In spite of the frequency of (weather) shocks in Malawi, only a small allowance is made in the budget for such contingencies.<sup>3</sup> As a result, shocks usually translate into higher domestic borrowing, and have a substantial impact on fiscal performance and macroeconomic stability. Further, the long-term impact of the volatility is substantial, as economic uncertainty hampers the country’s ability to generate and/or attract productive investments, to effectively compete in international markets, and, most important, to translate economic growth into employment and income generation that benefit those who need it most (World Bank, 2004; 2007a; 2007b). High level of risk has been identified as an important explanation for slow growth in Africa in general (Collier and Gunning, 1999). In fact, insufficient anti-shock action and finance has been a recipe for magnifying economic instability and other distortions, ending up costing far more in the long-term (Gelb and Eifert, 2006). As discussed above, such costs have been extremely high in the case of Malawi.

The significant direct and indirect impacts of weather shocks highlight the need to plan for contingencies. Possible remedial actions include (a) establishing contingency funds, and/or (b) increasing forex reserves for external shocks, and/or (c) piloting the use of national weather insurance. The government could consider establishing a Contingency Reserve Fund (CRF), linked to the potential scale of shocks (at around 8-10 percent of GDP). These funds are normal practice in developed economies, which are much less vulnerable to shocks. CRFs are important to lower vulnerability to shocks, as they can smooth out peak financing requirements, and are especially important for countries with limited or no capital market access. However, there are also a number of issues related with them, and notably (i) difficulty in properly accounting for CRFs; (ii) challenges related to asset management and investment strategy of the CRFs; and most important, (iii) CRFs may create corruption and governance issues, especially in weak

**Table 1: Malawi: Key Macroeconomic Indicators, 1999-2006**<sup>1</sup>

||**1999**|**2000**|**2001**|**2002**|**2003**|**2004**|**2005**|**2006**|
|---|---|---|---|---|---|---|---|---|
|GDP (US$ million)<sup>2</sup>|1,799|1,727|1,731|1,935|1,765|1,903|2,076|2,239|
|GDP Growth (%)|4.0|1.1|-4.2|2.1|3.9|5.1|2.1|8.5|
|Inflation (eop)|28.1|35.4|22.1|11.5|9.8|13.7|16.5|9.9|
|Revenues and grants<sup>3</sup>|24.1|27.4|23.5|26.7|34.7|37.5|42.5|42.1|
|Expenditures<sup>3</sup>|29.7|33.2|31.2|38.1|42.5|42.9|43.5|43.5|
|Of which: Domestic interest payments|2.3|3.0|3.9|5.5|9.1|7.4|5.5|4.1|
|Overall balance (including grants)<sup>3</sup>|-5.6|-5.8|-7.7|-11.6|-7.8|-5.4|-1.0|-1.4|
|Net domestic borrowing<sup>3</sup>|2.1|1.2|6.9|11.8|7.7|3.0|0.3|-1.9|
|Domestic Debt<sup>3</sup>|2.8|8.9|10.2|20.4|24.8|23.8|19.9|14.8|
|Gross reserves<sup>4</sup>|4.2|4.4|3.3|1.4|1.4|1.1|1.4|1.6|
|Current account balance (% GDP, including grants)|-8.2|-3.0|-6.8|-17.2|-7.9|-10.1|-16.2|-7.2|
|Exchange rate MWK /US$ (period average)|44.1|59.5|72.2|76.7|97.4|108.9|118.4|136.3|

Notes: 1. National Accounts estimates have been revised in 2007. All National Accounts figures in this report are based on the old national account series. Preliminary estimates from the revised national accounts indicate that the level of GDP has been revised upwards with an average of around 38 percent.

2. Calendar year basis.

3. Percent of GDP, fiscal year basis (Malawi fiscal years run from July 1<sup>st</sup> to June 30<sup>th</sup> ).

4. Months of current year's imports of goods and non-factor services, calendar year basis. Source: Ministry of Finance, Reserve Bank of Malawi, and IMF and World Bank staff calculations

- 3 A budget line for ‘unforeseen expenditures’ allows for such contingencies, amounting to about 1 percent of GDP. Malawi has traditionally relied on international assistance following climatic disasters.

4