## _092809

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### Executive Summary — Outlook for the world economy and commodities
- Global economy: beginning to pull out of the deepest slump since the Great Depression; stabilization uneven and recovery fragile.
- Commodity prices: collapsed in second half of 2008, stabilized in early 2009, strong rally in Q2 2009; future paths depend on timing and strength of global recovery.
- Global growth projections:
  - Global growth projected to contract by 1.1 percent in 2009, before expanding by around 3.1 percent in 2010.
  - Activity in the advanced economies projected to decline by 3.4 percent in 2009, followed by a modest rebound in 2010.
  - Emerging and developing economies projected at 1.7 percent in 2009, before rebounding to around 5 percent in 2010.
- Inflation:
  - Year-on-year world inflation moderated to 1.3 percent in August 2009, down from around 6 percent one year earlier.
  - Headline inflation in advanced economies turned negative in May (and continued to be so until August).
- Commodities:
  - Oil prices rose strongly in response to perceptions of impending turnaround and OPEC cuts.
  - Most metal prices rebounded in Q2 2009; China’s restocking supported recovery.
  - Food prices saw a modest recovery in spring 2009, but divergence across major crops; food prices not expected to rise through the global recovery though higher energy costs and increased biofuel usage pose upward risks longer term.

### How low-income countries (LICs) are affected — overview
- Immediate impacts:
  - Sharp contraction in export growth, FDI inflows, and remittances; lower-than-committed aid.
- Poverty:
  - World Bank estimates an additional 89 million people will be pushed into extreme poverty (below US$1.25 a day) by end-2010.
- Growth projections for LICs:
  - 2009 growth forecast at an average 2.4 percent.
  - Growth expected to recover to 4.2 percent in 2010.
  - Regional variation: Asia expected quick recovery; Latin America’s rebound expected much more modest.
- External accounts and reserves:
  - Despite sharper-than-expected drop in export growth, trade and current account balance projections remained broadly unchanged in 2009; no further deterioration expected for 2010.
  - Reserve coverage projected at an average 4.2 months of imports in 2009, remaining broadly unchanged in 2010, provided countries’ financing needs are met.
  - Projected reserves do not include the Fund’s SDR allocation provided in August 2009.
- Inflation and fiscal positions:
  - Median inflation in current projections for 2009 is 5.9 percent.
  - LICs’ overall fiscal balances projected to deteriorate on average by about 2.8 percent of GDP in 2009.
  - Two-thirds of LICs projected to see revenues fall relative to GDP; revenue loss for commodity exporters expected to be more than twice the average of all LICs.
  - On average, expenditure expected to increase as a share of GDP by almost 1.8 percentage points in 2009.
  - About one third of countries implement discretionary fiscal stimulus; capital expenditures see the largest average increases; civil service wage bill also forecast to grow.
- Fiscal outlook for 2010:
  - Overall balances expected to improve on average by around 1¼ percent of GDP in 2010.
  - Commodity exporters projected to adjust fiscal balances by about 2 percent of GDP in 2010.
  - Expected revenue rise on average by almost three-quarters of a percentage point of GDP in 2010; expected spending restraint accounts for the rest.

### Transmission channels and financial sector risks
- Main transmission channels to LICs:
  - Reduced demand for exports.
  - Lower FDI.
  - Reduced remittances.
  - Prospective aid flows falling short of donors’ commitments.
- Financial sector:
  - Direct impact from global financial crisis limited to date, but risks from domestic economic slowdown are a serious concern.
  - Indications that NPLs increased in 2009; many NPLs are relatively new and not yet fully provisioned.
  - Asset-quality deterioration also driven by falling equity prices and margin loans; some banks had placed up to 10 percent of total assets abroad.
  - Bank credit to private sector slowed sharply to June 2009; credit supply tightened and lending rates increased.

### External environment — trade, terms of trade, remittances, FDI, and aid
- Global trade volumes estimated to have fallen by 12 percent in 2009.
- LIC exports:
  - LIC exports began falling in October 2008; exports of goods and services expected to fall by 16 percent in 2009.
- Terms of trade and prices:
  - On average, LICs’ export prices fell by 12 percent; import prices declined slightly more.
  - Oil importers saw moderate terms of trade improvement; oil exporters suffered pronounced deterioration.
  - LIC terms of trade projected to change only slightly in 2010.
- Remittances:
  - Projected to fall by 10 percent in 2009 and recover modestly in 2010, remaining below pre-crisis levels.
  - Regional vulnerabilities: sub-Saharan Africa and Latin America likely strongly affected; many Asian remittance flows more resilient.
- FDI:
  - Gross FDI flows to LICs expected to fall by 25 percent in 2009.
  - Net FDI to LICs projected to decline by 7 percent.
  - FDI accounts for ¼ of gross fixed capital formation in LICs.
  - Outlook for 2010 shows only a slight recovery.
- Aid:
  - Overall aid flows to LICs expected to grow only marginally in 2009 and remain broadly stable in 2010.
  - To meet Gleneagles commitments, aid flows would need to grow by 11 percent in real terms per year during both 2009 and 2010; current donor plans fall short.

### Banking sector, sovereign and corporate market access
- Banking sector:
  - Funding pressures in some countries; some larger banks secured long-term funding from international financial institutions.
  - Effectiveness of domestic liquidity policies impeded by shallow domestic financial markets and limited collateral.
  - Rescue plans used in some countries to relieve pressure on systemically important banks.
- Sovereign access:
  - Potential access to commercial external financing appears to have improved somewhat.
  - Credit ratings: two downgrades (Mongolia, Sri Lanka), one upgrade (Pakistan), one positive outlook (Vietnam); contrast with broader emerging-market rating moves.
  - New syndicated loans to LIC sovereigns up 11 percent in H1 2009 vs H2 2008 (examples: Angola and Ghana).
  - International bond conditions eased but spreads remain significantly elevated.
- Corporate financing:
  - Externally sourced syndicated loans to corporates in LICs declined by around 8 percent in H1 2009 vs H2 2008.
  - Equity markets showed improvement in some indices (e.g., Merrill Lynch Africa Lions Index rose by close to 60 percent in Jan–Jun 2009).

### Fiscal responses, pre-crisis debt-risk profile, and social spending
- Fiscal easing prevalence:
  - Almost four-fifths of countries with low or moderate pre-crisis risk are projected to increase deficits between 2008 and 2009, compared to two-thirds of those at high risk or in debt distress.
  - One-third of countries in serious risk of debt distress projected to tighten fiscal policy.
  - Adjustment measures in tightening countries generally took the form of spending cuts on current (non-social) spending.
- Fund-supported programs versus non-program countries:
  - Social spending emphasized in about 70 percent of countries in both groups.
  - Program countries emphasize capital investment (88 percent) versus non-program countries (29 percent).
  - Structural reform in revenue administration, public financial management, and tax policy undertaken in almost one-half of program countries versus one-third of non-program countries.
- Social spending in LICs:
  - Sample of 31 countries: 24 LICs preserving or increasing real social spending, including 15 that initiated a Fund-supported program in 2008–09.
  - Social measures commonly: public works programs, cash transfer programs, increased subsidies.
  - Bank recapitalization costs: just over ¼ of LICs incurred fiscal costs for bank recapitalization since summer 2008, with budgetary impact averaging about 1.2 percent of GDP.

### LIC financing patterns, debt vulnerabilities, and DSA reclassification
- Financing patterns:
  - LICs relying primarily on additional domestic financing and to a lesser extent on external concessional support.
  - Across 40 countries with data, the increase in domestic financing projected to be six times as large as the increase in external financing.
- Public debt:
  - Public debt ratios were declining through 2008 but projected to rise in 2009 absent adjustment.
- DSA-based risk reclassification (pre-crisis vs post-crisis):
  - Pre-crisis risk of debt distress: Low 30%, Moderate 34%, High 23%, In debt distress 13%.
  - Post-crisis (recent DSAs and staff simulations): Low 20%, Moderate 30%, High 34%, In debt distress 16%.
  - Only Georgia has experienced a deterioration in its debt distress rating since the crisis; several countries could move into higher risk categories (e.g., Ethiopia, Lesotho, Malawi, Mauritania, Nepal, Nicaragua, St. Vincent and the Grenadines, Sierra Leone).
- Ten countries with flexible exchange rates and adverse terms-of-trade shocks allowed nominal effective exchange rate to depreciate on average by 10 percent since last December; real effective terms showed no significant improvement.

### Financing needs, Fund support, and IFI/aid scaling
- LICs’ net external financing needs in 2009–10 average about US$25 billion a year higher than in 2008.
- Fund lending and SDRs:
  - Fund expects to increase concessional lending in 2009–10 to around US$4 billion a year—up from US$1½ billion in 2008.
  - LICs received the equivalent of approximately US$20 billion from the SDR allocation in August 2009; SDRs estimated to contribute roughly US$10 billion in total to LICs’ financing needs.
  - Total additional Fund support for LICs around US$15 billion in 2009 and 2010 combined.
- Other IFIs:
  - World Bank Group will accelerate disbursements from IDA15; African Development Bank and Asian Development Bank have crisis-related facilities.
- Aid scaling:
  - If Gleneagles commitments were met, this could add US$15 billion for LICs in 2009–10; combined with Fund and IFI support, this would go most of the way toward meeting estimated financing needs.

### DSA simulations: objectives, scenarios, and assumptions
- Objective: simulate impact of the crisis on pre-crisis DSAs to assess debt vulnerabilities in LICs.
- Updating rules:
  - DSAs issued prior to May 31 updated using August WEO submissions.
  - DSAs issued after June 1 assumed based on frameworks that capture crisis impact.
  - Countries with DSAs after June 1 include: Benin, Burkina Faso, Central African Republic, Republic of Congo, Dominica, Georgia, Ghana, Grenada, Haiti, Lao PDR, Mozambique, Rwanda, St Lucia, Senegal.
- Baseline scenarios:
  - WEO fiscal scenario: financing needs = expenditures - government revenues - grants.
  - WEO external scenario: financing needs = imports - exports - current transfers - net FDI.
- Translation rule to external borrowing:
  - Increase in financing needs translates into additional external borrowing only if country runs a deficit under the WEO scenario; borrowing limited to deficit amount if LIC DSA showed a surplus.
  - Additional financing needs assumed met exclusively through external borrowing at a grant element of 45 percent to gauge maximum impact on external-debt vulnerability indicators.
- Projection dynamics:
  - 2008–14: WEO forecasts update measures of capacity to repay and financing-need variables.
  - From 2015: measures of capacity to repay, net FDI, net transfers and grants grow at same rate as initial LIC DSAs; transitory shocks treated as permanent level shocks.
  - 2015–19: financing needs return smoothly to LIC DSA levels (in percent of GDP) with adjustments in government expenditures and imports.
- Vulnerability criteria:
  - Low-risk countries deemed more vulnerable if breach of threshold under stress tests or baseline WEO scenarios.
  - Moderate-risk countries deemed more vulnerable if breach under baseline WEO scenarios.
  - High-risk countries deemed more vulnerable if at least two debt-burden indicators experience an average breach over the projection period of over 15 percentage points.
  - A 15 percent increase in debt-burden indicators above thresholds is consistent with an increase in probability of debt distress of about 10 percent.
- DSF indicators used:
  - PV of debt-to-GDP; PV of debt-to-exports; PV of debt-to-revenues; debt service-to-revenues; debt service-to-exports.
  - Risk ratings: low risk; moderate risk; high risk; in debt distress. Thresholds depend on three-year average CPIA index.

### Policy implications and recommendations (Challenges ahead)
- Short-term policy stance:
  - Use fiscal and other policies to counter the recession where appropriate until recovery is clearly underway; countries with fiscal space should maintain support for the duration of the downturn.
  - Maintain social support and protect social spending, finances permitting.
- Medium-term priorities:
  - Prepare to realign policies toward medium-term sustainability once recovery begins; scale back deficits and create fiscal space for pro-growth, poverty-reducing policies within a country-tailored medium-term framework.
  - Begin preparing to unwind stimulus measures when economic activity rebounds and to reduce public debt to sustainable levels.
- Debt and concessional finance:
  - Further increases in concessional financial support needed to help LICs smooth adjustment in 2009–10 without aggravating debt sustainability risks.
  - Shortfalls in aid could force premature adjustment or reliance on unaffordable nonconcessional debt.
- Structural reforms and capacity building:
  - Improve business environment; develop well-regulated local capital markets and banking systems; enhance public-sector efficiency; reform tax policy and revenue administration; reduce trade barriers; address infrastructure deficits.
  - Strengthen social safety nets and build mechanisms to channel support to vulnerable groups quickly and efficiently.
- International support:
  - Reform efforts will require sustained financial and technical support from the international community well beyond the present crisis.

*Source: Executive Summary and selected sections — IMF staff paper (pages 2–10 and relevant sections of the provided document).*

### Executive Summary ......................................................................................................

### Executive Summary

### Outlook for the world economy and commodities
- The world economy is beginning to pull out of the deepest slump since the Great Depression, but stabilization is uneven and the recovery remains fragile.
- After collapsing in the second half of 2008, commodity prices stabilized in early 2009 and staged a strong rally in the second quarter of 2009; future commodity price paths depend importantly on the timing and strength of the global recovery.
- Global growth projections:
  - Global growth is projected to contract by 1.1 percent in 2009, before expanding by around 3.1 percent in 2010.
  - Activity in the advanced economies is projected to decline by 3.4 percent in 2009, followed by a modest rebound in 2010.
  - Emerging and developing economies are projected at 1.7 percent in 2009, before rebounding to around 5 percent in 2010.
- Inflation:
  - Year-on-year world inflation moderated to 1.3 percent in August 2009, down from around 6 percent one year earlier.
  - Headline inflation in advanced economies turned negative in May (and continued to be so until August).
- Commodities:
  - Oil prices responded strongly to perceptions of an impending turnaround and OPEC production cuts.
  - Most metal prices rebounded in the second quarter of 2009, reflecting improved macroeconomic/financial outlook and China’s restocking.
  - Food prices enjoyed a broad-based and modest recovery in spring 2009, but recent commodity-specific fundamentals have led to wide divergence across major global crops.
  - For food commodities, prices are not expected to rise through the global economic recovery due to their relatively low sensitivity to the business cycle, though higher energy costs and increased biofuel usage could pose upward risks in the longer run.

### How low-income countries (LICs) are affected — overview
- LICs are being hit hard by the global financial crisis: sharp contraction in export growth, FDI inflows, and remittances, and lower-than-committed aid.
- Poverty impact:
  - The World Bank estimates an additional 89 million people will be pushed into extreme poverty (below US$1.25 a day) by end-2010.
- Growth projections for LICs:
  - 2009 growth forecast at an average 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.
  - Regional variation: Asia expected to witness a quick recovery; Latin America’s rebound expected to be much more modest.
- External accounts and reserves:
  - Despite a sharper-than-expected drop in export growth, trade and current account balance projections remained broadly unchanged in 2009, with no further deterioration expected for 2010.
  - Reserve coverage projected at an average 4.2 months of imports in 2009, remaining broadly unchanged in 2010, provided countries’ financing needs are met.
  - Note: the projected reserves do not include the Fund’s SDR allocation provided in August 2009.
- Inflation in LICs:
  - Inflation expected to drop sharply in 2009 from 2008 peaks and to ease further in 2010.
  - Median inflation in current projections for 2009 is 5.9 percent.
- Fiscal positions:
  - LICs’ overall fiscal balances are projected to deteriorate on average by about 2.8 percent of GDP in 2009.
  - Two-thirds of LICs are projected to see revenues fall relative to GDP.
  - The revenue loss for commodity exporters is expected to be more than twice the average of all LICs.
  - On average, expenditure is expected to increase as a share of GDP by almost 1.8 percentage points in 2009.
  - About one third of countries implement discretionary fiscal stimulus.
  - Capital expenditures see the largest average increases; the civil service wage bill in LICs is also forecast to grow.
- Fiscal outlook for 2010:
  - Overall balances expected to improve on average by around 1¼ percent of GDP in 2010.
  - Commodity exporters projected to adjust fiscal balances by about 2 percent of GDP in 2010.
  - Expected revenue rise on average by almost three-quarters of a percentage point of GDP in 2010; expected spending restraint accounts for the rest.

### Transmission channels and financial sector risks
- Main transmission channels:
  - Reduced demand for exports.
  - Lower FDI.
  - Reduced remittances.
  - Prospective aid flows falling short of donors’ commitments.
- Direct impact of the global financial crisis on LIC financial sectors has been limited to date, but:
  - Risks to the financial sector from a domestic economic slowdown are a serious concern and must be closely monitored.

### Policy responses in LICs
- Fiscal policy:
  - LICs are using fiscal policies to counter the effects of the crisis and should continue to do so, where appropriate, until the economic recovery is clearly underway.
  - About one third of LICs have augmented automatic stabilizers with discretionary fiscal stimulus, mainly targeted to the spending side.
  - Many countries appear to have chosen to increase recurrent spending; many are making efforts to preserve or expand social safety nets, constrained in many cases by the lack of existing mechanisms.
  - Countries should maintain social support for the duration of the downturn, their finances permitting.
- Debt sustainability and medium-term strategy:
  - While fiscal policies support growth, risks to debt sustainability are rising; countries should begin preparing to realign policies toward medium-term sustainability once recovery is clearly underway.
  - LICs are relying primarily on additional domestic financing and to a lesser extent on additional external concessional resources to finance increased deficits.
  - 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.
  - 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 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.
- Monetary and exchange rate policy:
  - Inflation risks have remained subdued, allowing some countries to ease monetary policy; many LICs with favorable inflationary conditions have reduced key policy rates.
  - Widespread reliance on exchange rates as a monetary anchor has limited the role of exchange rate adjustment in responding to terms-of-trade shocks.

### Financing needs and international support
- 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.
- The Fund’s planned expansion of lending to LICs and the recent SDR allocation could meet almost one third of these additional needs.
- Other international institutions are contributing by augmenting and frontloading financing activities.
- A further scaling-up of aid, at least in line with Gleneagles commitments, will be required to meet the needs, assist LICs in supporting growth, protect the poor, and maintain debt sustainability.

### Challenges ahead
- Key challenges:
  - Managing the trade-off between supporting growth in the short term and restoring debt sustainability over the medium term.
  - Implementing structural reforms (tax policy, revenue administration) and expenditure rationalization to augment revenues and improve spending efficiency.
  - Monitoring and containing financial sector risks arising from domestic economic slowdowns.
  - Ensuring adequate and timely external concessional financing to avoid premature fiscal consolidation that would undermine recovery and poverty reduction.

*Executive Summary — IMF staff paper (pages 2–10 of the provided document).*

### 18.       The external environ

### 18.       The external environ

### External trade and exports
- Global trade volumes are estimated to have fallen by 12 percent in 2009.
- LIC exports:
  - Following initial resilience, LIC exports started to fall in October 2008, about three months after exports began to decline in advanced and emerging market economies.
  - The onset of the decline in imports appears to have slightly lagged that of exports.
  - Exports of services, mainly tourism, have declined by much less than goods exports.
  - Overall exports of goods and services are expected to fall by 16 percent this year.

### Terms of trade and prices
- On average, LICs’ export prices fell by 12 percent.
- Import prices declined slightly more, due to lower oil prices and lower prices of manufactured goods.
- On average, oil importers have seen a moderate terms of trade improvement, while oil exporters suffered a pronounced terms of trade deterioration.
- LIC terms of trade are projected to change only slightly in 2010.

### Trade-volume projections (goods and services indices)
- Goods exports, services exports, goods imports, and services imports are tracked relative to 2007=100 with "Post-shock (current projections)" and "Pre-shock (Spring 2008 WEO)" series showing declines in 2009 and moderate recovery in 2010.

### Remittances
- Remittances to LICs are projected to fall by 10 percent in 2009 and to recover modestly in 2010, remaining below pre-crisis levels.
- Remittances had been growing at double-digit rates and had become the second largest flow to LICs prior to the shock.
- Regional impacts:
  - Remittances to sub-Saharan Africa likely to be affected strongly: in 2008 over three-quarters of Africa’s remittances came from Western Europe and the United States.
  - Remittances to Latin America likely to be affected strongly due to the downturn in the United States.
  - Some Commonwealth of Independent States countries likely to be severely affected by the contraction of the Russian economy and depreciation of the ruble.
  - Remittances to most Asian countries likely to be more resilient because of more diverse sources, in particular greater reliance on the Middle East.

### Foreign direct investment (FDI)
- Gross FDI flows to LICs are expected to fall by 25 percent this year.
- Net FDI to LICs is projected to decline by 7 percent.
- FDI accounts for ¼ of gross fixed capital formation in LICs.
- A survey suggests countries in Asia could be affected the most, and countries in sub-Saharan Africa the least, by downward revisions in FDI plans—implying natural resource-oriented FDI may be affected only to a limited extent.
- The outlook for FDI in 2010 shows only a slight recovery.

### Aid
- Overall aid flows to LICs are expected to grow only marginally in 2009 and remain broadly stable in 2010.
- To meet Gleneagles commitments, aid flows would need to grow by 11 percent in real terms per year during both 2009 and 2010; current indications are donor plans fall well short of this.

### Banking sector — direct financial channels and asset quality
- Direct impact of the global financial crisis on LIC banking systems has been limited due to little exposure to sub-prime mortgages and complex derivatives, but funding for bank operations has come under pressure in some countries.
- Some larger banks secured long-term funding from international financial institutions; foreign branches and subsidiaries reliant on parent credit lines faced strains.
- Effectiveness of policy responses to ease domestic liquidity has been impeded by shallow domestic financial markets and limited collateral.
- Nonperforming loans (NPLs):
  - Indications that NPLs have increased in 2009 as macroeconomic risks materialize; deterioration particularly acute where lending lacks sectoral diversity.
  - Many NPLs are relatively new and not yet fully provisioned, implying bank earnings are likely to deteriorate going forward.
  - Some banks have begun rescheduling and restructuring credit portfolios.
- Asset quality deterioration also resulted from falling equity prices affecting loans for share purchase and collateral in the form of shares; margin loans became non-performing and regulatory gaps were exposed.
- Falling international interest rates reduced earnings from foreign placements; banks in some LICs had placed up to 10 percent of total assets abroad.
- In response to lower returns and higher counterparty risk, some banks repatriated funds or reallocated foreign deposits.
- Declines in capital inflows and remittances reduced banks’ foreign-exchange operation earnings and contributed to declines in real estate prices and system deposits in some countries (e.g., Tajikistan).

### Domestic bank lending and credit supply
- Bank credit to the private sector slowed sharply in the year to June 2009 in almost all LICs, albeit from exceptionally rapid growth rates in some countries.
- In response to higher NPLs, lower profitability, and higher funding costs, many banks increased lending rates and tightened credit conditions.
- Credit to particular sectors (e.g., real estate) has been especially constrained in some countries.
- Rescue plans have been used in some countries to relieve pressure on systemically important financial institutions, likely reserved for large banks.

### Sovereign access to financing and market conditions
- Potential for LIC sovereigns to access commercial external financing appears to have improved somewhat.
- Credit ratings on LICs have held up well since September 2008: two downgrades (Mongolia, Sri Lanka), one upgrade (Pakistan), and one on positive outlook (Vietnam); by contrast, seven emerging markets were upgraded and 21 downgraded over the same period.
- Public sector activity in the external syndicated loan market: flow of new loans to LIC sovereigns up 11 percent in the first half of 2009 compared to the second half of 2008 (examples: Angola and Ghana).
- Conditions in international bond markets have eased, but spreads remain significantly elevated.
- Foreign investor activity in LIC debt securities increased in the 6 months to March 2009 in all regions barring Latin America, with most significant gains in Asia and Middle East and Europe; activity is mostly concentrated in local markets.
- Domestic financing conditions have been uneven: Asia saw yields fall across curves, while several sub-Saharan African LICs experienced yield increases at the short end due to tighter domestic liquidity.

### Corporate access to financing and markets
- Externally sourced syndicated loans to corporate sectors in LICs declined by around 8 percent in the first half of 2009 compared to the second half of 2008.
- Corporates face challenging financing conditions both externally and domestically amid significant refinancing needs.
- Maturities falling due on syndicated loans are concentrated in 2009–2014 for both public and corporate sectors, indicating near-term refinancing pressures.
- Equity markets showed some improvement: the Merrill Lynch Africa Lions Index rose by close to 60 percent in January–June 2009; similar patterns observed in some LICs (e.g., Sri Lanka and Vietnam), suggesting some corporates might access capital through stock markets.

### Policy responses — fiscal and monetary
- Most LICs are running fiscal countercyclical policies, preserving or expanding spending to support the economy and protect the poor.
- Given limited scaling-up of aid, many countries are resorting to domestic financing and some are taking risks with medium-term debt sustainability.
- These heightened vulnerabilities could be manageable under a combination of scale-up aid and fiscal adjustment.
- Some countries have eased monetary policy as pressures on inflation subsided, reflecting lower global commodity prices and reduced growth.
- Use of the exchange rate as a shock absorber appears to have been limited.
- Fiscal deficits are increasing in three-quarters of LICs, reflecting automatic stabilizers predominantly on the revenue side.
- Almost one-third of countries are augmenting automatic stabilizers with discretionary stimulus, typically concentrated on current spending; explicit overall fiscal stimulus in LICs has been more limited than that implemented in G20 countries.
- About one-third of countries could confront important challenges in ensuring fiscal sustainability in the medium and long term.

*Sources: WEO Database, IFS Database, and Fund staff calculations.*

### 40.      The prevalence of fiscal easing appears to have been greater in countries with

### 40.      The prevalence of fiscal easing appears to have been greater in countries with

### Fiscal responses and pre-crisis debt-risk profile
- Almost four-fifths of countries with low or moderate risk of fiscal distress prior to the crisis are projected to increase their deficits as a share of GDP between 2008 and 2009, compared to two-thirds of those at high risk of debt distress or in debt distress.
- One-third of countries in serious risk of debt distress are projected to tighten fiscal policy, compared with only one-fifth of those with low or moderate risk ratings.
- Adjustment measures in countries tightening generally took the form of spending cuts, most commonly on current (non-social) spending.

### Fund-supported programs versus non-program countries
- Fiscal stimulus measures in program and non-program countries both emphasize social spending in about 70 percent of countries in each group.
- Program countries place a stronger emphasis on capital investment: 88 percent versus 29 percent (program versus non-program).
- In non-program countries, increases in non-social current spending and tax cuts are more prevalent.
- Structural reform in areas such as revenue administration, public financial management, and tax policy have been undertaken in almost one-half of Fund-supported program countries, compared to one-third of non-program countries.
- Fund-supported programs have been flexible in allowing automatic stabilizers to work and accommodating fiscal stimulus.

### Commodity exporters
- Total expenditure as a share of GDP increased between 2007 and 2009 in many commodity exporters; it was financed mainly by a drawdown of deposits.
- Most commodity exporters intend to reduce their total spending in 2010 relative to 2009.

### Low-Income Countries (LICs): social spending and limitations
- Based on a sample of 31 countries for which data are available, 24 LICs are either preserving or increasing real social spending, including 15 countries that have initiated a Fund-supported program in 2008–09.
- Even in LICs that tightened fiscal policy, social spending appears to have been protected.
- Social support measures have most commonly taken the form of public works programs, cash transfer programs and increased subsidies.
- The ability of many countries to expand social safety net programs has been severely constrained by a lack of existing mechanisms on which to build.
- LICs are also incurring costs for bank recapitalization: just over ¼ of LICs have incurred fiscal costs for bank recapitalization since the summer of 2008, with the budgetary impact averaging about 1.2 percent of GDP. Very few LICs have seen contingent liabilities such as PPPs, concession guarantees, and credit guarantees materialize.

### LIC financing patterns and trends
- To finance larger deficits, LICs appear to be relying primarily on additional domestic financing and to a lesser extent on external concessional support.
- Across the 40 countries for which data are available, the increase in domestic financing is projected to be six times as large as the increase in external financing.
- A number of countries will have access to nonconcessional external financing, consistent with the improving conditions for LIC sovereigns.
- Public debt ratios were on a declining trend through 2008, reflecting an extended period of fiscal consolidation, strong growth and debt relief; on current projections, this trend will turn around in 2009 and (absent adjustment) could see rising debt ratios for several years to come.

### Debt vulnerabilities and DSA-based risk reclassification
- Pre-crisis risk of debt distress (based on DSAs mostly undertaken during the last year): Low 30%, Moderate 34%, High 23%, In debt distress 13%.
- Post-crisis DSAs and staff simulations (based on recent DSAs and simulations): Low 20%, Moderate 30%, High 34%, In debt distress 16%.
- Recent DSAs and staff simulations suggest that a number of countries could move into higher debt risk categories.
- Since the crisis broke, only one country (Georgia) has seen its debt distress rating deteriorate.
- Of those currently rated at high risk, only Afghanistan appears particularly vulnerable as a result of the crisis; Afghanistan’s vulnerabilities are mitigated by its eligibility for assistance under the Heavily Indebted Poor Countries (HIPC) Initiative.
- Eight moderate risk countries could face increased debt vulnerabilities: Ethiopia, Lesotho, Malawi, Mauritania, Nepal, Nicaragua, St. Vincent and the Grenadines, and Sierra Leone.

### Monetary, credit, and exchange rate policies
- Monetary policy has generally been eased as inflation subsided; many countries that saw a significant decline in inflationary pressures have reduced policy interest rates.
- Reserve money growth, after slowing in 2008 and becoming negative in the first quarter of 2009, increased in the second quarter for one-quarter of LICs for which data is available.
- Credit to the private sector slowed substantially in 2008 and early 2009; it is expected to resume in the second half of 2009 and is forecast to grow on average in real terms at 3.3 percent for the year.
- Almost a third of LICs witnessed a terms of trade deterioration greater than 5 percent; more than half of these have a de facto fixed exchange rate regime.
- Ten countries adversely affected by a terms of trade shock with a flexible exchange rate regime allowed the nominal effective exchange rate to depreciate on average by 10 percent since last December, but real effective terms have not shown significant improvement.

### Financing needs and international support (2009–10)
- LICs are facing large net external financing needs in 2009–10—averaging about US$25 billion a year higher than in 2008.
- The Fund expects to increase its concessional lending in 2009–10 to around US$4 billion a year—up from US$1½ billion in 2008.
- LICs received the equivalent of approximately US$20 billion from the SDR allocation made by the Fund in August 2009; the SDRs will make an important contribution—of roughly US$10 billion in total—to meeting LICs’ estimated financing needs.
- This brings total additional Fund support for LICs to around US$15 billion in 2009 and 2010 combined.
- Other IFIs have stepped up support: the World Bank Group will accelerate disbursements from IDA15; other institutions include the African Development Bank’s Emergency Liquidity Facility and Trade Finance Initiative, and the Asian Development Bank’s crisis-related lending programs.
- If the Gleneagles commitments were met, the result could be an additional US$15 billion for LICs in 2009–10; combined with increased support from the Fund and other IFIs, this would go most of the way toward meeting LICs’ financing needs.

### Policy implications and recommendations (Challenges ahead)
- The use of fiscal and other policies to counter the recession should continue, where appropriate, until it is clear that recovery is underway; countries that have fiscal space should maintain support for the duration of the downturn.
- With recovery prospects improving, policymakers should prepare to realign policies toward medium-term sustainability once recovery begins.
- Fiscal deficits should be scaled back to sustainable levels and fiscal space created to support policies that enhance growth and reduce poverty; adjustments should be implemented in the context of a medium-term framework tailored to country circumstances.
- Countries in debt distress will need to increase the efficiency of public spending and expand the revenue base; this is particularly important for commodity exporters where supporting structural reforms have been less prevalent.
- Prolonging expansionary fiscal policies unduly risks undermining medium-term growth as debts become unmanageable.

*Source: Fund staff estimates.*

### 55.      Further increases in concessional financial support are needed to help LICs

### Further increases in concessional financial support are needed to help LICs

### Concessional finance and aid needs
- Further increases in concessional financial support are needed to help LICs smooth adjustment in 2009–10 without further aggravating risks to debt sustainability.
- The estimated external financing needs for this year and next can be met only with a substantial scaling up of donor support, at least in line with the Gleneagles commitments.
- Shortfalls in aid could force countries either to adjust before the recovery is underway or to take on nonconcessional debt that they cannot afford.

### Medium-term prospects and structural reforms
- Although the world economy is on the mend, LICs cannot count on a return to the unusually supportive pre-crisis global environment, and will need new engines to drive strong economic growth.
- A rapid recovery in FDI flows and remittances seems unlikely given the possibility of sluggish growth in advanced economies for some time to come.
- Bank credit and portfolio flows may be similarly restrained by heightened risk aversion and weakened balance sheets.
- Policy implications and recommended reforms:
  - Improve the business environment.
  - Develop well-regulated local capital markets and banking systems.
  - Enhance efficiency in the public sector.
  - Bring down barriers to trade, notably across regional markets.
  - Channel resources to addressing the serious “infrastructure deficits” that most LICs face.
- These reform efforts will require strong financial and technical support from the international community, long after the present crisis is over.

### Social safety nets
- The recent crises—first the food and fuel price surges, and then the global recession—have highlighted deficiencies in most LICs’ social safety net systems.
- In many LICs, mechanisms to channel support to vulnerable groups quickly and efficiently often did not exist even where resources were available.
- Concerted actions are needed to remedy these deficiencies so countries are in a much better position to tackle the next crisis when it comes.

### Countries included in the analysis
- The group of LICs analyzed is formed by the 69 PRGF-eligible countries for which data were available.
- Regions and countries listed in the analysis include:
  - Sub-Saharan Africa: Angola, Benin, Burkina Faso, Burundi, Cameroon, Cape Verde, Central African Republic, Chad, Comoros, Democratic Republic of Congo, Republic of Congo, Côte d’Ivoire, Eritrea, Ethiopia, The Gambia, Ghana, Guinea, Guinea-Bissau, Kenya, Lesotho, Liberia, Madagascar, Malawi, Mali, Mozambique, Niger, Nigeria, Rwanda, São Tomé and Príncipe, Senegal, Sierra Leone, Tanzania, Togo, Uganda, and Zambia.
  - Middle East and Europe: Armenia, Azerbaijan, Djibouti, Georgia, Kyrgyz Republic, Mauritania, Moldova, Sudan, Tajikistan, Uzbekistan, and Republic of Yemen.
  - Asia: Afghanistan, Bangladesh, Bhutan, Cambodia, India, Lao People’s Democratic Republic, Maldives, Mongolia, Myanmar, Nepal, Pakistan, Papua New Guinea, Sri Lanka, and Vietnam.
  - Latin America: Bolivia, Dominica, Grenada, Guyana, Haiti, Honduras, Nicaragua, St. Lucia, and St. Vincent and the Grenadines.

### DSA simulations: objectives and methodology
- Purpose: simulate impact of the crisis on pre-crisis DSAs to assess debt vulnerabilities in LICs.
- Updating rules:
  - DSAs issued to the Board prior to May 31 are updated using August WEO submissions.
  - DSAs issued to the Board after June 1 are assumed to be based on macroeconomic frameworks that capture appropriately the impact of the crisis.
  - Countries with DSAs issued after June 1 include Benin, Burkina Faso, the Central African Republic, the Republic of Congo, Dominica, Georgia, Ghana, Grenada, Haiti, Lao PDR, Mozambique, Rwanda, St Lucia, and Senegal.
- Main outcome noted: while more recent DSAs typically show an increase in debt vulnerabilities, only Georgia has experienced a deterioration in its risk of debt distress.
- Starting point: most recent LIC DSA undertaken under the joint Bank-Fund Debt Sustainability Framework (DSF).
- DSAs provide evolution of: (i) measures of capacity to repay (GDP, exports and government revenues); (ii) variables used to assess external and fiscal financing needs; and (iii) measures of indebtedness (PV of PPG external debt and debt service).

### Scenarios and assumptions
- Two updated “baseline” scenarios:
  - WEO fiscal scenario: financing needs = expenditures - government revenues - grants.
  - WEO external scenario: financing needs = imports - exports - current transfers - net FDI.
- Rule on translation to external borrowing:
  - An increase in financing needs compared to the initial LIC DSA is assumed to translate into additional external borrowing only if the country is running a deficit under the WEO scenario.
  - This rule prevents borrowing by countries running surpluses in the LIC DSA and smaller surpluses in the WEO scenario. If a country runs a surplus in the LIC DSA and a deficit in the WEO scenario, the country is assumed to borrow only the amount of the deficit.
- Additional financing needs are assumed to be met exclusively through external borrowing to gauge the maximum impact on the vulnerability assessment (DSF thresholds relate to external debt).
  - Unlimited additional external financing is assumed to be available at a grant element of 45 percent. If external financing were obtained on less concessional terms, it would result in a greater deterioration of debt burden indicators. Conversely, if part of the fiscal financing needs are met with domestic borrowing, it would result in lower external debt burden indicators.

### Projection horizons and dynamics
- Over the 2008–14 period, WEO country forecasts update measures of capacity to repay and variables affecting financing needs.
- Starting in 2015, measures of capacity to repay, net FDI, net transfers and grants grow at the same rate envisaged under the initial LIC DSAs; transitory shocks to growth are not reversed in later years, resulting in a permanent shock to the level of variables.
- Over the 2015–19 period, financing needs in the WEO scenarios return smoothly to their respective LIC DSA level (in percentage of GDP). Government expenditures and imports adjust to achieve the targeted financing needs.

### Stress tests and vulnerability criteria
- Stress tests are not directly conducted in WEO scenarios; instead, the response of debt burden indicators to standard DSF stress tests is assumed similar to the initial LIC DSA.
- Criteria for deeming countries more vulnerable:
  - Countries initially classified as low risk are deemed more vulnerable if they experience a breach of threshold under the stress tests or the baseline WEO scenarios.
  - Countries initially classified as moderate risk are deemed more vulnerable if they experience a breach of a threshold under the “baseline” WEO scenarios.
  - Countries initially classified as high risk are deemed more vulnerable if at least two debt burden indicators experience an average breach over the projection period of over 15 percentage points.
- A 15 percent increase in debt burden indicators above their thresholds is consistent with an increase in the probability of debt distress of about 10 percent.

### Debt Sustainability Framework (DSF) overview
- Objective: support LICs achieve development goals without creating future debt problems.
- The DSA focuses on five debt burden indicators to assess risk of external public debt distress: (i) PV of debt-to-GDP; (ii) PV of debt-to-exports; (iii) PV of debt-to-revenues; (iv) debt service-to-revenues; and (v) debt service-to-exports.
- Risk ratings: low risk; moderate risk; high risk; in debt distress.
- Thresholds depend on quality of policies and institutions as measured by the three-year average CPIA index.

*Source: _092809 - 55.      Further increases in concessional financial support are needed to help LICs*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2009/_092809.pdf_