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.