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### Key findings and overview
- Two-thirds of low-income countries (LICs) registered positive real per capita GDP growth during the global crisis.
- Crisis transmission to LICs occurred mainly through contraction in export demand, foreign direct investment (FDI), and remittances; oil exporters were also hit by a sharp fall in oil prices.
- LICs experienced the sharpest decline in their economic growth rate over the last four decades, but this followed a period of strong expansion and real per capita GDP growth remained generally well above growth in richer countries.
- Median real spending is projected to grow by 4.6 percent annually through 2015 under baseline projections.
- The Fund committed about US$5 billion to LICs in concessional financial support since the beginning of 2009, roughly four times the historical average.

### Impact of the crisis — macro and distributional outcomes
- Transmission channels and macro outcomes:
  - Main channels: contraction in export demand, FDI, and remittances rather than terms-of-trade or global interest rates.
  - Terms-of-trade impact positive for most LICs, except oil exporters.
  - Fiscal and current account deficits widened in 2009.
  - Inflation declined; less than one-fourth of LICs had double-digit inflation in 2009, compared to nearly two-thirds in 2008.
  - Reserves held up well, partly reflecting the IMF’s general SDR allocation.
  - Public debt increased only slightly in most LICs; for countries reaching HIPC Decision/Completion Points in 2008–10, median public debt ratio fell from 76 percent of GDP to 57 percent over 2007–09.
- Distributional and labor impacts:
  - World Bank simulations: crisis will leave an additional 64 million people in extreme poverty by end-2010.
  - By 2015 global poverty rate projected at 15 percent, compared to 14.1 percent without the crisis.
  - ILO estimates: average unemployment rose by 1.2 percent in Latin America and the Caribbean in 2009; estimated rises of about 0.1–0.3 percent in 2009 in sub-Saharan Africa, the Middle East, East Asia, Southeast Asia/Pacific, and South Asia.
- Banking sector:
  - Direct impact limited due to low reliance on capital inflows and wholesale funding, low leverage, and relatively high pre-crisis capital adequacy ratios.
  - As macro conditions worsened: NPLs rose, profitability fell, credit standards tightened, and credit growth slowed before picking up in H2 2009.

### Domestic policy responses and pre-crisis buffers
- Countercyclical fiscal response:
  - Most LICs implemented a domestic countercyclical policy response and preserved vital spending, including social sectors and public investment.
  - Median increase in real primary spending higher than in the previous five years; real spending grew with a median increase of 7.4 percent in 2009 compared with 7.6 percent over the previous five years.
  - Public investment increased by 17 percent in real terms in 2009; health and education spending increased by 10 percent in real terms in 2009.
  - Almost 90 percent of program LICs increased real primary expenditures in 2009, compared with 67 percent of non-program LICs.
- Pre-crisis buffers:
  - LICs entered the crisis with lower inflation, smaller fiscal and current account deficits, higher international reserves, and reduced debt—buffers mainly built during the last decade.
  - LICs with stronger pre-crisis buffers made greater use of countercyclical fiscal policy in 2009.
  - Empirical regression evidence: Buffer Index coefficient -0.42**, t-statistic (-2.45); R-squared 0.29; # of observations 50 (stronger buffer index in 2008 associated with greater ability to increase spending in 2009).

### IMF and donor support
- IMF support and financing:
  - The Fund committed about US$5 billion in concessional financial support to LICs since the beginning of 2009.
  - LICs received SDR allocations in August and September 2009 amounting to about SDR 8.2 billion.
  - Fund-supported countries were able to boost spending more than non-program countries.
- Aid:
  - Official transfers (aid) held up during the crisis year.

### Prospects, regional variation, and vulnerabilities
- Recovery synchronization and drivers:
  - WEO baseline projects a sharp V-shaped recovery for world growth; LIC recovery projected to follow more closely that of the rest of the world.
  - Increased trade and financial integration and stronger domestic policies support a more synchronized LIC recovery.
  - In 38 percent of LICs with data, exports would account for more than half of total real GDP growth in 2010.
  - Regional projections: fastest growth in 2010/11 in Asian LICs; slower recoveries in Latin America and the Caribbean and in the Middle East and Central Asia.
- Baseline medium-term projections (2010–15):
  - Median real spending projected to increase by 4.6 percent annually.
  - Median LIC inflation forecast to fall to about 5 percent over the medium term.
  - 11 out of 64 countries experience double-digit inflation in 2010; another nine near-double digits.
  - Median improvement in the primary balance projected at 1.3 percentage points of GDP over five years.
  - Share of countries with fiscal deficits in excess of 5 percent of GDP projected to drop from almost one-half in 2009 to one-tenth by 2014.
  - By 2015, public debt < 40 percent of GDP in half of LICs; one-fifth would have debt > 65 percent of GDP.
  - Median reserve coverage projected around 4–4¼ months of imports over the medium term.
  - External borrowing expected to increase from around US$38 billion in 2010 to US$48 billion in 2014.
- Vulnerabilities and scenario outcomes:
  - Almost half of LICs could absorb another shock with limited or no need for adjustment; the other half face significant vulnerabilities under a sizeable shock.
  - Downside scenario: per capita real GDP growth in LICs lower than baseline by about 1 percentage point in 2011 (constructed from GPM-generated shocks to advanced and emerging economies; advanced/EM growth reductions relative to baseline: 0.3 percentage points in 2010, 1.4 percentage points in 2011, and 0.2 percentage points in 2012).
  - Under the downside scenario median structural primary deficit would worsen by about 0.5 percent of GDP; public debt-to-GDP ratio would increase by 3 percentage points by 2015 (excluding countries with expected debt relief).
  - Median reserve coverage could fall by almost one month of imports by 2012; about a quarter of LICs could have < two months of import coverage.

### Fiscal policy recommendations — rebuilding buffers and supporting growth
- General fiscal guidance:
  - Strengthen domestic revenues beyond the cyclical rebound to create fiscal space while preserving debt sustainability.
  - Continue to increase real spending focused on social sectors and infrastructure while improving spending efficiency.
- Revenue mobilization measures:
  - Potential revenue increases estimated in prior work in the range of 2–4 percent of GDP.
  - Measures: rationalize income tax incentives and VAT exemptions; increase excise taxes on alcohol, tobacco, and fuel; tap property taxes.
  - Strengthen tax administration: secure revenue from large and medium enterprises; tackle tax evasion via risk-based audits and compliance checks.
- Expenditure and PFM priorities:
  - Targeted real spending increases for health, education, and infrastructure.
  - Strengthen automatic fiscal stabilizers (targeted temporary income support, labor-intensive public works, cash transfers).
  - Improve expenditure efficiency: reduce poorly targeted subsidies (more than one-third of LICs have fuel price subsidies; projected for 2010 to exceed 1 percent of GDP in 6 countries).
  - Strengthen public financial management: treasury management, project appraisal, medium-term budget frameworks, and reflect recurrent costs of capital investment.
- Debt and financing mix:
  - Balance external nonconcessional financing against domestic financing and concessional support.
  - Most LICs remain vulnerable and will continue to need highly concessional donor support.
  - Develop domestic financial sectors and sound debt management frameworks to mobilize domestic savings and extend maturities.

### Monetary, exchange rate, and financial sector policy recommendations
- Monetary policy:
  - Inflation mostly benign at single digits; monetary policy could be accommodative in many LICs.
  - Fan chart result: 25 percent probability that half of LICs could experience inflation higher than baseline by at least 2 percentage points; number of countries with double-digit inflation could rise from 14 in 2009 to 19 in 2010 and 16 in 2011.
  - Two-thirds of countries could loosen monetary policy somewhat if external positions allow; if food and fuel prices rise, monetary policy should accommodate direct impacts but counter second-round inflationary and external effects.
- Exchange rate policy:
  - Use exchange rate flexibility to cushion volatility where possible; floating regimes largely avoided reserve losses by allowing depreciation.
  - Countries with low reserve buffers should allow exchange rates to adjust more flexibly; countries with floating rates and high reserves may consider lower reserves given costs of holding them.
- Financial sector and domestic debt markets:
  - Strengthen supervision, regulatory frameworks, and crisis management arrangements (bank resolution regimes, emergency liquidity arrangements, deposit insurance design).
  - Prompt balance-sheet clean-up, loss recognition, and shareholder capital injections where banks show significant strains.
  - Develop domestic debt markets to mobilize national savings and broaden financing options; deepen institutional investor base and extend maturities while containing costs.

### Capital markets, banking sector, and credit developments
- Sovereign and equity market developments:
  - International capital markets reopened: Senegal debut issuance in December 2009 (US$200 million); Vietnam issuance in January 2010 (US$1 billion).
  - Cost of domestic bond financing generally declined in line with improved international conditions; domestic market size and structure remain limited.
  - Asian LICs (e.g., Bangladesh, Mongolia) performed relatively well in equity markets.
- Banking sector indicators (2009–mid-2010):
  - NPLs increased sharply in 2009 and continued to rise in 2010H1, though at a slower pace.
  - Profitability declined due to higher loan loss provisions, stronger deposit competition, and limited scope to reduce operating costs.
  - Liquidity pressures eased and domestic deposit growth recovered in 2010; excess reserves increased in most countries.
  - New bank entry and expansion resumed in several LICs (examples: opening outlets in Ghana, Rwanda, Tanzania; new licenses in Kenya, Tanzania, Zambia).
- Domestic bond market indicators (selected entries preserved verbatim):
  - Kenya 52.2 23.3 8.5 36.7 2015 10.8
  - Tanzania ... 7.3 4.5 62.1 2012 9.3
  - Ghana 46.6 28.1 15.7 55.9 2011 18.2
  - Nigeria 86.1 13.0 6.0 46.2 2014 9.7
  - Vietnam 14.8 7.3 2.1 29.5 2012 9.8
  - Bangladesh ... 13.6 0.9 6.4 2015 11.5

### Illustrative downside scenario, buffers assessment, and policy typology
- Downside scenario construction:
  - Scenario assumes adverse shocks to advanced and emerging economies based on IMF Global Projection Model; advanced/EM growth deviations: -0.3 percentage points in 2010, -1.4 percentage points in 2011, -0.2 percentage points in 2012 relative to baseline.
  - LIC per capita growth falls about 1 percentage point in 2011 relative to baseline using regression-based transmission via trading partner exposures.
  - Limitations: method ignores associated commodity price, interest rate, and capital flow changes.
- Buffers assessment and country groupings:
  - Buffer index (components: overall fiscal balance, inflation, reserves in months of imports, public debt, current account balance + FDI; standardized by 2004–07 SDs) used to classify countries into low, medium, and high buffer groups (33rd and 66th percentile cut-offs in 2007).
  - Under the illustrative shock:
    - Median structural primary deficit worsens by about 0.5 percent of GDP.
    - Public debt-to-GDP ratio increases by 3 percentage points by 2015 (excluding those with expected debt relief).
    - Almost half of LICs would have sufficient policy space to absorb fiscal impacts; a third would face high debt and/or fiscal deficits; about one-third would face external vulnerabilities.
    - Regional note: sub-Saharan African LICs largely have policy space; Latin American and Caribbean LICs relatively weaker.
- Policy typology and recommended approaches:
  - About one quarter of LICs: can maintain accommodative fiscal and monetary policies and may expand spending beyond baseline.
  - Another quarter: moderate vulnerabilities; may need some adjustment determined by country specifics.
  - Remaining half divided into:
    - One-third: comfortable external positions but large fiscal deficits/high public debt — focus on medium-term fiscal realignment.
    - One-third: comfortable fiscal positions but low reserves/large current account deficits — focus on monetary/exchange rate realignment.
    - Final third (eleven countries): both significant external and fiscal vulnerabilities — need both monetary and fiscal adjustment and would benefit most from additional concessional support.

### Empirical methods and main regression results (selected)
- Growth regression (Appendix VII):
  - Panel IV regressions on 60 LICs over downturn episodes (1981–82, 1989–90, 2008–09); Δ(primary balance/GDP) instrumented by lagged macroeconomic stability indicator and current account to GDP; estimation by LIML.
  - Key coefficient: Change in the primary balance to GDP = -0.76** (All Countries, t-stat -2.35), indicating fiscal loosening associated with higher growth in crisis episodes.
  - Combined shocks indicator positive and significant: 0.3*** (t-stat 3.06).
- Fiscal response estimation (Appendix VI):
  - IV regressions on 50 LICs for change in primary balance in 2009:
    - Real GDP growth in 2009 coefficient 0.33* (1.67) for All Countries.
    - Buffer Index in 2008 coefficient -0.42** (-2.45).
    - Interpretation: stronger pre-crisis buffers allowed greater fiscal accommodation in 2009.

### Debt management, structural reforms, and market-development lessons
- Debt management and domestic market development:
  - Continue prudent use of domestic debt where costs and rollover risks are high; develop domestic institutional investor base to extend maturities and contain costs.
  - Robust debt management frameworks mitigate risks from greater domestic and external financial integration.
- Structural reforms and diversification:
  - Promote economic diversification via trade integration, business environment improvements, education, financial depth, labor market and firm-entry reforms, and social safety nets.
- Lessons from EMs (Box 3):
  - Turkey and Brazil examples emphasize reducing rollover and currency risks, extending maturities, strengthening primary dealer frameworks, cultivating institutional investors, and increasing domestic currency and fixed-rate instruments to build resilience.

*Source: Executive Summary and excerpts from IMF staff report and WEO (IMF staff study).*

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

### Executive Summary

### Key Findings and Overview
- While the global crisis was severe, real per capita GDP growth stayed positive in two-thirds of low-income countries (LICs).
- The crisis primarily hit LICs through a sharp contraction in export demand, foreign direct investment (FDI), and remittances; oil exporters also suffered from a sharp fall in oil prices.
- LICs experienced the sharpest decline in their economic growth rate over the last four decades, but this followed a period of strong expansion and real per capita GDP growth remained generally well above growth in richer countries.
- Median real spending is projected to grow by 4.6 percent annually through 2015 under baseline projections.
- The Fund committed about US$5 billion to LICs in concessional financial support since the beginning of 2009, roughly four times the historical average, in addition to the global SDR allocation.

### Impact of the Crisis
- Transmission channels:
  - Main channels were contraction in export demand, FDI, and remittances rather than terms-of-trade or global interest rates.
  - Terms-of-trade impact was positive for most LICs, except oil exporters.
- Macroeconomic outcomes in 2009:
  - Fiscal and current account deficits widened.
  - Inflation declined; less than one-fourth of LICs had double-digit inflation in 2009, compared to nearly two-thirds in 2008.
  - Reserves held up well, partly reflecting the IMF’s general SDR allocation.
  - Public debt increased only slightly in most LICs; for countries reaching HIPC Decision/Completion Points in 2008–10, median public debt ratio fell from 76 percent of GDP to 57 percent over 2007–09.
- Severe distributional and labor impacts:
  - World Bank simulations suggest the crisis will leave an additional 64 million people in extreme poverty by the end of 2010.
  - By 2015 the global poverty rate is projected to be 15 percent, compared to 14.1 percent without the crisis.
  - ILO estimates average unemployment rose by 1.2 percent in Latin America and the Caribbean in 2009; estimated rises of about 0.1–0.3 percent in 2009 in sub-Saharan Africa, the Middle East, East Asia, Southeast Asia/Pacific, and South Asia (based on official unemployment definitions).
- Banking sector:
  - Direct impact on LIC banking sectors was limited due to low reliance on capital inflows and wholesale funding, low leverage, and relatively high pre-crisis capital adequacy ratios.
  - As macro conditions worsened, NPLs rose, profitability fell, credit standards tightened, and credit growth slowed before picking up somewhat in H2 2009.

### Domestic Policy Responses and Pre-Crisis Buffers
- Countercyclical fiscal response:
  - Most LICs, for the first time, implemented a domestic countercyclical policy response and preserved vital spending, including social sectors and public investment.
  - The median increase in real primary spending was higher than in the previous five years.
  - Empirical analysis suggests the countercyclical response helped mitigate the impact on growth and the poor.
- Pre-crisis buffers:
  - LICs entered the crisis with stronger macroeconomic positions than in previous downturns: lower inflation, more manageable fiscal and current account deficits, higher international reserves, and reduced debt.
  - These buffers were built mainly over the last decade and supported the ability to respond countercyclically.
  - LICs with stronger pre-crisis buffers made greater use of countercyclical fiscal policy in 2009.

### IMF and Donor Support
- IMF support:
  - The Fund committed about US$5 billion in concessional financial support to LICs since the beginning of 2009, roughly four times the historical average.
  - LICs also benefited from the global SDR allocation; LICs received SDR allocations in August and September 2009 amounting to about SDR 8.2 billion.
  - Fund-supported countries were able to boost spending more than non-program countries.
- Aid:
  - Official transfers (aid) held up during the crisis year, consistent with past crisis experiences.

### Prospects and Risks
- Growth prospects:
  - LICs are expected to rebound quickly and more aligned with the rest of the world than in previous crises, reflecting greater trade and financial integration and stronger domestic policies.
  - Regional differences: LICs in Latin America and the Caribbean, and those in the Middle East and Central Asia, are expected to recover more slowly than LICs in Asia and sub-Saharan Africa.
- Vulnerabilities and scenarios:
  - Almost half of LICs could absorb another shock with limited or no need for adjustment; some could expand spending and absorption more rapidly.
  - The other half would face significant vulnerabilities under a sizeable shock; some would need fiscal realignment, others monetary and exchange rate adjustments, and a small group would face both external and fiscal pressures requiring overall adjustment and additional concessional support.
  - A downside scenario of lower world growth implies most LICs are moderately vulnerable to another global shock, with risks differing significantly across countries.
- Inflation and monetary policy:
  - Inflation is mostly benign at single digits, suggesting monetary policy could be accommodative.
  - Upside risks to food and fuel prices warrant preparedness to act against possible second-round inflation effects.
- Exchange rate and reserve guidance:
  - Many LICs with fixed exchange rate regimes could benefit from somewhat faster consolidation to rebuild reserves.
  - Some LICs with floating rates appear to have built more than adequate reserves and could raise spending and absorption.

### Policy Recommendations for Rebuilding Buffers and Supporting Growth
- Fiscal policy:
  - Strengthen domestic revenues beyond the cyclical rebound to create fiscal space while preserving debt sustainability.
  - Continue to increase real spending, focused on social sectors and infrastructure investment, while improving spending efficiency.
- Financing and savings:
  - Balance use of external non-concessional financing against expanded use of domestic financing and measures to boost domestic savings.
  - Support these measures by developing well-regulated domestic financial sectors and sound debt management frameworks.
- Structural reforms:
  - Advance structural reforms to sustain economic growth in a more volatile and integrated environment.
- Donor support:
  - Additional donor support will be an important ingredient for many LICs during the buffer-rebuilding process.

### How LICs Coping Evidenced in 2009 (Summary Points from Section I)
- The crisis affected LICs mainly through export demand, FDI, and remittances rather than terms-of-trade or interest rates.
- Most LICs reacted with countercyclical fiscal policy for the first time, preserving vital spending and cushioning growth declines.
- The ability to respond countercyclically was partly due to buffers built over the previous decade: lower fiscal and current account deficits, reduced debt levels, lower inflation, and comfortable reserves.

*Source: Executive Summary (IMF staff study).*

### 7. The small number of LICs with access to capital markets were affected by the

### 7. The small number of LICs with access to capital markets were affected by the turmoil in global markets in 2008/09, but have since benefited somewhat from renewed investors’ interest in EM bonds

### Capital markets and equity performance
- International capital markets reopened for LICs with Senegal’s debut issuance in December 2009 (US$200 million) and Vietnam’s issuance in January 2010 (US$1 billion), the first issuances of significant size since the crisis broke.
- Cost of domestic bond financing has generally declined in line with improved cost conditions in international markets, although the size and structure of these markets remains limited in LICs.
- In equity markets, Asian LICs, including Bangladesh and Mongolia, have performed relatively well.

### LICs’ pre-crisis macroeconomic position and buffers
- LICs entered the crisis with much stronger macroeconomic positions than in the past: far smaller fiscal and current account deficits, lower inflation, stronger international reserve coverage, and—thanks in part to debt relief—lower debt burdens.
- These “policy buffers” were built mostly during the last decade and are summarized in an overall policy buffer index comprising public debt, the fiscal balance, the current account balance plus FDI (all in percent of GDP), inflation, and reserve coverage in months of imports.
- Strength of pre-crisis policy buffers varied by group:
  - Commodity exporters on average had more reserves, lower public debt, smaller fiscal deficits, and stronger current account balances than non-commodity exporters, though inflation was still higher.
  - Countries with long-term IMF program engagement tended to build up reserves, reduce debt, and contain fiscal and current account deficits more significantly than other LICs.
- Compared with Emerging Markets (EMs) and Advanced Markets (AMs) as of end-2007:
  - EMs had higher international reserves coverage, lower public debt in percent of GDP, and a more comfortable current account position than LICs.
  - Fiscal deficits in AMs and EMs were smaller than those in LICs.

### Fiscal policy response during the crisis
- Most LICs adopted countercyclical fiscal policy; many did not curtail spending despite revenue declines.
- Aggregate fiscal impacts and financing:
  - The median fiscal overall deficit widened by about 2.7 percent of GDP.
  - The median primary deficit widened by 1.9 percent of GDP.
  - The median decline in revenue in LICs amounted to 0.3 percent of GDP.
  - Commodity exporters experienced a median revenue loss of 2.1 percent of GDP.
  - Real spending grew in LICs during the crisis, with a median increase of 7.4 percent in 2009 compared with 7.6 percent over the previous five years.
- Composition and distribution of spending:
  - Public investment in 2009 increased by 17 percent in real terms.
  - Health and education spending increased in real terms by 10 percent in 2009.
  - Growth in goods and services spending slowed.
  - Countries with IMF-supported programs exhibited higher growth in health and education spending.
  - Many LICs strengthened or introduced social protection measures (cash transfers) and implemented labor-intensive public works programs.
- Program vs non-program countries:
  - Almost 90 percent of program LICs increased real primary expenditures in 2009, compared with 67 percent of non-program LICs.
  - Median real expenditures among program LICs increased by about 8 percent, compared with 7 percent among non-program LICs.
- Financing of deficits:
  - More than half of the additional deficit was financed by domestic sources (domestic debt markets, central bank financing, drawing down government deposits).
  - External loans accounted for much of the remainder, with IMF financing a significant component.
  - Grants increased slightly in 2009.
  - Concessional support commitments have totaled US$5 billion since the beginning of 2009, compared to the historical average of US$1 billion per year.
- Empirical findings:
  - Pre-crisis policy buffers were a key factor determining the scope for fiscal accommodation in 2009; LICs with stronger pre-crisis buffers could better afford widening primary fiscal deficits and increased real spending.
  - Regression evidence: stronger buffer index in 2008 is associated with greater ability to increase spending in 2009 (see text table; Buffer Index coefficient -0.42**, t-statistic (-2.45); R-squared 0.29; # of observations 50).

### Monetary, exchange rate, and financial sector policies
- Monetary policy:
  - Monetary policy remained somewhat passive in most LICs during the crisis.
  - Almost two-thirds of the 39 LICs with available data lowered the nominal policy rate, but decreases were smaller than the globally-driven fall in inflation could have allowed, resulting in an increase in real rates at the peak of the crisis.
  - Constraints on monetary policy effectiveness included weak transmission channels and inefficient monetary policy frameworks.
- Financial sector measures:
  - Countries implemented measures ranging from enhanced surveillance to intervention and capital injection to mitigate banking sector impacts.
  - Box 1 examples of crisis-mitigating measures in the banking sector include:
    - Direct assistance via capital injection or intervention (Kenya, Nigeria, Uzbekistan).
    - Targeted assistance to affected sectors channeled via banks (Nigeria, Tanzania, Uganda).
    - Tightened supervision and stricter prudential limits (Moldova, Sierra Leone, Zambia); strengthened coordination between home/host supervisors (WAEMU).
    - Establishment of special monitoring units (Tanzania); high-level committee (Nigeria).
    - Temporary foreign exchange controls (Nigeria), later removed in July 2009.
    - Blanket restructuring of past-due loans and increasing credit line flexibility (Nicaragua).
    - Lowering Lombard facility costs (Tanzania).
    - Expanding deposit insurance mandate and exploring deposit insurance funds (Tanzania, Ghana, Malawi).
- Exchange rate policy:
  - LICs used exchange rate flexibility more than in previous crises, generally responding to downward exchange rate pressures by letting the exchange rate depreciate rather than allowing reserve losses.
  - Differences across sub-groups:
    - Both commodity exporters (including hard-hit oil exporters) and non-commodity exporters responded primarily by depreciation, but commodity exporters still incurred reserve losses.
  - The real exchange rate for countries experiencing an adverse terms-of-trade shock in 2009 depreciated relatively more than for countries with an improvement in the terms of trade; effect was stronger among floating-exchange rate countries.

### Emerging from the crisis — prospects and macroeconomic challenges
- Key outlook points:
  - LICs’ economic recovery is projected to be faster and more aligned with the rest of the world than in previous crises, although the pace of recovery will vary across regions.
  - Significant downside risks exist due to uncertain global economic prospects and somewhat weakened policy buffers.
  - Countries are expected to rebuild macroeconomic policy buffers as the recovery takes hold, particularly by consolidating fiscal and external positions; real spending is projected to continue to grow for almost all LICs.
  - The appropriate pace and extent of rebuilding buffers depends critically on country-specific vulnerabilities and resilience to further shocks.
- Policy guidance to rebuild buffers:
  - Strengthen domestic revenues.
  - Boost priority spending and improve the efficiency and allocation of spending.
  - Pursue cautious external and domestic borrowing strategies, supported by measures to boost domestic savings, develop domestic financial sectors, and prepare debt management frameworks.
  - Advance structural reforms, in particular to boost growth and manage volatility in an increasingly integrated global environment.

*Source: IMF staff report (excerpts provided in the content unit).*

### 20. Unlike during previous global

### _100510 - 20. Unlike during previous global

### Recovery synchronization and drivers
- WEO baseline projects a sharp V-shaped recovery for world growth; LIC recovery is projected to follow more closely that of the rest of the world, unlike previous downturns when LICs’ recovery dragged on over several years.
- Increased integration in world trade and finance and more robust domestic policy responses are cited as reasons for a more synchronized LIC recovery.
- Global demand, FDI, and remittances are playing a crucial role in the recovery; since 1990 global demand and financial flows have become important engines of growth in LICs.
- In 38 percent of LICs for which data are available, the contribution from exports would account for more than half of total real GDP growth in 2010.
- Domestic demand continues to be an important driver of growth, reflecting robust domestic policy responses that sustained investment throughout the crisis.
- Regional variation: growth in 2010/11 is projected to be fastest in Asian LICs; LICs in Latin America and the Caribbean face a much weaker recovery. The V-shaped nature of the recovery is generally less pronounced in LICs than in richer trading partners, except for LICs in the Middle East and Central Asia.

### Risks to the recovery
- Risks to LICs’ favorable recovery prospects are weighted to the downside, particularly if global recovery slows.
- A slower recovery in advanced and emerging economies could arise from renewed drops in confidence regarding fiscal sustainability, policy responses, and growth prospects.
- Risks related to donor support are on the downside as advanced countries tighten fiscal positions and may find it difficult to meet aid commitments.
- Section II.C contains an illustrative downside scenario.

### Macroeconomic outlook: realigning policies and rebuilding buffers
- LICs emerge from the crisis with somewhat less comfortable buffers, with significant cross-country variation.
- Baseline WEO projects gradual consolidation: improving fiscal and current account balances, low to moderate inflation, generally adequate reserves, and declining debt paths.
- Almost three-fourths of LICs are projected to improve macroeconomic policy buffers over the medium term.
- Rebuilding is most rapid for commodity exporters and Asian LICs, least pronounced for LICs in Latin America and the Caribbean.
- Number of countries in the “low buffer” category drops from 25 in 2009 to 11 by 2015.

Key observed and projected outcomes:
- Real public capital spending increased by 19 percent in 2009 and is expected to increase by 12 percent in 2010.
- Median LIC inflation is forecast to fall from its 2008 peak to about 5 percent over the medium term.
- 11 out of 64 countries experience double-digit inflation in 2010; another nine near-double digits.
- Median improvement in the primary balance is projected at 1.3 percentage points of GDP over five years.
- Share of countries with fiscal deficits in excess of 5 percent of GDP is projected to drop from almost one-half in 2009 to one-tenth by 2014.
- Almost half of countries are expected to have fiscal deficits below 2 percent of GDP by 2014, up from one-fourth of countries in 2009.
- By 2015, public debt would be less than 40 percent of GDP in half of LICs, and a fifth would have debt in excess of 65 percent of GDP.
- About one-third of the projected improvement in the primary balance is expected to come from the cyclical recovery in revenues; the remaining two-thirds mainly from measures to boost underlying revenue performance and trim non-priority spending.
- In sub-Saharan African LICs, projected structural fiscal adjustment is estimated at a median just over ½ percent of GDP over five years.
- Median real spending is projected to increase by 4.6 percent annually during 2010–15.
- One-fourth of countries in sub-Saharan Africa have medium-term projections that incorporate a significant fiscal expansion; five countries are expected to cut real spending over this period.
- Median reserve coverage is projected to be around 4–4¼ months of imports over the medium term.
  - One-seventh of LICs would have more than six months of import coverage.
  - About one-twentieth of the countries would have less than two months.
  - Countries with reserves below three months in 2009 are expected to improve but have median coverage of 2.7 months of imports.
- Over the medium term, eight LICs would have current account deficits (incl. FDI) in excess of 8 percent of GDP, compared to 16 at the end of 2009.
- Grants projected to increase slightly from around US$30 billion in 2010 to US$32 billion by 2014, but their contribution to external financing needs is expected to decline.
- External borrowing is expected to increase from around US$38 billion in 2010 to US$48 billion in 2014, and as a share of total financing.
- On average, FDI, grants, and borrowing are each expected to fill around a fourth of external financing needs, with the balance from private transfers and other capital flows.
- Almost half of LICs are projected to have relatively comfortable fiscal and external buffers by 2014; almost one-quarter will have significant fiscal or external vulnerabilities, or both.
- Latin American and Caribbean LICs are highlighted as the most vulnerable group: entered the crisis already in a vulnerable position, five out of nine countries are small islands, and they face relatively high debt, low reserve coverage, and large current account deficits over the medium term.

### Illustrative downside scenario and stress test
- Purpose: to stress-test LIC exposure to further shocks and inform policy choices on rebuilding macro buffers; not a blueprint for country-specific policy.
- Simulated “downside” scenario: per capita real GDP growth in LICs would be lower than the baseline by about 1 percentage point in 2011.
- Construction of the scenario:
  - Downside scenario for advanced and emerging economies is based on the IMF’s Global Projection Model (GPM), assuming shocks to financial conditions and domestic demand in advanced economies as large as those in 2008 and contagion to other financial markets reducing equity prices and dampening consumption.
  - Resulting reduction in growth in advanced and emerging economies relative to baseline: 0.3 percentage points in 2010, 1.4 percentage points in 2011, and 0.2 percentage points in 2012.
  - For each LIC:
    - Step 1: calculate by how much GDP growth in LICs’ trading partners would be lower relative to baseline using IMF Direction of Trade statistics.
    - Step 2: multiply the difference in trading partners’ growth by the estimated coefficient on partner country growth from a panel regression relating LIC growth to short-run determinants.
    - Step 3: subtract the result of step two from the baseline growth forecast.
- Limitations: the method considers only the impact of slower growth in advanced and emerging markets and ignores associated effects such as changes in commodity prices, interest rates, and capital flows.
- Implications of the simulated shock: it would widen fiscal and current account deficits of LICs, reduce reserve coverage, and increase public debt.

*Source: WEO, and Fund staff estimates (as presented in the supplied content).*

### 35. To assess the shock’s impact across different countries, an illustrative assessment of

### _100510 - 35. To assess the shock’s impact across different countries, an illustrative assessment of

### Assessment framework and overview
- Buffers assessment focuses on fiscal and external positions, where:
  - Relative fiscal strength is based on public debt and the fiscal deficit (Appendix IX).
  - Relative external strength is based on the current account balance plus FDI and reserves (Appendix IX).
- Pairing buffers with fiscal and external stocks and flows facilitates analysis of a country’s capacity to absorb and respond to future shocks.

### Fiscal impact and country distributions
- Median and aggregate impacts under the illustrative downside scenario:
  - Median structural primary deficit of LICs would worsen by about 0.5 percent of GDP.
  - Public debt-to-GDP ratio would increase by 3 percentage points by 2015 (excluding those countries with expected debt relief).
- Distributional outcomes across LICs:
  - Almost half of LICs would have sufficient policy space to absorb the impact on their fiscal balances.
  - Almost half of LICs would emerge from such a shock with still low or moderate debt and deficit levels.
  - A third of LICs would face high debt and/or fiscal deficits.
  - Half of the countries had fiscal vulnerabilities already prior to the current global crisis.
  - Countries with low buffers in 2009 (over a third of LICs) would need to respond with some fiscal adjustment.
  - Countries with medium and high buffers in 2009 would generally be able to absorb most of the shock without additional policy adjustment.
  - Regional differences: sub-Saharan African LICs largely have policy space; Latin American and Caribbean LICs are relatively weaker.
- Further risk caveat: if aid commitments, including budget support, were not fully realized, further risks would emerge for most LICs.

### External position impacts
- Median reserve coverage and current account impacts:
  - Median LIC reserve coverage could fall by almost one month of imports by 2012.
  - About a quarter of LICs would be left with less than two months of import coverage.
  - Countries with floating and fixed exchange rates would each end up with median reserve coverage of about three months of imports.
  - Latin American and Caribbean LICs would end up particularly vulnerable, with a median of less than two months of reserve coverage and double-digit current account deficits as a share of GDP.
- Grouping by external buffer outcomes:
  - Over a third of LICs would emerge from a shock with relatively comfortable external positions (adequate reserve coverage and low or moderate current account deficits).
  - About a third of countries would face either low reserves or large current account deficits or both; more than a third of this group had external vulnerabilities prior to the crisis.

### Policy recommendations — realigning policies and rebuilding buffers (high level)
- General guidance on macroeconomic policy mix:
  - Use combinations of fiscal, monetary, and exchange rate realignment to rebuild buffers.
  - Gradual reduction in fiscal deficits, supported by cyclical rebound and structural measures, to keep public debt manageable and preserve countercyclical response capacity.
  - Fiscal adjustment can support rebuilding external buffers and reconstituting reserves.
  - Monetary policy can reduce inflation if needed while supporting reserve buildup and current account narrowing.
- Country typology and recommended approaches:
  - About one quarter of LICs could comfortably absorb another sizeable shock and can maintain accommodative fiscal and monetary policies, with scope for additional spending beyond baseline projections.
  - Another quarter of LICs would face moderate vulnerabilities and may need some adjustment, determined by country-specific factors.
  - Of the remaining half of LICs:
    - About a third has more comfortable external positions but relatively large fiscal deficits and/or high public debt — suggesting more efforts on medium-term fiscal realignment.
    - Another third has more comfortable fiscal positions, but relatively low reserves or large current account deficits (or both) — suggesting focus on monetary and/or exchange rate realignment depending on exchange rate regime.
    - The final third of this group (eleven countries) faces both significant external and fiscal vulnerabilities — suggesting the need for both monetary and fiscal adjustment and would benefit most from additional concessional support.
  - Inflation context:
    - Inflation appears mostly benign at single digits, allowing accommodative monetary policy in many cases.
    - Risks to future food and fuel prices are on the upside; policymakers should be prepared to act against possible second-round effects on inflation should another global price shock occur.
  - Regional emphasis:
    - LICs in Latin America and the Caribbean are comparatively vulnerable and should step up rebuilding of buffers and reinforce growth-oriented policies.
  - Exchange rate regimes:
    - Many LICs with fixed exchange rate regimes could benefit from somewhat faster macroeconomic consolidation to rebuild reserves.
    - Some LICs with floating rates have built more than adequate reserves and could raise spending and absorption.

### Fiscal policy recommendations (detailed)
- Objectives:
  - Continue to increase real spending in priority areas while enhancing budget resilience to volatility.
  - Strengthen revenue collections, improve spending efficiency, and pursue careful debt management.
- Revenue mobilization:
  - LICs’ revenue-to-GDP ratios are below potential.
  - Potential revenue increases cited in prior estimates are in the range of 2–4 percent of GDP.
  - Measures: rationalize income tax incentives and VAT exemptions; increase excise taxes on alcohol, tobacco, and fuel; tap property taxes.
  - Tax administration: secure revenue from large and medium enterprises; tackle tax evasion and abuses of tax privileges through risk-based audits and compliance checks.
- Expenditure priorities and efficiency:
  - Most LICs have space to continue raising fiscal expenditures in real terms; increases should target health, education, and infrastructure.
  - Strengthen automatic fiscal stabilizers where feasible (e.g., targeted temporary income support, labor-intensive public works, cash transfers).
  - Improve expenditure efficiency: reduce costly and poorly targeted subsidies; more than one-third of LICs have fuel price subsidies, with these subsidies projected for 2010 to exceed 1 percent of GDP in 6 countries.
  - Strengthen public financial management: treasury management, budget preparation and implementation, appraisal and selection of infrastructure projects, move to medium-term budget frameworks with recurrent costs of capital investment reflected in the budget.
  - Consider multiyear fiscal frameworks with fiscal anchors or rules for some LICs.
- Debt and financing mix:
  - Balance nonconcessional external borrowing against domestic financing and concessional support.
  - Countries with stronger project selection and debt management capacity may tap nonconcessional borrowing if vulnerabilities are moderate and monitored.
  - Most LICs remain vulnerable and will continue to need highly concessional donor support.
  - Challenge of raising domestic savings and developing financial sectors to avoid overreliance on capital inflows.
  - As LICs increase market-based financing, strengthen capacity to manage portfolio risks.

### Monetary and exchange rate policy recommendations
- Monetary policy:
  - Could be accommodative in most countries from an inflation perspective.
  - Fan chart analysis: 25 percent probability that half of LICs could experience inflation higher than baseline by at least 2 percentage points.
  - This implies the number of countries with double-digit inflation could rise from 14 in 2009 to 19 in 2010 and 16 in 2011.
  - Two-thirds of countries would have space to loosen monetary policies somewhat if external positions allow.
  - If higher food and fuel prices materialize, monetary and interest rate policies should accommodate direct price-level impacts but counter second-round inflationary and external effects.
- Exchange rate policy:
  - Use exchange rate flexibility to cushion future volatility where possible.
  - Countries with floating regimes largely avoided reserve losses by letting exchange rates adjust; pegged regimes drew on reserves.
  - Countries with low reserve buffers should allow exchange rates to adjust more flexibly.
  - Countries with floating rates and high reserves should consider whether somewhat lower reserves may have net economic benefits given the costs of holding reserves.

### Financial sector and domestic debt market recommendations
- Strengthen regulatory frameworks, supervision, and financial institutions:
  - Ensure credit standards do not deteriorate during strong credit growth.
  - Focus supervision on bank risk profiles and sources of business growth.
  - Prompt supervisory action where noncompliance is found.
  - In banks with significant strains, proceed quickly with balance sheet clean-up, loss recognition, and shareholder capital injections as needed.
- Risk-mitigation reforms to consider:
  - Strengthen crisis management arrangements: special regimes for bank resolution; arrangements for emergency liquidity assistance; crisis contingency plans.
  - Consider stronger financial safety nets, including cautious introduction of deposit insurance with effective public information.
  - Enhance information-sharing between home and host supervisors for consolidated supervision of foreign financial entities.
  - Continue financial sector reforms such as establishing credit reference bureaux to mitigate credit risk and lower cost of credit.
- Develop domestic debt markets:
  - Mobilize national savings and increase policy buffers.
  - Domestic financing can cushion crisis impacts and create countercyclical policy space.
  - Policies to mobilize domestic savings and develop domestic debt markets broaden financing options alongside external financing.

*Italic: Sources: WEO, and Fund staff estimates.*

### 52. As LICs strengthen the broader macroeconomic policy framework, a sound debt

### 52. As LICs strengthen the broader macroeconomic policy framework, a sound debt

### Debt management and domestic market development
- LICs have generally been prudent in limiting their use of domestic debt where costs and rollover risks are relatively high.
- Countries should continue to actively develop the domestic financial system, including strengthening the local institutional investor base, to facilitate an extension of maturities on domestic debt issuance while containing costs.
- A robust debt management framework would help mitigate the risks associated with greater domestic and external financial integration.
- Reference to guidance: IMF and World Bank (2001). “Developing Government Bond Markets: A Handbook,” September 21, 2001.

### Other structural reforms
- Promoting economic diversification plays an important role in managing macroeconomic volatility and fostering durable economic growth.
- Diversification strategies are broad and require inclusion in comprehensive country development strategies.
- Key policy areas to support diversification:
  - Further trade integration and reforms of trade regimes (for LICs and trading partners).
  - Improvements in the business environment.
  - Reforms to improve education, financial depth, labor market flexibility, and firm entry flexibility (see Appendix XI in original).
  - Establishment of effective social safety nets to protect vulnerable groups in the event of social dislocation from economic transformation.

### Box 3 — Developing Debt Markets: Lessons from Emerging Markets (EMs)
- Sustained improvements in macroeconomic conditions are critical for debt market development.
- Turkey (post 2000–02 crisis):
  - Adopted debt management strategies targeted at reducing rollover and currency risks.
  - Sought opportunities to extend maturities, initially relying on floating rate notes, and reduced the share of foreign currency debt.
  - Strengthened primary dealer framework and cultivated domestic institutional investors.
  - As fundamentals improved, introduced long-term fixed rate instruments.
  - Improved portfolio resilience helped weather foreign exchange shocks during the recent global crisis.
- Brazil (over the past decade):
  - Focused debt management on reducing vulnerability to interest rate and exchange rate shocks.
  - Increased proportion of domestic currency debt, average maturity, and share of fixed rate instruments.
  - Used inflation-linked bonds significantly to meet objectives.
  - A strong domestic institutional investor base (e.g., pension funds) helped absorb foreign investor exit during crisis.
  - Improved debt structure provided significant resilience amid crisis-related market volatility.
- References cited in Box 3:
  - Undersecretariat of Treasury (Turkey) (2009). “Public Debt Management Report.”
  - National Treasury (Brazil) and World Bank (2010). “Public Debt: The Brazilian Experience.”

### Appendix I — List of LICs (64 PRGT-eligible countries analyzed)
- The group analyzed comprises the 64 Poverty Reduction and Growth Trust (PRGT)-eligible countries for which data were available.
- By region:
  - Sub-Saharan Africa: 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, Mauritania, Mozambique, Niger, Nigeria, Rwanda, São Tomé and Príncipe, Senegal, Sierra Leone, Tanzania, Togo, Uganda, and Zambia.
  - Middle East and Europe: Armenia, Djibouti, Georgia, Kyrgyz Republic, Moldova, Sudan, Tajikistan, Uzbekistan, and Republic of Yemen.
  - Asia: Afghanistan, Bangladesh, Bhutan, Cambodia, Lao People’s Democratic Republic, Maldives, Mongolia, Myanmar, Nepal, Papua New Guinea, and Vietnam.
  - Latin America and Caribbean: Bolivia, Dominica, Grenada, Guyana, Haiti, Honduras, Nicaragua, St. Lucia, and St. Vincent and the Grenadines.
- PRGT-eligible countries excluded due to data limitations: Kiribati, Samoa, Solomon Islands, Somalia, Timor-Leste, Tonga, and Vanuatu.

### Appendix II — Distribution of Median Real GDP Growth and Change in Real GDP Growth (1971–2009)
- Timeframe analyzed: 1971–2009, covering four global recessions including the global crisis in 2009.
- Key global recession years considered: 1975, 1982, 1991, and 2009.
- For each year the median level/change in growth is calculated across available countries and histograms of those medians are plotted to illustrate the distribution.
- Findings:
  - Unlike previous global downturns and in contrast to EMs and AMs, LICs’ real growth in 2009 remained positive and was close to the average of the last 39 years.
  - For the change in growth in LICs, the range of -1½ to -2 percent is a fat-tail event that includes the medians for two global downturns in 2009 and 1991.
  - With a histogram bin width of 0.5 percent about 13 percent of observations, i.e., about 5 years out of 38, recorded median change in growth in this range.
  - The drop in growth rate in 2009 was unprecedented for emerging market countries (being the only year in that tail range) and was one of two years out of 38 for advanced economies.

### Methodology (median histograms)
- For each year the median of variable X_t is calculated over N countries for which data is available.
- Medians are used instead of simple averages to capture common shocks affecting the majority of LICs and to provide robustness to outliers.
- Density is plotted on the y-axis so that the total area under bars adds up to one.

### Appendix III — Selected Economic Indicators (high-level notes)
- The source provides country-level annual indicators for 2007–2010 including GDP growth, inflation, reserves (months of imports), current account balance + FDI (in percent of GDP), fiscal balance (in percent of GDP), and gross public debt (in percent of GDP).
- Median series reported (selected rows shown in source):
  - All LICs medians (presented across years and indicators in the source tables and charts).
  - Regional and classification medians: Sub-Saharan Africa; Asia; Middle East and Europe; Latin American and Caribbean; Net Oil importers; Net Oil exporters; Program Countries; Non-Program Countries.
- Data sources: WEO database, and Fund staff calculations.

* _100510 - 52. As LICs strengthen the broader macroeconomic policy framework, a sound debt_*

### Appendix IV. The Impact of the Crisis on Financial Systems and Credit Developments

### Appendix IV. The Impact of the Crisis on Financial Systems and Credit Developments

### LICs’ Banking Sectors — key developments
- Elevated levels of NPLs: overdue loans increased sharply in 2009; NPLs continued to increase in the first half of 2010, although at a slower pace than in 2009.
- Declining profitability:
  - Higher loan loss provisions have exerted pressure on profitability, which continues to decline in mid-2010.
  - Erosion of banks’ earnings also reflects stronger competition for deposits and limited scope to reduce operating costs.
  - Banks became more risk averse, shifting portfolios toward safe instruments and curtailing lending; both net interest and non-interest income growth decelerated.
  - Spreads between lending and deposit rates have increased as banks sought to preserve profitability and domestic market and economic conditions became more volatile.
- Restored liquidity in banks:
  - Initial liquidity pressures eased and growth in domestic deposits began to recover in 2010.
  - Liquidity measured by excess reserves increased in most countries and remains, with a few exceptions, broadly in line with long-term trend.
  - Volatility of excess reserves amplified compared to pre-crisis levels, reflecting larger and more frequent changes in deposits.
  - Banks have tended to self-insure by augmenting liquidity buffers, bolstered by reduced use of foreign credit lines and more restrained lending activity.
- Expansion and entry:
  - In several countries banking activity expansion resumed; in some, banking sector assets grew faster than GDP in 2008–09.
  - Examples of expansion: opening new outlets (Ghana, Rwanda, Tanzania); cross-border subsidiaries/branches (Kenya, Nigeria).
  - New licenses: in 2009/first half of 2010 Kenya, Tanzania, and Zambia licensed four banks each; between 2007 and 2009 the number of banks operating in Lao P.D.R. rose from 13 to 23; The Gambia and São Tomé and Príncipe licensed seven and two banks, respectively.

### Financial sector reforms and supervisory changes
- Reforms postponed during 2008–09 are returning to center stage:
  - Steps to establish credit reference bureaus: Burundi, Kenya, Malawi, Tanzania, The Gambia.
  - Raising minimum capital requirements for commercial banks: Burundi, São Tomé and Príncipe, Tanzania, The Gambia, Vietnam, and WAEMU countries.
  - Adapting supervisory oversight to changing landscape and broadening access to financial services.

### Private and Public Sector Financing Conditions
- Credit growth prospects:
  - Resumption of robust credit growth likely to be gradual, dependent on pace of economic recovery and clean-up of banks’ balance sheets.
  - Supply-side constraints: slower deposit growth, curtailed external credit lines, capital losses (declining profitability and growing NPLs) increasing risk aversion and restraining lending.
  - Demand-side constraints: deteriorated macroeconomic environment raised uncertainty and depressed demand for credit.
  - Dollarized economies with limited hedging instruments experienced particularly strong increases in NPLs and sharp declines in assets and capital.
- Equity markets:
  - Mixed prospects for private sector access to domestic equity markets.
  - Asian LICs outperforming (e.g., Bangladesh and Mongolia); many African LICs relatively flat (e.g., Ghana, Kenya, Nigeria, Tanzania).
- Syndicated loans and maturities:
  - Private sector syndicated issuance (gross and net) fell in 2010 in most regions; syndicated loans market relatively stagnant.
  - Significant private sector maturities expected in 2011–14 raise concerns about rollover risks.
- Sovereign access and market re-opening:
  - Financing conditions for LIC sovereigns improving; international investor interest in frontier issuers reemerging and spreads declined sharply since mid-2009.
  - Notable issuances: Senegal debut issuance in December 2009 (US$200 million); Vietnam issuance in January 2010 (US$1 billion).
  - Several African countries considered potential debut issues: Angola, Kenya, Nigeria, Tanzania, Zambia; Ghana considering re-accessing the market.
- Domestic bond markets:
  - Cost of financing in domestic bond markets generally declined in line with international markets.
  - Foreign investors increasing presence in some domestic markets (example: Ghana, extension of maturities with successful 3-year Treasury issuances).
  - Where domestic markets are relatively deep and institutional investor base well developed (example: Kenya), domestic market provided viable and resilient financing.
  - Overall, the size and structure of domestic bond markets remain limited in LICs; enhancing depth and resilience should remain a policy priority.

### Local currency sovereign bond market indicators (selected LICs)
- Table entries (as presented):
  - Kenya 52.2 23.3 8.5 36.7 2015 10.8
  - Tanzania ... 7.3 4.5 62.1 2012 9.3
  - Ghana 46.6 28.1 15.7 55.9 2011 18.2
  - Nigeria 86.1 13.0 6.0 46.2 2014 9.7
  - Georgia 10.3 3.8 3.3 85.4 2011 12.7
  - Armenia 13.8 5.6 1.7 31.1 2014 10.4
  - Moldova 18.3 5.0 4.9 96.4 2011 0
  - Bangladesh ... 13.6 0.9 6.4 2015 11.5
  - Vietnam 14.8 7.3 2.1 29.5 2012 9.8
  - Bolivia 21.7 8.6 2.4 28.4 2015 5.9
  - Honduras 35.0 9.1 7.8 86.3 ......

### Yield curve evolution (selected snapshots)
- Yield curve observations shown for Jun-09, Dec-09, Jun-10 for countries including Ghana, Bolivia, Bangladesh, Moldova, Kenya, Vietnam across maturities (examples depicted for 1 month up to 20 year tenors).

### External financing and investor activity
- Foreign bank claims on banks in LICs fell sharply during the crisis, recovered slightly in 2009H2, but declined again in March 2010 (quarterly changes shown by region in BIS data).
- Foreign investor trading of debt instruments shows activity for Total LICs and Sub-Saharan Africa against Total Emerging Markets (figures reflect purchases and sales in secondary trading).

### Appendix V — Buffer Index: construction and interpretation
- Buffer measure at time t (B_it) = sum of five components:
  - overall fiscal balance in percent of GDP (fb_it),
  - inflation (inf_it),
  - international reserves in months of next year’s imports of goods and services (res_it),
  - public debt in percent of GDP (debt_it),
  - current account balance plus FDI in percent of GDP (cab_it).
- Each variable standardized by its standard deviation calculated for period 2004–07.
- For index values up to 2007:
  - flow variables (fb, inf, cab): country-specific four-year averages (e.g., average over 2004–07 used for t = 2007);
  - stock variables (res, debt): end-period value used.
- For index values after 2007: yearly values used for flow and stock variables.
- Index formula (as presented):
  - B_it = fb_it / sd_fb_2004-07 + inf_it / sd_inf_2004-07 + res_it / sd_res_2004-07 + cab_it / sd_cab_2004-07 + debt_it / sd_debt_2004-07
  - Note: inflation and public debt to GDP enter with a negative sign; thus, a high index value indicates a better policy buffer.
- Classification: countries assigned to “low,” “medium,” and “high” buffer groups using cut-offs at the 33rd and 66th percentiles of the buffer index in 2007.

### Appendix VI — Estimation of determinants of change in primary balance to GDP in 2009: methodology and results
- Objective: estimate fiscal response of LICs to weakening growth in 2009 using IV regressions on cross-section of annual data composed of 50 LICs; subgroups: 38 non-oil exporting LICs and 31 non-commodity exporters.
- Dependent variable: change in the primary balance to GDP in 2009 (ΔPB_2009 = PB_2009 − PB_2008).
- Key explanatory variable: real GDP growth in 2009; endogeneity addressed via instrumental variables.
- Instruments for real GDP growth in 2009:
  - real GDP growth in trading partners,
  - change in remittances scaled by GDP in 2008,
  - change in export deflator.
- Estimation method: generalized method of moments (GMM).
- Regression specification includes buffer index in 2008 as control; omission of the buffer index weakens statistical significance of real GDP growth.
- Main reported IV regression results (coefficients with t-statistics in parentheses; significance denoted by ***, **, * for 1, 5, 10 percent):
  - All Countries (50 obs; R-squared 0.29)
    - Real GDP growth in 2009: 0.33* (1.67)
    - Buffer Index in 2008: -0.42** (-2.45)
    - Constant: -2.84*** (-4.04)
  - Oil-Importers (38 obs; R-squared 0.44)
    - Real GDP growth in 2009: 0.31** (2.36)
    - Buffer Index in 2008: -0.45*** (-3.59)
    - Constant: -2.71*** (-7.75)
  - Non-Commodity Exporters (31 obs; R-squared 0.40)
    - Real GDP growth in 2009: 0.28*** (3.78)
    - Buffer Index in 2008: -0.31** (-1.97)
    - Constant: -2.25*** (-4.31)
- Interpretation and robustness:
  - Pre-crisis policy buffers (buffer index) are key determinants of fiscal response in 2009 (an increase in the index corresponds to an improvement in performance).
  - When individual components of the buffer index are included, the fiscal and current account balance components turn out significant, indicating the predominant role of pre-crisis fiscal and external buffers.
  - Results robust to change in reference year (to 2007 instead of 2008).

*Source: Appendix IV–VI, _100510 - Appendix IV. The Impact of the Crisis on Financial Systems and Credit Developments*

### Appendix VII. Growth Regression: Estimating the Impact of Fiscal Policy

### Appendix VII. Growth Regression: Estimating the Impact of Fiscal Policy

### Model specification and sample
- Short-run growth dynamics estimated by instrumental variable (IV) regressions on a panel of annual data composed of 60 LICs.  
- Episodes considered: global recessions and one year prior (1981–82, 1990–91, and 2008–09).  
- Country fixed effects (ߙ_i) included to control for fixed country characteristics.  
- Same specification also estimated for a subgroup of 51 non-oil exporting LICs.  
- Structural equation (as specified in source) models GDP growth for country i at year t as a function of:
  - lagged growth,
  - change in the primary balance to GDP (Δprimary balance/GDP),
  - combined contemporaneous external shocks indicator,
  - country fixed effects, and
  - an error term.

### Key variables and construction
- Dependent variable: GDP growth (country i, year t).  
- Fiscal policy variable: change in the primary balance to GDP (Δ(primary balance/GDP) = primary balance_it - primary balance_{i,t-1}).  
- Combined contemporaneous external shocks indicator (k_shocks_it) captures shocks to trade, remittances, FDI, and services exports, measured in percent of previous year’s GDP:  
  - k_shocks_it = (trade_shock_it) + (FDI_change_it) + (remittances_change_it) + (services_exports_change_it), each component constructed as contemporaneous percent changes weighted by previous-year shares in GDP (as specified in source).  
- Trade shocks are constructed from:
  - percentage change in export deflator (xdeflator_it) and real GDP growth in trading partners (trpartner_gdp_it), weighted by share of exports in GDP, plus
  - percentage change in import deflator weighted by share of imports in GDP (as specified in source).
- Instruments for Δ(primary balance/GDP):
  - lagged values of a composite macroeconomic (in)stability indicator (mitot_{i,t-1}), and
  - current account balance in percent of GDP.
- Macroeconomic (in)stability indicator (mitot):
  - Composite index (originating from Jaramillo and Sancak (2009); Bal Gündüz (2009) added black market premium) with formula given in source using inverse-standard-deviation weights for components: Δln(cpi), Δln(exchange rate), Δln(reserves), Δln(imports of goods and services), Δln(government balance to GDP), and black market premium components.  
  - Higher mitot indicates increased macroeconomic instability.  
  - Outliers removed: observations above the 95th percentile for inflation and depreciation, above the 97.5th or below the 2.5th percentile for change in reserve coverage, and below 5th percentile for government balance to GDP.

### Identification and estimation
- Endogeneity concern: reverse causality (policymakers set expansionary fiscal stance in response to weakening growth) could bias coefficient on fiscal variable (β1).  
- IV strategy: instrument Δ(primary balance/GDP) with lagged macroeconomic stability indicator and current account balance to GDP; assume instruments are uncorrelated with structural error term.  
- Estimation method: Panel IV regressions estimated by Limited Information Maximum Likelihood (LIML).  
- Note on identification risk: if the macro-stability instrument is positively correlated with the growth equation error term (e.g., macro-stability directly improves productive efficiency or investment), the fiscal multiplier could be overestimated; country fixed effects and lagged growth help capture persistent macro-stability effects.

### Empirical results (short-term determinants of growth during crisis episodes) 1/
- Table summary (as presented in source):
  - All Countries | Oil-Importers
  - Change in the primary balance to GDP: -0.76**    -0.79**  
    - t-statistics: (-2.35) (-2.13)
  - Lagged GDP growth: -0.02    -0.01  
    - t-statistics: (-0.09) (-0.04)
  - Combined Shocks Indicator 2/0.3*** 0.28***  
    - t-statistics: (3.06) (2.9)
  - # of observations: 161    141
  - # of countries: 60    51

- Notes from table footnote (verbatim as in source):
  - 1/ Panel instrumental variable regressions are estimated by Limited Information Maximum Likelihood (LIML). Sample includes downturns (1981–82; 1989–90; 2008–09). Change in primary balance to GDP is instrumented for by lagged values of macroeconomic stability indicator and the current account balance to GDP. t-statistics are in parenthesis. ***, **, and * denote significance at 1, 5, and 10 percent level, respectively.
  - 2/ The combined effect of contemporaneous external shocks to trade, remittances, FDI, and services exports in percent of previous year’s GDP. Negative value indicates adverse shocks.

### Interpretation and comparison with other work
- Estimated short-run coefficient on change in primary balance to GDP is negative and statistically significant at the 5 percent level in both samples (All Countries and Oil-Importers), suggesting that a decrease (loosening) in the primary balance (i.e., fiscal expansion) is associated with higher growth in crisis episodes.  
- The combined shocks indicator is positive and highly significant, indicating that contemporaneous external developments (as constructed) are strongly associated with growth outcomes in these episodes.  
- Empirical literature reference from source: Kraay (2010) estimates small fiscal multipliers in the range of zero to 0.3 for LICs. Quarterly VAR identification strategies (Blanchard and Perotti (2002) style) are not feasible for LICs due to lack of quarterly data and invalidity of the same recursive structure with annual data.

### Limitations and caveats (as discussed in source)
- Strong identifying assumption: instruments (lagged macroeconomic stability indicator and current account) are uncorrelated with the error term in the structural growth equation. Finding instruments that affect growth only through the fiscal variable is difficult.  
- Potential bias: a plausible positive correlation between macro-stability and the growth equation error term would lead to overestimating the fiscal multiplier (actual multiplier lower than estimated).  
- Persistent macro-stability may affect growth via higher productive efficiency and investment; a single-year macro-stability indicator may not capture this channel fully. Country fixed effects and lagged growth aim to capture persistent effects.

*Source: Appendix VII. Growth Regression: Estimating the Impact of Fiscal Policy (extracted content).*

### 2015. By contrast, countries with lower vulnerabilities are assumed to be able to allow their

### _100510 - 2015. By contrast, countries with lower vulnerabilities are assumed to be able to allow their

### Fiscal vulnerability, shock transmission, and policy response
- Fiscal vulnerability assessment uses both the debt outlook and how much fiscal adjustment was already assumed in the baseline projections (2010–15).
- The higher the degree of adjustment during 2010–15 already assumed in the baseline (Table AX.1, Columns 1–2) and the higher the debt level in 2015 (Column 3), the less room countries have to accommodate a shock-related increase in the fiscal deficit.
- For illustrative purposes, countries with debt level to GDP ratio higher than 40 percent by 2015 (Column 6) are assumed not to have the space to accommodate the fiscal impact of the shock but will have to adjust to offset the structural increase in the deficit arising from the shock (Column 7–8).
- The required adjustment for vulnerable countries: the adjustment will amount to the increase of spending in GDP terms produced by the shock.
- Table AX.1 summary indicators (selected rows/columns preserved verbatim):
  - Total: 1.3 0.94 0 -1.8 -1.14 30.44 0
  - Commodity Exporter: 0.9 0.54 2 -1.8 -1.14 50.34 2
  - Non-Commodity Exporter: 1.6 1.24 0 -1.8 -1.14 30.54 0
  - IMF Program: 1.0 0.53 9 -1.9 -1.14 30.54 0
  - Non–IMF Program: 2.2 2.14 2 -1.6 -1.04 50.44 2
  - Low Buffer: 2.6 2.35 0 -1.9 -1.25 30.65 1
  - Medium Buffer: 1.2 0.93 9 -2.0 -1.24 10.34 0
  - High Buffer: 0.5 0.32 9 -1.5 -0.83 20.03 2

### Growth shock: primary fiscal impacts (Table AX.2) — country and median impacts
- The shock consists of a lower growth scenario, arising from a shock in external aggregate demand qualitatively similar to the one in 2009.
- Change in fiscal balance: cumulative impact of shock 2010–12 shown as deviations of the primary and structural primary balance from the fiscal baseline.
- Selected country examples (Baseline / Shock entries from Table AX.2, in percent of GDP):
  - Afghanistan, I.S. of: -1.2 -0.9 -1.3 -1.3 (Baseline) ; -1.2 -1.0 -2.1 -1.7 (Shock)
  - Armenia: -7.3 -3.8 -2.6 -1.6 (Baseline) ; -7.3 -3.9 -3.7 -2.3 (Shock)
  - Ghana: -5.1 -5.3 -2.4 -0.7 (Baseline) ; -5.1 -5.4 -3.5 -1.5 (Shock)
  - Mozambique: -5.1 -4.8 -6.4 -5.5 (Baseline) ; -5.1 -5.0 -7.7 -6.7 (Shock)
- Median by group (Baseline / Shock, in percent of GDP):
  - All LICs: -2.4 -1.8 -1.9 -1.5 (Baseline) ; -2.4 -1.9 -2.9 -2.2 (Shock)
  - Program: -2.3 -1.8 -1.8 -1.6 (Baseline) ; -2.3 -1.9 -2.9 -2.3 (Shock)
  - Non-program: -3.2 -1.9 -2.0 -1.4 (Baseline) ; -3.2 -2.1 -3.1 -1.8 (Shock)

### Gross debt implications (Table AX.3) — levels of debt (in percent of GDP)
- Table AX.3 reports gross debt of LICs in percent of GDP (Baseline and Shock).
- Selected country debt levels (Baseline / Shock, in percent of GDP):
  - Afghanistan, I.S. of: 10.1 11.1 12.3 13.4 (Baseline) ; 10.1 11.2 13.2 14.8 (Shock)
  - Armenia: 40.6 44.8 52.0 48.4 (Baseline) ; 40.6 44.9 53.2 50.3 (Shock)
  - Bangladesh: 46.6 45.2 44.3 43.4 (Baseline) ; 46.6 45.3 45.4 44.9 (Shock)
  - Liberia: 224.1 45.0 40.5 34.8 (Baseline) ; 224.1 45.2 41.9 37.2 (Shock)
- Median by group (Baseline / Shock, in percent of GDP):
  - All LICs: 49.1 45.1 45.2 44.0 (Baseline) ; 49.1 45.3 46.1 45.8 (Shock)
  - Program: 54.1 45.0 47.4 44.6 (Baseline) ; 54.1 45.2 48.7 46.5 (Shock)

### Current account and international reserves (Tables AX.4 and AX.5)
- Coefficients for reserve impacts were derived from median impacts of lower growth on exports, remittances, and FDI in 2009 and earlier, separating LICs into oil-importers and oil-exporters.
- Reserve shock simulation assumption: import levels are maintained as under the baseline and the shortfall in inflows is fully offset by a decline in reserves (Table AX.4). In practice countries may choose to depreciate or tighten policies rather than run down reserves to this extent.
- Current account balance impacts were assessed for lower exports and remittances generated by the shock (Table AX.5).
- Selected reserve outcomes (Table AX.4, in months of prospective imports):
  - Median by group, All LICs: 4.5 4.2 4.2 4.1 (Baseline) ; 4.5 4.2 3.6 3.2 (Shock)
- Selected current account outcomes (Table AX.5, in percent of GDP):
  - Country examples (Baseline / Shock):
    - Afghanistan, I.S. of: -1.8 0.6 -0.4 -1.9 (Baseline) ; -1.8 0.5 -1.0 -2.6 (Shock)
    - Armenia: -16.0 -14.6 -12.6 -11.7 (Baseline) ; -16.0 -14.7 -13.8 -13.2 (Shock)
    - Bangladesh: 3.3 2.5 1.1 0.3 (Baseline) ; 3.3 2.5 0.4 -0.4 (Shock)
  - Median by group, All LICs: -8.2 -8.7 -9.1 -8.4 (Baseline) ; -8.2 -8.9 -10.5 -10.6 (Shock)

### Growth effect of trade openness and complementarities (Appendix XI)
- Growth simulation basis: Chang, Kaltani, and Loayza (2009) analysis of the link between trade openness and economic growth for five-year period averages between 1960 and 2000.
- Eight complementary reform areas interacting with trade openness: educational investment, financial depth, telecommunications infrastructure, inflation, governance, labor-market flexibility, firm-entry flexibility, firm-exit flexibility.
- Formula used to compute total growth impact of a change in openness:
  - Δ Growth = (β2 + β3 * Complementary Reform) * Δ Openness
    - where Δ indicates change, β2 and β3 are the estimated coefficients on openness and the interaction term, respectively, and Δ Openness is set equal to the average of the openness measure in the period 2010–14.
- Simulation notes:
  - The total impact depends on country-specific values of complementary reforms; the growth effect of a change in openness is a linear function of each complementary reform.
  - Proxies for some complementary reforms (educational investment, financial depth, telecommunications infrastructure, and inflation) are in log form and can take negative and positive values. Governance, labor market flexibility, firm entry flexibility, and firm exit flexibility are indices spanning only the positive space.
- The figures simulate Δ Growth across the sample ranges (2006–08) for each reform, with regional plots for Africa, Asia, Latin America and the Caribbean, and Middle East and Central Asia (panels A–H corresponding to the eight reform areas).

*Sources: WEO, and Fund staff estimates.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2010/_100510.pdf_