Technology that could save Malawi’s fiscal consolidation

At the end of her visit to Malawi a fortnight ago, International Monetary Fund (IMF) first deputy managing director Gita Gopinath said she was impressed with the progress the Malawi government had made in implementing some policy reforms to restore economic stability.

The IMF deputy head, however, stressed that Malawi will have to step up its game on fiscal consolidation to solidify the gains the country has made over the past two years.

It was a relatively glowing assessment that will give the Malawi team a significant confidence at a time the IMF team is in the country to assess Malawi’s readiness to transition from the current Staff Monitored Programme with Executive Board Involvement to an Extended Credit Facility (ECF).

But it brings to the fore two critical issues. One, Malawi needs external financing to address its pressing developmental challenges. The country simply cannot manage to finance all its recurrent expenditures and development activities on its shoestring budget.

Two, the government will have to strengthen its fiscal consolidation strategy.

Addressing the governance concerns to contain the misprocurement in government ministries, departments and agencies (MDAs) will be crucial to ensure that the government does not experience expenditure overruns that will ultimately lead to more budget deficits and unsustainable debt.

Minister of Finance and Economic Affairs Sosten Gwengwe knows this. He acknowledged on the sidelines of the meeting that even if Malawi secures an ECF agreement with the fund, it will not be a “silver bullet” that will solve all of Malawi’s problems.

Staying the course on the reforms, especially fiscal consolidation, will be key to ensuring that Malawi continued economic stability.

Policy misalignments undermine progress

However, the Ministry of Finance and Economic Affairs and the Reserve Bank of Malawi (RBM) will have to find a way to address the apparent conflict in the monetary policy and fiscal policy.

There is a “conflict”, for lack of a better term, between the tight monetary policy stance the central bank has adopted to rein in inflation and restore economic stability and the expansionary fiscal policy the government has adopted to catalyse economic activity in the aftermath of external shocks such as the Covid-19 pandemic, the Russia-Ukraine war and Cyclone Freddy.

The government has been borrowing extensively to finance its commitments. The rise in government debt has led to a significant rise in broad money growth.

In its July 2023 issue of the Malawi Economic Monitor titled ‘Powering Malawi’s transformation’, the World Bank observed that “the tightening of monetary conditions has been insufficient to contain inflationary pressures due to the continued increase in the money supply”.

While raising the policy rate may not have produced the intended effect on restoring economic stability and keeping inflation within the prescribed targets of five percent, it definitely has made borrowing more expensive for consumers.

This has a negative impact on economic growth. When consumers, who are already reeling from the high inflation rate, are denied access to consumptive needs it dampens prospects for local demand growth and leads to subdued economic activity and growth.

It does not help that the government’s heavy appetite for domestic borrowing, and the increase in broad money supply that inevitably follows, is exerting inflationary pressures on the economy and undermining prospects for economic stability.

Why fiscal consolidation is key

This is where fiscal consolidation becomes key for Malawi’s economic prospects. Prudent spending can help reduce perennial deficits and lessen the pressure on the government to borrow.

Note that fiscal consolidation has two dimensions. First, the government has to boost its revenue generation either by introducing and/or expanding the country’s tax base. Second, the government, through the Ministry of Finance and Economic Affairs, has to ensure that the country is spending within its means.

So far, the Ministry of Finance and Economic Affairs has focused its fiscal consolidation on introducing new taxes and expanding the scope of existing ones. Last year, the government introduced a presumptive tax on small and medium enterprises with a turnover of less than K12.5 million.

There was a botched attempt earlier this year to raise the tax on imports of second-hand vehicles. The government also intends to introduce taxes on income generated from rental incomes, according to the Memorandum of Fiscal and Economic Policies signed with the IMF in June this year.

On paper, these taxes seem to have merit, but it is important to note that the last two taxes would also exert inflationary pressures. If the government moves ahead with this proposal, car dealers and homeowners will just pass on the cost to consumers. It is a never-ending cycle.

Government should focus on the reforms

A prudent course of action for the government would be to recommit to the reforms they agreed with the fund in November 2022 when it signed the Rapid Credit Facility (RCF) agreement.

In the agreement, the government committed to implement the Integrated Financial Management Information System (Ifmis) and Integrated Tax Administration System (Itas).

The government committed to roll out a fully functional Ifmis in all MDAs capable of capturing all existing commitments/contracts and issuing quarterly spending limits and monthly payment funding. It would also require that all financial transactions be processed through the system.

If implemented correctly, the system would “improve internal control over the transaction, eliminate unnecessary duplication and reduce vulnerabilities to corruption”. The Ifmis would also ensure new Ifmis delivers on accountability and efficiency in the execution of Public Finance Management (PFM) reforms.

It is an open secret that corruption has been a major drain on the budget. Some economic analysts estimate that 30 percent of the budget is lost to corruption each year.

Using the Ifmis to ensure compliance to PFM reforms could eliminate the misprocurements that have cost the country billions of kwacha of taxpayer’s money.

Congruently, the Itas would help to improve the country’s tax management, by ensuring that existing taxpayer comply with their tax obligations and improve the performance of non-tax revenue.

The memorandum reads: “These include reviewing fees and charges to ensure that they reflect full cost recovery and ensuring that MDAs account for their revenue collections in Ifmis and remit nontax revenue collections to Malawi Government consolidated account.”

If incorporated correctly, the Itas and Ifmis would ensure that the government is more effective with its revenue collection efforts under the existing tax laws and ensure that the money is disbursed to approved budget lines, respectively.

This would reduce expenditure overruns that would culminate in budget deficits and debt, without putting pressure on consumers and dampening prospects for demand growth, a key component for promoting economic growth.