World Bank Document · in the 1980s. Between 1964 and 1979 real GNP per capita growth averaged 3...

Document of

The World Bank

FOR OFFIC IAI. USE ONLY

Report No. 9096-MAI

STAFF APPRAISAL REPORT

MALAWI

FINANCIAL SECTOR AND ENTERPRISE DEVELOPMENT PROJECT

FEBRUARY 25, 1991

Industry and Energy Operations DivisionSouthern Africa Department

This document has a restricted distribution and mas be used by recipients only in the performance oftheir official duties. Its contents mav not otherwise be disclosed without World Bank authorization.

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C'IJRKENCY EQUIVALENTi S

Currency Unit = Malawi Kwacha (MK)USS 1.00 = MK 2.65 (January 1991)MK 1.00 = US$ 0.38MK 1.00 = 100 tambalas

GLOSSARY OF ABBREVIATIONS

ADMARC Agricultural Development and Marketing CorporationASAC Agriculture Sector Adjustment CreditCBM Commercial Bank of MalawiDEVPOL Statement of Developmenit PoliciesDFI Development Finance InstitutionsECMAC Entrepreneurship and Capital Market Adjustment

CreditEEC European Ecomomic CommunityECGF Export Credit Guarantee Facility

AfricaESAF Enhanced Structural Adjustment FacilityFIAS Foreign Investment Advisory ServicesIFC International Finance CorporationINDEBANK Investment and Development Bank of MalawiINDEFUND Investment and Development FundIMF International Monetary FundITPAC Industrial and Trade Policy Adjustment CreditLFC Leasing and Finance Company of MalawiMDC Malawi Development CorporationMEPC Malawi Export Promotion CouncilMIM Malawi Institute of ManagementMOA Ministry of AgricultureMTIT Ministry of Trade, Industry and TourismNBM National Bank of MalawiNBS New Building SocietyNBFIs Non-banks Financial InstitutionsPFIs Participating Financial IntermediariesPPF Project Preparation FacilityPOSB Post Office Savings BankRBM Reserve Bank of MalawiSEDOM Small Enterprise Development Organization of MalawiSME Small and Medium EnterpriseSSIU Small Scale Industry UnitUSAID United States Agency for International DevelopmentWWBM Women's World Banking of Malawi

FISCAL YEAR

April 1 - Marchi 31

FOR OFFICIAL USE ONLY

MALAWI


TABLE OF CONTENTS

CREDIT AND PROJECT SUMMARY . . . . . . . . . . . . . . . . .i-ii

I. SECTORAL ENVIRONMENT . . . . . . . . . . . . . . . . . . . . 1

Economic Setting . . . . . . . . . . . . . . . . . . . . . . 1Structural Adjustment Policies . . . . . . . . . . . . . . . 1The Financial Sector . . . . . . . . . . . . . . . . . . . . 3Institutional Structure . . . . . . . . . . . . . . . . . . . 3Monetary Developments . . . . . . . . . . . . . . . . . . . . 4Resource Mobilization .................... 5

Resource Allocation . . . . . . . . . . . . . . . . . . . . . 6Issues in the Financial Sector . . . . . . . . . . . . . . . 6Conclusions . . . . . . . . . . . . . . . . . . . . . . . . 12Industrial Sector . . . . . . . . . . . . . . . . . . . . . 13Issues in the Industrial Sector . . . . . . . . . . . . . . 15Demand for Investment Credit . . . . . . . . . . . . . . . 17Government and Bank Strategy . . . . . . . . . . . . . . . 18

II. PROJECT RELATED INSTITUTIONS . . . . . . . . . . . . . . . 19

Introduction . . . . . . . . . . . . . . . . . . . . . . . 19The Reserve Bank of Malawi . . . . . . . . . . . . . . . . 20Commercial Bank . . . . . . . . . . . . . . . . . . . . . . 21Leasing and Finance Corporation . . . . . . . . . . . . . . 22Investment and Development Bank of Malawi(INDEBANK) . . . . . . . . . . . . I . . . . . . . . . . 23

The Malawi Development Corporation (MDC) . . . . . . . . . 24

This report is based on the findings of an appraisal mission whichvisited Malawi in June 1990. The mission comprised Vincent M. Rague (MissionLeader), Mr. Simon Bell, Financial Economist (AF6IE); Mr. Roy Karaoglan,Sr. Banking Specialist (AFTTF); Ms. Catherine Seibert covered Small andMedium Enterprise issues (AF6IE); and Messrs. Paak , Benvenisti andLethbridge (Consultants). Messrs. Paul Ballard, ;.icipal IndustrialEconomist and K. J. Walraven (AFTIE) were the peer reviewers for theoperation. Secretarial support was provided by Mesdames Irene Chacon andNuria Plaza (AF6IE). Messrs. David Cook (AF6IE) and Stephen Denning (AF6DR)are the managing Division Chief and Department Director, respectively.

This document has a restricted distribution and may be used by recipients only in the performranceof their offlcial duties Its contents mas not otherwise be disclosed without World Bank authorization

MALAWI


TABLE OF CONTENTS (Cont.)

III. THE PROJECT . . . . . . . . . . o . . . . . . . . . . . 25

Project Origin and Rationale . . . . . . . . . . . . . . . 25

Project Objectives and Design . . . . . . . . . . . . . . . 26

Project Description .... . . . . . . . . . . . . . . . . 26

Sector Policy Measures and Conditions . . . . . . . . . . . .. 28

Eligibility Criteria for PFls . . . . . . . . . . . . . . . 30

Eligibility Criteria for Subprojects . . . . . . . . .. 31

Subloan Processing and Administration . . . . . . . . . . . 32

Institutional Capacity Development Component . . . . . . . 33

Project Cost, Financing and Co-financing . . . . . . . . . 36

Terms and Conditions .... . . . . . . . . . . . . . . . 37

Project Implementation . . . . . . . . . . . . . . . . . . 37

Environmental Assessment ... . . . . . . . . . . . . . . 38

Procurement and Disbursement . . . . . . . . . . . . . . . 38

Special Account . . . . . . . . . . . . . . . . . . . . . . 41

Auditing, Accounting and Reporting Requirements . . . . . . 42

IDA Supervision .... . . . . . . . . . . . . . . . . . . 42

Project Benefits and Risks ... . . . . . . . . . . . . . 43

IV. AGREEMENTS AND UNDERSTANDINGS . . . . . . . . . . . . . . . 43

LIST OF TEXT TABLES

Table 1 Loans Advanced: Informal and FormalSME Credit Sources . . . . . . . . . . . . . . . . . 10

Table 2 Estimated Project Cost and Financial Plan . . . . . . . 36

Table 3 Procurement Arrangements . . . . . . . . . . . . . . . 40

Table 4 Allocation of IDA Credit . . . . . . . . . . . . . . . 41

lIST OF ANNEXES

Annex I Gross Domestic Product by Industrial Origin 1973-89Annex II Distribution of Financial Sector Assets, 1985-88Annex III Principal Interest RatesAnnex IV Commercial Banks: Advances by Main SectorsAnnex V Credit Extended by Non-Bank Financial InstitutionsAnnex VI Commercial Banks in MalawiAnnex VII Leasing and Finance Company of MalawiAnnex VIII Investment and Development Bank of Malawi LimitedAnnex IX Comparison of Ratios of Operating Costs of Banks

in Selected Sub-Saharan African CountriesAnnex X Malawi Development CorporationAnnex XI TOR for Consultancy on Monitoring and

Forecasting Monetary AggregatesAnnex XII TOR for Consultancy on the Restructuring of the

POSBAnnex XIII Export Credit Guarantee FacilityAnnex XIV TOR for Investment Promotion AgencyAnnex XV SME Technical Assistance and Training FundAnnex XVI Apex UnitAnnex XVII Schedule of DisbursementsAnnex XVIII Supervision Plan

MALAWI

FINANCIAL SECTOR AND ENTERPRISE DEVELOPMENT CREDIT

CREDIT AND PROJECT SUMMARY

Borrower: Republic of Malawi

Beneficiaries: Reserve Bank of Malawi (RBM), participating financial

intermediaries (PFIs), Ministry of Trade, Industry and Tourism

(MTIT), the Post Office Savings Bank (POSB), the Chamber of

Commerce and lddustry, 'lalawi Development Corporation (MDC),

Investment and .e-lpmenc Bantc of Malawi (INDEBANK), and various

local SME-Suppor: institutions.

Amount: SDR 22.3 icillion, US$32 million equivalent

Terms: Standard IDA, witvi 4'! years maturity

Onlending Terms: RBM would through an Apex Ur:it onlend IJS$27.4 million equivalent

of the IDA Credit to eligible PFIs in local currency at a pre-

determined reference rate. The reference rate would be determined

by RBM as the prevailing average cost of term borrowing in The

financial system (about 13.625 percent in December 1990,

calculated as a simple average of all prevailing interest rates

on term deposits in Malawi). PFIs would relend the funds at

market rates to finance viable subprojects in the productive

sectors. RBM would pass to the Government the interest received

from PFIs, less a 0.5 percentage point fee to cover RBM's

administrative costs for operating the Apex Unit. The Government

would bear the foreign exchange risk out of the interest received

from PFIs. The Government would provide US$4.6 million equivalent

through RBM for institutional capacity development to

beneficiaries on a grant basis.

ProjectObiectives: The objectives of the project are to support Government efforts

to expand exports and improve the policy and institutional

framework relevant to private sector investment. These objectives

would be achieved by: (i) encouraging the commercial banks and

nonbank financial intermediaries (NBFIs) to c,igage in term

financing of viable enterprises in the p-oductive sectors,

including SMEs and enterprises owned 1y womin; (ii) improving the

institutional framework for export ,inance and investment

promotion, including support for a p.oposed investment promotion

agency and an industrial infrastructure and factory shell

development program; (iii) supporting the strengthening and

operational diversification of financial institutions; and (iv)

improving monetary policy management.

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ProiectDescription: The project would have three components. The Investment finaace

component (USS2C.4 million equivalent) would be onlent to eligiblePFIs through an apex arrangement at the RBM to finance projectsin the productive sectors promoted by foreign and indigenousentrepreneurs. FFIs would make subloans through mechanisms suchas leasing, equity finance and term loans. Equity investmentswould give preference to new ventures and be channelled throughthe development finance institutions (DFIs). The industrial sitescomponent (US$7 million), as an apex arrangement at the RBM,would ensure timely availability of industrial infrastructure toindustrial sites and factory shells to encourage investment byindigenous and foreign investors, especially those investing inexport-oriented activities. To qualify as PFIs under these twocomponents, financial institutions would have to be in compliancewith the provisions of the revised Banking Act and meet additionaleligibility criteria acceptable to IDA. The institutionalcapacity development component (US$4.6 million) would providetechnical assistance and training to: (i) strengthen RBM'smonetary policy management capability; (ii) assist Governmentto develop the institutional framework for the promotion offoreign and domestic investmen.t; (iii) support programs for MDC'sreorientation, and INDEBANK's diversification into merchantbanking and; (iv) to restructure the Post Office Savings Bank(POSB) into an autonomous and efficient financial institution;and (v) train local financial institutions' staff in projectappraisal-related issues, especially the institutions that supportSMEs and women entrepreneurs.

Benefitsand Risks: The proposed IDA Credit would fill a major gap in term financing

for the productive sectors in Malawi. Using the existingintermediaries, including the commercial banks and NBFIs, theproject would help strengthen institutional capabilities topromote, appraise and supervise viable projects. By increasingcompetition and the range of financial instruments, the projectwould enhance efficiency in term resource mobilization andallocation. Broader access to credit for investment willencourage real sector supply response and contribute significantlyto the Government's growth and adjustment strategy. Investmentpromotion would help diversify Malawi's base for foreign exchangeearnings by encouraging investments in export oriented activities.Initial investments are likely to be in labor intensive productiveactivities that would help alleviate the unemployment problem.Support for SMEs will also benefit women, three quarters of whomengage in some form of off-farm income generating activities.The major risks are the possibility of an economic slowdown,(which would discourage new investment), the conservative attitudeof banks and large enterprises, and Government slackening onreforms. Malawi has in the past achieved high rates of growth,primarily through a steady expansion in agriculture. The risk

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is alleviated by Government's continued emphasis on thedevelopment of agriculture as the mainstay of the economy, recentadjustment measures, and its strong commitment to implementingthe reform program. Recent industrial and financial sectorreforms have introduced competition in both sectors, which ischanging conservative attitudes and making banks and enterprisesmore responsive to market forces. Another risk is the possibilityof low investor response. This risk is mitigated by the favorableinvestment climate which is being created by the Government.

Proiect Cost Suzmnary

Estimated Costs: Local Foreign Total(US$ Million)_

Invest. Finance Comoonent: 11.9 20.0 31.9Industrial Sites Component 2.9 7.0 9.9Institutional Capacity Development 2.8 2.6 5.4

Total 17.6 29.6 47.2

Financing Plan:

IDA 2.4 29.6 32.0Government 0.4 --- 0.4Co-financing 0.1 0.0 0.1Project Sponsors 14.7 - 14.7

Total 17.6 29.6 47.2

Estimated Disbursements:

Fiscal Year FY91 FY92 FY93 FY94 FY95 FY96 FY97

Annual 0.5 2.9 6.3 7.3 6.1 5.1 3.5Cumulative 0.5 3.4 9.7 17.0 23.4 28.5 32.0

*Including the Repayment of PPF advances.

Estimated Completion Date: June 30, 1997Economic Rate of Return: Not Applicable

MALA.


I. SECTORAL ENVIRONMENT

Economic Setting 1/

1.01 Malawi, with a population of 8 million and pe. capita income ofUSS170, remains one of the poorest countries in the world. The economy hasa fragile and narrow resourse base that is dependent upon a few exports anda small domestic market. Such features make Malawi's economy vulnerable toexternal shocks, with the result that real growth in GDP fluctuates markedlyfrom year to year. On average, the economy performed better during the 1960sand 19'70s, led by higher investment in agriculture and infrastructure, thanin the 1980s. Between 1964 and 1979 real GNP per capita growth averaged3 percent per annum, making it one of the fastest growing economies in theregion. However, in the late 1970s, Malawi experienced a series of exogenousshocks and domestic policy weaknesses that substantially reduced per capitaincome growth. These shocks included a deterioration in terms of trade,ribing oil prices, and a civil war in Mozambique that disrupted traditionalexternal transpo:t routes and led to higher transport costs that posed aseriou,s challenge to an economy that has historically been characterized bypragmatic management. In addition, prolonged drought in the early 1980sfurther exacerbated the situation by severely reducing export volumes. TheGovernment's economic recovery program was impeded by further external shocksstarting in the mid-1980s, which included the closure of the main externaltransport routes, worsening terms of trade, and an influx of displacedpersons from Mozambique.

Structural Adiustment Policies

1.02 The Government launched a series of structural adjustment programsthroughout the 1980s in response to the repeated external shocks. Ultimatelyin 1987, the Government introduced a comprehensive structural adjustmentprogram, which was supported by the International Monetary Fund (IMF) underits Enhanced Structural Adjustment Facility, and two World Bank operations:Industrial and Trade Policy Adjustment Credit (ITPAC) and the AgricultureSector Adjustment Credit (ASAC). The macroeconomic objective of theadjustment effort is the resumption of higher levels of economic growth ona sustainable basis.

1/ A detailed review of the Malawi's economy is contained in the CountryEconomic Memorandum entitled "Malawi, Growth Through Poverty Reduction,"(Report No. 8140-MAI), dated March 22, 1990. A Third-Year PolicyFramework Paper (PFP), was reviewed by the Committee of the Whole inAugust 1990.

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1.03 In_the External Sector, the liberalization of foreign exchanigeallocattion and flexible management of the exchange rate are proceeding welland have resulted in substantial gains, by stimulating investment andincreasing capacity utilization. In general, the Gov rnment growth strategyromains to ensure further liberalization of trade and payments system and the.ILtinlellanCe of external competitiveness.

1.04 Fiscal Policy under the program aims at reducing public sectordeficits and macroeconomic imbalances caused by expansionary fiscal policyin previous years, and helping to mobilize domestic resources to supportprivate sector investment. Higher revenues and lower expenditures have beenachieved through expenditure controls, specific tax reforms and improvementin administration. The budget deficit excluding official transfers declinedto 6.6 percent of GDP in 1988/89 from 9.6 percent in 1987. A furtherreduction was expected in 1990.

1.05 Sectoral Policies. The Government also introduced reforms inseveral sectors. In agriculture, the reforms emphasize enhanced foodsecurity and efficient resource use by improved producer prices, eliminationof crop restrictions and increased support of the smallholder sector. In thefinancial sector, reform is focusing on increasing the role of market forcesin resource mobilization and allocation and in the conduct of monetarypolicy. Reforms are also being implemented to improve the financialperformance of the parastatal sector.

1.06 Implementation of the adjustment program has already had a favorableimpact on economic performance as reflected in a reversal of negative GDPgrowth in 1987 to positive levels from 1988 through 1990 (GDP grew by 4.3percent in 1989 and is estimated to have grown by 4.8 percent in 1990).Annex I shows the structure of GDP. Inflation decelerated from over 30percent in 1988 to 15.7 percent in 1989. The import liberalization programhas led to a strong recovery in manufacturing, construction and financialservices, supported by an expansion in fixed investment, which increased from13 percent of GDP in 1987 to 16 percent in 1989. About half of theinvestment was financed through national savings.

1.07 Despite the breadth of the reforms, Malawi's future growth facesuncertainty because of some remaining structural weaknesses that constraindevelopment of a sustainable response. The specific reforms needed tcaddress these structural weaknesses are highlighted in the following briefreview of the financial and industrial sectors. The proposed project wouldsupport the implementation of the reform objectives in both sectors.

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The Financial Sector 2/

Institutional Structure

1.08 The financial sector in Malawi is small and not yet well developed,but operates with very few distortions. The sector consists of formal sideinformal market segments. The formal sector comprises a central bank(Reserve Bank of Malawi); two commercial banks (the Nationa' Batik of Malawiand the Commercial Bank of Malawi); two finance houses (Mercantile Credit anidLeasing and Finance Company of Malawi Limited - LFC); a building society (Nt,wBuilding Society - NBS); four development finance institutions (DFIs); twosavings institutions; an insurance industry comprising a series of insurancecompanies and brokers as well as several pension and provident fund managers.Securities markets are almost non-existent and the issue of treasury billsand Government local registered stoAk (LRS) is limited to institutionalinvestors. The DFIs are the Investment and Development Bank of Malawi(INDEBANK), the Malawi Development Corporation (MDC), the Investment andDevelopment Fund (INDEFUND), and the Small Enterprise DevelopmentOrganization of Malawi (SEDOM). The savings organizations are the PostOffice Savings Bank (POSB) and the Malawi Union of Savings and CreditCooperatives Limited (MUSCCO). Annex II provides summary data on thedistribution of financial sector assets.

1.09 The Reserve Bank of Malawi (RBM) was established at the time ofindependence in 1964 and provides all the normal central banking services.RBM is charged with the responsibility of managing Malawt's foreign exchangereserves and the exchange rate, promoting monetary stability and a soundfinancial system, and acting as banker and ad-. isor to the Government. Inaddition, the central bank administers Malawi's exchange control regulations,issues and underwrites Government securities and regulates and supervises theactivities of most Cinancial institutions. Regulatory and supervisoryfunctions are being strengthened to respond to the new responsibilities andpowers of the RBM under the revised RBM Act (para 2.05).

1.10 Recent Performance. The health of the financial system in Malawitends to mirror the health of the overall economy. The commercial banks andall the major non-bank financial intermediaries (NBFIs) appear to be soundfinancially. The financial system in Malawi has recovered from a period ofuncertainty and general decline in the mid-1980s and has emerged stronger andmore efficient. The good performance is a tribute to the non-interventionistpolicies of the Government of Malawi that have allowed the fina.cialinstitutions to make autonomous operating and lending decisions based oncommercial considerations.

2/ A detailed description and analysis of the financial sector is availablein the Financial Sector Report No. 9009-MAI. This section of the SARgives a brief overview of the financial sector and highlights issues tobe addressed under the proposed IDA credit.

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1. 11 The two Commercial Batiks the National Bank of Malawi (:iM) and th1eCotmmnercial HanK of Malawi (CBM), have a long history of opera>'CInIS in Malawiandl are generally well regar-led by the banking public. Tho wicle branchnetwork and the use of mobile units in rural areas, lhas helped to goneratea large deposit base. Both banks have competent management and soundprofessional staff, who run the institutions on a commercial basis atndprofitably. In the early 1980s, the banks faced liquidity and portfolioprobleva; because of over-expo3ure to estate agriculture (tobacco).Throughout the mid-1980s, management focused on rebuilding the banks initoviable financial institutions with strong balance sheets. The process wascompleted in 1987. In the last five years, both banks earned an averagereturn on assets of becween 1 and 1.5 percent per annum. In the process ofrebuildirng the banks, management followed a highly conservative approachi tolending and business development, focusing on cash flow leieding for shlort-term working capital, supported by adequate collateral.

1.12 The larger NBFIs also appear to be in sound financial condition andhave played an important role in allocating and mobilizing fin.ancialresources in Malawi. Even the smaller financial institutions have performedreasonably well. INDEFUND, which targets medium scale enterprises, forexample, has operated cautiously and managed to achieve profitable operationsin 1988 and 1989. The DFIs among the NBFIs also play an important role inresource allocation, their capacity has been constrained by the lack ofaccess .o term funds. For those DFIs targeting Small and Medium Enterprises(SMEs) (such as INLEFUND and SEDOM), the constraint has been weakinstitucional capacity to promote, evaluate and monitor projects and toprovide effective technical assistance to SME entrepreneurs.

Monetary Developments

1.13 Monetary developments in Malawi have tended to reflect underlyingmacroeconomic and fiscal developments. Short-term fluctuations in the mainmonetary aggregates are pronounced, responding to changes in the countr-'sexternal position and fiscal policy stance under the constraint of currencyinconvertibility. The direct transmission of monetary effect is due, on theone hand, to the economy's narrow resource base and sensitivity to internaland external shocks, and on the other hand, to the shallowness of thefinancial system. Fiscal policy has exerted a major influence on the growthof the monetary base, with the borrowing requirements of the public sectorbeing a consistent and increasing source of monetary growth. In most yearssince 1979, credit extended by RBM to the Government and public enterprisesrepresented a large injection into the money base. Although the financialsystem has permitted financial resources to move out of narrow money intoquasi money, the lack of depth has prevented the further diversification intoalternative financial instruments. This situation partly explains a buildup in excess liquidity in the commercial banking system.

1.14 Historically, monetary policy relied on the use of credit ceilingsand flexible administration of interest rates. Other tools of monetarypolicy were sparsely, if ever, used. Towards the end of the 1080s, however,the Government and RBM initiated a process of reform thiat aimed to increasethe effectiveness of monetary policy and, thereby, improve the effiziency of

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resource mobilization and allocation. The main thrust of the reform, mostof which has already been implemented, is to move away from directquantitative monetary control mechanisms and toward the use of more flexible,market-oriented and indirect monetary instruments.

1.15 Credit Ceilings. A major element of the ongoing reform was theabolition of credit ceilings by the end of 1990. Necessary as these ceilingswere during the difficult 1980s for bringing macroeconomic aggregates undercontrol, they have had a detrimental effect on the development of thefinancial system.

1.16 Interest rates have been gradually liberalized during the secondhalf of the 1980s. From a system of complete administrative control before1985, the monetary authorities gradually deregulated the interest rate systemby mid-1990. This deregulation already has yielded positive real interestrates, lower lending rates and higher deposit rates in the commercial bankingsystem. Principal interest rates in Malawi over the period 1985 to 1989 aregiven in Annex III.

1.17 Excess Liquidity reduces the effectiveness of monetary policymanagement. Commercial banks with excess financial resources are not reliantupon the central bank for funding and monetary policy levers such as the bankrate, and liquidity and reserve requirements, are rendered less effective.This was the case in Malawi in the second part of the 1980s and forced themonetary authorities to resort to the use of tools such as credit ceilingsand direct inte-est rate management. Beginning in 1989, RBM started aprocess of using more indirect methods of monetary management, such asreserve requirements (since June 1989) to sterilize excess liquidity.Recently there has been a general decline in excess liquidity caused byeconomic recovery.

1.18 Development of Money Markets. Discount and Advance Facilities of RBM1have rarely been used in the past and have remained inoperative during therecent period of excess liquidity. The decline in overall liquidity levelsand the move toward the use of indirect monetary instruments will increasethe importance of such facilities and thereby the ability of RBM to influencethe level of interest rates. Primary sales of Government securities alsohave been sparsely used but the lower level of liquidity and the ongoingreforms will also foster the expanded use of the facilities and encourage thedevelopment of a money market. The IMF has provided an advisor on moneymarket development (para 2.06).

Resource Mobilization

1.19 Resource mobiliz. .- in Malawi has been hindered by many economicuncertainties, includint, e), -. l shocks and relatively high levels ofinflation. Although mobilization by NBFIs, especially the non-insurancefinancial institutions, grew by 18.5 percent per annum over the 1980s, anaverage annual rate of inflation of 16.9 percent meant that real growth wasconsiderably slower. Although there is seemingly not a strong relationship

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between deposit mobilization and the level of inflation, in the longer termthe real returns on savings have an impact on mobilization levels. Hence,the maintenance of positive real interest rates is an important determinantof long-term savings patterns.

Resource Allocdtion

1.20 In general, the financial system tended to act as a conduit of fundsfrom the private to the public sector over the 1980s. This resulted from thevarious economic shocks over the past decade which led to fiscal imbalancesand a growing reliance upon the domestic financial system as a sour:e ofpublic funding. This situation began to change in 1988 and increasingly morefinance was freed for use by private sector investment. Nonetheless, theoligopolistic nature of the economy and the skewed distribution of incomesin Malawi will continue to provide some bias against the allocation ofresources throughout the economy. The fragmented nature of the financialsystem and the high level of specialization of financial services has alsotended to work against a better allocation of resources. Introduction ofmore institutions in the financial market and development of more multi-purpose financial institutions could provide an element of competition withbenefits for both depositors and borrowers. As a longer term development,the evolution of a wider selection cf marketable financial instruments willalso serve to raise additional funds and allocate them in a more appropriatemanner.

Issues in the Financial Sector

1.21 The Government's strategy for the financial sector, as outlined inthe Statement of Development Policies (DevPol) and in the Third-Year PolicyFramework Paper, involves strengthening monetary control, deepening thefinancial system and improving the efficiency of resource allocation forprivate sector investment. The major issue in the sector has been itsinability to respond with flexibility to investor financing needs. TheGovernment of Malawi, therefore, with IDA support undertook a review of thefinancial system that identified necessary policy reforms to deepen financialmarkets and improve efficiency in resource mobilization and allocation.Several of these reforms in monetary policy have already been implemented ashighlighted above, while others are in the process of being implemented.

1.22 Asset Concentration. The financial sector has a high degree ofasset concentration. Most banks and NBFIs are effectively controlled by asmall number of agricultural and industrial conglomerates, which havedominant market positions in Malawi through interlocking ownerships. Theresulting concentration of deposits and loans goes against sound bankingprinciples of deposit and loan diversification and reduces intermediationefficiency. Several steps have been initiated by the authorities that couldhelp mitigate the more perverse effects of excessive banking concentrations.These include encouraging the entry of new players into the banking sector,switching parastatal financing from the budget to the commercial banks, andsyndication of large loans so as to spread their risk. Nonetheless, the

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problem of concentration will remain into the future. In the medium term,the authorities should also encourage the stronger financial institutions tooffer equity shares to the general public as a means of de-concentratingownership and broadening Malawian participation in the economy.

1.23 Lack of comietition. The high concentration, has led to concernsover the lack of competitive pressure in the banking sector. Severaldevelopments are now occurring which make this less of an issue for thefuture. These developments, include emerging competition between the twocommercial banks; the aggressive entry by LFC into the market; the movementby the commercial banks into non-traditional areas of activity such as termlending; and the granting of a license to INDEBANK to engage in a wider rangeof merchant banking and financial services. The authorities are also hopingto attract more players into the market and gradually deconcentrate theownership structure within the banking sector. As a first step theauthorities plan to adopt an open and transparent process in theconsideration of applications for entry into the banking system by bothforeign and domestic financial institutions and NBFIs. The banking licenseto INDEBANK was the first granted under the new process. The proposedProject would complement efforts to introduce competition by supporting thereorientation and diversification of several NBFIs (paras 2.14 - 2.20).

1.24 Term Finance. In the recent past, the commercial banks tended toinvest the excess of their liquid funds in Government securities. The excessliquidity reflected both the very conservative lending policies of thecommercial banks as well as the attractive yield offered by Governmentsecurities. For the insurance companies and POSB, which are the mainmobilizers of term savings, investment in Government securities has in thepast been mandatory. The other NBFIs that potentially represent the mostinnovative part of the financial market, are constrained by the lack ofadequate term resources. INDEBANK and MDC have in the past dependedexclusively on external borrowing to fund their lending activities. Thechallenge is therefore to create effective intra-market intermediationmechanisms in Malawi that facilitate the flow of resources betweeninstitutions and enable some term transformation to take place. In thelonger term, a likely solution will be to encourage the development of newnegotiable instruments, loan syndications, direct domestic depositmobilization by the DFIs and the issue of equity shares as a means ofmobilizing longer term resources. The proposed Project would support thedevelopment of new financial instruments (the project has already supportedthe flotation of a bond by INDEBANK) and encourage the commercial banks toundertake term lending.

1.25 Asricultural Finance. Agriculture is a large and important part ofthe Malawi economy. This is reflected in a substantial proportion of thecommercial bank's loan portfolio allocated to agriculture. However, banklending to agriculture is almost exclusively to the large estate sector whilemedium and small-scale agriculturalists are locked out of the more formalfinancial markets by a lack of security and an absence of an establishedbanking history. Outside the estate sector, the typical farmer is very smallwith holdings of less than one hectare. These farmers are served, to someextent, by the Smallholder Agricultural Credit Administration (SACA) that ismanaged by the Ministry of Agriculture (MOA). Together with agricultural

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services, SACA provides mainly short-term seasonal input loans. Thie 6clk ce,which has been limited to larger small-scale farmere, has bee,, .elysuccessful with collection ratios of between 75 and 95 percent. Although,the scheme has recently been expanded to cover a wider range of small-scalefarmers, further steps will be needed to cater fully for the needs ofsmallholder agriculture. Under ASAC, the Government is reforming agricultureto increase productivity of a broader range of small holders and estatesincluding changing laws to allow smallholders to grow high-value cash crops.These reforms will increase smallholder access to credit.

1.26 Parastatal Finance. The performance of the parastatal sector, whic1hforma a large part of the total economy and contributes around one quarterto national income, has been erratic. Poor performance in the mid-1980s ledto a World Bank survey of the seccor in 1987 that identifi2d the followingmain problems: a focus on bureaucratic detail at the expense of biggerissues; a focus on smaller parastatals and inadequate monitoring of largerones; insufficient attention paid to efficiency; and an over centralizationby Government of decisions best made at the parastatal level. Since thenrationalization and restructuring of many of the parastatals has led to asubstantially improved financial position. The restructuring of theparastatal sector included the reorganization of the Agricultural andMarketing Corporation (ADMARC), MDC and the privately held Press Group (whichoperates like a quasi-public entity).

1.27 The issues that remain of concern in parastatal finance inc)ude:intermediated loans to private companies through parastatals by the RBM; alack of consistency in the passing of foreign exchange risk to parastatalsand the level of interest rates charged; streamlining and reorientating POSBoperations (para 1.29); the current dormant state of MDC; and the relianceof parastatals on Government financing. The Financial Sector Reportrecommended that: intermediated loans through parastatals to privatecompanies should be discontinued; a consistent set of rules on interest ratesand exchange rate risk should be applied; MDC should be strengthened andassisted to adopt a more aggressive and catalytic developmental role in boththe financial and industrial sectors; and, more parastatal financing shouldbe moved to the commercial banking sector and away from its current relianceupon Government. Measures to address several of these issues have beeninitiated by Government with IDA support.

1.28 The Post Office SavinRs Bank (POSB) was established in 1911 tcprovide savings facilities for small rural and urban savers through theMalawi post office system. POSB plays an important role in mobilizingsavings by providing a geographically wide service through 158 post officesand 126 agencies. As at the end of 1987, POSB had total deposits of K89.4million against total liabilities of K104.1 million. All of POSB'S resourcesare invested in Government securities. The POSB system apparently functionedwell until 1986 and, although it has faced technical difficulties since then,it is still considered to be financially sound.

1.29 After 1986, POSB suffered from a major change in computing systems,which resulted in a work backlog exceeding two years that has persisted untilnow. Other problems still exist such as determining the new sources ofinvestment for an institution traditionally reliant upon Government paper (in

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an environment where such paper is in increasingly ohort tuppiy) ; the needto eliminate provision of a tax exempt status on savings deposits tocorporate savers who are frequently holding multiple accotunits; anddetermining the future role of the POSB in the evolving financial system.In addition, the current organizational structure makes POSB management notfocussed and without necessary discretionary authority to successfully runa commercially oriented institution. The POSB currently operates as adepartment of the Malawi Post Office, which in turn operates as a TreasuryFund in the Ministry of Finance. The proposed Project would help Governmentand the POSB address the operational issues and efforts to create the POSBas a separate legal entity operating separately from the Malawi Post Office.

1.30 Small and Medium Enterprise Finance. Financial services to thesector are from three primary sources: (a) DFIs which onlend donor orGovernment supplied funds; (b) the informal financial sector; and(c) personal and internally generated savings. The two commercial banks arehesitant to service the SME sector because of the high administrative costsand the perceived high-risk associated with clients in the sector. TheGovernment is committed to liberalize the financial sector in order toprovide adequate finance and ease access to credit for SMEs.

1.31 During the 1980s, financial institutions (SEDOM, INDEFUND, andMUSCCO) were established to service the SME sector. These institutions hadprovided as of end-1989 a combined total of K26 million (approximatelyUS$9.6 Million) through 1,076 term loans and 2,684 short term credits to atotal of 3,861 clients. Most of the funds were largely disbursed as termcredits with average maturity of 60 months and interest rates ranging from16.5 to 18.5 percent (slightly below prime). Seventy-two percent of thetotal number of loans disbursed have been working capital loans extendedthrough SEDOM. These 12 month credits at 18 percent per annum are animportant source of funding for entrepreneurs given the limited availabilityof commercial banking services for the smaller enterprise sector. Agro-industry is the principal sector served, ranging from 32 to 39 percent of theportfolios of DFIs.

1.32 The Informal Credit Market provides a significant share of the SMEsector's capital requirements. Although providing only 35 percent of thetotal value of loans, more than 10,000 SMEs are estimated to have borrowedfrom the informal institutions. Informal financial intermediaries providecredit services that are suited to the needs of their borrowers, includingease of access to credit, simple procedures, personal guarantees that areconsistent with the repayment ability of the borrower, absence of controlsand restrictions on the uses to which loans can be put, flexibility inrepayment terms, confidentiality, and low transaction costs to the borrower.The very high interest rates do not seem to discourage borrowers (Table 1).

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Table 1:MALAWI - 1988 Loans Advanced From Informal & Formal SME Credit Sources

Amount InterestLender (KOOO) Number Rates

Money Lenders 2,106 10,582 50-100% a/

Traditional Creditand SavingsAssociation 1,221 NA 10-13%

Targeted FormalLenders 6,316 694 16-18%

Sources: Chipeta, C. The Informal Financial Sector as Survival Strategy.

Author's elaboration of data from 1988 financial statements for

INDEFUND, SEDOM, MUSCCO

a/ These interest rates may apply for periods varying from a few days to

several months. Consequently, the annualized rates end to be

substantially higher.

1.33 The recently established Malawi Mudzi Furd is modelled after the

successful Grameen Bank of Bangladesh will supplement the lending activities

of SACA in rural areas. Mudzi Fund only commenced operations in mid-1990 and

hence no assessment of its role has been possible. SACA, which lends through

farmers clubs, has demonstrated the benefits which can flow from group

lending activities. The development of the Mudzi Fund is a further extension

of the group lending concept. Group financial activities have proved

themselves more amenable to repayment of loans and hence enhance the capacity

for further, future borrowing.

1.34 Technical assistance to SMEs for the development of new

entrepreneurs is provided by a number of programs subsidized by donor

agencies. Delivery is undertaken by SEDOM, MUSCCO, the Development of

Malawian Traders Trust (DEMATT) and, to a lesser extent, the Malawian

Entrepreneurs Development Institute (MEDI), the Rural Trade School, the

Polytechnic and a technical training school at Salima. Program objectives

have so far been modest relative to demand and have favored new

entrepreneurs. Existing entrepreneurs would benefit from more and better

structured business administration courses. Technical assistance is needed

particularly for the training of trainers.

1.35 Constraints to SME Borrowers. Principal constraints to financing

SMEs through formal financial institutions include the ability of the

borrowers to meet project preparation requirements, equity contribution

ratios, collateral requirements and, at times, the viability of project

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proposals. Equally important is a policy environment that has been a majorconstraint on SME development. The reactivation of a credit guaranteefacility operated by SEDOM and possible establishment of venture capital orequity funds might help to overcome local bankers' reluctance to lend to non-prime borrowers. The recent introduction of market-determined interestrates, together with modifications to the management of the money supplyoutlined above, would improve incentives to lend to non-prime borrowers. TheGovernment is committed to encouraging lending to SMEs to be based on marketdetermined interest rates (with appropriate adjustments for risk). Equallyimportant the Government and the donors involved in the sector agree on theneed for DFIs supporting the SME sector to be self-sustaining in theirlending operations. The Government plans to introduce policy changes thatreduce key restrictions on the development of SMEs, including liberalizationlof the blanket prohibition of any business activity in residential areas.

1.36 Particular Challenges of Women Borrowers. A large number (about 75percent) of women engage in some form of non-farm enterprise as an importantsource of revenue. Nevertheless, women have limited access to the servicesprovided by most financial institutions. For SME assistance organizationsto better reach women, they need to broaden their target groups to includethe types of enterprises in which rural women participate, experiment withassistance strategies that more effectively reach women and include morewomen on their staffs. The recent initiatives such as the MUDZI Fund and thenewly established Women's World Banking of Malawi (WWBM) may help to addresssome of these constraints faced by women entrepreneurs.

1.37 Capacity Constraints of SME Institutions. Virtually all of theinstitutions which service the SME sector are relatively new having begantheir operations in the last dozen years. A review of these institutionsdemonstrates mixed performances. Management talent is relatively scarce,hindering the ability of the institutions to effectively deliver technicalassistance to SMEs. For these institutions to reach their potential theywill have to develop an aggressive human development resource strategy whichwill groom talent from within their ranks. The newly established MalawiInstitute of Management (MIM) is a resource which can be more fully utilizedto foster depth in the management ranks (a write up on MIM is available onProject File). The College of Accountancy also provides a variety of coursesthat are well suited to strengthen the skills of lower-level professionalstaff.

1.38 Development of Capital Markets. Capital markets are underdevelopedin Malawi, however, the Government is committed to encouraging thedevelopment of money and capital markets. Although the types of instrumentsthat capital market development would provide are currently not available,recent studies show that there would be a reasonable demand for these typesof instruments. In 1990, the passing of the Capital Market Development Actand the issue of bonds in the local market by INDEBANK are a significanitfirst step towards the development of a capital market in Malawi. As themarket develops further, brokers/dealers need to emerge to provide asecondary market to primary issues of capital market instruments. A majorissue in Malawi is the lack of incentives for private companies to issuetheir shares to the public. As a result there virtually are no publiccompanies in Malawi. Under current legislation, private companies are

r t i I • Ic r am'.. i he: timr £mretm U', or h a vIrng twr.(, I '.inL 50SlAroho I d(ora !l afi/ / makinz g .iy Inv it at ion to the public t mc qkiirc' any

charet (r (kmbeloa OLr ( of liet com1panly. Inlt ial] y, to stimulate tho market , t hoaut horlt i (!3 may have a O pvovl deo .neilm iven to companies t hat go p blic: andto individlime s. AnId toilpanies that purchase debt and equity thruugtl cpitalma,ket mechaisiamu. The ocitablishrnent of an investment or unit. trust, holdingthe shareb of some parastataJi; to be privatized, could also assist In marketgrowth. Thle propose-o IDA cdit would support the ongoing initiative., intialawi to develop a m;simla1l uimmrket, including the development of a prudentialregulatory and superVi;oYy tramework. The authoritie6 will, by September 30,

1991, establish a stonci-ig committee, to provide guidance and oversight tothe development .2f capital markets in Malawi. To ensure efficientdevelopment of capital markets, the authorities plan to rationalize the taxtreatment of various financial instruments, including taxation of dividendsand capital gains, and the removal of the tax exempt status of interestearned on deposits at POSB.

Conclusions

1.39 The new direction of monetary management and the development of thefinancial system have been significant since late 1988, as the Government andRBM have initiated a comprehensive financial sector reform program. Thesystem of rigid and direct controls which was used for most of the 1980s isbeing superseded by a more market-oriented system of monetary policymanagement.

1.40 Recognizing the strong linkages between an efficienL financialsystem and the quality of investment, the authorities are seeking to enhancecompetition, by allowing new financial institutions (both local and foreign)to enter the market and by licensing existing institutions to broaden thescope of their activities. Steps have already been taken on the latter bygranting a banking license to INDEBANK and by initiating measures to re-orientate the operations of POSB. It is also likely that other existingfinancial institutions will branch out ineo new areas of activity, such aslease financing. If the financial sector is to become more dynamic andcontribute more to economic development, among issues which need to be keptunder active review are: a reduction in direct or indirect public ownershipof financial institutions; Government maintenance of fiscal discipline inorder to avoid crowding out the privace sector; maintenance of marketdetermined interest rate policy; and shifting parastatal borrowingrequirements to the commercial banks rather than the Government. As part ofthe ongoing dialogue with Government, IDA will work toward findingappropriate means and ways of deconcentrating asset ownership and increasingprivate participation in the economy. One of the most significant measuresrecently taken is the enactment of the Capital Market Development Act, thatprovides the legal framework for the longer term development of a capitalmarket in Malawi. Besides introducing competition, a capital market wouldfoster a more efficient intermediation process and direct financial flows inappropriate maturities and price to investments with the highest return.

1.41 Basing monetary policy and future developments on the aboveprinciples will help to ensure that the financial sector contributes moreefficiently to future economic growth. The proposed Project would support

I I

implementation of the reforms out Ii ned above and t e &I 't i- I iV Of f OrtSmodernize and deepen the sector.

Industrial Sector 3/

1.42 Introduction. The contribution of Ma3awi's 1i,0doitrial se.-tor toeconiomic growth, employment and exports was negligible dirliig thie 1980s.This performance s-ands in sharp contrast to the sector's record during tlbe1970s, wlheni manufactLuring output grew from abouit 9 percent to 12 percent ofCDP and employment. Industry's strong performance during the late 1960s andthroughout the 1970s was in large measure a reflection of the underlyinlmacroeconomic developments. The down ttirn in industrial performance has iel,nin part the result of the external shocks anid lnterrial policy weaklinsseF.

1.43 The pattern of industrial production in Malawi is typical ofcountries at an early stage of industrial development and relatively lowlevels of per capita income. The bulk of industrial production stems fromfive subsectors, food, beverages, tobacco, textiles, and clothing and leathergoods.

1.44 Concentration. Malawi's domestic industrial market, like thefinancial sector, is characterized by a great concentration of output andownership. The three holding companies -- Press Holdings, the MalawiDevelopment Corporation (MDC), and the Agricultural and Marketing Corporation(ADMARC) -- own a sizable percentage of the sector's total equity. Finally,there are very close relations between industrial and financial institutions:Press Holdings and ADMARC own controlling interests in the majority offinancial institutions in the country. The authorities recognize that thedegree of concentration is a problem and have in the past tried to addressit by restructuring the three major corporations, Press, MDC and AD11ARC.

1.45 The high degree of concentration is neither surprising nor, in theshort term, necessarily bad for a country with a small domestic market andlow per capita income. Domestic firms cannot be expected to provide a widerange of goods at a reasonable cost because efficiency often requires longproduction runs. The size of the market then dictates concentration on thoseproduct lines that can be produced at reasonable cost. However,concentration implies that domestic competition cannot be expected toengender pressure to reduce costs and improve quality. These pressures mustcome from imported products and in the medium term, from delibrrate effortsby the authorities to deconcentrate the market by allowing .nd enc ourag r-'entry by more efficient and viable import-txbstituting ^.,d oy;ort- i.tccproducers.

1.46 Export Orientation and Import Dependence. Malawi's landlockedposition gives rise to high transport costs that provide a natural protect0onagainst imports, but also acts as an obstacle to exports. In 1980, tlhe CIF

3/ Detailed description of the industrial sector is contained in the Wor:dBank's "Malawi, Industrial Sector Memorandum," Report No. 74302-MAI ofDecember 14, 1989.

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value of imports was 38 percent higher than the FOB value. As a result ofthe clobure of the Mozambique trade routes during the 1980s, the CIF marginis now about 40-45 percent. Such high transport costs markedly reduce theprofitability of industrial exports, especially those based on imported rawmaterials, and could discourage potential export producers. At presentindustrial exports account for about 3-8 percent of all exports. Of thisproportion, about two-thirds are textiles and clothing products that areprimarily based on domestic raw materials and whose value-to-weight ratio ishigh. The authorities are eager to encourage investment in export-orientedproduction of high value added products.

1.47 There appears to be reasonable scope for expansion of exportoriented activities in Malawi. Although transportation costs will continueto reduce Malawi's comparative advantages in export production compared tocountries in the region, it does have certain other export advantages. Withits low-cost and productive labor and fertile soils, Malawi can expandproduction of agricultural export commodities with a low transport component.Such high value, non-traditional export commodities include spices (chilies,cardamoms, dhalls), specialty nuts (notably, macadamia nuts) and otherhorticultural products. In addition, textile producers could make greateruse of the various export quota arrangements under the Lome Convention andthe Generalized System of Preferences, to export larger volumes of clothing(as has been done successfully in Zimbabwe and Lesotho). In the medium term,the normalization of operation of the Nacala railway line, means thatexporters should position themselves to take full advantage to expand exportproduction in concert with a greater carrying capacity on the line.

1.48 Industrial Efficiency. About one-half of the country's exportearnings is used to import raw materials for industry. In addition, industryimports fuel and capital goods. Considering that foreign exchange is likelyto be the most important growth constraint in the medium term, the efficiencywith which industrial enterprises transform inputs into outputs is a crucialconcern. Fortunately, the majority of Malawian firms are efficient from aneconomic view point. About 90 percent of the value added generated in themanufacturing sector in 1987 was done under clearly efficient conditions andless than 3 percent under clearly inefficient ones (largely the result of lowcapacity utilization because of foreign exchange scarcity for raw materialimports at that time). In 1987, this degree of efficiency places Malawi ina select group of sub-Saharan African countries that includes Kenya andZimbabwe.

1.49 Growth Prospects. Despite its lackluster performance in recentyears, manufacturing is capable of contributing to future growth of output,employment, and exports. Growth prospects have improved with recent higherinflows of foreign exchanga resources and an opening up of foreign exchangefor imports. In the short run, industrial output can expand to satisfy thegrowing domestic market needs. In the medium- to longer-run, further growthwill have to come from exports, but a sustained export drive will requiresubstantial amounts of foreign exchange for investment in new lines ofproduction and further policy change. Malawi's wages are among the lowestin the world, consequently, Malawian industry has an advantage in labor-intensive processes and could increase its exports even if only to theregion. Moreover prospects now appear brighter for reopening of Malawi's

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traditional trade routes through Mozambique, with a consequent reduction intransport costs. With appropriate training of the labor force and the righttechnology, the potential for diversification and increasing industrialexports would be considerably enhanced.

Issues in the Industrial Sector

1.50 The Government has moved substantially towards creating a moreliberal trade regime. In 1988, under ITPAC and subsequent reform programs,the Government introduced several reforms including trade liberalization,deregulation of pricing, flexible management of the exchange rate, andliberalization of foreign exchange allocation. The industrial sector,however, still faces several constraints that hold back its contribution toeconomic development. To encourage new investment, the Government plans tofurther reduce both the level and dispersion of protection and simplifyimport and export licensing requirements. As part of the project preparationof the proposed IDA P.roject, the Government requested Bank assistance inidentifying these constraints and recommending measures that would hellstimulate investment in Malawi. In April 1990, an IFC/MIGA ForeignInvestment Advisory Service (FIAS) mission carried out a diagnostic reviewof Malawi's investment climate. In October 1990, the Government drafted anInvestment Policy Statement that outlines policies regarding taxation,exports, exchange controls, investment protection, industrial land, andinvestment promotion. A copy of the Investment Policy statement wassubmitted to IDA by Government at negotiations. The following is an overviewof the major issues identified and suggested solutions that would translatethe Investment Policy objectives in an implementable action program.

1.51 Regulatorv and Procedural Framework. The FIAS review found that theregulatory and administrative procedures for treating foreign investment havenot been liberalized to keep pace with the Government's macroeconomic policyreforms. The attitude of control continues to dominate and discourageinvestment. The attitude is prevalent, particularly in five key areas:(a) industrial licensing; (b) company formation; (c) capital transfers (bothinward and outward); (d) trade licensing; and (e) access to land. TheGovernment is committed to reducing bureaucratic delays in industriallicensing and company formation to one step with the Registrar of companies,eliminating the requirement of approval by Ministry of Trade, Industry andTourism (MTIT) and the Police. The Government will also ease foreignexchange controls to facilitate capital flows and streamline theadministrative procedures that delay access to industrial land. Access toland is one of the most serious problems undermining the investment climatein Malawi. To help reduce the delay, the Government proposes to provide forthe timely availability of ready-made factory shells for potential investors.Leases for the factory shells would be speedily processed, because the landalready would have been properly zoned and surveyed, plus the necessarybuilding permits would have been obtained. The proposed Project wouldsupport these efforts by financing the commercial development of factoryshells program and the necessary supporting infrastructure.

1.52 Encouraging Export-Oriented Investment. The Government hasintroduced a series of measures to encourage export-oriented investment innon-traditional export products. The measures include: a reduction of

16

protection given to) producers for the domestic market; elimination or

reduction of taxes on imported inputs; allowing manutifacturing-in-bond;provision of a syntem of duty drawbacks; and strengtheninig of the Malawi

Export Promotion Coonl-i; to sutpport export promotion and development.

Additional measures to be taken include:

(a) streamlinIng adminiistration of the current incentive system,includinig manufactturinig-in-bond and the duty drawback system;

(b) establishing a system for providing export credit and infrastructure

at. competitive and market-determined prices;

(c) eliminating disincentives to exports including reduced domestic

protection through a rationalization of trade taxes and duties and

maintenance of an appropriate exchange rate; and

(d) increasing incentives for exporters, including a lower competitive

corporate tax rate and possible development of aa export processing

zone.

1.53 DeveloRing the Institutional Framework for Investment Promotion.

Presently, Malawi lacks a centraJ office to promote investment in the

country. Assistance to potential investors is ad hoc and dispensed by a

large number of institutions. The lack of a central promotion office forces

investors to fend for themselves, without any sense that they are welcome in

the country. Although the absence of a professional promotion effort does

not undermine the investment environment, it probably reduces the amount of

investment flowing into Malawi. The proposed IDA Project would assist the

Government establish an investment promotion agency to help investors

interact with the Government and obtain official support services, as well

as to promote local and foreign investment in Malawi.

1.54 Government Policies and Promoting SME Development. The development

of SMEs remains a critical element in the Government's strategy to support

economic growth, employment generation, and poverty alleviation. As

highlighted elsewhere in this report, the major constraints on the sector

are: limited access to credit for working capital; inadequate initial start-

up capital; and restrictive regulatory policies. Under the Lome IV

Agreement, the EEC and KFW plan to assist the Government to significantly

expand the pool of resources available to SMEs. USAID is also providing

significant funding for the sector. The amount to be provided, which has not

yet been determined, would be provided as parallel cofinancing to the

proposed IDA project. The Government, with funding from UNDP and support

from other donors including UNIDO, GTZ, EEC and the World Bank, will review

regulations regarding business locetion and licensing, land use zoning and

introduce measures aimed at stimulating growth in the sector. Progress has

been made in recent years in the policy framework for SMEs. The proposed

Project would support SME development by providing technical assistance for

training and dissemination of information on business opportunities and

technology.

1 7

Demand for Investment Credit

I *.)) I[A'; growth projections estimate a real GDE' growthl rate of 5per(ceut for 1991, aii average of 4.5 percent during the period 1992-93, and') porceilnt for 1994-95. These projections are based o01 assumptions ofconit iniued good performance in the agricultural sector, a favorabletmcroeconomic envirotunent, and higher levels of investment in response to thieonyIluFg reform program. T:iis growth strategy implies a gradual increase inthme rate of fixed investment {ron, the 1989 level of 16 percent of GDP to 18.5peroent in 1995. The major source of investment growth will come from theprivate sector aid will be financed primarily by domestic savings,complemented by foreign savings. Domestic savings are projected tostrengthen from about 12 percent of GDP in 1989 to 15 percent over thieporiod, based on a conservative estimate of the impact on domestic resourcemobilization of the ongoing reform of the financial sector.

1.56 Short-term Working Capital Credit. The working capital needs of thelarger enterprises, which tend to be creditworthy and have adequatecollateral, ere financed by the banking system. SMEs generally rely onpersonal or internal cash generation, loans from the informal system, anddonor or Government supplied funds through specialized agencies. Due to therecent excess liquidity and lack of alternative investment opportunities,commercial banks hc.ve begun Fo lend to well-collateralized SMEs. Theexpectation is that enterprises will continue to fund their working capitalneeds mainly through existing institutional arrangements.

1.57 Demand for Term Credit. Investment in industrial production fordomestic consumption has been adversely affected over the past decade by anuncertain investment climate generated by economic instability. Demand forterm credit is expected to increase substantially, now that the economy isclearly on a growth path. This project will, therefore, play an importantrole in providing financing for plant modernization and expansion, to allowdomestic producers to increase production to meet the needs of the localmarket. Additional demand will be generated by firms diversifying or makingnew investments for export production, in response to the proposed exportincentives package.

1.58 A review of the project pipeline of financial institutions activein the provision of credit suggests that for the larger enterprises,effective demand based on actual loan applications and commitments amount toaround K69.3 million for 1989. Demand for term credit by SMEs in the formalsector was estimated at around K9.6 million for the same period. Therefore,a term credit demand estimate of K80 million by the formal enterprise sectorfor 1990-91 appears reasonable. A conservative assumption of an annualgrowth rate of around 5 percent in demand for term credit over the next threeyears, in line with GDP growth projections, would lead to an estimated K375million (US$150 million equivalent) in term credit demand by the formalsector during the 1991-93 period.

1.59 Supply of Term Credit. As indicated above, foreign savings willhave to complement domestic savings if the Government's growth strategy isto be achieved. Although the commercial banks have recently provided someterm credit, they will continue to provide short-term credit and leave demand

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fu.- torm credit unsatisfied because lack of access to long term resourcesmake; it difficult for them to sustain lending of similar maturity. The DFIsservitig tthe larger enterprises are emall and, therefore, c.n not satisfy thel(marnd for te-m credit. It is in this context that the proposed Project wasdeveloped, to provide term resources and thereby encourage the commercialbankss to inC rease the level of term lending.

1.6U IThe estimated term credit demand of US$150 million would be financedfrotm various sources. The European Economic Community (EEC), KFW and USAIDare expected to make sufficient funds available to meet the credit needs ofthe SME sector. The amounts have not yet been specified, but are estimatedto be in the order of US$30 million over the next three year6, in line withesttlmated demand for the sector. The proposed IDA project credit wouldprovide US$28 million for term financing. The local financial institutionsand project sponsors would need to provide the balance of about US$100million. Foreign exchange for this part of the total investment would beavailable through the proposed Entrepreneurial and Capital Market AdiustmentCredit (ECMAC) of US$60 million and other donors. The proposed !DA projectline of credit of US$28 million is therefore a conservative amount, relativeto expected total needs.

Government and Bank Strategy

1.61 The World Bank's Country Strategy. The Bank country assistancestrategy supports the Government of Malawi's medium-term developmentstrategy. Support i8 directed at four critical and interdependent areas ofthe Government's development agenda: (i) economic growth; (ii) sustainablelong-term development; (iii) poverty reduction; and (iv) public sectormanagement, within the context of macroeconomic scability. The support isbeing provided through a mix of project and non-project lending, economic andsector work and aid coordination. Based on the lessons learned from pastBank performanc;. in Malawi, the following features have been incorporatedinto the country strategy: (a) institutional strengthening to improvecapability in policy formulation and implementation; (b) better integrationof macroeconomic and sectoral issues; (c) emphasis on secto. adjustmentoperations to concentrate the policy dialogue on a smaller, more manageableset of priority policy issues; (d) emphasizing the role of the private sectorin the delivery of goods and services; and (e) improving the efficiency ofdonor programs. The proposed Financial Sector and Enterprise DevelopmentProject (FSEDP) is a key component of the overall Bank strategy. Theproposed FSEDP would provide investment resources and technical assistanceto facilitate a strong supply response from the strategy.

1.62 Past Bank Strategy. The Bank's lending and economic work over thepast decade has played a role in supporting the Government's efforts tostabilize the economy and renew growth. In particular, the Bank's analyticalwork and policy dialogue have helped Government identify and implementappropriate policy responses to emerging issues of macroeconomic management.The provision of quick-disbursing funds under SAL operations providedessential resources to relieve balance of payments pressures and supportprivate sector import requirements. In addition, project lending continuedto support sectoral development strategies and high priority public sector

-1 9 -

investment programs. Finally, the Bank has been instrumental in coordinatiiigdonor assistance and mobilizing substantial amounts of external resources tosupport Malawi's financing requirements. The most visible donors in theindustrial seccor, especially in SME sector have been the EEC, KFW, FMO,USAID and UNDP.

1.63 Previous Bank Operations. As of June 30, 1990, the Bank Group lhadapproved 58 projects amounting to US$1,029 million (excluding cancellations),consisting of 53 IDA credit (US$897 million), 10 IBRD loans (US$106 million,and 5 IFC operations (US$25.8 million). In industry the Bank has approvedthree projects for Malawi (totalling US$81 million): (a) ITPAC (US$70million equivalent) to support policy reforms; (b) the INDEBANK Loan No.1610-MAI (US$2.76 million) to support investment; and (c) the Industrial andAgriculture Credit No. 2646-MAI (US$7.8 million) also for investment. Thecredits in industry have all been successfully implemented and are eitlherclosed or nearing completion, with a minimum of cancellations. A ProjectCompletion Report (PCR), No. 6334-MAI of June 27, 1986, was prepared for theINDEBANK loan. One of the most important lessons learnt from previousoperations is to avoid separate treatment of financial institutions in Malawithrough different onlending terms and conditions. Experience from theIndustrial and Agricultural Credit (Loan 2646-MAI), which initially movedslowly, suggests that INDEBANK's borrowers who had to assume the foreignexchange risk under the industrial component were initially reluctant toborrow because of difficulties in servicing their subloans in an environmentwhere there were major currency depreciations and no mechanism for hedgingagainst such risks. The clients were able to subsequer.tly borrow as themacroeconomic situation stabilized. Under the proDospd credit, unifiedtreatment of financial intermediaries and their clients aiross sectors willpromote a generalized set of financial characterist:L . (interest rates,exchange risk assumptions, etc.) that will ensure thaL .rvestments in allproductive sectors will be treated equitably. The degree of exclusivityenjoyed by INDEBANK under previous arrangements will a'so be replaced by amore competitive degree of access to resources.

II. PROJECT RELATED INSTITUTIONS

Introduction

2.01 The proposed Project will promote the diversification of Malawi'seconomy by providing term funds (both equity and loan) fot investment inproductive activities, especially non-traditional export products. Equallyimportant, the project would assist in strengthening and reorientating keyfinancial institutions in order to deepen the financial sector, and enhancedelivery and access to financial services by industry. The Project wouidalso help strengthen several institutions that provide non-financialassistance to the industrial SME and export sectors. This Chapter reviewsthe principal financial institutions that are expected to intermediatefinancial resources under the proposed Project. More detailed analysis ofthe institutions is given in the Annexes.

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The ReRerve Bank of Halawi (RBM)

2.02 UJnider the proposed Project, RBM will be responsible for managingthe Investment Finance and Industrial Sites Components via an apex unit,supervising thle participating financial intermediaries ('FIs), managing thietechnical assistance component, implementing financial sector reforms, anidoverseeing general project implementation including procurement,disbursements, accounting and auditing, and special accounts.

2.03 RBM operates under a Board of Directors chaired by the Governor.In addition to the Governor and the Deputy Governor, day-to-day managementconsists of a General Manager (currently vacant) and four deputy GeneralManagers, each for the following key functional areas: economic services;operations; administration and bank secretary; and the Blantyre Branch.Below the Deputy General Managers are the departments: Accounts;Administration; Bank Inspection and Audit; Banking and Currency; Dataprocessing (computer services); Exchange Control; Foreign Exchange; andResearch and Statistics. The Research and Statistics Department has in thepast been successful in managing IDA credits to Malawi as well as other donorcredits. The Director of Research and Statistics heads the Department andis supported by a team of competent economists. The apex unit that would beresponsible for the administration of the proposed IDA credit is located inthe Research and Statistics Department (para. 3.37). The Research andStatistics Department will also be responsible for coordinating andsupervising the establishment of an Export Credit Guarantee Facility.

2.04 At the end of 1988, RBM accounted for 41 percent or K938 million ofthe banking system's assets. Total assets of RBM have been expanding by 24percent per annum since the beginning of the decade. By far, the majorassets of RBM have been credits to the Government and statutory bodies in theform of Treasury Bilic, direct Government loans and RBM purchase of LRS. In1987, lending in its various forms to the public sector in Malawi accountedfor 82 percent of the total assets of RBM, although the percentage fell to62 in 1989. On average, over the nine years from 1980, public sector lendinghas comprised more than three quarters of the assets of the central bank.

2.05 Prudential Regulation and Sui,ervision. Until relatively recently,supervision of banks was considered inadequate. However, the IMF hasprovided an experienced bank supervisor, under its technical assistanceprogram, to strengthen the regulatory and supervisory function at RBM. Theinitial focus was on providing an effective regulatory framework by r visingthe Banking Act and the Reserve Bank of Malawi Act. The revised Acts :ovidefor a comprehensive but uncomplicated regulatory environment by as gningmore discretionary regulatory power over all financial institutions vo theRBM.2.06 Financial Sector Reform. RBM is taking the lead in theimplementation of the financial sector reforms described in Chapter I.Considerable progress has already been made in strengthening RBM's capacityto implement the project and the reforms. Besides providing an advisor onregulation and supervision, the IMF has also provided an advisor on capitaland money market operations. Through a PPF advance, IDA has complemented IMFsupport by strengthening RBM's monetary programming capability. Money marketauctions of 90-dav Treaaury Bills will be introduced by December 1990, with

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varying yield6 based on monetary considerations. Ultimately, the Balk Rate,to be linked to the auction rate, will be the key guiding interest rate,incluiding for commercial bank interest rates. Following the introduction ofthe Capital Market Act, the Government will encourage n w capital marketactivity such as brokerage houses, issuance of company stock to the generalpublic, unit trusts, and employee stock ow'uership programs.

Commercial Banks

2.07 The National Bank of Malawi (NBM) was founded in 1971 from a mergerof the subsidiaries of Standard Bank of South Africa (Limited) and BarclaysBank. From its head office in Blantyre, NBM operates fourteen branches,eighteen agencies and twenty-eight mobile units. Authorized and issued sharecapital was R20 million at the end of 1988. The bank is owned by the PressCorporation (47.35 percent), the Agricultural Development MarketingCorporation (ADMARC) (32.65 percent) and Standard Chartered Bank(20 percent). At the end of 1989, it had total assets of K590 million,representing a growth of 5.6 percent from the previous year. By contrast,over the period from 1980 to 1988, total assets grew at an annual rate of18.5 percent. This recent slow down in the growth of the bank partlyreflects the increased fiscal discipline of the Government as well as theoverall tighter monetary conditions which prevailed during 1988 and 1989.

2.08 The Commercial Bank of Malawi (CBM) was established in 1970 as anexclusively Malawi bank, but with a fairly heavy international staff. Bankof America NT&SA acquired a 30 percent participation in 1976 and providedtechnical support until this shareholding was relinquished in 1983. Throughits head office in Blantyre CBM operates fourteen branches, two staticagencies and forty-six mobile units designed to effectively serve the remoteor rural areas. CBM had an authorized share capital of K6.5 million, and apaid up capital of K6 million (1988) which is held by the Press Corporation(40 percent), the Malawi Government (30 percent) and MDC (30 percent).

2.09 Both banks offer normal commercial banking services. On theborrowing side, they offer deposit services: checking, call, savings andtime accounts at market rates. Over the period 1980-89, the trend was fordeposits to flow from time and savings deposits to demand deposits becauseof the excess liquidity in the banking system. At the end of 1988 demanddeposits accounted for 37 percent of total deposits (K629 million) comparedto 29 percent of total deposits of K545 million in 1987. By the end of 1989,the trend had been reversed because of tightening liquidity that forced thebanks to reintroduce longer dated deposits (12 to 24 months). On the lendingside, the banks provide loans primarily for short-term working capitalsupported by adequate collateral, and a limited amount for longer term loans(up to seven years) supported by adequate collateral. At the end of 1989,the banks had total outstanding credit of K497 million, made up of K383million to the private sector and K114 million to the public sector. Theagricultural sector has traditionally received the bulk of commercial bankcredit, consistently accounting for more than 50 percent of total credit overthe period 1980-89. Trade was second with an average of 17 percent over theperiod, followed by manufacturing which saw its share of credit increase from4 percent in 1980 to 18 percent in 1989. Detailed analysis and financialstatements for both banks are provided in Annex VI.

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2.10 Both commercial banks are well managed, sound financial institutionswith competent staff. Operating policies and procedures are complete and upto date. Management information systems are also adequate for budgeting,planning, loan quality control, and credit evaluation. They have specialloan recovery units and have built up the capacity to take over themanagement of troubled estates and rebuild them. This is a defensive measurebased on past experience.

2.11 The systems established by the banks have been geared toward short-term lending, with the result that the banks have not developed the capacityfor term lending. In the past, they have relied on external consultants,including the African Project Development Facility (APDF), to appraise largerprojects. The proposed Project will provide term funds as a means ofencouraging the banks to engage in more project-based lending, plus technicalassistance for developing their project appraisal capability.

Leasing and Finance Corporation (LFC)

2.12 LFC is owned by INDEBANK (36 percent), the Finance Corporation ofMalawi (15 percent), U.D.C. Limited (Zimbabwe) (10 percent), Old Mutual (10percent), the German Development Bank (DEG) (10 percent), EconomicDevelopment of Equatorial and Southern Africa (EDESA) (9 percent) and theInternational Finance Corporation (10 percent). LFC operates through oneoffice in Blantyre, but its impact is felt well beyond the confines ofBlantyre. Since it began operations in September 1986, LFC's total assetshave grown rapidly, increasing by around 100 percent per annum, from K11.7million to K46 million between August 1987 and August 1989. Much of theearly growth of LFC was associated with truck leasing activities which wereactively encouraged by the Government as a result of the closure of therailway lines through Mozambique. By early 1990, it was vying with POSB andNBS as the largest NBFI. Annex VII provides a more detailed analysis of LFC.LFC is well managed with high calibre staff, is organizationally adequate andoperates according to sound commercial principles.

2.13 LFC has played an important role in the credit market by providingfinancing to clients that would not have otherwise been able to obtain fundsfrom the commercial banking system. LFC's lending decisions emphasize theviability of a project and monitoring project implementation and cash flowto ensure full debt recovery. The operating policies and procedures arecomplete and adequate for LFC's operations. By early 1990, the majorconstraint to further expansion by LFC was a shortage of term funds. Toovercome the funding constraint, LFC is exploring the possibility of a bondissue sometime in 1990. However, LFC will still need access to more termresources because of the tighter liquidity situation in the domestic market.The objective of the proposed Project is to support LFC increase access tocredit by non-traditional bank clients, especially SMEs. LFC will also haveaccess to technical assistance under the Project for training staff inproject appraisal techniques.

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Investment and Development Bank of Malawi (INDEBANK)

2.14 INDEBANK's financial activities include providing equity and loanfunds to subsidiary and associated companies. INDEBANK was established in1972 as a limited liability company, with the objective of fostering economicdevelopment through the investment in, and financing of, productive businessenterprises in Malawi. Its shareholding is predominantly foreign, althoughthe largest shareholder is the Agricultural Development and MarketingCorporation (ADMARC), a Malawi Government-owned institution. The fourremaining shareholders are the Commonwealth Development Corporation (CDC),the Netherlands development finance company (FMO), the German finance companyfor investments in developing countries (DEG) and the International FinanceCorporation (IFC). They jointly account for 76.4 percent of the paid-incapital, which amounted to K6.8 million as at June 30 1990. A more detailedreview of INDEBANK is provided in Annex VIII.

2.15 INDEBANK has a strong management team, with an independent Board ofDirectors that has clearly defined the bank's general investment policies andset-investment limits. INDEBANK is expected to operate on a prudentcommercial basis and profitably. INDEBANK's operating guidelines includeprovisions that preclude it from participating in refinancing operations.INDEBANK also requires: a minimum 25 percent contribution to total projectcost from sponsors of the project; and availability of competent andcontinuous management for the project. These qualities have made INDEBANKone of the more successful DFIs in Africa (Annex IX).

2.16 During the five-year period 1984-1989, INDEBANK's assets increasedby 59.2 percent to reacb of K42.4 million at year-end, while net investments(net of provisions and diminution in value of equity investments) more thandoubled to app'., ch K38 million. Consequently, the ratio of net investmentsto total asseLs increased from 70.9 percent to 89.6 percent. INDEBANK'scapital adequacy ratio increased to 20.5 percent and its debt/equity ratiodecreased to 3.37. 4/ By the end of 1989, the outstanding loan portfolioconsisted of 61 loans totalling K32.2 million (or an average loan size ofK527 thousand), while the equity portfolio consisted of 23 participationstotalling K10 million (or an average equity investment of K435 thousand).INDEBANK's staff of the Project Investigation Department have developedexpertise in all aspects of project analysis and appraisal and are wellacquainted with World Bank credit requirements. INDEBANK has benefitted fromtwo previous World Bank loans for industry.

2.17 The dependence of INDEBANK on external funding has acted as aconstraint on its ability to increase resource allocation. However, INDEBANKhas recently floated a local currency bond, which represents a first steptowards mobilizing longer term resources from the local financial market.In support of INDEBANK's future diversification, the RBM has approved abanking license that would allow INDEBANK to initiate new banking activities.

4/ Capital adequacy is defined as shareholder capital plus retained earningsand capital reserves (but excluding revaluation reserves) as a percent ofweighted risk assets. The bank for International Settlement guidelinessuggest a capital adequacy ratio of 8% for commercial banks.

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The license will enable INDEBANK to accept deposits and introduce new baiikiibproducts and services, gradually moving towards becoming a merchant baink.INDEBANK will still require to borrow a significant amount of term funds fromexternal sources during the transition to a full merchant bank. The proposedProject will support INDEBANK's reorientation program, and provide termresources during the transition period, and strengthen its capacity tomobilize domestic resources.

The Malawi Development Corporation (MDC)

2.18 MDC was established under an Act of Parliament in 1964 as astatutory body (parastatal), owned 100 percent by the Government of Malawi,to be the focal institution in the area of economic development and to helpachieve greater participation by Malawians in business and industry. MDC'sstatutes give it a broad mandate to undertake investments or developinvestment ideas in all productive sectors of the economy and to provideservices beyond the scope of conventional development banks. MDC has beenencouraged in this endeavour by the Government, which recapitalized theCorporation as part of the restructuring process. As at December 31, 1989,MDC had an equity base of K99.4m: K20m in paid-in share capital; over K73.9inin non distributable reserves; and K5.5m in distributable reserves. Out ofan investment portfolio of K232 million (before adjusting for provisions fordoubtful debt and investments) as at December 31, 1989, MDC's ratio ofinvestment in loan and equity was split approximately 15 percent and 85percent, respectively.

2.19 In the early 1980s, MDC faced serious financial difficulties as aresult of rapid and poorly managed growth, which forced the Government toundertake a major restructuring of the Corporation, involving a divestmentand consolidation of operations. The restructuring, which was completed in1987, has resulted in a leaner and more profitable organization withinvestments in 18 companies (down from 32 before the divestiture). Totalassets of K257 .aillion at the end of 1989 still make MDC one of the largestcorporations in Malawi which, therefore, gives it the potential to become animportant contributor to development in Malawi in several ways. First, MDCcould act as a catalyst in the development of capital markets through thesale of equity shares to the public in some of the more profitable companieswhere it is the major shareholder. Second, MDC could play a lead role insupporting the Government's efforts to promote investment by providing ready-made factory shells to investors. MDC has a subsidiary, the Malawi PropertyInvestment Company (MPICO), that has been successful as a commercial realestate developer and, with adequate support, could conceivably expand intoindustrial estate development.

2.20 Although MDC has the potential to be an important contributor to thedevelopment of both the financial and industrial sectors it has, since itsrestructuring, virtually remained dormant. Part of the reason has been thelack of autonomy of the Board of Directors and limited discretionaryauthority for management. The other reason has been generally weakmanagement. Both of these issues will need to be addressed if MDC is to

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fur.-~tion successfully as a commercially oriented institutioni. The proposedProject will assist MDC to become a more dynamic agent for development andassist it to expand into providing factory shells on a commercial basis. Adetailed review of MDC is provided in Annex X.

III. THE PROJECT

Project Origin and Rationale

3.01 The proposed Project culminates preparatory work by Bank staffextending over a two year period and is designed to support Malawi's ongoingreform program that seeks to diversify the economy, generate employment, andalleviate poverty. IDA has played a key role in assisting Government torestructure the economy, formulate strategies in the industrial and financialsectors and mobilize significant external resources. The support has beenunderpinned by substantive sector work. In 1989, the Bank prepared the"Malawi, Industrial Sector Memorandum" (Report No. 74302-MAI) and a CountryEconomic Memorandum (Report No. 8140-MAI). These were followed by an IDAfinancial sector review mission in November 1989, which prepared a GreenCover Financial Sector Report in February 1991 (Report No. 9009-MAI). Theindustrial and financial sector reports identified a number of reforms andrecommendations to improve efficiency in buth sectors as highlighted inChapter I. In 1990, FIAS undertook diagnostic review of the investmentclimate (para 1.50). As part of the Financial Sector Review and projectpreparation, Government already has implemented several key policy reformshighlighted in Chapter I. The reforms outlined above have been agreedbetween Government, the World Bank and the IMF and are reflected in theThird-Year PFP.

3.02 The impact of the policy changes on the industrial and financialsectors has been impressive during the period 1987-1990. The proposedProject will enable IDA to assist the Government in further improving theinvestment environment by supporting ongoing reforms, encouraging exports,and strengthening institutions engaged in term finance and pron.otinginvestment. The project will be complementary to the activities of otherdonors in providing support for economically viable production activities,especially in the SME sector. The Project will also be complementary to theproposed Entrepreneurship and Capital Market Adjustment Credit (ECMAC) whichwould focus on broader macroeconomic policy issues in both sectors.

3.03 The Project will be a departure from previous interventions for termfinancing in Malawi. Instead of allocating term financing to separatesectors through specialized financial institutions at different interestrates, terms and conditions, the apex approach would consolidate IDA's termlending in Malawi for all productive sectors. The funds provided under theProject will fill an important gap in term financing during the transitionperiod as the sector deepens and becomes better able to mobilize and allocatedomestic savings.

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Project Objectives and Desi,n

3.04 The objective of the project is to support Government efforts toexpand exports and improve the policy and institutional framework relevantto private foreign and local investment. This objective will be achieved by:(i) including the commercial banke and leasing companies in the Project toexpand term financing of viable enterprises in the productive sectors,including SMEs and enterprises owned by women; (ii) improving theinstitutional framework for export finance, investment promotion, includingsupport for a proposed investment promotion agency, and industrial land andfactory shell development program; (iii) strengthening and supporting theoperational diversification of key financial institutions; and(iv) supporting improvements in monetary policy management.

3.05 The project, which will involve an IDA credit to the Government ofMalawi of US$32 million equivalent (SDR 22.3 million) to finance investmentand technical assistance to key institutions, would have the followingcomponents:

(i) an Investment Finance Component to provide term finance toprojects in productive sectors promoted by foreign and indigenousprivate sector entrepreneurs, including SMEs and business ownedand operated by women;

(ii) an industrial sites component to provide industrial infrastructureto industrial sites and factory shells to facilitate investmentby indigenous enterprises and foreign investors, especially thoseinvesting in export-oriented activities; and

(iii) a multi-faceted institutional capacity development component tosupport implementation of the reform program in the financial andindustrial sectors. Activities supported by this component wouldinclude staff training for participating financial intermediaries(PFIs), and SME support institutions, strengthening RBM's capacityto manage monetary policy, investment promotion, and supportingthe deepening of the financial sector by helping with thediversification and reorientation of several financialinstitutions.

A more detailed description of the three components is provided below.

Proiect Description

3.06 Investment Finance Component of US$20.4 million in IDA funds willbe made available through an apex arrangement at RBM for lending to eligiblePFIs which will onlend the funds to viable enterprises to finance investmentin productive activities, through normal term financing mechanisms such asleasing, equity finance and term loans. The subprojects could range fromsmall to large scale and will include various mixes of private, public,foreign and Malawian ownership. The following is a brief elaboration of thevarious financing mechanisms:

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- Term and Working Capital Credit will provide term loan finanicing to

viable enterprises, covering plant and equipment, as well as, 'he

working capital requirements associated with investment in plzlt anldequipment.

- Lease Financing will provide finance to PFIs for the purchase ofequipment which they would lease to eligible subborrowers underlease agreements. Although lease finance in Malawi is currc-ntlvprovided by only two companies, Mercantile Credit anid LFC,competition for this line of business is expected to increase withentry of other financial institutions. As a medium-term financialinstrument, lease financing will improve access to credit for SMEsthat are commercially viable, but otherwise are locked out of formalsector credit because of lack of adequate tangible collateral.

- Equity and Quasi-Equity Finance will provide financing for equityand quasi-equity investments by PFIs against their financingsubborrowers' purchase of equipment, goods, services and civilworks. Such investments will include common or preferred stock,convertible debentures or subordinated debt, which could be usedalone or packaged in combination with debt. The equity investmentswill give preference to new ventures, especially indigenous-ownedenterprises. Equity funds will be channelled through either theDFIs or venture capital funds that are autonomous, managed on acommercial basis, with policies and procedures that meet eligibilitycriteria for PFIs. All equity investments by PFIs will be requiredto include an exit clause to ensure that the equity investment canbe sold at maturity and not be subject to the preemptive shareholderclauses that apply under corporate law in Malawi. Both INDEBANK andMDC (the two participating DFIs and likely utilizers of equityfinance) were reviewed during appraisal of the project and theirprocedures were found to be acceptable to IDA. INDEBANK has in thepast participated in IDA operations and is familiar with IDArequirements for equity investments.

3.07 Initially, no one financial intermediary will have access to morethan 20 percent (or about US$4 million) of the total funds available under

the Investment Finance Component. However, this limitation will be reviewedregularly, beginning in the first year of pro4ect implementation and wouldbe adjusted as necessary. During implementation, the IDA funds will be

allocated among various financing instruments (loan, equity, and leasing)depending on actual demand.

3.08 Industrial Sites Conponent (USS7 million) will be lent by the RBMto PFIs for onlending to eligible developers of industrial sites. Thecomponent would ensure timely availability of in.ustrial infrastructure foruse by investors by providing long term financing of infrastructure(equipment and civil works for roads, electricity, water andtelecommunications infrastructure and factory shells) on industrial sites.It is anticipated that MDC will be the primary, but not sole, developer of

industrial sites in Malawi. Other PFIs will be eligible to participate foronlending to factory shell developers. Initially, no one PFI will haveaccess to more than 40 percent of the total funds under this component. This

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allocation will be ;ul,ject to review after the first year of projectimplementation. O-nlending from RBM to the PFIo will be at the reference ratedetermined by RBM. The Governtmient will through the Department of Lands andValuation, coordirnate and uupervise the allocation of industrial land and theprovision of services to ±ndastrinl sites. MDC and other developers will use

the leased land to develop well serviced industrial sites for lease byinvestors. Primary leates to developers would be long enough (currently 99years) to allow the developer to offer subleases for a minimum of 10 years.A po,Lcys;_tatement for the developnment of iiifrastructure on industrial siteswas a at negdt iations. The policy statemenit would include guidelineson cost recovery on infrastructure, procuremenit and disbursement proceduresand responsibilities for setting of standards and supervising civil works.The development of industrial sites for export-oriented production is likelyto require large public expenditures. lt is understood that the Governmenthas approached the African Development Bank (ADB) to support, throughparallel financing, a program for developing specialized export processingzones. Other bilateral donors have expressed interest in supporting thedevelopment of industrial infrastructure aS, parallel cofinancing to theFSEDP.

Sector Policy Measures and Conditions

3.09 As indicated above, although the proposed Credit is an investmentoperation, a large number of key policy issues identified in Chapter 1, werediscussed with Government during project preparation. The Government hasmoved quickly to either introduce or initiate reforms to address several ofthese issues, and has been steadfast in its commitment to the overall reformprogram. Maintaining momentum in implementing ongoing and proposed policyreforms is considered critical to achieving fully the development objectivesof the proposed project.

3.10 In the area of financial sector policies, reform has focused onthree key areas involving:

(a) movement towards more indirect, market-oriented monetarycontrol. This involves the setting up of a money market deskat RBM, regular auctions of Treasury bills and other Governmentpaper, and more use of indirect monetary control instrumentssuch as reserve requirements. The proposed Project has,through PPF financing, provided support to RBM in developinga monetary programming model;

(b) encouraging competition. The monetary authorities agreed tointroduce a more open and transparent process for considerationof banking applications. A banking license to INDEBANK hasalready been approved under the new process, while consultants(financed through a PPF) have been retained to assistGovernment in re-orientating POSB into an autonomous financialinstitution (paras 1.23 and 1.29); and

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(c' ) en'oguratijng tlie d(evP Iopm(Tlt _ of c a) i t al r m,-ket s . Thiae

aut horities propose to rationalize t he tax treatmellt offinancial instrumeiit s, I lt1udi ng taxat ion ot dividt nds and

capital gains and removal of the tax exempt tio0 for intrerutearnied on deposits at the NBS and POSB (para 1.38);

3.11 In the industrial sector, Government haci eombarked on an ambitiou.,program aimed at diversifying rho economy, withi thei reform process focul.inpon:

(a) Investment Promotion. In response to concorns about adequateinvestment response, the Government has set up allinterministerial working group to provide policy guidance andrevrient investment policy. To ensure that the investorcommunity is fully aware of the recent policy changes and theadministrative, institutional (an Investment Promotion Agency)and legal support available to investors in Malawi, theGovernment proposes to issue an Investment Policy Statement(para 1.50). A draft copy was issued to IDA at negotiations;

(b) Availability of industrial land for private development. TheGovernment proposes to make comprehensive procedural changesthat are needed to accelerate land transfers for newinvestments to comply with the intentions expressed in thePolicy Statement. The land lease approval process will bestrpamlined and the leases to private developers would be long,-iough to enable such developers to offer equally longsubleases to industrial enterprises for factory shells;

(c) Industrial Infrastructure. The Government proposes todecentralize the development of industrial parks, incorporatingthe construction of advance factory shells for lease or saleto investors, by allowing such parks to be developed on acommercial basis, including development by private developers.Leadership within Government for coordinating and supervisingthe provision of industrial infrastructure to industrial siteswill be provided by the Department of Economic Planning andDevelopment (EP&D) in the Office of the President and Cabinet.The Government will issues guidelines of the development ofindustrial parks; and

(d) Trade Liberalization. The Government aim. at reducing thelevel and dispersion of protecti.on throu:.h further trade tariffreforms. Significant progress already has been made ineliminating import and export licensing requirements.

3.12 As a background to this project, the Government provided a draftletter of commitment to continuing the program of financial and industrialsector reforms described earlier in Chapter 1.

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Eligibility Criteria for PFIs

3.13 For purposes of the Investment Finance and the Industrial Siteecornponellts, any financial intermediary that meets the requirements of therevised Banking Act for engaging in lending activities would be eligible toparticipate. The revised Banking Act is administered by RBM and stipulatesthe rules for the operation of new and existing financial institutionsincluding inter alia definition of financial institution, requirements forthie issuance or revocation of a license, capital adequa.y ratios, 5/comnpetenice and expertise of management, structure of the organization,minimum capital base and earnings from operations, scope for prudentialregulation, and audit and reporting requirements. To be able to participateas a PFI in the two components of the proposed project, a financialintermediary would be required to be fully in compliance with the provisionsof the Act. The PFIs come under the regulatory and supervisory oversight ofRBM's Bank Inspection Department, which would monitor the PFIs' operationsand financial position and would cut off the use of IDA funds if the qualityof a PFI's portfolio deteriorates too much or it fails to remain in soundfinancial condition. In addition to meeting the requirements of the Act,PFIs will be required to have experienced management, to follow sound,commercially oriented banking practices, and to have their annual financialstatements audited by an independent auditor acceptable to IDA.

3.14 Initially, the only institutions that meet the requirements of theAct are. the two commercial banks, INDEBANK, LFC, and MDC. The commercialbanks and INDEBANK are established institutions with considerable experienceworking with RBM and on IDA operations. LFC and MDC, although lessexperienced, have adequate operating procedures for channelling funds toenterprises. Moreover, technical assistance is included in the project tostrengthen PFIs capacity for appraising and supervising projects. However,RBM would retain the discretion to qualify additional institutions toparticipate in the two components on the basis of eligibility criteriasatisfactory to IDA. Mercantile Credit is currently dormant, but would beevaluated by RBM should it wish to participate in the project. The otherinstitutions, such as INDEFUND, SEDOM, MUDZI FUND, and WWBM, do not currentlymeet the eligibility criteria for a various financial, managerial andoperational reasons.

3.15 All PFIs will be required to enter into a participation agreementwith RBM. The participation agreement would, inter alia, specify that thePFI would: (i) perform satisfactory subproject appraisal for longer terminvestment; (ii) supervise subprojects financed under the credit to ensurethat resources are used for intended purposes and repaid; (iii) make periodicreports to the apex unit; (iv) ensure that national environmental regulationsand IDA guidelines on environment are followed by subprojects; (v) help toidentify technical assistance requirements of SMEs; (vi) provide the ApexUnit and IDA with such information (including audited financial state-mentsand statement of expenditures) as they may reasonably request;

5/ The Banking Act defines capital adequacy as the minimum capitalrequirements as a percent of a class of assets and risk bearingcommitments. Capital adequacy ratios are prescribed by RBM.

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(vii) designate qualified staff to manage the credits financed under theproject; and (viii) adhere to terms of lending and repayment of loans.Rceeipt by EPA of a satisfactory signed agreement between the RBM and a PFIis a conAdition of disbursement to that intermediary.

Eligibility Criteria for Subprojects

3.16 The investment finance and industrial sites components will financefixed assets, civil works and permanent working capital for enterprises. Allproductive activities and industrial sites development, except housingconstruction and land acquisition, that contribute to the economicdevelopment of Malawi would be eligible. Both foreign and local costs willbe eligible for financing, with the latter being limited to a maximum of 90percent of financing by the IDA line of credit. The Industrial SitesComponent will provide free-standing sub-loans to clients borrowing throughMDC or other eligible PFIs for factory shell construction. Identicaldisbursement procedures would be used under both components.

3.17 Enterprises and eligible subprojects to be financed under componentswill be required to meet the following conditions which would be subject toperiodic review and possible amendment if circumstances warrant duringproject implementation:

(a) demonstrate technical, financial and economic viability.Subloans over US$100,000 equivalent would be required to havean expected financial rate of return of at least 12 percent ontotal subproject investment;

(b) the projected debt service coverage ratio should not be lessthan 1.3 over the life of the subproject and the debt/equityratio should not exceed 3:1, with the ratios calculated on thebasis of the enterprise's total debts, inclusive of those tobe incurred under the subproject;

(c) Project sponsors would be required to finance the followingproportions of the total cost of subprojects: at least 20percent for expansion or modernization subprojects; and atleast 30 percent for new subprojects;

(d) the amount of each subloan, including leases, would be limitedto a maximum of US$2 million, to ensure that no one companyabsorbs more than ten percent of the total credit amount. Theamount would be reviewed and, if necessary, revised duringproject implementation. Subloans would be for a maximum of 12years, with up to three years of grace.

(e) for equity investments, prudent investment policies would berequired to be followed, including the following tworequirements: (i) investments in any one company should notexceed 25 percent of the paid-up share capital and revenuereserves of the PFI; and (ii) the equity investment ratio,

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d1fined n.-, equity investments divided by paid-up share caritalof the I'FI, should not exceed 1:1.2. No limitation wou.d beimnposod oJL the size of the enterprise or subproject, but

iII(lividtlal investments should not exceed US$2 milliotn;

(f) for 1ndustria] sites and factory shell subprojects, prudentcommnercial inivestment policies would be followed, including:(i) firn lease commitments from potential clients of thefactory sholls; (Ii) charging cost recover, rents sufficientto cover the debt repayment and operating cost obligations; and(iii) oreforceable lease agreements between the developer andthe lossee;

(g) for lease financing, there would be an enforceable legalagreemenit betweeni the PFI and the lessee, including an optionfor the lessee to buy the asset at the end of the lease. Theterm of the initial equipment lease may not exceed 12 years.

Subloan Processing and Administration

3.18 Subloan processing under the project will be coordinated andsupervised by the Apex Unit, which would serve as the principal link betweenIDA, PFIs and beneficiaries of the investment finance and industrial sitescomponents.

3.19 Subprojects will be prepared by the beneficiaries with, ifnecessary, assistance of independent consultants, and presented to the PFI.The PFI would review the subprojects in accordance with loan appraisalprocedures and internal operating requirements acceptable to IDA. Theproject appraisal policies and lending procedures of the currently eligiblePFIs were reviewed by the appraisal mission and found to be generallysatisfactory. The exception was MDC, which would be required to address itsinstitutional weaknesses before drawing on the Credit fur.ds. PFIs wouldpresent their appraisal report, together with supporting documentation, tothe Apex Unit for refinancing under the line of credit and industrial sitescomponent. This appraisal report, which will be presented in a standardformat prescribed by the Apex Unit, would vary in depth and sophisticationdepending on size and complexity of the subprojects. The report would coverall relevant information about the enterprise and the proposed investment.The Apex Unit would review the appraisal reports to verify that alleligibility criteria are adequately met. This review will be carried out inthe form of a check-list approach for subloans of lees than US$100,000equivalent, and through a more in-depth review for subloans above US$100,000.The PFIs would have primary responsibility for the sub-loan appraisal andwould carry the lending risk.

3.20 At least one subproject from each intermediary will be subject toprior IDA review and approval. Thereafter, assuming satisfactory standardsare achieved, IDA would review a sample of subprojects on an ex-post basisduring supervision missions.

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3.21 The RBM would be responsible fcr disbursement and collection offurnds granted to PFIs. The Research Department would manage the Apex Unit,whlile the Foreign Exchange Department would make payments upon approval bythe Apex Unit. PFIs will be responsible for preparing their own disbursementapplications for presentation to the Apex Unit. The Apex UJnit would thensimply check the applications for accuracy and completeness before disbursingtlie funds to the PFIs. RBM would be responsible for preparing and submittingrequests to IDA for the replenishment of the Special Account.

3.22 Under the participation agreement with the RBM, PFIs will beresponsible for supervising IDA-financed subprojects and maintaining adequaterecords. The PFIs will submit periodic supervision reports, in a standardformat prescribed by the Apex Unit, until the subloan Is repaid. Theserecords would be made available to IDA supervision missions for review andcomment.

Institutional Capacity Development Component

3.23 The overall objective of the institutional capacity developmentcomponent is to support Government efforts in economic diversification byproviding technical assistance and training to: (a) strengthen a number uffinancial institutions that finance investment; (b) assist Government tostrengthen its investment promotion capacity; and (c) strengthen the capacityof institutions that support SMEs by providing technical assistance andtraining. A detailed breakdown of technical assistance and cost estimatesis provided below:

3.24 Support to RBM (USS400,000). Strengthening RBM's capability inmonetary policy management, is estimated at US$150,000 and includes 6 man-months of consultants plus computers and equipment. The consultants willassist RBM to: (i) develop an econometric model for forecasting credit andmonetary developments; (ii) re-organize and strengthen the existingstatistical data base; and (iii) train its staff in econometric methods.The terms of reference for this sub-component are provided in Annex XI.Initial work in this area has already been undertaken, financed through anIDA Project Preparation Facility (PPF) advance. During projectimplementation, additional support (two man-years of consultant services) atan estimated cost of US$250,000 would be provided to RBM to assist inestablishing money market operations and training for relevant localcounterpart staff.

3.25 Restructuring of the Post Office Savings Bank (POSB) (USS900.000).Funds will be allocated to finance consultant services, vehicles andequipment to assist the Government to streamline the operations of the POSBand, as part of the initiative to increase competition in the financialsystem, gradually restructure and reorient (including broadening itsactivities) it into an independent commercially-oriented financialinstitution along tho lines of the POSB in the United Kingdom and savingsbanks other European countries. In order not to disrupt the currentsuccessful deposit mobilization activities of the POSB, the reorientationwould be phased with the initial focus being on streamlining operations(clearing an operational backlog), improving deposit mobilization andstrengthening POSB's management capacity to make sound, commercial investment

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decisions. In the longer term the POSB could be involved in lending.Consultants have been retained at a cost of US$360,000 through an IDA PPFadvance to assist the POSB in streamlining operations and developing astrategic plan for the future evolution of the POSB. Terms of reference forconsultant services were agreed upon prior to appraisal and are provided inAnniex XI. Implementation of the business plan to be developed by theconsultant will require additional financing estimated at US$190,000 for theconsultant services (some to be procured locally), vehicles and equipment.Formulation of a restructuring and strategic plan would be completed bySeptember 30. 1991.

3.26 An ExRort Credit Guarantee Facility (ECGF (USS180.000). IDA willfinance 100 percent of the cost of assistance to help establish and operatean export credit guarantee facility and train staff of the PFIs in exportfinancing. Support to RBM would include (i) consultant services of 8 man-months, of which 2 man-months are expected to be procured locally, and (ii)vehicles and equipment. The consultants will assist RBM to formulateoperating policies and procedures, design the management systems for thefacility, and provide the training to relevant staff. The rationale,description and terms of reference for the ECGF were agreed duringnegotiations (Annex XIII). The establishment and adeauate staffing of theExport Credit Guarantee Facility is a condition of disbursement under thecomponent.

3.27 Investment Promotion (USS1.000.000). The IDA credit will assistthe Government establish and operate an investment promotion agency. Thesupport would finance: (i) start-up costs (estimated at US$55,000) coveringvehicles and equipment and civil works; (ii) annual operating costs over afive-year period (US$350,000) covering a manager, 2 senior staff, and 3support staff; (iii) investment promotion (estimated at US$350,000) includingpublic relations, research, travel and communications, and office expenses;and (iv) one man-year in the form of a resident advisor (trainer) at anestimated cost of US$150,000. The estimates include appropriate pricecontingencies. Draft terms of reference and preliminary cost estimates forthe establishment of an investment promotion agency are provided in AnnexXIV. Co-financing for this component is being sought. Establishment of theInvestment Promotion Agency. with terms of reference. staffing level, costs.and Procedures acceptable to IDA is a condition of disbursement of thisfinancing. As a condition of effectiveness, the Government will have toaspoint a committee chaired by the Principal Secretary to the Department ofEconomic Planning and Development to oversee the implementation of actionsneeded to set up the Agency and meet the obiectives of the Investment PolicyStatement.

3.28 SME Training and Technical Assistance Fund ($1.000.000). To supportthe development of the private sector including SME, the project willestablish a technical assistance and training fund. IDA will financeUS$1,000,000, with additional support being provided by other donors thatcould benefit SMEs. The Fund will make resources available for(i) development of professional staff at all levels in institutions thatsupport private sector investment; (ii) the development of curriculum fortraining; and (iii) the training of entrepreneurs. The bulk of the resourceswould be directed to in-country training initiatives. Operation of the fund

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will be demand driven, with institutions desiring assistance submitting theirproposals for review and approval for funding. It is anticipated that thefollowing institutions would be interested in participating in the fund:INDEFUND, SEDOM, DEMATT, MUSCCO, MEDI, the commercial banks, CCAM, MACOHA,MUDZI FUND, Women's World Banking of Malawi (WWBM), and other NGOs. The Fundwould also strengthen the capability of the Ministry of Trade and Industryand the Department of Economic Planning and Development to support industrialdevelopment in Malawi, especially in the SME sector. The proposed Fund willbuild on and complement existing initiatives by Government and other donors.Agreement on the terms of reference, operating policies and procedures andeligibilitv criteria for Fund beneficiaries was reached during negotiations.The EEC has provided finance for consultant services at an estimated cost ofECU60,000 (US$84,000 equivalent) to hel? define the institutional set-up,final cost estimates, and develop procedures for the operation of the Fund.EEC may provide additional funding for the Fund through parallel co-financing under the Lome IV agreement. A profile of the Fund and terms ofreference for the EEC-financed consultant services are provided in Annex XVI.

3.29 Diversification of INDEBANK (US$350,000). The credit would assistINDEBANK to become a broader-based financial institution. The two majorelements of the INDEBANK program are: (a) mobilization of additional kwacharesources, including the private placement of a KIO million local bond issue;and (b) expansion into merchant banking activities, including wholesaledomestic deposit taking, dealing in bankers acceptances and subsequentlyforeign exchange trading. The project would also strengthen managementinformation systems, through the development and training of the managementteam and the recruitment of an experienced merchant banking advisor and headof corporate finance. As regards merchant banking, IDA supports INDEBANK'sgeneral objectives and the measures being taken to diversify its operations,which would increase the range of financial instruments. The terms ofreference for a consultant to assist INDEBANK review the options forexpansion have been cleared by IDA. The Project would finance: (i) two man-years for an advisor on merchant banking; (ii) four man-years for short-termconsultants with relevant experience (one in deposit taking and the other inforeign exchange transactions) to establish these activities and trainINDEBANK staff; and (iii) equipment and vehicles and related operating costsfor two years. Agreement on the terms of reference for hiring an advisor toassist INDEBANK with its diversification was reached during negotiations.

3.30 Malawi Development Corporation (MDC) (USS700.000). The Project willhelp MDC: (i) strengthen its management by financing the cost of anexperienced projects advisor; (ii) build up capacity to develop factoryshells on a commercial basis; and (iii) equipment and vehicles. An appraisalof MDC indicates that it is a financially sound corporation and possessesattributes that make it a potentially dynamic institution able to take onadditional functions and play a leading developmental role in both thefinancial and industrial sectors in Malawi. However, for this to happen,management will need to be strengthened and the reporting arrangementsbetween MDC, Department of Statutory Bodies (DSB) and other Governmentagencies re-examined, so thst with stronger management, the Corporation would

_ 36 -

be granted the autonomy to effectively run its operations. These reformswill not delay the start of new initiatives at MDC or hold backimplementation of the rest of the project. Agreement on a future developmentprogram, including terms of reference, for MDC was reached at negotiations.

Pro ect Cost. Financing and Co-financing

3.31 Total project cost is estimated at US$47.2 m'llion equivalent, withan IDA contribution of US$32 million equivalent (68 percent). The remainder,amounting to USS15.2 million equivalent, would be financed by localcontributions and co-financiers. EEC has already co-financed the project andmay also provide additional funds through parallel co-financing under LomeIV Agreement. A summary of the project costs and expected financing is givenin Table 2.

3.32 Co-financing. The Bank's Resident Mission in Malawi has been quitesuccessful in improving and strengthening aid coordination. The ResidentRepresentative provides leadership to an active local donor's aidcoordination effort. The bi-annual Consultative Group (CG) Meetings haveprovided an effective mechanism for donor support for the Government's highpriority investment areas and co-financing for Bank operations. Severaldonors have provided a tentative indication of support to Malawi as parallelco-financing to the FSEDP. The most prominent among these are: UNDP, EEC(under LOME IV), EIB (under Lome IV), and USAID. Amounts for potential co-financiers have not yet been determined.

Table 2: 0ALAWI - Estimated Project Costs and Financing Plan(US$ million)

Local Foreign Total 2

Estimated Cost:Line of Credit 11.9 20.0 31.9 67.0Industrial Sites 2.9 7.0 9.9 21.0Institutional CapacityDevelopment 2.8 2.6 5.4 11.4

TOTAL 17.6 29.6 47.2 100.0

Financing Plan:Sub-borrower 14.7 - 14.7 31.1Government 0.4 - 0.4 0.9Proposed IDA Credit 2.4 29.6 ,2.0 67.8Co-financier (EEC) 0.1 - 0.1 0.2

TOTAL 17.6 29.6 47.2 100.0

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Terms and Conditions

3.33 The proposed IDA credit will be made to the Republic of Malawi onstandard IDA terms. The Borrower would pass on US$27.4 million equivalentof the IDA Credit to RBM at the reference rate determined by RBM foronlending in local currency through an apex unit to eligible PFIs. The PFIswould relend the local currency funds with maturities of up to 12 years,including a grace period of up to 3 years under the Investment FinanceComponent.

3.34 The funds allocated for the institutional capacity developmentcomponent (US$4.6 million) will be passed on as a grant from Government tothe implementing agencies and beneficiaries. The TA to RBM, INDEBANK andMDC will be managed by each respective institution, while the balance of thetechnical assistance would be administered by MOF, which will in turndelegate management of the SME Technical Assistance and Training Fund to theMalawi Institute of Management (MIM) or other training institutions, whichhave the capacity to assume such responsibility. The TA to POSB would bemanaged by RBM. Information on MIM is available on the Project file.Agreement on the general administration of the Institutional CapacityDevelopment Component was reached at negotiations.

3.35 Foreign Exchange Risk and Interest Rates. RBM would, through anApex arrangement, onlend US$27.4 million equivalent of the IDA credit toeligible PFIs at a pre-determined reference rate. The reference rate ofinterest would be determined by RBM from time to time, and would reflect theaverage cost of term borrowings in the financial system. In the absence ofa developed capital market that could be used to determine the long-term costof borrowing in Malawi, the reference rate of interest will be set in thefirst year of project implementation as a simple average of all prevailinginterest rates on long term deposits at the commercial banks (currently13.625 percent per annum). RBM would pass to the Government the interestreceived from PFIs, less a 0.5 percentage point fee to cover RBM'sadministrative cost for operating the Apex Unit. The Government would bearthe foreign exchange risk out of the interest received from PFIS. The PFIswould bear the full credit risk. The interest rates to final sub-borrowerswould be set at the discretion of each individual PFI, based on the PFI'sassessment of the underlying lending risk. Both the onlending and finallending rates would be adjusted periodically in line with changes in marketrates. Interest rates in Malawi are market determined and are positive inreal terms.

Project Implementation

3.36 The Apex Unit. The Apex Unit would serve as the principal linkbetween IDA, PFIs, and the final beneficiaries of the investment finance andthe industrial sites components. It would also be responsible fordisbursement, accounting and loan administration in respect of the TechnicalAssistance Component. The Research and Statistics Department of the RBMalready has a claims and loan disbursement unit with a permanent staff ofthree professionals, but is able to call upon extra manpower from theResearch and Statistics Department as and when necessary. The Apex Unitwould be expanded by the recruitment of one more professional to enable it

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to tackle the additional workload envisioned under the proposed FSEDP.Adequate staffing of the Apex Unit is a condition of effectiveness.

3.37 The staff of the Apex Unit are competent and familiar with IDAdisbursement procedures and reporting requirements, having been responsiblefor managing several IDA credits. The unit has access to computer facilitiesfor accounting and record-keeping purposes and has a secure room within theRBM premisas for safe storage of relevant documentation.

3.38 The staff of the Apex Unit is under the management of the Directorof Research and Statistics. The Director will wor' with an AssistantDirector, who will be responsible for the day-to-day ..dnning of the wholeunit, including supervision of the four core staff of the unit. Two of thestaff will concentrate exclusively on the FSEDP and the IDA-financedAgricultural Mlarketing and Estate Development Project, with the other twomanaging the ITPAC and ASAC operations. A fuller description of thefunctions of the Apex Unit is provided in Annex XVI.

Environmental Assessment

3.39 The Malawi Government has established a special unit to integrateassessment of environmental issues into its planning process. The proposedproject would use the unit to vet the potential environmental impact ofsubprojects to be financed. The unit would provide to PFIs and investorsguidelines outlining the new investments that would require its endorsementbefore a licence to operate is issued.

3.40 Projects to be financed through the Investment Finance Component andthe Industrial Sites Component would be evaluated as appropriate by the PFIsto determine whether the investment project has any potential adverseenvironmental effects. For subprojects that are found to have potentialadverse environmental effects, an environmental assessment would be carriedout and the subproject design would include measures to minimize the impact.Subprojects with environmental effects that cannot be mitigated would not beeligible for financing from the IDA credit funds. The PFIs would annuallysubmit their lending program to the environmental assessment unit for reviewand comment.

Procurement and Disbursement

3.41 Procurement. Procurement for subprojects financed under theinvestment finance and industrial sites components of the Credit wouldgenerally be made on the basis of current procurement procedures of theparticipating financial institutions. These procedures, which are in linewith normal commercial practice (minimum of three quotations and awarded tothe lowest evaluated bidder), have been reviewed and found acceptable to IDA.Generally, the PFIs review items to be procured by their subborrowers toensure that a representative cross section of suppliers have been canvassedand that the proposed procurement is from the most advartageous source. Anycontracts for goods valued at or over $1 million would be procured throughInternational Competitive Bidding (ICB) procedures in accordance with IDAProcurement Guidelines. Local Competitive Bidding (LCB) procurement wouldbe limited and mainly for the procurement of civil works (foreign firms would

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be allowed to participate in such bids in accordance with local proceduresacceptable to IDA). Items or groups of equipment and vehicles required bysix separate institutions, spaced over time and relatively small in valueindividually and aggregating to US$400,000 would be procured through LCBprocedures. Direct contracting could be used only for proprietary equipmentor where compatibility with existing equipment would require standardizedequipment or spare parts. Consultant services would be procured inaccordance with Bank Group Guidelines. All consultant contracts would haveterms of reference and consultant selection subject to IDA approval beforecontracts are awarded. The Apex Unit would supervise procurement under theproject and ensure that all procurement is done under procedures acceptableto IDA. PFIs would maintain records of the procurement methods and documentsin subproject implementation in order to monitor use of credit funds. IDAsupervision missions would review procurement procedures to ensure compliancewith the agreed Procurement Guidelines. Procurement arrangements aresummarized in the following table, with amounts to be financed by the IDAcredit in parentheses.

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Table 3: MALAWI - Procurement Arrangements

Procurement Method(USS million) Total

Project Component ICB LCB Other N.A. Cost

Investment andIndustrial Sites 7.0 - 34.8 - 41.8Subloans a/ (3.4) (24.0) - (27.4)

Equipment and Vehicles - 0.7 - - 0.7(0.4) - - (0.4)

Consultants, - - 2.5 b/ - 2.5Training and Technical (2.4) (2.4)Assistance

Incremental OperatingExpenses - - - 1.6 1.6

(1.2) (1.2)

PPF Refinancing - - - 0.6 0.6(0.6) (0.6)

TOTAL 7.0 0.7 33.7 5.8 47.2(3.4) (0.4) (24.4) (3.8) (32.0)

a/ Standard Commercial Practice. Contracts for goods exceedingUS$1,000,000 equivalent would be procured through ICB. Figures inparenthesis represent procurement methods for IDA funds.

b/ In accordance with IDA guidelines.

3.42 Disbursements. The investment finance and industrial sitescomponents would be disbursed as follows: (i) for subloans financing newoperations, up to 70 percent of total subproject cost for new operations, andfor expansion operations, up to 80 percent of total cost of the subproject;and (ii) the institutional capacity development and training component: 100percent of the cost of consultants, training and the c.i.f cost of goodsdirectly imported; and 80 percent of local cost goods. The IDA credit wouldreimburse the PPF advance and would finance eligible expenditures that weremade no more than 90 days prior to tiLe receipt by IDA of information relatir.gto a subloan or investment operation, or before the receipt of the requestby IDA for approval of the subproject. During negotiations, it was agreedthat withdrawals in an amount not exceeding the equivalent of SDR 700,000 maybe made in respect of the investment finance component for payments made tocover expenditures incurred not more than 90 days before the signing of theCredit. The objective of this retroactive financing is to allow continuityin the operation of certain PFIs.

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3.43 The project disbursement schedule (Annex XVIII) is based ondisbursement schedule for industrial development and finance projects inAfrica. It is expected that the line of credit component would be disbursedin seven years and the institutional capacity development component over afour-year period. Funds under the investment finance component and theindustrial sites component would be available for commitment until December31, 1995, while, disbureements and the Credit Closing Date would be by June30, 1997.

Table 4: MALAWI - Allocation of IDA Credit

Disbursements of IDA Credit(US$ Million)

Categcory Percentage

Investment and IndustrialSites Components 27.4 up to 70% of total

subproject costs for newoperations and 802 forexpansion operations andcivil works.

Equipment and Vehicles 0.4 100% of total costs.

Consultants, Training andTechnical Assistance 2.4 100% of total foreign and

local costs.

Incremental Operating Expense 1.2 80% of total costPPF Refinancing 0.6

TOTAL 32.0

Special Account

3.44 To expedite disbursements, three special accounts for each of thethree project components will be set up in a commercial bank acceptable toIDA, into which would be deposited initial allocations of: (a; US$2 millionfor the Investment Finance component (about four months of disbursements);(b) US$750,000 for industrial sites; and (c) US$250,000 for drawninstitutional capacity development from the proposed Credit immediately aftercredit effectiveness. All expenditures under US$100,000 would be disbursedfrom the Special Account on the basis of statements of expenditure (SOEs).The documentation for withdrawals made under SOEs would be retained by theApex Unit for 10 years and would be reviewed by supervision missions and

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audited annually. All other disbursements would be on the basis of full andacceptable documentation. The Special Account would be audited annually byindependent auditors and audit reports would be submitted to IDA within sixmonths of the end of the fiscal year. RBM would submit to IDA a quarterlystatement of transactions on the Special Account. Requests for replenishmentof the Special Account would be submitted every two months or whenever fundsin the account are not sufficient to meet outstanding and committedobligations.

Auditing. Accounting and Re2orting Reauirements

3.45 The Apex Unit located in the RBM would maintain accounts and recordsadequate to reflect the project's operations and financial situation inaccordance with sound accounting principles. Separate accounts will bemaintained for each of the PFIs and all other entities receiving technicalassistance. Independent auditors acceptable to IDA would annually review:(a) project accounts kept by the implementing agency; (b) the SpecialAccount; (c) financial statements of each PFI, including a separate audit ofSOEs and, for subprojects, a statement on compliance with eligibilitycriteria and subloan covenants; and (d) use of technical assistance funds.PFIs have adequate capacity and competence to prepare financial accounts forexternal auditing. The Apex Unit will be responsible for coordinating allaudit reports, which would be submitted to IDA no later than six months afterthe end of the entities financial year.

3.46 On the basis of information gathered from participatinginstitutions, the Apex Unit would submit half-yearly and annual progressreports on Project Components. The Apex Unit would be required to submitannual progress reports to IDA within three months after the end of eachcalendar year. PFIs would submit to the Apex Unit each quarter a reportshowing: (a) the status of the portfolio of subloans and investmentsfinanced with project funds; and (b) statement of financial and resourceposition. The Apex Unit would prepare the required part of ProjectCompletion Report within six months of the closing date of the Project.

IDA Suvervision

3.47 During appraisal, detailed discussions were held with potentialimplementing agencies to familiarize them with aspects of the project.Nonetheless, the project will still require close IDA supervision during thefirst three years. The first mission would be a project launch workshop,which would provide training for staff in project entities in IDA projectcycle, procurement and disbursement procedures, accounting and auditingrequirements, reporting requirements, and special account management.Subsequent missions would consist of an appropriate mix of skills foreffective supervision of the various project components. The Governmentwould organize a Mid-Term Review in consultation with IDA to evaluateprogress and status of project implementation and, if necessary, redesign theproject to ensure that the original objectives are achieved. The Ministryof Finance would be responsible for coordinating supervision missions and theApex Unit would be responsible for providing information required by themissions. Other project beneficiaries would be required to supplyinformation and reports as specified by the Apex Unit. For all missions,

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the Government would be responsible for providing counterpart staff toaccompany the missions. A detailed supervision plan is contained inAnnex XVIII. The Supervision arrangements, including the Mid-Term Review,were confirmed during negotiations.

Project Benefits and Risks

3.48 Benefits. The proposed IDA credit would fill a major gap in termfinancing for enterprises in the productive sectors in Malawi. Using theexisting financial intermediaries, including the coimercial banks and NBFIs,the project would help strengthen institutional capabilities to promote,appraise and supervise viable projects. By increasing competition and therange of financial instruments, the project would enhance efficiency in termresource mobilization and allocation. Bros:ader access to credit forinvestment under the investment finance and the industrial sites componentswill encourage real sector supply response and contribute significantly tothe Government's growth and adjustment strategy. Investment promotion wouldhelp diversify Malawi's base for foreign exchange earnings by encouraginginvestments in export oriented activities. The majority of initialinvestments are likely to be in projects with low capital intensity thatfavor labor intensive operations to help alleviate the unemployment problem.Support for SMEs, including women entrepreneurs, is likely to generate higherlevels of employment. Three quarters of women in Malawi engage in some formof off-farm income generating activities. Women also are heads of 28 percentof Malawi households, and yet, they receive only a small proportion offinancial services.

3.49 Risks,, The major risks are the possibility of an economicslowdown, (whi_h would discourage new investment), the conservative attitudeof banks and large enterprises, and Government slackening on reforms. Malawihas in the past achieved high rates of growth, primarily through a steadyexpansion in agriculture. The Government's continued emphasis on thedevelopment of agriculture as the mainstay of the economy, recent adjustmentmeasures, and its strong commitment to implementing the reform programminimize the risk of economic slowdown. Recent industrial and financialsector reforms have introduced competition in both sectors, which is changingconservative attitudes and making banks and enterprises more responsive tomarket forces. Another risk is tl-3 possibility of low investor response.This risk is mitigated by the favorable investment climate which is beingcreated by the Government and the high competitiveness of Malawi as aproduction site with low labor costs.

IV. AGREEMENTS AND UNDERSTANDINGS

4.01 During negotiations, agreements and understandings were reached withthe Borrower on the following:

(i) Financial Sector

- The RBM onlending rates, as well as the interest ratescharged by the PFIs on the subloans would be market based and

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reflect the average cost of term borrowings in the financialsyotem, including the implicit foreign exchange risk (paras.3.33 - 3.35);

- Covernment's letter of commitment to continuing the programof financial sector reforms (para. 3.12);

(ii) Industrial Sector

- an Investment Policy Statement, that clearly outlinespolicies regarding taxation, exports, exchange controls,investment protection, industrial land, and investmentpromotion (para. 1.50);

- A policy statement for the development of industrial sitesand supporting infrastructure (para 3.08);

(iii) General

Procedures and arrangements for: (a) managing projectimplementation; (b) procurement and disbursement; (c)environmental assessment; and (d) the institutional capacitydevelopment component; (paras. 3.36 - 3.38);

(iv) terms of reference for establishment of the Export CreditGuarantee Facility (para. 3.26);

(v) details of the future development program for MDC (para.3.30);

(vi) accounting and audit requiretents (paras 3.45 and 3.46); and

(vii) supervision arrangements, including the Mid-Term Review (para3.47).

4.02 Conditions of Effectiveness

- adequate staffing of the Apex unit in the RBM for themanagement of the credit funds (para. 3.36); and

- appointment of a committee to be chaired by the PrincipalSecretary to Economic Planning and Development to overseeimplementation of actions needed to set up the InvestmentPromotion Agency (para. 3.27).

4.03 Conditions of Disbursement

- Signing of a satisfactory participation agreement between theRBM and the PFI would be a condition of disbursement for eachPF1 (para. 3.15);

- 4 ') -

establishment of the Investment Promotioni Agency, withi termsof reference and adequate staffing leveli;, and operatingpolicies and procedures acceptable to 1DA is a condition ofdisburserment for invesitment protma)tlon activities(para. 3.27); and

withdrawals in an amount not exceeding the equivalent ofSDR 700,000 may be made itn respect of the investment financecomponent for paymenits made to cover expenditures incurrednot more than 90 days before the signing of the Credit (para.3.42).

4.04 Dated Covenants

development of an action plan for the restructuring of thePOSB by September 30, 1991 (para. 3.25); and

establishment of a steering committee by September 30, 1991to coordinate the development of capital markets in Malawi(para 1.38).

4.05 Subject to the above assurances and conditions, the projectconstitutes a suitable basis for an IDA Credit of US$32 million equivalentto the Republic of Malawi.

- 4#6 -

MALAWI


ANNEXES

i 1AWI - QRS iESTIC PRODUCT BY Di TRh OIGIN D CIN t.NT PRICES(mIlIeI s K.OG.b)

1973 1974 1975 1970 1977 1979 1979 1966 1901 1102 190 1964 1965 1956 1967 i6 1s5

Agriculture 139.7 168.7 14.2 226.7 286.6 294.9 811.9 536.3 36.8 420.8 487.7 681.8 835.1 72e.8 9el 4 11b8.4 1466.5

SaonIseal- 121.2 144.9 18.1 192.1 2i8.4 246.8 269.3 272.7 290.9 827.8 876.5 487.8 499.6 588.7 762.2 889.2 1651.7

Larg"cale 18.6 28.8 81.1 84.7 47.4 46.6 62.6 62.6 59.5 93.6 111.2 124.6 138.1 162.1 199 1 269.3 364 7

Manufacturing a/ 88.r 61.1 64.9 ".6 65.8 64.6 9 .6 104.3 127.1 189.6 166.2 191.2 214.0 246. 384 2 396.a 537 o

Construction 18t 21.9 27.1 28.0 W.0 46.2 48.6 61.8 49.8 54.7 55.6 60.2 70.7 72.6 8s,3 136.6 184.5

Elc. A Water 6.2 6.1 6.0 9.6 11.8 12.5 18.5 16.6 19.) 22.1 26.6 3a.6 , U.S 40.2 63.1 8 6 89 4

Distribution 46.8 06.0 78.6 n.6 u. 164.M 167.6 16.2 185.6 145.6 165.9 197.6 286.1 286.6 US. 1 38a.e 487.4

Transport & Co . 23.2 86.1 8.1 40.2 46.0 44.7 52.0 61.7 67.0 71.6 77.4 89.2 182.1 120.6 139.5 179.6 229.2

Fin & Comm Services 18.9 26.6 24.6 29.6 n7.7 48.3 61.9 61.8 56.2 74.3 64.6 97.2 118.4 125.1 162.8 201.S 262.7

Ownership of Dwellings 12.7 16.8 18.1 21.9 26.9 29.6 82.3 88.2 44.1 49.7 50.9 65.7 74.5 66.1 1 66 138.4 174.6

Gover mnt Services 31.9 42.1 46.6 58.9 68.9 67.2 74.1 92.5 115.6 18..2 166.1 193.1 223.1 274.4 382.1 657.7 619.8

Priv.Soc.&Comm Services 16.9 19.3 26.9 2n.4 25.9 20.9 26.6 84.8 42.8 46.1 66.6 86.9 72.6 67.7 169.1 142.7 176 7

Unall. Fin. Charge -4.8 -7.6 -9.0 -7.2 -12.6 -12.1 -20.9 -24.6 -26.7 -29.9 -14.2 -39.1 -45.6 -60.6 -61.6 -81.8 -106.8

GDP (Factor Coat) 3US. 488.3 494.7 573.8 66.9 742.5 766. 961.6 11.3 1129.5 1297.4 1529.3 1714.9 1976.8 24806. 8231.1 4041.8

GDP (Market Prices) 864.0 461.5 5M9.7 012.0 723.0 6.? 64.5 16IN.1 1105.1 1245.6 14?7.6 1707.4 1958.9 2194.7 2148.3 3868s. 4467.3

Indirect 7Txes 23.2 26.2 86.6 83.7 44.1 58.2 77.7 16.5 167.0 116.1 189.6 176.1 216.6 216.4 268.3 349.4 41U.5

CDP Deflator (N) b/ 62.6 73.9 9.0 U-8. 99.6 165.6 102.6 116.0 1".1 161.6 168.2 189.6 20. 2 232.0 'P4.1 as8.5 4360.

GDP Deflator (MP) (X) 62.6 73.9 N5.6 6.6 99.2 1U.0 16U.4 119.6 189.4 152.9 170.0 191.7 299.6 238 2 , a 4 Mo.04 434 8

NOTES:*/ including x;ning and quarrying.b/ based on GDP at factor cost in current prices divided by 0P at facto; cost iIX constet 1976 priccs.

1917 numbers ore am sries.1969 numbers are estimates.SOURCE* 1914-1909 DP (UP) and Indirect Tax data - Government Estimates (Jdnvery 1996 printout based on EP & D, RIM. Treasury end NSO data).

* Industry Values in current prices based on MWICDPCON (constant value) *eex_sbet. Coeveralon d_o vning oDP deflator indicatod.

* 1978-1915 DATA - iALAW1 - EP. and D. Printout, May 1969. >

a 1973-1977 DATA - MALAWI - CEx, Oct. 1966. Jr

C.

WAAUA - SS CAESTIC PllCT EY DSUSMUIAL .Q DI I4 197 I uCOsuT PRICES

1973 1974 167 1976 1977 1976 1907 IM 1w1 1662 196U 1964 1965 196 1667 166 MM

Agriculture 223.6 226.2 26.8 217.6 286.6 294.9 JM4.1 264.2 266.9 277.0 239.9 366.5 *. mg 69 917.3 328.1 327.1Sellscal. 194.0 190.0 191.4 216.2 239.0 246.3 252.0 281.2 210.6 215.9 223.8 246.9 242.6 244.5 247.2 246.0 244.6

Largecale 29.6 32.2 U.9 39.4 47.6 46.6 51.3 t.0 50..3 61.7 86.1 6.6 60.6 65.4 76.1 75.1 62.5

Menutacturing a/ 61.9 09.1 01.1 ?S.2 * .5 64.6 U. "6.6 n2.6 91.7 96.2 166.7 1N.6 166.1 167.1 116.6 124.9

Constrection 26.9 29.6 U.9 32.? 3.1 46.2 42.7 43.5 35.9 6.1 33. 29.0 37.2 31.2 31.1 36.7 42.9

Electricity A Water 0.4 *.2 16.0 10.0 11.8 12.5 13.2 14.2 14.3 14.6 16.6 10.1 16.4 17.3 18.7 19.1 20.0

Distributieo 74.1 67.9 91.9 96.7 69.6 1M.4 1S.1 110.4 90.3 96.2 96.6 104.1 114.0 199.9 197.4 166.0 166.7

Transpert A Cem. $7.2 46.7 43.9 45.7 40.1 44.7 61.5 62.3 46.5 47.2 46.6 47.6 49.5 61.6 49.1 56.1 63.3

Fin.oCem. Services 22.2 27.7 31.6 U.. 87.6 43.3 56.6 52.8 47.9 49.9 t6.4 51.2 55.0 53.6 53.2 56.2 61.1

buership of DmslliIgl 26.4 21.4 22.6 24.9 27.6 29.3 31.5 32.4 81.9 32.6 5.6 34.6 136.3 36.6 37.3 36.6 46.6

Gev. Services 51.1 56.9 56.2 01.2 64.0 67.2 72.3 73.4 33.3 67.9 92.2 161.7 166.2 116.0 134.5 141.6 144.1

Priv.Sec.Cem.Serv 26.4 26.6 26.1 26.6 26.0 26.9 26.1 20.1 6.6 31.7 33.6 34.7 3.2 37.7 86.4 39.6 41.1

UoalI Fin. Chargs -7.7 -16.1 -11.3 -4.2 -12.8 -12.1 -26.4 -21.0 -19.3 -19.7 -26.8 -26.6 -?2.2 -21.7 -21.7 -22.6 -24.6

GP (Factor Cost) 546.5 50.1 616.5 657.9 66.6 742.5 767.2 764.3 724.3 746.1 771.2 66.6 641.4 63.6 673.0 961.2 946.0

Ct (Merket Prices) 562.6 624.3 062.3 695.3 729.t7 6M.7 SU.7 39.6 794.0 014.6 U64.1 696.S 911.1 029.1 949.5 977.1 16265.

lndirect Taxes 37.1 66.2 43.8 33.3 44.2 56.2 66.5 74.7 76.6 09.7 73.9 U4.9 69.7 78.6 76.5 75.9 65.

NOTES:.a/ icluds mining sMd wurrying.1967 date ts Ne Serle.1909 Is so estimate.SOLCS:* 1964-1969 DATA - Gevermnt estimates (Jesury 1990 EP A D. 111. Tresary Iad 69 dat).* 197t-19U3 DATA - ALAI - E.P. & D. Printout My 10M.s 1973-1977 DATA - MALAWI - CEII Oct. 1965.

ft2;

0o

- 49 _

ANNEX IIPage 1 of I

MIALAWI

DISTRIBUTION OF FINANCIAL SECTOR ASSETS, (1985 TO 1988)(percent)

1985 1986 1987 1988

Reserve Bank of Malawi 34.1 33.7 36.8 40.5

Commercial Banks 42.5 42.9 41.0 36.5National Bank of Malawi 30.2 31.5 28.4 24.2Commercial Bank of Malawi 12.3 11.4 12.6 12.3

Leasing Companies 0.4 0.7 1.3 1.8

New Building Society 2.4 2.3 2.4 2.9

Development Finance Institutions 7.4 6.8 6.1 5.6

Post Office Savings Bank 5.4 5.2 5.5 6.1

Insurance Industry 7.8 8.4 7.0 6.7

TOTAL 100.0 100.0 100.01 100.0

Source: Reserve Bank of Malawi, Annual Report and World Bank estimates.

- J0

ANNEX IIIPage 1 of 1

MALAWI - PRINCIPAL INTEREST RATES

1985 1986 1987 1988 1989

OFFICIAL RATES

Bank Rate 11.00 11.00 14.00 11.00 11.00

Treasury Bills (91 days) 12.75 12.75 15.75 15.75 15.75

Local Registered Stock 11.00 11.00 14.00 11.00

COMMERCIAL BANKS

A. Deposit RatesSavings Deposits 10.75 10.75 13.75 10.75 10.75

30 day call 11.50 11.50 14.50 8.75 8.75

3 months fixed 12.75 12.75 15.75 12.75 12.75

6 months fixed 13.25 13.25 16.25 13.00 13.00

12 months fixed 14.25 14.25 17.25 13.25 13.25

B. Lending RatesMinimum Lending Rate 16.00 16.00 16.00 18.00

Maximum Lending Rate 19.00 19.00 23.00 23.00

NEW BUILDING SOCIETY

A. Deposit RatesSavings 10.75 10.75 13.75 10.75 10.75Investments 12.25 12.75 15.75 12.25 12.756 - 12 months fixed 12.25 13.25 16.25 13.25 13.25

13- 24 months fixed 12.75 14.25 17.25 13.75 13.75

B. Lending RatesOwner Occ'd (< K20,000) 13.75 13.75 13.75 12.75Owner Occ'd (> K20,000) 13.75 13.75 13.25Rental 16.25 19.00 16.75Commercial 17.75 17.75 20.00 17.75

POST OFFICE SAVINGS BANK

Savings 10.75 10.75 13.75 10.75

Source: Reserve Bank of Malavi, Annual Report.

COMMERCIAL BANKS: ADVANCES BY MAIN SECTORS(K aillion)

Agriculture Electricity TransportForestry Water Cons & Comm-and Manufac- and truc unica- Commun-

Fishing Mining turing Gas tion Trade tion Finance ity Personal TOTAL

1980 92.7 0.4 6.7 0.0 1.5 16.5 4.0 35.5 9.7 5.2 172.2

1981 94.3 0.3 6.1 0.0 1.3 20.4 6.8 39.7 13.9 7.0 189.8

1982 115.1 0.2 7.8 0.1 1.3 19.7 3.4 45.8 22.4 6.3 222.1

1983 138.5 0.3 10.8 0.1 0.9 30.7 8.5 55.2 15.8 3.3 264.1

1984 113.5 - 19.8 0.5 0.4 29.8 1.1 18.4 7.5 13.3 204.3

1985 11'.9 0.3 9.2 0.0 1.0 69.0 1.7 2.3 12.8 6.6 22n.8

1986 133.5 0.0 15.3 0.0 1.4 41.5 0.7 6.5 25.2 8.1 232.4

1937 109.0 0.0 24.7 0.0 1.7 34.7 0.6 2.3 23.6 6.6 203.4

1988 92.3 0.6 48.6 0.2 1.4 71.8 0.9 20.3 24.9 9.3 270.3

Source: Reserve Bank of Malawi, Annual Report.

.,,

N&LAVI

CREDIT EXTENIDD BY NON-BANK FINANCIAL INSTITUTIONS(K million)

N.B.S. P.O.S.B. INDEBANK INSURANCEMercantile --------------- -------- --------------- --------------- AnnualCredit L.F.C. Public Private Public Public Private Public Private TOTAL Growth

1980 2.0 0.0 6.9 1.1 22.4 2.7 14.7 10.3 11.1 71.11981 2.3 0.0 7.2 1.1 25.5 2.7 17.5 8.5 10.5 75.3 5.91982 2.2 0.0 8.3 3.9 31.0 2.6 20.4 10.8 14.2 93.3 23.91983 2.3 0.0 10.6 4.0 48.2 4.0 20.2 14.9 19.2 123.4 32.31984 2.7 0.0 12.5 2.0 55.3 5.8 18.2 23.7 22.9 143.0 15.91985 3.8 0.0 12.3 7.7 64.0 4.0 22.4 36.6 26.2 177.0 23.71986 3.7 0.0 18.6 8.6 72.8 2.1 25.6 45.2 32.8 209.4 18.31987 4.7 15.9 21.9 13.1 92.1 1.8 26.0 42.7 35.0 253.3 21.01988 3.7 31.6 25.9 24.6 112.7 2.1 27.6 57.8 42.6 328.5 29.71989 5.9 63.2 33.3 25.3 112.7 2.1 27.9 71.7 50.4 392.6 19.5

NOTEt The 1989 figure for L.F.C. is based on estimated growth rate.The 1988 figure for P.O.S.B. is based on trend. The 1989 figure is estimated to be the same as1988.The 1989 data for INDEBANK is based on June 1989 figures.The 1989 data for the insurance companies is based on extrapolated trends.

tD rn2X

ci

- 53 -

ANNEX VIPago 1 of 8

MALAWI


COMMERCIAL BANKS IN MALAWI

I. Goneral Bankina Practices in Halawi

1. Thia section reviews general banking practices common to both of thecommercial banks in Malawi.

2. Lendint Practices of the commercial banks focus on cash flow lendingfor short term working capital, supported by adequate collateral. Mortgages anddebenturos on land and equipment are routinely obtainable and are legallyenforceable in non-traditional areas. The banks take a general lien on allassets owned by the borrower, regardless of the size of the loan. Leasingcircumvents the problem, since title to the additional equipment is retained bythe financing institution, and thus is not touched by the debenture. Neitherof the two banks at the moment engages in lease finance.

3. Credit controls have resulted in an informal credit allocationsystem, with agricultural lending to existing clients given top priority, sinceagriculture is the mainstay of the economy and existing clients are known risks.At the end of the line comes credit to private industry and commerce, particular-ly to newer or smaller companies that do not have established credit facilities.Because of the banks' conservative lending practices, they are reputed to beunlikely to considor a credit request from a new client, especially SMEs. Thistends to discourage such requests and consequently new projects that wouldrequire short term bank financing.

4. IutercouD-an Transactions. The Press group conducts an activeinternal treasury management function that minimizes bank intermediation betweensubeidiaries. This is a normal and proper activity between related companieswhere credit risk is not an issue. While there has been some question that thismight in effect causo Press to be functioning as a bank, in practice inter-company traaaactions between unrelated companies are common in developedfinancial markets, although tho rights of the various parties aro generallyclarified through appropriato mechanisms, such as commercial paper, that mayinclude back-up lines from banks.

5. Branch Networks. Each bank operates a network of branches in eachof the significant comeorcial centers. In addition, each operates mobilebranches that make regular stops in rural areas to provide basic banking servicesto remote locations. However, the deposits generated by these mobile brancheshave declined substantially and forced the banks to rationalize their mobile unit

ihNNEX VIPago 2 of 8

operations to minimize costs. While a "second tier" institution such as POSBmay be beneficial in lower income areas not adequately serviced by the commercialbanks, such an institution would have to run on a minimum overhead basis in orderto serve the small average account size.

6. Services. Both banks offer the normal checking, call, savings andtime accounts. The Malawi payment systems appear effective and well suited tothe environment. Superior payment services generally follow competition fordeposits, which is limited in the present environment with excess liquidity.The fact that the payment system appears quite efficient is a reflection on theprofessionalism of the two commercial banks. Both banks provide fullinternational documentary and payment service. Pricing is identicaland issanctioned by RBM. The services are of high quality by international standards.The two banks generally have a set client base, but where they compete, they doso on the basis of service quality, not price.

7. Staffinz. Management has full hire and fire authority. However,staff are often given a second chance where in developed countries such a secondchance would not be given. Staff management appears pragmatic and constructive.

8. Financial TransparencE. The financial statement of the two bankswere reviewed and were found to be generally informative and relatively complete.The RBM receives more complete information as part of the regulatory supervisionprocess, but some higher level of detail than is currently required in thepublished financial statements is needed to bring Malawi up to internationalstandards in this respect.

1I. National Bank of Malawi

9. History. The NBM grew out of a fusion of the operations of StandardBank (now Standard Chartered Bank, "SCB") and Barclays Bank ("BB") in 1971, inwhich the Press group took over 48 percent and the Government owned ADMARC 32percent, leaving SCB and BB with 10 percent each. Operating management of theinstitution rotated every two years between SCB and BB, resulting in repetitiveswitches in operating policies and hiring procedures that resulted in unclearmanagement direction. In 1985 BB sold its share of the bank to SCB, which tookover executive management through a management agreement.

10. The clarification of responsibility established continuity inmanagement and allowed the introduction of up-to-date management and controltechniques and expanded training of local staff. An annual budgeting andplanning process has been introduced, weekly MIS provides management with theinstitution's financial condition, and all but two small branches have automatedaccounting systems. Credit policies and procedures have been formalized and loanapproval documentation has been updated to conform to those of Standard CharteredBank (International) Plc. The format is as complete and operational, and guidesthe branch loan officer through a careful financial and business analysis ofeach client. Lending products have been revised and a new updated creditpolicies and procedures manual has been prepared.

ANNEX VIPage 3 of 8

11. Through the 1980s NBM added to provisions and wrote down non-recoverable loans, thus improving the bank's asset quality. By about 1986sufficient provisions and write-offs had been taken to ensure that the assetvalues shown on the balance sheet fairly reflected reality, and loan recoveriescontinued, exceeding new provisions in 1988. From a somewhat disorganized,technically insolvent institution in the -arly 1980s NBM has evolved into a wellmanaged, sound financial institution.

12. Risk Assets. All loans are reviewed annually and require approvalat progressively higher management levels as the risk increases, with a lowerlimit established for unsecured credit than for secured credit. The rates chargedon loans vary from prime minus 2 for the top company to prime plus 4 for theleast credit worthy. A series of asset quality control mechanisms have beenintroduced, including:

(a) Tight control over disbursements and recoveries on crop finance, whichforms the bulk of NBM's business. A target of 40 percent of theexpected inputs should be financed by the borrower, although actualpercentage participation varies depending on the financial conditionand track record of the borrower. All disbursements are to a singleloan account for that particular crop, while proceeds of the sale ofthe crop are paid directly to the bank and credited to a separatereceipts account, with the borrower charged interest only on the netdifference between the two. This ensures that full audit trails aremaintained of all disbursements and receipts relating to that crop,eliminating the possibility of redrawing and misusing the proceeds ofsales.

(b) Each loan is reclassified at each disbursement into one of nine riskcategories ranging from least to highest risk. Management thus hasa continuously updating view of the institution's risk profile.

(c) A special recoveries unit staffed by two of the top credit staffmonitors and follows up on all troubled credits, thus ensuring thatthe branch managers keep on top of their loan portfolios.

(d) NBh has built up the capacity to take over the management of troubledplantations and rebuild them. This has been a defensive measure sincewhile repossession and sale are technically feasible, in reality thisis not usually possible.

13. Small scale lending is generally avoided as uneconomical, althoughno cost analysis was found that indicated the break-even size at differinginterest rates and loss rates, as would be necessary to determine an empiricalrather than judgmental cut off point. However, a brochure that provides guidanceto small scale borrowers on how to prepare their loan application and what to

56 -

ANNEX VIPage 4 of 8

expect from the bank. A portion of agricultural lending to landholders is passeddown to tenant farmers in the form of fertilizer and other support provided bythe landholder, so in effect an amount that is not quatitified of bank financingis reaching small scale tenant farmers.

14. Lease financing is being contemplated by N8M. At the moment thereis no obvious advantage to the bank since the tax benefit of depreciation accruesto the user of the equipment. As such there is no practical difference to thelender between collateralized lending and leasing if NBM already has a debentureon all the borrower's assets.

15. Earnings. The income figures reflect core operating earnings, andthus exclude non-operating income (net of the 50 percent income tax) from therevaluation of assets in 1986 and 1988. Reported earnings including revalua-tion less appropriate taxes gave 1.88 in 1986 and 1.25 in 1988. NBM's loan lossprovisions rose in 1986 as the underlying earnings capacity improved, and rosefurther in 1987, but declined in 1988 as core earnings declined. This downwardtrend was reversed in 1989.

16. Intermediation Costs reflect the efficiency of the bank. Generaloperating expenses had been relatively stable through 1987 as a percentage oftotal assets (at 0.70 percent in 1986 and 1987), but jumped significantly in 1988to 0.87 percent of total assets. Depreciation remained stable, provisions aresomewhat inversely related to profitability. Profit (including the effect ofasset revaluations) showed significant fluctuation, while taxes showed an upwardtrend and represented the largest single component of the cost of interme-diation.

17. Liquidity. Adequate liquidity is essential to ensure that afinancial institution can meet depositor demands for funds. However, excessliquidity can mean under investment of depositor funds. NBM recently had excessliquidity as its lending activities have failed to keep pace with the growth indeposits. This is a natural consequence of ceilings on lending and a lack ofsound lending opportunities.

18. Capital Adeauacv. Shareholder capital and retained earnings(including capital reserves) form the cushion that protects the institutionagainst insolvency in case of adversity. Given NBh's heavy concentration ofagriculture, the quality of its asset base is more volatile than that of a normalcommercial bank, so capital adequacy should be somewhat higher than the 8 percentof risk weighted assets suggested by the Basle Committee at the BIS. NBM'scapital position appears quite sound compared to all risk assets, reaching 10.2percent if revaluation reserves are excluded (as recommended by the BasleCommittee) or 15.8 percent if these are included. Clearly, this relatively highcapitalization with respect to all risk assets is due to the high liquidity.Any significant reduction in the current high liquidity could thus causepotential capital adequacy problems.

19. Staffin . NBM hires from two streams. The general practice is tohire some two high dozen school leavers per year, and put them through a seriesof rotational job and training assignments. Some half dozen university graduates

- 57 -

ANNEX VIPage 5 of 8

per year were hired from 1984 to 1988 (none in 1989) and put through an ac-celerated training course aimed at management responsibility. NBM provides in-house course* based on training needs identified by supervisors. Staff areencouraged to take the London Chrartered Institute of Banking exams, and the bankprovides partial financial support to those that take this additional training,and provides full reimbursement of all costs plus a bonus and grade promotionto those who pass. Staff are evaluated at least annually, and the staff memberhas an opportunity to comment in writing on the review. Performance incentivesare limited to special grade promotions. This explains the relatively high levelof responsibility given to each staff member and the high morale and low turn-over observed. Attrition of supervisors and above prior to retirement isessentially zero, and losses of clerical staff are generally limited to staffwho had entered bank service with unrealistic expectations.

20. Accountina. NBM has simple but effective accounting and qualitycontrol systems. These systems form the primary accounting records of the bank,produce appropriate strip listings for audit trail and reconciliation purposes,maintain full accounting sub-ledgers through to the branch general ledgers, andprovide branch managers with a daily trial balances and exception reports.Backup is housed both on-site and off-site. Consolidation into the bank wideposition is performed manually each week based on printed branch statements.

III. Commercial Bank of Malawi

21. History. The Commercial Bank of Malawi was formed in 1970 to be anexclusively Malawi bank. Initial staffing was based on whatever local staffcould be poached from other institutions and supplemented by a fairly heavyinternational staff. Bank of America NT&SA acquired a 30 percent participationin 1976 and provided technical support until this shareholding was relinquishedin 1983.

22. In the late 1970s early 1980. CBM expanded rapidly into tobaccofinance as Rhodesia/Zimbabwe withdrew from the market. CBM has reduced its badloan portfoLao and has fully reserved or written off all problem loans. CBM hasgrown into a professionally staffed and managed institution, and is now some onehalf the size of NBM. Expatriate staff are down to six from 16 five years ago.CBM has been able to pay a thirteenth month's salary as bonus to staff for thelast three years, and in early 1988 resumed term lending, primarily foragricultural equipment.

23. Budastina and Plannlna. An annual budget process establishes thecapital, the income and expense budgets fo- CBM. Branch managers submit theirown proposals - these are discussed with senior management to develop rationalbudgets for each branch and for the bank. Each branch is a profit center, withsurplus branches paid for funds transferred to the system, while deficit branches(more loans than deposits) are charged for funds provided. Performance isreviewed against budget every two months to coincide with board meetings, andprojections are revised as necessary to reflect changes in the economicenvironment - twice in 1988 but not yet necessary in 1989.

ANNEX VIPago 6 of 8

24. Risk Assets. The instruction sheet to the client is straightforward, the forms appear rational and the data content brief but to the point.Loan applications are submitted by the client to the branch, which does a writeup on the client, using a pre-printed check list. Credit authority iscentralized except for small limits delegated to the two regional managers. Allother credits require approval of the management, which has approval authorityup to KI million, with amounts above that subject to approval by the CreditStanding Committee of the Board, which has unlimited approval authority. Turnaround time is claimed to be very rapid since the management and board committeeare accessible and able to make quick decisions.

25. Interest rates range from prime (currently 18 percent) for soundcorporate clients to 5 perrent over prime in unusual, high risk situations.Rates on agricultural lending were held below other rates until relativelyrecently. CBM assesses the risk premium primarily on the credit worthiness ofthe borrower.

26 Loan classification procedures are based on a three level systembased on normal, 50 percent reserve and 100 percent reserve. Each loan isreviewed at least annually and specific reserves adjusted to reflect changes inthe quality of the credit. A small general reserve is also established as partof equity reserves, reflecting the normal expectation that a certain percentageof any new loans will become troubled. The current policy on loan lossprovisions appears conservative, and the balance sheet of CBM should reflect thevalue of the loan portfolio, providing that the bank's own guidelines arefollowed. CBM has taken very substantial loan loss provisions, and managementis comfortable with the adequacy of provisions.

27. Earnlins. The underlying earnings performance of CBM has been highlyerratic, which shows the annualized return on assets adjusted to remove (net oftaxes) the substantial revaluation of assets in 1986 and 1987. The average loanrate declined from 23.9 percent in 1986 to 21.2 percent in 1987 (as opposed toNBM's rise fro-m 21.2 percent to 29.7 percent, respectively).

33. Intermediation Costs. The cost of intermediation by CBM is substan-tially higher than that of NBM. CBM's operating expenses as a percentage oftotal assets have ranged from 4.5 times those of NBM to 9.6 times.

34. MW9i4.dfty. CBM's loan to deposit ratio has been erratic, with whatmay be an avers. .ension of credit in 1986 followed by an excessive contractionin 1987. Howevar, comparison with NBM's figures indicate that to some extentthis is attributable to changes in the general market environment - particularlycut-backs in lending due to the lack of foreign exchange for imports.

35. Capita?. Adequacv. CBM's nominal capital may appear adequate againstall risk assets at .2.4 percent in 1988, close to half this is attributable torevaluation reserves.

ANNEX VIPage 7 of 8

36. Staffing. CBM seeks the best staff it can find, anid coapentsates thiemwell. The minimum standard has been a high school diploma this is beingupgraded to candidates with several years university or with certificates inaccountitng. An accelerated programn for university graduatesi is also in place,including intensive two year in-house training followed by six to nine mnonlthlseach in supervisory rotatiorn, advances department and the internationaldepartment, followed by overseas studies for a masters degree. Twenty staff arein this program. Reviews are performed throughout the year and summarized atthe end of each year. Results are discussed with the staff, and an appealprocess exists if the staff member is not in agreement with his supervisor'sreview. The primary financial motivator is up to two salary increments abovegrade for top performers. The management has full hire and fire authority, butuses the latter sparingly. Disciplinary options include probation and demotion.Staff turnover is minimal.

37. Accounting. CBM has been using a centralized accounting system.The branches were tied in on line, with look-up and data capture at the branchlevel and centralized branch and general ledger maintenance. Branch levelprocessing involves during-the-day memo posting and evening batch updating. Thewaste system has essentially disappeared, since both sides of the transactionare entered into the accounting system together. Sorting of the paperdocumentation is done manually after the fact, confirmed against the stripreports genera,e( by the system. This has proven more flexible than the olderprocess of separating debit and credits, then entering them independently andsorting them at the time of entry, with the computer performing a reconciliationand re-merging of the independently processed debits and credits. Statementsare produced on a client determined cycle.

- h) -

ANNEX VIPage 8 of 8

Table 6.1:MALAWI - COMMERCIAL BANK - ASSETS, (1980 TO 1989)

(K million)

Claims Claims on Govt.on the Govt. Claims onForeign Securi- T Stat Reserve Other Pvt. Other TOTALSector ties Bills TOTAL Bodies Banks Banks Sector Assets ASSETS

1980 5.6 13.6 11.7 25.3 24.0 17.6 4.8 182.4 18.8 278.61981 6.5 13.6 11.1 24.7 22.7 30.9 8.5 191.8 16.8 301.81982 9.0 13.6 11.1 24.7 29.1 34.4 17.4 219.0 21.7 355.61983 13.7 15.6 12.4 27.9 24.4 33.4 21.5 254.7 22.6 398.21984 9.5 74.3 12.4 86.7 32.0 91.5 17.9 228.4 22.6 488.61985 13.0 72.2 25.7 97.9 46.8 96.5 13.1 212.6 24.0 503.91986 10.4 71.8 25.7 97.5 41.1 189.7 24.6 236.3 29.8 629.41987 6.3 67.8 26.2 94.0 53.4 303.8 43.3 205.4 27.1 733.21988 14.8 67.1 26.2 93.3 23.8 288.2 54.9 262.3 39.0 776.21989 22.2 60.5 22.4 82.9 30.5 225.6 50.1 383.1 58.5 852.9

Source: Reserve Bank of Malawi, Annual Report.

Table 6.2:MALAWI - COMMERCIAL BANK - LIABILITIES, (1980 TO 1989)

(K million)

Due to Non Savings Other TOTALOther Resi- and Capital Liabili- LIABI-Banks dents Demand Time TOTAL Accounts ties LITIES

1980 48.0 10.3 61.4 94.3 166.0 25.8 38.7 278.61981 22.4 9.3 73.9 126.7 209.9 24.9 44.7 301.81982 24.2 11.5 80.4 145.6 237.5 32.4 61.4 355.61983 40.8 9.7 71.6 165.0 246.3 36.2 73.9 398.21984 44.8 9.2 87.7 234.0 330.9 41.3 71.5 488.61985 60.4 11.5 97.5 217.5 326.5 46.4 70.6 503.91986 91.0 13.7 124.1 268.0 405.8 58.7 74.0 629.41987 52.6 18.4 156.5 370.4 545.3 62.4 72.9 733.21988 29.5 22.1 230.1 376.6 628.8 67.4 50.6 776.21989 35.4 25.5 230.9 409.0 665.4 99.3 52.8 852.9

Source: Reserve Bank of Halawi, Annual Report.

- bl - ljmEX VII

Pago I of 11

MALAWI


LEASING AND FINANCE COMPANY OF MALAWI LIMITED

1. Introduction. The Leasing and Finance Company of Malawi (LFC) wasincorporated on April 29, 1986 as a limited liability company and registeredunder the Banking Act in August 1986. Shareholders are the Investment andDevelopment Bank of Malawi Ltd (INDEBANK) 36 percent, Finance Corporation ofMalawi Limited (FINCOM) -15 percent, Old Mutual (RSA) Insurance company -10percent, UDC (Zimbabwe) Limited -10 percent, International Finance Corporati-on (IFC) 10 percent, DEG 10 percent, and Economic Development for Equatorialand Southern Africa (Edesa SA) 9 percent.

2. Structure and StafinQm. LFC's Board of Directors is made up of ninemembers representing its shareholders. The foreign shareholders -- UDC,EDESA, DEG and IFC-- have local alternates, as this facilitates fasterdecision making. UDC provides management under a management agreement whichgives LFC access to trained international staff, including the GeneralManager (GM). The General Manager manages the day-to-day operations and hasthe flexibility to offer competitive compensation for Malawi staff. As aresult, the calibre of the staff and morale appears high, with a lowturnover. A Manager serves as deputy to the GM. Between September 1986 andmid-1990 staff numbers had grown from 4 to 15. The company is currently toosmall to operate on the basis of separate departments and a formalizedorganization chart. Nonetheless, there is an appraisal section (threedevelopment officers), a customer accounts officer, and an accountant (plustwo assistant accountants). Two thirds of the officers have universitydegrees, and most of the other staff have high school diplomas. LFC alsoemploys five support staff.

Lendina Policies. Term. and Procedures

3. Services. The LFC offers leasing facilities based on recovering100 percent of the acquisition cost of the leased assets during the leaseterm, with the lessee responsible for all maintenance, insurance and taxesor duties on equipment. Proper vehicle maintenance is assured through aservice contract wl., a local garage, part of which includes notification toLFC if a scheduled maintenance is missed so that LFC can follow up with thelessee to ensure that this key function is performed. In addition, LFCoffers sale and lease back arrangements and residual value leases, althoughthis does not account for a large proportion of the lease portfolio. In1990, LFC expanded operations by opening a one-man branch office in Lilongwe.LFC also plans to start providing factoring services at some future date.

ANNEX VIIPage 2 of 11

4. Special Leasiny Arrangements. The majority of LFC's leasingactivities are undertaKen on a commercial basis with leases priced to reflectrisk. The only exception to this is the provision of 6ub-leases totransporters, which aMount to approximately K12 million and are treated asoff-balance sheet items. Under this arrangement, concessional bilateralfunding amoounting to KIO million, has been made available to the Governmentfrom the UK, German and United States governments to finance transportersthrough LFC to help alleviate the transport ituation. The interest rate onthese leases has been set at 14 percent by the Government, with LFC receivinga commission on these deals.

S. Interest Rates. Interest rates at LFC are fully market determinedand are now positive in real terms. As a new institution in a traditionallyconservative financial enviroament, LFC has to offer higher interest ratE3than the commercial banks to attract depositors. In addition, LFC has tomatch its deposit book with the longer term leasing arrangements that itintended to undertake. Prior to the ffay 1990, deposit interest rates rangedfrom 14 to 19.25 percent at LFC compared to 12 to 13.25 percent at commercialbanks. In addition, LFC has entered into long term deposit arrangements withdepositors, offering terms of up to ten years.

6. As a consequence of high deposit rates, lending rates werecorrespondingly high. When the LFC commenced operations, leasing ratesranged from 26 to 29 percent at a time when commercial bank lending rangedbetween 18 and 23 percent. In 1988 lending rates declined to 24 to 27percent without any corresponding drop in deposit rates. With theliberalization of interest rates in Malawi in May 1990, combined with areduction in excess liquidity and a generally healthier economy the rateswere further reduced to 22 to 25 percent.

7. Interest rate policy at LFC is largely determined by the need tomobilize deposits in a tight monetary environment. LFC currently has apipeline of K1O million in committed leases which cannot be funded for lackof resources. Although a bond issue is currently being considered, it is notgoing to be adequate and LFC will be obliged to seek other sources offunding. Another determinant of interest rate policy is the t"jective ofmaintaining an average of spread of about 6.5 percent between the averagecost of funds and the average lending rate.

8. Lease Maturities range from several months to over five years. LFCattempts to match the maturity of their deposit base with that of theirleasing portfolio. At thG end of May 1990 the average maturity of depositswas 16.7 months while the average maturity of the leasing portfolio was 16.17months. The policy of LFC is to ensure that these two average maturities donot differ by more than two months. Access to longer term funding, such asthe proposed bond issue and offshore borrowing, will assist in increasing theaverage maturity profile of their liabilities and risk assets.

9. Procedures. LFC has clearly defined project identification,appraisal and monitoring procedures. A large number of e.quiries for leasingfinance are received, with an estimated 60 percent reaching a more formalizedstage of making a written application. Applications are followed by e sitevisit rnd a request fsr financial information, 1:ncluding a flow of funds


statement, and verification of collateral security. Limited access tofunding has forced LFC to be selective in choosing its clientele, which isan important explanation for their high success rate and low arrearage.Credit approval comes from management with the local manager having a creditapproval limit of up to K200,000 and the general manager having the authorityfor approvals above this level. Although there is no centralized informationdata base on clients' repayment records, LFC is establishing its ownrecording system and all leases are graded either "A", "B", or "C" during theterm of the lease, depending on the underlying risk.

10. Appraisal procedures are outlined in a manual and the appraisalprocess is comprehensive and is extensively used by the development officers.Monitoring of lease arrangements is equally exhaustive. The staff in thecustomer accounts department record debtors on a "debtors record program" andweekly runs are undertaken. Any lease arrangement which is overdue isfollowed up by telephone calls and letters. The appraisal process andmonitoring system has contributed to LFC maintenance of a sound leaseportfolio, with no experience of losses.

11. Leasina Portfolio. As shown in Table 7.1, total leasing activityhas increased dramatically over the four years of LFC's operation. BetweenAugust 1987 and 1988 it increased by almost 150 percent (or 185 percent ifGovernment sub-leasing activity is taken into account). This rapid growthslowed somewhat but still remained at 95 percent in the 12 months to August1989. The changing financial environment, especially the recent decline inexcess liquidity, has meant that new leasing activity has been even moreconstrained by the availability of funding. Hence in the six months toFebruary 1990, total leasing activity only increased by 52 percent on anannualized basis. Management admits that grcwth over the past four years hasbeen heady and is looking forward to slower and more sustainable developmentin future.

- 64 -ANNEX VIIPage 4 of 11

Table 7.1: MALAWI - Total Leasing ActLvity and its Growth(K '000 and percent)

Aug Aug Aug Feb1987 1988 1989 1990

Lease Debtors 8,301 20,492 39,987 50,348Growth 146.92 95.12 51.82 I/Government Sub-leases 0 3,212 11,079 11,079

TOTAL 8,301 23,704 51,066 61,427

Growth 185.62 115.42 40.62 #I

*l This is clculated aos the annualized rate of growth based on now loasingactivity in the first six months of the year.

12. Sectoral Distribution. Over the decade, the Gov-rnoent's prioritywas developing Malawi's transport infrastructure as rapidly as possible tominimize the adverse impact on tho closure of the railway lines throughMozambique. As a result, LFC entered into a large number of leases f ortrucks and transport equipment in addition to sub-leases which it made on anagency basis for the Government. This has led to a large exposure in thetransport sector. By August 1989, over 55 percent of its total leasingportfolio was extended to haulage contractors, j/ while bus oporatorsaccount'd for a further 8 percent. With the reopening of the Vacala line,LPC plans to reduce its exposure In the transport sector. As of May 1990,the exposure has been reduceod to under 50 percent.

13. The most Important growth sector has been manufacturing whichaccounted for 10 percent of all leases at the end of 1989. This representsa steady incroase from 4 percent of the portfolio In 1987 and 8 percent in1988. LIC plans to switch further into this sector.

14. Exposure to estate agriculture has rumained relatively low becausethe soector has traditionally been adequately supplied with finance from thecooercial banking system. However, LFC is considering the possibility ofentering this sector.

j, This exposure includes approximately [10 million of 12 percent of totalleasing, which is Government sub-leases with no rilk to the LFC.

- 65 - ANNEX VII

Pago 5 of 11

15. Size Distribution of Leases. Total leasing business as at the endof May 1990, was 524 lease agreements with a value of K79.3 million. Theaverage lease value was K150,000, although after the deduction of unearnedinterest income, this was closer to K120,000. Half of the lease agreements,were under R80,000 and two thirds were under K150,000. In terms of valueof lending, half of all leasing, by kwacha value, is accounted for by leasingagreements of less than K350,000. Hence, the distribution of lease valuesis highly skewed. The largest lease entered into by LFC was around K1.5million to the Portland Cement factory.

16. Arrears and Overdue. To date, LFC has experienced very few problemswith arrears, except for seasonal fluctuations of the transport activity thatcoincides with the tobacco season. During the off-season, from November toMarch, many transporters typically fall behind in their repaymentobligations. Interest is charged on all overdue amounts thereby providinga strong incentive to repay. However, the seaosonal problems are recognizedand LFC is prepared to reschedule payments over this period. By the end ofAugust 1989, total arrears accounted for less than 1 percent of the totalvalue of lease contracts. The substantially higher arrears figure, of 2percent of total leases, for May 1990 reflects the seasonal pattern discussedabove. By mid-June this figure had already fallen by around K0.5 million andfurther reductions were expected as seasonal effects subside. Althoughseveral repossessions have occurred (four over the past four years), LFC didnot make a loss because the lease was either taken over by another lessee orthe repossessed item was re-sold at a profit. The existing lease portfoliois considered sound.

17. Rescheduling of Debts. Any re-scheduling that does occur is mainlyrelated to seasonal effects in the transport sector and only involvesrescheduling for several months. Debts have tended to be rescheduled at therequest of the lessee when it is recognized that seasonal factors are likelyto disrupt scheduled repayments.

18. Provisions. Despite a good record on arrears, LFC has a clearpolicy on provisions for bad and doubtful dobts. Two percent of total leasecontracts (minus Government sub-leases) is the aim of LFC, and at thebeginning of each year a monthly allocation to provisions is estimated basedupon anticipated total leases by year end. At the end of the year anadjustment is made as a consequence of a higher/lower than anticipated valueof leasing contracts entered into during the year. Given LFC'o past record,this policy is conservative and ensures sufficient coverage for a possibleincrease In bad and doubtful debts.

Sources of fundine

19. Deposits. The major source of funding for LFC has been depositsfrom the private sc'tor. Despite a rapid increase of over 20 percent from1987 to 1990, the deposits have not been sufficient to cover the higher andequally rapid growth in leasing activity. In 1990 a substantial proportionof deposits wero for periods greater than 365 days (just over 50 percent).An important contribution of LFC to the financial system in Malawi has beenits emphasis on the mobilization of long term deposits. The average size of


deposit is almost K90,000 indicating the larger type of depositor whooperates with LFC. Half of depositors funds have a maturity of less thantwelve months. On the other hand, 14.4 percent of deposits are for periodsexceeding 36 months with some deposits as long as n:.ne years.

20. The average return on each maturity classification starts at anaverage of 14.29 percent on deposits of up to 6 month and progresses to19.75 percent on 96 to 108 month deposits. On the total deposit portfolio,the average return is 16.43 percent which compares favorably with returns oncommercial bank deposits.

21. Shareholders Loans. LFC's funding is also derived from shareholderloans. By August 1989, shareholder loans amounted to K3.3 million, just over7 percent of total liabilities, and included: Old Mutual - an unsecured 3-year loan of K500,000 (fully repaid) and another unsecured 10-year loan ofK500,000; (ii) INDEBANK - an unsecured 5-year loan of K750,000; (iii) DEG -an unsecured loan of DM780,000 at an interest rate of 8.5 percent; (iv) Edesa- an unsecured loan of US$500,000 at an interest rate of 8.5 percent; (v) £FC- a Swiss franc, 7-year loan of HF1,136,000 at an interest rate of 8.25percent.

22. Bond Issue. As demand for lease finance has outstripped the supplyof domestic savings, LFC has been forced to investigate alternative methodsof raising financial resources. Currently, a K10 million bond issue is underconsideration. This would be the second bond issue in Malawi (INDEBANKissued a bond in July 1990) and represents an important development for thefinancial market.

23. Comiutina and Information Systemt. LFC is well served by goodcomputing systems that include accounting packages, a debtors program, adepositors program, some simple financial analysis packages and wordprocessing. All professional staff are computer literate. The 13 staff have5 IBM personal computers for their use that are net-worked for generalizedaccess to information by all users.

24. Management is constantly upgrading its computing facilities and hasplaced an order for a computer to expand capacity to computerize informationon new activities. Deposit and credit information is backed up on a regularweekly basis and updated tapes are kept in a safety deposit box. Reportingsystems within LFC are regular and timely and are adequate for its currentlevel of activity.

Financial Performance

25. After three years of operation, by August 1989 the profitability ofLFC was 10 times higher than the original best case scenario forecast at thetime of incorporation. The financial performance of LFC has vastly exceededeven the beet estimates of its sponsors.

26. Table 7.3 gives the profit and loss statements while Table 7.4provides the balance sheet of LFC over years 1987-89. After an eight fold

- 67 -

ANNEX VIIPago 7 of 11

increase in net profit between 1987 and 1988, it doubled in 1989 and, basedon resUlts of the first half of 1990, it is on target to double again.

Despite the paper intensive nature of dealing with numerous small leases,

operating efficiency, as measured by the cost of intermediation, declined

from d start-up level in 1987 of 7.8 percent of average total assets to 3.14percent in 1988 and 3.48 percent in 1989. The rise in 1989 is attributable

to increased Government lease expenses due to additional sub-leasing

contracts entered into in the second half of 1988. A large part of the

reduction in intermediation costs has came from a reduction in the percentage

contribution of staff costs to average total assets, which fell from 6.16

percent to 1.89 percent over this period. LFC is second only to the NBMamongst Malawi financial institutions in terms of operating efficiency.

27. High profitability has also been reflected in a high return onaverage assets (ROA) ratio. This has steadily improved from 2.4 percent in1987 to 4.2 percent in 1988 and 4.6 percent in 1989. Assuming a continuationof the same growth in the second half of 1989/90 as occurred in the firsthalf of the year, LFC will have an even higher ROAs of 5.3 percent in thecurrent FY.

28. High profitability has allowed LFC to pay a high dividend as wellas accumulate high levels of reserves. Dividends were 16.7 tambala and 33.3tambala on a one Kwaha share in 1988 and 1989, respectively. A 1990 dividendof 18.9 tambala is estimated based on a payout ratio of one third of profitsafter tax (the payout policy adopted by the Board). The reduction in payoutin 1989 is a consequence of a substantial increase in share capital during1989/90 from K1.5 million to K4.5 million.

Capital Structure

29. At the end of August 1989, LFC had capital and reserves of K3.4

million, comprised of K1.5 million in capital and K1.9 million in revenuereserve. This changed at the end of August 1990 because of a new sharesubscription during the year, bringing capital to K4.5 million in capital andK2.8 million in revenue reserve for a total capital and reserves of K7.3million. Hence, capital and reserves, as a percentage of total assetsincreased from 7.4 to 10.5 percent.

Conc lusio2

30. The concerns of LFC are its ability to continue providing adequateappraisal and monitoring procedures for a rapidly growing lending portfolioand the likely effect of any competition. With regard to rapid growth, thisposition is partly being addressed by a slow down in the overall growth ofthe LFC. Management is aware of the risk of rapid growth which couldoutstrip the capacity of the institution and is now planning for asubstantially lower growth pattern. In addition, the staff and theinformation systems in LFC appear to have adjusted to the rapid growth of therecent past. There was no indication of an inability to handle the current

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ANNEX VIIPage 8 of I1

portfolio, rather there was a concern that the recent reductions in liquidityand availability of funding had actually reduced the work load to what theycould tolerably manage.

31. The effects of competition are less easy to gauge. There are anumber of institutions considering entering the lease finance market,including the two co= orcial banks. Despite these possible sources ofcompetition, LFC is in a position to cope in a more competitive environment.

32. Overall, the LFC appears to be in very sound financial condition andwell placed to utilize the line of credit as set out under the proposedproject in as prudent a manner.

- 69 - AIIEX VII

Page 9 of 11

Table 7.2KALAWI LEASING AND FINANCE COMPANY Of MALAWI

LEASING BUSINESS BY SECTOR(percent)

1987 1988 1989

FARMING 6.80 5.37 5.64Comercial Vehicles (2.86) (2.41) (1.44)Tractor& (2.74) (0.83) (2.99)Trailers (0.02) (0.32) (0.10)Trucks (1.18) (1.59) (0.81)Implements & Machinery (0.00) (0.14) (0.29)Irrigation Equipment (0.00) (0.08) (0.01)

MANUFACTURING 4.22 7.92 10.08Commercial Vehicles (1.08) (6.56) (6.10)Industrial Machinery (0.95) (0.24) (2.56)Computers (2.19) (0.98) (0.32)Office Machinery/Equipment (0.00) (0.14) (0.07)Trucks (0.00) (0.00) (1.03)

RAULAGE CONTRACTORS 47.42 52.86 55.65Commcrcial Vohiclls (0.00) (4.23) (1.61)Trucks (6.52) (6.61) (23.81)Mechanical Tractors (11.22) (13.57) (4.62)Mechanical Tractors Trailer421.35) (24.27) (23.80)Trailers (8.33) (4.18) (1.81)

BUS OPERATORS 4.16 15.31 8.06Buses (2.92) (14.99) (7.74)Trucks (1.24) (0.32) (0.07)Commercial Vehicles (0.00) (0.00) (0.25)

OTHERS 37.40 18.54 20.57Comarcial Vehicles (16.20) (10.51) (1.81)Trucks (0.43) (1.61) (0.48)Office Machinery (0.27) (0.86) (0.19)Computers (6.08) (2.07) (0.54)Industrial Machinery (0.01) (0.98) (0.32)Aircraft (0.00) (0.46) (0.35)Earthmoving Equipment (1.50) (0.16) (0.37)Others (12.91) (1.89) (16.51)

TOTAL

- 70 - iANNEX VII

Page 10 of 11

Table 7.3 KALAWI - LEASING AND FINANCE COMPANY OF MALAWIPROFIT AND LOSS ACCOUNT

(K '000)

August August August Feb1987 1988 1989 1990

INCOME

Income from Leasing Finance 1,536 4,336 7,648 6,066Income from Investments 76 372 569 437Income from Government Leases 16 400 419Profit on Sale of Fixed Assets 5 105

TOTAL INCOME 1,612 4,724 8,623 7,027

EXPENSES

Interest on Deposits 515 2,119 3,865 3,328Expenses on Shareholder's Loans344 350 457 18Interest on Bank Overdraft 17 4 6 11Auditor's Remuneration 13 16 22 11Depreciation of Fixed Assets 28 43 89 60Management Fee 56 86 56 35Other Administrative Expenses 360 433 689 459Preliminary Expenses 48 48 24

TOTAL EXPENSES 1,334 3,199 5,232 3,946

Profit before Taxation anExtraordinary Item 279 ;,624 3,391 3,946

Taxation 139 820 1,714 1,510Profit after Taxation 139 804 1,677 1,570Extraordinary Item 39 0 0 0

Profit after Taxation and 100 804 1,677 1,570Extraordinary Item

Retained Profit at beginning 100 250 1,118of year

Available for Appropriation 100 905 1,927 2,688Transfer to Contingency Reserve 405 359 408Proposed Dividend 250 450 1,500

RETAINED PROFIT AT END OF YEAR100 250 1,118 780

- 71 - ANNEX VII

Page 11 of 11

Table 7.4LEASING AND FINANCE COMPANY OF MALAWL

BALANCE SHEET SUMMARY(K thousand)

August August August Feb1987 1988 1989 1990

Local Registered Stock 300 2,200 2,600 0

Bank Balances and Cash 2,700 490 2,469 0

Liquid Assets 3,000 2,690 5,069 6,595Debtors and Prepayments 8,301 20,492 39,987 51,348

Preliminary Expenses 192 144 96 72

FIXED ASSETS 186 277 828 1,059

TOTAL ASSETS 11,679 23,603 45,980 59,075

LIABILITIES & SHAREHOLDERS FUNDSAmounts Due to Banks 0 117 355 2,652Amounts Due to Depositors 7,625 17,620 33,215 42,779Government of Malawi Leases 0 3,267 532 0Other Liabilities 383 288 995 2,948Taxation 64 823 1,531 1,984Deferred Taxation 66 72 104 0Proposed Dividend 0 250 450 166

8,138 22,437 37,183 50,528

SHAREHOLDER'S LOANS 1,941 2,223 5,416 875

CAPITAL AND RESERVESShare Capital 1,500 1,500 1,500 4,200Revenue Reserves 100 655 1,882 3,402

TOTAL SHAREHOLDER'S FUNDS 1,600 2,155 3,382 7,602

TOTAL LIABILITIES &SHAREHOLDER'S FUNDS 11,679 26,815 45,980 59,005

- 72 -

ANNEX VIIIPage 1 of 16

MALAWI

FINANCIAL SECTOR AND ZNTERPRISE DEMELOPMENT PROJECT

INVESTMENT AND DEVELOPMENT BANK Or KALAWI LIMITED

1.. Backaround. The Investment and Development Bank of Malawi Limited(INDEBANK) was established in 1972 as a limited liability company, with theobjective of fostering economic development through the investment and financingof productive enterprises in Malawi. Its shareholding is predominantly foreign,although the largest shareholder is ADMARC (owned 100 percent by Goverrment).The four remaining shareholders are the Commonwealth Development Corporation(CDC) of U.K., PMO of the Netherlands, DEG of Germany, and the InternationalFinance Corporation (IFC). They joiritly account for 76.4 percent of its paid-in capital, which amounted to K6.8 million at the end of June 1990.

2. Structure and Staff nm. INDEBANK's Board of Directors, consists ofnine members (two members representing each of the four major shareholders --ADMARC, CDC, FHO and DEG, and one member representing IFC), reviews theinvestment policy principles and operating procedures annually, and plays a veryactive role in all decisions relating to investments. INDEBANK is managed bya General Manager, assisted by four controllers, each of whom heads a department.INDEBANK's current staff numbers 28, equally divided between professional andsupport staff.

3. The staff of the Project Investigations Department have developedexpertise in all aspects of project analysis and appraisal. Consequently, theproject appraisal reports submitted to the Board are generally of an acceptablequality. Once an investment is approved by the Board, the project's file isturned over to the Projects Monitoring Department, whose function is to monitorthe projects, first during the implementation phase and, later on, during therepayment phase. There is a need to improve INDEBANK's projects monitoringfunction, which would require an increase in the number of professionals and theformulation of a uniform reporting system to be required from all borrowers.At present, projects are monitored during the implementation phase primarily withrespect to IWDIBAN's disbursements. No information is available on the actualcosts of projects, as compared to the original estimates. Information on theextent and causes of cost overruns and delays in implementation would be of greatusefulness to the project analysis group in the design of new projects.Furthermore, given that the monitoring team consists of only two officers andthat priority is given to 'problem' projects, "performing" projects are not

- 73 -


currently inspected as frequently as thoy ought to be. Regular inspection ofall projects, coupled with regula.- reporting by all borrowers on their projects,would enable INDEBANK's management to identify problems earlier than at present,which should in principle lead to earlier resolution of these problems and animprovement in the performance of borrowers.

4. Investment Policies. The Board of Directors has clearly definedINDEBANK's general investment policies and set various investment limits.INDEBANK is expected to make investments only in commercially viable enterprises,preferably in limited liability companies formed under the Companies Act. Exceptin special circumstances, INDEBANK does not participate in refinancingoperations. It requires minimum contribution from the sponsors of a project,normally equivalent to at least 25 percent of the cost of the project. It alsorequires the availability of competent and continuous management for the project,since it will not participate in any project that would require it to assumeprimary management responsibility. In addition, INDEBANK's guidelines call fora diversification of its investments, both geographically and by sector.

5. In addition to the above general investment policies, the Board hasset a number of conditions, as well as single and aggregate limits, relating toINDEBANK's lending activities, equity participation or investments in general.INDEBANK's loans are normally in the form of secured debentures, and are notadvanced until the borrowers' capital has been fully paid-up. Loans are normallyfor a period of not less than five years, but not exceeding the economic lifeof the assets on which they are secured. INDEBANK does not normally provideshort-term finance and will not compete with comuercial banks in providingseasonal working capital. The rate of interest on loans and its modality varieswith the type of loan and its duration, the project risks involved, the securityoffered and the source of funding. INDEBANK does not normally charge any fees

for investigation and other specialist expenses connected with a project, but

charges a commitment fee of 0.1 percent per month on the undisbursed balancesof loans. INDEBANK will not normally accept to finance le than 10 percent ofa project's medium- and long-term borrowing requirements nor provide more than50 percent of a new project's borrowing requirements (or 60 percent in the caseof project expansions). At any rate, the Board has set a limit to INDEBANK'stotal exposure (i.e., loans plus equity participation) in any one project,equivalent to 25 percent of its shareholders' funds.

6. Sound investment principles require that limits be set for INDEBANK'sindividual and aggregate equity investments. INDEBANK will not normally acquireless than 10 percent or more than 35 percent of the shares of any company. Theamount of any singlo equity participation should not normally exceed 10 percentof INDEBANK's shareholders' funds, or one-third the amount of its loan to the

company, in cases where INDEBANK is also financing the project. INDEBANK'saggregate investments in shares, which will be made out of its Kwacha resources,should not exceed 120 percent of its shareholders' funds. Since INDEBANK wouldlike to play the rolo of a venture capital company, it should, in principle, tryto liquidate its equity participation once tho projoct has matured. However,given tho nature of the agreements that it has so far had with the majorityshareholders, whereby the latter benefit from a pre-emption of sale clause,

'UNME VXlIPago 3 of 16

1N1)FhANK hiiui) oui l1f( LI0 1h J L itoioid to t(juicdato any of ito equity participation

at. f iii. rtiroki pLi (El 1UlwIebVb lre(i(lcg thle number of projoct S In which it canbe invrolved.

1. It tvJI t:iu.h, Ai L to-nd of 1984, INDEBANK' o anaetot totalled K?26.6nli)' loll, u/,l -li KIt .9 willolo (( ,xlotiaied of livoutfurito (not of provisions),and .4.l / r! 1 LonL Qf 1o).d ingeo of L'.ov'iarnont. securities. With shareholders' fundsamouLnti i11 to IAIC)Llt IQ inillion, equivalent to 18.7 percent of total assets,INDEBANKL us, audqu otly c pil ' 2 ed. li(Kever, its main source of fundingconiosted of predioualantlly io J.gn borroving in the form of income notes or linesof credit. At i1ho. end of t.94, total borrowing amounted to K20.2 million,implying a dubt/ciquity ratio of 4.06. During the five-year period 1984-1989,INDEBANK's aosers increaeud by 59.2 percnent to reach the level of K42.4 millionat year-end, whilh i(!' ituvaetments more than dcubled to approach the level ofK38.0 million. Cw. .v- the ratio of net investments to total assetsincreased from 70.9 percent to 89.6 percent. This was made possible partly bythe decrease in INDEBANM's holdings of government securities (from 17.7 percentof total assets at the ent of 1984 to 0.7 percent at the end of 1989) and partlyto the increase in the amount of borrowing. However, since the relative increaseof shareholders' funds (74.8 percent) outstripped that of borrowing (44.9percent), INDEBANK's capital adequacy ratio increased to 20.5 percent and itsdebt/equity ratio decreased to 3.37.

8. During the first half of 1990, INDEBANK's assets increased furtherto K47.2 million, an increase of 19 percent over the level reached a yearearlier. Net investments increased significantly to approach the level of K 41.3million, 5.8 percent above budget forecast and 39.7 percent above the levelreached a year earlier. This increased level of investment was financed partlyby an increase in the external lines of credit and partly by a decrease inINDEBANK's balances with banks. Consequently, INDEBANK's liquidity was reducedsignificantly during the past year.

9. Sectoral Breakdown of Investments Portfolio. At the end of 1984,INDEBANK's outstanding investments portfolio consisted of 54 loans valued at K16million (or an average loan size of K297,000) and 19 equity investments of [4.6million (or an average equity investment of K 243,000 equivalent). By the endof 1989, the outstanding loan portfolio consisted of 6' loans totalling [32.2million (or an average loan size of K 527,000), while the equity portfolioconsisted of 23 participation totalling K10 million (or an average equityinvestment of K 435,000).

10. An increasing shAre of INDEBANK's investments are in the agro-industrial and industrial sectors. Whereas at the end of 1984, the grossinvestments in these two sectors accounted for 57 percent of INDEBANK's totalinvestments, by the end of 1989 the proportion had increased to 70.3 percent.INDEBANK's investments in the co-riercial, serrices and financial sectors alsoincreased substantially from the equivalent of 2.1 percent of total investmentsat the end of 1984 to 9.6 percent by the end of 1989. This substantial increaseis the result of INDEBANK's involvement in one of its subsidiaries (IndefundLimited) and in LFC.


11. Qu-lity of Investments Portfolio. INDFBANK's mtrsvegement has adopteda prudent poJlcy of making provisions for investmPrit losses. Loan lossprovisions are usually made when the net asset backitng for a loan Pnd securityare inadequate and the profitability of the borrower Is uncertain, or when thefinancial position of the borrower has deteriorated to such an extent thatmanagement feels that the borrower will have severe difficulties in meetingfuture loan obligations. Arrears in loan repayments exceeding one year areautomatically provided for. Furthermore, when loans are rescheduled, thuscapitalizing loan interest, provisions might be taken with respect to thecapitalized loan interest. As far as equity participation are concerned,provisions are taken when the net asset value is less than the cost of theinvestment and when future profitability of the company is uncertain.

12. In view of the conservative making provisions policy, provisions forinvestment losses totalled K1.8 million at the end of 1984, equivalent to 8.5percent of gross investments. By tILe end of ;989, provisions for investmentlosses approached the level of K4.2 million, equivalent to 9.9 percent of grossinvestments. The deterioration in the quality of Ut1DEBANK's investments was theresult of the deterioration in the quality of its equity portfolio, with theratio of provisions to total equity participation .ncreasing from 6.5 percentto 15.8 percent during the interval. The quality of the lo&a portfolio has beenimproving, with the ratio of loan loss provisions to gross outstanding loansdecreasing from '.1 percent at the end of 1984 to 8 percent et the end of 1989.

13. The investments in the property development and the agro-industrysectors are the best performing ones, judged by the low ratios of provisions togross investments. On the oti:er hand, the risks Involved in inivesting in theagricultural sector will continue to be rather high. Thio implies that the shareof the agrictultural sector in total investments is expected to decrease furtherover time.

14. The data do not reflect fully INDEBANK's provisions for investmentlosses, since certain reschedul,o loan interest repaymerts in arrears are takenout of the investments portfolio and included under trade debtors. If theprovisions taken against these accounts, which have steadily increased fromK116,000 by the end of 1984 to K356,000 by the end of June 1990, are added tothe provisions taken for investment losses, then the ratio of total provisionsto outstanding investments (including trade debtors) would !,eve been 8.9 percentat the end of 1984, 10.1 percent At the end of 1989, ar; 9.9 percent by the endof June 1990.

15. INDEBANK's loan collection record hb.s been quite gooc. Overdue loanpayments do not usually oxceed three months. At the end of l984, arrears inexcess of three months stood at K113,00O, equivalent to only 0.7 percent of theoutstanding loan portfolio at the time. During the pamt four years, four loans(three industrial and one touriam) required rescheduling for reasons thet variedfrom the Kwacha devaluation to operational difficultico and unexpectod delaysin production start-up. Although arrears increased to 11,534,000 at the end ofJune 1990, the ratio in excess of three months decresa.d to 17.7 pereent. Duringthe period January 1986-June 1990, loan collections 4cro oquAl to 96.5 percent

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AMNNC VIIIPago 5 of 16

of repayments, a clear indication of the absence of serious loan repaymentproblems at INDEBANK. Consequently, provisions taken for investment losses seemto be more than adequattc to meet all potential future losses.

16. Borrowing. INDEBANK relies heavily on external sources of funding,a good part of which is in foreign currency. Borrowing is in the form eitherof unsecured long-term income notes issued in local currency, or of lines ofcredits, most of which are provided in foreign currency. The income notesoutstanding increased from less than K 11.3 million at the end of 1984 to K 14.8million at the end of 1989. These carry interest rates of 8 percent to 9 percentper annum and are held by four of INDEBANK'. five shareholders. The principalamounts outstanding under the various lines of credit increased from theequivalent of less than K9 million at the end of 1984 to K14.5 million at theend of 1989, and to K18 million by the end of June 1990. Thus at the end ofJune 1990, lines of credit outstanding accounted for 54.9 percent of INDEBANK'stotal borrowing, as compared to 44.4 percent at the end of 1984. In additionto the earlier lines of credit extended by the European Investment Bank (1977,1980), CDC (1978) and IBRD (1978), INDEBANK has benefitted from additional linesof credit from EIB (1985), CDC (1986) and IBRD (1986) and new lines of creditfrom FhO (1985) and most recently IDA (1989).

17i Financial Performance. INDEBANK'* financial performance has steadilyimproved during the past five years. Profits after tex increased from K192,000in 1985 to K1,623,000 in 1989, and to K1,360,000 during the first half of 1990,implying an improvement in the ROE and ROA. As shown below, the return onaverage shareholders' funds increased from 3.79 percent in 1985 to 19.57 percentin 1989 and to an annualized figure of 29.02 percent in the first half of 1990,while the ROAA increaced from 0.68 percent in 1985 to 3.99 percent in 1989 andto an annualized figure of 6.07 percent in the first half of 1990. Because ofthe devaluation of the Kwacha, the improvement in the return on equity is lessignificant when measured in foreign currencies of foreign shareholders. Duringthe five-year period 1985-1989, INDEBANK paid dividends totalling K2.1 million,equivalent to 51.6 percent of its net profits.

- -


HALAWI - INDEBANK'S PROFITABILITY RATIOS(in thousand kwacha)

Return onAverage Return Average

Average Share- Profit on Share-Total holders' After Average holders

Assets a/ Funds a/ Tax Assets (2) Funds (S)

1985 28,080 5,071 192 0.68 3.791986 30,535 5,205 375 1.22 7.201987 32,593 5,307 5 '9 1.60 9.801988 36,278 6,632 1,369 3.77 20.641989 40,651 8,293 1,623 3.99 19.571990 (First Half) 44,825 9,374 1,360 6.07 _/ 29.02 _/

a/ Estimates refer to the arithmetic mean of two successivo end-year (or endperiod) figures.

b/ Annualized ratios.

18. INDEBANK's detailed profit and loss accounts are shown in Table 8. 1,while Table 8.2 gives detailed balance sheets. Between 1985 and 1989, the grossearnings margin (or operating income) increased by 123.2 percent, mainly becauseof a 162.3 percent increase in dividends, but also due to a 75.6 percent increasein the interest margin. Over the same period, operating costs increased by only34.8 percent, other costs (consisting of net provisions for investment lossesand bad debts and dopreciation costs) actually decreased by 73.9 percent, andother income (consisting mainly of foreign exchange profits, profits on the saleof fixed assets, and grants) increased by more than six-folds. Consequently,profits before tex increased from K387,000 in 1985 to K4,663,000 in 1985.Roughly 62 percent of this increase In gross profits is explained by the increasein the net earnings mergin, 19.5 percent by the increase in other income, and18.5 percent by tho substantial decrease in the not provisions taken forinvestment losses and bad dobts.

19. The increase in tho intorest margin since the end of 1984 was aresult partly of the increase in the volume of lending activities and partly ofthe increase in the average interest spread. As shown below, the average lendingrate (computed by dividing the interest on loans by the average gross loanportfolio) increased from 12.4 percent in 1985 to 13.7 percent in 1989 and 14.6perceont during the first half of 1990, while the average cost of borrowing


appears to have decreased from 8.6 percent in 1985 to 8.2 percent during thefirst half of 1990. Consequently, the average interest spread increased from3.8 percent in 1985 to 5.6 percent in 1989 and 6.4 percent during the first halfof 1990. The improvement in the profitability of the lending activities between1985 and 1989 was, however, mainly due to the significant decrease in the netloan lose provisions. Whereas in 1985, net loan lose provisions (as distinctfrom the net provisions taken on equity investments) amounted to K732,000,equivalent to 22.4 percent of the interest incomo from loans, in 1989, the amountof loan provisions written back actually exceeded the amount of new loan lossprovisions by K32,000.

MALAWI - INDEBANK'S AVERAGE LENDING AND BORROWING RATES */(in percent per annum)

Average Average Returnon

Average cost of interest averagelending borrowing spread equity

Year rate (1) (2) (3)-(1)-(2) Portfolio

1985 12.4 8.6 3.8 25.61986 13.0 8.3 4.7 31.01987 13.8 8.2 5.6 21.01988 14.7 8.4 6.3 36.01989 13.7 8.1 5.6 38.71990 (First Half) 14.6 8.2 6.4 39.6

aI/ All these rates are rough estimates that refor to the income derived or costincurred during the year divided by the average amount of lending, borrowingor equity investment. Averages refer to the arithmetic mean of two successiveend-year (or end period) figures.

20. The ROE on INDEBANK's equity portfolio have been relatively good,even after allowance is made for the substantial provisions taken. The grossreturns on the average equity portfolio increased from 25.6 porcent in 1985 to38.7 percent in 1989, and to 39.6 percent during the first half of 1990. Thenot provisions taken decreased from K248,000 in 1985 (equivalent to 20.4 percentof the dividends received), to K220,000 in 1989 (equivalent to 6.9 percent ofthe dividends). However, during the first half of 1990, the amount of additionalprovisions taken on equity investments, which totalled K189,000, was equivalentto 9.4 percent of the dividends received.

- 19 _

ANNEX VIIIPoge 8 of 16

21. INDEBANK's equity investments were estimated, on the basis of theirnet asset values, at K19.1 million at the end of 1989, as compared to a bookvalue of K10.0 million, implying substantial capital gains. However, untilINDEBANK manages to insert in its future agreements with the majorityshareholdars a performance related formula for determining the eventual saleprice of shares, it will be difficult for it to realize its capital gainsregularly, and hence play the role of a venture capital company.

22. The elements of INDEBANK's cost of intermediation are summarizedbelow. In the wake of the significant increase in the level of dividends, theratio of the gross earnings margin to average total assets increased from 8.8percent in 1985 to 13.6 percent in 1989, and to about 15.2 percent in the firsthalf of 1990. On the other hand, the ratio of operating costs to average totalassets decreased from 4.1 percent in 1985 to 3.8 percent in 1989-1990. As aresult of the gradual decrease in the number of staff, from 40 (including 28professionals) in 1985 to 28 at present, the ratio of staff costs to averagetotal assets decreased from more than 2.4 percent in 1985 to less than 2.3percent in 1989-1990. And with the decrease in other costs (consisting mainlyof net provisions for investment losses and bad debts), the ratio of profitbefore tax to average total assets increased from 1.4 percent in 1985 to anexceptionally high 11.5 percent in 1989, and to 11 percent in the first half of1990.

- 80 -

AMNXC VIIIPage 9 of 16

HALAWI - INDEBANK'S COST OF INTERNEDIATION(in percent of avorag, total assets)

FirstHalf

1985 1989 1990

Interest income 10.94 10.97 11.45Interest cost 6.64 5.76 5.61Interest margin 4.30 5.21 5.84

Dividends 4.32 7.83 8.96Fees 0e19 0.54 0 35Gross earnings matgin 8.81 13.58 15.15

Staff costs 2.44 2.26 2.29Occupancy costs 0.38 0.52 0.53Other operating costs LZA 24Q0 Q 9Operating costs 4.06 3.78 3.80

Net earnings margin 4.75 9.80 11.35

Other income 0.45 2.36 1.08

Depreciation costs 0.33 0.23 0.23Net provisions for losses 3 49 046 117

Other costs 3.82 0.69 1.40

Profit before tax 1.38 11.47 11.03Taxes 0L70 7.48 496Profit after tax 0.68 3.99 6.07

Future Divelrsificatt0

23. Notwithstanding the good results achieved since 1988, INDEBANK hasbeen facing a number of problems relating to funding and to the emergence ofcompetition from the two commercial banks as well as from Its mn leasingaffiliate, LFC. Consequently, INDIDBNK has started to develop new sources offunding, and to look into possibilities of expanding and diversifying itsactivities into merchant banking.

24* Given that the commercial banks have recently increased the volumeof their term lending activities, thereby encroaching upon INDIANKI'a traditionalterritory, and given that LPC competes with INDIIUJI for medium-term equipmentfinance, INDEBANK's management decided to introduce now financial products and

- 81 -


services such as the taking of deposits, bankers acceptances and the provisionof foreign exchange dealing services. The Board has cautiously approved, inprinciple, management's plan to diversify its operations, including management'sproposal to retain che services of an experienced merchant banker. The banker'stask would be to assess the feasibility and implications of introducing thesuggested new products, and to submit reco-endations to the Board a businessplan outlining INDEBANK's future development.

25. INDEBANK's desire to mobilize new domestic sources of funding wasmotivated by the restrictions imposed by the foreign and international lendingagencies on the uses of borrowed funds. The process of identifying viabledevelopmental projects has been constrained by the fact that most lines of creditobtained from foreign lending agencies are earmarked for specific project sectors(i.e. mainly agricultural and agro-processing sectors). Moreover, an increasingnumbor of INDEBANK's current and prospective customers are reluctant to assumethe foreign exchange risks involved in borrowing in foreign currencies. In thelight of these difficulties, management decided to tap the domestic market andto endeavor to obtain in the future foreign exchange funds through grants andcredits obtained by Government and onlent to it in local currency.

26. In May 1990, management concluded that a debenture issue would bethe best instrument to achieve INDEBANK's imediate objective for raising doesticlong term finance, estimated at K 7-11 million for 1990/1991. On tho basis ofits assessment of market conditions and sentiment, a private placement of a [15million 10-year debenture issue, carrying a rate of interest ranging from 14.3percent to 15.5 percent per annum, was made in July 1990. The results ofINDEBANK's first private placement were disappointing, since only threeinstitutions (including the NBM) subscribed to a total of [4.3 million ofunsecured debentures carrying a fixed rate of 15.5 percent per annum (as comparodto the current prime lending rate of 15 percent in Malawi). A number ofpotential investors indicated a willingness to subscribe to future INDEBANKissues provided the rate of interest were raised to 16.5 percent por annum andthe placement vwa public.

27. In anticipation of future diversification, INDEBANK had applied toRBM for a banking liconcs, which has just boon approved. The license will enableINDEBANK to accept deposits and introduce new banking products and services.

Proiected Growth asd Profitability

28. INDEBAN['s projections over the next 5-years (1990-1994) assume anannual growth of 20 porcent in investments (net of provisions). The implicationsof the 5-year corporate plan is that INDEIANK's profitability ratios are expectedto decline. As implied by Tables 8.3 and 8.4 below, the RO and ROL are expectedto be lower than the levels achieved in 1989 and in the first half of 1990, butfairly high f or a DPI. The main reasons for this decreaso in relativeprofitability aro the projected increasing reliance on domestic borrowing andthe substantial allocations for provisions for investment losses. The corporate


plan assumes an interest spread of 3.5 percent on domestic borrowing, which isexpected to account for roughly 52 percent of total borrowing by 1994, therebyreducing the overall interest spread.

29. Projected provisions for investment losses are substantial, if oneassumes that investments will be appraised as carefully as in the past, and ifthe staff involved in project monitoring is strengthened. According to thecorporate plan, provisions taken for investment losses will gradually increasefrom K821,000 in 1990 to K1.843 million in 1994. As a percentaga of tho interestmargin, these annual allocations range from 29 percent to 40 percent, which isrelatively high. Consequently, barring a deterioration in the quality of theinvestments portfolio, these provitions are more than adequate to meet futureportfolio losses.

30. On the other hand, the corporate plan forecasts a gradual decreasein the ratio of operating costs to average total assets from 3.8 percent in 1989to less than 2.9 percent in 1994. This implies a decrease in the ratio of staffcosts to average total assets from about 2.3 percent in 1989 to just over 1.5percent in 1994. It is unlikely that such an improvement in efficiency can beachieved at a time when INDEBANK is about to launch new products that willrequire the recruitment of skilled professional staff.

31. Finally, INDEBANK's performance in the years ahead will, to asignificant extent, depend on the performance of its equity portfolio. Theprojected return on the average equity portfolio, which rangeo from 30 percentto 35 percent, though surpassed since 1988, is not an easy target to achieve.To obtain such returns requires the management to demonstrate an acute sense oftiming and alertness in the identification of profitable ventures.

32. Conclusions and Recm mendations. INDEBANK is one of the mostsuccessful DPIs operating in Africa (Annex IX). Two of the main reasons for itssuccess are the quality of its management and senior staff, and the positiveactive role played, in terms of financing, by its foreign shareholders.INDEBANK's investment policies are sound arAd the Board has prudently followeda conservative policy in provisions for its loan and equity portfolios. Therecent decision to increase its share capital by K4 million will improveINDEBANK's borrowing capability, and will enable it to increase the limit of itsexposure in any single proj6ct, thereby increasing the average size of itsinvestments.

33. INDEIANK's current policy is to reduce its dependence on externallines of credit denominated in foreign currencies. Therefore, in order tomaintain its growth momentum, INDEBANK would have to scceed in tapping thedomestic sources of funding. Its first private placement cannot be deemed asuccess, since it raised less than 30 percent of the targeted amount. However,there is evidence that INDEBANK would be able to raise more funds from domesticsources through the issuance of medium-term debentures if it were to offer moreattractive terms.

- 83 -


34. The emerging competition from the commercial banks and the LFC in

the field of term lending, requires that INDEBANK diversify its operations.

Consequently, it is recommended that the recruitment of an experienced banker,

who will act in the capacity of short-term advisor to the General Manager, be

expedited. With the RBM's favorable response to its request for a banking

license, INDEBANK's priorities should be the formulation of the best and most

efficient strategy for deposit taking, and the choice of the new financial

products and services to be introduced. Given INDEBANK's expertise in project

evaluation, which is its major strength, it is recommended that it specializes

in the packaging and syndication of developmental pro4ecta. INDEBANK should not

have much difficulty in selling participation to the commercial banks and to the

other sources of long-term domestic funds. Such an activity would not only

generate more fee income, but would reduce INDEBANK's dependence on dividend and

4 terest income, and raise its profitability ratios.

35. It is recommended that the staff of the Project. Monitoring

Department be strengthened, and a uniform reporting system be required from all

borrowers. Furthermore, the proper promotion of the loan packaging and

syndication activity would require the strengthening of the staff of the Project

Investigations Department by the addition of personnel with specialized skills.

36. Finally, it is recommended that INDEBANK refrains from making large

equity investments before having reached agreement with the majority shareholders

on a performance related formula for determining the eventual sale price ofshares. An exit clause on this basis should be incorporated in all future equity

investments.

- 84 - AME VIIIPage 13 of 16

Table 8.1HALAWI - IVESTHMT AND DEVELOPMENT BANK 0 MALAWI LIMITED

PROFIT AND LOSS ACCOUNTS FOR THE YEARS 1985-1989(In thousand [wacha)

1985 1986 1987 1988 1989

IncomeInterest on loans 2,269 2,854 3,266 3,768 4,054Dividends 1,214 1,589 1,212 2,267 3,184Fees 54 83 164 198 220Interest on securitiesand bank balances 803 426 330 500 406

Other income / 125 172 117 308 95A?Total Income 4,465 5,124 5,109 7,041 8,821

CostsInterest on income notes 900 900 905 1,074 1,225Interest on lines of credit 965 1,075 1,148 1,237 1,116Forex losses - _ 40 -

Cost of Borrowing 1,865 1,975 2,093 2,311 2,341

Staff costs b/ 684 831 821 952 918Occupancy costs 108 120 108 113 213Other operating costs 34 313 297 414 406Operating Costs 1,140 1,264 1,226 1,479 1,537

Depreciation costs 93 98 106 74 92Provisions for losseson investmente 845 765 756 442 ( 8)

Net provisions for bad debts 135 233 ( 186) 21) 196Other Costs 1,073 1,096 676 495 280

Total Costs 4,078 4,335 3,995 4,285 4,158

Profit before Tax 387 789 1,114 2,756 4,663

Taxes 195 414 594 1.387 3.040 8Profit after Tax 192 375 520 1,369 1,623of which:Dividends ( -) ( 300) ( 390) ( 683) ( 820)Retained earnings ( 192) ( 75) ( 130) ( 686) ( 803)

a/ Including proeilts on exchange, profits on sale of fixed aststs,grants and other income.

h/ Including staff housing.S/ Including an amount of Kwacha 681 thousand relating to provisions

on equity holdings taken in previous years, but subsequentlydisallowed by the tax authorities.

Source: INDEBANK.

- 85 - ANEX VIIIPago 14 of 16

Table 8.2MALAWI - IVVEST1MET AND DEVELOPIaNT SAN, O MALAWI LIMITED

BALANCE SUITS FOR TEZ TYEAS 1985-1989(In thoussad Kwacha as at end December)

1985 1986 1987 1988 1989

ASSETSCash and banks 417 528 3,839 6,412 1,408Government securities 3,389 1,680 1,030 500 300Investments (net) */ 22,992 25,480 26,524 29,136 37,989

Current loan maturities ( 2,719) ( 6,752) ( 4,653) ( 5,591) ( 6,658)Term loans and equity (20,273) (18,728) (21,871) (23,545) (31,331)

Fixed assets (not) 521 497 462 379 372Other asasot 2,200 3,366 1,780 2,475 2,331

Trade debtor l/ ( 735) ( 1,461) ( 662) ( 1,068) ( 1,186)Other assets / 1.,465) 1.905) I1.118) ( 1.407) (.1145)

Total Asset. 29.51 .63 38.9602 42.400

LIBILITIES

Borrowing 23,133 24,670 26,363 28,451 29,303Current maturities ( 2,021) ( 4,649) ( 2,590) ( 3,636) ( 3,032)Lines of credit ( 9,862) ( 8,771) (10,623) (10,005) (11,461)Income notoe (11,250) (11,250) (13,150) (14,810) (14,810)

OTHER LIABILITIES 1,219 1,639 1,900 2,560 4,403Creditors 4/ ( 1,219) ( 1,339) ( 1,551) ( 1,649) (2,276)Taxes payable -) ( -) C -42) ( 227) ( 1,307)Dividends payable ( -) I 300) ( 391)2( 684) ( 820L

Total Liabilities 24,352 26,309 28,263 31,011 33,706

SHAREHOLDERS' FUNDS

Share capital 5,000 5,000 5,000 6,833 6,833Reserves 167 __242 372 1 058 1 861Total 5,167 5,242 S 372 7.891 8.694

Total Liabilities andShareholders' Funds 59 31551 , 3 38 902 42400

gJ Not of provisions for diminution in value of invoestunte.a/ Not of provisions for bad debt.£/ Consisting mainly of accrued incomes end prepayment.d/ Consisting mainly of accrued interest.

Sourcet INDEBANK.

- 86 - ANNEX VIIIPage 1S of 16

Table 8.3KALAWI - INVESTMENT AND DEVELOPMENT BANK 0f MLAWI LIMITEDPROJECTED PROFIT AND LOSS ACCOUNTS FOR TEE YEARS 1990-1994

(In thousand kwacha)

1990 1991 1992 1993 1994

Income

Interest on loans 5,543 6,890 8,799 10,952 14,057Dividends 3,030 3,424 3,869 4,410 5,027Other income 502 608 678 765 927Total Income 9,075 10,922 13,346 16,127 20,011

CostsInterest on income notes 985 905 905 9)5 905Interest on lines of credit 1,976 3,186 2,841 2,549 3,690Interest on domestic borrowing _ 242 1.094 2.444 4.299Cost of Borrowing 2,961 4,333 4,840 5,898 8,894

Staff costs 940 1,054 1,204 1,346 1,504Occupancy costs 235 263 308 357 414Other operating costs 516 566 661 764 881Operating Costs 1,691 1,883 2,173 2,467 2,799

Depreciation costs 114 148 162 197 237Provisions for losseson investments 743 923 1,108 1,330 1,673

Net provisions for bad debts 78 98 LL8 14L L70Other Costs 935 1,169 1,388 1,668 2,080Total Costs 5,587 7,385 8,401 10,033 13,773

Profit before Tax 3,488 3,537 4,945 6,094 6,238

Taxes 1.744 L.783 2.488 3.1S9 3.192Profit after Taz 1,744 1,754 2,457 2,935 3,046

of whichsDividends (1,180) (1,300) (1,300) ;1,300) (1,300)Retained earnings 564) ( 454) (1,157) (1,635) (1,746)

Source: INDEBANK.

- 87 -- ANNEX VIIIPage 16 of 16

Table 8.4MALAWI - INVESTMENT AND DEVELOPMENT BANK 0 HaLAWI LIHITED

PROJECTED BALANCE SHEETS FOR THlE YEAS 1990-1994(In thousand Kwacha as at sud Decomber)

1990 1991 1992 1993 1994

Assets

Cash and banks 2,107 1,967 2,052 2,365 2,075

Investments (net) a/ 46,391 55,729 66,934 80,379 96,417

Current loan maturities ( 6,028) ( 7,792) ( 9,419) (12,712) (16,052)

Term loans and equity (40,363) (47,937) (57,515) (67,667) (80,365)

Fixed assets (not) 325 477 315 388 311

Other assets bi 5.370 4.648 5.979 6.717 7.920

Total Asset. 54.193 62.821 74.815 89.384 106.730

LiabilitiesBorrowing 37,491 45,253 55,536 67,404 82,077

Lines of credit (19,681) (20,843) (22,126) (24,394) (25,287)

Income notes (10,810) (10,810) (10,810) (10,810) (10,810)

New Kwacha loans (7,000) (13,600) (22,600) (32,200) (45,980)

Other liabilities 3,444 3,856 4,875 5,941 6,403

Creditors c/ ( 2,035) ( 2,485) ( 3,022) ( 3,687) ( 4,425)Taxes payable ( 229) ( 71) ( 553) ( 954) ( 678)Dividends payable 1.180) (1.300) 1 1.300) 1300) 300)

Total Liabilities 40,935 49,109 60,411 73,345 88,480

Shareholderc' Fund.Share capital 10,833 10,833 10,833 10,833 10,833

Reserves 2.425 2.879 4.036 5.671 7.417

Total 13.258 .13.712 14,869 16.504 18.250Total Liabilities andShareholdors' Funds 54.193 62.821 75.'80 89.849 106.730

a/ Net of provisions for diminution in value of investments.b/ Including trade debtors, prepayments and accrued income,

not of provisions for bad debts.c/ Consisting mainly of accrued interest.

Source: INDEBANK, with minor adjustments, to correct for inconsistencies

in original projections.

- 88 - ANNEX IX

Pago 1 of I

HAIAWICOMPARISON OF RATIOS OF OPERATING COSTS TO AVERAGE TOTAL ASSETS

OF BANKS IN SELECTED SUB-SAHARAN AFRICAN COUNTRIES */

PercentageNumber of of TotalInstitutions Assets in Ratio

Country Covered Category Year (S)

A. Co =ercial Banks

Malawi 2 100 1988 2.6Lesotho 3 100 1988 3.3Rwanda 3 100 1989 3.7geria 24 79 1986 4.2

r abwe ? 45 E 1989 4.4Zambia 3 40 1989 5.0Ghana 6 99 1989 5.8Guinea 4 100 1987 8.7Uganda 9 100 1989 19.4

B. Development Finance Institutions

Rwanda 1 100 1989 2.3Zaire 1 100 1989 3.2Zambia 1 100 1989 3.6Malawi 1 14 1989 3.8Somalia 1 100 1989(9 mths) 4.9Botswana 2 100 1989 7.1Ghana 3 100 1989 8.9Uganda 1 28 1989 12.4Lesotho 1 32 1989 14.3

C. Merchant Banks

Zimbabwe 4 100 1989 2.9Nigeria 12 64 1986 3.1Ghana 1 100 1989 4.7Zambia 1 100 1989 7.8

a/ Equivalent to the arithmetic mean of two sucessive end-year in a-icountries except in Uganda, where the geometric mean was used instead.

Source: Compiled by the staff of Trade and Finance Division, Africa TechnicalDepartment.

- 89 -

ANNE= SPago 1 of 25

MALAWI

FINANCIAL SECTOR &ND ENTERPRISE DEVELOPMENT PROJECT

MALAWI DEVELOPMENT CORPORATION

Sumnary of Recommndations

I. Introduction and Backiround

1. Introduction. The Malawi Development Corporation was establishedunder an Act of Parliament in 1964 and was incorporated as a statutory body(parastatal) owned 100 percent by the Government of Malawi. MDC was set upto be the focal institution for the Government of Malawi in the area ofeconomic development and to help achieve greater participation by Malawiansin business and industry. MDC's statutes, give it a broad mandate toundertake investmercs or develop investment ideas in all productive sectorsof the economy anl to provide services beyond the scope of conventionaldevelopment banks, and has been encouraged in this endeavour by theGovernment, which recapitalized the Corporation as part of the restructuringprocess. The objectives of MDC may be sumarized as: developingagricultural, commercial, industrial and mineral resources and the economyof Malawi, using sound business principles. As at 31 December 1989, MDC hadan equity base of K99.4m: K20m in paid-in share capital; over R73.9m in nondistributable reserves; and K5.5m in distributable reserves.

2. NDC's objectives are set out fully in the Investment PolicyStatement and Guidelines document. To carry out these objectives, MDC isexpected to identify, promote, evaluate and structure comercially viableprojects; attract technical and comrercial know how, managerial competenceand investment capital; participate with equity and loans; support new orexisting projects; and give priority to those projects with a developmentimpact. In course of its evolution, MDC has modified or given more emphasisto some aspects of these objectives, while overlooking or de-emphasizingothers. for example, promotional orientation, which is essential inencouraging investments ha boen completely neglected by MDC.

3. In the early 1980's, MDC faced significant financial and operationaldifficulties stmming from very rapid and poorly managed growth. To dealwith tho problems, the Government undertook a major restructuring of the'Porporation, irvolving a series of major disinvestment and equity portfolioswitches with the Press Group and a consolidation of operations. While therestructuring exercise was completed in 1987 and resulted in a leaner andmore profitalble organization with ivestments in 18 companies (down from 32before the divestments), the consolidation process is just ending. Even withthe downsizing, MDC with assets of K257 million at the end of 1989 stillremains one of the largest corporations in Malawi and has the potential tobecome a significant contributor to the development of the economy. However,

Poge 2 oi 25

(." I'wy t ' - ' F' -' i't,:Qht, i IlI!)U('f I, ) porat.i onf (DYCa) in othler partsof aouthaei t Ai ;ct ( ! NblL'tt alreadv ope3ratang in Malawi, -DC doce notplay a p4l'1 lcitiarlI lJynl.:iuc Lolh ii, deve-lopment for a variety of reasona.This aUalysis, !tJ1n ('v{u¶! the post. restructuring period 1985-1989, is anattempt at identl i : tIe leasons for MDC's dormant state and providesrecommendations oL. ( ths Corporation could be made more dynamic andcontribute to the ,tJ iment of Malawi.

II- Orgauizatioa 1 I eu&jawt and Staff

4. The Board of _ivectors. MDC'. Board of Directors comprises sevenmembers, all of wlom are nominated by the Government of Malawi. Three of themembers represent the shareholder (Government of Valawi), and the other fourrepresent vavied interests. Until recently, there were two private sectorrepresentatives, however, the tenure of one of them was not renewed whichleaves only one private sector voice on the Board. Ministry and othernominees rarely attand (perhaps one or two meetings a year), but do sendstaff as alternates to represent them at Board meetings. The lack ofattendance at meetings by senior board members does not lead to anycontinuity of thinking at Board level, and combined with the limitedrepresentation on the Poard from commerce and industry, has tended to dampenmotivation by the Board to actively pursue a business oriented approach. TheBoard needs to be strengthened through a stronger private sectorrepresentation, regular attendance by Government policy makers. This wouldenable the Board to play its rightful role of providing policy guidance tomanagement and of ensuring that management rune the Corporationprofessionally and in a manner that would enable it to contributesignificantly to the economic welfare of Malawians.

5. Bureaucracy is often blamed for an organization's failures toachieve its objective. and there may well be some minor areas in thisconnection that need to be addressed. At MDC, the relationship betweenmanagement and the Board of Directors at one and the Board and Government atthe other raises questions as to whether MDC is being effectively managed.The powors on the Board vis-a-vis commercial decieions are not very clearlydefined, for example, in certain instancoe, although a project may have beenapproved by the Board, such approval still has to be sanctioned by either theController of Statutory Bodies or, at times, Economic Planning andDevelopment (EPD). This could, in the event of projects arising, lead toundue delays in disbursement of funds, and could well deter other potentialclients from uven approaching MDC. Once the composition of the Board isstrengthened, Covernment should grant is increased decision making autonomy.

6. The organization as currently constituted consists of four maindepartments which report to the General Manager, viz; Projects, Finance(which is split into Accounting and Monitoring); Company Secretary andInternal Legal Co'unsellor; and Administration/Personnel Department. Inpractice, however, authority and delegation seem to be concentrated in theGeneral Manager and the Company Secretary. The General Manager's office andthe Company Secretary have taken on the Project Department's functions. The

ANNEX Y'rge 3 of 25

General Manager and Company Secretary are directly handling the Cape McClearhotel expansion project, the only major project current)y urnder review. Thissitiation, together with inactivity lhas resulted in morale problems withinthe Projects Department. Whereas it would be expected that Projects takesthe lead in MDC's activities, it has keen run down and ignored. There areno management committees or clear channels of communication between theGeneral Manager and other senior members of the maniagemeTt team, such thatmost business is dealt with on a case-by-case, often ad hoc, basis. Thislack of clear channels of communication has led to low morale among staffwho, at times, are not sure of their role in the organization. The lowmorale is compounded by the lack of job descriptions, excessive numbers ofadministrative staff, and comprehensive manpower development plans. This maybe a serious shortcoming if the Government plans to have MDC play a moredynamic leadership role in the economic development of the country. Thelarge numbers of administrative staff who are not fully occupied creates anatmosphere lacking in urgency throughout the organization.

7. Staff. MDC's staff of 41 as of December 31, 1989, included 13professionals, 18 clerical and support staff, and 10 operatives.Professional staff includes accountants, economists and engineers. Thesebreakdowns suggest that MDC has a low ratio (31 percent) of professional toother categories of staff (69 percent), which must weigh against performanceand motivation. The breakdown could also imply that there are manyunderemployed personnel in support roles, perticularly in the administrativearea, where there are seven drivers and messengers. Secretarial staff isalso thought to be too large for the few people at MDC that are likely toneed such services, especially if one takes into account the low level ofactivity at MDC.

8. Salaries have been mentioned as a constraint in obtainingsufficiently competent and motivated staff. No comparison with otherorganizations existed at the time of the mission to be able to effectiveiycomment on salary levels, however, it does appear that MDC salaries may bebelow those of comparator institutions. Government has indicated that it isnot rigid about salary scales, but rather approves parastatal staff budgetsbased on the performance of individual organizations, with management beinggiven the discretion to allocate the budget among its staff. There isevidence that this has been the case with at least two superior performingparastatals. MDC has opted to compensate for its lower salary leovls througha "top up" directors fees for its senior managers who sit or the boards ofdirectors of its subsidiaries. The fees are paid directly to themselvos.Whilst this may not be considered a major scnstraint, nae directorships arenot spread evenly, which raises equity and confliro of interost questions.It must croate a divided loyalty to MDC and ir 'i suggemted that appropriatelevels of componsation should be transperent and equitable. It isrecomended that Government review the remuneration packnge for MDC stnff andbring it to a level where it is competiti4e within the ferket place. Oncea competitive package is granted, this should be accompeniod by the abolitionof directors fees for 'DC staff. However, if Governmmnis Ys to be convincedthat MDC deserves better remuneration, management wov]60 bho-c to damonotratsthat it deserves to be compensatod competitively by bni.fq wu7c; pvootivo and

- 92 - ANNEXPag. 4 of 25

developmental. A schedule of the directorships by department shows thefollowing:

Table 9.1 MALAWI - DIRECTOR'S FEES FOR MDC STAFF(Kwachas)

Number Fees a/

General Manager 10 12,900Company Secretary 13 18,000Projects Manager 5 6,400Chief Accountant 4 4,600Monitoring Manager 5 6,800Projects Deputy 3 3,500Internal Legal Counselor 2 1.000

a/ As of January 1, 1989 - latest not supplied.

9. Although salaries may be a binding conctraint in attractingcompetent staff, high salaries alone are not a sufficient attraction formotivated personnel. A further constraint in terms of motivation must be thelack of a clearly defined training and manpower development program at MDC.It appears that whilst staff are reimbursed for seminars and courses, noactual plan exiqts to uplift the skills and abilities of the existing staff.A further constraint on motivation may well be the fact that despite anappraisal system being in existence, it appears that appraisals are notreviewed in a systematic manner with the staff concerned, nor are objectivesset for the forthcoming period.

10. The most serious area of weaknesses in MDC, therefore, is in itsmanagement structure. If MDC is to fulfill its proper role in thedevelopment of the economy it will need to strengthen management through:(a) a clear assignment of responsibility and authority to line managerst(b) develop a coherent manpower development program; (c) be more comerciallyorientedl and (d) rationalize its staffing by filling vacant positions,eliminating those that are not vital to its operations, and strengthening theweak departments (such as Monitoring). If MDC decides to diversify intoother areas of activity, including industrial estate development, and thereis no evidence that it can not do so if the needed changes were made, therewill be need to recruit an experienced Estates Officer to motivate, andcontrol the real estate developments. Financial planning will also neod ahigher priority at a higher level. Currently two positions are vacant, thatof a Deputy General Manager (whose exact role does not appear to be clear)and a Financial Controller (whose position has been vacant for over five

-93 - ANNEX XPage 5 of 25

years apparently). There does not seem to be need to fill the Deputy GeneralManager's position, as this would prove a block of the aspirations of otherdepartment heads, and certainly the volume of work does not justify theposition.

11. Communication and Motivation. The most effective organizations tendto be those with good motivation in terms of targets and interpersonalrelationships between the key management and indeed all the way down theline. This does not appear to be the case within MDC. Comunication isapparently poor and certain departments are left feeling unsure about theirexact role in the Corporation. This has tended to raise certain internalconflicts, jealousies and low morale. A solution would be the institutionof a regular and open channels of communication for discussion of key mattersaffecting the Corporation's progress. To motivate staff, management shouldcreate proper targets in terms of the business activities for the keymanagers who are able to carry them out, and in turn set targets in terms ofachievement for other members of staff. These do not have to be overorganized, but could take the form of the senior management getting togetherwith the General Manager weekly for as long as it takes, to settle what ishappening in the week to come and what progress occurred in the previousweek. This in itself would overcome some of the current suspicions andprovide the motivation for these who are currently lacking any goals.

III. ORerating Policies and Management Information Syste2s

12. The operations policy guidelines specify the investment principles,criteria and terms and conditions for equity and loan investments by MDC.The policy stipulates that MDC's investments in a new or existing project maybe in the form of minority share participation or through medium to longterms loans. In the past MDC has tended to concentrate on equityinvestments, and only provided loans to its subsidiaries. The policy alsosets the maximum MDC investment per project, which should not exceed 10percent of the Corporation's issued share capital plus reserves or 50 percentof the total project cost. Project sponsors are normally expected to provideat least 25 percent of the share capital of the project. Although MDC equityinvestments are supposed to be disposed of at the earliest opportunity, thishas not happened in reality, such that MDC has over time become less dynamicin the development or promotion of new investments end become more of aholding company.

13. In broad terms it would appear that MDC has all the basicinformation to be able to plan, lead, organize and control et 'ctively, butthe records could be usod more analytically and as a e to promoteinvestment and employment creation. The areas that need improvement andstrengthening are briefly outlined below.

14. Profoct Identification. The Projects Department appears to haveno plan for searching for new business, does not keep records in a systematicmanner of enquiries made, nor the action to be taken in order to be able tofollow up enquiries. There is a spasmodic update of the project pipeline insome dotail. The analysis is lacking in so far as no details are given of

_ 9 ~~ANNE xPage 6 of 25

funds disbursed to date in order to plan funding requirements into thefuture, and a number of projects have had no changes in the comments made tothem for over two years. The project profile is in many respects identicalto that presented over two years ago, with very little action having takenplace. This in part may be result of the current dormant state of MDC andmanagement attitude, existence of a vicious circle, whereby management doe.not encourage staff to be more proactive in identifying projects because oflack of funding, while funding is not sought because the pipeline is weak.

15. Project ARprai.al and Monitoring. The lack of dynamism at MDC hasleft the Projects Department with little work and very low morale for thestaff. There is no project appraisal manual and no follow up on project.under implementation or already implemented. Since there hasn't been anyproject appraisal in recent years, it was difficult to *asess the quality ofappraisal reports or capability of MDC's projects staff. The MonitoringDepartment produces some comprehensive records in terms of a quarterly reviewof the portfolio by company and an annual profile of each company, whichdetails the main financial results and some ratios for each company. Theinsistence on annual budgets for incorporation in the annual profile iscounendable and shows that the interest in the portfolio extends beyond merehistorical/financial recording, but the forecasts do not extend to any longerperiod, which would be essential in any longer term planning for MDC.Monitoring is in favor of monthly reports and believes, that effectiveinformation is only of value if it is presented in a timely manner and MDCis in a position to take effective action, should it be necessary.

16. Financial Accounts. Quarterly, the Chief Accountant prepares acomprehensive set of statements covering the Income Statement, Balance Shoet,Cash Flow, Capital expenditure, and Cash Projection for the balance of thefinancial year, together with supporting detailed schedules and analyses.It should be noted that these are not supported by commentary or suggestionsfor the guidance of management or directors. An ares where more immediateand direct comparison could well be provided is in the form of a comparisonagainst budget in terms of sectoral performance. Ideally such a comparisonshould bo provided monthly, and to achieve this situation, it would benecessary to produce MDC financial results monthly. An accounting manualdoes exist to cover routine transactions and was compiled in August 1987.Computers are used reasonably extensively in the accounting function and forspreadsheet use when project analysis and projections are required. Everyoffice has vord processing facilities.

IV. Portfolio Overview

17. The results of the portfolio analysis are reviewed in terms of acomparison of the various sectoral performances, the portfolio performancefor 1988 to the anticipated 1990, the disbursements by sector and by loan andequity over the years and the investment by sector and by loan and equityover the years.

ANNE:. X

Page 7 of 25

18. Disbursements. MDC's operations data only shows the level ofdisbursements, but does not include a breakdown of approvals and commitmentsby sector or between equity and loans. The last few years have seen adisbursement level of approximately K7m per annum, or approximately 7.5percent of the capital employed. This only serves to confirm the low levelof activity. The bulk of the disbursements (87 percent) has gone to theindustrial sector, whereas this sector only represents 50 percent of thecompanies and about 42 percent of the funds invented. Recently moredisbursements have been made to the Hotels sector. It is worth noting thatthe proportion of disbursements recently has reversed to more loans, but themajor part of these loans have been to one company.

19. Investments. Industry represents some 42 percent of funds invested,followed by hotels at 31 percent and trading at 11 percent. Real estate andfinancial institutions are approximately 7.5 percent each. It is worthcommenting that a comparable DFC in Southern Africa has invested as much inreal estate as in industry and the pattern of growth for the two sectors hasbeen identical. This suggests that the lead may have to come from MDC interms of developing industrial land and estates in order to attract and boostthe investment climate and growth of industry in Malavi. Currently, someK107,3m or 84 percent of investments are in equity, and K21,l1 or 16 percentin loan.

20. Emplovment. Whereas the percentage of employment for which MDC isresponsible in the industry sector is similar to the percentage of investmentin the same sector. Trading represents 24 percent (11 percent investment),hotels 20 percent (31 percent investment), financial institutions 14 percent(8 percent investment). Other than some small increases in the existingcompanies, employment has not been supplementetd by MDC. Little emphasisappears to be placed on employment creation. The analysis suggects thatgreater employment might have been achieved at a lower cost, had moreemphasis been placed on employment creation and selective investment.

21. Contribution. In terms of contribution to MDC, industry and tradingrepresent more than 74 percent of the total income, as opposed to utilizing53 percent of the funds. In this respect, the ratio has been consistent overthe years. It does, however, raise a question as to why more emphasis hasnot been laid on selective investment in industry and trading, although thistrend does nov appear to be under consideration.

22. Rturns on Funds. If MDC's funds invested are measured against thegross mncome it has received by sector, the only sector to have given asatisfactory return of over 15 percent consistently has been trading.Investments in financial institutions have provided the next best return,which has begun to pick up after a slight drop in 1988. The industrialsector and real estate sector have averaged around 5 percent. Hotels haveprovided a minimal return. There would appear to be grounds for justifyingthe continuation of investment and expansion into industry and tradingsectors, because these sectors have provided the greatest employment increaseand show rising returns on capital and equity. It appears that to attractthe appropriate investment into these sectore, any expansion will need to beaccompanied by a similar expansion in the real estate sector. An example of

- 96 - ANNEX Page 8 of 25

such complementary development has been observe in another DYC in theSouthern Africa region, where the two sectors have groun together and at analmost identical rate of disbursement and investment. Depending onGovernment policy, such an expansion will require substantial funding and itis likely that such an investment will be largely, if not entirely, in thehands of MDC. It is unlikely that private investors v'.l1 have *s;fficientfunds to invest in premises, as well as the investment required in a project.In most instances, investors tend to borrow construction loans for premises,which put considerable strain on their cashflow. By developing industrialpremises, MDC would help ease pressure on enterprise cashflow during thostart-up period, thereby, playing an important developmental role.

V. Portoflio Quality

23. Amongst the beet measures of performance are Return on Capital (ROC)and Return on Equity (ROE), followed by Employment creation, as the latterwould appear to be one of the main reasons for MDC's existence. The detailson portfolio performance are extensive, but could be sumarized as followsin terms of a few major ratios:

97 ANNEX XPage 9 of 25

Table 9.2HALAWI - SELECTED STATISTICS FROH 1988 TO 1990

Invested Rank ROC Rank ROE Rank Rank(K'0OOs) 2 S Emplmt Nos.

INDUSTRYBata Shoe Co. 6,548 11 54 5 58 4 376 6Chllington Agrimal 3,824 13 15 13 16 13 258 9Encor 1,826 14 108 1 114 1 219 10Leopard Match 6,520 12 27 10 33 10 123 13Miscor 1,680 15 34 9 67 3 85 14Packaging Industries 15,221 7 50 7 56 6 368 8Pipe Extruders 9,110 10 75 2 75 2 394 5Portland Cement 31,421 2 6 15 4 15 700 4Eco 248 17 - 17 - 17 - 18TRADINGImport & Export Co 14,861 8 57 4 55 7 1568 1REAL ESTATEMPICO 41,509 1 9 14 8 14 27 16HOTELS & TOURISMTDIC 21,727 4 2 16 - 16 140 12Capital H cels 12,841 9 17 11 17 11 376 7Malavi Hotels 18,696 5 16 12 16 12 734 2Soche Tours 458 16 51 6 49 8 36 15

FINANCIAL INSTITUTIONSCommercial Bank 27,786 3 57 3 57 5 727 3National Insuranco Co. 17,631 6 34 8 35 9 212 11MININGGem Co 201 18 Lose 18 Loss 18 6 17

TOTAL [18 companies] 232,108 26 29 6349

Notes: Invested equals Capital Employed as expected at 1990: ROC equals ReturnOn Capitals ROE equals Return On Equity: Employment equals Jobs expectedin 1990: Rank equals position in terms of performance.

24. It will be seen from Table 9.2 that tho best companies in terms ofROC and ROE are those companies in the industrial/trading and financialinstitutions sectors, whereaos the best companios in trms of employmentnumbers are also those companies in the industrial/trading sector. In thepast two years, the total capital employed has increased by some K68,6m foran increase in employment of 452 persons, or, an average cost of K1S1,770 perjob. A brief outline of increase in capital employed, jobs created and cost

98 ANX xPage 10 of 25

per job created for the period 1988/90 are shown in Table 9.3 below. Of theincrease in capital within the industr.y sector, K13,2m has been in onecompany for and increase in jobs of only 22, at cost per job of K598,409.The investment of K1,078m in mining has incurred a loss to date, with theresult that KO.498m has been written off the investment, the mine closed,and 55 jobs lost.

Table 9.3MAIAWI - ECONOMIC IMPACT OF INVESTMENTS 1 MDC

Increase inCapital Jobs Ctcated Cost Per JobEmployed in Period in PeriodK'000a No. K

Industry 29,7 224 132,589Trading 1,2 104 11,538Real Estate (2,8) (1) -Hotels 21,3 138 154,348Financial 19,1 41 465,854Mining (0,1) (55)

TOTAL 68,6 452 151,770

NOTE: It should be notod that the comparison above is not a reflection ofMDC's disbursements, but the totgl increase in the Capital Employedof the companies in which MDC has an intorest.

25. In terms of effectiveness, therefore, this reinforces therecommondation that future expansion should be directed into the areas oftrading and selective industrial invostments, along with expansion ofinvestment in real estate. MDC has some experience in the commercial realestate development area through its subsidiary, the Malawi PropertyDevelopment Company (MPICO). MDC could build on that experience either byexpanding the mandate of MPICO or setting up another subsidiary to specializein industrial estate development. Alternatively once management issues havebeen dealt with, the operation could be set up as a department within MDC.We must emphasize that this should only happen once management has beenstreamlined. Other areas that might be considered by MDC, and which willrequire considerable investigation, are construction, concret3 products, andbricks, as these would stem from increased activity in the real estate area.Possibilities also exist in furniturv manufacture, and wholesaling, but thesesuggestions require some exhaustive analysis and thorough research. In thafinancial area, there may be possibilities for setting up an investment trustin the future, and such an institution, combined with a move towards the

- 99_ ANE= XPage 1l of 25

raising of loans and capital via the mooted capital market structurc, suggestthe possibility of a stockbroking firm, which MDC might operato as a jointventure with other local interests in the financial sector or corporateprivate sector. Such a firm could be the fororunner to an eventual stockexchange. Thaes measures would help MDC play a more aggreasivo role in thedevelopment of the privato sector in Malawi, and help achieve its objectiveof incroasing the participation of Malawians in the economy. Similarly, itwould assist MDC with the divestiture of mature equity investments throughthe sale cf shares to the general public in Malawi.

26. The objective of diveating mature investmenta forms part of MDC'scharter. This may prove difficult initially, as there is currently nosocondarv matket for equities and, because of low income levels of mostMalawians, demand for such instruments would not permit the large scalepurchase. Nonetheloes, institutional invostors such as the insurancecompanies have indicated that they would be willing to purchase largeramounts of equity in domestic companioe if it was availablel and that theywould be willing to do so in the absence of a formalized ascondary market.

27. To moot its wider objectives, such as a reduction in companyconcentration through a dispersion of share ownership, it could be possibleto place some initial restrictions on the proportion of shares in a companysold to a single purchaser. In addition, MDC could initially even play asecondary market role to repurchase shares when a market participant wishedto "liquidate' his shareholding. Given the dovelopmental orientation of MDC,it is not unreasonable for it to play a role in the establihbment of suchprimary and secondary markets in equities. Few other institutions currentlyoperating in Malaft would be better placed to assist in the growth of sucha market. If such a market could be developed, it would help to ease someof MDC's funding problems and, in conjunction with an ability to raise fundsthrough the issue of domestic bonds, would put the Corporation on a clearerpath to self sustained growth more in line with the dictates of its owncharter.

28. One concern has been that Malawians ore too poor to become involvedin an equity market. Although this is a binding constraint, it doos beliethe very reason why share markets were originally established - i.e. toassist small scale investors contribute to tho equity of much largercompanies and thereby participate in the potential rewards from such smallscale investment. Within Malawi, there is no reason why shares could not besold in small enough denominations to make them attractive, at least to urbanMalawians with access to small amounts of savings. The very presence ofexcess liquidity in the economy suggests that there has boon savings soekinga remunerative return.

VI. Jinancial Performance Reviw

29. The MDC Group performance has been favorable, and by and large,shows an upward trend in profitability and all the ratios are as would beexpected. The Group consolidatod balance shoots, annual statements andselected aumary ratios are shown in Tables 9.6 and 9.7.

-100- ANNEX XPage 12 of 25

30. Profitabiltv. Whilst MDC has shown a steadily increasing netprofit before tax to 1989, the ROC is not adequate and has averagedapproximately 4.42 percent in the last four years. This is not sufficientto match inflation, which in the same period has exceeded a rate ofapproximately 15 percent. Similarly, the ROE (i.e to the only shareholder,the Government of Malawi) has been les than 3.86 per cent. Neitiher ratesare sufficient to see MDC in the position of generating any significantamount of funds for major projects. The net profit on revenue is high, butit is not considered the best yardstick of measurement.

31. Dividends. Dividends were only commenced in 1987, when arrears onthe preference capital were paid up in full. Since then provision has beenmade for the preference dividend only. It should be noted that as atDecember 31, 1989, the 1988 dividend had not been paid. If dividends arerelated to the ordinary and preference share capital then the returns tothe shareholder have been extremely low - less than half of one percent.

32. Intorest Har-in. MDC's average margin has been calculated by takingthe interest earned minus the interest paid and expressing the former as apercentage of the opening and closing loans granted as per the balancesheet, and the latter as a percentage of the opening and closing loansavailable as the balance sheet. This is an approximate comparison only, butit serves as a guide. The results show that the past four years haveaveraged a margin of over 6.7 percent which is considered to be more thanadequate. It does soeem to contradict the stated policy of a 2 percentmargin. It was apparent during discussions with various members ofmanagement, that the policy (in a number of instances) is to charge 2 percentover prime rate and not 2 percent over borrowing cost. This may explain whythe margin is higher than expected.

33. Interest Earned. The average over the past four years has been 11.9percent, but has declined from a high of 14.7 percent in 1986, to 9.31percent in 1989. The proportion that interest earned represents of totalrevenue at 26 percent, compares to 30 percent in a comparable organization.However, this is purely a factor of the lower investment in loans, which isreferred to below.

34. Interest Coct. IDC has a relatively low cost of borrowing and viththe cheap fundc available, at an average of around 5 percent in recent years,it is surprising that sufficient projects have not been forthcoming to havebeen able to use funds effectively. However, because of the low rovenue andlow usage, interest cost has formed a much higher percentage of total revenuethan is the case in comparable DFCs. Interest represents approximately 32percent of reveva4e.

35. Dividends received on eoultv lwvestmonts. It is noticeable thatdividends expressed as a percentage of equity investments, represent anaverage of 5.16 percent in the past four years. A return of about 20percent is considered average in comparable DFCe.

36. Staff Costs. Despite a regularly stated opinion that salaries arelov, the staff costs at MDC are relatively high in total, representing over

- 101 - A uXPage 13 of 25

30 percsnt of revenue. There would appear to be far too many administrativestaff for the organization's operations. Detailed coments are mads in thesection on Organization, but suffice to say that it appears there is over-staffing for the MDC's current sizc and level of activity. An analysis ofthe stafi shoves

Table 9.4HALAI DEM LOPMNUT CORPORATION - COMPOSITION OF STAFF

Typo Number Percent

Profesional 13 32Secretarial 9 22Administrative 19 6

41 100

The above would indicate that the emphasis has possibly been placed onquantity rather than quality.

37. OceratW Ma imi. Because of the low finance and interost costs,the oporating margin is high and could be even higher were staff costslowered by rationalize. ton of positions. Profit per member of staff hasrecently stabilized at around K6,000 per member of staff. With staffrationalization the figure could be dramatically increased.

38. Capital Adeauauc. On the level at which MDC has operated, theCapital has beon more than adequate, and is reflected in the low debt toequity ratio, now at a level of 0.34. This indicates that greater use couldhave beon made of resources in the past. On the other hand, it has taken aperiod of five years to reduce the ratio of investment in equity to MDC'sequity to a level normally acceptable for DPCe of 1.1. It should be notedthat a major part of this change has occuxrred through revaluation of assetsand is not In the form of distributable reserves. Thus, of the equity baseat Doember 31, 1989, of 199.4mO K20 is in sharo capital, over K73.9 is innon-distributatio reserves, whilst only K5.5= is in distributable resorves.Whilst this c .ctainly showve DC'e balance shoot in a favorable light in somerespects, it is not capital that is readily available for distribution.

39. fundin and Liauidit. In the past, MDC relied heavily on externalborrowing, both from local (Govornment and Insurance industry) and foreign(primarily multilateral sources). To help MDC achieve the promotionalaspogts of its mandate, most of the funds were generally provided at veryfavorable torms. In view of the current budgetary constraints, however, theGovernment is no longet able to maet all the funding requirements, and MDC

_I 10 ANNX XPage 14 of 25

is expected now to raise its resoLrce requirements from thi. market atcompetitive rates. This is bound to raise the cost of funds to MDC. MDC hasconsequently reached a period of transition where it has to reposition itselfto ensure lcng-term financial v4ability without abandoning its basicobjective. Recently MDC has not borrowed, in part because it ha' elected tofund its investments from internelly generatod fu-ds, and also because itdoes not have a strong project pipeline with which to justify borrowing.If MDC were to provide a reasonable project pipeline and an Action Plan thatplots out clearly its future growth pattern, tho World bank in add6tion toother multilateral lenders or even the local institutional market would bewillinng to support MDC's funding requirements. The multilateral agencieswauld also be willing to provido institutional support during this transitionphase when MDC would be moving towarda becoming a more caemrcially-orienteddevelopment institution.

40. An examination of the financial statemonts reveals that MDC doesnot appear to have borrowed to tho extent that it could have undor any normalcommercial judgment, and a ratio of borrowed funds to own funds could,therefore, have been incceased. Whother or not this has been a constrainton the business is not known, but it does not seem to havo been so.Alternatively, MDC could have paid higher dividends. Cash funding forfinancin, of projects in the past has been distorted by sales of investmentsand by the additional injection of capital in 1986, but since that time therequirenente of MDC have been extremely moderate. As projects have beennegligible, such disbursoments *a have occurred have been used by additionalloan. Since 1984, MDC has never had a liquidity problem, and it could bestated that a current ratio in recent years of bordering on 2sl is too highand has not exhibit.d the best use of funds nor has it put any strain on theCorporation's ability to commit funds. The current non shareholder fundingis approximatoly K 33.5m, made up as followst

Table 9.5 MALAWI - MDC SOURCES 0 FUNDING

Interest(Type From KOOO Repayable

Secured Loans S A Mutual Life Assurance 1,500 '5,5 1991/1997Unsecured Loanst Gover, ent of Malawi 9,617 10,0 1989/2001

Government of Malavi 3,225 3,75 1990/1994Europoan Investment Bank 6,127 2,0 1990/2002European Investment Bank 8,254 5,0 1990/2001kuropean Investment Bank 4,786 2,0 2001/2011

33,509 5,18 [average]

Repayments on the loans only commence in 1990

- 1u - ANX xPogo 15 of 25

41. AssetslLiabilities. The ratio has crept up over the years and isnow touching 4:1, which suggescs that MDC could have used capital moreefficiently. A large part of the increase is created by revaluations overthe years. If revaluation of assets were to be ignored, the ratio would be1.69:1. An analysis of gross assets reveals that 94.76 percent are ininvestments, which is corsidered good. Liabilities are primarily made upof the loans referred to above of K33.5ur plus local trade creditors. Thereare no arrears in the portfolio, only one account was in arrears at December31 1989, subsequently paid.

42. Investment in Loan/Equitv. The ratio of investment in loans ofapproximately 15 percent, compared to 85 percent in equity, is relativelylow. This accounts for the higher interest cost referred to above, and itis suggested that moves be made to reverse the ratio by a greater investment

in loans. An opportunity exists for MDC to use funding available and toshift emphasis towards loan as opposed to equity investments.

43. Staff Productivitv. The number of companies in which MDC isinvolved by way of equity or loan is small (18) in relation to staff, whichsuggests that staff could handle a greater work load. In terms ofinvestments, the volume of funds handled is slightly higher and representsapproximately K3m per member of staff. However, if revaluat5ons areexcluded, then the ratio drops to K1,3m. Employment in MDC subsidiaries permember of staff is at 153 employed persons to l member of MDC staff, whichis low relative to other DFCs in the region. This possibly is reflected inMDC's involvement in a small number of large companies.

VII. Future ProoaDcts

44. Management has explained the lack of activity as being the resultof the restructuring program, which has taken much longer to implement thanoriginally anticipated. In the early 1980s, MDC was considered technicallyinsolvent. As a result, its activities were reviewed as part of an overallparastatal restructuring package. A series of measures were implemented overthe period 1984 to 1987, which led to the creation of a much leaner andfinancially stronger institution. Among the measures taken as part ofrestructuring were: (a) portfolio rationalization, which meant the exchangeof shares and selective sale of MDC companies which were not compatible withits developmental role and in order to generate cash to service its debt.It is not clear from a review of the companies left in MDC's portfolio whatwas the criteria for divestiture; (b) strengthening of management andfinancial performance of MDC and of those companies that were to be retainedin its portfolio; and (c) recapitalization and re-activation of MDC as adevelopment catalyst.

45. As a consequence of the restructuring, some of the objectives havealready been achieved. MDC reduced the number of companies in which it hadan equity interest from 32 to 18 and its financial position is stronger thanbefore. However, management remains weak and MDC has not assumed the leadrole as a development catalyst as was envisaged at the time the restructuring

- 104 - ANNEX IPago 16 of 25

program was initiated. The Corporation, therefore, is at a crossroads whereit has to clearly map out its future role in the fast changing industrial andsectors in Malawi. A lot of the functions that it has performed in the pastor it was act up to foster, will increasingly be undertaken by other playersin the market, which would marginalize MDC if it continued to operate on thecurrent basis.

46. Proct Pipeline. The projects under consideration are limitedand seem to be incurring very little action to get any of them 'off theground." The schedule has not been updated over the past two yeara, and,apart from the Cape McClear hotel project, does not appear to be reachingconclusion on any major projects.

47. The project pipeline does not highlight the emphasis on money valueor jobs to be created sufficiently to draw attention to what is required.The project pipeline has actually decreased both in number of projects andin value. In fact, only two additional projects of minor valuo have beenadded in the last two years, and the apparent lack of progress on a numberof the previous projects, where the commento of two years ago appear to bethe same as now, indicates the otatic naturo of any progress on projectidentification and implementation. Certain projects have not been updatedin valuo, which are unlikely to have changes because of inflation.

48. The current project pipeline, is thus very sparse, and is notsufficient to keep the Projects Department very busy nor sustain any growthfor MDC. On this basis, it seems unlikely that MDC has any chance ofachieving the original plan, unless some extreme action is taken to increaseactivity by staff and encourage investors. In this connection, variousmeasures concerning motivation, attitude towards loan investments, interestrates and investment promotion need to be tackled urgently.

Recommendations and Action Plan for MDC

49. In discussions with management, it was apparent that they would liketo see MDC play a more aggressive leadership role in the development of theproductive end service sectors of the economy in Malawi. In order to emergefrom its current dormant *tat&, MDC will need to develop a comprehensiveAction Plan that deals with its organizational weaknesses and inefficiencies.If acceptable, the World Bank would be willing to support such an action planunder the proposed Financial Sector and Enterprise Development Project. Morespocifically, the Plan would have to addres the following issuesa

50. Conrorat, Planin. A major constraint to any organization mustbe to operate without a Plan. Without a Plan, departments and individualshavo no target and, unless extremely self motivated, the will to succeedwill not be there. Targets need to be set to overcome the malaise ofattitude. MDC'a Corporate Plan prepared in July 1988 has not been updatedother than in the preparation of the last two annual budgets. The Plan doesnot specify areas of investment and disbursement, number and size ofinvestments, jobs to be created. The lack of an up-to-date and realizable

- 105 - ANNEXSPage 17 of 25

plan does not provide the motivation for tkrgeting on specific tasks orcreating the atmosphere conducive to a goal orientetd organization. A perusalof recent Board Papers suggests that discussion is limited to updates ofinformation and comments on any amendments to old proposed projects, on whichvery little progress appears to have taken place. To effectively plan, MDCneeds to identify the areas in which it will operate. There does not appearto be any restriction in terms of the organization's mandate, but the areasare not defined by the plan. Witho-it the defined areas, it is left toProjects to find their own way, which is, in itself, a further constraint.Among the criteria that MDC should use are the followingt

(a) the level of sustainable growth in percentage terms;

(b) the target level of investment in loan as opposed to equity;

(c) the target sectors for investment and the types of businesses,the companies, the employment generation levels, and the stafflevels required to reach these targets. The aim of creatingemployment, which is not even contained in the Corporation'sobjectives, seems to be a serious constraint in planning andmotivation of staff; and

(d) a return for the shareholder will need to be established, andassuming the main objective of "sound business principles" isto remain, this return in the form of dividends should not beless than the rate of inflation. Having established such areturn, MDC then has a profit target and all the other actionsdescribed become subsidiary to achieving that goal. TheCorporation's returns, whillt higher than achieved in the pastfew years, are still not at a level to equate to inflation andmay not be regarded as overly ambitious;

51. To provide a greater return to the shareholder and enhance thedevelopment role, it is believed that MDC, must carry out some seriouseconomic analysis of the opportunities available and push these to fruitionby some intensive proactive project promotion and investment analysis, thisshould be supplemented with incentives to investors, such as the building ofindustrial estates and premises. This will not only provide the attractionfor investors of ready made premises but will force the Projects Departmentto actively look for projects to occupy the premises, which would beoperated on a commercial basis. For this reason it is important for MDC'.plan to bo updated. To this end the sectoral breakdown is essential interms of measuring the likely returns from each sector and hence the overallMDC performance. It is of little value to state an amount of money to bedisbursed, without identifying the area into which disbursements will bemade.

52. Ortaniatlog an_d Kana-ement. Since Government expects that MDCshould operate on commercial principles, it is suggested that MDC's Board,whose directors are approved by Government, be given autonomy and theauthority so that it can be held accountable for the success or failure ofMDC. Government would be expected to provide clear and monitorable operating

- ANNEX I

Page 18 of 25

guidelines and performance indicators to which MDC must adhere in carryingout its mandate.

53. Similarly, the powers of the General Manager should be clearlydefined. Government did not seem to have problems with doing this andindicated that currently there is little interference with the powers of theGeneral Manager in such matters as the hiring or dismissal of staff atcertain levels. It is suggested that the point of reference for the GeneralManager on senior staff matters and investment approvals should be the Board.In fact the General Manager should be granted a higher discretionary limitat which he can approve a project without prior approval of the Board andthen only later present it to the Board for endorsement. The currentmonetary authority extends to only K50,000, and, if this is true, then itcertainly needs to be revised upwards to [say) K250,000. However, thisdiscretionary limit should only be authorized after MDC management hasestablished an unblemished investment track record.

54. Internal management also needs to be reorganized with cleardelegation of authority and accountability. Management needs to clearlyarticulate the distinction between line and functional management and openup lines of communication in order to restore morale in the organization.It may be useful if Government together with MDC undertook a managementreview and institute the necessary changes, even if it may mean replacingsome members of the management team.

55. Kanipower Planning and Dovelopment.1 To attract and retain competentstaff, MDC needs to%

(a) develop a comprehensive manpower development program;

(b) provide a work program that keeps staff busy and challenged;and

(c) streamline and strengthen its Projects Department. Monitoringis another area that needs to be strengthened. Currently,there is very little follow-up on project implementation andthis would need to be addressed if MDC were to considerbecoming dynamic. Monthly reports will be essential tomonitor, not only new projects, but existing investments.

-~ - ANNEX XPage 19 of 25

Appendix 1

MALAWI

FINANCIAL AND ENTERPRISE DEVELOPMENT PROJECT

MALAWI DEVELOPMENT CORPORATION

DRAFT GUIDELINES FOR THE PREPARATION OF A fTATEMENT OF OPERATIONAL STRATEGY

I. Introduction

1.1 As a result of a comprehensive restructuring program, the MalawiDevelopment Corporation (MDC) has now reached a period of transitionwhere it has to reposition itself to resume dynamic growth andensure long-term financial viability without abandoning its basicdevelopmental objective. The long-term objective of MDC is todevelop, increase and accelerate the active participation ofMalav:ans in the productive and service sectors of the economy. Itis with this in mind that the management of MDC, with support fromthe Government, has decided to develop a Statement of OperationalStrategy that will help guide the Corporation through thistransitional period.

1.2 The World Bank, through the proposed Financial Sector and EnterpriseDevelopment Project, would be willing to provide financial andinstitution building support for implementation of the Strategies.Other agencies, both international multilateral and localinstitutions, may also be interested in providing financial supportto MDC.

1.3 The Statement of Operational Strategy, including an A..tion Programto deal with the constraints currently facing MDC. is for the nextfive years (1991-1995) and is to be used to gt'ae MDC through thetransition period when it is movina from b.±ng a dormant holdingcompany to a more dynamic, commerC4 .. ±1y-oriented developmentinstitution. MDC may wish, in developing the strategy, to focusmore sharply on the first few (two or three) years. The Statementof Operational Strategy should then become the framework withinwhich MDC can explain and link its financial projections to theoverall Corporate Plan.

- 108 - ANNEX X

Page 20 of 25

2. Operation Targets

2.1 The first few years of the program, say 1991-1993, are the mostcritical since they represent a period of evaluation and transition.MDC will need to critically review its past performance, includingan assessment of the success of the restructuring program, financialperformance, and growth. Based on this evaluation, MDC should thenset realistic targets for achieving consistent and sustainablegrowth in the future.

2.2 MDC should also strengthen its co-litment to development activities,such as entrepreneur development programs, and introduction of newinstruments designed to increase Malavian participation in economicactivities (these could include a program to divest mature companiesin which MDC has equity, creation of investment trusts, etc). Theimportance of these activities should be reflected in numericaltargets, such as how targets for future shareholdings in specificcompanies could be divested to Malawians, and how many entrepreneurscould be trained in a year. Such activities are critical to therealization of MDC's objectives while they also help create thebasis for its future lending business. These should be accompaniedwith plans on how MDC proposes to implement the objectives.

2.3 MDC should also choose (with appropriate analysis) the sv:tor(s) itwishes to emphasize in its operations to ensure its priorities arein line with those of the Government for the overall economy. Ifthis sectoral emphasis is maintained, MDC should show what itstarget is in terms of the sector's share of annual loan and equitycomitments by the end of the plan period.

2.4 In addition to emphasizing certain sectors, MDC should evaluate thepossibility of diversifying into other priority activities, such asthe development of industrial *estates. Those new initiatives shouldbe developed on the basis of a thorough evaluation of MDC's existingprograms and activities. The aim of this evaluation vill be todetermine the most desirable activities from the points of view ofnational prioritieo, optimum utilization of limited and increasinglycostly (for MDC) resources and efficiency and effectiveness ofstaff. Such evaluation should be completed as soon as possible (atloast by June 30, 1991). MDC should then use the results of suchan evaluation exercise not only to maximize the cost-benefits of thevarious current operational activities, but also to use them todevelop a long-term plan for HDC's future. In this context, MDCshould consider introducing a Profit Center Concept as the basis forclosely monitor its operations and determining how much eachfunctional area costs to operate.

2.5 Evaluate now ares in which it may wish to expand, including theprovision of industrial premises for enterprises. A guidingprinciple behind new activities of a developmental nature should betheir operation on a comnercial basis and their long term viability.

- 109 - ANNEX SPogo 21 of 25

3. Resource Requirements

MDC's operations are currently constrained by a shortage ofresources. Historically, MDC has almost completely depended on theGovernment for its capital, and on the Government and internationalmultilateral institutions for other long-term resources. Inrecognition of the country's fiscal situation, MDC should graduallyreduce this dependence, particularly at a time when the Governmentis faced with severe budgetary constraints. MDC should develop aplan to raise funds from the financial markets as well as the Worldbank and other international sources. The plan should show MDC'sresource needs and the planned sources of funds and each source'scontribution to the funding needs of MDC over time.

4. Equitv Requirements

At the moment, MDC seems to be adequately capitalized, so thisshould not be an issue. However, MDC should undertake to reviewperiodically its capital adequacy and, when necessary, negotiate theinjection of fresh capital by its shareholder(s) either through newcapital or conversion of long term loans into equity.

5. Lending Rate Structure

5.1 In the past, MDC was able to secure subsidized resources from theGovernment, Old Mutual, and EIB at an average cost of some 5.2percent. On this basis, the Corporation was assured of an averagespread of 6.7 percent over its cost of funds, which enabled itslending operations to be profitable. In the future, MDC will befaced with increasing resource costs since a major portion of itsresources will not come from Government budgetary allocations. MDCwill need to calculate an estimate of the target spread that itrequires in order to meet its administrative costs, make provisionsfor doubtful debts (if any), build up required reserves and earn aprofit to maintain financial soundness as well as fulfill itsdevelopment objectives.

5.2 In view of this, MDC will review its interest rate structure andmodify its lending strategies in order tot

(a) bring average interest rates in line with the market (currentlybetween 16 percent and 22 percent);

(b) raise funds in the financial market at rates below or equal tothose prevailing in the market (currently between 10 percentand 16 percent);

(c) blend purely developmental and commercial functions with theaim to ensure continued financial soundness; and

(d) achieve the target spread mentioned in 5.1 above.

-: 1 ' - ANNEX XPage 22 of 25

5.4 MDC would periodically review its interest rate structure and makeappropriate adjustments if and when required by a significant changein the inflation rate, its borrowing cost or the overall ratestructure in the economy.

6. Operational Effici*ncy Improvemfnt

In view ongoing and planned changes, MDC must strengthen itsorganization and increase its operational efficiency. To this endan action program should be developed in the following areas:

(a) Management. MDC mus- undertake a candid review of thestrengths and weaknesses in its management (style, structureand delegation of authority and responsibility). Such a reviewshould be quickly followed by implementation of the drasticchanges that are needed to realign and strengthen managementso that it can provide effective leadership and restore morale;

(b) ManRower DeveloRment. A comprehensive manpower developmentprogram should be developed that will upgrade staff throughpertinent external (external to MDC) and intensive on-the-jobtraining. Both efforts would be geared towards uplifting theskills and efficiency of existing and new staffs

(c) Strengthenint Proiects Deioartment. Project promotion,identification, appraisal, and monitoring need to bestrengthened. Projects Department should form the core of MDCoperations because its work feeds into all other functionalareas, and ought to be one of the strongest in terms ofpersonnel quality. MDC should, therefore, prepare a plan ofaction on how to improve performance in this area;

(d) Develoomont of Industrial Estates. A realistic action program,outlining how MDC plans to expand into this area, should beprepared and submitted to Government for review and approvalas soon as possible. During discussions between the World Bankand MDC management, three options were considered potentiallyviables (i) set up a separate subsidiary; (b) establish a newdepartment within MDC; and (c) expand the mandate of MPICO,MDC's co-uercial estate developer. The choice of an optionwould depend on several kev variables. The first could bechosen because MDC is unable to offer an attractive package toattract personnel with expertise in industrial estatedevelopment (external technical assistance may be used ininterim to overcome this constraint). The second option wouldbe viable if MDC were to become dynamic and overcome thecompensation constraint, while third would be chosen if bothone and two are not initially feasible; and

(e) Makina HDC's Staff Romuneration Packate =mnetitive. MDC'scurrent compensation and benefits packA!o is slightly belowthat of peer institutions and needs 0-o be reviewed. How.ver,

- ll - ANNE x

Page 23 of 25

while undertaking such a review, it should be borne in mindthat salaries in of themselves are not sufficient motivator ofall people. MDC will have to demonstrate that it can offer itsstaff more than just an attractive remuneration package,through a strong work program that challenges staff to produceat h4gher levels. Simply put, reward must be tied to output,and so far MDC has not demonstrated that it is ready to becomea significant player in the economy. Currently MDC operateslike a holding company and is, therefore, unlikely to convincea lot of skeptical people that its headquarters staff deservea competitive compensation package.

7. Proiected Financial Performance

Successful formulation and implementation of development strategiesshould ensure future growth for MDC. It is important, therefore,that MDC set realistic targets against which it can measure itsperformance. These ought to include, but not be limited tot

(a) Profitabilitv Measures for both MDC and for those companies inwhich it has majority equity share interest. These shouldinclude targets for Return on Equity (ROE), Return on Capital(ROC), and Return on Average Total Assets;

(b) Cash flow projections over the plan period; and

(c) Numerical targets for employment creation and investment growth(net commitments and disbursements), revenue, assets, etc.

8. Corporate Plan

As mentioned above, the strategy statement should be linked to MDCCorporate Plan. The strategy should be based on realistic assumptionsl forexample, at the moment it can be assumed that economic conditions in thecountry will remain stable or improve. MDC should undertake to periodicallyreview the strategy and revise it annually on the basis of previous year'sperformance and the budget estimates for the following year. Such periodicreviews should take into account significant changes in the overall nationaland international economic and monetary situation, for example the impact ofthe current escalation in oil prices, and changes in the Government'e basicpolicies and priorities that may require a redirection of the strategy.

-112- llIKE xPae. 24 of 25

Toble 9.6: NALAUI DEVELCEWT AOOOTIOU

INCCM STATEMENT FO THE YEARS 198-19S9(In Thousnwd of Kwscha e at wid Dcesbr)

1983 1984 198S 1966 198? 1988 1989

Turnover: 2,284 2,534 4,628 3,928 4,744 5,712 6,299

Interest Income 346 201 1,078 1,017 1,240 1,522 1,62?

Dividend Income 1,647 1,936 2,806 2,345 3,164 3,941 4,400

Other Income 1/ 291 397 744 566 340 249 272

Expenditure:Auditors' Fees 26 22 27 30 28 4S 30

Depreciation 153 203 228 241 291 305 127

Directors Fees & Expenses 10 13 14 11 10 1S 11

Operating Profit Before Interest 1,238 1,571 3,441 2,586 3,18S 4,178 4,129

Interest 2,193 1,888 1,610 1,267 1,S48 1,856 1,887

Operating Profit (9S) (317) 1,831 1,319 1,637 2,322 2,242

Plus _ Net ExceptionalItem y/ (1,868) 5,939 8,782 (574) 793 446 731

Net Profit Bfore Tax (2,823) S,622 10,613 74S 2.430 2,768 2,973

Net Profit Tax After Tax (2,823) 5,622 10,613 745 2,430 2,768 2,973

Transfer from HonDistributable Reserves 5 S3 53 24

Net Profit (2,823) 5,622 10,613 745 2,483 2,821 2,997

Dividend (Preference) - - - 1059 115 11S

Retained Earings -2823 5622 10613 745 1424 2706 2882

KEY RATIOS

Net Profit as Percent of Revenu -123.60 221.86 229.32 18.97 51.22 48.46 47.20

Dividend es Percent of Rev nu 0.00 0.00 0.00 0.00 22.32 2.01 1.83

Return on Equity Investmsnt 5.33 S.44 6.35 4.83 5.67 6.11 4.06

Di vidnd Coverag ERR ERR ERn ERR 2.29 24.07 25.85

Revenue on Cepitel -41.61 82.86 156.42 3.73 12.15 13.84 14.87

Source: IC Aimt Reorts

A/ Other Ineome fnclud royelties receivable, extraordinary profits, and an adjustmnnt for roundins

differences.

g/ Exceptional Item includes Itnei from profit In sate of asets, income from recovery of deficits

aninvestment revatuetion, writebe ks, etC. Less Exceptional expenses an foreign exchange conversions,

staff termfnat benfits, etc.

- 113 - ANNEX IPage 25 of 25

MALWI

Table 9.7: WLAMI OEWLWIENT CORPOATIC6

O tlono Sheet for th- Yers 193-19s9(In Thousand of Kimdca - at *nd 0ecibwr)

1983 1984 1985 1966 1987 19M8 1989

ASSETS

Banks and Cash 38 210 1,370 244 311 373 744Other Current Assets 498 - 4,292 1,154 1,4S0 2,172 2,054Short term Loans 320 8,665 972 521 239 356 315Trade Debtors and Stocks 789 77m 1,864 1,5?3 3,269 1,207 1,924

Totat Current Assets 1,645 9,650 8,496 3,492 5,269 4,108 5,037

Fixed Assets 4,404 4,300 4,028 4,932 5,772 1,854 2,049Investments: 32,521 30,959 48,225 54,641 66,822 75,547 126,285

Properties - -Subsidiaries 11,431 21,504 38,127 44,128 55,86 64,797 107,986Associated Cog anies 21,090 9,455 10,096 10,513 10,953 13,750 18,299

Other Assets 583 5,310 2,266 1,700 1,312 1,075 1,859

Total Assets 39,153 50,219 63,017 64,765 79,175 85,54 13S,230

LIABILITIES

Overdrafts 367 55 - 444Dividends Payable 146 146 146 - 1,059 115 230Taxation - -

Current Maturities of L-T Debt 4,332Short-term Borrowing 4,767 4,262 1,037 1,132 1,196 2,821Creditors and Other Liabilitieo 1,057 1,174 1,715 624 476 871 2,038

Total Current Liabilities 5,902 6,142 6,123 1,661 2,667 2,626 5,089

Deferred TaxationLong-Term Lon 180,819 29,268 39,255 26,634 31,78t 27,48 30,688

Shareholders Funds: 14,432 14,809 17,639 36,470 4,724 55,474 99,453Reserves ,647 8,024 10,854 16,470 24,7n4 35,474 79,453Shere Capital 6,785 6,75M 6,75S 20,000 20,000 20,000 20,000

Totat Capital Employed 33,251 44,077 56,894 63,104 76,506 82,958 130,141

Total LfabIlities adShereholdwem Funds 39,153 50,219 63,017 64,765 79,175 85,584 13S,230

KEY RATIOS (Percentoge)

Asset Growth Rate 28.26 25.48 2.77 22.25 8.09 58.01

Return on Capital (ROC) .1.09 17.04 21.48 3.19 5.20 5.57 3.73

Return on Equity (RNE) -19.56 37.96 60.17 2.04 5.43 4.99 2.99

Debt/Equity Ratio 1.63 2.30 2.47 0.76 0.74 0.53 0.34

Current Ratio 0.28 1.57 1.39 2.10 1.96 1.56 0.99

Source: IDC AImal Reports

ANNEX XIPage I of 3

MALAWI


TERMS OF REFERENCE FOR CONSULTANCY ON MONITORING ANDFORECASTING OF TRENDS AND DEVELOPMENTS IN MONETARY AGGREGATES

A. Objective

1. The Government, in consultation with the Reserve Bank of Malawi (RBM),have embarked on a reorientation of the implementation of monetarypolicy from being based on direct control of credit and interest ratesto indirect monetary instruments and mechanisms. This shift of focusin the conduct of monetary policy calls for the transformation of thefinancial sector and for more effective monetary programming.

B. Assignment Summarv

2. In the light of the above, the assignment of the consultant willconsist essentially, but not exclu3ively, in assisting RBM toreorganize and strengthen the system for monitoring and forecastingcredit and monetary developments and trends in order to provide inputsfor the monetary programming process and thereby improve regularplanning and review of monetary policy actions. More specifically,this will entail:

(i) reorganizing and strengthening the existing statistical database according to the requirements of monetary programming andrelating it to the model mentioned below;

(ii) formulating an operational econometric model in order toforecast developments and trends in money and credit; and

(iii) providing operational training to staff of RBM in order to allowit to maintain and improve the statistical data base and run andfurther develop the forecasting model.

C. Assitmnet locus

3. The assignment will focus mainly on assisting RBM in establishing astrong data base and practical and operational modelling capacity forforecasting developments and trends in money and credit. Theassistance to be provided must ensure that all the elements necessaryfor RBM to carry out and develop independently, statistical andmodelling work in the monetary area, be firmly in place when theassignment ends.

- 115 _ ANNEX XIPage 2 of 3

D. Framework for this Assainment

4. RBM uses the standard IMF, statistical framework. Tne Central BankingDepartment of the Fund made a number of recommendations forstrengthening and developing monetary programming in its reportentitled "The Monetary Policy Framework in malawvi ImprovingInstruments and Markets." The consulting company will work withinthis IMF framework ensuring that the data base and the econometricmodel (and its output) are fully compatible with the IMF statisticalrequirements and the Report's recommendations. Close liaison withthe IMF and IMF assistance programs during the assignment will haveto be maintained.

E. Initial Areas of Focus

5. Because of the specific objectives and operational outcome expectedfrom this assignment, RBM, with the assistance of the consultingcompany, will ultimately decide which areas are to be focused on andin which order of priority. The areas listed below are in allprobability those that will have to be addressed. The list, however,is not inclusive nor, at this stage, binding. The final program willbe established' in conJln'vcion with RBM.

(a) Re-oraanization of the Data Base

The component requires provision of assistance to RBM in thefollowing areas, among others: (i) revision and improvement ofthe existing data base on credit, money and financialinstitutions; (ii) development of existing or new components ofthe data base when warranted in general or specifically formodelling; and (iii) maintenance of full compatibility with theIMF statistical requirements int he tasks listed in thisparagraph;

(b) Formulation of an Ooerational Econometric Model

This component requires provision of assistance to RBM in,inter alia, formulation of an econometric model to forecasttrends and developments in money (and its components) and creditthat will be a major input in the monetary programing systemof RBM. The model may have to be supported or complemented byanalytical projection. that the consulting company is also todevelop. Particular attention will have to be paid on cropfinancing cycles and patterns of foreign exchange inflows, inas far as these are affected by seasonal factors.

(c) Testina and Running-in the Model

6. The carrying out of the three components mentioned above need to beintegrated within an associated training program for a team ofprofessionals RBM will assign to monetary modelling and programing.rhe consulting company is to develop this training program and run itjoirtly with its other assistance in the statistical and econometric

- 116 - ANNEX XIPogo 3 of 3

field. The objective of this tral.ning is to strengthen the teamcapacity in such a way that in the future it can carry outindependently the statistical and econometric tasks mentioned above.

G. Hardware and Software Reauired

7. The consulting company will assist RBM in equippitng itself with theappropriate hardware and software for carrying out end developing itsstatistical, econometric and monitoring work related to credit andmoney management.

H. Linkaaes with Other Proiect Co2Monents

8. The development of this component of the envisaged TechnicalAssistance Project will be closel4 linked and related to the two othercomponents, namely with the organization of an auction s7stem anddevelopment of a money market" and the "establishment of a venturecapital fund."

- 117 - ANNEX XII

Page I of 2

MALAWI


TERMS OF REFERENCE FOR CONSULTANCY ON THE RESTRUCTURINGOF THE POST OFFICE SAVINGS BANK (POSB)

1. To review the spin-off of the Post Office Savings Bank (POSB) from themalavi Post Office system and restructuring of the POSB as anindependent body on the basis of a modified legal structure. this taskwill also entail the proposal of an effective and efficientorganizational link-up with the Malawi Post Office system to ensurecontinued acceptance and repayment of saving deposits through country-wide post offices.

2. Reviewing the objectives, policies and functions in the context of therestructuring of the POSB. This exercise is expected to yield arealistic corporate strategy and plan which determines the operationaltargets, results and time-frame for the new POSB on the basis of itsredefined objectives. In establishing the POSB'S strategy and corporateplan, due consideration is to be given to its posinion vis-a-vis itscompetitors such as commercial banks and cooperatives (MUSCCO). Thisexercise should also focus on the need to improve barking services inrural areas.

3. Review of the accounting system to determine its suitability and toensure that deposit and interest recording and )verall financialstatements are up-to-date. This ahould also include a proposal of thehardware and software requiremeLtts for effective comp ':er operations.

4. An assessment of liquidity and capital criteria ir line with RBMrequirements on the basis of the &Aisting banking legi3sqtion, as wellas to modify the current investment policy of the POSB. This exerciseshould aim at introducing lending operations, establit,'.Vg a lendingcriteria, determining the scope of future operations, and developingguidelines on acceptance of deposits in order to ensure viability of arestructured POSB without exposing it to undue risks.

5. Review of the tax-free status for interest of POSB deposits and theGovernment guarantee arrangement for the POSB's savings deposits and topropose options.

6. Reexamination of the POSB's interest rate structure to facilitateresource mobilization and ensure financial viability and soundness,taking into account the need for gradual-broadening of the POSB'scapital base. This exercise must take due regard of the objectives ofthe POSB and the prevailing interest rate structure in the market.

- 118 - ANNEX XII

Page 2 of 2

7. Determination of the functions of the Board cf an independent POSB andpropose an appropriate composition of the membership of the Board.

8. Review of the existing cost-sharing arrangement between POSB and PostOffice for services rendered (acceptance and repayment of deposits) bythe latter, as well as to propose a management information system whichshould be an integral part of the imminent prudential and monetarysupervision requirements of RBM.

9. Determination of staffing needs, qualifications and remuneration ofmembers of staff for an independent POSB, including identification oftraining needs and programs, and technical assistance requirements.

10. Revision of the POSB legislation to be compatible with a restructuredPOSB.

Finally, the restructuring of the POSB will be undertaken in closeconsultation with the Treasury and the Reserve Bank of Malawi.

- l!9 - ANNEX XIII

Page 1 of 9

MALAWI


DEVELOPMENT OF FINANCIAL SERVICES FORNON-TRADITIONAL EXPORT SECTOR

1. Background

First suggestions to introduce financial services and incentives forexport development were made in 1982 by a committee of the Malawi ExportPromotion Council (MECP). In the following year, a mission of theInternational Trade Centre UNCTAD/GATT (ITC) made recommendations to theMalawi Government to establish, inter alia, suitable export finance,refinance and insurance schemes. Those recommendations were followed-up in 1986-88 by Mr. V.H. Pandya, Senior Adviser in Export CreditSystems from ITC, whose findings together with memorandums of officialdiscussions were compiled in a report dated September 16, 1988. Thisconsultancy project was financed by the World Bank and counterpartagencies in malawi were the Reserve Ba-k of Malawi (RBM) and theMinistry of Trade, Industry and Tourism.

The following schemes were introduced in the report for gradualimplementationt

(a) Short-term Pre-shipment and Post-shipment Export Financing Scheme;(b) Short-term Export Credit Refinance Scheme;(c) Export Credit Guarantee Scheme; and(d) Foreign Exchange Revolving Fund Scheme.

At the time of the report, exporters faced serious difficulties toprocure foreign inputs for production and Foreign Exchange RevolvingFund (the Fund) was considered the most crucial scheme to help non-traditional exporters. Consequently, an Act was passed in theParliament for its implementation with two other export incentives(Income tax allowance, Duty drawback). According to the Act exportersare to be registered by the secretariat of National Export PolicyCommittee. The Fund is to be managed by RBM in accordance with thestanding orders of the Committee prescribing a ceiling for the use ofthe Pund by each exporter.

2. Beneficiaries of the Fund

The target group of the Fund (and other recommended schemes) were andstill are non-traditional exporters, the concept of which usuallyexcludes tobacco, tea and sugar producers. The export value of non-traditional agro-processed and manufactured products totaled K 119million (about US$40 million) in 1988 or 16S of the total exports of thecountry. According to a World Bank estimate, out of the totalindustrial production only about 3t are exported. This indicates, that

- 120 - ANNEX XIIIPage 2 of 9

there are very few if any producers who are operating solely inexporting business and that major needs for foreign currency arise fromdomestic production. If those needs are not met it is quite obviousthat enterprises are not able to uphold their export production, either.As a conclusion, the Fund might appear to be inefficient should theoverall foreign exchange availability deteriorate for some reason orother.

3. Present Situation

Since the ITC report, none of the recommended schemes is in operation.As far as the Fund is concerned RBM has prepared for its implementationa brief procedural guidelines (modus operandi). The following reasonsmay have affected for the slow progress to implement the Fund. First,due to the increased support by multilateral development financeinstitutions and bilateral donors, foreign exchange availability hasimproved since 1988 and a need for any specific arrangement lessened.At the same time the ongoing import liberalization programme of Malawihas made it easier for exporters to procure foreign inputs of productionsuch as raw materials, spare parts and intermediate goods. Second,there seem to have been certain conceptual discrepancy between variousparties regarding the operational mechanism of the Fund. On one hand,it has been understood as a pool of foreign exchange that would be madeavailable against Kwacha equivalent payments by exporters without acredit element. On the other hand, it has been perceived not only asa source of foreign exchange but also a short-term export creditrefinancing facility. Both the interpretations are Jasically possiblewith a difference that the latter alternative offers a better mechanismto control the credit terms to ultimate beneficiaries (exporters).

Apart from improved availability of foreign exchange, also thecommercial banks have developed their financial services thus decreasingrequirements to introduce Government-supported special schemes. Forexample, the banks seem to be able to provide sufficient short termfinancing for exporting purposes provided that sufficient collateral isoffered. For those (small-scale) clients who are short of collateralsone of the banks is planning to open-up a pilot scheme whereby aclient's viable business can be accepted as a security for the repaymentof the credit. RBM, on the other, hand, is going to expand itsrediscounting facility to commercial banks should there arise liquidityshortage. Regardirg credit insurance, one of the schemes recommendedearlier, it was noticed during the Mission that as exports are usuallypaid by Letter of Credit and there would be limited demand for a newinsurance scheme. Also, foreign buyer and country risk assessmentswould require considerable resources in relation to benefits.

4. Measures to be Taken

The discussions with RBM and commercial banks led to a conclusion thatunder the present situation in Malawi the only urgently needed financialservice would be a guarantee scheme to secure pre- and post-shipmentfinance for non-traditional exporters. The guarantee should cover the

- 121 - ANNEX XIIIPage 3 of 9

lending bank and in case the exporter defaults, a certain percentage ofthe lose suffered by the bank would be reimbursed by the guaranteeinstitution that is designed to be RBM. On that basis proposals weredrafted during the Mission for operating policies, procedures and majoroutlines of an Export Credit Guarantee Facility (the Facility) and theywere discussed with RBM, various ministries and commercial banke,Annex 1. To strengthen thu professional capacity of RBM to implementand to operate the new Facility a technical assistance component isproposed to be included in the Project, Annex 2.

ANNEX XIIIPage 4 of 9

J:Xi-'oR CREDIT GIJARANTEE FACILITY

A. 01S C VE

il Fxpl- Cro-il ClGlral',toe Vacility (the Facility) will contributet k 'ilA' ab'/ d JAhO or f i cation of Lilt Malawi export base by providingc:o laterai &upporpl t hiel-kgh guarantuets to the banks extending pre- or post-Thiptaent finanLinKg to onterprises for nortLraditional export production andsales. This fdcility wi3l help sucli exporters secure financing and theFacility will incroa-.e confidence among foreign buyers that Malawi exporterscan fulfil their cox ractual commitmeents as reliable suppliers.

The Faci)!.ty is expected to be financially self-supporting in thelong-run which means that the guarantee fee income will have to coveradministration costs and claim payments. In order to fulfil its exportdevelopment function9 however, certain risks and guarantee losses will beinevitable and will lijve to be accepted.

B. Oierational Mechaniam of the Facilitt

The exporter would submit a credit guarantee application through hiscommercial bank to the Reserve Bank of Malawi (RBM) for setting a guaranteelimit on revolving basis. Based on a risk assessment of the exporter andother relevant factors REM/Treasury would agree to assume a maximum liabilityunder the guarantee that will cover all the bank's pre- and post-shipmentadvances to the exporter during a period of one year. The bank would openan account in the name of the exporter which would only be used for creditsunder the Facility. Based on the export orders already received and/orexport orders in the pipeline, the exporter would then submit applicationsto his bank fo-r short-term financing. The bank would process thoseapplications on their own merits and present the periodic statements to RBMshowing the details of the credit advances and the exporter's repayments.The proceeds of export sales in Kwacha will be deposited on said account andused for repayment of the loan. If the exporter defaults on his repaymentobligation and if the default persists the bank would put in a claim and RBMwould pay the bank the agreed percentage of loss.

C. Maior Outlinee of the Facility

i. Institutional Set-up

The implementing and managing agency of the Facility would be RBMwhich Will develop required administrative services and establish an ExportCredit Guarantee Fund (ECGF) to meet claims and to be credited with guaranteefee payments by participating banks. The Facility will maintain separateaccounts from those of the RBM which would be annually audited. A separateaccounting system will support the reputation of RBM's role as a specificguarantee organization. Periodic management reports will be prepared on theoperations of the Facility.

ANNEX XlIIPage 5 of 9

Participating banks are expepe'ed to iave an important role in the

institutional set-up of the Facility, They would iiot cnly extend financing

t, De guaranteed but also maintain suitable records on export credit and

guarantee transactions for monitoring purposes and promote exporters to use

the Facility. To strengthen the collaboration, RBM and participating banks

will establish arn inTformal Cnnsul tat ive Crnup for tlie ru,pport of the

cperat±ve staff to:

(a) discuss on-going export credit and guarantee activities; and

(b) provide guidance and recommendations to improve the

performance of the Facility.

The preliminary plan is that the Facility be located in the Export

Section of the Exchange Control Department of the RBM. Currently the Section

employs five professional staff dealing with export payments. Their know-

how would support the new activities although it is not directly of the kind

required to run the Facility. The immediate professional staffing needs of

the Facility include two senior officers; one for supervision of activities

and administration of the ECGF and the other for operations to process

guarantee claim applications. Their organizational and reporting positions

should be designed to attract skilled and motivated individuals to run the

Facility.

Finally, a separate body (the Board) will have to be nominated forapproval of gu..cantees, claim settlements and any exceptional deviation f-om

established policies and procedures.

2. The Policies

Risks Covered

The RBM credit guarantees will cover the risk of non-payment of

exporters to the participating ban;s. The principal repayment source for abank credit will be the export bill but it is the exporter's responsibilityto repay the credit notwithstanding the foreign buyer's payment.

Guarantee Optiono

(a) Pro-shipment Credit GuaranteeThe pro-shipment Credit Guarantee is drdigned to providecollateral for bank credit of up to e maximum of 180 days,that is granted in an amour:t up to the domesticproduction/processing cost of the products to be exported.The credit can be drawr in tranchaes according to theproduction/processing costs. The validity of the Guaranteewill always be in accordance with the production period, thatis, from the purchase of inputs until the d&to of shipment andequal to the duration cf the credit. Because tho domestic

cost may include refundable duties at shipment, it is possiblethat pre-shipment credit guarantee need to bo higher than theexport price of the product.

124 - ANNEX XIII

Page 6 of 9

(b) Post-shipment Credit GuaranteeThe post-shipment Credit Guarantee is designed to providecollateral to a bank credit that is granted to refinance thesupplier credit extended by the exporter to its foreign buyer.The maximum amount of credit to be guaranteed is the same asthe supplier credit and the maximum guarantee period 180 days.and

(c) Packing/Individual Credit GuaranteeUnder the above categories of pre- and post-shipment creditguarantees, a guarantee limit is usually granted within whichindividual export transactions of the exporter are thenfinanced and guaranteed (Packing Credit Guarantee). AGuarantee may also be provided without a pre-established limitagainst a specific export order to cover pre- and post-shipment advances to the exporter who is occasionally sellingabroad (Individual Credit Guarantee).

It is expected that a guarantee for pre-shipment finance will bemore often used than post-shipment guarantees because the exporter is usuallypaid under a Letter of Credit. When this is the case the exporter will notneed either post-shipment finance or guarantee coverage.

Eliaibilitv

The primary objective of the Facility is to increase production forexport. Therefore, the Facility will be available to all types of Malawiexporters of non-traditional products including not only industrial andagricultural producers but also export merchants and traders. However, tobe eligible for the guarantee of the Facility manufacturers have to show thattheir export products contain at least 30S local value added. Similarly,export traders have to prove that their products are locally manufacturedwith a value added as mentioned above.

Although the Facility is designod to complement rather thansubstitute normal collateral, exporters will not be classified in this regardin order to widen the risk spread of the guarantee portfolio so as tostrengthen the self-sustaining nature of the Facility.

Guaranteo teo

Depending on the risk assessment, the guarantee fee may vary between1 - 1.52 per annum for pre-shipment stage and 0.75 - 1.252 for post-shipment. The fee is charged on the highest amount outstanding at any timeduring the month. In addition to risk assessment the size of the guaranteefee is also dependent on the operating cost of the Facility.

Recourse and Risk Assessment

RBM will not require any counter-guarantee or collateral from theexporter. However, foreign receivabloe will be usually transferred to the

- l125 -ANNEX XIIIPage 7 of 9

benlefit of the bank or RBM. RBM reserves the right of recourse to theexporter to the extent that claims have been paid to a bank due to thedefault of the exporter. The aim of a recourse to the exporter is todiscourage a solvent exporter escaping his repayment obligations to the bankjust because the bank has secured a guarantee cover for the credit.

It is expected that the banks would be inclined to seek guaranteesto cover clients who, in their judgement, are potentially risky. It istherefore important sufficient expertise be developed in RBM for its won riskassessment on exporters and their foreign transactions to minimize guaranteelosses.

D. Export Credit Guarantee Fund

The Facility includes an Export Credit Guarantee Fund (ECGF) thatis needed as a resource base to meet claims if and when they arise. Thecreation of the ECGF will also provide assurance that the RBM/Treasury isprepared to pay those claims. In addition to claims, the capital income ofECGF may be used for covering the operating cost in initial stages ofexporter's development.

ECGF would be composed of the capital itself, guarantee fee incomeand interest received on investments of ECGF. It is not expected that theFund would be immediately required for claims, because guarantee liabilitieswill accumulate slowly. As for determining its size, the statistical baseis vague because commercial banks do not separate advances to foreign anddomestic production of their clients. However, based on the annual non-traditional exports volume (roughly KIOO million) and assumptions on turnoverand utilization of bank advances it is estimated that K4 million will besufficient. It would provide a cover for a guarantee portfolio of K40million applying a risk ratio of 10 percent.

E. Action Plan

The main steps during the implementation of the Export CreditGuarantee Facility are expected to be the following:

1. At the direction of the Government, RBM will make a formaldecision to establish the Facility and accordingly will takethe initiative to create the necessary legal andadministrative framework for the Facility. Financial sourceswill be identified for the ECGF, technical assistance andinitial operating costs.

2. A senior officer will be appointed to be in charge ofimplementation and necessary measures taken to reserve officeaccommodation in RBM for the Facility.

3. An experienced consultant will be hired to assist RBM in thepreparation and start-up of the Facility and a detailed workplan prepared.

- l 6 -


4. RbM and participating banks will nominiate a Consultative

Group, holding periodic meetings to monitor the progress of

implementation and to provide advice once the Facility is

operative for solving various problems as they may arise.

A separat.e body (the board) will be nominated for guarantee

decislons, claim settlements and exceptional needs.

5. RBM will make arrangements with selected institutions for

overseas training of two officers and respective study

programs will be prepared and approved.

It is estimated that a maximum of six months is needed from the

decision to establish the Facility to the commencemenc of operations. The

current estimate is that the Facility will be operative by the date of

effectiveness of the proposed Financial Sector and Enterprise Development

Project, which is expected to be the first half of 1991.


MALAWI


EXPORT CREDIT GUARANTEE FACILITYTECRNICAL ASSISTANCE TO THE RESERVE BANK OF MALAWI (RBM)

The establishment and start-up of the Facility will be supported bymeans of technical assistance which will be provided to the Reserve Bank ofMalawi (RBM). A minor part of the assistance will be given to participatingbanks to train '.eir staff. By keeping records on export credit andguarantee transacations through specific accounts, participating banks willlessen the administrative burden the RBM. The most importantresponsibilities of RBM will be to process guarantee and claim applicationsbut will also include monitoring and administarative tasks.

Technical assistance to RBM will include (a) consultancy servicesof eight man-months, of which two man-months will be local consultancyt

- to formulate operating policies and procedures;- to prepare guidelines to banks and exporters on ;.arms and

conditions of exports credits and reporting requirements;- to design the administrative routines, accounting and

management information systemt- to prepare presentation material for joint seminars and

training courses with commercial banks;- to provide management and administrative support to RBM once

the Facility is in operation; andfor micro computer related training (local consultant).

(b) procurement of a micro computer with software and equipment foraccounting, monitoring and management information systems on the operations;(c) travel cost of two RBM officers to visit relevant countires experiencedin short term export credits and guarantees; one of the officers toconcentrate on risk assessment techniquoe and the other to review guaranteepolicies and to identify potential operating risks anticipated in Malawi; and(d) workshops for 100 participants, brochures and printed materials.

The total cost of the technical assistance is estimated atUS$138,000 with the following breakdown:

TotalCost Item K'OOO US$ 000 US$ 000

Consultancy services 17 72 78Computer, Office Equipment 20 20Overseas Training 19 19Workshops 14 5Printed Materials 13 5Contingency 6 9 11TOTAL 51 120 138

ANNEX XIVPage 1 of 3

MALAWI


ESTABLISHMENT OF AN INVESTMENT PROMOTION AGENCY IN MALAWIDRAFT TERMS OF REFERENCE

Backaround

1. The Government of Malawi has placed high priority to diversifyingthe country's traditional exports bass, by offering enhanced incentives andinfrastructure to exporters. The Government recognizes the important rolethat private investment, both foreign and local, can play in the successfulimplementation of an export-oriented development strategy. To this end theGovernment will introduce and Investment Policy Statement that includes itspolicy towards the private sector, both local and foreign, and the incentivesoffered to investors that contribute towards the achieving of the country'sdevelopment goals. Because it does not have experience in private investmentpromotion, the Government will establish a small but influential agency tohelp investors interact with Government and obtain official support services,as well as promote local and foreign investment in Malawi. A number ofdecisions are needed in order to establish the agency. Its mandate andpowers need to be clearly defined. Its legal character needs to bedetermined, particularly whether it will be a public or private or "mixed"organization. Its level of influence needs to be fixed high enough to beuseful to investors. Administrative issues of staffing and budget must beresolved and a strategy of investment promotion has to be developed.

Concept

2. Active investment promotion is only one of several tools availableto countries *ager to increase their entrepreneurial pool and the level ofinvestment activity. Investment promotion activities consist of providinginformation and services to poteutial investors. With foreign investmentother activities are added -- the creation of an image of the country as aplace to invest, outreach to attract investors and efforts at home toidentify and build-up local partners.

3. In recent years there has been growing interest in developingcountries in foreign investment as a result of growing foreign debt,budgetary constraints and a desire to involve the private sector in thedevelopment process. To this end many developing countries have eitherrecently started activo investment promotion programs, or are moving toenhance the effectiveness of existing agencies.

4. For Malavi, the proposal is for the agency to have an independentexistence (either as a corporation or a statutory body) and should report toa board of directors, composed of public and private sector representatives.The chairman of the board should be from the highest level of Government,with sufficient authority to make decisions on matters affecting investors.


The agency should have only a small staff, recruited from the private sector.Its budgct should only be large enough to carry out a modest promotional.strategy.

5. Even before the agency is officially established, Government willselect an individual who will eventually head the agency. The selection willbe made in consultation with IDA. The individual selected will be put incharge of following up all the actions needed to implement the Investment

Policy Statement and initiate the process of creating the agency.

6. Investment Promotion Strateav. Experience shows that the mostsuccessful investment promotion programs rigorously target the countries anidsectors where they seek foreign investors. Sector targets, of course, haveto be based on analysis of sectors where the country has attractiveinvestment opportunities as a result of its resource base, markets, locationand other factors. Sector targets also have to take into account thepropensitise of foreign investors and capabilities of local investors. Thepraparation of a strategy for Malawi should identify the sector prioritiesfor investment promotion.

7. In addition to sector targets the strategy should identify thecountry of origin of potential investors in Malawi. Country targets shouldbe linked to sector targets. That is, the countrites to be targeted shouldbe those where there are investors in the targeted sectors, and thoseinvestors have reason to be looking for alternative investment sites.Country targets also may take into account special factors, such as tradeagreements with the promoting country and historical or political ties.

8. The last *lement of investment promotion strategy to be studies isthe choice of investment promotion techniques. A country can focus oncreating awareness of its existence and its strength and improve its imagewithin the investment community as a favorable investment location. Or, itcan start direct "ales" efforts by targeting and approaching specificinvestors and convincing them to locate their future investment in thecountry. Or, it can provide incoming (and existing) investors with servicesthat will facilitate the investment process. Investment promotion alwaysinvolves a mix of these activities. The study will determine that is theproper mix considering the available resources and what is the correctsequencing of their use.

9. Structure of the Agency. The individual selected should addressthe detailed steps necessary for implementing the preferred form, includingthe legal character of the institution, the composition of a pos3ible Boardof Directors, its relationship to Goverrment ministries and agencies, theagency internal structure and functional responsibilities, the budgetaryrequirements and possible sources of external finance and the agencyperformance evaluation including the developmesnt of an "investor tracking"system to follow up the promotion activities. Below is a tentative budgetestimate for the agency.

- 'l -(


MALAWI

FINAkCIAL SECTOR AND ENTERPRISE DEVELOPMENT PROJECT

INVESTMENT PROMOTION AGENCY - COST ESTIMATES(US Dollars)

Initial Investment in Establishing the Unit (if decided) will be:

2 cars 30,000

Computer, printer, faxcopier, etc. 10,000

Furniture 7,500

Office alterations 7,500

TO1*td 55,000

The Annual Operating Costs of the Unit will be:

Manager 10,000

2 senior staff 10,000

3 secretarial staff andassistants 7,500

Public relations 30,000

Travel, communicetions 20,000

Office expenses 20e500

TOTAL 98,000

NOIEQ The total for five years will be US$545,000. In addition, theproject vill need technical assistance in the form of a residentadviser (and trainer) for one year at an estimated costs ofUS$150,000.

The above budget estimates is based on the assumption that Malawiwill be engaged in a moderate promotion effort (not includinginvestor's targeting).

A.NN' EX XV- 131 - Page 1 of 6

WORLD BANK


Small and Medium-Scale Enterprsies Component:SME Technical Assistance and Training Fund

The following is a discussion paper for Government and potential donors.

Background

During the 1980s, a framework of institutions came into being to serve thefinancial and TAS/BAS needs of small and medium-scale enterprises (SMEs).Financial support for these institutions has come from Government and throughdonor agenc'es, especially USAID, UNDP and EEC. Financial services to SMEs areprovided by tNDEFUND, SEDOM, MUSCCO and the kdlawi Mudzi Fund (MMF); assistanceis provided through DEMATT, SEDOM and MEDI. Credit institutions have indicatedthat they have sufficient resources for the next three to five years. However,SHEs continue to face a credit constraint due largely to the limits of SMEsupport institutions. The impact of SHE support institutions is constrained bylimited staff resources. Management talent is thin and there is a need to groommid and junior-level officers to assume increasing responsibilities. DFIprofessional staff are frequently recruited from university, and so often lackskills, in addition to experience. Commercial bank staff have little exposure.and therefore understanding of, SME needs; in addition, their staff is nottrained in term-lending.

Precis of proposed fund

The proposed SME technical assistance and training fund would address thehuman resource constraint by improving the skill level of professional staff andof entrenpreneurs. The fund would make resources available for: (i) thedevelopment of professional staff at all levels in SME institutions; (ii) thedevelopment of curriculum for training; and (iii) the training of entrepreneurs.The majority of resources would be directed to in-country training initiatives.Assistance would not be limited to the SME support institutions; otherinstitutions, such as NGOs, would be eligible to draw upon the funds.Institutions desiring assistance would develop proposals that would be reviewedand approved by an SME TA and Training Committee to be under the umbrella of

. An annual cycle of proposal submission, review and approval would beinstituted, with guidelines established for project selection and allocation ofresources across organizations.

Rationale for fund and for IDA involvement

The TA and Training Fund is intended to strengthen the institutions thathave already been established by increasing their service delivery capacity.In so doing, the fund would also promote the development of in-country trainingfacilities. The proposed fund would build on and leverage existing initiatives.

- 132 - ANNEX XVPage 2 of 6

Location of fund

The location of the fund is not yet determined. In chosing a location.it is important to keep the following criteria in mind: (i) neutrality of theorganization toward potential users and suppliers of TA/training; (ii) capacityto administer funds; (iii) knowledge of SMEs. Possible locations for the fundinclude in MTIT/SSIU, OPC/DPMT, an academic organization, creation of neworganization. The fund should not be located in any of the SME supportinstitutions.

Wherever the location, a policy group will be formed that will meetquarterly to set policies for the use of the fund, and review the progress ofthe implementation. This group would include representatives form Government(MTIT, OPC), SME support institutions (DEMATT, SEDOM, etc.), academia (MIM.College of Accountancy), private sector (ABA, Chamber of Commerce), donors andWorld Bank.

Evaluation process

A one-year cycle of planning and project approval would be used. Annually.participating organizations would s,*t forth their training plans and requestsfor staff and entrepreneur training, along established formats. Proposals wouldaddress how the training complements the overall institutional developmentstrategy of the organization. Proposals for curriculum development would definethe training service, the target audience and demonstrate that demand for thisservice exists.

To evaluate proposals, a committee would be established consisting ofrepresentatives from: MTIT, DPMT, an academic institution (e.g., University ofMalawi, Malawi Institute of Management) and the private sector (e.g., Chamberof Commerce, African Businessmen's Asociation). This selection would ensurethat: the Government agencies with critical responsibilities are represented;acceptable levels of training are promoted, through the inclusion of an academicinstitution; the needs of the entrepreneurs are heard and addressed, through aprivate sector representative. The principal SME support institutions that areexpected to use and benefit from the funds would not sit directly on thecommittee, although they would have inputs at the policy group level..

Individual training would be available, but not limited to, the followingareas: management development (e.g., strategic planning, project administration,staff developient), accounting and administration (financial planning, budgeting,basic and intermediate accounting), project officer training (project preparationand analysis, project supervision), extension agent training (field supervisiontechnicques, marketing, financial management, pricing and costing procedures).Training for entrepreneurs could include: marketing, accounting and finance,production and lay-out, personnel relations, project preparation.

Maximum limits would be established per grant and per organization. Out-of-country training would be limited to a specified percentage (e.g., 20 percent)of the total financial support received by any single organization. A seriesof guidelines for the evaluation of these requests would be established inadvance.

- 133 - ANNEX XVPage 3 if h

Careful evaluation would be done of each training assistance; a shortevaluation would be conducted at the completion of the training and a morecomprehensive evaluation would be done six months after completion, when thebenefits of the training would be clearer. If satisfactory results were notattained, no future resources would be provided.

Potertial Users and Demand for Fund

It is anticipated that, among others, the following institutions would beinterested in participating in the fund: INDEFUND, SEDOM, MUSCCO. DEMATT, MEDI,the commercial banks, CCAM, MACOHA, Mudzi Fund, Women's World Banking of Malawi,Council for Social Welfare Services, indigenous NGOs, POET. While acomprehensive assessment of the training and management development requirementsof the existing SME institutions is needed to further refine projections, thefollowing is an estimated assessment of training needs per targeted SMEinstitution. These estimates are only indicative; actual training budgets wouldbe developed organization by organization, on a yearly basis. It is not expectedthat the proposed TA and Training Fund would fully meet the training expensesof SME-related institutions, but to act as a supplement.

SEDOM (US$25,000 per year, four-year total of US$100,000). In 1988, SEDOMspunt about US$112,0000 on training and entrepreneur programs. Training forSEDOH personnel may include: financial administration for accounting and financepersonnel, advanced project appraisal and project packaging assistance, creditsupervision. Training for entrepreneurs may include: business opportunityidentification, bookkeeping, and activity-specific workshops (e.g., in tailoring,metal-working, agro-itdustry).

INDEFUND (US$25,000 per year, four-year total of US$100,000). In 1989,INDEFUND invested about US$83,000 in staff and client training. Possibletraining for INDEFUND would parallel many of the themes identified for SEDOM;however, in view of the scale and complexity of INDEFUND projects, INDEFUNDpersonnel may require more advanced courses.

MUSCCO (US$35,000 per yea. four-year total of US$110,000). MUSCCO doesnot segregate training expenses, because a large share of MUSCCO activitiesrelates to training and TA for member cooperatives. Resources may be providedfor attendance of credit cooperative managers in the management certificateprogram at the College of Accountancy. Additional training and 'residencies*could be conducted for coop managers and coop credit committees, and financialadministration and accounting for other member coop staffs.

MEDI (US$20.000 per year, four-year total of US$80,000). Both MEDI andDEMATT are potential users as well as suppliers of technical assistance andtraining under the proposed fund. A particular area of common need for suchinstitutions is to provide cross training among staff so that trainers with anindustrial focus become knowledgeable in financial administration and marketing.Such cross training would entail a modest expenditure because of MEDI's in-house training capabilities. MEDI management may seek project planning andadministration programs conducted by HIM.

DEKATT (US$25,000 per year, three-year total of US$75,000). DEMATT hasan ambitious staff training program, even though there is no specific lineallocation in the DEMATT budget. While it is difficult to anticipate total

- 134 - ANNEX X;.Page .,1 tr

training needs, specific sections of the in-house training curriculum would beeligible for support.

Commercial banks (US$20,000 per year per bank, four-year total ofUS$200,000). Commercial banks have expressed interest in resources for staffdevelopment and training. Experiences in other countrie, indicate that lendingto SMEs can be stimulated through staff training and seminars that educatecommercial bank staff on appropriate lending and monitoring strategies for SMEproject lending. In the past, the Malawi College of Accountancy has providedsome training services to the commercial banks.

Non-governmental organizations (US$100,000 per year, four-year total ofUS$400,000). There are numerous organizations that are not directly supportedby the donor community to any great extent, but that provide some services tolocal enterprises. In many cases, the personnel of these organizations are notwell-prepared to undertake their responsibilities and would significantlybenefits from training. Organizations under this category include groups localgovernment, CCAM, MACOHA, member organizations of the Council for Social WelfareServices, and other chamber-like organizations including the MalawiBusinesswomen's Association, Chamber of Commerce, Exporters Association. Eachorganization would have the opportunity to submit proposals to seek financialsupport for their member training needs.

Entrepreneurship training through multiRle training institutions(US$100,000 per year, four-year total of US$400,000). MEDI and POET presentlyprovide specialized entrepreneurship training. Neither organization is strong,although efforts are underway to strengt'ien them. There may be specificentrepreneurship training activities provided by these institutions that couldbe supported under the proposed fund. In addition, there are other in-countryinstitutions, such as the Mudzi Fund, that may respond with entrepreneur trainingin areas such as marketing, production, financial planning, working capitalmanagement.

Potential Sources of TA and Technical Assistance

Malavi College of Accountancy (QLCA. MCA provides professional full andpart-time technical level training in accounting and other aspects of financialadministration. In addition to their standard course sequences, MCA hasdeveloped specialized courses that are targeted to meet a particular relatedtraining need, for example, in commercial banking and business computing. Inconjunction with MUSCCO, MCA developed a 14-month sequence of courses thatresults in a certificate of management. MCA could use fund resources to expandtheir certificate of management program or other programs as interest and demandrises.

Malavi Institute of Management (MIM). MIM combines consulting serviceswith training workshops for management of diverse institutional types. Mostworkshops are short. HIM courses that may be of interest to SME supportinstitutions include: planning, time management, marketing management andbusiness development, finance for financial managers, budgeting for the non-profit sector. If demand warrants, MIM may use fund resources to develop coursesspecifically geared to the needs of SME support institutions.

DEKATT. While DEMATT is principally known for its assistance to

entrepreneurs, it has also trained extension agent personnel from other

organizations, including MACOHA, Ministry of Community Services and World Vision.DEMATT does not have sufficient training resources to train both DEMATT staffand staff from other organizations. Under the proposed fund, DEMATT may be ableto expand their training of other organizations, making use of training materialsoriginally developed in-house. Non-governmental organizations that assistwomen's income-generating activities frequently could benefit from the kind of

applied business training provided by DEMATT.

Other training sources. It has not been possible to visit and interviewall potential training sources. Training, for example, may be available from

the University of Malawi or from private sector sources.

Administration of Fund

It is expected that the services of an expatriate fund manager would beneeded for 18 to 24 months to establish administrative systems and definestandards and guidelines. A critical part of the would be to train a Malawiancounterpart. In addition to the expatriate and Malawian counterpart, one projectofficer, one secretary and one clerk would be needed. The anticipated costs ofadministering the fund are in the attached table.

Next Steps

Agreement needs to be reached on the location and administration of thefund. Overlap with other donor programs should be examined, and donor interestin cofinancing should be explored.

- 136 - ANNEX XV

Page 6 of 6

MALAWI


TRAINING AND TECHNICAL ASSISTANCE FUND

Year 1 Year 2 Year 3 Year 4 Year 5 Total

Staffing:

Consultant Services(two years) 120.0 120.0 0.0 0.0 0.0 240.0

Counterpart Manager 9.0 10.0 12.0 14.0 16.0 61.0Project Officer 4.3 4.9 5.7 6.5 7.5 28.9Secretary 2.5 2.9 3.3 3.8 4.4 16.9Clerk 1.4 1.6 1.9 2.2 2.5 9.6

Staff Training 4.0 4.6 5.3 6.1 7.0 27.0Furniture 5.0 0.5 0.5 0.5 0.5 7.0Equipment and Supplies 10.0 1.5 1.5 1.5 1.5 16.0Publicity 5.0 1.5 1.5 1.5 1.5 11.0Miscellaneous 5.0 5.0 5.0 5.0 5.0 25.0

TA Fund Manage-ment 166.2 152.5 36.7 41.1 45.9 442.4

TA to Fin. Insts. 70 80.5 92.6 106.5 122.4 472.0

Contingencies 23.6 23 3 12.9 14.8 91.4

TOTAL 259.8 256.4 142.2 162.3 185.1 1,005.8

Assumptionst

Consultant services and equipment/supplies are assumed to be in foreignexchange. Rate of MR 2.80 - US$1 is used.

Inflation of 10S assumed.

Staffing%

- Consultant services would be needed for two years.- Salary increase are calculated at 52 per year.- Starting salaries: for counterpart manager, MR 25,000; for project -officer, MR 12,000; for secretary, MN 7,000; for clerk MR 4,000.

- 137 -ANNEX XVIPage I of 2

HALAWI

FINANCIAL SECTOR AND ENTERPRISE DEVELOPMENT PROJECT (FSEDP)

APEX UNIT

A. Description of the Unit

1. The Apex Unit will serve as the principal link between IDA,Participating Financial Institutions (PFIs) and beneficiaries of the line ofcredit and export development components.

2. The RBM's Research & Statistics Department already has a claims andloan disbursement unit with a permanent staffing level of three economists,but is able to call upon extra manpower from the department as and whennecessary. This unit will be expanded by the addition of one more economistto enable it to tackle the additional workload envisioned under FSEDP.

3. The unit, in its present format, is very familiar with IDAdisbursement and reporting procedures. It is this unit which was responsiblefor managing external lines of credit to the Government under SALs I to IIIand currently is responsible for managing ITPAC, ASAC and AgriculturalMarketing & Estate Development funds. The unit has a secure room in the Bankreserved for the storage of relevant supporting documentation and has accessto computer facilities for accounting and record-keeping purposes.

4. The Apex Unit will be reorganized as follows. Overallresponsibility for the smooth operation of the Apex Unit will rest with theDirector of Research & Statistics who will report directly to the SeniorManagement of the Reserve Bank. An assistant Director will, however, beresponsible for the day-to-day running of the whole unit. The AssistantDirector will have a group of four core staff; two of whom will concentratesolely on FSEDP and the Agricultural Marketing & Estate Development Projectsince the operational arrangements are more or less similar. The other twomembers will continue managing ITPAC and ASAC operations.

B. Function. of the Apex Unit

5. The overall function of the Unit will be the processing andadministration of subloans. More specifically, the unit will carry out thefollowing:

(i) review of appraisal reports prepared by PFIs to ensure thatall eligibility criteria are adequately meti

ANNEX XVIPage 2 of 2

(ii) disbursement and collection of funds granted to PFIs inconjunction with the Foreign Exchange Department wherenecessary;

(iii) supervision of procurement under the project and ensuring thatall procurement is done under procedures acceptable to IDA;

(iv) managing the Special Account through the Foreign ExchangeDepartment including submission of monthly statement oftransactions on the account;

(v) maintaining accounts and records adequate to reflect theproject's operations and financial situation in accordancewith sound accounting principles. In addition, arrange forthe auditing of same, annually, by independent auditors; and

(vi) submit to IDA:

periodic reports on the status of the portfolio of subloansand investments;

disbursement reports on the project accounts;

periodic reports on the use of technical assistance/trainingfund; and

progress reports on the key areas of the project within sixmonths after the end of each calendar year.

- 139 - AMX xvii

Page 1 of L

MALAWI


SCHEDULE OF DISBURSEMENTS(Cumulative USS Thousands)

IDA Fiscal Year Credit T.A. Cumulativeand Quarter Ending Component Component Total 2

FY91June 30, 1991 ---- 500 500 1.62

FY92September 30, 1991 600 600 1.9SDecember 31, 1991 400 800 1200 3.82March 31, 1992 1000 900 1900 5.9SJune 30, 1992 2200 1200 3400 10.62

FY93September 30, 1992 3350 1550 4900 15.32December 31, 1992 4600 1700 6300 19.72March 31, 1993 5900 1750 7650 23.92June 30, 1993 7800 1900 9700 30.32




FY97September 30, 1996 24950. 4550 29500 92.22December 31, 1996 26050 4550 30600 95.62March 31, 1997 26810 4550 31360 98.02June 30, 1997 27450 4550 32000 100.02

ANNEX XVIII

Page I of 4

MALAWI


SUPERVISION PLAN

1. Bank Supervision Input into Key Activities. The staff inputindicated in the attached table is in addition to regular supervisionneeds, such as the review of progress reports, procurement and disbursementactions, and correspondence. In view of the complexity of the project,supervision is expected to require 16 staffweeks per year during the firstthree project years (of which eight will be in the field) and 11 staffweeksfor each year thereafter (of which six will be spent in the field).

2. Borrower's Contribution to Supervision.

(a) Progress Reports are to be submitted as follows:

(i) every six months (a) a report on thestatus of the portfolio financed withcredit funds (based on quarterly reportsfrom PFIs indicating status of portfoliofinanced with project funds andstatements of financial and resourceposisiton); (b) disbursements reports onproject accounts; (c) quarterly reportson the technical assistance trainingfund; and (d) three months after the endof the financial year, annual reports onkey project areas.

(ii) at the end of September of each year;

(iii) by the Apex Unit, with significant input from theMalawi Institute of Management for report (c).

(b) Project monitoring and coordination will be theresponsibility of the Apex Unit, withsignificant input from the Malawi Institute ofManagement for the Training Fund. Reviewmeetings with the participation of the variousproject agencies will be held normally inMinistry of Finance, unless otherwise indicatedby Government, of each year. The meetings willbe chaired by MOF.

l-41 -

ANNEX XVIIIPage 2 of 4

(c) The Ministry of Finance and will be responsible forcoordinating arrangements for Bank supervision missionsincluding the selection of appropriate local personnel toaccompany the missions. The Apex Unit will beresponsible for providing information required bymissions. For missions of a specialized nature, theborrower will make available appropriately skilled staffto work with the missions;

(d) Mission briefing meetings and arrival, and wrap-up meetings will normally be chaired by the MOFwith the participation of other projectentities.

3. T&iis supervision plan will be updated formally once a year,during the Annual Review of Implementation and Supervision(August/September) and more frequently as changing country and projectcircumstances may require.

- 142 - ANNEX XVIII

Page 3 of 4

MALAW!


SuD.rvision Plan: Bank Sup.rvision Input into Key Activities

ApproximateDatss Expected Sklll Staff Input)

(month/year) Activity Requirements (staffweeks)

(3/91 Board approval)

5/91 Sunervision/Prolect Launch Operations Officer 2.0Mission: focus on statusof conditionsKey activities, by component:Line of Credit

- status of Apex Unit- PPI participation - esp.

PFIs new to IDA lending- streamlining of industrial

land allocationIndustrial Sites- Status of action programTA- status of ECGFPOSB

- investment promotionstrategy

- MTIT studies- INDEaBsK diversification- str egthening of MDC

- training fundProject Launch Workshop- Project cycle- Procurement- Disbursement

5/91 Review of INDEBANK Bankingdiversification

TOTAL FY 91 4.0

ANNI:X XVI I1Page 4 of 4

ApproximateDates Expected Skill Staff Input

(nonth/year) Activity Requirements (staffweeks)

FY 92

9/91 Review of ECGF Export Development 1.5Expert

9/91 Supervision Mission: focus on Operations officer (2) 7.5procedures for use of credit Disbursements/and review of POSB work procurement 2.0- disbursements, procurement,

reporting- DFI participation- POSB work

TOTAL FY 92 11.0

FY93 - Supervision Missions(2 2er year) Operations officer 11.0

FY94 Su2ervision Mission: Mid-term Operations officer 12.0Review Disbursements/- achievement of development prc 2urement

objectives- review of project implementation- review of legal covenants (esp.audit and reporting requirements)

FY95 Su2ervision Missions (2): focus Operations officers iO.0on commitment of credit funds

FY96) Supervision Missions:(2 ger rear) Operations officer 10.0

FY97 SuperVision Mission: focus on Operations officer 9.0closing and data forpreparation of PCR

FY98 Closinf Date/PC Preparation 6.0

,nr.~ 1(924

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World Bank Document · in the 1980s. Between 1964 and 1979 real GNP per capita growth averaged 3...

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Transcript of World Bank Document · in the 1980s. Between 1964 and 1979 real GNP per capita growth averaged 3...