EXECUTIVE SUMMARYDonors have suspended some aid disbursements to Malawi in response to a scandalinvolving the theft of public funds. A group of public servants exploited weaknesses in thecontrol environment of the government's Integrated Financial Management Information System(IFMIS) to make fraudulent payments to several entities that had not provided any goods orservices to the government. The authorities are implementing an Action Plan of remedialmeasures to prevent the recurrence of the fraud. Key elements of the action plan includestrengthening security and management of IFMIS, a forensic audit, and identifying andprosecuting the perpetrators of the fraud.Recovery is underway in many sectors of the economy, facilitated by increased availability offoreign exchange. This reflects the impact of policy reforms, including a strong response toexchange rate adjustment from the tobacco sector and re-established external credit lines.Inflation is falling, although more slowly than programmed.Performance in relation to quantitative targets for the third ECF review (March test date)was good, but weakened for the fourth review (September test date). There was significantfiscal slippage (excessive domestic borrowing) during July-September 2013. This constrained theroom for substituting domestic borrowing for the shortfall in aid flows. There has been progressin implementing structural benchmarks, but at a slower pace than programmed.Discussions focused on managing the fall-out from the fiscal scandal and policies toreverse the fiscal slippage and lower inflation. A substantial decrease in aid receipts for theremainder of the fiscal year necessitated some reprioritization of spending plans as well asexpenditure cuts. Fiscal and monetary policy need to be tightened to lower inflation pressuresand safeguard international reserves.Staff supports the

authorities' requests for waivers based on corrective actions and policycommitments. The authorities are implementing strong corrective actions to address the fraudand fiscal slippage, including several prior actions, and have also strengthened external debtmanagement to ensure that they observe their commitment not to contract nonconcessionalexternal debt. Staff further supports the requests for extension of the arrangement, rephasing ofdisbursements (including a halving of the disbursements originally associated with the third andfourth reviews and applying the balance to an additional review) and modifications ofperformance criteria.