MALAWI – HIPC AAP REPORT 2004 October 1, 2004

MALAWI

COUNTRY ASSESSMENT

AND ACTION PLAN FOR HIPCs

October 2004

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TABLE OF CONTENTS

EXECUTIVE SUMMARY 5

I. INTRODUCTION 11

II. HIPC RESOURCES, PRO-POOR EXPENDITURES AND THE MALAWI POVERTY REDUCTION STRATEGY (MPRS) 15

HIPC resources and Pro-Poor Expenditure in Malawi 15 Links between the budget and the MPRSP 18 Decentralization and the involvement of different levels of government 20

III. BUDGET FORMULATION 21 Indicator 1~ Coverage of the budget or fiscal reporting entity 21 Indicator 2 ~ Degree of spending being funded by extrabudgetary sources 22 Indicator 3 ~ Reliability of budget as a guide to future 24 Indicator 4 ~ Inclusion of donor funds 27 Indicator 5 ~ Classification 29 Indicator 6 ~ Identification of poverty-reducing spending 31 Indicator 7 ~ Integration of medium-term forecasts 32

IV. BUDGET EXECUTION 34 Indicator 8 ~ Evidence of budget execution problems – Arrears 34 Indicator 9 ~ Effectiveness of the internal control system 36 Indicator 10 ~ Tracking surveys are in use 38 Indicator 11 ~ Quality of fiscal information 39

V. BUDGET REPORTING 40 Indicator 12 ~ Regularity of timely internal fiscal reporting 40 Indicator 14 ~ Closing the accounts 43 Indicator 15 ~ Timeliness of audited financial information 44 Indicator 16 ~ Efficiency and effectiveness of the public procurement system 46

VI. PROGRESS SINCE 2001 REPORT AND ACTION PLAN FOR THE FUTURE 48 Comparison with 2001 HIPC AAP report: achievements and setbacks 48 Action Plan to upgrade PEM capacity in Malawi 50

VII. DONOR INITIATIVES 53 IMF 53

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World Bank 53 AfDB 54 CIDA 54 DFID 55 EU 55 GTZ 55 JBIC 56 NORWAY / SWEDEN 56 UNDP 56 USAID 57

VIII. SUMMARY TABLES 58 Table S1: Public Expenditure Management AAP Indicators in Malawi 58 Table S2: Overview of Technical and Donor Assistance in Public Expenditure Management in Malawi 59 Table S3: Implementation Status of Actions to Strengthen Tracking of Poverty-Reducing Public Spending in Malawi 60 Table S4: Action plan to upgrade PEM capacity in Malawi 61

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ABBREVIATIONS AND ACRONYMS

AAP Assessment and action plan FY Fiscal Year HIPC Heavily indebted poor country MOF Ministry of finance MPRSP Malawi Poverty Reduction Strategy paper MTEF Medium term expenditure framework PAF Poverty action fund PEM Public expenditure management PETS Public expenditure tracking survey PRSP Poverty reduction strategy paper SAI Supreme audit institution

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EXECUTIVE SUMMARY In the context of the Enhanced HIPC Initiative, the IMF and the World Bank initiated the ‘HIPC Assessments and Action Plans (AAP).’ Each assessment evaluates the existing Public Expenditure Management (PEM) system against a selected number of performance indicators, in order to determine countries’ capacity for tracking public spending with a particular focus on pro-poor spending. A first round of field assessments was carried out in 2001 in 24 countries, including Malawi. This report presents the findings of the second round of field assessment carried out in Malawi in April 2004. The Malawi 2004 HIPC AAP review has been conducted by the IMF and the World Bank in collaboration with the authorities and the representatives of the EU, UK-DFID and Norway i.e. most of the donors providing BoP support to Malawi. The government has provided substantial input into the HIPC AAP both by facilitating and participating in the main fact-finding mission, and subsequently by clarifying various issues as they arose during the drafting of the report. All donors active in Malawi (JICA, USA, Germany, Canada, UNDP) have been consulted and have provided input into the AAP report. Substantial work as been made in assessing the status of PEM systems in Malawi reporting the last few years. This AAP report draws significantly on these studies, notably the 2002 Country Financial Accountability Assessment (CFAA), the 2003 Malawi Financial Accountability Action Plan (MFAAP), and the 2004 MTEF II, updating the information as required, and complementing their analyses in areas which were not explicitly addressed. This AAP report provides an update on the status of existing PEM systems, and a priority action plan to help the government develop a strategy of implementation that can be programmed over the next several years. In addition, the AAP also highlights the importance for the government to accelerate the implementation of the MFAAP in a more decisive and coordinated manner, and helps to further align the work of the Bank, IMF, government, and other donors behind a common assessment, strategy and action plan. Status of Public Expenditure Management systems and comparison with 2001 HIPC AAP report The 2004 HIPC AAP results indicate that Malawi currently meets the benchmarks for 5 indicators (out of 16 indicators—see details in Summary Table S1). This is less than the 7 benchmarks Malawi met in the first AAP assessment in 2001. In fact, four indicators have been rated lower in the 2004 assessment than they were in the 2001 assessment. A preliminary reading of the results of the 2004 assessment may therefore give the reader the false impression of a deterioration in the status of PEM in Malawi during the period from 2001 to 2004. However, the changes do not reflect a deterioration in actual practice. Rather they result from an improved information basis, and some adjustments in the evaluation criteria (as the 2004 assessment methodology was refined to take into account the experiences of the 2001 exercise). In fact there have been improvements in several indicators, mainly in the area of final accounts and audit. Although the improvements since 2001 have not been sufficient to

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warrant any increase in the ratings, Malawi is now closer to meeting the threshold level for several indicators: • Firstly, Malawi is currently executing its first PETS in the education sector (indicator 10). The authorities have expressed their intention to also carry out PETS in health and agriculture during 2005. PETS could be very useful in Malawi as an interim instrument for monitoring budget execution and MPRS implementation until internal control and audit systems are functioning well.

• Also, the reconciliation of fiscal and banking records (indicator 11) has improved significantly. The backload of bank reconciliation has been reduced from 18 months to an average 6 months during the period, and further improvements are expected in the preparation of the IFMIS.

• Very good progress has also been made in shortening the length of time between the end of the fiscal year and the closing of the accounts (indicator 14). The AGD finished entering the 2002/03 transactions in the final accounts’ computer system in December 2003, about 6 months after the end of the fiscal year. This compares with the financial statement for 2001/02, which was submitted to the Auditor General some 14 months after the end of the fiscal year. Hence Malawi has made substantial progress and with some effort could meet the target to enter all routine transactions into the main accounting system(s) within two months after the end of the fiscal year.

• Further, significant improvement has been made in the preparation and audit of the final accounts (indicator 15). Until recently there was a 2-3 years time lag between the end of the relevant fiscal year and the presentation of the audited accounts and report to the legislature, implying that the official accounting records were not very useful for fiscal management purposes. At the time of the assessment mission the Auditor General was ready to present the 2001/02 audited accounts to the new legislature, and was in the process of preparing the audit report for the 2002/03 accounts. In the event, the 2002/03 audited accounts were ready for presentation to Parliament before June 30, 2004 (i.e. within 12 months after the end of the fiscal year), but were not submitted because of national elections in May 2004. Although submission before June 30, 2004 was not achieved, Malawi is well placed to meet the benchmark for the 2003/04 audited accounts.

Unfortunately, there are also several areas in which Malawi has failed to make much progress, and overall the quality of Public Expenditure Management systems in Malawi remains very weak. • The coverage of fiscal reporting is still very incomplete (indicator 1), and falls short of the Government Finance Statistics definition of the general government sector. There is a need to expand the coverage of fiscal reports and prepare consolidated general government statements, both for ex-ante fiscal plans in conjunction with the budget presentation, and for ex-post reporting in conjunction with the final accounts.

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• Secondly, budget outturn data continue to differ considerably from the original budget (indicator 3). Actual expenditures have differed from the original budget estimates by 2-3 percent of GDP on average, or 6-9 percent of expenditures. In 2003/04 expenditures exceeded the original budget by nearly 11 percent of GDP, of which only about 5 percent of GDP can be attributed to higher interest payments. Mostly, the aggregate variation is the result of regular overshooting of the recurrent budget, and specifically with higher than anticipated interest payments on domestic debt. However, variations in discretionary recurrent expenditures are also quite large, notably benefiting the Office of the President, the State Residences, the Police, the Ministry of Defense, and the Ministry of Foreign Affairs. Reasons for these variations are manifold. The wide variance on recurrent expenditures renders the budget irrelevant as a guide to resource availability during budget execution, resulting in a weakened budget planning process, and attempts by ministries to retain control over resources.

• Thirdly, the development budget still does not include the large majority of donor funded projects (indicator 4). According to anecdotal estimates, the central government budget only includes 30 to 50 percent of donor sponsored projects funded by grants and executed by government agencies. Grant-funded projects are typically included in the budget when domestic counterpart funds are required. It is understood that loan funded projects are included in the budget. A comprehensive list of all donor projects is now available in the database maintained by Debt and Aid Division, in the Ministry of Finance. However, this information is not included in the budget. There is a need to define a strategy to bring all the donor development projects into the budget, and strengthen timely reporting. A task force could be set up with the purpose to develop clear instructions and operating procedures, and to discuss these with donors.

• Information and controls on the accumulation of expenditure arrears are inadequate and accumulation of domestic arrears continues to be a problem (indicator 8). A special external audit of 9 ministries and the pension system carried out in 2004 by KPMG under the auspices of the Auditor General has highlighted that domestic arrears amount to about ¾ percent of GDP or 1.7 percent of 2003/04 expenditure, more than 3 times the previous estimate. The audit is expected to continue and cover the whole government. There is a need to prevent the formation of new arrears by strengthening budget preparation and control. Reducing the stock of existing arrears requires establishing a comprehensive database of arrears, and formulating a strategy to clear the backlog.

• The overall control environment for public expenditure management remains weak (indicator 9). Malawi has an overall sound legal and regulatory framework for public expenditure management. Malawi also has in place a number of systems and procedures that are designed to ensure proper management of public funds, some of which were only introduced recently. Nevertheless, the overall control environment remains weak, and there is less than full compliance with plans, procedures, laws and regulations as stipulated in various guiding documents.

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• Finally, the quality of internal fiscal reporting continues to be inadequate (indicators 12 and 13). Most ministries submit monthly expenditure returns within two weeks of the end of the month. The quality of these reports is improving, but there remain significant gaps and as a result they are not useful for fiscal management. The poor quality of the reports from the ministries is mainly attributed to inadequate capacity due to low staff skills, inadequate numbers of staff and constant movement of staff from the ministries.

• Fiscal reports classify spending to program, sub program and economic item levels. However, the present classification is not sufficient to track PPE expenditures, since these are identified at the activity level, and not at the program / sub-program level on which detailed budget reports and accounts are prepared. The changes required to enable tracking of PPE expenditures are technically simple to implement, and would allow Malawi to meet this indicator.

• Finally, improvements are also needed in the efficiency and effectiveness of the public procurement system (indicator 16). The procurement system is in transition. Clear and enforceable rules that promote competition, transparency and value for money have been introduced with the 2003 Public Procurement Act. However, implementation of the new rules has only just started.

Action Plan to upgrade PEM capacity in Malawi It is important that the government revamps the efforts to strengthen public expenditure management. As mentioned, this HIPC AAP report draws significantly on other recent substantial analyses of Malawi’s PEM systems, that were consolidated into the Malawi Financial Accountability Action Plan (MFAAP) approved by Cabinet in May 2004. The MFAAP constitutes the ‘framework document’ intended to guide the overall work program on public expenditure management systems in Malawi. It provides a comprehensive list of actionable recommendations to address problems in budget planning, execution, and monitoring, and in public procurement. Within the context of the MFAAP, this AAP report provides an update on the status of existing PEM systems, and a smaller priority action plan to be pursued in the near future. More generally, this AAP reiterates the importance for the government to accelerate the implementation of the MFAAP in a more decisive and coordinated manner, and to facilitate the coordination of the donors support in this area. Progress with implementation of the MFAAP recommendations has been mixed. On the positive side, new legislation (Public Finance Management Act, Public Audit Act and Public Procurement Act) has been passed in May 2003, and the relevant desk manuals and instructions have been almost finalized. However, only limited progress has been made in other areas.

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In line with the discussion above and the assessment for the individual indicators presented in the previous sections, a number of actions have been identified for implementation within the next 12 months and over the medium term. These actions are briefly summarized below (see also Summary Table S4). Actions to be implemented in the short term: In budget formulation:

• Expand coverage of fiscal reporting to include financial position or detailed accounts of autonomous agencies and treasury funds.

• Strengthen budget planning (in line with the “MTEF II work plan”—see details under indicator 3).

• Improve dialogue with donors on available financing. • Maintain comprehensive list of all donor projects, ongoing and under preparation (in

line with CIDA Database). • Define a strategy to bring all donor development projects into the budget. • Develop estimates of disbursements by year, and required counterpart funding. • Classify all PPEs as programs and sub-programs. Alternatively, (or in the medium-

term) develop the classification system to ensure that PPEs classified as activities can be recorded throughout the expenditure process.

In budget execution:

• Establish a comprehensive database of arrears, and verify reported arrears. • Strengthen the internal audit function: formulate internal audit program, approve IA

charter, develop IA manual, follow up on implementation of recommendations, and formulate government wide plans to protect assets.

• Develop of a complete list of government bank accounts and close all unnecessary accounts.

• Ensure monthly reconciliations are consistently done In budget reporting:

• Strengthen budget monitoring and reporting (in line with the “MTEF II work plan”—see details under indicator 12).

• Ensure predictable and adequate funding for the National Audit Office (NAO). • Develop an audit program (NAO).

In public procurement:

• Operationalize the Office of the Director of Public Procurement (DoPP). • Introduce an independent complaints mechanism.

Actions to be implemented in the medium term: In budget formulation:

• Rationalize spending and align with available resources, e.g. by implementing recommendations from functional or public expenditure reviews.

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• Expand coverage to include accounts of local government agencies including reporting on pro-poor expenditure.

• Develop PSIP and improve linkage with budget preparation. • Prepare a medium-term plan for implementation of donor projects, and the recurrent

cost implications. • Develop accounting and recording procedures capable of following the flow of the

money. • Strengthen reporting mechanisms on the implementation of donor projects. • Further align annual budget allocations with MPRS activities.

In budget execution:

• Formulate a program to clear backlog of arrears. • Expand use of PETS tracking surveys. • Reconcile all bank accounts for the below the line expenditures and bring them above

the line. In budget reporting:

• Pursue development and implementation of IFMIS. • Strengthen capacity of NAO.

In public procurement:

• Make fully operational the cadre of public procurement professionals • Implement new and comprehensive training programs for procurement staff

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I. INTRODUCTION In the context of the Enhanced HIPC Initiative, the IMF and the World Bank initiated the so-called ‘HIPC Assessments and Action Plans (AAP).’ Each assessment evaluates the existing Public Expenditure Management (PEM) system against a selected number of performance indicators, in order to determine countries’ capacity for tracking public spending with a particular focus on pro-poor spending. Following initial desk assessments, a first round of field assessments in close collaboration with the respective governments was carried out in 2001 in 24 countries that received support under the Enhanced HIPC Initiative. On the basis of these assessments, action plans were developed aimed at addressing the shortcomings in the area of public finance. The initial HIPC AAP for Malawi was finalized in November 2001. This report presents the findings of the 2004 second round of the AAP process aimed at conducting a comprehensive reassessment of the PEM system. This comparative review is designed to update the findings of the initial evaluation and to assess progress in improving PEM including tracking of poverty related expenditures.1 Substantial work has been made in assessing the status of PEM systems in Malawi since the 2001 AAP report. A Country Financial Accountability Assessment (CFAA) has been prepared by a team of World Bank staff, donor consultants and Government of Malawi officials, and was presented in April 2002. Subsequent to the distribution of the CFAA report, the Government of Malawi and donors jointly agreed that a CFAA action plan was needed that would serve as a comprehensive guide to the government’s activities in strengthening financial accountability. The Canadian International Development Agency (CIDA) and the UK Department for International Development (DFID) agreed to jointly support development of the action plan. The resulting document, the Malawi Financial Accountability Action Plan (MFAAP), flows largely, but not exclusively, from the 2002 CFAA report and the two documents are closely linked. The MFAAP was finalized in early 2003, and approved by Cabinet in May 2004. In January 2004, as part of the implementation of the MFAAP the Government (in collaboration with the UK-DFID) has presented the MTEF Phase II work plan, which identifies a set of activities to strengthen budget preparation, execution and monitoring.

1 It should be noted that the indicators and assessment criteria were refined for this second round of AAPs, taking into account experiences of the 2001 assessments. Hence, there are a few indicators for which the evaluation standards were clarified or adjusted. Still, each assessment is considered a snapshot of the best available information at the time, and thus no 2001 assessment was changed on the basis of additional information obtained since. This approach, however, has the drawback that a change in assessment may be reported, even though country practices have not materially changed; alternatively, an improvement in practices may not be recognized in the formal rating. The narrative to each indicator points out such cases.

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This AAP report draws significantly on the CFAA, the MFAAP, and the MTEF II, updating the information as required, and complementing their analysis in areas which were not explicitly addressed. This AAP report provides an update on the status of existing PEM systems, and a priority action plan to help the government develop a strategy of implementation that can be programmed over the next several years. In addition, the AAP also highlights the importance for the Government to accelerate the implementation of the MFAAP in a more decisive and coordinated manner, and helps to further align the work of the Bank, IMF, government, and other donors behind a common assessment, strategy and action plan. The Malawi 2004 HIPC AAP review has been conducted by the IMF and the World Bank in collaboration with the authorities and the representatives of the EU, UK-DFID and Norway i.e. most of the donors providing BoP support to Malawi. The government has provided substantial input into the HIPC AAP both by facilitating and participating in the main fact-finding mission, and subsequently by clarifying various issues as they arose during the drafting of the report. All donors active in Malawi (JICA, USA, Germany, Canada, UNDP) have been consulted and have provided input into the AAP report. 2 The main work was conducted during a joint IMF / WB / donors mission between April 13 to 21, 2004. The team comprised Antonio Nucifora (World Bank, Economist, Mission Leader), Donald Mphande (World Bank, Senior Financial Management Specialist), Patricia Palale (World Bank, Public Sector Management Specialist), Christiane Roehler (IMF, Fiscal Affairs Department), Tori Hoven (Norwegian Embassy, Country Economist), Jomo Matululu (EU, Macro Economist), and Lindsay Mangham (DfID, Economist). The main counterparts from the Government were Mr Z. Soko, Director, Debt and Aid Division, Ministry of Finance, and Mrs D. Banda, Director, Budget Division, Ministry of Finance. The mission gratefully acknowledges the support and helpful input received from numerous other staff. In the Ministry of Finance, contributors were in particular Mr C. Simwaka (Deputy Director, Budget Planning Section, Budget Division), Mr C. Chiunda (Senior Deputy Budget Director, Budget Division), Mr Chipatso (Deputy Director, Budget Monitoring Section, Budget Division), Mr P. Kampanje (Accountant General), Mr Matanda (Deputy Accountant General), and Ms M. Maganga (Deputy Director, Debt and Aid Division). Key contributors to the review in other government ministries and organizations included Mr. Kalongonda (Auditor General, National Audit office), Mr. Kambalame (General Manager Operations, Reserve Bank of Malawi), Mr. Hassan (Director of Internal Audit,

2 The four members of the CABS-Group (Common Approach to Budget Support) are the EU, UK, Norway, and Sweden, but Sweden is not present in Malawi. AfDB was invited but could not participate.

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Office of the President & Cabinet), Mr. Mhango (Deputy Director of Public Procurement, Department of Public Procurement), Mr. M. Kutengule (Principal Secretary, Ministry of Economic Planning & Development), Mr B. Botolo (Director Monitoring and Evaluation Division, Ministry of Economic Planning & Development), and Mr B. Mtonya (Director, Strategic Planning Division, Ministry of Economic Planning & Development). The AAP report is structured as follows: Section II briefly discusses the use of HIPC resources in Malawi. Sections III, IV and V presents the updated assessment of public expenditure management systems against a high-level set of 16 de minimus performance indicators for budget preparation, execution and monitoring, respectively. For each indicator the report includes a brief narrative that provides the context, detail, and argumentation of the assessment of the current status and the agreed follow up action plan. Section VI presents a brief description of the main ongoing donor activities in support of public expenditure management systems. Section VII presents the summary tables, including a summary indicators table (Table 1); a donor support table, indicating current donor assistance in support of the action plan in any of the 16 core areas (Table 2); an update of the status of actions committed to in the previous AAP (Table 3); and a summary action plan table, indicating short- and medium-term actions planned by the government to redress weaknesses identified in the current assessment (Table 4).

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Box 1. The HIPC AAP Comprehensive Reassessment Cycle 2003-2004 The aim of the HIPC AAP exercise is to carry out an assessment of the quality of the public expenditure management systems in each country and reflect this in the public expenditure management assessment and action plan, and the associated table of 16 key indicators. These assessments will serve three main purposes: • to assess the existing capacity for tracking overall public spending, including poverty-reducing spending; • to create an understanding of risks associated with implementing poverty-reducing spending in, especially,

but not solely, the context of receiving debt relief; and • to clarify what donor and technical assistance should be provided to improve systems for managing poverty-

reducing and other public spending. These assessments and the ensuing action plans will focus on the primary dimensions of PEM performance: • Budget formulation: covering the design of basic budgetary institutions and aspects of the process to prepare

the annual budget; • Budget execution: covering core aspects required to implement the budget; and • Budget reporting: covering in-year, and end-of-year financial statements. This document provides answers to 16 core questions to probe the standard of PEM in a country, and to inform the judgment about the correct assessment for each of 16 key indicators. In each case the requirements for meeting a reasonable performance against the indicator is described as a benchmark. These benchmarks are struck at a level to indicate reasonable, rather than world-leading, practice. Expanded explanations to the benchmarks and the rankings are available upon request and consist of a set of guidelines designed to assist the carrying out these assessments.

Completed assessments generally provide five related outputs: (i) a summary indicators table; (ii) a donor support table, indicating current donor assistance in support of the action plan or in any of the 16 core areas ; (iii) a summary action plan table, indicating short- and medium-term actions planned by the country to redress weaknesses identified in the prior assessment ; (iv) an update of the status of actions committed to in the previous AAP; and (v) a country assessment and action plan narrative that provides additional context, detail, and argumentation supporting the assessment, action plan, and donor support summary tables.

This instrument focuses on public expenditure management in general, with emphasis on poverty reducing spending. The definition of what constitutes poverty-reducing spending is country determined, often through each country’s Poverty Reduction Strategy Paper (PRSP).

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II. HIPC RESOURCES, PRO-POOR EXPENDITURES AND THE MALAWI POVERTY REDUCTION STRATEGY (MPRS)3 HIPC resources and Pro-Poor Expenditure in Malawi Malawi has been granted debt relief under the enhanced HIPC initiative (amounting to about 55% of its debt repayments in NPV terms). The debt relief started with interim debt relief at the decision point in December 2000, and will become irrevocable once Malawi reaches the completion point.4 Under the HIPC initiative, it is presumed that public resources can be redirected from debt service towards increased pro-poor spending. Such priority areas are identified in Malawi’s Poverty Reduction Strategy Paper (PRSP). An interim-PRSP was completed in August 2000, and a full MPRSP in April 2002. In Malawi, HIPC debt relief resources are channeled directly into the government budget, not kept as a separate poverty fund. HIPC debt relief resources allow the government, in the context of the normal budget prioritization process, to increase funding to poverty reducing areas, supplementing domestic revenues. In order to allow monitoring of inflows, it was agreed that HIPC resources would be administered through a separate bank account that initially was not a sub-account of the government main bank account. Further, in order to ensure that these windfall resources would be used well, and more generally high priority pro-poor expenditures would be protected, a small subset of high-priority activities from the interim-MPRSP (since the full MPRSP had not yet been completed) was identified as priority Pro-Poor Expenditures (PPEs), and specifically monitored. Although the use of HIPC resources cannot be directly tracked to PPEs, the total level of annual funding for PPEs was expected to increase by at least as much as the HIPC debt relief provision. The 2001/02 budget was the first budget to include PPEs in its budget plan..5 The PPEs have now become a standard feature of the budget process. In line with government’s efforts to promote transparency and accountability, it was agreed that the funding allocations to PPEs would be published on the Ministry of Finance website (www.finance.malawi.gov.mw/priorityexp.htm). Further, in the event of shortfalls in revenues, funding for PPE expenditures would be protected to ensure uninterrupted service

3 This section draws heavily on the budget documents for fiscal years 2002/03 and 2003/04. 4 In the case of IDA, the interim assistance provided by IDA prior to reaching completion point, will not exceed one third of the total NPV assistance to be provided by IDA as agreed at the decision point. Other creditors have different conditions. 5 A different arrangement was initially pursued during FY 2000/01. Immediately following the approval of the decision point document in December 2000, ministries were invited to propose projects that could be funded from the immediate HIPC resource inflow during the second half of FY2000/01. A set of projects was selected and benefited from this initial round of funding.

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delivery (and hence PPEs are also referred to as Protected Pro-poor Expenditures).6 Table 1 shows the development in PPEs over time. Table 1 – Protected Pro-poor Expenditures Over Time1 Protected Pro-poor Expenditures 1999/2000

Revised 2000/01 Revised

2001/02 Revised

2002/03 Revised

2003/04 Estimate2

Total PPEs (Malawi Kwacha, thousand) 3,823,058 5,063,230 8,661,203 11,134,479 11,875,600Funded by GOM 3,823,058 4,484,430 5,363,703 7,623,949 6,576,000

Funded by HIPC - 578,800 3,297,500 3,510,530 5,300,000

Total PPEs (US dollars, thousand) 73,778 76,864 116,351 127,922 115,638Funded by GOM 73,778 68,078 72,054 87,590 64,031

Funded by HIPC 8,787 44,297 40,332 51,607

Total PPEs as percentage of GDP 4.2 4.5 6.5 7.2 6.8

Source: Government of Malawi, Budget Document N.4, Approved Estimates of Expenditure on Recurrent and Capital Accounts for the Fiscal Year 2003/2004 (Output Based), Table 2, page 4. Note: 1. The government for reporting purposes calculates PPEs funded from GOM resources and from HIPC resources. However, this distinction is not relevant during budget planning or execution, as ministries request only one allocation for PPE activities. 2. Revised to exclude MASAF expenditures (which were included in the original table, but are not part of PPEs). As shown in Table 1, total PPEs increased from MK 3.8 billion in FY 1999/00 to MK 11.1 billion in FY 2002/03, and are budgeted at MK 11.9 billion in FY 2003/04. The level of PPEs during the period has increased in line with the level of HIPC inflows. In fact, the rate of funding for PPEs had been increasing faster than the HIPC inflows up to FY 2002/03, thanks to the increasing level of the government’s own allocation. However, this positive trend was reversed during FY 2003/04. The level of PPEs as a percentage of GDP as been increasing steadily during the four years since the HIPC decision point in December 2000. Both recurrent expenditures, and personnel emoluments are being identified as PPEs. Table 2 shows the breakdown of allocations and funding to individual PPE activities during Fiscal Years 2001/02, 2002/03 and 2003/04.7 It is worth noting that the period was characterized by substantially lower than expected financial inflows from donors, which forced the government to revise budget allocations downwards. However, despite these resource constraints, funding to PPE activities was kept higher than the approved levels in every single year. Actual funding for PPEs was 107 percent of the approved resources in FY 2001/02, 112 percent of approved allocation in FY 2002/038 and approximately at the approved allocation in FY 2003/04. 6 Funding to the PPEs is specifically identified in the written funding instructions to the ministries when they are being informed about their monthly cash allocations, that are authorized and monitored through the government’s payment management system, the Credit Ceiling Authority (CCA) system. However, PPEs cannot be automatically traced in the CCA system because no separate bank accounts are maintained for PPEs. 7 Detailed breakdowns of PPE funding by program and sub-program are available on the government website. 8 The over performance could be explained by the extended Targeted Inputs Program, increased Teachers' Salaries, and further adjustments to allocations on Teachers' Housing. The only PPE activities that were

(continued...)

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Table 2 PPE allocations and funding in FYs 2001/02, 2002/03 and 2003/04 (MK million) 2001/02 2002/03 2003/04

Pillar/Sector/Activity Approved Revised % use Approved Revised % use Approved Revised % use Total Protected Pro-Poor Expenditures 8,163.5 8,727.7 106.9 9966.3 11134.5 111.7% 11,875.6 12,162.7 102.4Pillar 1: Pro-Poor Growth 1649.1 1527.8 92.6% Agriculture 528.6 542.8 102.7% 928.1 897.3 96.7 Agriculture Extension and Small Scale Irrigation 217.3 165.4 76.1 528.6 542.8 102.7% 855.3 824.6 96.4 Research extension and farmertechnology 72.8 72.8 100.0Water 275.0 216.1 92.1% 173.0 143.0 82.7 Rural Water Supplies 77.2 67.8 87.8 75.0 53.7 78.6% 30.2 28.2 93.3 Borehole Construction/Dam 350.0 262.9 75.1 200.0 162.5 71.5% 142.7 114.8 80.4Roads 400.0 320.0 80.0% 200 150 75.0 Rural Feeder Roads 471.4 801.0 169.9 400.0 320.0 80.0% 200 150 75.0Natural Resources 161.3 159.9 99.2% 154.2 128.4 88.4 Small-scale mining 77.5 44.4 57.3 78.3 78.2 99.9% 111.1 92.9 83.7 Small-scale fish farming 82.9 81.7 98.5% 34.1 35.4 103.9Labor 168.1 169.4 100.8% 192.3 198.5 103.2 Technical and Vocational Training 219.6 114.1 52.0 168.1 169.4 100.8% 162.3 168.5 103.8 TEVET 30.0 30.0 100.0Commerce 24.9 24.9 100.0% 137.7 135.8 98.6 Small-scale and Medium Enterprise Promotion 168.9 47.3 28.0 24.9 24.9 100.0% 137.7 135.8 98.6Tourism 91.3 94.7 103.7% 111.8 100.3 89.7 Promotion of tourism 95.3 35.7 37.5 33.6 34.0 101.2% 48.6 42.9 88.2 Conservation & Protection of Wildlife 57.7 60.6 105.2% 63.2 57.4 90.8Pillar 2: Human Capital Development 7866.0 8926.8 113.5% Education 4953.8 5909.8 119.3% 6,197.4 6,695.9 108.0 Primary Education 2,844.9 822.3 28.9 3825.6 4582.6 119.8% 4,301.0 4663.5 108.4 Teaching and Learning Materials 628.9 678.5 107.9 436.3 436.3 100.0% 320.7 577.0 179.9 Teachers' Salaries 1,502.6 2,304.2 153.3 3184.8 3940.7 123.7% 3,691.2 3,815.6 103.4 Secondary Education 831.6 231.5 27.8 667.2 815.2 122.2% 1,489.6 1690.9 113.5 Teaching and Learning Materials 61.9 61.9 100.0% 200.0 424.4 212.2 Teachers' Salaries 319.8 395.8 123.4% 880.9 910.5 103.4 Teacher Training 347.6 130.0 37.4 351.0 372.1 106.0% 313.0 295.6 94.4 Teacher housing 110.0 140.0 127.3% 93.8 45.9 48.9Health 2767.9 2865.1 103.5% 3,064.6 2995.1 97.7 Preventive Health Care 1,068.0 652.8 61.1 856.8 869.9 101.5% 693.3 709.4 102.3 Curative Health Care 24.3 21.1 86.8 24.3 24.4 100.8% 870.7 906.7 104.1 Infrastructure development, and maintenance 1,105.7 662.7 59.9 567.7 568.1 100.1% 102.4 104.8 102.3 Health Workers' Training 150.0 125.0 83.3 317.2 317.2 100.0% 141.3 148.8 105.3 Drugs 1,108.5 794.0 71.6 1002.0 1085.5 108.3% 1.207 1077.4 89.2 Health Workers Salaries 807.4 839.1 103.9 Health technical services 22..8 21.9 96.0 Clinical and population services 26..8 26.1 97.4Gender, Comm. Services, Sports and Culture 144.3 151.8 105.2% 139.9 141.0 100.6 Family Welfare Services 18.8 11.3 60.1 61.3 63.9 104.2% 51.8 47.3 91.4 Children Services 11.7 6.6 56.4 9.2 9.5 103.4% 9.9 9.9 100.1 Adult Literacy Education 74.1 59.7 80.6 73.8 78.5 106.3% 55..2 55.3 100.2 Youth, sports and culture 23.1 28.5 123.5Pillar 3: Improving Life of the Most Vulnerable 100.0 323.0 323.0% Agriculture 100.0 323.0 323.0% Targeted Inputs Program 160.0 196.0 122.5 100.0 323.0 323.0% 151.5 134.9 89.1Pillar 4: Good Governance 351.3 356.9 101.6% Police 351.3 356.9 101.6% 434.0 442.6 102.0 Community Policing 12.3 2.8 22.8 219.5 223.2 101.7% 185.4 175.3 94.6 Police Officer Training 131.8 133.7 101.5% 103.4 108.2 104.6 Crime and investigation prevention 145.1 159.0 109.6Cross Cutting Gender Mainstreaming 64.3 44.2 68.7

Source: PPE tables on Ministry of Finance website: http://www.finance.malawi.gov.mw/priorityexp.htm

partially funded were Rural Water Supplies, Borehole construction and Dams and Rural Feeder Roads. The Government's commitment to fund PPEs fully remained constant in spite of the tight fiscal position faced throughout the year.

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Note: Some activities appear to have been allocated funds only in FY 2003/04. However, the same activities might have had allocations in previous years, only they were not classified as PPE-activities.

Links between the budget and the MPRSP As mentioned above, the PPEs are only a partial set of high-priority expenditures dedicated toward poverty reduction. The overall priorities of government policies are laid out in the MPRSP, which should provide the comprehensive basis for the government annual budget. The MPRS identifies four pillars that form the main strategic components of a coherent framework for poverty reduction:

1. Sustainable Pro-Poor Economic Growth – economically empowering the poor by ensuring macroeconomic stability, access to credit and markets, skills development and employment generation. 2. Human Capital Development – ensuring the poor have the health status and education to lift themselves out of poverty. 3. Improving the Quality of Life for the Most Vulnerable – providing sustainable safety nets for those who are unable to benefit from the first two pillars. 4. Good Governance – ensuring that public and civil society institutions and systems protect and benefit the poor.

In addition, there are four issues that cut across these pillars: HIV/AIDS, Gender, Environment, and Science and Technology. Ultimately, it is expected that government implements only the MPRSP which also provides a resource envelope for essential statehood activities of the government. The MPRSP contains a costed and prioritized action plan matrix, which forms the basis for preparing each Ministry’s budget estimates. The matrix was designed to match Government’s resource constraints, and reflects a consensus on Malawi’s priorities that has been built through a highly participatory process and reference to ongoing programs. The full implementation of the MPRSP will require a restructuring of government to focus on delivering MPRSP activities. In particular, human resources will have to be reassigned to priority activities and ultimately ministries and departments implementing non-MPRSP activities should be phased out. Efforts to link the MPRSP to the budget are the first stages in a process that will take several years. In principle, the budgeting under a strategic framework like the MPRSP should be output oriented, but there is currently limited capacity at the line ministry level to produce MPRSP and output-based budget estimates. At present the output based estimates largely cover only Other Recurrent Transactions (ORT), rather than Personal Emoluments (PE) and the Development Budget, but additional steps are being taken. The authorities are in the process of reviving the Public Sector Investment Programme (PSIP) to improve prioritization in the development budget; the PSIP is to be guided by the MPRSP. The authorities also have

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developed a separate growth strategy that is meant to operationalize the growth objective (pillar 1) of the MPRSP. The government has taken first steps toward that objective. Starting with the 2002/03 budget (the first to implement the finalized MPRSP) the key principle employed in budget preparation has been to provide adequate resources to priority activities in the MPRSP and to scale down or stop completely implementation of low priority activities. In preparing their budget estimates, each Ministry and Department was instructed to use the MPRSP as a guiding framework and was requested to link each of its planned activities to an MPRSP activity using a six-digit code. This has enabled an estimate of the proportion of each Ministry and Department’s Other Recurrent Transaction (ORT) budget that is allocated to MPRSP activities for each of the four MPRSP Pillars. Table 3 presents a summary of this information for the 2002/03 budget. Unfortunately this calculation has not been carried out for fiscal year 2003/04. As shown in Table 3, about 72 percent of total ORT in FY 2002/03 was allocated to MPRSP activities (including 8 percent allocated to Statehood Activities), leaving about 28 percent to activities outside the MPRSP. Thus a significant share of the budget for ORT expenditures supports the implementation of the MPRSP.9 In future years, the government intends to further align the Budget with the MPRSP, by continuing to phase out non-MPRSP activities and implementing only new activities which are included in the MPRSP.10 Table 3 The allocation of FY 2002/03 budget by MPRSP Pillar (ORT Only)

MK as % total voted ORT

as % allocation to MPRSP activities

Total Voted ORT 15,078.50 Total MPRSP Activities 9,569.44 63.5% Pillar 1 3,141.94 20.8% 32.8% Pillar 2 5,081.76 33.7% 53.1% Pillar 3 119.97 0.8% 1.3% Pillar 4 1,116.93 7.4% 11.7% Cross-Cutting 66.57 0.4% 0.7% Implementation and Monitoring 42.26 0.3% 0.4% Statehood Activities 1,218.94 8.1% Other (Outside MPRSP) 4,290.12 28.5%

Source: Government of Malawi, Budget Document N.4, Approved Estimates of Expenditure on Recurrent and Capital Accounts for the Fiscal Year 2002/2003 (Output Based), Table 3, page 5.

9 Unfortunately the analysis only covers ORT expenditures. It is expected that in future years the analysis will cover all expenditures, including personal emoluments and the development budget. 10 See: Government of Malawi (2002), Approved Estimates of Expenditure on Recurrent and Capital Accounts for the Financial Year 2002/2003 (Output Based), Budget Document N.4, Page 4.

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In terms of the allocation between the four Pillars of the MPRSP, the budgetary allocations are in line with the MPRSP shares, with Pillar 2 receiving the biggest share (53 percent in the MPRSP against 52 percent in the budget), followed by Pillar 1 (33 percent in the MPRSP against 34 percent in the budget) and Pillar 4 (12 percent in the MPRSP against 12 percent in the Budget). Decentralization and the involvement of different levels of government Malawi has two tiers of elected government: the central government and local assemblies at the district level (a total of 31 districts). To date, the level of involvement of local government has been low. The present policy is that 5 percent of domestic revenues should be passed directly to local government as unconditional grants. The actual amount has been increasing from less than 1 percent in 2001/02 (the first year of activity of local assemblies) to about 1.6 percent in the current fiscal year 2003/04. However, Malawi is planning to decentralize major policy responsibilities to local government, and to increase the participation of lower levels of government in delivering poverty-related spending. The Ministry of Agriculture has undertaken to decentralize ORT funding for extension services to local assemblies, and the decentralization of ORT funding for health facilities and for primary education to local assemblies is planned soon. These three activities represent over 10 percent of the revenues. Plans for further decentralization in other areas are also fairly advanced. Over the next few year, therefore, financial information and reporting basis for the lower level of government is a significant issue. Currently, district assemblies prepare their budgets and accounts in a standardized classification, which however differs from the one used by central government. An interface between the two systems is planned. The plans are to require classification on the same basis as the central government. The Ministry of Local Government currently receives quarterly and monthly reports on the use of financial resources by the district assemblies, although compliance falls short of perfect. While the share of general government executed at the local level is expected to increase over the next years, this report deals with central government spending only. This seems justified, as own revenue of local government likely will remain small, and there do not seem be plans to reassign tax revenues. Hence, the majority of local level resources will be provided through transfers from the central government, allowing at least some basic monitoring from central government records.

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III. BUDGET FORMULATION Indicator 1~ Coverage of the budget or fiscal reporting entity Target: Fiscal reporting covers the Government Finance Statistics definition of the general government sector, i.e., including central, regional, and local governments, and all government operations, whether funded through the budget or not. Assessment: There are considerable differences from GFS definition. Aggregate government fiscal reports focus on the central government budget sector and do not include local government (district assemblies). They also do not include the own accounts of autonomous government agencies like the Malawi Revenue Authorities, National Food Reserve Agency, National Road Fund, and subvented organizations like universities. Only the transfers to these agencies appear in the budget and fiscal reports. Similarly, the operations of treasury funds are only reflected in the budget appropriations that government agencies use to purchase services from agencies like Central Medical Stores. Even though no consolidated statements for general government are being prepared, the financial statements of many general government agencies are available at a central level. The district assemblies are required to submit their budgets and financial statements to the National Local Government Finance Committee which is charged with supporting financial management of local governments. Autonomous government agencies are expected to prepare their own budgets and submit budgets and final accounts to parliament. The government final accounts include a number of separate statements on autonomous government agencies, and treasury funds. Action plan: Expand the coverage of fiscal reports and prepare consolidated general government statements, both for ex ante fiscal plans in conjunction with the budget presentation, and for ex post reporting in conjunction with the final accounts. In particular:

Include financial position or detailed accounts of autonomous central government agencies and treasury funds;

Include the accounts of local government agencies including reporting on pro-poor expenditure, especially after the devolution of functions to district assemblies becomes effective.

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Indicator 2 ~ Degree of spending being funded by extrabudgetary sources Target: Government activities are not funded through extrabudgetary sources to a significant degree. Assessment: Government activities funded through extrabudgetary sources are deemed to be not significant. However, the share of spending is difficult to assess. Ministries are expected to remit all revenues and fees to the central treasury, but central monitoring and auditing of revenue collection is weak and some agencies may not report their revenue.11 Ministries at times may also obtain additional resources by overdrawing miscellaneous deposit accounts; the 2002/03 Final Accounts, Statement 11 show that a number of such accounts have a negative balance. The levies collected by the Petroleum Control Commission on oil products are included in overall fiscal reporting, including those levies that are earmarked for the National Road Agency (NRA). Own revenues of other autonomous agencies (e.g. university fees) and of district assemblies (fees and charges) are not included in fiscal reporting. The civil service pension scheme is funded from the budget (pay-as-you-go). The government operates more than 30 treasury funds as revolving funds12. It seems that many are primarily funded from general budget allocation for procurement (like Central Medical Stores, Central General Stores, Government Press Fund), others may have revenues from fees from their activities (Tourism Marketing Fund), while others appear to have been funded by donors (Transportation and Aviation Japanese Counterpart Fund). Treasury funds account for their operations according to commercial accounting principles, and statements for some of these funds are annexed to the final accounts. Tax expenditures appear to be small. The Malawi Revenue Authority (MRA) remits gross tax collections to the treasury. The MRA’s operating expenses are funded by a 2.5 percent share of gross tax collections which is transferred by standing instructions from the main government account, and the MRA also receives dedicated funding for tax refunds. In the past, tariff exemptions were quite common, and the Minister of Finance had significant discretion over granting such exemptions. In 2003 all special tariff exemptions were repealed, and under the IMF PRGF the authorities committed not to grant new exemptions.

11 For example, the final accounts 2002/03 show some revenue lines for which revenue collections were budgeted, but for which no actuals are reported. 12 Treasury funds (TF) are: Plant and Vehicle Hire Organization (PVHO) TF, Government Press Fund, Government Printer Advances, Malawi Social Action Fund (MASAF II), Smallholder Macademia Development Project, Horticulture and Food Crops Development Project, Central Medical Stores, Central Government Stores, Borehole Construction (Agriculture), Rural Electrification Fund (Forestry), Public Land Development TF, Lands TF, Lands and Valuation, Local Government TF, Government Hostels, Prison Reward Fund, Japanese Counterpart Fund (Transportation and Aviation), Tourism Marketing Fund, Gender and Community TF, Police TF, Ex-CCCD TF, UNDP Housing Fund, National Parks Fund, Salima ADD Cultivation Assistance Fund, Rural Housing Project Fund, Scholarship Fund, National Disaster Fund, Secondary Development Centers Program Fund, Fisheries Training Project Fund, Civil Service Housing Fund, Energy Fund.

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A significant share of donor project grants is not included in the budget or accounts (see indicator 4). Action Plan:

Expand coverage of fiscal reports (see indicator 1). Strengthen enforcement of public finance management regulations, and internal

controls (see indicator 9).

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Indicator 3 ~ Reliability of budget as a guide to future Target: Budget outturn data are quite close to the original budget. Assessment: Budget outturn data are not close to the original budget. Budget outturns in recent years have differed considerably from the original budget, both in level and composition (Tables 4 and 5).13 Actual expenditures have differed from the original budget estimates by 2-3 percent of GDP on average, or 6-9 percent of expenditures. In 2003/04 expenditures exceeded the original budget by nearly 11 percent of GDP, of which only about 5 percent can be attributed to higher interest payments. The aggregate variation is the result of regular under-spending of the development budget including because of cuts to the domestically financed component, and overshooting of the recurrent budget. Most of the difference in the recurrent budget is associated with higher than anticipated interest payments on debt, but variations in discretionary recurrent expenditures are also quite large. Variations at the aggregate level are on average plus or minus 10 percent, and changes to the allocations of individual agencies are even more steep: more than half of public institutions regularly receive either 10 percent more or 10 percent less than originally programmed, and it is not uncommon for institutions to receive 30 percent more or less than originally anticipated. The main net beneficiaries have been the Office of the President, the State Residences, the Police, the Ministry of Defense, and the Ministry of Foreign Affairs. Reasons for these variations are manifold. In some years, the government has implemented unanticipated policies like increases in civil service allowances (housing allowances in 2001/02, and other ad hoc wage adjustments), and increased expenditures for special activities and subventions. Almost every year there has been an unexpected crisis with costly fiscal policy responses, like unanticipated parastatal debt, arrears, or a natural disaster such as drought or floods. Recent examples include the purchase of maize in 2002/03 in the amount of approximately 4 percent of GDP, or in 2000-2001 unbudgeted transfers to the NFRA of 1.6 percent of GDP and the assumption of ADMARC debt of 1.6 percent of GDP. However, the budget only includes small contingency allowances. In addition, some of these changes reflect weak expenditure monitoring and control. For example, in 2001/02 according to the Auditor General’s statement, 13 out of 47 votes overspent relative to their revised budget allocation. Variations to the budget plan also result from repeated attempts to achieve within-year reductions of expenditures (both by administrative means, and through a supplementary budget), to contain the increase in domestic debt. Reasons for this increase include the new policies mentioned above, delays in expected budget support from donors, and a rapid

13 Domestically funded non-interest expenditure range from about 18 percent in 1999/2000 to about 27.2 percent in 2002/03 (including 4.9 percent of GDP for maize purchases and associated interest costs).

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increase in the domestic interest bill (from 2.3 percent of GDP in 1999/00 to 9.5 percent of GDP in 2003/04 according to the preliminary outturn). The steep annual increases in the interest bill were usually not correctly foreseen at the time of budget preparation. Table 4: Variability of budget outturn with respect to original budget , 1993/94 - 2001/02.

1993/94 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01 2001/02 2002/03 %Variance on Expenditure 18.2 44.8 15.2 17 1.6 18.8 34.8 16.4 11.8 11.2

% Variance on Statutory Expenditures 46.9 66.2 151.2 54.2 6.2 61.1 124.4 28.1 15.2 8.3

% Variance on Votes 30.4 73.8 19.3 1.9 5.5 1.9 9 9.5 2.8 0.2

Sum of Vote Excesses as % Original Budget 18.4 80.5 11.2 10.6 10.1 6.9 12.9 16.7 11.2 34.0

Sum of Vote Cuts as % Original Budget -48.9 -6.7 -30.6 -12.5 -4.6 -8.8 -4 -26.2 -8.3 42.6

% Votes less than 90% of budget 7.7 12.2 50 44.2 36 22.9 4.4 13.3 34.0 13.0

% Votes greater than 110% of budget 56.4 70.7 22 30.8 20 35.4 53.3 51.1 42.6 6.5

Source: Fozzard et al.(2002), ODI Working Paper N.166; updated by staff. Table 5: Deviations of expenditure outturns from budget (as percentage of GDP), 1993/94 - 2001/02

1999/00 1999/00 Discrepancy 2000/01 2000/01 Discrepancy 2001/02 2001/02 Discrepancy

Approved Actual (as % of Approved) Approved Actual (as % of

Approved) Approved estimate (as % of Approved)

RECURRENT EXPENDITURES General Administration 6.0 4.1 -31.2 9.6 11.3 18.0 7.2 7.4 3.4 Social Services 6.3 6.3 0.0 5.8 6.2 6.9 8.6 6.1 -28.9 Of which: Education 2.6 2.8 8.3 2.6 2.8 6.2 3.0 3.6 21.3 Health 1.6 1.6 -4.7 1.6 2.0 26.5 2.3 2.1 -8.7 Social Security and Welfare Services 1.8 1.7 -3.7 1.5 1.3 -13.1 3.0 0.2 -93.0 Community and Social Development* 0.3 0.2 -22.4 0.2 0.2 11.8 0.3 0.2 -34.6 Economic Services 1.7 1.2 -26.3 1.3 1.3 -1.1 1.8 2.0 8.4 Total Discretionary Expenditures 14.0 11.7 -16.6 16.7 18.8 12.7 17.6 15.5 -11.9 Unallocable Services** 1.8 3.5 93.1 1.0 3.8 296.0 4.7 7.0 48.4 Total Recurrent expenditure 15.8 15.2 -3.8 17.7 22.6 28.0 22.3 22.5 0.8 DEVELOPMENT EXPENDITURES Total Development Expenditure 9.3 10.1 8.2 11.2 10.3 -8.7 9.5 7.3 -22.6

TOTAL EXPENDITURES (as % of GDP) 25.1 25.3 0.6 28.9 32.8 13.7 31.7 29.8 -6.2

GDP at current market prices (million MK) 91639 91639 109060 109060 144515 144515

* Includes Housing and Community Amenity Services; Recreational, Cultural and Other Social Services; and Broadcasting and Publishing Services ** Public debt service, pensions and gratuities, and other statutory expenditures

Source: World Bank calculations based on official data. Attempted expenditure reductions focused on non-priority expenditures, while pro-poor expenditures remained protected, or even were increased. However, changes to the expenditure program were not always fully implemented, leading to a second or third round of budget adjustments. The domestically funded development budget was cut by 25 percent for 3 of the last 4 years. It should be noted that an exact analysis of the budget outturn is hampered by the weak fiscal data. Within-year monitoring of expenditures is based on funding information from treasury (i.e. authorized cash releases). Not all cash releases are spent immediately, but these cash

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releases are the legal upper limit on commitments and expenditures. However, ministries keep incurring arrears (while they also clear some arrears), providing some indication that ministries incur commitments in excess of cash releases. In contrast, within-year expenditure returns from ministries show significantly lower expenditures than authorized funding even at times of very low cash releases, casting doubt on the comprehensiveness of these returns. Similarly, because the final accounts are based on expenditure records from the ministries, total expenditures reported in the final accounts may be understated. For example, the draft 2002/03 final accounts report no actual expenditures for some items even though their revised budget allocation was increased. The wide variance on recurrent expenditures renders the budget irrelevant as a guide to resource availability during budget execution, resulting in a weakened budget planning process, and attempts by ministries to retain control over resources (like donor funded projects, and self-generated revenues). This reduces ministries’ incentives to prepare realistic budgets, and the Ministry of Finance is not always able to verify the feasibility of the proposed expenditure reductions or implement supporting policy changes. For instance, the 2002/03 wage bill for education was budgeted at around MK300 million per month while the payroll in previous months had been approximately MK380 million, leading to over-expenditures of MK80 million. Similarly, the 2002/03 budget for utilities by individual line ministries were only about 70 percent to 80 percent of actual expenditures during the previous year and no actions were planned to enforce the budgeted reductions in these expenditures. Action plan: Short-term

Strengthen budget planning: Design and implement an improved budget-planning calendar; Include all foreseeable and required expenditures in the budget Prepare a detailed financing plan for both foreign and domestic resources, identify

the use of any financing resources linked to particular expenditures in the current budget, and carefully project interest costs

Identify non-priority expenditures whose implementation begins later in the fiscal and which could be further delayed if financing constraints force expenditure reductions.

Strengthen budget monitoring and reporting (see indicator 12). Continue and deepen the dialogue with donors on available financing.

Medium-term

Review major areas of fiscal policy and expenditures, e.g. through a public expenditure review, to help align spending with available resources.

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Indicator 4 ~ Inclusion of donor funds Target: Budgets at all levels of government include, without exception, grants projected to be provided by donors, and the capital and current expenditure of all multilateral and bilaterals. Assessment: Fiscal reports include a fraction of donor grants. The central government budget only includes a fraction of donor sponsored projects funded by grants and executed by government agencies. According to anecdotal estimates, 50 to 70 percent of such projects may be excluded. Grant-funded projects are typically included in the budget when domestic counterpart funds are required. It is understood that loan funded projects are included in the budget. Donor-funded projects are shown in the development budget part I. While the development budget is viewed as being the capital budget, it is believed that many donor-funded projects include a recurrent cost component (such as drug purchases and project operating costs). Reporting on donor funded projects is based mainly on information by the Debt and Aid Unit in the MoF, which is charged with monitoring foreign inflows. The Debt and Aid Unit, however, reports mainly on disbursements from multilateral organizations, and has only partial information on bilateral donors. The monitoring also does not properly account for timing differences in disbursements of loans or grants and the actual expenditures. Information from ministries or project managers is weak, even though many bank accounts for projects are managed directly by the implementing agency. Statement 19 of the final accounts on loans and grants is not being published. Efforts are being made to improve the coordination of donor development projects in the budget, but there appear to be no clear strategy to bring these projects into the budget. The Ministry of Economic Planning and Development has restarted the Public Sector Investment Program (PSIP) process and is in the process of putting together a comprehensive database of all projects. There is a need to reconcile this effort with the existing database being assembled in the Ministry of Finance, Debt and Aid Division, with support from CIDA. The PSIP process envisages a prioritization of development projects in line with MPRS priorities, and presupposes that the individual ministries will only seek funding for the agreed upon priorities. As yet there exists is no established provision to link the PSIP into the budget preparation process although the Government intention is to closely link the two processes. Action plan: Short term

Maintain / update a comprehensive list of all donor projects, ongoing and under preparation (CIDA-supported Database).

Develop estimates of disbursements by year, and required counterpart funding.

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Define a strategy to bring all the donor development projects into the budget. A task force could be set up with the purpose to develop clear instructions and operating procedures, and to discuss these with donors.

Medium term

Develop further the use of a PSIP that is clearly integrated with the MPRSP, and improve its linkage with budget preparation.

In conjunction with medium term planning, prepare a medium-term plan for the implementation of donor projects, and the recurrent cost implications of the projects.

Develop accounting and recording procedures that are capable of following the flow of the money from initial disbursement to final expenditure.

Strengthen reporting mechanisms on the implementation of donor sponsored projects, both by requesting donors to submit information on a quarterly basis (to account for differences in fiscal years), and by strengthening reporting from project managers and ministries.

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Indicator 5 ~ Classification Target: Budget expenditures are classified on an administrative, economic, and detailed functional or programmatic basis. Assessment: Malawi’s budget expenditures are classified on an administrative, economic, and detailed programmatic basis, but not on a functional basis. The detailed program classification allows mapping into functions. There was no change in the main classification structure in budget documents and for budget execution since 2001. An activities-based classification has been added to the budget documents since 2001/02. Malawi’s detailed budget classification is structured as show below. This structure is also used for maintaining the accounts, reporting expenditures, and presenting the final accounts. Depart- Budget Cost Sub- Sub- Sector Ministry ment Type Center Program program Donor Project Item Item

2 340 1 1 01 02 02 00 000 24 07

Budget type refers to either the recurrent or the development budget. Items and sub-items reflect the economic classification. With the 2003/04 fiscal year, the structure of programs was standardized across all ministries, and now a total of 48 programs are being used. All program definitions are now related to objectives and service delivery. The standardization will also facilitate budget analysis, and the implementation of an Integrated Financial Management Information System (IFMIS). In addition to this detailed classification, since 2001/02 the budget is presented in an output oriented breakdown by ministry and activities. For the recurrent budget, activities are classified under programs, but do not necessarily align with subprograms, and hence constitute a parallel breakdown. The development budget essentially is presented by project (which are subordinated to sub-programs), occasionally with additional descriptors about outputs or activities. Hence, bridging between sub-programs and activities is not possible, and the impact of the activities’ classification in budget execution presumably is small. The budget document also provides information on the share of expenditures for each ministry that are in support of each of the four pillars of the MPRSP, the four cross-cutting issues of the MPRSP, and the decentralization strategy. However, in the 2003/04 budget identification of activities in support of the MPRSP was only carried out for some votes. Action plan:

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Further develop the classification system to ensure that each transaction can be classified and recorded according to all relevant criteria, including activities that are pro-poor and/ or in support of the MPRSP. In the short term an alignment of activities with subprograms (which have already been reformulated with objectives in mind) seems the quickest way forward. Alternatively, or at a later stage, the classification structure could be expanded.

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Indicator 6 ~ Identification of poverty-reducing spending Target: Poverty-reducing expenditures are clearly identified in the budget.

Assessment: Poverty-reducing spending is clearly identified in the budget using the existing budgetary classification system. The quality of the classification system clearly supports the identification of poverty-related expenditures. Protected Pro-Poor Expenditures (PPEs) are shown as an integral component of the central government budget. In the budget, funding for these activities is clearly identified in the output-oriented activities-based presentation for each vote and by economic classification. However, PPEs cannot be identified directly in the main program / sub-program classification of the budget, which is the classification in which budget execution is monitored. During the last two years the budget document has included a summary table on planned levels of funding for protected Pro-Poor Expenditures (amounting to some 7 percent of GDP—Table 2 above shows detailed PPE allocations by activities during FY 2001/02, 2002/03 and 2003/04). In the event of a shortfall in resources available to the budget, these expenditures are protected from ensuing expenditure cuts. The Ministry of Finance reports funding released to ministries for PPEs on a quarterly basis. These reports are posted on the Ministry of Finance website: http://www.finance.malawi.gov.mw/priorityexp.htm Ministries or departments are instructed on the portion of their funding intended for PPEs and are expected not to divert these resources to other non-priority areas. However, monitoring of PPEs in the budget execution process currently would only be possible through supplementary reports by ministries, not through the normal budget monitoring and reporting mechanisms. First, funding ceiling through the Credit Ceiling Authority system (CCA – see indicator 9) are issued as combined totals for PPEs and non-PPEs. Second, actual expenditures are reported by subprogram, which does not allow the tracking of expenditures at the activity level (see indicator 13). Thus at present there is no process to ensure that the allocated resources are being used for the poverty reducing activities. Action Plan:

Further develop the classification system to ensure that each transaction can be classified and recorded according to all relevant criteria. Preferably (because easier in the short-term), all PPEs should be classified as programs and sub-programs. Alternatively, as some PPEs are defined by activity, there is a need for the classification system to identify these expenditures throughout the budget process.

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Indicator 7 ~ Integration of medium-term forecasts Target: Multi-year expenditure projections are integrated into the budget formulation process. Assessment: Multiyear projections exist, but are not integrated into the budget formulation cycle. Malawi has attempted to introduce the Medium Term Expenditure Framework (MTEF) since 1995. However, so far, the links between the framework and the annual budget have not worked well, however. The framework has not been used as a rolling three year plan, instead each year the exercise begins anew. Yearly expenditure ceilings indicated in the annual Budget Instructions—“the call circular”— are determined on the basis of actual expenditures from previous years (and projections for the current fiscal year), and do not rely on MTEF projections. The latter are updated at the time of budget presentation, but are deemed unreliable and are not further used for fiscal policy decisions. The MTEF in 1995 was introduced as a budget formulation tool to link strategic objectives to the budget over a medium term planning horizon. Further, it was to bring the development expenditure of the Public Sector Investment Program (PSIP) and the recurrent expenditure budget together into a comprehensive budget framework. The MTEF was to change budgeting from a centralized inventory of inputs adjusted annually on an incremental basis, to an output focused approach based on priorities developed from long term strategic planning. In 1999/2000 the Government of Malawi (GOM) conducted a comprehensive review which concluded that the budget was not operating as an authoritative and credible fiscal management tool. The early indications were that the MTEF program was too narrowly focused on budget formulation and that critical weaknesses elsewhere were undermining its implementation. While there was substantial progress to develop a viable MTEF budget formulation process, this progress was slowed by: weak capacity to drive the reform forward; insufficient technical capacity for realistic revenue and expenditure forecasting; lack of hard budget expenditure ceilings, with lax controls over expenditure commitments; and continued attempts to pursue programs and expenditure patterns which, in aggregate, were unaffordable. In spite of the difficulties experienced in its implementation, there has been recognition that the original objectives of the MTEF plan remained critical. Therefore the Government has been working toward the development of a Phase II for the MTEF and a work plan was presented to development partners in 2004. The document recognizes that planned budgets and actual outturns have deviated significantly for the last few years (see indicator 3) and that systemic weaknesses of the budget cycle (both budget planning and budget execution) also undermine the MTEF. The MTEF II Framework document represents a coordinating framework for donor assistance to strengthen the annual budget process. Eliminating the weaknesses in the execution of the annual budget should eventually make it possible to

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develop meaningful medium term projections. DFID and CIDA have agreed in principle to support the implementation of Phase II. There are two other sources of multi-year projections in Malawi, the MPRSP and the PSIP, but neither of these projections are being used at present. Multi-year projections are included as part of the Malawi PRSP (approved in April 2002), which includes medium-term expenditure forecasts for each activity. However, the budgets for 2002/03 and 2003/04 have not resembled the MPRSP forecasts, and the latter seem to have become obsolete. Similarly, the Public Sector Investment Program (PSIP), which had been dormant since 1997, has recently been restarted with the aim of progressively aligning the development projects with MPRS priorities (see indicator 5). At this stage, however, the PSIP is limited to prioritization of project in line with MPRS objectives, and does not yet attempt to deal with the financing side of development projects. Action Plan:

Strengthen the preparation and execution of the annual budget as a prerequisite for the use of meaningful medium term projections.

Develop further the use of the PSIP, integrating it fully into budget preparation and the prioritization of expenditures within the resource constraint.

Further align annual budget allocations with MPRS activities.

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IV. BUDGET EXECUTION

Indicator 8 ~ Evidence of budget execution problems – Arrears Target: Small stock of expenditure arrears, with little accumulation of arrears over the previous year.

Assessment: Domestic arrears identified by a special external audit of 9 ministries and the pension system amount to about ¾ percent of GDP or 1.7 percent of 2003/04 expenditure, more than 3 times the previous estimate. The audit is expected to continue and cover the whole government.14

Regular government estimates on arrears are based on reports from the Commitment Control System and certified by the Auditor General. These official estimates put the stock of arrears in June 2003 at about MK400m, which corresponds to about 0.25 percent of GDP, or less than 1 percent of total expenditures. Total outstanding bills were reported to be only slightly higher at less than MK500 million. However, payments effected in fiscal year 2003/04 cast doubt on this estimate of the total stock of outstanding bills. More than MK1.8 billion has been paid for obligations incurred before June 2003, including more than 1.2 billion for utility arrears. As arrears have been a recurrent issue, the government initiated a comprehensive audit of arrears, which was started in January 2004.15 This audit is conducted by KPMG under the auspices of the Auditor General, and supported by donor funding. Due to time and resource constraints, the first phase of the audit focused on nine ministries that represented about 85 percent of the previously reported arrears. In addition, the civil service pension system that is administered by the Ministry of Finance was audited. Preliminary estimates by KPMG of identified but not verified arrears (as of December 2003) for these ministries were 1.3 billion or ¾ percent of GDP. It is possible, that since the audit, some arrears may have been cleared, although it cannot be excluded that other bills became overdue at the same time. The authorities are in the process of securing additional funding to complete the audit for the whole government in about 6 months. The recent information suggests that the stock of arrears is significantly larger than indicated in official estimates. It is plausible to assume that official data underestimated the extent of arrears already at the time of the 2001 HIPC AAP. Therefore it is unclear that the arrears 14 KPMG has undertaken an audit of arrears in 9 ministries. The estimates of arrears reported in the assessment were provided to the IMF in August, but the report was not yet available in early September. 15 The use of an external auditor for a comprehensive audit of arrears was already contemplated in mid-2002 (see the Malawi Government’s Memorandum of Economic and Financial Policies of July 19, 2002)

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situation has improved or worsened since the 2001 assessment. Either way the rating for this indicator has been adjusted to reflect the new information available. The government recognizes that the extent of this problem is larger than previously thought and is taking steps to verify and clear the backlog of arrears. During the last few years the government has already taken a few measures to try to prevent arrears. A Commitment Control System (CCS) was introduced, that required ministries to initiate recording their obligations at the point in time when the obligation was incurred (e.g. at issuance of a contract), not only when an invoice was received. However, the Commitment Control System has so far operated imperfectly and the understanding of operating the system varies from ministry to ministry. The CCS system also requires ministries to report on arrears to the Ministry of Finance. As arrears to utility companies are one of the major sources of arrears, in June 2002 the government decided to centralize the payments for the key utility bills (water, telephone and electricity bills) of the larger ministries and budget entities that have disregarded their payment obligations for these services in the past. The office of Accountant General was put in charge of making direct payments for State Residences, Ministries of Defense, Home Affairs which include Police and Prisons, Health, and Education, and more recently Parliament and the Department of Civil Aviation. Utility companies have also been informed that they may turn off utility services to ministries. These measures seem to have assisted in controlling the accumulation of new arrears for utilities. Action plan: There is a need to prevent the formation of new arrears and to reduce the backlog of existing arrears. Prevention of new arrears requires strengthening budget preparation and control (see indicators 3 and 9). Reducing the stock of existing arrears would be assisted by:

Establish a comprehensive database of arrears, including information on interest and penalties, and verify reported arrears.

Formulate a strategy to clear the backlog of arrears.

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Indicator 9 ~ Effectiveness of the internal control system Target: Internal control is effective.

Assessment: Internal controls are partially effective. Malawi has an overall sound legal and regulatory framework for public expenditure management. In 2003, the legal framework was strengthened by a new Public Finance Management Act, Audit Act, and Public Procurement Act in 2003. Regulations and desk instructions to implement these Acts are being prepared. However, even the old regulations which are currently still applied were sound, but outdated. Malawi also has in place a number of systems and procedures that are designed to ensure proper management of public funds, some of which were only introduced recently. Cash releases from the main Malawi government account are managed through a centralized cash management system. This system is designed to verify that payments are only made up to pre-specified funding ceilings released by the Ministry of Finance, the Credit Ceiling Authority (CCA). This makes it difficult for ministries to authorize payments in excess of overall authorized funding, but virements at the level below the CCA cannot be controlled. The CCA system is implemented through the Reserve Bank of Malawi (RBM) and the commercial banking system. While ministries maintain bank accounts in commercial banks (at least one each for salaries and wages, recurrent expenditures, and domestically funded development expenditures (Part II)), these bank accounts operate on an overdraft arrangement with the RBM. The operating accounts of the ministries are mirrored in a set of holding accounts in the RBM. Usually twice a month, funding ceilings – CCAs – are released from the Ministry of Finance, and communicated to the RBM and ministries, and through the RBM to commercial banks. When a ministry authorizes a payment from its accounts, the bank first checks whether this payment can be accommodated under the CCA limit. If so, the bank makes the payment, and then claims reimbursement from the RBM. Each payment is posted against a holding account, allowing the RBM, too, to verify the observance of the CCAs. Staff in the Ministry of Finance also have access to the information. Malawi has also instituted a Commitment Control System (CCS) that is designed to capture obligations when they arise, not only when payment is requested. Payroll administration is also being strengthened. Salaries for employees of the Ministry of Agriculture, Ministry of Health and Ministry of Education are now paid through smart cards, which identify the owner of the card by biometric features. This makes it more difficult for ghost workers to claim payment. Eventually, most civil servants are to be paid through smart cards. The government has also taken steps to strengthen the internal audit function by establishing an Internal Audit Unit in the Office of the President, which is in the start up phase. A director

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has been appointed, but most of the posts are yet to be filled. Most staff currently employed as internal auditors operate at junior level, and about 10 percent of the workload is taken up by pre-audits. The new system of internal audit is still decentralized to the various ministries, but the central Internal Audit Unit has taken over supervision and direction of the function for both central and local government internal auditors. As the 2003 Public Financial Management Act does not provide a comprehensive legal framework for the internal audit function, a draft audit charter and Internal Audit Law are being developed. A government wide central internal audit committee has been established, tasked with monitoring the level of internal controls and receiving internal audit reports with serious issues. It is expected that each ministry will have an internal audit committee chaired by a controlling officer. Nevertheless, the overall control environment remains weak, and there is less than full compliance with plans, procedures, laws and regulations as stipulated in various guiding documents. Monthly reports from different sources often provide a significantly different picture on the status of budget execution (see indicator 12 on fiscal reporting). There is a lack of consistent records of physical and inventory stock, and the recent establishment of the physical assets management department is an attempt to protect government assets. Government vehicles are already recorded in an assets register by Private Vehicle Hire Organization (PVHO), but information on the number of government vehicles seems elusive. Reasons for the current status includes lack of trained and qualified staff to run the government financial management system, and weak supervision at the ministry level and enforcement of regulations from the Ministry of Finance and the Accountant General. Penalties, which are provided for in public finance legislation, do not seem to be applied. A systematic analysis of error rates in routine financial documents has not been carried out. While internal audit during the last years was not very active, some reports have been prepared which raise issues like the management of drugs, ghost workers, fraud, procurement, or bank reconciliations. Serious issues raised in the internal audit report have been taken up by the Auditor General in the national audit report. However, so far there has been little follow-up on audit reports. The new Director of Internal Audit has prepared a review of recommendations from internal audit reports for the last three years, and has started to follow up with controlling officers if recommendations have not been implemented. A summary of outstanding recommendations has been made, though without correction rates. Action Plan: The following are some of the actions that need to be taken to strengthen the internal audit function:

Formulate an internal audit program, based on perceived risks Approve Internal Audit Charter Follow up on implementation of recommendations Develop an internal audit manual. Formulate government wide plan to protect assets.

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Indicator 10 ~ Tracking surveys are in use Target: Tracking surveys are used, where necessary, to supplement internal control, but may not yet be a regular feature of the PEM system.

Assessment: Tracking surveys have not yet been used in Malawi, but preparations for the first Public Expenditure Tracking Survey are currently underway. 16

Malawi is currently preparing to execute its first Public Expenditure Tracking Survey (PETS) in the education sector. Since this is the first time Malawi embarks on a PETS, a pilot has been undertaken initially in four districts before launching the full scale survey; the fieldwork for the pilot has been completed and the report is under preparation. The authorities have expressed the intention to expand the program of PETS. Following the full survey in the education sector, tentative plans are being discussed to also carry out surveys in the health sector and in agriculture, and possibly other sectors (depending on available resources).

The authorities have a clear understanding of the use of this diagnostic exercise and look forward to the findings. PETS are especially useful in Malawi, since they provide an interim instrument for monitoring budget execution and MPRS implementation (until internal control and audit systems are functioning well). Furthermore, the existing accounting classification does not allow reliable tracking of resource transfers through to service delivery units and through them to the final uses (see indicator 13). Hence, there is a need to scale up the use of PETS to generate accurate and timely information on levels of resource leakage between cost centers and facilities.

Action Plan: Expand the use of public expenditure tracking surveys as an instrument for monitoring budget execution (until internal control and audit systems are functioning well) and MPRS implementation (requires cooperation by the Budget Monitoring Section, Ministry of Finance, and the Monitoring and Evaluation Division, Ministry of Economic Planning and Development).

16 The 2001 HIPC AAP reported that according to the Ministry of Finance and Economic Planning several ministries regularly carry out PETS-type surveys. In the context of preparing the current PETS in the education sector, it became clear that, contrary to what was believed in 2001, line ministries do not regularly carry out PETS-type surveys. The internal ‘expenditure tracking’ exercises conducted occasionally by a few ministries were undertaken with inadequate preparation and cannot be reasonably described as expenditure tracking surveys. As a result, the appropriate rating in the 2001 report would have been “C”, rather than “A”, and Malawi has now improved to “B” in the current review. It is worth noting therefore that the adjustment in the ratings, masks the fact that there has been an improvement since 2001, and the first PETS in Malawi was trialed in 2004.

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Indicator 11 ~ Quality of fiscal information Target: Satisfactory reconciliation of fiscal and banking records is undertaken routinely. Assessment: Substantial progress has been achieved in reducing the backlog of unreconciled accounts, and Malawi is now close to satisfying this indicator. Additional progress is needed in the quality of the reconciliation since significant amounts of transactions remain posted to below the line accounts. Good progress has been made in the last three fiscal years to reduce the backload of bank reconciliation which is estimated to been reduced from 18 months to about 6 months on average. Records on the extent of reconciled accounts are maintained by the Accountant General. The September 2003 reconciliation report indicates that as many as 75 percent of bank accounts (out of a total of approximately 750 accounts) were reconciled by June 2003. In fact, the Accountant General indicates that bank reconciliations are up to date in more than twenty ministries (out of a total of 55), in preparation for change over to Integrated Financial Management Information Systems (IFMIS). However, while many of the accounts are formally reconciled, significant amounts of transactions remain posted to below the line accounts. Reconciliations of bank account records with corresponding accounting records in the form of vote ledgers and cashbooks are usually untimely. Mispostings to the ledgers at ministry level and to the computerized records at the Accountant Generals department explain the backlog. The Accountant General currently demands submission of vote ledger reports and supporting documentation (primary records) for inputting into a computerized cash control system (this process is done independently from the monthly expenditure returns produced by the ministries and submitted to the Ministry of Finance, which are a requirement for monthly funding – see indicator 13). Further, there is no system for ensuring that all accounts have been reconciled in ministries that have a lot of bank accounts such as agriculture, health and education. This is especially important because the total number of bank accounts held by government institutions is very large at around 750 accounts. Action Plan: The following measures need to be taken to improve the quality of fiscal and banking records:

Develop a complete list of bank accounts of the government and close all accounts that are not required for the operation of the CCA system or agreements with donors;

Ensure monthly reconciliations are consistently done, and are reviewed and signed off monthly by Directors of Finance.

Program to reconcile all bank accounts for the below the line expenditures and bringing them above the line.

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V. BUDGET REPORTING Indicator 12 ~ Regularity of timely internal fiscal reporting Target: Internal Budget reports received within four weeks of the end of the relevant period. Assessment: Most ministries submit monthly expenditure returns within two weeks of the end of the month. The quality of these reports is improving, but there remain significant gaps and as a result they are not useful for fiscal management. All government ministries and departments are required to submit Monthly Expenditure Reports to Treasury by the 10th of the following month. About 90% of ministries meet the target, others submit the reports within the month. Treasury issued a circular indicating that ministries would not be funded for their month’s activities until the previous months returns had been submitted. This has increased the level of compliance regarding submission of the returns, however the quality of reports submitted by ministries remains poor. . The poor quality of the reports from the ministries is attributed to inadequate capacity due to low staff skills, inadequate numbers of staff and constant movement of staff from the ministries. In order to address these problems the Ministry of Finance is providing in-service training to the staff, and has assigned a number of desk officers who have the task to review and correct the returns that are submitted by the various ministries in collaboration with the ministries concerned Once problems are identified with the returns, the desk officers assist the accountants make corrections to these reports. In addition, the Ministry of Finance is trying to facilitate the submission of the returns by using excel spreadsheets. Currently the practice is that reports are manually prepared by the various ministries and re-entered centrally by the Monitoring Section when preparing the consolidated report. The spreadsheet will be issued to all ministries so that all returns will be submitted by diskette (this is an interim measure till the roll out of IFMIS is complete). The Budget Monitoring Section of the Ministry of Finance consolidates the monthly expenditure reports on a quarterly basis and reports on the consolidated expenditures. The information reported includes monthly expenditure figures and a list of commitments. On occasion these reports have been posted on the ministry web site. Little reliance is placed on the information from the ministries. The Accountant General for example prepares his own financial reports using actual primary documents from the ministries and not based on the reports submitted (see indicator). There are four types of monthly budget reports available in Malawi: i) Monthly expenditure returns from ministries include both traditional expenditure returns discussed above and reports on PPEs. ii) Funding reports relate to information available on CCA and the database on CCAs.

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iii) Commitment reports are part of the commitment control system and present a list of commitments incurred and unpaid invoices with age profile. iv) Reimbursement reports deal with the utilization of CCA and cash releases by RBM (and reconciliation with commercial bank accounts). These reports show a breakdown of the amounts separately for ORT, Personal Emolument and development. Action Plan: Short term:

Strengthen budget monitoring and reporting: Update daily the information on authorized funding, and include all credit ceiling

authorities, supplemental credit ceiling authorities, and funding releases by direct instruction. Compile summary reports on funding for PE, ORT and development expenditure by line ministries, and by economic category within two weeks of the end of each month.

Enforce the timely submission of monthly expenditure returns and other monthly reports (like reports on the commitment control system, and on pro-poor expenditures) from ministries.

Reconcile monthly funding information and releases of credit ceiling authority (CCA) with information on commitments, expenditures, cash releases by the RBM, and reimbursements claimed by the commercial banks for each line ministry and bank account. Follow-up with ministries on any inconsistencies. Prepare summary report.

Prepare a monthly consolidated report on the status of budget execution, which should include (i) the revenue and expenditure position by major categories, (ii) an analysis of the overall position in comparison to the budget, and any cases of significant shortfalls, over funding of cash, over expenditures, or unauthorized virements, and (iii) the financing position including updated interest projections.

Introduce a program of inspection visits to line ministries to monitor / enforce / improve fiscal reporting.

Update daily the information on authorized funding, and include all credit ceiling. Enforce public finance management regulations, and take appropriate actions against controlling officers who violate the regulations.

Medium term:

Pursue the development and implementation of IFMIS to introduce an accounting system based on principles of best practice

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Indicator 13 ~ Regular fiscal reports track poverty reducing spending Target: Good quality classification of poverty reducing spending is reflected in the in-year budget reports. Assessment: Expenditure reports classify spending to program, sub program and economic item levels. However, the present classification is not sufficient to track PPE expenditures, since these are identified at the activity level (which cannot be bridged into sub-programs), and not at the program / sub-program level on which detailed budget reports and accounts are prepared. The changes required to enable tracking of PPE expenditures are technically simple to implement, and would allow Malawi to meet this indicator. The monthly expenditures returns by ministries are broken down to program, sub-program and item levels in line with the highly detailed chart of accounts (see indicators 5 and 6). Pro-poor expenditures (PPEs) can be categorized as programs, sub program or activities. PPEs that are categorized as programs or sub-programs can be easily reflected in the monthly expenditure reports. However if PPEs are only specified at activity levels they will not be distinctly reflected in the monthly reports. Government regularly reports on a quarterly basis funding (cash releases) for PPEs allocations in the national media and on their website. However, the quarterly reports indicate funding for pro-poor activities rather than actual expenditures.17 Auditing and tracking of pro-poor expenditures is difficult as information on actual expenditures is not readily reported at the activity level. Action Plan:

Further develop the classification system to ensure that expenditures on PPEs can be classified and recorded.

17 It should be noted, that all timely fiscal data in Malawi are reported on the basis of funding data, not expenditure data.

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Indicator 14 ~ Closing the accounts Target: Routine transactions are entered into the main accounting system(s) within two months after the end of the fiscal year. Assessment: Routine Transactions are entered into the main accounting system within two months and six months after the end of the fiscal year. Very good progress has been made in shortening the length of time between the end of the fiscal year and the closing of the accounts. Currently these financial statements are six months in arrears and so the ministries are still behind in the reconciliation of their financial records to those maintained by AGD. This situation has been brought about because the current financial system does not allow multi year processing. So up to the time the previous fiscal years accounts are closed and removed from the system, the accounts staff cannot begin to process current year transactions. The Integrated Financial Management Systems (IFMIS) will address this problem once it is in place as multi year processing is part of the specifications. Towards the end of the fiscal year, AGD has issued a circular instructing all ministries to close their books by 31 July (meaning that all checks against ceilings for the previous fiscal year had to be issued by that date) to allow for processing of any backlog of transactions. For the fiscal year 2002/03, AGD was able to ensure that the ministries met this target. AGD finished entering transactions in the centralized accounting system used to prepare the final accounts in December 2003, about 6 months after the end of the fiscal year, and submitted the financial statement to the Auditor General in January 2004, some seven months after the end of the fiscal year. This compares with the financial statement for 2001/02, which was submitted to the Auditor General some 14 months after the end of the fiscal year. Hence Malawi has made substantial progress and with some effort could meet the target to enter all routine transactions into the main accounting system(s) within two months after the end of the fiscal year. Action Plan:

Maintain effort to clear backlog of reconciliation Full implementation of IFMIS in all the ministries will improve the speed with which

financial transactions are captured into the system.

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Indicator 15 ~ Timeliness of audited financial information Target: An audited record of the financial outturn should be presented to the public / legislature within twelve months of the end of the fiscal year. Assessment: This indicator was not satisfied for the accounts up to 2001/02. The 2002/03 accounts were ready within 12 months, but were not presented as parliament had been dissolved for national elections. The current status of the audited accounts reflects significant improvement from the last time the assessment was undertaken in 2001 in terms of preparation and audit of the accounts. Until recently there was a 2-3 years time lag between the end of the relevant fiscal year and the presentation of the audited accounts and report to the legislature, implying that the official accounting records are not very useful for fiscal management purposes. The 2002/03 accounts have been audited by the Auditor General’s office. .At the time of the assessment mission the Auditor General was ready to present the 2001/02 audited accounts to the new legislature, and was in the process of preparing the detailed audit report for the 2002/03 accounts. In the event, the 2002/03 audited accounts were ready for presentation to Parliament before June 30, 2004 (i.e. within 12 months after the end of the fiscal year), but were not submitted because of national elections in May 2004. Although submission before June 30, 2004 was not achieved, Malawi is well placed to meet the target for the 2003/04 audited accounts. Due to general weaknesses in the internal control environment and non-reliance on the work of the internal auditors, most of the work carried out by the National Audit Office (NAO) relates to substantive compliance testing rather performance audits. Although the NAO has achieved operational and administrative independence under the new Act, it is still financially dependent on cash releases from the Ministry of Finance. The following challenges affect NAO’s ability to carry out its work efficiently: • Funding – the ORT funding to NAO is erratic and normally less than what is budgeted.

This affects the implementation of the annual work plan which has to be constantly changed. This has reduced the number of audits carried out per year; the most affected government branches are the districts. However in order for the AG to issue an opinion on the accounts, at least 80% of the revenues disbursed must have been audited.

• Staffing – the current establishment of professional and technical staff of the NAO is 200, currently there are 150 in place. The situation is further adversely affected because most of the audit staff in place are inadequately trained and qualified for their positions. The Malawi CFAA18 indicated that there were only six qualified accountants and that the

18 Malawi Country Financial Accountability Assessment, September 2003, Page 30 para 9

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salaries paid were not competitive enough to attract qualified staff. NAO is receiving support to address the capacity building challenges from the World Bank under the FIMTAP project and from Norway and Sweden under a recently signed contract.

Action Plan: The critical steps to be implemented are:

Accelerate capacity building of NAO staff in accounting, systems and performance audits

Ensure predictable and adequate funding for NAO. Develop an audit program.

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Indicator 16 ~ Efficiency and effectiveness of the public procurement system Target: The procurement system supports efficiency and effectiveness in the expenditure of public funds through clear and enforceable rules that promote competition, transparency and value for money. Assessment: The procurement system is in transition. Clear and enforceable rules that promote competition, transparency and value for money have been introduced with the 2003 Public Procurement Act. However, implementation of the new rules has only just started. The Government has been taking positive steps to reform the public procurement system. In 2003, the Malawi Parliament passed a new procurement law, the Public Procurement Act of 2003, which became effective in August of that year. The new Procurement Act requires procurement regulations to provide, inter alia, thresholds for the use of the various procurement methods, bid and bid evaluation procedures and contract management.

The weaknesses in the current procurement procedures are revealed in the survey done in the context of the CPAR for Bank financed projects, as well as in the World Bank Country Portfolio Performance Review (CPPR) of February 2003, which identified delays in the procurement process, insufficient capacity, and inadequacies in procurement organization, documents and management. Delays in procurement processing due to faulty procurement management are costly to the State in lost benefits that could have been gained by getting projects on stream earlier, had the procedures been handled properly. The challenge for Malawi is implementation. Malawi is starting its procurement reform activities with a clean slate – essentially from scratch; its main existing plank is the relatively good Public Procurement Act. This poses a positive opportunity for installing a new good public procurement system. Government has also re-iterated its strong commitment to eradicate corruption, including in activities related to procurement. Action Plan: Some critical steps to be implemented are:

Operationalize the Office of the Director of Public Procurement (DoPP) responsible for policy and regulations, and establish an effective complaints review mechanism in line with the 2003 Public Procurement Act.

Decentralize public procurement decisions and responsibility to the procuring entities – ministries and other government agencies, through the creation of Internal Procurement Committees (IPCs) and their Special Procurement Units (SPUs).

Effective application and enforcement of new regulations soon to be announced. Establishment of a procurement cadre. Procurement capacity needs immediate and sustained strengthening through

substantial training efforts. The Government is to be complemented for taking advance action in training up procurement staff by retaining consultants, over a year ago, for such a task.

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With the introduction of a decentralized procurement system, the DoPP should build adequate capacity for effective monitoring and enforcement of procurement functions.

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VI. PROGRESS SINCE 2001 REPORT AND ACTION PLAN FOR THE FUTURE Comparison with 2001 HIPC AAP report: achievements and setbacks The analysis of the various indicators in the previous sections is summarized in Table S1 below. The table also shows the comparison between the levels achieved for each indicator with those attained in the first AAP assessment in 2001. Four indicators have been rated lower than in the 2001 assessment, and currently Malawi meets the benchmarks for 5 indicators (as opposed to 7 in 2001). However, the changes do not reflect a deterioration in actual practice. Rather they result from an improved information basis, and some adjustments in the evaluation criteria (as the 2004 assessment methodology was refined to take into account the experiences of the 2001 exercise). Specifically the following four indicators have been adjusted downwards (from “A” to “B” ratings – see Table S1): • The indicator on classification of budget expenditures (indicator 5) has been lowered to

reflect the fact that Malawi’s classification of budget expenditures provides an administrative, economic, and detailed programmatic basis, but does not allow directly a classification on a functional basis. The evaluation criteria for the 2004 assessment require a detailed programmatic and functional classification to warrant an “A” rating.

• The indicator on arrears (indicator 8) has been adjusted downwards to take into account

recent information from a special external audit of arrears, which uncovered substantial additional arrears. Evaluation of this indicator does no longer only rely on routine information from the government’s commitment control system.

• The indicator on expenditure tracking surveys (indicator 10) has also benefited from

additional information. In the context of preparing the current PETS in the education sector, it became clear that, contrary to what was believed in 2001, line ministries do not carry out PETS-type surveys. The internal ‘expenditure tracking’ exercises conducted occasionally by a few ministries were undertaken with inadequate preparation and cannot be reasonably described as expenditure tracking surveys. It is worth noting that the adjustment in the rating masks the progress made in carrying out PETS (the first PETS has been trialed in 2004).

• Finally, although the classification of poverty reducing spending is very good, the

availability of this classification is not sufficient to track poverty reducing expenditures in within-year reports (indicator 13). This is because PPEs are classified at the activity level, and not at the program / subprogram level on which detailed budget reports and accounts are prepared. The changes required to enable tracking of PPE expenditures is technically simple to implement, and would allow Malawi to meet this indicator.

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A preliminary reading of Table S1, therefore, may give the reader the false impression of a deterioration in the status of PEM in Malawi during the period from 2001 to 2004. In fact there have been improvements in several indicators, mainly in the area of final accounts and auditing. Although the improvements since 2001 have not been sufficient to warrant any increase in the ratings, Malawi is now closer to meeting the threshold level for several indicators. • Firstly, as mentioned above, Malawi is currently executing its first PETS in the education

sector (indicator 10). The authorities have expressed their intention to also carry out PETS in health and agriculture during 2005. PETS could be very useful in Malawi as an interim instrument for monitoring budget execution and MPRS implementation (until internal control and audit systems are functioning well).

• Also, the reconciliation of fiscal and banking records (indicator 11) has improved

significantly. The backload of bank reconciliation has been reduced from 18 months to an average 6 months during the period, and further improvements are expected in the preparation of the IFMIS.

• Very good progress has also been made in shortening the length of time between the end

of the fiscal year and the closing of the accounts (indicator 14). The AGD finished entering the 2002/03 transactions in the final accounts’ computer system in December 2003, about 6 months after the end of the fiscal year. This compares with the financial statement for 2001/02, which was submitted to the Auditor General some 14 months after the end of the fiscal year. Hence Malawi has made substantial progress and with some effort could meet the target to enter all routine transactions into the main accounting system(s) within two months after the end of the fiscal year.

• Further, significant improvement has been made in the preparation and audit of the final

accounts (indicator 15). Until recently there was a 2-3 years time lag between the end of the relevant fiscal year and the presentation of the audited accounts and report to the legislature, implying that the official accounting records are not very useful for fiscal management purposes. At the time of the assessment mission the Auditor General was ready to present the 2001/02 audited accounts to the new legislature, and was in the process of preparing the audit report for the 2002/03 accounts. In the event, the 2002/03 audited accounts were ready for presentation to Parliament before June 30, 2004 (i.e. within 12 months after the end of the fiscal year), but were not submitted because of national elections in May 2004. Although submission before June 30, 2004 was not achieved, Malawi is well placed to meet the benchmark for the 2003/04 audited accounts.

Unfortunately, there are also several areas in which Malawi has failed to make much progress. Notably, the coverage of fiscal reporting is still very incomplete, budget outturn data continue to differ considerably from the original budget, the development budget still does not include the large majority of donor funded projects, information and controls on the accumulations expenditure arrears are inadequate, the overall control environment for public

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expenditure management remains weak, and the quality of internal fiscal reporting continues to be inadequate. Action Plan to upgrade PEM capacity in Malawi It is important that the government revamps the efforts to strengthen public expenditure management. As mentioned in the introduction, this HIPC AAP report draws significantly on other recent substantial analyses of Malawi’s PEM systems that were consolidated into the Malawi Financial Accountability Action Plan (MFAAP) approved by Cabinet in May 2004. The MFAAP constitutes the ‘framework document’ intended to guide the overall work program on public expenditure management systems in Malawi. It provides a comprehensive list of actionable recommendations to address problems in budget planning, execution, and monitoring, and in public procurement. Within the context of the MFAAP, this AAP report provides an update on the status of existing PEM systems, and a smaller priority action plan to be pursued in the near future. More generally, this AAP reiterates the importance for the Government to accelerate the implementation of the MFAAP in a more decisive and coordinated manner, and to facilitate the coordination of the donors support in this area. Progress with implementation of the MFAAP recommendations has been mixed. On the positive side, new legislation (Public Finance Management Act, Public Audit Act and Public Procurement Act) has been passed in May 2003, and the relevant desk manuals and instructions have been almost finalized. However, only limited progress has been made in other areas. In line with the discussion above and the assessment for the individual indicators presented in the previous sections, a number of actions have been identified for implementation within the next 12 months and over the medium term. These actions are briefly summarized below (see also Summary Table S4 below). Actions to be implemented in the short term: In budget formulation:

• Expand coverage of fiscal reporting to include financial position or detailed accounts of autonomous agencies and treasury funds.

• Strengthen budget planning (in line with the “MTEF II work plan”—see details under indicator 3).

• Improve dialogue with donors on available financing. • Maintain comprehensive list of all donor projects, ongoing and under preparation (in

line with CIDA Database). • Define a strategy to bring all donor development projects into the budget. • Develop estimates of disbursements by year, and required counterpart funding.

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• Classify all PPEs as programs and sub-programs. Alternatively, (or in the medium-term) develop the classification system to ensure that PPEs classified as activities can be recorded throughout the expenditure process.

In budget execution:

• Establish a comprehensive database of arrears, and verify reported arrears. • Strengthen the internal audit function: formulate internal audit program, approve IA

charter, develop IA manual, follow up on implementation of recommendations, and formulate government wide plans to protect assets.

• Develop of a complete list of government bank accounts and close all unnecessary accounts.

• Ensure monthly reconciliations are consistently done In budget reporting:

• Strengthen budget monitoring and reporting (in line with the “MTEF II work plan”—see details under indicator 12).

• Ensure predictable and adequate funding for the National Audit Office (NAO). • Develop an audit program (NAO).

In public procurement:

• Operationalize the Office of the Director of Public Procurement (DoPP). • Establish an effective complaints review mechanism in line with the Public

Procurement Act. • Prepare a national strategy for procurement capacity building.

Actions to be implemented in the medium term: In budget formulation:

• Rationalize spending and align with available resources, e.g. by implementing recommendations from functional or public expenditure reviews.

• Expand coverage to include accounts of local government agencies including reporting on pro-poor expenditure.

• Develop PSIP and improve linkage with budget preparation. • Prepare a medium-term plan for implementation of donor projects, and the recurrent

cost implications. • Develop accounting and recording procedures capable of following the flow of the

money. • Strengthen reporting mechanisms on the implementation of donor projects. • Further align annual budget allocations with MPRS activities.

In budget execution:

• Formulate a program to clear backlog of arrears. • Expand use of PETS tracking surveys.

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• Reconcile all bank accounts for the below the line expenditures and bring them above the line.

In budget reporting:

• Pursue development and implementation of IFMIS. • Strengthen capacity of NAO.

In public procurement:

• Make fully operational the cadre of public procurement professionals • Implement national strategy for procurement capacity building, including

comprehensive training programs for procurement staff.

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VII. DONOR INITIATIVES As discussed earlier, the Malawi Financial Accountability Action Plan (MFAAP), approved by Cabinet in May 2004, constitutes the ‘framework document’ intended to guide the overall work program on public expenditure management systems in Malawi. Individual donors’ initiatives are expected to support the implementation of MFAAP. In this context, the MFAAP also proposes a mechanism for coordinating the various initiatives (by donors, as well as government) on Public Expenditure Management, via the establishment of a joint donor-government committee on PEM reforms under the leadership of the Government. It is important that the Government establishes this joint committee, which will facilitate implementation of the MFAAP. Donor and donor/ government coordination currently takes place mainly through the monthly meetings of the “Group on Financial and Economic Management,” but government participation in the past has been weak. Since spring 2004, the group has been co-chaired by the Accountant General and a donor (currently the EU), with the aim to improve government participation. At present, several donors have active programs in support of public expenditure management reforms and/or capacity building. In addition to the IMF and the World Bank, other active donors include the AfDB, CIDA, DFID, the EU, GTZ, JBIC, NORWAY, UNDP, and USAID. The rest of this section presents the main areas of support by individual donors (both ongoing programs or about to start operations—see also Summary Table S4): IMF The IMF PRGF program effectively lapsed in June 2004, following repeated delays in the completion of the program’s 2nd review. In September 2004, the Government and IMF reached agreement on a new Staff Monitored Program (SMP), which could form the basis for a future PRGF. As in the past, future IMF programs in Malawi will likely directly include a focus on PEM reforms. The IMF has provided a resident advisor to the Ministry of Finance until mid-2003, but currently does not provide technical assistance. It is holding discussions with the new government about re-engagement. Specific expenditure management reforms that could be implemented in the short term on the basis of previous advice were outlined in a letter to the Government in October 2003. World Bank The FIMAG Structural Adjustment Credit approved in April 2004 directly links the provision of balance of payments support to the government to progress in the implementation of the Financial Management Act, Public Audit Act and Public Procurement Act, and the establishment of a functioning Directorate of Public Procurement (DPP) and an Internal Audit Unit. The Government has agreed to use part of the FIMAG credit (or other funds available to Government) to acquire the technical assistance needed to successfully

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implement the reforms. Implementation of the reforms agreed as part of the credit is anticipated before end-2005. The Financial Management, Transparency and Accountability Project (FIMTAP) approved in 2003 and expected to last until 2007, aims to build a financial management system that supports sound budget planning and implementation. Its major output is the development of an integrated financial management information system (IFMIS). A fully operational IFMIS will support strategic, medium-term result-oriented budgeting in a number of ways. However, the system itself will only be effective if it is installed in an environment where the established incentives, rules and processes support sound budgeting and expenditure control. The project also provides direct financial support for capacity building and training in the areas of accounting, auditing, and procurement. Further, the project also supports capacity building to the Parliamentary Budget and Finance Committee and the Public Accounts Committee. AfDB The institutional support project for Aid-Debt management and governance involves capacity building of all the ministries and agencies engaged in aid and debt management through the creation of a well trained staff in related areas, such as aid and debt analysis and policy; financial management and public expenditure review methods; project management, monitoring and evaluation; sectoral planning; financial management of aid programs; computer applications; and aid/debt data and information systems. The project also provides assistance in the formulation of an aid and debt management policy framework, the development of a common plan to coordinate the support of different donors as well as the establishment of an effective and efficient system of data collection, analysis and information dissemination of external aid resources and utilization. The project also involves the strengthening of the capacity of the civil society and assisting it to assume its role as a monitor for the utilization of public resources. The project was approved in 2001 and will continue until 2005. CIDA The Government Assistance Project (GAP) is a CIDA-funded project that provides flexible support to improve the effectiveness of the Government. The GAP started in 2002 and is a 5-year project designed to assist the Government in building capacity within the civil service, and addressing the problems associated with the weak revenue base, insufficient resources and limited capacity in the public service. In addition to this, the GAP also provides support to ministries with issues of transparency, public accountability, civil society participation and other issues. One of the focus areas of the GAP is the provision of support to ministries in strategic planning, including strengthening the budgeting capacity of ministries, and also the technical capacity for macro-economic projections. The Project on Economic Governance (PEG) is a CIDA funded initiative to build capacity of the various stakeholders to engage with economic issues and the budget process, thus

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improving governance. The PEG provides funding to build the capacity of institutions and public (NGOs, cabinet, parliamentary committees, media, private sector) to participate actively in the budget process, thereby improving oversight and accountability. DFID The preparation for MTEF II program was carried out in close collaboration with the Government during 2003-2004, and included the provision of technical assistance and financial support to review the experience with the implementation of the MTEF and identify a plan to address the shortcomings. A report was completed in January 2004 that will inform the implementation phase. The MTEF II program is meant to operationalize key areas of the MFAAP. The implementation of the MTEF II program supports activities designed to strengthen the annual budget process and core functions of the Ministry of Finance and the Accountant General’s Office, thereby, providing the basis for reviving the MTEF. The implementation program is expected to start before the end of 2004 (possibly with funding by several donors in a basket fund arrangement). The focus of the program is on three areas: strengthening and revising the budget planning process; strengthening financial control and accountability; and improving budget transparency and political accountability. The program is based in the Budget Division of the Ministry of Finance, and includes the provision of a long-term technical adviser. DFID provides financial support to National Democratic Institute (NDI) for capacity building of civil society and parliamentary committees (jointly with USAID—see above). EU The Capacity Building Project for Economic Management and Policy Coordination (CDPEMPC) is an EU funded project providing support (to the Ministry of Economic Planning and Development, the Ministry of Finance, and the Office of the Vice-President) for policy development and economic management. The project started in 2003 and is expected to continue until 2007. Amongst its focus areas, the project supports strengthening the technical capacity for macro-economic projections and for developing a focused and viable PSIP. The EU is also providing funding for the external audit of domestic arrears. Technical assistance in financial management to Ministry of Finance, Ministry of Health and the National Roads Authority has been provides as part of the EU 1999-2004 SAF IV assistance framework, which has recently expired and is undergoing assessment prior to its next phase. GTZ The Macroeconomic Advisory Services Project is a GTZ-funded project which aims to strengthen macroeconomic planning and budgeting, and macroeconomic management, by

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funding capacity building activities in the Ministry of Economic Planning and Development. The project started in 2004 and is expected to continue until 2006. Areas of focus include the strengthening of macroeconomic analysis, by expanding the use of macroeconomic modeling, and of the policy planning process, by strengthening the preparation of the development budget via the formulation of the Public Sector Investment Plan (PSIP). The project also aims to strengthen the linkages between policy formulation and resource allocation, by facilitating the establishment of institutional linkages between development planning, annual budgeting and medium term expenditure forecasts. Finally, the project supports fresh analysis into the specification of pro-poor policies and potential sources of pro-poor growth. JBIC The Special Assistance for Project Sustainability for Public Financial Management Program provides technical assistance in the form of a study to improve the budget preparation process. The scope of the study will be a review of the budget preparation activities in the Ministry of Finance and in some line ministries, leading to a set of recommendations, including areas for capacity building, to address any bottlenecks identified. The study has started in April 2004 and is expected be ready before the end of 2004. NORWAY / SWEDEN The program for capacity building in the National Statistical Office (NSO) and the Ministry of Economic Planning and Development (MEPD) started in 2003 and is expected to last for three years until 2006. The program provides technical assistance to the NSO in the areas of national accounts and household surveys, and to MEPD in the areas of macro-economic planning/modeling and policy analysis. The program for capacity building in National Audit Office (NAO) started in 2004 and is expected to last until 2007. The project regards capacity building and institutional support to the NAO in a twinning arrangement with Swedish National Audit Office. The program is equally funded by Norway and Sweden. The goal is to promote good governance, transparency and accountability in public institutions in Malawi by reforming and strengthening NAO, and its ability to fulfill its constitutional audit mandate. The NAO has identified a number of areas that need to be addressed to enhance its institutional and operational capacity. UNDP The Public Sector Management Reform Program is designed to provide support for strengthening capacity in the public sector related to development management in formulating, implementing and monitoring national, sectoral and district / community level policies and actions crucial to poverty reductions. The program started in 2002 and is expected to continue until 2006. Specifically the program focuses on four core areas: (i) strengthening the institutional capacity of the public sector to manage the MPRSP and

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deliver basic services; (ii) strengthening public policy formulation, management and implementation; (iii) improving transparency and accountability in the management of public resources; (iv) support capacity development for pro-poor service delivery by facilitating a well managed division of responsibilities between central and local government, the private sector and NGOs for the provision of public services. The consolidation of democratic governance program aims to strengthen the Parliament to increase its effectiveness in the performance of its legislative and oversight functions. This capacity building program has started in 2002 and is expected to last at least until 2006. As part of its efforts, the UNDP has also facilitated the formulation of a Parliament Training Program for the period 2004-2009 that serves as the common guiding framework to coordinate the training initiatives supported by individual donors. USAID DfID and USAID jointly provide funding support to the National Democratic Institute training activities for Parliament and civil society to increase citizen input into the legislative and governance processes in Malawi, particularly with respect to the country's PRSP. The NDI capacity building program started in 2001 and is expected to continue at least until 2006. NDI's support to Parliament focuses on the strengthening the capacity of parliamentary committees as venues for building relationships between MPs, government officials and civil society, and to increase Parliament's capacity to function as an independent and representative body. NDI is currently providing training and technical assistance in advocacy and lobbying to parliamentary committees that have oversight of government ministries. Prior to NDI's involvement, most of these committees were dormant. NDI also trains and provides technical assistance for clerks and other parliamentary staff to improve support for MPs. NDI's program for civil society seeks to enhance the capacity of civil society organizations to advocate effectively on a variety of public policies and legislative issues. NDI monitors and advises civic organizations that work on advocacy campaigns for issues related to agriculture, commerce and industry, education, environment, health, governance and human rights. Assisted by NDI, civic groups are advocating for issues related to the national AIDS Policy, domestic violence legislation, budget monitoring, the penal code, and several other public policy issues. NDI collaborates on these issues with a number of key civic networks in Malawi, including the Malawi Health Equity Network (MHEN), the Civil Society Agriculture Network (CISANET), the Civil Society Coalition for Quality Basic Education (CSCQBE), the Malawi Economic Justice Network (MEJN) and the NGO Gender Network.

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VIII. SUMMARY TABLES Table S1: Public Expenditure Management AAP Indicators in Malawi

Summary Table S1: Public Expenditure Management AAP Indicators in Malawi ASSESSMENT

Standard Desk 2001 2004 Level Assessment Assessment Assessment FORMULATION COMPREHENSIVENESS

1 Fiscal reporting adequately covers the Government Finance Statistics definition of the general government sector A C C C

2 Government activities are not funded through inadequately reported extrabudgetary sources to a significant degree A A A A

3 Budget outturn data are quite close to the original budget B B C C 4 Fiscal reports include grants projected to be provided by donors A B B B CLASSIFICATION

5 Budget expenditures are classified on an administrative, economic, and detailed functional or programmatic basis B B A1 B

6 Poverty-reducing expenditures are clearly defined A A A A PROJECTION

7 Multi-year expenditure projections are integrated into the budget formulation process A B B B

EXECUTION INTERNAL CONTROL

8 There exists a small stock of expenditure arrears, with little accumulation of arrears over the previous year A A A2 B

9 Internal control is effective A B B B 10 Tracking surveys are in use, or are unnecessary B A A3 B

RECONCILIATION

11 Satisfactory reconciliation of fiscal and banking records is undertaken routinely A B B B

REPORTING IN-YEAR REPORTING

12 Internal fiscal repots are received within four weeks of the end of the relevant period B B B B

13 Good-quality classification of poverty reducing spending is reflected in the in-year budget reports A A A4 B*

FINAL AUDITED ACCOUNTS

14 Routine transactions are entered into the main accounting system (s) within two months of the end of the fiscal year A C B B

15 An audited record of the financial outturn is presented to the legislature within twelve months of the end of the fiscal year B C C C*

NEW PROCUREMENT

16

The procurement system supports efficiency and effectiveness in the expenditure of public funds through clear and enforceable rules that promote competition, transparency and value for money. A -- -- B

TOTAL NUMBER OF BENCHMARKS MET 8 7 5

Notes: Please shade cells in cases where the assessed indicator meets or exceeds the standard target level

Notes: 1. The 2001 rating has been lowered because Malawi’s classification of budget expenditures does not allow directly a classification on a functional basis, which is required for “A” rating in the 2004 assessment (the standard for evaluating this indicator requires a detailed programmatic and functional classification to warrant an “A” rating). 2. The 2001 assessment was based on official reports from the Commitment Control System. However, a special external audit carried out in 2004 has uncovered a significantly larger stock of arrears. Hence the rating has been adjusted to account for this new information. 3. The 2001 assessment was based on self-reporting by authorities; in hindsight, the expenditure tracking exercises carried out in 2001 could not be classified as PETS. The new rating is based on better understanding of the use of PETS in Malawi. 4. The 2001 rating has been adjusted to reflect the fact that Malawi’s classification of poverty reducing spending in principle is very good, but is not used to track poverty reducing expenditures in within-year reports.

Notes: * indicates that the standard level could be easily achieved within the next 6 months.

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Table S2: Overview of Technical and Donor Assistance in Public Expenditure Management in Malawi

Summary Table S2: Overview of Technical and Donor Assistance in Public Expenditure Management in Malawi RECENT*/ONGOING assistance by major project PLANNED assistance by major project Donor/

Provider** Description Dates Description Dates

AfDB Institutional support project: training staff of Ministry of Finance in financial management and public expenditure review methods.

2001-2005

CIDA Government Assistance Project (GAP): flexible support to include effectives of GOM strategic planning; and effectiveness)

2001-2006

Project on Economic Governance (PEG): capacity building for increased participation in budget process of institutions and public (NGOs, cabinet, parliamentary committees, media, private sector.

DFID Support to NDI for capacity building activities for parliamentary committees. 2001-2004

Support to MTEF II preparation (design phase: technical assistance and financial support)

2003-2004 Support to MTEF II implementation (implementation phase: capacity building, technical - (to start before end 2004)

2004-2007

EU

Capacity Building Project for Economic Management and Policy Coordination CDPEMPC (based in MEPD, but also support to MOF, Office of the First Vice President); Financial management): Policy Developments: coordination of key ministry involved in policy formulation (technical capacity for macro-economic projections; PSIP;)

2003-2007

Technical assistance to MOF, MOH and NRA in financial management of SAF IV

1999-2004

GTZ Capacity building at MEPD: strengthening planning and budgeting system in MEPD; developing framework for PSIP and IT aspects.

2004-2006

IMF Resident Advisor to MoF 2002-2003 Renewed assistance under discussion (possible missions, experts)

JBIC Assessment of budget preparation process. 2004 (April-

December)

NORWAY / SWEDEN

Capacity building in National Statistical Office (National Accounts and surveys) and MEPD (Macro-economic planning model and policy analysis)

2003-2006

Capacity building in National Audit Office: capacity building for financial audit (and also performance audit)

2004-2007

UNDP Consolidation of democratic governance program: strengthening Parliament to increase its effectiveness to perform its legislative and oversight functions.

2002-2006

USAID Support to NDI for capacity building activities for parliamentary committees. 2001-2004

World Bank FIMTAP project: Capacity building and training (accounting, auditing, procurement, etc) and support the implementation of IFMIS.

2003-2007

FRDP III TA Component: Financial support to revision of Financial Management Act, Public Audit Act and Public Procurement Act. Reform of Procurement and Internal Audit. Capacity building in PEM systems.

2001-2004

FIMAG: Financial support to implementation of Financial Management Act, Public Audit Act and Public Procurement Act. Establishment of functioning Directorate of Public Procurement (DPP) and Internal Audit Unit.

2004-2005

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Table S3: Implementation Status of Actions to Strengthen Tracking of Poverty-Reducing Public Spending in Malawi

Summary Table 3: Implementation Status of Actions to Strengthen Tracking of Poverty-Reducing Public Spending in Malawi

Relates to Timing Status Date # Actions1 Indicator2 (S/M)3 (FI/II/NS)4 Achieved Comments5

Actions to strengthen budget formulation

1 Review of Finance and Audit Act to be made comprehensive 1 S FI April-03

The Financial management Act, Procurement Act, and Audit Act were passed in April 2003

Amend comprehensiveness in line with the GFS Manual 1 M NS 2 Implement IFMIS (pilots in four ministries) 3 S FI March-03 Prior action for FIMTAP 2003.

3 Continue with IFMIS 3 M NS Not yet started.

4 Bolster consistent approach to budget support with all donors, and increase the predictability of flows 4 S II

Good progress in improved coordination (e.g. plans to adopt PAF in the context of CABS - Coordinated Approach to Budgetary Support which includes EU, UK, Norway/Sweden); problems with predictability of inflows.

5 Specify PPEs in detail in terms of programs, subprograms and economic objects 6 S FI June-02

Implemented since FY2002/03 budget; however tracking of PPEs expenditures still not possible.

6 Roll-over 2002-03 estimates from MTEF for start of the 2002 budget process 7 S NS

Focus has shifted into strengthening annual budget process as a pre-requisite for MTEF

N Actions to strengthen budget execution

1 Assign central agency responsibility for internal audit 9 S FI March-04 Assigned to President’s Office (OPC). Agency needs staff, training and equipment.

2 Bolster internal audit through allocating central agency responsibilities and developing manuals 9 M II Central unit responsibilities are clear; manuals being developed.

3 Introduce CCA (Credit Ceiling Authority) for PPEs 9 S NS

4 Procurement reform 9 S FI March-04 Public Procurement Act approved; DPP created; director appointed; manuals drafted. Implementation still to begin.

5 Continue program to update routine reconciliation process in preparation of IFMIS 11 S II

Good progress: lag in reconciliation estimated down from about 18 months to about 6 months. As many as 75% of Bank Accounts reconciled by June 03.

N Actions to strengthen financial reporting 1 Implement IFMIS 12 S NS Not yet started.

2 Data quality 12 S II IMF Fiscal advisor between may 2002 and March 2003. Not much progress.

3 Institutional strengthening - audit 15 S FI April-03

Financial Management Act approved; institutional independence achieved; financial independence not yet achieved; training underway. Further strengthening is required.

N Actions to strengthen public procurement 1

2

N Notes: 1. Actions reflect the descriptions held by FAD-PREM in the March 2003 Board Paper and should relate to the earlier action plans developed in prior AAPs. 2. Show to which of the 16 indicators from the AAP the action chiefly relates. 3. S=Short term action (within 12 months of action); M=medium term action. 4. FI=fully implemented, II=Implementation initiated, NS=Not started 5. Comments may explain any changes in the nature of proposed actions or changes to the timing of their implementation.

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Table S4: Action plan to upgrade PEM capacity in Malawi

wb154310 C:\Documents and Settings\wb154310\Desktop\MALAWI - HIPC AAP - Vers 101004.doc October 14, 2004 4:11 PM

Summary Table S4: Action plan to upgrade PEM capacity in Malawi

SHORT-TERM MEASURES (Within next 12 months) MEDIUM-TERM MEASURES (12 months to 3 years)

No.* Action **

Relates to indicator

no. TA Provider*** No.* Action**

Relates to indicator

no. TA

Provider*** FORMULATION

Comprehensiveness Expand coverage to include financial position or detailed accounts of autonomous agencies and treasury funds 1

Expand coverage to include accounts of local government agencies including reporting on pro-poor expenditure, 1

Improve dialogue with donors on available financing 3 Align spending with available resources (PER). 3 World Bank

Strengthen budget planning (MTEF II work plan): (see details in indicator 3). 3 / 7 DFID / CIDA

Develop PSIP and improve linkage with budget preparation. 4 / 7

Maintain comprehensive list of all donor projects, ongoing and under preparation (CIDA Database). 4 CIDA

Define a strategy to bring all the donor development projects into the budget. 4

Prepare a medium-term plan for implementation of donor projects, and the recurrent cost implications. 4

Develop estimates of disbursements by year, and required counterpart funding. 4

Develop accounting and recording procedures capable of following the flow of the money. 4

Strengthen reporting mechanisms on the implementation of donor projects. 4

Classification

Classify all PPEs as programs and sub-programs. Alternatively, (or in the medium-term) develop the classification system to ensure that PPEs classified as activities can be recorded throughout the expenditure process. 5 / 6 /13

Projection Further align annual budget allocations with MPRS activities. 7

EXECUTION

Internal Controls Establish a comprehensive database of arrears, and verify reported arrears. 8 Formulation of a program to clear backlog of arrears. 8

Strengthen the internal audit function: formulate internal audit program, approve IA charter, develop IA manual, follow up on implementation of recommendations, formulate Govt wide plans to protect assets. 9

World Bank, CIDA, EU and

USAID Expand use of PETS tracking surveys. 10 World Bank and

DFID

Reconciliation Develop of a complete list of government bank accounts and close all unnecessary accounts. 11

Reconcile all bank accounts for the below the line expenditures and bringing them above the line. 11

Ensure monthly reconciliations are consistently done 11 / 14 REPORTING

In-Year Reporting Strengthen budget monitoring and reporting (MTEF II work plan.): (see details in indicator 12). 12 DFID / CIDA Pursue development and implementation of IFMIS. 12 / 14 World Bank

Final Audited Ensure predictable and adequate funding for NAO. 15 Strengthen capacity of NAO. 15 Norway Accounts Develop an audit program. 15 NEW

Procurement Operationalize the Office of the Director of Public Procurement (DoPP). 16 World Bank

Make fully operational the cadre of public procurement professionals 16

Establish an effective complaints review mechanism in line with the Public Procurement Act. 16

Implement strategy for capacity building, including comprehensive training programs for procurement staff. 16 World Bank

Prepare a national strategy for procurement capacity building. 16