2015 ANNUAL ECONOMIC REVIEW AND 2016 OUTLOOK

2015 ANNUAL ECONOMIC REVIEW AND 2016 OUTLOOK

The tobacco season of 2015 was marked by complaints of farmers about poor prices and a high rejection rate 2

This report covers developments in the domestic economy between January and December, 2015.The report also includes an outlook for the year 2016.All analyses are based on information sourced from relevant government authorities, financial sector agencies, public enterprises and other private sector sources. The views expressed in this report, however, are those of this authority and do not necessarily represent those of the source of data. We thank all those who have contributed to the publication of this report including the provision of the information contained herein. Alliance Capital Limited Old Air Malawi Building Website:www.alliancecapitalmw.com Email:info@alliancecapitalmw.com 3

LIST OF ABBREVIATIONS IBR FDH FDI FISP GDP IMF LRR MERA MITC MRA MSB MSE PTA RBM SAP SME Interbank Rate First Discount House Foreign Direct Investment Fertilizer Input Subsidy Program Gross Domestic Product International Monetary Fund Liquidity Reserve Requirement Malawi Energy Regulatory Authority Malawi Investment Trade Centre Malawi Revenue Authority Malawi Savings Bank Malawi Stock Exchange COMESA s Preferential Trade Area Bank Reserve Bank of Malawi Structural Adjustment Program Small and Medium Enterprises 4

MACROECONOMIC AND FINANCIAL DEVELOPMENTS GLOBAL DEVELOPMENTS The global economy was expected to register a slower growth in 2015 at 3.1 percent compared to 2014 at 3.4 percent as can be seen in figure below (Source: IMF). Emerging and developing countries are yet to reach the mature stage of development and hence are drivers of global economic development; their recent weakened economic growth is the cause of the registered slow global economy growth. China's reduced economic growth in 2015 has also contributed to the weakened growth of the global economy. As can be seen in figure below, China is the major contributor to global economic growth and hence a reduced growth in its economy results into an overall weakened global economic growth. Sub-Saharan Africa Economic activity in Sub Saharan Africa was estimated to grow by 3.8 percent in 2015 from 5.0 percent in 2014(Source: EIU).This is on account of a combination of the following ailments: low global oil and commodity prices; slowdown of industrialization in China, the region's largest single trade partner; and the consequent effect of these events on government budgets and the banking sector (Source: IMF). China is rebalancing its growth away from manufacturing, construction, and exports- where production inputs are highly skewed toward raw materials (registering a reduced demand in products)toward the services sector and consumption(source: IMF). -This represents a very strong shock to countries, whose exports to China account for a very significant share of total exports, namely: Angola; Democratic Republic of Congo; The Republic of Congo; Sierra Leone, South Africa; and Zambia. 5

Economic Risks: Poor harvest High inflation rates Intermittent power supply Intermittent water supply Adverse weather conditions ECONOMIC HIGHLIGHTS National Bank of Malawi bought 97.05 percent shareholding in IndeBank Limited with the remaining 2.95 percent being owned by staff of IndeBank through an employee share ownership scheme. Meanwhile, the Malawi Savings Bank (MSB) was sold to First Discount House (FDH) Holdings Limited committing an investment of K9.5 billion. The mergers are expected to be concluded between early to mid-2016. The Tobacco Industry saw two new entrants under the Auction System namely African Tobacco Services, a South African based company and Vision International Tobacco (VIT), a Chinese firm. Government reduced the total farm input subsidy allocation by almost 30.5 percent to K41.5 Billion. A pilot scheme permitting private sector to participate in the scheme was also adopted. RBM has proposed an increase in the capital requirements for insurance companies in Malawi. The proposed requirements are set to be effected between December 2015 and December 2016 seeing general insurers' capital requirements rising by 1400% to K750 million from K50 million; Life insurers from K75 million to K1 billion(1233% rise); and reinsurers requirements rising to K1.5 billion from K100 million(1400% rise). Following Parliament s approval of the 2015/2016 National Budget, The Reserve Bank of Malawi, introduced the issuance calendar for Government domestic debt (Treasury Bills and Notes). The issuance calendar outlines (on an indicative basis) Government s domestic borrowing requirements in the 2015/2016 fiscal year and aims at preparing the public on forthcoming auctions and issues of treasury bills and notes. At the end of the first half, IMF board applauded Government s for sound fiscal management and released $18 million from its Extended Credit Facility. However, in September 2015, the Malawi s economy was declared off track due to fiscal policy slippages arising from overspending on wage bill. Real Insurance rebranded to Britam after the latter acquired 99% percent stake in Real Kenya, Real Malawi s major shareholder. 6

KEY ECONOMIC INDICATORS GROSS DOMESTIC PRODUCT The World Bank projections show that the GDP growth rate for Malawi in 2015 is expected to be 2.8 percent. This is a downward estimate from the previously rate of 5.1 percent. The slowdown was on account of severe utility problems especially power shortages that negatively affected SMEs and the manufacturing sector but also heavy floods in early 2015 followed by drought that resulted in an estimated decline of about 30 percent in the maize harvest. Consequently the lower agricultural output adversely affected other sectors such as the manufacturing and wholesale and retail trade owing to a strong linkage between these sectors. The steep decline in the maize harvest also created severe food insecurity for an estimated 2.8 million persons, about 16 percent of the population (IMF staff report, 2015). INFLATION Annual inflation declined by 6 percentage points from end-2014 to 18% by the end of 1Q15, owing to the effects of tight monetary policy, currency appreciation, and lower international fuel prices. However, this trend quickly reversed as inflation rose sharply to 24% as at mid 4Q15 on account of rising food prices; with the figure below showing rural inflation being higher than urban inflation overall. This reflects the reality where inflation has been driven by increase in maize prices (caused by shortage in maize), where rural areas have few substitutes to maize compared to urban areas. 7

GROSS OFFICIAL RESERVES Total gross official reserves rose steadily from 1Q15 to 2Q15 to reach US$ 712.0 million (equivalent to 3.4 months of import cover) by the end of 2Q15, compared to US$ 467.0 million (2.4 months of import cover) by the end t he same period 2014.The closure of the tobacco market led to a decline in forex, aided by an increased demand for foreign currency. Appendix 1 shows the top 4 product forex earners in Malawi and the ranking of the partner countries in world imports of the products. The trends show that Malawi's exports are targeted to highly ranked world importers of the products. This signifies a potential for increased forex as there is high demand in these markets. EXCHANGE RATE In the first two quarters of the 2015, the Kwacha grew in strength against the major currencies, appreciating by an average of 10.5% against the US Dollar. From the beginning of 3Q15, the Kwacha fell sharply against all major trading currencies namely the US Dollar, Pound Sterling and South African Rand. The Malawi exchange rate is affected mostly by the availability of forex on the market as can be seen in the figure beside, where an increase in forex in the first two quarters led to the appreciation of the currency in the corresponding period; with a corresponding depreciation after the month of July due to a steady decline in forex. INTEREST RATES Interest rates depicted mixed movements during the period. The Monetary Policy rate is now at 27 percent effective 4 November 2015from a previous rate of 25 percent. Commercial banks base lending rates range between 34.0 percent and 38.0 percent (2014: between 37.0 percent and 39.0 percent), with the interbank rates ranging from 6 percent to 27 percent. The downward movement of the interbank rates was due the increased money supply due to a reduced LRR from 15.5 percent to 7.5 percent. 8

DOMESTIC DEVELOPMENTS Tobacco While tobacco sales have declined marginally during the 2015 export season, this sector still provided a significant seasonal boost to foreign exchange earnings. The figures below show that from week 1- week 14, prices and revenue in 2015 were higher than those in 2014; however, after the 14th week, 2015 prices and revenue dropped below those of 2014 till the close of the tobacco market. Analysis: The low prices are due to the following reasons: i) The map below shows that Belgium is largest importer of tobacco from Malawi with the other graph showing that the Belgium import growth from Malawi is lower than its import growth from rest of world. This presence of alternative markets for Belgium leads to lower prices for Malawi product ii) Creation of tobacco price ceilings in Belgium; Antwerp in Belgium is the world's biggest tobacco port, which translates to European countries pushing for lower prices in order to reduce their total costs when they Incorporate transportation costs. 9

Fuel Adjustments On 11 December MERA announced a reduction of pump prices; Petrol from K723.60 to K711.90 (1.62% decrease), Diesel from K734.60 to K732.70 (0.26% decrease) and Paraffin from K633.20 to K573.10 (9.49% decrease).the reduction is due to the Automatic adjustment system adopted by MERA in June 2012, where the prices of fuel are linked to the prices of oil. As can be seen in the figures below: Fuel prices followed the rise in global crude oil prices from the month of March 2015 to the month of May 2015; both Fuel prices and oil prices started falling from the month of May 2015 to the month of December 2015.The Automatic adjustment system is however undermined due to the effect of a depreciating currency that outweighs the effect of a fall in oil prices on the fuel prices. Foreign Direct Investment Malawi is expected to attract foreign investment through a forum that was organized by the Malawi Investment Trade Centre (MITC). The forum targeted the following sectors; agriculture, tourism, manufacturing, energy, infrastructure, mining and financial services. The figures below show reduced tariffs overtime, which is favorable for inward Foreign direct investment. 10

FISCAL POLICY The FY15/16 budget was premised on a GDP growth rate of 5.4 percent, an average inflation rate of 16.4 percent, and an exchange rate of 450 Kwacha to the US dollar. Total expenditures for the 2015/16 budget were projected at K901 billion against revenues of K763 billion, resulting in a deficit of K138 billion (15.3% of expenditures). Tax revenues were expected to increase by 1.9 percent to K592.4 billion as the Malawi revenue Authority sought to increase the tax base by strengthening the tax administration regime. This year s budget was prepared with uncertainty of foreign inflows from Malawi s donors. With approximately 40 percent of the budget involving expenditure on items that are priced in foreign currency, depreciations in the value of the Kwacha and the continued absence of donor aid, it is apparent that the dynamics have been far much worse than expected. The total value of collected revenues fell 5% short of targets in the first half of the financial year. MRA collected only K233.6 billion against a target of K247 billion. Weaker consumer demand, the decline in business activity, and disruptions to utility services had an adverse impact on the value of collected VAT, corporate income tax and import duties. MONETARY POLICY Liquidity Reserve Requirement (LRR) was revised downwards to 7.5 percent in July 2015 from 15.5 percent. The objective of monetary policy of the Reserve Bank of Malawi (RBM) is to promote price stability, protect foreign exchange reserves and support growth. Currently, Malawi uses the policy rate, Liquidity Reserve Requirement Ratio (LRRR) and open market operations (OMO) as the major monetary policy instruments in line with the IMF s SAPs. Monetary policy remained tight throughout the period under review. 10

OUTLOOK FOR 2016 The outlook for 2016 is mixed and murky. The Malawi economy is passing through tough times arising from poor agricultural output, a volatile exchange rate, an increasing fiscal deficit coupled with the ongoing suspension of budget support and inflation still above 20%. Prices are expected to soar even high in the short term owing to two dynamics; the country has generally experienced a late onset in the rainfall especially in the central region. This will push the food lean period further, thereby putting pressure on food prices. The effects of the forecasted El Nino are also expected to hit hard on crop output. Secondly, the continued depreciation of the Malawi Kwacha at an unprecedented pace largely due to the absence of bilateral donor inflows will also enhance inflationary pressure. 1.Exchange rate: The exchange rate is expected to depreciate further, especially against the US Dollar as exports remain weak. The Kwacha is expected to continue depreciating in the short term as the tobacco season is now closed, the lean season continues and donors continue to withhold budgetary support. The demand for imported farm inputs may also put pressure on the currency in the short term. In the medium to long term the currency will depreciate on account of the significant current account deficit and weak investment inflows despite tobacco exports and steady forex reserves. In a net importing economy like Malawi already dealing with a wide balance of payments and a sluggish export pace, the effects on the kwacha will be negative. The country needs a diversified export base to offset the gaining of the US Dollar. 2.Inflation: decreased from the month of October 2015 to November 2015 from 24.7 percent to 24.6 percent. Inflation is however expected to remain elevated as a result of the rising food prices from lower than expected harvest, high interest rates on account of continued government deficit financing through domestic sources and the depreciating currency but the pressure will be partly offset by the lower global oil prices even as the currency depreciates. The rise of maize prices will be dependent on whether the government can meet the maize shortage and distribute to those in need during the lean season. Currently the government is having challenges in the procurement of enough grain to sustain the entire lean season. However the 2015/16 agricultural season may be affected by the El Nino which will affect production unless the mitigation of the risks takes place. 3.Interest rates: The monetary policy committee adjusted the monetary policy rate to 27 percent from 25 percent effective 4 November 2015. Banks have already raised their base lending rates in response to the change in the monetary policy rates to a range of 34 percent and 38 percent. Interest rates on the interbank market are expected to increase due to the volatility of the market liquidity and the change in the policy rate. Treasury bill yields are also expected to increase as investors seek to receive real returns in light of the persistently high inflation rates. RBM has stated that they will continue to implement a tight monetary policy that is in tandem with the fiscal policy. 10

ECONOMIC RISKS Risk Impact On Economy Mitigation Poor Harvest Demand-driven inflation; Low Government intervention to boost maize production e.g. Farm input supply of maize unable to subsidies, Greenbelt Initiative meet the demand, will lead to Promotion of high tolerant agricultural seeds rise in prices of maize. Intermittent Power supply Poor economic performance(productivity); due to low energy supply to industries Development of new power plants. Importation of electricity from neighboring countries Discourage investors Intermittent water supply Poor economic performance due to low water supply to industries Discourage investors High inflation rates High cost of living Lowers the returns on savings and investments Privatization of energy producing companies to enhance efficiency and productivity. Seek alternative sources of water supply Privatization of water producing companies to enhance efficiency and productivity Tighten monetary policy by central government Boost production of maize to dampen the prices of maize; as maize is main driver of inflation in Malawi Lowers disposable income of households, and hence lead to lower savings Adverse weather conditions Low agricultural output; hence lower export base and higher inflation Expedite the rolling out of Ethanol as a source of fuel and energy to counter cost push inflation Improved geological interventions Promotion of high tolerant agricultural seeds High interest rates High lending rates will lead to slower private sector growth and a decrease in capital investments High interest rates will also lead to higher rates of non performing loans 10 Recapitalization of some bank Reduce Government borrowing

Appendix 1 : Malawi Top 4 Product Forex Earners Fig.1b Coffee, tea, mate and spices 10

Fig.1c Sugar Fig.1d Oil seed, Oleagic fruits, grain, seed, fruit 10