US embassy cable - 04LILONGWE768

UNCLAS SECTION 01 OF 02 LILONGWE 000768 
 
SIPDIS 
 
TREASURY FOR LUKAS KOHLER 
STATE FOR EB/IFD/OMA FRANCES CHISHOLM 
STATE FOR EB/IFC/ODF MARLENE BREEN 
 
E.O. 12958: N/A 
TAGS: EFIN, ECON, EINV, PREL, MI, Economic 
SUBJECT: MALAWI AT A CROSSROADS WITH IMF 
 
REF: A. LILONGWE 719 
 
     B. LILONGWE 728 
 
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SUMMARY 
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1. (SBU) At last week's outbriefing to donor countries, the 
IMF's Article IV assessment team said Malawi's new government 
is going in the right economic direction and that the IMF 
team would recommend a Staff Monitoring Program for the 
2004/05 fiscal year.  They assessed the GOM's draft budget as 
realistic and workable, though tight, and expressed 
confidence that the GOM would succeed in establishing 
budgetary discipline.  The new government is showing signs of 
the political will needed to achieve macroeconomic stability. 
 If the new government succeeds in sticking to its budget 
over the next several months, donors will have to act quickly 
to avoid a balance of payments crisis late in the calendar 
year.  END SUMMARY. 
 
 
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IMF ENCOURAGED, READY WITH MONITORING PROGRAM 
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2. (U) At the end of a two-week Article IV assessment, a team 
from the International Monetary Fund (IMF) described 
themselves as "not at the end of a mission, but at the 
beginning of a new relationship."  They said that the new 
government is going in the right direction, based on 
 
 - the team's review of June results, where targets were 
achieved "by a wide margin," 
 
 - the draft budget for the July-June fiscal year just begun, 
and 
 
 - a review of achieved and proposed structural reforms. 
 
The team characterized the budget as tight but workable, and 
perhaps most importantly, as inclusive of all forseeable 
expenditures.  Team leader John Green said the team saw good 
confidence in the economy, such that if the GOM sticks to its 
budget, economic conditions, particularly interest rates, 
should improve.  Green said his team would recommend a 
12-month Staff Monitoring Program, starting with July 2004, 
with reviews in September and December.  The earliest 
recommendation for a new Poverty Relief and Growth Facility 
(PRGF) would be in December. 
 
3. (U) In addition to the sanguine assessment of financial 
indicators, the team took note of the new government's 
behavioral shift from the previous administration.  The GOM 
has recently said no to extra funding requests, moved the 
President and Cabinet to Lilongwe to save travel costs, 
reduced the size of the Cabinet, and resolved to close five 
to seven embassies.  (NOTE: The IMF team also mentioned the 
government's refusal to give Parliament a large pay increase, 
but unconfirmed media reports have since said GOM has agreed 
to an even larger pay package.  END NOTE.)  GOM officials 
have also said they are close to announcing a civil service 
wage reform package, designed to raise salaries, especially 
at the bottom of the scale, and reduce the numerous tax-free 
allowances for high-ranking civil servants.  The team noted 
that its financial targets would allow for government grain 
purchases for this hunger season (late 2004 - early 2005) and 
for fertilizer subsidies for the 2004/5 growing season, 
provided the GOM can keep recurring costs within the new 
budget. 
 
 
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GONDWE: IT'S POSSIBLE, BUT NOT EASY 
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4. (U) Responding to the IMF's briefing, Finance Minister 
Goodall Gondwe, a retired IMF official, said he welcomes the 
IMF's involvement as an opportunity for the GOM to get its 
financial house in order.  He said he would be surprised if 
the needed reforms are not done in six months.  That said, 
Gondwe noted two factors working against GOM's fiscal reform: 
a possible food shortage late this year, and a need to build 
grain stocks in advance of a crisis, and a continuing need 
for fertilizer subsidies for the 65 percent of the population 
below the poverty line.  He added to this an urgent need for 
civil service wage reforms.  All of these will require 
relatively heavy government spending before the end of 
October and thus before donor assistance starts.  In order to 
avoid another round of inflationary spending, he said, the 
Combined Approach to Budgetary Support (CABS) group of donors 
(which provide direct budgetary support) and the World Bank 
must release funds as early as possible. 
 
 
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COMMENT: SPENDING DISCIPLINE, THEN QUICK DONOR REACTION 
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5. (SBU) Whether Malawi falls into an inflationary spiral 
between now and the end of the calendar year depends on two 
things: the political will to reduce government spending, and 
the donors' ability to respond quickly should the GOM 
succeed.  While it is still too early to judge the political 
will, the signs thus far are encouraging.  The Mutharika 
government has shown signs of independence from the United 
Democratic Front (UDF) old guard (former president Muluzi's 
allies) in several ways, including its resistance to requests 
for off-budget funding, its replacing the director of public 
prosecution, a declared intent to prosecute former ministers 
for corruption, and a halt to privatizations pending 
investigation of financial irregularities.  Mutharika's 
ability to change the GOM's spending behavior depends on his 
ability to garner support outside of established UDF/Muluzi 
circles, and in defiance of many entrenched political 
interests.  Whether he can do so remains to be seen. 
 
6. (SBU) If Mutharika succeeds in taming government 
profligacy, at least one hazard remains: the timing of 
foreign currency revenues at the end of the tobacco buying 
season.  With the CABS donors and World Bank holding 
disbursements until the GOM has established its fiscal 
responsibility more firmly, a balance of payments crisis is a 
real possibility.  These groups appear to want a clear signal 
from the IMF September review, a position we believe is 
prudent.  This means that if the GOM performs well, donors 
will have to move quickly to avoid a devaluation of the 
currency at precisely the time that the economy is most 
susceptible to inflation.  Mixed signals from the GOM on 
fiscal discipline or on the political stability needed to 
maintain that discipline will make a timely decision 
difficult. 
 
 
RASPOLIC