Public Information Notice: IMF Executive Board Discusses Global Risks, Vulnerabilities, and Policy Challenges Facing Low-Income Countries
November 15, 2012
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
November 15, 2012
On November 2, 2012, the Executive Board of the International Monetary Fund (IMF) met to discuss Global Risks, Vulnerabilities, and Policy Challenges Facing Low-Income Countries in an uncertain global environment.
The rapid recovery in many low-income countries (LICs) following the 2009 global crisis has been sustained in 2012. Lower commodity prices have led to moderating inflation pressures in most LICs. However, progress in rebuilding policy buffers has halted over the past two years, despite the continued strong growth. As a result, many LICs have more limited fiscal buffers and larger current account deficits than prior to the crisis. Furthermore, although the near term risks for LICs of a shock-induced recession have been reduced since the 2009 crisis, vulnerabilities are re-emerging in 2012 given the lower macroeconomic policy buffers.
Short-term risks to the global outlook are tilted to the downside, and LICs remain highly vulnerable to a euro-centered growth shock, a protracted slowdown in global growth, and spikes in global food and fuel prices. To assess LICs’ vulnerabilities to these emerging risks and explore related policy challenges, IMF staff conducted its annual vulnerability exercise for LICs (VE-LIC) based on an analytical framework developed in 2011.
Executive Board Assessment
Executive Directors considered appropriate and timely the report’s focus on risks to low-income countries (LICs) from a sharp downturn in global growth, a more protracted slowdown in growth, and a spike in food and fuel prices. They concurred with staff’s policy recommendations, while emphasizing the importance of a more discriminating analysis based on individual country or regional differences. Directors called on staff to take concrete steps to incorporate these recommendations into Fund surveillance, lending programs, and technical assistance, taking into account country-specific circumstances and constraints, particularly in the case of small countries.
Directors noted that most LICs exhibited continued strong growth since the global financial crisis, benefitting from the enhanced economic resilience and solid macroeconomic positions built up in previous years as a result of improved policy frameworks. However, they were concerned that the rebuilding of policy buffers has halted, making many LICs less prepared now to deal with external shocks than before the crisis. Directors encouraged LICs to continue to rebuild policy buffers, while balancing adjustment against the need to maintain or raise growth and preserve priority spending. They highlighted several broad priorities for stoking domestic engines of growth to substitute for weaker global demand and reduce the impact of external shocks. These include deepening financial sector development, developing domestic debt markets, strengthening financial regulation and supervision, improving the business climate, and better targeting investments in infrastructure to increase productivity and long-term inclusive growth. Some Directors emphasized that enhanced technical assistance would contribute to accelerating these reforms in LICs.
Directors observed that a sharp slowdown of global growth could have a significant impact on LICs, leaving many with larger financing needs and reserve coverage below three months of imports. They agreed that, to avoid aggravating the negative economic and social impact of such a shock, countries with sufficient fiscal room should seek to maintain growth-friendly spending, particularly on infrastructure. They noted, however, that with donors facing severe budget constraints, some LICs may find it difficult to finance increasing deficits, and that some adjustment would be appropriate and inevitable.
Directors emphasized that the impact of a protracted global growth slowdown would be more substantial over the medium term, given the potential permanent output losses that accumulate over time. They cautioned that, absent adjustment, unsustainable financing needs could emerge in LICs. In this context, they noted that most LICs would need to be ready to adjust, although the pace of adjustment should take into consideration countries’ available fiscal space and growth prospects. Directors emphasized the importance of striking the right balance between revenue and expenditure measures, while noting that monetary policy and exchange rate flexibility could play an important role in facilitating adjustment in the event of a protracted growth decline. A few Directors noted, however, that monetary policy would necessarily play a secondary role to fiscal policy in many countries, given limitations in the transmission mechanism and poorly-anchored inflationary expectations.
Directors noted that many LICs remain highly vulnerable to global commodity price shocks. They concurred that the impact on inflation and poverty of the food price increase could be significant because of the large share of food in consumer baskets, with implications for social and priority fiscal spending. An oil price increase, while having a lesser impact on inflation and the poor because of pervasive fuel price controls, would generate large fiscal costs and increase financing needs. Directors observed that the fiscal exposure to commodity price shocks could be significantly reduced by eliminating domestic food and fuel price controls while building effective social safety nets. They also noted that monetary policy should respond quickly to such shocks to curb second-round inflationary pressures.
Directors noted the potential increased demand on Fund resources if these risks materialize. They underscored that the Fund should stand ready to provide additional financial and technical support to LICs if needed. In this regard, they reiterated the importance of the Fund having adequate concessional resources, as highlighted during the recent review of facilities for LICs and in the decision on the “Proposal to Distribute Remaining Windfall Gold Sale Profits and Strategy to Make the Poverty Reduction and Growth Trust Sustainable.”