Monday, November 19, 2012

Policy challenges facing low income countries due to re-emerging vulnerabilities

In its latest brief, the IMF argues that at present the low income countries (LICs) have limited fiscal space and larger current account deficits than prior to the crisis. The lower macroeconomic policy buffers and additional risk factors would mean that LICs are more vulnerable to both internal (additional financing needs due to natural disasters) and external shocks (Euro zone shock, oil and food price shocks).

Under a euro-centered growth shock, the median LIC would suffer a significant loss in output, fiscal balances would worsen, and more than half of all LICs would see reserve coverage fall below three months of imports. External financing needs would also rise. Given donors’ fiscal constraints, aid is unlikely to come to the rescue as it did in 2009. Countries would either have to take on more nonconcessional debt, deplete reserves, or make pro-cyclical policy adjustment. The IMF would also likely be called upon to provide additional financial assistance.
The effects of a protracted global growth slowdown would be less severe in the short run. However, due to permanent output losses that accumulate over time, the effect would be substantial in the medium term. Absent adjustment, additional external financing needs would mushroom: since this is unsustainable, almost all LICs would need to adjust to some degree depending on prevailing cyclical conditions, supported by Fund financing. Policymakers would have to balance their adjustment decisions with the need to support or maintain growth and preserve priority spending.

The IMF argues that a spike in global food prices would have less severe effects on fiscal and external gaps than the other shocks, it would have larger impact on inflation and poverty due to the high weight of food in consumer baskets. Meantime, a spike in global oil prices would create additional financing needs for LICs comparable to the euro-centered growth shock.

NEPAL: With GDP growth rate estimated at 3.6% (lower than in FY2012), inflation 8%, international reserves (in months on next year imports) 6.5 months, fiscal balance –0.8% of GDP, positive current account, and gross public debt at 27.4% of GDP, Nepal fares much better than other LICs in FY2013 in terms of macro and external sector stability. However, there are downside risks from low agriculture output, high oil and fuel prices, and weak demand from developed countries.