The IMF is carrying out an extensive research program to examine key macroeconomic issues that confront low-income countries in the design and implementation of their national poverty reduction strategies. Drawing on findings from the 2002 joint World Bank-IMF review of the Poverty Reduction Strategy Paper approach and the IMF review of the Poverty Reduction Growth Facility, research projects are planned and under way in five priority areas:

• Improving growth outcomes,

• Assessing the macroeconomic impact of larger aid flows,

• Addressing vulnerability and exogenous shocks,

• Assessing debt sustainability,

• Accessing private capital markets.

Improving Growth Outcomes

Increasing and sustaining growth is essential for poverty reduction. The research program will look into the role of macroeconomic policies in generating growth, as well as specific channels that transmit macroeconomic policies into growth.

Assessing the Macroeconomic Consequences of Aid

Countries with sound poverty reduction strategies and public expenditure management systems should benefit from these flows under the PRSP approach. In most countries, greater aid flows can easily be absorbed. However, rapidly increased concessional flows sometimes have negative macroeconomic consequences. Research in this area will therefore assess how monetary and exchange rate policies should respond to increased aid inflows and the effects of debt and grant aid on key macroeconomic variables.

Foreign aid inflows affect the growth of a recipient economy through various channels. “How Monetary and Exchange Rate Policy Should Respond (or Not) to Increased Aid Inflows” will develop a framework that accounts for both productivity-enhancing effects (such as human capital formation) and adverse effects (“Dutch disease”) of official development assistance. The framework takes into account the timing of disbursements and the composition of aid. The project will discuss whether sterilizing the monetary impact of aid inflows is appropriate and how this policy should take into account the degree of concessionality of aid flows and the possible crowding out of investment. A novel measure of real exchange rates—based on black-market rates—is used. Preliminary results suggest, first, that large foreign aid inflows are generally associated with real exchange rate appreciation and, second, that the appreciation takes place mainly in the parallel exchange market. The findings also show that sterilization significantly reduces the real exchange rate appreciation associated with foreign aid inflows.

• Research Department

  Alessandro Prati (aprati@imf.org)

  Ratna Sahay (rsahay@imf.org)

  Thierry Tressel (ttressel@imf.org)

“Exchange Rate Flexibility and the Monetary Management of Aid Flows in Africa” will focus on selected African countries where money-based stabilization programs in the 1990s succeeded in bringing inflation to relatively low levels while maintaining a market-determined exchange rate. The paper focuses on highly persistent shocks to aid flows, including PRSP-related increases in net flows. Such shocks have beneficent long-run effects; but when the substitutability between domestic and foreign currencies is relatively high, they can produce dramatic, short-run macroeconomic management problems. The question, then, is: What is the appropriate mix of money and exchange rate targeting and the role of temporary sterilization? The study develops an intertemporal optimizing model in which the budgetary contribution of aid may be partly spent and partly devoted to reducing the government’s seigniorage requirement. Preliminary results indicate that when the credibility of policymakers’ commitment to low inflation is firm, the most attractive short-run approach appears to be some degree of “dirty floating” along with partial sterilization of increases in the monetary base.

• Research Department

  Catherine Pattillo (cpattillo@imf.org)

“Debt Relief, Additionality, and Aid Allocation in Low-Income Countries” will provide empirical analysis on whether debt relief crowds out other aid flows. It asks whether debt relief has had a significant impact on the overall level of resource transfers from official donors as a group. Using an aid allocation model, the paper compares the experiences of countries receiving debt relief from IDA-only with countries that have not.

• African Department

  Robert Powell (rpowell@imf.org)

“Grants Versus Loans” will analyze the trade-offs faced by international development agencies when determining the grant component of an aid package. The project will assess how recipient countries’ characteristics and policy environments influence the relative effectiveness of grants versus loans in promoting growth.

• Research Department

  Tito Cordelia (tcordella@imf.org)

  Ratna Sahay (rsahay@imf.org)

  Hulya Ulku (hulku@imf.org)

“Conditional Aid, Sovereign Debt, and Debt Relief” asks whether debt relief is the best instrument for raising consumption by the poor in HIPCs. To answer this question, the project will develop a model of conditional aid based on a “contract” between altruistic donors concerned with consumption by the poor and recipient governments representing the interests of those who are well off. This implicit contract is played out over an infinite horizon and is supported by threats of punishment for deviation. The research will examine how debt relief in an optimal conditional-aid relationship can reduce the welfare of the poor. The framework will offer new explanations of why aid flows can be procyclical and why donors who are themselves debt-holders continue to provide aid without granting debt relief.

• Research Department

  Tito Cordelia (tcordella@imf.org)

  Giovanni Dell’Ariccia (gdellariccia@imf.org)

  Ken Kletzer (University of California at Santa Barbara)

Addressing Vulnerability and Exogenous Shocks

Macroeconomic research in this area examines how commodity prices affect exchange rate fluctuations and the design of inflation targets in commodity-dependent low-income countries. “How Monetary and Exchange Rate Policies Should Take Into Account Commodity Prices and Terms of Trade Shocks” has thus far focused on identifying countries with “commodity currencies”—meaning countries where real exchange rates are chiefly determined by movements in the real prices of their commodity exports. For countries with commodity currencies—most of which are low-income countries—commodity prices can be a useful benchmark signaling that exchange rates have deviated excessively from their equilibrium value. In addition, policymakers in commodity-currency countries can use information on spot or futures prices to guide monetary policy. Subsequent research on commodity-dependent countries will examine the efficacy of alternative nominal exchange rate anchors, especially the use of spot (world) commodity prices, and the role of commodity prices in inflation targeting when commodity-dependent countries wish to move toward greater flexibility in their nominal exchange rates.

• Research Department

  Paul Cashin (pcashin@imf.org)

“Identifying Vulnerabilities in CIS Countries” will take stock of the peculiar features of the CIS economies and will identify their vulnerabilities to specific shocks. The emphasis in the general literature on volatile short-term capital flows and banking sector fragility is less relevant in CIS countries because of their typically small banking sectors and the absence of links to the international capital market. Instead, these countries are prone to commodity-price shocks (especially oil), economic downturn in Russia, and domestic shocks related to political crisis, the weather, and so forth, which are exacerbated by their structural and institutional rigidities. The impact of the 1998 Russian crisis will be explored and might provide useful evidence. The study may also construct hypothetical scenarios of the processes that lead to full-blown crises.

• Research Department and European Department

  Ratna Sahay (rsahay@imf.org)

  José Fajgenbaum (jfajgenbaum@imf.org)

  Francesco Luna (fluna@imf.org)

Assessing Debt Sustainability

Higher aid flows in support of poverty reduction can affect the debt sustainability of low-income countries, and overly optimistic projections regarding growth and export can paint a distorted picture of whether it can be sustained. The IMF research program in this area will develop a debt sustainability framework and will assess overoptimism in the projections that underpin sustainability analyses.

“Debt Sustainability in Low-Income Countries” will discuss how the framework recently adopted by the IMF for middle-and upper-income countries can be adapted to low-income countries. The framework for low-income countries will cover issues of both external sector sustainability and fiscal sustainability, examining how sustainability can be achieved on both fronts. Creating such a framework presents a number of analytical challenges, considering the marked differences between low- and middle-income economies. The former are characterized by limited access to private capital markets, highly concessional debt that is usually at interest rates far below projected growth, and heavy reliance on primary commodities exports. Consequently, debt sustainability analysis for low-income countries should cover a longer projection period in order to capture the implications of future graduation from highly concessional assistance. The study will apply the new framework to several countries. Stress tests will be used to demonstrate the effects of shocks (for example, lower-than-expected commodity prices or economic growth) on external and fiscal sustainability. The paper will also discuss how official financing in a post-HIPC setting could broadly affect debt sustainability.

• Fiscal Affairs Department

  Emanuele Baldacci (ebaldacci@imf.org)

  Kevin Fletcher (kfletcher2@imf.org)

Accessing Private Capital Markets

The ability to tap into private credit markets is decisively determined by a country’s vulnerability to shocks and the perceived quality of its policies. IMF research on accessing private capital markets will examine these key determinants of low-income countries’ access to credit markets.

“Private Capital Market Access by Developing Countries: The Role of Policies and Vulnerability” will employ detailed data on sovereign bond issuances and public syndicated bank loans since the outset of the Latin American debt crisis in 1982. In addition to covering factors traditionally in the literature, this project will investigate the importance of vulnerability—with regard to terms-of-trade shacks, for example—in determining credit constraints. In examining the role of government policies, this study will go beyond previous research by using, first, a comprehensive, detailed data set on the quality of government policies and, second, a panel approach that controls for fixed country characteristics and time-varying global conditions.

• Research Department

  Gaston Gelos (ggelos@imf.org)

  Ratna Sahay (rsahay@imf.org)

“Overcoming Financial Market Deficiencies in Sub-Saharan Africa” will look at financial market deficiencies in sub-Saharan Africa. The paper will examine efforts worldwide to overcome institutional and regulatory hindrances to financial services in rural areas and access to credit by small and medium-sized enterprises.

• African Department

  Lelde Schmitz (lschmitz@imf.org)