IMF Executive Board Discusses Managing Global Growth Risks and Commodity Price Shocks—Vulnerabilities and Policy Challenges for Low-Income CountriesPublic Information Notice (PIN) No. 11/139
November 14, 2011
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On November 2, 2011, the Executive Board of the International Monetary Fund (IMF) met to discuss vulnerabilities and policy challenges facing low-income countries in a highly uncertain global environment.
Growth held up relatively well in most low-income countries (LICs) during the 2009 global crisis compared to advanced and emerging market countries. Thanks to strong macroeconomic buffers built over the previous decade, many LICs were able, for the first time, to pursue a countercyclical fiscal policy response, safeguarding and often increasing spending during the crisis. Also, in contrast to past global downturns, the recovery in LICs was swift, and growth has remained strong in 2011. The renewed spike in global commodity prices earlier this year led to a moderate uptick in inflation in most LICs, while strong external demand and higher export prices have mitigated the impact of the commodity price surge on trade balances for many LICs.
Despite the strong recovery, progress in rebuilding macroeconomic buffers after the crisis has been slow in many LICs, partly reflecting measures adopted to mitigate the social impact of the recent price spikes. As a result, most LICs are now in a weaker position to deal with external shocks than they were prior to the crisis, given the more limited fiscal buffers and constrained aid envelopes. Furthermore, there are now severe downside risks to the global outlook, and LICs are highly vulnerable to a sharp global downturn. Moreover, LICs remain exposed to commodity price volatility given, in particular, the impact of high food prices on poverty. To assess LICs’ vulnerabilities to these emerging risks and explore related policy challenges, IMF staff conducted, for the first time, a comprehensive vulnerability exercise for LICs (VE-LIC) based on an analytical framework developed earlier this year.
Executive Board Assessment
Executive Directors considered that the report’s focus on risks from a sharp downturn in global growth and a spike in commodity price volatility is appropriate and timely. A few Directors called for consideration of other shocks, and a few others suggested undertaking vulnerability exercises for non-PRGT (Poverty Reduction and Growth Trust) small middle income states. Noting that the staff’s policy recommendations are understandably general, Directors looked forward to building on the report’s cross-country analysis to provide LIC members with better tailored and pragmatic policy advice in the context of their bilateral engagement with the Fund, including through technical assistance. More broadly, Directors stressed the importance of continuing to work closely with other stakeholders within the respective mandates to ensure the implementation of reform priorities.
Directors welcomed that most LICs have recovered swiftly from the global crisis. In contrast to past global downturns, LICs were able to rely on their strong pre-crisis macroeconomic buffers to pursue countercyclical policies and protect high-priority spending. Moreover, while the uptick in commodity prices earlier this year contributed to inflation pressures in a few countries, its impact in most LICs has been limited.
Looking ahead, however, Directors cautioned that downside risks to global growth have increased at a time when the capacity of many LICs to absorb further shocks has yet to be re-built. As a result, Directors expressed concern that many LICs are now less well prepared to deal with external shocks.
Directors observed that the scope for fiscal stimulus to counter a sharp weakening of global growth is more limited than pre-crisis for most LICs, given depleted fiscal buffers and constrained aid envelopes. Nevertheless, countries with sufficient fiscal room should maintain spending levels to avoid aggravating the negative economic and social effects of such a shock. In addition, most Directors considered that, in countries with moderate inflation, monetary and exchange rate policy could be used actively for countercyclical support. If the downturn were to persist over the medium term, however, further realignment of macroeconomic policies may be necessary.
Directors cautioned that the majority of LICs remain vulnerable to further spikes in commodity prices, especially given the high share of food in these countries’ consumption baskets. They noted in particular the potential adverse impact of commodity price shocks on inflation, the fiscal accounts, the external position, and poverty. Directors generally supported a pragmatic policy response in the event of commodity price shocks, which could include targeted measures to protect the poor, depending on the available fiscal space. Most Directors considered that, typically, monetary policy could largely accommodate the first-round impact on inflation, although LICs with already limited reserves and high inflation may need to tighten policies to restore external and price stability. A few Directors, however, cautioned that a monetary policy response should not weaken central bank credibility or destabilize inflation expectations, and some other Directors considered that the uncertain effectiveness of monetary policy in many LICs should also be taken into account.
Directors highlighted, as a central policy challenge for LICs, the need to continue rebuilding macroeconomic buffers while also meeting pressing spending needs to support poverty reduction and growth. They recognized that this challenge could involve difficult trade-offs and that the variety of country circumstances precludes a one-size-fits-all policy approach. Directors pointed to several broad priorities that would help most LICs manage these trade-offs. Among other measures, these include: (i) boosting the domestic revenue base; (ii) improving spending efficiency and public financial management, with a view to increasing spending in priority areas; (iii) developing targeted social support mechanisms that can strengthen automatic stabilizers during crises; (iv) pursuing prudent borrowing strategies, supported by measures to boost domestic savings, develop financial sectors, and enhance debt management frameworks; and (v) advancing structural reforms that help increase economic diversification and productivity.
Directors stressed that a large number of LICs would need additional concessional financing from the international community if tail risks materialize to protect vital spending and safeguard debt sustainability. They also noted that LICs could benefit from coordinated international initiatives aimed at improving the functioning of global commodity markets.