Document of The World Bank Report No: ICR3296 IMPLEMENTATION COMPLETION AND RESULTS REPORT (IDA-H8490) ON A GRANT IN THE AMOUNT OF SDR 33.4 MILLION (US$ 50 MILLION EQUIVALENT) TO THE REPUBLIC OF MALAWI FOR AN ECONOMIC RECOVERY DEVELOPMENT POLICY OPERATION August 28, 2015 Macroeconomics and Fiscal Management Global Practice GMFDR Country Department AFCE1 Africa Region CURRENCY EQUIVALENTS (Exchange Rate Effective as of February 28, 2015) Currency Unit = Malawi Kwacha MWK 460 = US$ 1 FISCAL YEAR July 1 – June 30 WEIGHTS AND MEASURES Metric system ABBREVIATIONS AND ACRONYMS ASWAp Agricultural Sector Wide Approach CABS Common Approach to Budget Support CAS Country Assistance Strategy DO Development Objective DPO Development Policy Operation DPL Development Policy Loan DSA Debt Sustainability Analysis ECF Extended Credit Facility ERP Economic Recovery Plan FISP Farm Input Subsidy Program GDP Gross Domestic Product HIPC Highly Indebted Poor Countries ICR Implementation Completion and Results Report IDA International Development Association IFMIS Integrated Financial Management Information System IHPS Integrated Household Panel Survey IMF International Monetary Fund IPP Independent Power Producer ISR Implementation Status and Results Report M&E Monitoring and Evaluation MDAs Ministries, Departments and Agencies MGDS Malawi Growth and Development Strategy ODA Official Development Assistance PAF Performance Assessment Framework PDO Program Development Objective PFEM-RP Public Finance and Economic Management Reform Program PFM Public Financial Management QEA Quality at Entry QSA Quality of Supervision SADC Southern Africa Development Community SDR Special Drawing Rights SOE State Owned Enterprise WBG World Bank Group Regional Vice President : Makhtar Diop Country Director : Bella Bird Senior Practice Director : Marcelo Giugale Practice Manager : Albert Zeufack Program Team Leader : Appolenia Mbowe ICR Team Leader : Richard Record MALAWI ECONOMIC RECOVERY DEVELOPMENT POLICY OPERATION TABLE OF CONTENTS DATA SHEET ............................................................................................................................... ii  A. Basic Information ................................................................................................................... ii  B. Key Dates ............................................................................................................................... ii  C. Ratings Summary ................................................................................................................... ii  D. Sector and Theme Codes ....................................................................................................... iii  E. Bank Staff .............................................................................................................................. iii  F. Results Framework Analysis ................................................................................................. iii  G. Ratings of Project Performance in ISRs ................................................................................. v  H. Restructuring (if any) ............................................................................................................. v  IMPLEMENTATION COMPLETION AND RESULTS REPORT ........................................ 1  1. Program Context, Development Objectives and Design ......................................................... 1  2. Key Factors Affecting Implementation and Outcomes ........................................................... 4  3. Assessment of Outcomes ........................................................................................................ 9  4. Assessment of Risk to Development Outcome ..................................................................... 16  5. Assessment of Bank and Borrower Performance .................................................................. 16  6. Lessons Learned .................................................................................................................... 18  7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners ....................... 20  Annex 1: Bank Lending and Implementation Support/Supervision Processes ............................. 21  Annex 2: Beneficiary Survey Results............................................................................................ 22  Annex 3: Stakeholder Workshop Report and Results ................................................................... 22  Annex 4: Summary of Borrower's ICR and/or Comments on Draft ICR ...................................... 23  Annex 5: Comments of Cofinanciers and Other Partners/Stakeholders ........................................ 24  Annex 6: List of Supporting Documents ....................................................................................... 25  MALAWI ECONOMIC RECOVERY DEVELOPMENT POLICY OPERATION DATA SHEET A. Basic Information Economic Recovery Development Country: Malawi Project Name: Policy Operation Project ID: P133663 L/C/TF Number(s): IDA-H8490 ICR Date: 08/28/2015 ICR Type: Core ICR Lending Instrument: DPL Borrower: Government of Malawi Original Total SDR 33.4 million Disbursed Amount: SDR 33.4 million Commitment: Implementing Agency: Ministry of Finance, Economic Planning and Development Cofinanciers and Other External Partners: B. Key Dates Revised / Actual Process Date Process Original Date Date(s) Concept Review: 12/18/2012 Effectiveness: 6/10/2013 6/10/2013 Appraisal: 04/08/2013 Restructuring(s): Approval: 05/28/2013 Mid-term Review: Closing: 12/31/2013 12/31/2013 C. Ratings Summary C.1 Performance Rating by ICR Outcomes: Unsatisfactory Risk to Development Outcome: High Bank Performance: Moderately Unsatisfactory Borrower Performance: Moderately Unsatisfactory C.2 Detailed Ratings of Bank and Borrower Performance (by ICR) Bank Ratings Borrower Ratings Quality at Entry: Moderately Unsatisfactory Government: Unsatisfactory Implementing Quality of Supervision: Moderately Satisfactory Moderately Unsatisfactory Agency/Agencies: Overall Borrower Overall Bank Performance: Moderately Unsatisfactory Moderately Unsatisfactory Performance: C.3 Quality at Entry and Implementation Performance Indicators QAG Assessments (if Implementation Performance Indicators Rating any) Potential Problem Project at No Quality at Entry (QEA): None any time (Yes/No): Problem Project at any time Quality of Supervision No None (Yes/No): (QSA): DO rating before Moderately Unsatisfactory Closing/Inactive status: D. Sector and Theme Codes Original Actual Sector Code (as % of total Bank financing) Central government administration 67 67 General energy sector 17 17 Other social services 16 16 Theme Code (as % of total Bank financing) Public expenditure, financial management and procurement 50 50 Regulation and competition policy 17 17 Vulnerability assessment and monitoring 17 17 Debt management and fiscal sustainability 16 16 E. Bank Staff Positions At ICR At Approval Vice President: Makhtar Diop Makhtar Diop Country Director: Bella Bird Kundhavi Kadiresan Practice/Sector Manager: Albert Zeufack John Panzer Program Team Leader: Appolenia Mbowe Appolenia Mbowe ICR Team Leader: Richard Record ICR Primary Author: Richard Record F. Results Framework Analysis Program Development Objectives (from Program Document) The development objectives of the Economic Recovery DPO series were to strengthen macroeconomic and public finance management and to lay the foundation for stronger growth and protection of the poor. The program was geared towards consolidating macroeconomic policy reforms implemented under the stabilization effort undertaken since May 2012, as well as to prepare the ground for longer term structural reforms for the post-election period. Revised Program Development Objectives (as approved by original approving authority) Not applicable. (a) PDO Indicator(s) Original Target Values Formally Actual Value Achieved Indicator Baseline Value (from approval Revised Target at Completion or Target documents) Values Years Indicator 1 : Reduction in the stock of domestic payment arrears owed by State Owned Enterprises MWK 9 billion Value Zero 50 percent cleared (26 percent cleared) Date achieved 05/28/2013 06/30/2016 06/30/2014 By end June 2014, MWK 9 billion out of the MWK 35 billion total stock of SOE arrears had been settled based on the maturity profile of promissory notes (out of a total stock of arrears of MWK 72 billion identified at appraisal). Hence, at the time of the ICR around 26 percent of the stock of domestic payment arrears by SOEs had been cleared, less than the 50 percent clearance of the 2016 program target indicator, but on track in terms of incremental progress. However, Comments while progress was made in addressing the initial stock of arrears owned by SOEs identified at the time of appraisal of DPO-1 in early 2013, during late 2013/early 2014 a significant amount of new arrears were built up by MDAs estimated at MWK 170 billion as of end FY13/14. This occurred as a result of the negative fiscal impact of the large scale theft of public funds in 2013 (known as “cashgate”), which triggered the withdrawal of planned budget support and resultant shortfalls in resources to run government operations. Reduction in the variance in primary expenditure between approved budget and actual Indicator 2 : outturn Value 12 percent < 8 percent 13 percent Date achieved 05/28/2013 06/30/2016 06/30/2014 As a result of the “cashgate” public financial management scandal and the resultant suspension of budget support by development partners, Malawi saw sharply lower grants in FY13/14. Coupled with significant overspending on recurrent expenditures, this resulted in a substantially Comments larger budget deficit than anticipated. The gap was financed in part by higher domestic borrowing, but the fiscal year also closed with substantial outstanding payment arrears owed by the Government. Hence, the FY13/14 variance in primary expenditure was 13 percent, above the program target indicator of less than 8 percent. Indicator 3 : Reduction in the rate of recurrent Audit Committee findings Value 90 percent 50 percent 82 percent Date achieved 05/28/2013 06/30/2016 12/31/2014 Five Audit Committees have been re-established with independent membership, each of which is responsible for four MDAs. However, the Audit Committees have only met twice in total with Comments limited progress in addressing findings. At the time of the ICR, a total stock of 93 of 114 audit issues (82 percent) remained unresolved. Indicator 4 : Increase in the number of power generation licenses for Independent Power Producers Value Zero At least one Zero Date achieved 05/28/2013 06/30/2016 12/31/2014 At the time of the ICR, no IPP generation licenses have been granted (although steps towards the issuance of a first license is at an advanced stage). However, reforms undertaken by the Comments authorities have removed some of the policy restrictions that prevented market access for IPPs. Electricity tariffs have been adjusted aiming to bring prices closer to cost recovery levels, a prerequisite for attracting private investment. Increase in the number of National Social Support Program beneficiaries with savings of Indicator 5 : at least 30 percent of public works wage one year after participation Value 13,000 49,000 78,330 Date achieved 05/28/2013 06/30/2016 12/31/2014 A total of 99,153 people have joined the Community Savings and Investment Program of the National Social Support Program. Of this total, 78,330 (79 percent) meet the savings criteria at Comments the time of the ICR, substantially exceeding the program target indicator. Of this total, 47,781 (61 percent) of the beneficiaries are female. (b) Intermediate Outcome Indicator(s) Original Target Values Formally Actual Value Achieved Indicator Baseline Value (from approval Revised Target at Completion or Target documents) Values Years Strengthening macroeconomic and public finance management Indicator 1 : Zero ceiling on accumulation of new arrears by Ministries, Departments and Agencies Value Zero Zero MWK 30 billion Date achieved 05/28/2013 06/30/2016 12/31/2014 The stock of domestic payment arrears grew substantially over the course of FY13/14, with an Comments estimated MWK 30 billion in arrears accumulated during the fiscal year and a cumulative stock of arrears owned by MDAs reaching an estimated MWK 170 billion as of end FY13/14. Indicator 2 : Reduction in the backlog of Treasury Minutes Value > 60 months < 48 months > 60 months Date achieved 05/28/2013 06/30/2016 12/31/2014 No Treasury Minutes were prepared during the period from appraisal of the operation to ICR. Comments Thus the backlog has remained at above 60 months and in excess of the program target indicator. Indicator 3 : Reduction in the fertilizer share of the agriculture budget Public investments in agriculture equally Value 85 percent 80 percent distributed among the three ASWAp pillars Date achieved 05/28/2013 06/30/2016 12/31/2014 The share of fertilizer costs in the agricultural recurrent budget has slightly decreased, making some progress towards the program target indicator. Part of these savings came from a decrease in international fertilizer prices. Another part of the savings is however the result of a change, Comments promoted under this DPO series, in the procurement of fertilizer with the introduction of a method based on unit prices to bring value-for-money in the selection of fertilizer suppliers and in the award of fertilizer tonnage to be delivered by the lowest cost suppliers. Laying the foundations for stronger growth and protection of the poor Indicator 4 : Increase in legume production 1,138,505 metric tons Value 949,454 metric tons 20 percent increase (19.9 percent increase) Date achieved 05/28/2013 06/30/2016 12/31/2014 Legume production in the 2013/2014 cropping season has significantly increased compared to the previous 2012/2013 campaign, growing by 19.9 percent and already effectively meeting the Comments program target indicator. This increase is for a large part attributable to good weather conditions but the distribution of subsidized legume seeds under the FISP has also contributed to the facilitation of greater access to seeds for smallholder farmers. Increase in the number of quarterly Malawi Growth and Development Strategy progress Indicator 5 : reports published Value Zero Four One Date achieved 05/28/2013 06/30/2016 12/31/2014 At the time of the ICR, quarterly progress reports are being produced on average once per year, below the program target indicator. Efforts to increase the availability of MGDS reporting have Comments had mixed impact, with no sanctions for failure to submit quarterly reports. The only active sector working groups out of the 16 are Education, Health, Trade, Democratic Governance, Decentralization and Agriculture. G. Ratings of Project Performance in ISRs Date ISR Actual Disbursements No. DO IP Archived (US$ million) 1 06/11/2014 Moderately Unsatisfactory Moderately Unsatisfactory 50.55 H. Restructuring (if any) Not applicable. MALAWI ECONOMIC RECOVERY DEVELOPMENT POLICY OPERATION IMPLEMENTATION COMPLETION AND RESULTS REPORT 1. Program Context, Development Objectives and Design 1.1 Context at Appraisal Malawi is an agrarian economy and relies on a limited number of primary commodities as the main source of growth and exports. This has left the country vulnerable to weather related and terms of trade shocks. Limited natural resource endowments, coupled with poor quality productive infrastructure and landlocked supply chains have hampered efforts to diversify the economy. In recent years Malawi has also struggled to address systemic weaknesses in standards of governance and public financial management, undermining efforts to improve service delivery. The country is also highly aid dependent, an additional source of vulnerability. Throughout recent decades, Malawi has suffered from persistent boom-and-bust economic cycles, mostly tied to shifting political cycles, where periods of economic growth have been followed by bursts of inflation, fiscal imbalances and high interest rates. Coupled with an unreformed and high cost investment climate, the economy has seen limited private sector investment and job creation. Poverty remains severe with an estimated 38.7 percent of the population living below the national poverty line in 2013 (according to estimates from the Integrated Household Panel Survey). Per capita GDP of just US$ 253 in 2014 means that the country is among the world’s poorest. The Economic Recovery Development Policy Operation (DPO) was prepared in a period of renewed optimism and in the aftermath of a period of significant political uncertainty in Malawi where a severe economic and governance crisis in 2011 had threatened to push the economy into a policy-induced recession. The timely implementation of adjustment measures to address long standing internal and external imbalances in the economy by the new administration of President Joyce Banda, who came to office in April 2012 following the death of her predecessor President Bingu wa Mutharika, helped to avert a full blown economic crisis. Macroeconomic imbalances included severe shortages of foreign exchange and fuel, the accumulation of an estimated MWK 72 billion in domestic payment arrears owed by the Government and external payment arrears owed by the private sector estimated at about US$ 600 million. Reforms enacted facilitated the removal of key market distortions, most notably in the petroleum and foreign exchange markets. These reforms were supported through a coordinated response by the international community, including by the World Bank Group (WBG) via a package of IDA operations that included a Rapid Response Development Policy Grant. Preparation of the Economic Recovery DPO built on the results of a prior Rapid Response Operation, as well as significant earlier experience of budget support in Malawi through a series of three Poverty Reduction Support Credits, in addition to the longstanding partnership arrangements established under the Common Approach to Budget Support (CABS) group. The DPO was prepared at a time when Malawi was experiencing major economic turbulence, and focused on supporting efforts by the Government to put the economy back on track after the 2011 1 political and economic crisis, with a longer term program of reforms to support a sustainable economy recovery. The operation was informed by longstanding dialogue and analytic work undertaken by the Bank on macroeconomic policies, public financial management, agriculture and energy sector reform. The first of a series of three programmatic operations was prepared a year before Malawi’s 2014 presidential elections and it was anticipated that the series would straddle two governments, helping to sustain and give continuity to key economic policy reforms. The Economic Recovery DPO was an integral part of the World Bank Group’s FY13-16 Country Assistance Strategy (CAS) for Malawi, contributing in particular to CAS objectives to promote more diversified, competitive, shock-resilient economic growth as well as efforts to mainstream governance for enhanced development effectiveness. The programmatic series of three operations aimed to support both the short term reforms necessary to consolidate macroeconomic stabilization, as well as longer term reforms seeking to improve the efficiency of public expenditure, remove the constraints to growth and diversification as well as improving the effectiveness of social safety nets. 1.2 Original Program Development Objective (PDO) and Key Indicators (as approved) The program development objective of the Economic Recovery DPO was to strengthen macroeconomic and public financial management, and to lay the foundation for strong growth and protection of the poor. The operation was prepared as the first in a programmatic series of three operations, intending to support the implementation of the Government’s medium term development plan, the Second Malawi Growth and Development Strategy (MGDS II) 2011-16 approved in April 2012, as well as the Economic Recovery Plan (ERP) adopted by the administration of President Joyce Banda in September 2012, that provided for a series of short-term measures to restore macroeconomic stability while aiming to mitigate the effect of structural reforms on the poor and most vulnerable segments of society. The program built on policy dialogue and reforms undertaken under the earlier Rapid Response Development Policy Grant approved in July 2012 and aimed to consolidate reforms supported by the three-year arrangement for Malawi under the IMF Extended Credit Facility (ECF) program also approved in July 2012. The program was geared towards consolidating macroeconomic policy reforms implemented under the stabilization effort undertaken since May 2012, as well as preparing the ground for longer term structural reforms after the May 2014 elections. The following specific outcomes were expected as a result of the operation:  A reduction in the stock of domestic payment arrears owed by State Owned Enterprises;  A reduction in the variance in primary expenditure between the approved budget and actual outturns;  A reduction in the rate of recurrent audit findings;  An increase in the number of power generation licenses for independent power producers; and,  An increase in the number of beneficiaries with savings of at least 30 percent1 of the public works wage one year after participation. 1 Note that while the target outlined under the description of policy areas in the Program Document (p.34) and in the results framework (p.59) is for beneficiaries of the National Social Support Program with savings of at least 30 percent 2 1.3 Revised PDO (as approved by original approving authority) and Key Indicators, and Reasons/Justification The PDO was not revised. 1.4 Original Policy Areas Supported by the Program (as approved) The policy areas supported by the program were aimed at strengthening macroeconomic and public financial management, and laying the foundations for stronger growth and protection of the poor. The program was closely aligned with the Government’s MGDS II and ERP, as well as the Public Finance and Economic Management Reform Program (PFEM-RP) with the objectives of accelerating the economic recovery process and getting the economy back on a sustainable growth path. The framework for the Economic Recovery DPO, provided for two main policy areas— strengthening macroeconomic and public financial management, and laying the foundation for stronger growth and protection of the poor—each with a series of related reform objectives, as illustrated below. Main policy areas Reform objectives Pillar 1: Strengthening  Strengthen fiscal discipline to entrench macro-stability macroeconomic and through the clearance of domestic payment arrears. public financial  Enhance the efficiency and transparency of public finance management. management by: o strengthening the budget policy framework and improving medium-term orientation; o strengthening external oversight of public finances; o strengthening internal controls on public finances; and, o enhancing efficiency in the use of public resources. Pillar 2: Laying the  Enhance agricultural productivity and diversification; foundation for stronger  Improve energy efficiency and the regulatory environment; growth and protection of  Improve efficiency in the provision of social safety nets; and, the poor.  Strengthen the country’s statistical capacity. 1.5 Revised Policy Areas (if applicable) Not applicable. 1.6 Other significant changes The Economic Recovery DPO was prepared as the first of a series of three programmatic development policy financing operations. After completion of the first operation (DPO-1), preparation of the second operation (DPO-2) was suspended at an advanced stage (prior to negotiations in April 2014) following the exposure of serious weaknesses in the country’s public of the public works wage one year after participation, the grant and program summary (p.vii) refers to a target of 50 percent of the public works wage. For the purposes of the ICR, the target of 30 percent has been treated as the correct figure. 3 financial management (PFM) systems. The revelation of the large scale theft of public resources in a scandal known locally as “cashgate” undermined confidence in the effectiveness of PFM in Malawi. As a consequence, significant aspects of the program went off track, as did the IMF program. Multiple development partners suspended budget support operations citing fiduciary concerns, placing Malawi’s fiscal position under significant strain, increasing uncertainty and further contributing to macroeconomic instability. As a response, the government attempted to address weaknesses in PFM systems via a short-term action plan. However, in the interim period there was a change in government (in May 2014) and a shift in political focus from one of economic recovery to deeper reform of public financial management and economic governance as part of efforts to rebuild confidence. As such, it made greater sense for the Bank to consider a new program. Hence, the second and third operations in the series were dropped and the ICR has been prepared on the basis of a single Economic Recovery DPO only. 2. Key Factors Affecting Implementation and Outcomes 2.1 Program Performance The Economic Recovery DPO was prepared as a single tranche operation, intended as the first in a programmatic series of three development policy operations. It was prepared during a period of renewed optimism after the formation of a new administration following the 2011 governance crisis as Malawi looked towards restoring macroeconomic balances. The critical prior actions supported under the DPO represented a combination of actions that would contribute to implementation of the government’s medium term policy (the MGDS II) as well as the shorter term Economic Recovery Plan. The program was prepared in a consultative manner with dialogue undertaken within the CABS group of development partners providing general and/or sector budget support to the Government of Malawi. This involved the agreement between government and development partners on the use of a common Performance Assessment Framework (PAF), from which prior actions and triggers were extracted for inclusion in the program documents of individual development partner budgets support operations. The following table lists the agreed policy areas and prior actions of the program across the two pillars of engagement. Policy areas Prior actions for DPO-1 Status Pillar 1: Strengthening macroeconomic and public finance management 1 Strengthening fiscal The recipient, through the Ministry of Finance, Met discipline to entrench validated its outstanding payment arrears and macro-stability developed a plan for the full clearance of said arrears for State Owned Enterprises and Ministries, Departments and Agencies 2 Strengthening the budget The recipient, through the Ministry of Finance, Met policy framework and adopted a detailed budget formulation calendar. improving medium-term orientation 3 Strengthening external The recipient, through the Ministry of Finance, Met oversight of public submitted Treasury Minutes for fiscal years finances 2005/06 and 2006/07 to Parliament. 4 Enhancing efficiency in the The recipient, through the Ministry of Met use of public resources Agriculture and Food Security, revised the 4 bidding documents for the annual procurement of fertilizer under the Farm Input Subsidy Program to align the allocation of tonnage demand with unit price ranking for the purpose of increasing the recipient’s value for money. Pillar 2: Laying the foundation for stronger growth and protection of the poor 5 Improving energy The recipient, through the Malawi Energy Met efficiency and the Regulatory Authority, undertook monthly regulatory environment reviews of the Automatic Tariff Adjustment Formula for electricity covering the period May to November 2012. 6 Improving efficiency in the The recipient approved the National Social Met provision of social safety Support Program. nets The program document for DPO-1 included six prior actions across the program, as well as a series of indicative triggers for the proposed successor operations in the series (DPO-2 and DPO-3). Result indicators were articulated at the program level with a baseline set at the time of preparation of DPO-1, and target result indicators set for the end of the series (anticipated to conclude in 2016). In the absence of the second and third operations in the series, the following table listing the proposed triggers for DPO-2 as presented in the Program Document for DPO-1, provides a useful proxy of implementation performance. Policy areas Triggers for DPO-22 Status Pillar 1: Strengthening macroeconomic and public finance management 1 Strengthening fiscal The recipient, through the Ministry of Finance, Partially discipline to entrench cleared 25 percent of the outstanding stock of Met macro-stability domestic payment arrears owed by State Owned Enterprises and has rolled out commitment control under IFMIS to all Ministries, Departments and Agencies, and to local district councils. 2 Strengthening the budget The recipient, through the Ministry of Finance, Met policy framework and approved the Budget Framework Paper for improving medium-term 2013/14. orientation 3 Strengthening external The recipient, through the Ministry of Finance, Not met oversight of public submitted Treasury Minutes for fiscal years finances 2007/08, 2008/09, 2009/10 and 2010/11 to Parliament and has created baseline data of 2 Note that indicative triggers for DPO-2 were set out in the Program Document for DPO-1. During the preparation of DPO-2, a number of revisions were proposed to the prior actions for DPO-2, with justifications for changes outlined in the draft Program Document. These changes included the inclusion of six supplementary prior actions for DPO-2 based on government’s emergency performance assessment framework drawn up in the immediate aftermath of the “cashgate” crisis and in order to address immediate PFM weaknesses under the program. Since preparation of DPO-2 was suspended and hence the operation was not completed (or the Program Document presented to the board), in this ICR we refer to the original indicative triggers for DPO-2 as intermediate benchmarks for the performance of the program. 5 pending audit queries by Ministries, Departments and Agencies. 4 Strengthening internal The recipient instructed the ten largest spending Not met controls on public finances ministries to ensure that respective Audit Committees are functional and baseline data of pending bank reconciliation has been created per Ministries, Departments and Agencies as evidenced by an at least 80 percent reduction in the rate of recurrent audit findings and at least one meeting held by all ten Audit Committees during the first half of 2013/14. 5 Enhancing efficiency in the The recipient, through the Ministry of Met use of public resources Agriculture and Food Security, reviewed the design of the Farm Input Subsidy Program in light of findings of various impact evaluations, the Agriculture Public Expenditure Review and consultations, with the recommendations submitted to Cabinet. Pillar 2: Laying the foundation for stronger growth and protection of the poor 6 Enhancing agricultural The recipient, through the Ministry of Partially productivity and Agriculture and Food Security, completed a Met diversification review of the legal and regulatory framework for quality seed production. 7 Improving energy The recipient, through the Ministry of Energy, Met efficiency and the reviewed the Energy Policy and through the regulatory environment Malawi Energy Regulatory Authority, undertook monthly reviews of the Automatic Tariff Adjustment Formula for electricity. 8 Improving efficiency in the The recipient, through the Ministry of Economic Met provision of social safety Planning and Development, established a nets monitoring and evaluation system for the National Social Support Program. 9 Strengthening the country’s The recipient, through the National Statistical Met statistical capacity Office, developed the National Statistics System Strategic Plan 2013-2017. 2.2 Major Factors Affecting Implementation The DPO was prepared as part of a medium-term support package to the—at the time—new administration of President Joyce Banda. Following on from a standalone Rapid Response Development Policy Grant, the Economic Recovery DPO series provided for support to strengthening macroeconomic and public financial management, as well as laying the foundations for stronger growth and protection of the poor. Preparation of the program built on lessons learned from the earlier series of three Poverty Reduction Support Credits during 2007-11, as well as the Rapid Response Development Policy Grant. These included:  Government ownership, political will and commitment are key determinants in the successful implementation of institutional and structural reforms;  Progress tends to be slower in reform areas where the political economy context is critical, yet not adequately understood; 6  Working within the harmonized framework for the provision of budget support—the CABS group—has enhanced the quality of policy dialogue, albeit with limited impact;  Flexibility in the CABS Performance Assessment Framework should be encouraged to enable it to adapt to unforeseen external shocks and changing government priorities and programs; and,  The importance of implementation capacity for the successful implementation of policy and structural reforms cannot be overemphasized. The program was informed by significant analytical work by the World Bank including the 2010 Country Economic Memorandum identifying the key constraints to growth; an exchange rate and foreign exchange study estimating underlying causes of persistent external imbalances in Malawi, as well as work to assess the welfare impact of a parallel official and black market exchange rates. A Public Expenditure and Financial Accountability assessment, as well as budget technical assistance, helped to identify a number of priority reform areas to address weaknesses in the core PFM systems of the government. This background analysis provided a sound basis to inform the design of the operation. The macroeconomic framework underlying the operation was informed by the assessment made by the IMF in the context of the new three year ECF-supported program for Malawi, approved in July 2012 which also formed part of the international community’s response to front-load macroeconomic and structural reforms implemented by the new Joyce Banda administration. The Economic Recovery DPO was complementary to the ECF, providing a medium term agenda to the latter’s objectives of improving fiscal sustainability and providing for a gradual build-up of international resources to help cushion the economy against external shocks. Technical assistance in support of a number of policy areas in the program came from a number of Bank-financed investment lending operations, several of which were co-financed by other development partners. These included the Financial Reporting and Oversight Improvement Project, which was geared towards improving internal controls, reporting and oversight of government finances; the Agriculture Sector Wide Approach (ASWAp), which focused on improving the effectiveness of food security investments; the Energy Support Project, which aimed to improve the reliability and quality of national electricity supply; and the Third Social Action Fund, which sought to improve the livelihoods of poor and vulnerable households. The exposure in September 2013 of the large-scale theft of public resources by a group of individuals working both inside and outside of government who exploited weaknesses in the Integrated Financial Management Information System (IFMIS) placed Malawi in a vulnerable position. Following the attempted assassination of a Ministry of Finance official, it was revealed that a high-level syndicate had gained illegal access to the national payment system and stolen public funds worth over US$ 50 million. This included over-invoicing for goods supplied to government as well as payment against invoices to companies that did not provide government with any goods and services. After release of funds, transactions were then deleted from the payments system. Such practices required considerable organization with collusion at multiple levels of transacting and approving authority. The incident exposed deeply entrenched corruption and fundamental weaknesses in the country’s PFM systems. The repercussions of this scandal, which became known locally as “cashgate”, caused a huge public outcry, the arrest of a number of government officials, the dissolution of the Cabinet, and the suspension of critical external budget support by CABS development partners. More generally, a number of key development partners ceased using government systems altogether and suspended the channeling of Official Development Assistance (ODA) through the budget. In an environment of weak expenditure management and commitment control, this in turn put the fiscal accounts and efforts to consolidate 7 expenditures under significant stress, triggering a substantially enlarged budget deficit, high cost domestic borrowing, the build-up of arrears and resurgent inflation. As the country’s fiscal position deteriorated, uncertainty increased and private sector confidence slumped, along with Malawi’s global reputation. Consequently, significant aspects of the program went off track, as did the IMF program primarily as a result of sharply increased domestic borrowing requirements to fill the gap in public finances. As such, a public finance crisis triggered fiscal instability, which then resulted in a loss of macroeconomic stability, making a difficult situation even more challenging. As a response, the government attempted to address weaknesses in PFM systems via a short-term action plan. The Bank and a core of CABS group members that remained, in principle, committed to budget support worked with the Government in the preparation and implementation of this short- term action plan. Preparation of the second operation (DPO-2) continued up to an advanced stage, but with a substantially revised program of proposed prior actions, incorporating key aspects of the short-term action plan, as part of efforts to restore basic PFM controls and plug priority gaps in government’s financial management and payment systems. However, in the intervening period the May 2014 elections saw a change in government that in turn triggered a period of reflection and a shift in political focus from one of short-term recovery to deeper reform of public financial management and economic governance. The new government indicated its intention to initially operate without budget support from development partners while efforts were made to rebuild confidence and trust among both domestic and international stakeholders. As such, it made greater sense for the Bank to consider a new program. The series was terminated after just one operation (DPO-1) and the second (DPO-2) and third (DPO-3) operations in the series were dropped. 2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization As a programmatic series, monitoring of DPO-1 took place as part of the preparation process for DPO-2. This involved keeping track of progress in the implementation of the prior actions for DPO- 1 and policy dialogue around the proposed triggers for DPO-2. The team had regular contact with the authorities, including through meetings of the CABS group, to monitor implementation of the program. The team also worked closely to track progress towards the achievement of expected outcomes of the series of DPOs as presented in the results matrix of the program document for DPO-1. Monitoring of progress on the macroeconomic program was supported through preparation of quarterly economic updates and participation in IMF ECF review missions. As a result of the “cashgate” PFM scandal, a number of course corrections were made to the Bank’s engagement on governance issues. In an effort to restore confidence and focus reforms around a narrower set of systemic issues, government and the CABS development partners agreed on an “extraordinary Performance Assessment Framework” to monitor progress in addressing PFM weaknesses. The proposed program for DPO-2, which was suspended at an advanced stage, included a number of additional prior actions drawn from this extraordinary PAF, in addition to triggers proposed in the program document for DPO-1. Similarly, progress on governance reforms was monitored under the Financial Reporting and Oversight Improvement Project, including through the scaling up of a Multi Donor Trust Fund to support critical improvements to systems, controls and procedures to address weaknesses exposed as part of the “cashgate” scandal. 2.4 Expected Next Phase/Follow-up Operation (if any) The early termination of the Economic Recovery DPO series points to a number of challenges in both the appropriateness of the macroeconomic environment for providing budget support in 8 Malawi, and the integrity of PFM systems into which the proceeds of DPOs are disbursed. Slippages in a number of the core public financial management policy areas supported under the program raise concerns about Malawi’s ability to strengthen economic governance, despite long periods of technical assistance and policy dialogue. Similarly, the evidence in Malawi suggests that uncertainty with regard to the disbursement of the proceeds of DPOs can in turn contribute to wider fiscal instability and dampen investor sentiment, triggering broader feedback loops. The new government—which took office in May 2014—has made commitments to reform the PFM framework and early signs suggest that reform efforts are genuine. In support of these efforts, the Bank in partnership with other development partners is providing assistance to improve the integrity of PFM systems via the Financial Reporting and Oversight Improvement Project. The Bank is also continuing to engage on macroeconomic, governance and public finance issues. Should these reforms gain traction, then there would be scope for reengaging with the authorities with development policy financing as part of a mix of instruments. 3. Assessment of Outcomes 3.1 Relevance of Objectives, Design and Implementation The operation was prepared during a period of high expectations for Malawi following the implementation of critical macroeconomic and structural reforms frontloaded by the Joyce Banda administration to stabilize macroeconomic imbalances and assuage fuel and foreign exchange shortages. This in turn helped avoid a policy induced recession and put the economy on a path to stability. The Economic Recovery DPO aimed to consolidate stabilization efforts supported by the Rapid Response Development Policy Grant, and to lay the foundation for stronger growth and more effective poverty reduction. The program formed an integral part of both the Bank Group’s CAS as well as the Government’s MGDS II and the ERP. Despite the challenges experienced during implementation of the Economic Recovery DPO, and the dropping of the second and third operations in the series, the broad objectives remain highly relevant and the need for improved macroeconomic management and the maintenance of internal and external balances is of continued importance to the country. Malawi continues to suffer from persistent volatility in terms of macroeconomic policy and performance, with a stop-go cycle that has damaged private sector investment and job creation and hampered efforts to diversify the economy. Improving macroeconomic management is an essential pre-requisite if Malawi is to succeed in meeting the twin goals of ending extreme poverty and boosting shared prosperity. The Bank Group’s program in Malawi on macroeconomics and fiscal management issues thus remains of central importance and the objectives of the Economic Recovery DPO series, where the Bank aimed to support a set of structural and macroeconomic reforms necessary to restore internal and external balances, and put the country back onto a stable economic pathway, remain highly relevant at the time of ICR preparation. 3.2 Achievement of Program Development Objectives The overall expected result at the end of the program period was strengthened macroeconomic and public financial management, laying the foundation for stronger growth and protection of the poor. At the time of the ICR, which was triggered by an early termination of the series after the completion of just one of the planned three operations, and in the wake of a substantial public finance integrity scandal, the results are decidedly poor. Early progress appeared to be on track with incremental headway towards result objectives, but the operation was unable to survive the impact and fallout of the “cashgate”—essentially a risk that materialized—and resulted in 9 significant disruption to the program and ultimately undermined efforts to achieve the program development objectives. Similarly, and with the benefit of hindsight, it is clear that the development objectives of the series were set at an overly ambitious level. Nevertheless, aspects of the program have achieved results at an intermediate level, and a number of useful lessons have been learned on how best to engage in support of governance reforms in a fragile institutional context. While progress towards reform objectives in a number of the main policy areas stalled when the DPO series was suspended, positive movement towards some intermediate reform objectives was achieved, demonstrating sustained ownership in a challenging policy environment. The Economic Recovery DPO included two main policy areas—strengthening macroeconomic and public financial management, and laying the foundation for stronger growth and protection of the poor—each with a set of related reform objectives, as illustrated below. Main policy areas Reform objectives Pillar 1: Strengthening  Strengthen fiscal discipline to entrench macro-stability macroeconomic and through the clearance of domestic payment arrears. public financial  Enhance the efficiency and transparency of public finance management. management by: o strengthening the budget policy framework and improving medium-term orientation; o strengthening external oversight of public finances; o strengthening internal controls on public finances; and, o enhancing efficiency in the use of public resources. Pillar 2: Laying the  Enhance agricultural productivity and diversification; foundation for stronger  Improve energy efficiency and the regulatory environment; growth and protection of  Improve efficiency in the provision of social safety nets; and, the poor.  Strengthen the country’s statistical capacity. Strengthen fiscal discipline to entrench macro-stability through the clearance of domestic payment arrears. The expected results under this reform objective were that the stock of outstanding public payment arrears owed by State Owned Enterprises (SOEs) would be reduced by 50 percent by the end of the program, and that a zero ceiling would be imposed for the accumulation of new arrears by Ministries, Departments and Agencies. The medium term expected outcomes were strengthened fiscal discipline and no build-up of new domestic payment arrears. Policies supported under the Economic Recovery DPO-1 included the validation of outstanding payment arrears and the development of a plan for the full clearance of arrears owned by SOEs and MDAs. At the time of preparation of DPO-1, the stock of arrears was estimated to be MWK 72 billion, of which MWK 35 billion was owed by SOEs. Progress towards the indicative trigger for DPO-2 was on track, with 26 percent of the stock of SOE arrears (MWK 9 billion) cleared by the time of the ICR. The 2016 end of program target was for 50 percent of SOE arrears to be cleared. However, while encouraging progress was made towards clearing the stock of arrears identified at the time of appraisal of DPO-1, the fallout from “cashgate” and the resultant suspension of budget support from development partners (which resulted in significant cuts in budgetary allocations to MDAs) coupled with weak commitment control across MDAs saw a significant increase in new arrears incurred during late 2013 and early 2014. As of end FY13/14, the total stock of arrears owed by MDAs had ballooned to an estimated MWK 170 billion, directly as a result of fiscal 10 pressures arising from the suspension of budget support. This total dwarfed earlier attempts to clear arrears and indicates the depth of the challenge faced by authorities in controlling public expenditure and preventing the accumulation of arrears by MDAs. Enhance the efficiency and transparency of public finance management by: strengthening the budget policy framework and improving medium-term orientation. The expected result under this reform objective was that the variance between the approved expenditure and actual outturns would be reduced from 12 percent to below 8 percent by the end of the program. DPO-1 supported the preparation and adoption of a detailed budget formulation calendar, as part of renewed efforts to operate a Medium Term Expenditure Framework. Incremental efforts under the program saw progress with work towards the approval of the Budget Framework Paper for 2013/14 on track (the indicative trigger for DPO-2). However, as with the arrears position, despite attempts to improve planning and budgeting, the link between activities supported under the program and observed outcomes were eclipsed by events surrounding “cashgate”, the suspension of budget support, and underlying weaknesses in expenditure management and commitment control. Sharply lower grants in FY13/14, coupled with significant overspending on recurrent expenditures resulted in a substantially larger budget deficit than anticipated. The gap was financed in part by higher domestic borrowing, but the fiscal year also closed with substantial outstanding payment arrears owed by the government. Hence, the FY13/14 variance in primary expenditure was 13 percent, above the baseline figure of 12 percent and above also program target indicator of less than 8 percent. Enhance the efficiency and transparency of public finance management by: strengthening external oversight of public finances. The expected result under this reform objective was a reduction in the backlog of Treasury Minutes from over 60 months in 2012 to 48 months by the end of the program. DPO-1 supported the submission of Treasury minutes for the FY05/06 and FY07/08 to the Public Accounts Committee of Parliament, as part of efforts to strengthen accountability over the use of public funds and improve value-for-money. The breakdown of public finance controls that occurred in the aftermath of the “cashgate”, the build-up of significant off-budget payment arrears, and a prolonged period during which IFMIS was suspended and payments made manually, has caused significant disruption to the normal process of preparing government’s annual financial statements. This in turn affected the auditing of government’s financial statements by the National Audit Office, presentation to parliament of these statements, and finally the preparation of Treasury Minutes by government in response to control weaknesses highlighted during parliamentary discussion of the audited financial statements. At the time of ICR, there is a three year backlog in the preparation of audited financial statements. As such, no Treasury Minutes were prepared during the period from appraisal of the operation to ICR. The backlog has remained at above 60 months and in excess of the program target indicator. Enhance the efficiency and transparency of public finance management by: strengthening internal controls on public finances. The expected result under this reform objective was a reduction in the rate of recurring audit findings from 90 percent in 2012, to 50 percent by the end of the program. The medium term expected outcome was strengthened external oversight of public finances. DPO-1 did not include any prior action under this reform area, but progress towards the indicative DPO-2 trigger of instructing the ten largest spending ministries to ensure that respective Audit Committees are functional, with baseline data of pending bank reconciliation created, and a reduction in the rate of recurrent audit findings showed mixed progress. 11 Five Audit Committees have been re-established with independent membership, each of which is responsible for four MDAs. However, the Audit Committees have only met twice in total with limited progress in addressing findings. At the time of the ICR, a total stock of 93 of 114 audit issues (82 percent) remain unresolved. This reflects some modest progress from the baseline of 90 percent in 2012, but well short of the end of series target of 50 percent. Enhance the efficiency and transparency of public finance management by: enhancing efficiency in the use of public resources. The expected result under this reform objective was that public investments in agriculture be equally distributed among the three ASWAp pillars by the end of the program. The program supported under DPO-1 included the revision of bidding documents for the annual procurement of fertilizer under the Farm Input Subsidy Program (FISP) in order to align the allocation of tonnage demand with unit price ranking in order to increase value-for-money. This reform contributed to a more efficient procurement of fertilizer, achieving cost savings in FY13/14 estimated at US$ 10 million. However, a weaker application of the tonnage allocation formula in FY14/15 reduced the efficiency of the procurement process somewhat. Progress towards the DPO- 2 indicative trigger to review the FISP in light of new research findings and the Agriculture Public Expenditure Review saw more limited progress. While the FISP has been credited with increasing maize yields, the basic subsistence crop in Malawi, the program is widely considered to be inefficient and subject to abuse. The costs and management of the program crowd out other longer term agricultural productivity enhancing activities, and the program imposes a substantial fiscal burden on Government finances. In broad terms, the FISP continues to dominate public expenditure on agriculture. Efforts to see a more balanced distribution of public investments in agriculture and reduce the share of fertilizer in the agriculture budget are progressing slowly under the ASWAp process whereby agricultural stakeholders regularly meet to discuss policy issues. There is a growing consensus on the need to reform FISP by revisiting its objectives, its targeting and implementation modalities to reduce its fiscal burden, to improve its technical and financial efficiency and to promote both higher productivity and crop diversification. The Bank has contributed to this FISP reform dialogue by producing policy briefs to help summarize the findings and evidences of various research papers and to help formulate clear reform options. The Agricultural Sector Public Expenditure review, completed in 2013, has also been instrumental in providing evidence on the need to rebalance the agricultural budget beyond the ASWAp Food Security pillar in general and beyond FISP in particular. Enhance agricultural productivity and diversification. The expected result under this reform objective was an increase in legume production by 20 percent compared to the 2012 level by the end of the program. Legume production in the 2013/2014 cropping season significantly increased compared to the previous 2012/2013 campaign (by 19.9 percent in just one year). This increase is for a large part attributable to good weather conditions but the distribution of subsidized legume seeds under the FISP also contributed to increased access to seeds and to making improved varieties more affordable to a greater number of smallholder farmers. No specific prior actions were included under DPO-1 in this policy area, but an indicative DPO-2 trigger provided for the completion of a review of the legal and regulatory framework for quality seed production. The objective being to remove blockages preventing the greater availability of modern seeds and to open the seed market to varieties accredited in other countries of the Southern Africa Development Community (SADC), thereby facilitating increased agricultural productivity and crop diversification. The DPO has been instrumental in moving this agenda forward and in 12 ensuring that private sector, especially seed companies, will be consulted on the proposed legal reform agenda of the seed act. A draft Seed Act has been finalized and is being discussed with the Ministry of Justice and should be submitted to Parliament’s approval in 2015. The Bank, with complementary instruments, is now supporting the Government in elaborating a new seed policy and strategy to guide the implementation of the new seed act and to further clarify some SADC harmonization requirements as well. Improve energy efficiency and the regulatory environment. The expected result under this reform objective was the issuance of at least one power generation license to an independent power producer by the end of the program. DPO-1 supported the undertaking of monthly reviews of the Automatic Tariff Adjustment Formula for electricity as part of efforts to ensure that electricity tariffs reflect market fundamentals, a particularly challenging area of reform. The objective being to both safeguard the financial viability and reinvestment capacity of the Electricity Supply Corporation of Malawi, as well as increasing the likelihood of Malawi attracting new investment by Independent Power Producers (IPPs). The end of program target provided for the granting of at least one power generation license to an IPP by 2016. Efforts to reform the energy policy, the indicative trigger for DPO-2, were on track. At the time of the ICR there were no longer any policy restrictions preventing market access for IPPs and while one license was close to being granted, there are as yet no formal approvals of IPPs in Malawi. Improve efficiency in the provision of social safety nets. The expected result under this reform objective was an increase in the number of National Social Support Program beneficiaries with savings of at least 30 percent of the public works wage one year after participation from 13,000 in 2012 to 49,000 by the end of the program. The expected outcome was a more responsive system for cushioning the poor and most vulnerable. DPO-1 supported the approval of the National Social Support Program as part of efforts to create an enabling policy environment for the implementation of social protection interventions in Malawi. DPO-2 provided for the establishment of a M&E system. As of end FY13/14, a total of 99,153 people had joined the Community Savings and Investment Program of the National Social Support Program. Of this total, 78,330 (79 percent) meet the savings criteria of at least 30 percent of the public works wage one year after participation. This substantially exceeds the 2016 end of program target. Of this total, 47,781 of the beneficiaries (61 percent) are female, suggesting highly positive gender outcomes. Strengthen the country’s statistical capacity. The expected result under this reform objective was an increase in the number of MGDS quarterly reports published from zero in 2012 to four by 2016. The expected outcome was the production of high quality, timely and accessible statistical information. There were no prior actions under this reform area under DPO-1, but DPO-2 provided for an indicative trigger supporting the development of the National Statistics System Strategic Plan 2013- 17, which was approved in 2013. Progress in efforts to increase the availability of MGDS reporting had a more limited impact, partly due to the lack of sanctions for failure to submit quarterly reports. At the time of the ICR, quarterly progress reports were being produced by sector working groups on average once per year, below the end of program target indicator of four per year. 13 3.4 Justification of Overall Outcome Rating Rating: Unsatisfactory Evaluation of the operation is complicated by the fact that result indicators were set assuming a series of three operations (anticipated at the time of appraisal of DPO-1 to conclude in 2016). With the dropping of the second and third operations (DPO-2 and DPO-3), some judgment must be exercised on the contribution of the one completed operation, against the broader results framework for the series. Nevertheless, the overall outcome rating is judged to be “unsatisfactory” given the lack of significant progress towards the program core goals of improved macroeconomic and public financial management. In hindsight, the program development objectives were set at an overly ambitious level. While incremental process was achieved across a number of intermediate aspects of the program (particularly under Pillar 2), the Malawi’s public financial management system and the resultant theft of substantial amounts of public resources served to dramatically undermine the overall effectiveness of the program. That a proposed three-year program went so significantly off track so soon after approval, it is hard to consider an overall outcome rating that is anything other than “unsatisfactory”. However, while the aggregate impact of the program was less than anticipated, a number of sector specific reforms within the program did gain traction and achieve results at the intermediate level. Of these, incremental reforms in agriculture (and in particular on FISP procurement) and in energy pricing were notable. Perhaps most critically, the objectives of the program—namely to support improved macroeconomic and fiscal policies, and to maintain international and external balances—continue to be highly relevant to Malawi’s development needs and remain at the core of the WBG’s County Partnership Strategy for Malawi. The WBG remains closely engaged in these areas via a mix of instruments. 3.5 Overarching Themes, Other Outcomes and Impacts (a) Poverty Impacts, Gender Aspects, and Social Development Data from the IHPS indicates that the overall incidence of poverty in Malawi fell slightly from 40.2 percent of the population in 2010 to 38.7 percent in 2013. Urban areas displayed an increase in poverty over this period, while rural areas experienced a slight decline in the share of those who are poor. Rural areas have a significantly higher poverty incidence than urban areas, but the difference is shrinking over time as rural areas see a relative improvement while the situation in urban areas is deteriorating. Substantial mobility into or out of poverty was experienced by around a third of the population over 2010-13. Some two thirds of Malawi’s population did not see much mobility over 2010-13 either into or out of poverty: 44 percent remained non-poor while 23 percent remained poor over this period. But substantial mobility was experienced by the remaining third of the population: around 17 percent managed to escape poverty during this period while 15 percent became poor. Consumption inequality declined somewhat between 2010 and 2013, suggesting a slight improvement in shared prosperity over this period. That is, the shares of overall national 14 consumption of the bottom four quintiles increased modestly from 2010 to 2013, while the share of the 20 percent of the population with the highest consumption declined over the same period. Incidence of poverty, 2010 and 2013 Consumption shares by quintile Percentage of the population, Integrated Household Panel Survey, 2010 and Integrated Household Panel Survey, 2010 and 2013 2013 2010 2013 45 40 2010 2013 Estimate Standard Estimate Standard 35 error error 30 Malawi 40.2 1.8 38.7 1.8 25 Urban 17.9 4.9 26.2 5.3 20 Rural 44.0 2.0 40.9 1.9 15 10 North 50.2 3.8 43.3 3.9 5 Centre 33.5 2.8 39.0 2.7 0 South 45.0 2.8 37.3 2.7 1 2 3 4 5 Source: NSO and World Bank IHPS Source: NSO and World Bank IHPS If implemented as anticipated at the time of appraisal, the reform program supported by the Economic Recovery DPO should have had beneficial effects on the poor by helping to establish a more stable macroeconomic environment. Prior actions on public financial management are necessary in order to improve the efficiency and effectiveness of public spending, particularly in key social sectors that would be likely to directly benefit the poor. In practice, the continued large stock of payment arrears owed by government has served to undermine private sector confidence and the investment and job creation that is necessary to propel economic growth in Malawi. Similarly continued macroeconomic uncertainty, and in particular persistently high rates of inflation, discourage saving and depress the purchasing power of the poor in particular. However, intermediate aspects of the program have achieved encouraging results at the meso level. In particular, the successful implementation of the National Social Support Program saw substantially greater participation and impact than anticipated, with very strong female participation. Similarly, strong growth in the production of legumes, in part facilitated by increased access to seeds under FISP, is expected to have strong positive poverty and gender effects. (b) Institutional Change/Strengthening Malawi has suffered from persistent and recurring bouts of macroeconomic instability throughout much of its economic history, with the effect that spells of economic growth have rarely been sustained for long enough periods to have a meaningful impact on poverty. A proximate cause of the persistent macroeconomic imbalances has been institutional weaknesses and a wide governance gap between policies enacted and those actually implemented. While many of the weaknesses in Malawi’s PFM systems had been present for a long time, the systemic breakdown and large scale theft of public resources was exposed shortly after the completion of the Economic Recovery DPO- 1, and served to destabilize the political setting and government’s reform program. Institutional change is clearly a long term and challenging agenda in Malawi, and a process which will require strong national ownership and drive to achieve results. DPOs can play an important role during such a transition but, evidence from other countries suggests, are most effective as part of a mix of ODA instruments including not only budget support, but also investment lending and technical assistance. 15 (c) Other Unintended Outcomes and Impacts (positive or negative, if any) The fallout from Malawi’s “cashgate” PFM scandal had a number of effects. Firstly and most significantly, the public exposure of the theft of resources resulted in immediate and substantial reductions in the volume of assistance disbursed through government systems, as well as the withdrawal of bilateral development partners from the CABS group. Multilateral development partners in the CABS group (including the World Bank, the European Union and the African Development Bank) remained broadly committed to budget support in principle, but delayed and/or suspended ongoing operations pending the implementation of structural reforms to improve PFM systems. While the net impact on total ODA received by Malawi was more ambiguous, the sudden loss of budget support and a sharply reduced share of development assistance received on-budget placed the government’s FY13/14 fiscal account under immediate stress. The financing gap was filled by increased domestic borrowing, driving up inflation and interest rates, as well as by substantial payment arrears, in turn damaging macroeconomic stability. In aggregate, efforts over many years in Malawi to pool resources, reduce aid transactions costs, improve predictability and gradually increase the use of national systems were reversed in a very short space of time. 3.6 Summary of Findings of Beneficiary Survey and/or Stakeholder Workshops Not applicable. 4. Assessment of Risk to Development Outcome Rating: High Malawi’s economic and governance institutions remain fragile, with a still contested consensus on the causes of the country’s poor growth performance and on the underlying reasons for the breakdown of PFM systems. Incremental progress on aspects of the program was achieved, with a number of preliminary policies put in place to support macroeconomic stability, better growth prospects and improved protection of the poor. However, the as-yet limited impact between reforms undertaken and higher level development outcomes suggest both weak causality and the primacy of broader factors outside the program. 5. Assessment of Bank and Borrower Performance 5.1 Bank Performance (a) Bank Performance in Ensuring Quality at Entry Rating: Moderately Unsatisfactory The operation was prepared in a timely fashion and in response to a window of opportunity to consolidate reforms enacted by the (at the time) new administration of President Joyce Banda, and support efforts by the government to move towards a medium term economic reform program. The team involved participants from across the WBG’s sectors/practices, attempting to address the critical challenges associated with macroeconomic management, public finance, agriculture and social safety nets. Preparation took place in a coordinated manner, with the Bank working alongside other development partners within the CABS group. The program was, at both the time of appraisal and ICR, highly relevant to Malawi’s developmental needs. 16 However, overly ambitious objectives and assumptions, together with the fact that the program unraveled so soon after approval suggest key weaknesses in quality of entry. Furthermore, risks to reforms supported by the operation might have benefitted from a deeper appreciation of the local political economy context and a fuller understanding of the extent to which the (formal) PFM system was operating in a weak (informal) governance environment. As an example, the policy area on strengthening external oversight had a corresponding prior action on the submission of treasury minutes for 2005-07, for an operation that was approved in 2013. This severe issue in the timeliness of basic budget information is, in retrospect, an indication that there was a lot about the contemporaneous budget process that the Bank did not know, and perhaps should had provided a warning sign. Hence, in aggregate a rating of “moderately unsatisfactory” is proposed for quality of entry. (b) Quality of Supervision Rating: Moderately Satisfactory Supervision of the operation, the first in an intended series of three, was undertaken as part of the preparation of the second operation in the series. Monitoring of the results indicators also took place as part of regular economic policy dialogue with the authorities. Despite challenges associated with the fallout of the “cashgate” PFM scandal—the culmination of a chain of events that caught everybody off guard—efforts were made to complete preparation of the second operation, with an increased focus on remedial measures aimed at restoring basic controls and oversight. However, preparation of the second operation was later suspended and the series terminated when there was a change in government and a change in the focus of government policy. (c) Justification of Rating for Overall Bank Performance Rating: Moderately Unsatisfactory Despite disappointing results at the PDO level, the operation was appropriate in its design, highly relevant to and closely aligned with Malawi’s development strategy. The breakdown in confidence in the country’s PFM framework, and in particular the massive collusion in the circumvention of PFM controls that allowed the theft of resources to take place, was hard to foresee. However, poor results and the termination of the series so soon after board approval raises questions about the adequacy of preparation. As such, the overall Bank performance is judged to be “moderately unsatisfactory”. 5.2 Borrower Performance (a) Government Performance Rating: Unsatisfactory The reform program supported under the Economic Recovery DPO involved the participation of a number agencies, including the Ministry of Finance, Economic Planning and Development; the Ministry of Agriculture; and the Ministry of Energy. While the weaknesses in the integrity and management of PFM systems in Malawi had existed for several years, the extent and gravity of these weaknesses came to light only after the public exposure of the theft of public resources during the course of the program. The fiscal pressures that ensued as development partners withdrew resources, basic planning, budgeting and commitment 17 controls broke down, saw a crescendo of macroeconomic and fiscal instability that undermined the development objectives of the operation. Similarly, these challenges also resulted in the IMF program going off track. Aggregate government performance is therefore rated “unsatisfactory”. (b) Implementing Agency or Agencies Performance Rating: Moderately Unsatisfactory The primary agency responsible for coordination during the preparation and implementation of the operation was the Debt and Aid Division of the Ministry of Finance, Economic Planning and Development. Malawi’s coordinated approach towards development policy financing under the CABS group is notable, even if the results have been mixed. The division exercised strong management and coordination throughout the preparation and implementation of the program. However, concerns over the appropriateness of design for a program that went off track so soon after approval also weigh on the rating for implementing agency performance. (c) Justification of Rating for Overall Borrower Performance Rating: Moderately Unsatisfactory The negative impact of systemic institutional weaknesses in the integrity of Malawi’s public finances, together with a lack of oversight and culture of impunity outweigh the efforts of key implementing agencies. As such the overall rating for borrower performance is “moderately unsatisfactory”. 6. Lessons Learned The mixed results of the Economic Recovery DPO provide some useful lessons learned on the effectiveness of development policy / budget support operations in the context of a fragile institutional environment. Malawi has a long history of budget support provided by development partners, with well-established coordination arrangements under the CABS group. Similarly, the Bank has significant prior experience with DPOs in Malawi, having financed three programmatic Poverty Reduction Support Grants (during 2008-11) and a standalone Rapid Response Development Policy Grant (in 2012), prior to the preparation of the Economic Recovery DPO series. The program was well prepared, relevant to the Government of Malawi’s needs, closely embedded in existing strategies and processes, informed by a solid base of underpinning analytic work, and aligned with the objectives of the MGDS II and ERP. Lessons learned from previous DPOs were applied during the preparation of the Economic Recovery DPO, including careful alignment with government priorities, strong coordination with other development partners, and complementarity between Bank-financed investment lending operations and the DPO series to generate mutual leverage for achieving development objectives. However, the experience of the DPO also points to the risks of “partial reform syndrome”, a situation where governments undertake reforms at a superficial level only producing the form but not the substance of modernized institutions. The breakdown of Malawi’s PFM that occurred in 2013 highlights the need for a thorough understanding of the local political economy of reform and the importance of looking beyond the veneer of formal rules-based systems, to the underlying informal arrangements that allowed for collusive behavior to take place. 18 The fallout from Malawi’s “cashgate” saga, and the resultant suspension of budget support by development partners similarly raises questions about the role and purpose of budget support in an aid-dependent economy such as Malawi. At the time of ICR preparation, the authorities are struggling to execute the budget in a highly constrained environment with a much diminished resource envelope. Spending demands have been hard to rein in, and having resorted to financing an enlarged budget deficit via high cost domestic borrowing, Malawi has entered into a high inflation, high interest rate equilibrium, weakening growth prospects. Similarly the negative signaling effect of the loss of budget support has dampened private sector confidence and played a part in the depreciation of the domestic currency, in turn putting the fiscal accounts under increased pressure and further stoking inflationary risks. Development policy financing could be seen as a two-edged sword with the provision and then suspension of budget support serving to amplify political/business cycles in the economy. Thus the withdrawal of budget support has placed the government under significant and increased pressure. In Malawi’s case this has produced a number of negative effects and may damage growth and poverty reduction prospects. However, it also has the potential for positive impact by sending a strong message on the need for structural reforms to public financial management and integrity to be undertaken before budget support can be resumed. Thus at the time of the ICR, while the Bank and other CABS donors are not currently disbursing DPOs3, policy dialogue on the issues continues and by keeping the option of resuming budget support at a future date on the table, there are positive incentives in support of critical reforms. In addition, despite mixed results at the overall outcome level, the Economic Recovery DPO did achieve meaningful results at the technical level in a number of areas of the program on agriculture, energy and social safety nets. The most notable area of progress was on reforms to fertilizer procurement under FISP, an area that lays at the core of Malawi’s public policy, where the introduction of a revised tonnage allocation formula helped reduce costs and improve allocative efficiency. Similarly, reforms on energy pricing were sustained beyond the program, pointing to deeper ownership. Despite challenges, development policy lending remains a key instrument in support of Malawi’s development agenda and forms part of a mix of ODA modalities available to the country. In the right circumstances, DPOs can play an instrumental role and as part of a mix of aid instruments by helping (at the margin) to support critical reforms necessary for stronger and more resilient growth and poverty reduction. In moving forward, key lessons learned for future DPOs in Malawi are highlighted below:  Greater attention will need to be paid to the financial management domain in highly aid dependent environments so as to avoid pro-cyclicality in budget support. The fiduciary element to the “cashgate” revelations in Malawi created a highly damaging multiplier effect as a series of development partners who were providing budget support and reliant upon government’s financial management, simultaneously withdrew resources.  There is a sense that government is no longer driving the policy agenda, responding to policy proposals that are put forward by development partners, and therefore exercising weak ownership over the program leading to “partial reform syndrome”. This calls for a rethink in the way that a future program may be put together, with much greater emphasis placed on ensuring strong government ownership over reforms. Similarly, and in a low 3At the time of ICR, the African Development Bank was considering a sector policy lending instrument that would provide a form of budget support, earmarked for expenditure within the social sectors. 19 capacity environment this would suggest the identification of a program with a narrower focus, and with prior actions and triggers formulated at a more downstream/outcome oriented level. Lessons from the “cashgate” experience also point to the need for increased use of independent verification methods to confirm the actual status of reform measures adopted, particularly with regards to PFM systems and controls.  The experience of the Economic Recovery DPO points to the need for a strong focus on timeliness of fiscal information and integrity of systems, suggesting that these features in particular (as opposed to other PFM elements which could matter in other contexts) need to be priorities in any future budget support operations. Furthermore, the fact that there was partial success across a range of structural areas of the program, but not complete (or irreversible) success in any, suggests the need to narrow the scope of structural reforms to only the most macro-critical areas where progress would be harder to unwind after completion of an operation. 7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners (a) Borrower/Implementing Agencies The ICR was shared and discussed with the Ministry of Finance, Economic Planning and Development. Comments provided by government have been incorporated into the document. (b) Cofinanciers Not applicable. (c) Other Partners and Stakeholders The ICR was shared and discussed with the remaining CABS/budget support development partners operating in Malawi (the African Development Bank and the European Union). Comments have been incorporated into the document. 20 Annex 1: Bank Lending and Implementation Support/Supervision Processes (a) Task team members Responsibility/ Names Title Unit Specialty Lending Appolenia Mbowe Senior Economist AFTP1 Task Team Leader Praveen Kumar Lead Economist AFTP1 Olivier Durand Senior Agricultural Specialist AFTAR Pazhayannur Subramanian Lead Financial Management Specialist AFTFM Ida Manjolo Senior Social Protection Specialist AFTSP Temwa Gondwe Economist AFTP1 Rob Mills Senior Economist AFTP1 Steve Mhone Procurement Specialist AFTPC Nneoma Veronica Nwogu Counsel LEGAM Luis Schwarz Senior Finance Officer CTRLA Trust Chimaliro Financial Management Specialist AFTFM Jos Verbeek Lead Economist DECDG Peer Reviewer William Battaile Senior Economist PRMED Peer Reviewer Deliwe Ziyendammanja Team Assistant AFMMW Supervision Appolenia Mbowe Senior Economist GMFDR Task Team Leader Richard Record Senior Country Economist GMFDR ICR Team Leader Praveen Kumar Program Leader AFCS3 Priscilla Kandoole Country Economist GMFDR Olivier Durand Senior Agricultural Specialist GFADR Daniel Domelevo Senior Financial Management Specialist GGODR Kevin Carey Lead Economist GMFDR Vivek Srivastava Lead Public Sector Specialist GGODR Peer Reviewer Genevieve Boyreau Senior Country Economist SACBT Peer Reviewer Deliwe Ziyendammanja Team Assistant AFMMW (b) Staff time and cost Staff Time and Cost (Bank Budget Only) Stage USD Thousands (including No. of staff weeks travel and consultant costs) Lending FY13 35.8 184.78 Total: 35.8 184.78 Supervision/ICR FY15 10.5 23.60 Total: 10.5 23.60 21 Annex 2: Beneficiary Survey Results Not applicable. Annex 3: Stakeholder Meeting Report and Results Not applicable. 22 Annex 4: Summary of Borrower's ICR and/or Comments on Draft ICR The ICR was shared and discussed with the Ministry of Finance, Economic Planning and Development. Comments provided by government have been incorporated into the document. 23 Annex 5: Comments of Cofinanciers and Other Partners/Stakeholders The ICR was shared and discussed with the remaining CABS/budget support development partners operating in Malawi (the African Development Bank and the European Union). Comments have been incorporated into the document. 24 Annex 6: List of Supporting Documents International Development Association (2012) Country Assistance Strategy for the Republic of Malawi for the Period FY13-16, Report No. 74159-MW, Africa Region, December 17, Washington, DC: The World Bank. International Development Association (2013a) Program Document for a Proposed Grant to the Republic of Malawi for an Economic Recovery Development Policy Operation, Report No. 73110- MW, Africa Region, April 29, Washington, DC: The World Bank. International Development Association (2013b) Implementation Completion and Results Report on a Grant to the Republic of Malawi for a Rapid Response Development Policy Operation, Report No. ICR2720, Africa Region, December 25, Washington, DC: The World Bank. International Development Association (2015) Malawi Country Assistance Strategy FY13-16 – Performance and Learning Review, draft manuscript, Africa Region, Washington, DC: The World Bank. International Monetary Fund (2014) Aide Memoire for a Staff Visit under the Extended Credit Facility, July 15, 2014. The World Bank (2013) Malawi Public Expenditure Review, Report No. 79865-MW, Poverty Reduction and Economic Management Unit, Africa Region, Washington, DC: The World Bank. The World Bank (2014) Malawi Economic Recovery Development Policy Operation – Implementation Status and Results Report (Sequence 1), June, Poverty Reduction and Economic Management Unit, Africa Region, Washington, DC: The World Bank. The World Bank (2015) Malawi Economic Monitor – Managing Fiscal Pressures, March, Macroeconomics and Fiscal Management Global Practice, Lilongwe: The World Bank. 25