The Global Financial Crisis and Low-Income Countries—Domestic and International Policy ResponsesRemarks by Dominique Strauss-Kahn, Managing Director, International Monetary Fund
At an event sponsored by the Center for Global Development, Washington DC,
September 17, 2009
As Prepared for Delivery
Good morning. I am very pleased to take part in this extremely important conversation, a conversation about the plight of the low-income countries in the ongoing global economic crisis. I would like to thank Nancy Birdsall and the Center for Global Development for organizing this event.
Almost exactly six months ago, I gave a similar talk at the Brookings Institution. Shortly after that, I met with African leaders in Tanzania, and we sent a joint message to the G-20 leaders meeting in London, asking them not to forget those countries with the greatest need. And following that summit, leaders pledged to double IMF lending capacity to low-income countries.
I have some bad news and some good news this morning. The bad news is that, as we feared, low-income countries have been hit hard by the global crisis, somewhat harder than we thought in March. The good news is that policymakers have responded aggressively, more aggressively than in the past. And as countries eased macroeconomic policies, IMF financing provided some much-needed breathing space. This policy response, coupled with the dawning of a global recovery, leads me to be hopeful. But low-income countries remain highly vulnerable and financing needs remain great, so we cannot be complacent.
Let me begin by talking about the crisis in low-income countries, including the policy response, and then move on to the IMF’s role.
The crisis and the low-income countries
We all know that low-income countries are innocent victims of this crisis. They did not make the mistakes of the advanced countries. On the contrary, many did the right things in recent years—strengthening fiscal positions, reducing debt burdens, bearing down on inflation, liberalizing product markets, and building comfortable reserve cushions. Helped by debt relief, they were finally reaping the rewards of difficult reforms. The result was the longest and broadest economic expansion among the low-income countries in modern history, especially in sub-Saharan Africa.
And then came a reversal of fortune. First came the food and fuel price shock. And just as the low-income countries started to catch their breath, the global financial crisis made landfall. And it landed with great ferocity. We see low-income country growth in 2009 dropping to less than half pre-crisis rates, which is worse than we expected last March.
This crisis is striking through many different channels, all pointing to its global and all-encompassing nature.
Trade has slumped, as the whole world fell into in recession. Low-income countries’ exports of goods and services could drop this year by 16 percent.
Remittances—a life-line for many families in low-income countries—have also plummeted. They may fall this year by up to 10 percent, a major setback after years of strong growth.
Given the depressed economic conditions in advanced economies, we think FDI flows to low-income countries may fall by 25 percent this year.
Aid flows have not kept pace with Gleneagles commitments.
What about financial channels? Well, banks in low-income countries typically steered clear of subprime mortgage loans and complex financial engineering. Still, some banks are having trouble with liquidity and are facing higher funding costs—not surprising in the uncertain global environment. And more loans are turning bad as economic conditions worsen. All of this means slower credit growth, which reinforces the slowdown.
I do expect a recovery in 2010, when low-income countries should be able to ride the wave of rising world demand. But we cannot take things for granted. The pace of global recovery is far from assured, and the poorer countries may suffer after-effects for years to come. There is also the ever-present risk of new shocks. The ongoing drought in East Africa is a terrible example—a drought that is putting pressure on basic food prices and straining government budgets. As many as 17 million people are facing severe food shortages and may need emergency food aid.
We must never forget the stakes. If our colleagues at the World Bank are right, we could be talking about an additional 90 million people pushed into extreme poverty. In low-income countries, this crisis could very well be a matter of life and death. And we could see social strife, political instability, even war. This is what matters—we need to help Sub-Saharan countries not only because the resources we provide are needed for growth, but also because we need to keep peace.
Policy responses in low-income countries
Let me turn now to some good news. Some of this good news is home grown—always the best kind. Since many of these countries ran good policies, they built foundations to ward off the storm. This is something new. In the past, many low-income countries facing such a financial squeeze would have been forced to slash government spending, put administrative constraints on imports, or simply not pay their bills—making the crisis worse.
But this time is different. Debt positions had improved substantially, creating the breathing space for countercyclical policy. In fact, we estimate that almost two-thirds of low-income countries are at low or moderate risk of debt distress—this flows from better policies, and also from more aid and debt relief.
Clearly, we want fiscal policies to counteract the crisis, not make it worse. And this is happening. More than three quarters of low-income countries let budget deficits get bigger as revenue fell. One third also introduced a discretionary fiscal stimulus. As you know, the IMF has—for some time—been calling for a global fiscal stimulus for countries that can afford it. Some claimed this was a rich country privilege. This is not the case.
Another benefit of the fiscal cushion is that it can protect the poor and vulnerable from the ravages of the crisis. For many people in these countries, when food prices triple, when jobs are lost, when remittance flows are severed, public social benefits are the only answer. I am heartened that governments have done their best to protect social safety nets. Of 27 low-income countries with available data, 26 have preserved or increased social spending—no mean feat in the current environment.
In all of this, let’s not downplay the risks either. Too often, countries are financing deficits by borrowing domestically, as concessional support from abroad is not keeping up. Clearly, as the recovery takes hold, stimulus measures will need to be unwound and deficits reduced, to preserve debt sustainability. But countries should not be forced to tighten too soon, and risk jeopardizing the recovery, simply because they can’t get affordable financing. This is why scaled-up concessional financial support is so important.
Increased IMF resources
This brings me to my next point. The world community must support the low-income countries by providing more concessional financing. Without this lifeline, the costs of the crisis will be greater and people will suffer.
I am proud to note that the IMF is playing its part, going above and beyond what the G-20 asked of us at the London summit in April. We are bumping up our concessional lending by up to $17 billion through 2014, and are front-loading this assistance so that $8 billion becomes available in the first two years, when needs are greatest. Let’s put this in perspective. The support in 2009-10 will be more than triple what was available before the crisis. This is an unprecedented scaling up of resources, but the circumstances demand nothing less. And so that countries can benefit from this, we have doubled the limit on what a country can borrow from us.
The IMF’s membership also supported a $250 billion increase in Special Drawing Rights—reserve assets that can be tapped on demand. All our members get some of this, in proportion to quota. For the low-income countries, this means $18 billion in resources—and these resources can be used to shore up reserves or, if reserves are at a safe level, relax financing constraints.
Reforming concessional lending
But it’s not just about how much we lend, it’s also about how we lend. We want faster, cheaper, and better targeted lending. Our recent reforms have transformed the way we can respond to the needs of the low-income countries.
The first thing we are doing is making our financing cheaper. Zero interest will be charged on concessional lending through the end of 2011. And even beyond this, when the crisis is over, interest rates will be more concessional than in the past. Our commitment to the low-income countries is a lasting one.
The crisis has also shown us that not all low-income countries should be thrown into the same basket. Different countries have different needs, and we should respond to these needs in different ways. And so the IMF has introduced a variety of different lending windows, to make lending more flexible, better tailored to the needs of the country.
Until now, the centerpiece of support to low-income countries was the Poverty Reduction and Growth Facility, the PRGF. It was designed to address deep-rooted balance of payments problems that required longer-term structural solutions. Today, some countries still face these same challenges. For these countries, we can offer the successor to the PRGF, the Extended Credit Facility—this kind of financing is designed for countries that need multi-year support.
But others don’t need this kind of arrangement. Some low-income countries can finance themselves from regular sources in normal times. They only need the IMF when they hit a bump on the road, and face a temporary financing gap. This is not unlike the predicament faced by many emerging markets, and it shows that low-income countries are indeed climbing the ladder. For these countries, we are creating the Stand-By Credit Facility, which mirrors the standard emerging market lending window—short-term borrowing, but on concessional terms. This facility can also be used on a precautionary basis. The country might not need the money today, but it has the security blanket of immediate IMF support if needed.
There is a third option. Some countries need financing, but—for various reasons—an adjustment program might not be suitable. Perhaps they face a natural disaster, or a temporary external shock. Or perhaps they have very limited institutional capacity for policy adjustment. For these countries, the new Rapid Credit Facility can deliver financing pretty quickly, in smaller amounts, but with lighter policy conditions.
I hope that this new flexible approach to lending—“ a facility for all seasons”—will meet the diverse needs of a diverse group of countries.
A new approach to conditionality
It’s no secret that our lending programs attracted some criticism over the years. People said our conditions were too harsh, too intrusive, or even misguided. I accept some of that criticism. We made mistakes, but we always try to learn from our mistakes. Overall, I think the PRGF was a success. Countries with sustained program engagement over the past two decades saw bigger boosts to growth than those without such involvement.
Still, we need to make sure that the medicine does not harm the patient. Over the past few years, we have been streamlining our conditionality, focusing on core policy measures that are critical for macroeconomic stability, poverty reduction, and growth. Too many conditions in too many different areas can reduce effectiveness and lead to a loss of legitimacy. Across low-income country programs, the number of conditions has fallen by one third compared with the beginning of the decade. About 40 percent of these conditions are now focused on improving public resource management and accountability—such as expenditure control and tax administration. Almost everybody agrees that these are the core areas needing improvement. As we would expect, the new approach is leading to more country ownership—more reforms are being implemented today than in the past.
Recent reforms have gone even further. From now on, our loans no longer include binding conditions on specific measures. Instead, programs will focus on meeting the overall objectives of the reforms, giving governments more leeway in reaching their goals.
We must also make sure that programs do not work against domestic countercyclical policies. During the food and fuel price crisis, we revised inflation targets upwards to accommodate sharply rising prices. In this global downturn, programs are accommodating higher budget deficits. And we give special place to protecting the most vulnerable. Most low-income countries with a program have budgeted higher social spending and many are making efforts to better target spending toward the poor.
There is still one more component. We all know that low-income countries lack sufficient infrastructure for development. In the past, low-income country programs permitted only highly concessional borrowing, typically ruling out the kind of private sector borrowing needed to expand investment. From now on, the IMF will take a more flexible approach to debt, and programs will allow countries with lower debt vulnerability to borrow more, from both concessional and non-concessional sources. Over time, we expect more and more countries to benefit from this flexibility—and we will help them do so.
To conclude, we must make sure that any global recovery also lifts the low-income countries. These countries desperately need financing to tide them over, to give them adequate breathing space to cope with the crisis. We must also be in a position to help counties as they face new challenges, and the recent drought in East Africa suggests that we might be tested early.
The IMF has stepped up to this challenge. But the IMF cannot go it alone. We think that low-income countries need about $55 billion in additional external financing for this year and next. Of this, the IMF can provide about one-third, from the SDR allocation and the bump-up in concessional lending. Other international institutions are contributing too. But donors also need to play their part. A further scaling up of aid at least in line with Gleneagles commitments is needed urgently.
At times like this, there is always a temptation for countries to retreat inwards, to look first to their own problems, to respond primarily to domestic political needs and demands. I understand that. But the world community cannot ignore the needs of the low-income countries, especially since the poorer countries are paying the price for rich country mistakes. Countries must resist the temptation to reduce aid, or to engage in trade or financial protectionism. If this happens, the poorest countries will suffer, and years of progress may be undone. If it happens, democracy will be at risk. This is an outcome we should all strive to prevent.