Press Release No. 09/340

Press Release: Crisis Hits Low-Income Countries Worse than Anticipated, but Flexible Program Design has Given Governments Greater Policy Space to Respond, IMF Studies Show

October 1, 2009

The global economic crisis is hitting low-income countries harder than anticipated, increasing their need for donor aid. However, past gains from macroeconomic stabilization and debt reduction, together with some increase in aid, have created space in many countries for countercyclical policies, and Fund-supported programs have accommodated such policies to address the impact of the global food, fuel and financial crises, according to two International Monetary Fund (IMF) studies published today. The IMF announced an unprecedented increase in its aid to low-income countries in July, including an increase in concessional lending of up to US$17 billion through 2014, new lending instruments and zero interest on concessional loans through end-2011 (see Press Release No. 09/268). But the donor community needs to do more.

“Low-income countries need further increases in concessional financial support to help their smooth adjustment in 2009-10 without further aggravating risks to debt sustainability. Aid shortfalls could force countries either to adjust before the recovery is underway or to take on nonconcessional debt that they cannot afford,” said Hugh Bredenkamp, Deputy Director of the Fund’s Strategy, Policy and Review Department, who oversaw production of the papers.

Projections from the latest World Economic Outlook show the economic crisis is hitting low-income countries (LICs) harder than forecast six months ago, according to one of the reports, The Implications of the Global Financial Crisis—An Update:

• LICs are facing a sharp contraction in export growth, FDI inflows and remittances, and lower-than-committed aid. As a result, LICs’ 2009 growth is now projected at 2.4 percent, down from pre-crisis rates in the 5–7 percent range. Growth is expected to recover to 4.2 percent in 2010, helped by rising world demand and supported by short-term domestic policies.

• Countries are using fiscal and monetary policies to respond to the crisis. Fiscal deficits are increasing in three-quarters of the countries. While the composition of the stimulus packages have varied, many countries have chosen to increase current spending. Inflation risks have remained subdued, allowing some countries to ease monetary policy, while the use of the exchange rate as a shock absorber appears to have been limited.

• While LICs have sought to preserve or increase social spending, the ability of many to expand social safety nets has been constrained by the lack of effective mechanisms on which to build. Concerted actions are needed to remedy this problem, so that countries are in a much better position to tackle the next crisis when it comes.

• Though several countries are using the buffers built in the past to respond to the crisis, public debt in a number of LICs is expected to increase markedly in the coming years. In some cases, the risk of external debt distress is increasing.

• Policies to counter the effects of the crisis should continue, where appropriate, until the economic recovery is clearly underway. As the recovery gains strength, however, countries should be prepared to realign policies toward medium-term sustainability. Additional donor support is required to avoid premature adjustments and facilitate a smooth return to a sustainable growth path over the medium run.

• LICs’ external financing needs in 2009–10 are estimated to increase by around US$25 billion a year, on average, relative to pre-crisis levels. Increased Fund support could meet almost one third of LICs’ financing needs.

• A return to the unusually supportive pre-crisis global environment cannot be taken for granted—new engines to drive strong growth will be needed in the post-crisis period. A rapid recovery of FDI and remittances seems unlikely. Measures to improve the business environment, develop well-regulated capital markets, and enhance efficiency in the public sector will be crucial. These efforts will require strong financial and technical support from the international community long after the present crisis is over.

The second report, Creating Policy Space—Responsive Design and Streamlined Conditionality in Recent Low-Income Country Programs, examines the IMF’s role in helping low-income countries address the impact of the global food, fuel and financial crises. The study finds Fund-supported programs in LICs have provided expanded policy space and incorporated more streamlined structural conditionality in recent years, including ending so-called structural performance criteria—binding conditions for loan disbursements.

“This study shows how the Fund has made its program design more flexible, so that policies can adapt to changing circumstances, and streamlined structural conditionality to enhance ownership of programs by governments,” Mr. Bredenkamp said.

Key findings of the second study, which focused on countries with continuous Fund-supported programs throughout the 2007-09 period, include:

• Accommodating higher inflation targets: As the impact of rising global food and fuel prices intensified in the first half of 2008, inflation targets were raised to take account of the first-round effects of soaring prices. When world prices began to fall in mid-2008, inflation targets were adjusted downward gradually to allow monetary policy to continue supporting economic activity in the wake of the global financial crisis.

• Easing fiscal policy: The majority of programs built in widening budget deficits in 2008-09. In most programs, fiscal easing involved increases in government spending despite the bleaker revenue outlook. On average, total spending was programmed to increase by close to 2 percent of GDP over the period 2006-09—in real terms this translates into an average annual increase of almost 7½ percent.

• Strengthening social protection: Most programs initiated in 2008-09 incorporated higher social spending, with a greater focus on targeted support for vulnerable groups.

• Alleviating external adjustment pressure: Programs have accommodated widening external current account deficits, partly financed by drawdowns of official reserves. Increased donor support has helped fill some resource gaps, and the scaling up of IMF financial assistance has played an important role in easing financing constraints.

• More parsimonious and focused structural conditionality; better implementation: The average number of conditions per review has declined by one third since 2001-04, from nine to six, with public sector resource management and accountability remaining the dominant focus of structural conditionality. As the number conditions fell, enabling governments to concentrate scarce administrative resources on priority reforms, implementation of conditionality has improved.

Both studies highlight the challenges LICs will continue to face in the period ahead. Domestic policies should continue to support economic activity until the recovery is clearly on the move. Once economic activity rebounds, stimulus measures will need to be unwound, deficits restrained, and debt reduced to sustainable levels consistent with fiscal policies that enhance growth and reduce poverty. Additional highly concessional donor support is needed to ensure that countries are not forced to make premature adjustments, and to facilitate a smooth return to a sustainable debt path, with strong growth, over the medium term.