimates. The informal sector, operating exclusively
with currency, is largely unaffected by demand deposit
parameters, and would account for the strangely inert "excess
liquidity" in Malawi's monetary system.) Mbewe did, however,
tell us that he is considering how to jump-start private
lending. RBM and the finance ministry are pondering a move
based on the relatively low non-food inflation rate; Mbewe
indicated he would try to move rates before lowering the
liquidity reserve requirement for banks.


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COMMENT: NOT QUITE BROKEN, BUT IT NEEDS FIXING
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6. (C) While these conversations hardly constitute an
epiphany on Malawi's economic policies, they do bring out
some nuances. Most importantly, it is clear that Gondwe is
manipulating monetary policy to hit IMF fiscal targets;
specifically, he is keeping the kwacha high as long as the
GOM is importing food and fertilizer for this hunger season.
With the import season winding down, he will soon be ready to
let the kwacha drift. We also find it interesting that the
Cabinet has not given Gondwe unquestioning support. Private
sector interests are being represented by the trade minister
and the central banker, although they have not prevailed up
to now, and we got the impression that the key economic
actors have been shouting at one another and intensely
jostling to achieve the President's ear.


7. (C) Finally, it appears that the prospect of an IMF
mission in February is heating up an internal debate over
foreign exchange policy. It should also start a debate about
the RBM's institutional independence and the necessity of its
playing by the rules. As things stand now, the bank serves
only government's interests, possibly to the detriment of a
private sector that is starved for affordable capital. While
Gondwe surely has the nation's broadest interests at heart
(the game really is about fiscal discipline at this point),
an independent central bank would be a valuable--and in the
final analysis, necessary--counterbalance to the government's
unilateral power in setting monetary policy.
EASTHAM