September 30, 2013
On September 24, 2013, the Executive Board of the International Monetary Fund (IMF) met to discuss the 2013 Low-Income Countries Global Risks and Vulnerabilities Report.
An assessment of vulnerabilities and risks in low-income countries (LICs) remains important. The exercise provides a cross-cutting analysis of the economic vulnerabilities of LICs, delivers a richer coverage of developments in LICs, and provides useful information to other international financial institutions (IFIs) and donors that provide financial resources to LICs. The 2013 report enhances granularity in the presentation of results, focusing on four sub-groups of countries: oil exporters, fragile states, small states, and other (core) LICs as well as additional analysis of frontier LICs that are rapidly integrating into global financial markets. It modifies the methodology underpinning the vulnerability assessment by taking into account possible policy responses to external shocks that would contain LICs’ external financing needs.
LICs have demonstrated significant resilience over the course of the global crisis, particularly those referred to as the “core” LICs, reflecting relatively stronger macroeconomic fundamentals. The composition of public spending has been broadly supportive of inclusive growth. Since the crisis, diminished room for fiscal maneuver has increased LICs’ exposure to global shocks, particularly for oil exporters and small states while core LICs maintained some room for maneuver. While the risk of an acute crisis is lower, the global macroeconomic environment facing LICs is not expected to improve significantly in the near term. The near-term risk of a shock-induced recession across LICs as a group remains elevated, though moderately lower than at end-2012. Vulnerabilities are concentrated in small and/or fragile states and oil exporters; the number of “core” LICs with significant vulnerabilities has steadily declined. The 2013 exercise examines the impact on all LICs of a deeper-than-expected slowdown in emerging markets and a protracted period of slower Euro area growth. The impact of a reversal in capital flows to LICs resulting from higher U.S. interest rates is also discussed.
Executive Board Assessment
Executive Directors welcomed the staff’s assessment of vulnerabilities faced by low-income countries (LICs) and concurred that the examination of specific adverse shock scenarios—a temporary shock to growth in emerging markets and a protracted sluggish growth shock in the euro area—was both timely and appropriate. Directors noted that the shocks considered were smaller in magnitude than those examined in the 2012 Board paper on LIC vulnerabilities, reflecting a decision to focus on proximate risks rather than less probable tail risk scenarios.
Directors welcomed modifications made to the methodology employed in the vulnerability analysis from 2012, including the introduction of a fiscal policy feedback rule dependent on country circumstances. They also appreciated the more granular assessment of strengths and vulnerabilities across clearly-defined LIC sub-groups, which has revealed significant differences in vulnerabilities across country groups. With more LICs gaining access to international markets, some Directors saw a need to better integrate the financial sector into the analytical framework. Fine-tuning the LIC sub-groupings would also be useful.
Directors welcomed the analysis of an adverse emerging market shock. A severe shock along these lines would create difficulties for many LICs, most notably commodity exporters, but also small states and fragile states, where policy buffers are weak. Directors also noted that “frontier market” LICs that have attracted significant portfolio investment in recent years are vulnerable to shifts in investor sentiment and capital flow reversals as monetary accommodation in advanced economies is scaled back in response to stronger growth and employment.
Directors broadly agreed with the policy recommendations of the report. They welcomed the continued resilience of growth in most LICs since the global financial crisis, but noted that there is little room for complacency given the uneven progress in rebuilding fiscal and external buffers and the significant downside risks to the global economy. In addition, some Directors noted the vulnerabilities of many small states related to the high probability and relative costs of natural disasters and environmental factors, and to constraints inherent in their small size. Directors called for countries to enhance their resilience through rebuilding fiscal and external buffers and developing well-targeted fiscal adjustment measures, stronger efforts to develop domestic financial markets, and a strengthening of institutional capacity. A proactive engagement between LICs and the Fund will be important, including technical assistance that is well aligned with the reform needs in vulnerable countries.
Should an adverse global shock materialize, Directors agreed that the appropriate policy response would depend on country circumstances, including on the scope for an autonomous monetary policy response, exchange rate flexibility, and the availability of macroeconomic policy buffers. In situations where fiscal adjustment would be needed, Directors emphasized that this adjustment should safeguard priority expenditures, including infrastructure and poverty-related spending, and prioritize measures such as phasing out universal energy subsidies, strengthening revenue administration, and implementing well-designed tax reforms.
Directors noted that, in the event of a serious adverse external shock, the external financing needs of LICs would need to be filled by a combination of domestic policy adjustment and external support depending on country circumstances. The Fund and other IFIs are well positioned to provide financing in support of sound policies, but increased aid from bilateral donors would also be needed. Some Directors noted that the Fund should be prepared to enhance its support to LICs in case bilateral donor financing was not sufficiently forthcoming. Directors reiterated the importance of concluding the distribution of the remaining gold sales windfall profits to secure the Fund’s ability to provide adequate financial support to LICs over the longer term. Given limits on the available external financing, Directors underscored the importance of channeling resources to vulnerable countries and those most affected by shocks.
Directors acknowledged the relevance of LIC vulnerability assessments to the Fund’s membership and the international community. They considered that further analysis of vulnerabilities faced by LICs, and of appropriate and specific policy responses to adverse global shocks, would be valuable. Directors highlighted the importance of integrating the results of the LIC vulnerability exercise into Fund surveillance and program-related work.