The Change in Demand for Debt: The New Landscape in Low-income Countries
IMF Blog, February 17, 2016
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- Authors: Min Zhu, Andrea Presbitero
- Published: February 17, 2016
Shifts in capital inflows and financing sources
- Many low-income developing countries have joined the group of Eurobond issuers across the globe—in sub-Saharan Africa (for example, Senegal, Zambia, and Ghana), Asia (for example, Mongolia) and elsewhere—raising over US$21 billion cumulatively over the past decade.
- Capital inflows increased sharply since 2004 in two distinct waves:
- from 2.1 percent of GDP in 2004 to 6.9 percent in 2007;
- after a temporary dip during the global financial crisis, a strong rebound, reaching 6.3 percent of GDP in 2012.
- In 2012, private capital flows were larger than either aid or remittance inflows, which amounted to 3.5 and 5.2 percent of GDP respectively.
- Composition changes:
- Early 2000s inflows consisted primarily of foreign direct investment.
- Post-global crisis period saw an acceleration in portfolio debt and equity inflows, and other inflows to the non-official sector (such as cross-border bank lending).
- A handful of fast-growing frontier economies drove much of the uptick; many are now as open as emerging markets and receive inflows comparable to emerging markets.
Sovereign bond issuance and cross-border bank lending
- Sovereign bonds issued by low-income countries amounted to US$4 billion in 2013 and to US$8 billion in 2014, supported by issuances from Côte d’Ivoire, Ethiopia, Ghana, Kenya, Senegal, Vietnam, and Zambia.
- In 2015, weaker global conditions and falling commodity prices led to a decline in the number of issuances and significantly higher yields for new issuers.
- Cross-border bank syndicated loans contributed substantially to "other inflows":
- These loans amounted to more than US$73 billion over the period 2000–2014.
- For some countries, these loans were large relative to the size of GDP.
Economic effects: benefits and risks of inflows
- Benefits observed:
- Capital inflows are an important external funding source that can stimulate investment and promote financial deepening.
- The recent increase in capital inflows (other than foreign direct investment) has been associated with a rise in public investment in many low-income countries.
- Downsides observed:
- Higher capital inflows have also funded higher public consumption in several countries.
- In several countries that recently issued sovereign bonds, including Ghana, Mongolia, Vietnam, and Zambia—on average—portfolio debt issuances have coincided not only with increases in public investment but also public consumption.
- If inflows are not used productively to increase economic potential, countries will face a significant future debt service burden that will weigh on income levels.
- External vulnerabilities:
- Increased financial integration raises exposure to external shocks (for example, swings in commodity prices and exchange rates).
- Three main external risks to the scale of capital inflows are identified:
- the gradual increase in global interest rates;
- the retreat in commodity prices;
- the rebalancing of the Chinese economy.
- Market sensitivity example: the Federal Reserve announcement in May 2013 about the possibility of tapering its bond purchases sooner than previously expected caused market turbulence that affected exchange rates, bond prices in emerging markets, and sovereign bond spreads in frontier economies.
- Domestic determinants of funding costs and access:
- The price of new external funding tends to rise with higher current account and fiscal deficits, higher public debt, and lower foreign reserves.
Policy messages and recommendations
- Domestic economic policies matter:
- The level and terms at which countries receive external financing respond to both external and domestic economic conditions.
- Important domestic objectives include solid fiscal and external balances, sustainable debt levels, and strong foreign reserves.
- Consequences of weak policy management:
- Countries with weak or slipping domestic economic policy management are likely to experience a sharp retrenchment in access and/or pricing of external financing.
- Such retrenchments may require significant changes to fiscal policies and investment plans.
- Managing capital account liberalization and inflows:
- Countries need to recognize the double-edged nature of capital inflows when considering the pace and sequencing of capital account liberalization.
- Make effective use of external private financing to increase economic potential through productive investment.
- Build economic resilience to handle additional financial volatility and associated risks.
- Maintain strong economic policies and build public debt management capacity.
Source: The Change in Demand for Debt: The New Landscape in Low-income Countries — Min Zhu, Andrea F. Presbitero, February 17, 2016
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