# **6. Conclusions**

Climatic shocks are frequent in Malawi and constitute a major impediment to economic growth and poverty reduction. Moreover, global climate change models suggest that future volatility in weather patterns in Sub-Saharan Africa are likely to become even more pronounced. Their impact goes far beyond the initial need for emergency relief, and the resulting macroeconomic instability has presented a major constraint to growth and poverty reduction in Malawi.

This paper describes an innovative financial instrument, namely an index-based drought derivative contract, which could allow the Government of Malawi to transfer the financial risk of severe and catastrophic national drought to the international risk markets. It aims to enable Malawi to manage risks, rather than managing crises. The development of an this risk management instrument will create a new opportunity for the government to financially manage its budgetary exposure to drought and its impact on (maize production) risk using _ex ante_ market-based instruments, complementing and enhancing the price and other risk management tools the government already has within its portfolio. Through price discovery it will facilitate government and donor planning and preparedness for drought-related food shortages and, as an additional instrument, it will assist the government in developing a comprehensive and cost effective national food security strategy for each agricultural season. The development of this financial instrument could ultimately enhance the government’s response to drought-induced food shortages, and mitigate the impact of weather-related shocks on macroeconomic performance, thereby facilitating investments, economic growth, and poverty reduction.

Such innovative transaction was pioneered in 2008/2009, and was a first for a sovereign entity in Africa. The next step is for the Government of Malawi to build onto the initial pilot transaction and continue to pilot this instrument. In fact, several piloting seasons will be necessary to understand the scope and limitations of weather derivative contract, and its role within the government’s evolving strategy, contingency planning and operational drought response framework. The pilots should not aim to cover the entire financial magnitude of such a potential drought response in the country. Rather they should provide coverage for a defined percentage of this risk as part of a broader (maize) risk management program and will test the feasibility and cost of transferring Malawi’s drought risk to the international risk markets. The objective of piloting is not only to secure limited drought financing in a timely and objective manner but moreover to establish a price for Malawian drought risk. In the future as more and more transactions of this type occur, as commercial portfolios become more diversified and the market by the MMS and Ministry of Agriculture and Food Security). This will facilitate early decision making for superior risk management by Government and ultimately the development of a comprehensive risk management strategy for food security each season. The investments will also further improve the underlying rainfall index for a derivative transaction by: a) expanding the MMS’s weather station network so that more stations can be included in the index, increasing its national coverage and therefore accuracy and; b) strengthening the early estimates of national maize production levels by linking the improved quality and timeliness of reported weather data with improved crop modeling. Upgrading will also provide the MMS the required capacity to communicate rainfall data reliably in realtime to the World Meteorological Organization’s Global Telecommunications System (GTS). This will help ensure that the Government will be able to access the international markets and benefit from such risk management products.

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