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National drought insurance for Malawi
January 2010
Joanna Syroka, Antonio Nucifora

Acknowledgements: FANRPAN acknowledges The World Bank: Development Research Group as the source of this document


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Malawi has experienced several catastrophic droughts over the past few decades. The impact of these shocks has been far reaching, and the resulting macroeconomic instability has been a major constraint to growth and poverty reduction in Malawi. This paper describes a weather risk management tool that has been developed to help the government manage the financial impact of drought-related national maize production shortfalls. The instrument is an index-based weather derivative contract designed to transfer the financial risk of severe and catastrophic national drought that adversely impacts the government’s budget to the international risk markets. Because rainfall and maize yields are highly correlated, changes in rainfall—its timing, cumulative amount, and distribution—can act as an accurate proxy for maize losses.

An index has been constructed using rainfall data from 23 weather stations throughout Malawi and uses daily rainfall as an input to predict maize yields and therefore production throughout the country. The index picks up the well documented historical drought events in 2005, 1995, 1994, and 1992 and a weather derivative contract based on such an index would have triggered timely cash payouts to the government in those years. This innovative risk management instrument was pioneered in 2008/2009 by the Government of Malawi, with the assistance of the World Bank, and was a first for a sovereign entity in Africa. Several piloting seasons will be necessary to understand the scope and limitations of such contracts, and their role in the government’s strategy, contingency planning, and operational drought response framework.


Introduction

Malawi has experienced several catastrophic droughts over the past few decades. The recurrent weather shocks have resulted in low economic growth and significant volatility from year to year. This is because Malawi’s agriculture constitutes about 40 percent of the economy, largely smallholder farming and mostly rain-fed maize production. As a result, weather patterns deeply affect agricultural production and Malawi’s GDP. Further since the Malawian diet is overwhelmingly dominated by maize consumption, which comprises over 50 percent of total calories, changes in maize production also have a direct impact on food security. Most recently, the adverse weather in 2001, 2002 and 2005 brought dramatic swings in agricultural output in the past decade.

In recent years the Government of Malawi has been pursuing innovative approaches towards developing a comprehensive national food security strategy. In this context, the World Bank has been exploring the use of ex-ante market-based instruments to assist the government to manage the financial risks associated with volatility in maize production. This paper discusses an innovative instrument that has been designed to assist the Government of Malawi in managing the risks associated with the impact of weather shocks. The next section highlights some of the indirect costs faced by Malawians as a result of these shocks. Section 3 provides background information on the design and limitations of index-based drought risk management instruments. Section 4 describes the development of such an instrument for Malawi. Section 5 provides some steps ahead and conclusions.

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