Medium-Term Prospects and Policy Issues in Developing Countries
- International Monetary Fund. Research Dept.
- Published Date:
- January 1990
In a large number of developing countries, notably those that encountered debt-servicing difficulties, the decade of the 1980s was one of slow growth and declining per capita output. By contrast, many countries that were able to avoid debt-servicing difficulties have achieved very high growth rates and substantial gains in real income. These differences can be attributed to several factors. Most important, policies have differed significantly among the indebted developing countries. Countries that avoided debt-servicing difficulties have generally pursued more cautious financial policies and have placed greater emphasis on reducing structural rigidities and distortions in their economies than the countries with debt-servicing difficulties. Macroeconomic instability and persistent foreign financing constraints have adversely affected capital formation in many countries that encountered debt-servicing difficulties. Also, the international trading environment has not been equally favorable for all countries. While most exporters of manufactures have benefited from strong growth in the industrial countries, many exporters of primary products have faced deteriorating terms of trade.
Domestic economic policies play a critical role in the medium-term outlook for the developing countries, particularly in view of the recent increase in oil prices. The conclusions of the discussion of the appropriate policy response to these developments in the industrial countries discussed in the Box in Chapter II appear generally applicable to the oil importing developing countries. In particular, attempts to insulate domestic oil markets through subsidies or price controls, and efforts to dampen the adverse effects of the oil shock by easing macroeconomic policies would only create more serious problems for the future. In addition, in those developing countries where public sector wage policies, wage indexation mechanisms, or other forms of incomes policies are prevalent, it will be important to ensure that the onetime increase in domestic prices stemming from the rise in oil costs is not translated into an escalation of wages and subsequent wage/ price spiral. Inasmuch as the rise in oil prices involves a decline in national income, it must be clearly understood by both producers and consumers that real wages as well as profits will unavoidably be lower than they otherwise would have been.
In a number of oil importing developing countries, including several that are currently engaged in stabilization efforts and structural reforms in the context of Fund- and Bank-supported adjustment programs, the effects of persistently higher oil prices, aggravated by lower external demand and higher interest rates, could be very serious. For these countries, there is a need for a careful evaluation of the implications for external viability of the changed external environment, and the appropriate adjustment/financing mix will have to be determined in the particular circumstances of each country.
In some of the major oil exporting countries, the rise in export revenue will be reflected predominantly in a substantial accumulation of external assets. In the net debtor fuel exporting developing countries, part of the rise in export revenue will be absorbed by higher interest payments abroad, but in most cases there will be a net favorable impact on the current account. It will be important to ensure that this improvement serves to ameliorate the countries’ official reserve position and, where applicable, to reduce external indebtedness and arrears and to increase productive investment. In several oil exporting countries, the opportunity provided by the improved economic situation should be used to allow domestic oil prices to reflect more closely world market conditions.
This chapter reviews the medium-term outlook for the net debtor developing countries and discusses a number of issues related to the revival of growth and the restoration of debt-servicing capacity in the countries that have repeatedly encountered debt-servicing difficulties. Below, the staff presents its medium-term baseline projection; it is little changed from the May 1990 World Economic Outlook and shows a significant improvement in growth, inflation, and debt ratios in the medium term. In the following section, an alternative scenario is constructed on the basis of more pessimistic assumptions about domestic policies; it indicates a significant worsening in the outlook for the developing countries if projected improvements in the domestic policies of countries with adjustment programs do not fully materialize. The chapter then addresses the importance of fiscal adjustment for Stabilization, and the link between structural reforms and economic growth in developing countries. Turning to the external environment, the staff emphasizes an issue of current concern, namely the crucial importance of a successful outcome to the Uruguay Round for developing countries in terms of improved access to industrial country markets. Finally, the chapter discusses recent progress in the debt strategy, highlighting the importance of domestic stabilization policies, particularly measures to reduce fiscal deficits, and the role of debt restructuring.
The staff’s medium-term projections are, by convention, based on the assumption of unchanged policies, with two important exceptions. Policy measures that have already been announced and appear certain to gain approval, as well as policy changes that have been or are expected to be included in a Fund- or Bank-supported adjustment program, are also taken into account. Partly in view of these assumptions, the medium-term baseline projection for the developing countries as a group involves a substantial tightening of fiscal and monetary policies compared with recent experience. For example, monetary growth rates in countries with recent debt-servicing difficulties are projected to decline from the exceptionally high average rate of 281 percent in 1989 to an average of about 15 percent between 1992 and 1995. Fiscal deficits are projected to be stable or to decline in most of the major developing countries, with several countries expected to run a fiscal surplus in 1992–95. Planned improvements in structural policies, leading to an increase in efficiency, are also incorporated in the projections. Achievement of these policy objectives would in some cases require considerable and sustained adjustment efforts and there is a danger that the medium-term projections may therefore be too optimistic. The sensitivity of the medium-term projections to the policy assumptions is examined in the next section.
The global economic environment is expected to be slightly more favorable over the medium term for developing countries than in 1990–91. As indicated in Chapter II, real GDP growth in the industrial countries is projected to increase slightly from 2½ percent in 1991 to an average of 3 percent between 1992 and 1995. This would be accompanied by world trade growth of about 6 percent, somewhat below the exceptionally rapid growth rates of recent years. A positive outcome to the Uruguay Round could increase this significantly, as discussed later in the chapter; conversely, a failure could have adverse repercussions for the expansion of world trade. The terms of trade for developing countries are projected to improve slightly from 1992 on. The oil price is assumed to fall to $21 a barrel by the end of 1991 and then to remain constant in real terms for the rest of the projection period. Interest rates would decline a little from current levels, with the six-month dollar LIBOR assumed to be 8 percent between 1992 and 1995.
The availability of external financing plays an important role in the projections for developing countries. Over the medium term, on the assumption that net debtor countries gradually regain creditworthiness, some slight recovery in lending by commercial banks is projected, but flows of new finance would remain substantially below the figures registered in the late 1970s and early 1980s.71 In the next few years, debt and debt-service reduction operations will begin to make an impact on the debt-service burden for some debtors, and this has been taken into account in cases where agreement has been reached or seems likely. However, the projections also assume that there will be substantial continued involvement of official creditors, particularly, but not exclusively, vis-a-vis the poorest debtors, and many countries will continue to face tight constraints with respect to the availability of external financing.
Details of the staff’s medium-term baseline projection are provided in Tables A 51–A53 of the Statistical Appendix and summarized in Table 14. Growth in net debtor developing countries as a group is projected to rise to 5 percent in the medium term, with most of the increase assumed to occur in countries that have experienced recent debt-servicing difficulties. Investment ratios in these countries are projected to rise by nearly 5 percentage points from 1990 to 1995 and the efficiency of investment is also projected to increase, reflecting, in part, the assumption of improved policies in countries implementing Fund- or Bank-supported adjustment programs. Consumer price inflation is projected to decline gradually after 1992, reaching an average of 10 percent in 1995 in countries with debt-servicing difficulties and 7 percent in other net debtor countries, although again this would require considerable efforts and steadiness in policy implementation in some countries that have experienced high inflation for many years.
|Net debtor countries, total|
|(Annual changes in percent or percent of GDP)|
|Import volume||5.3||3.7||4 4||7.1|
|Terms of trade||2.3||–1.8||–1.3||0.4|
|(Annual averages, in billions of U.S. dollars)|
|Current account balance||49.2||–34.0||–33.7||–31.5|
|Total net external credit||61.9||42.9||58.5||54.7|
|Net official credit2||16.0||29.1||40.9||33.2|
|Net bank credit3||…||6.0||–11.3||3.5|
|(As percent of exports of goods and services, period averages)|
|Total external debt4||166.8||152.5||139.4||111.1|
|Of which; interest payments||8.2||12.6||9.3||7.7|
|Countries with recent debt-servicing difficulties|
|(Annual changes in percent or percent of GDP)|
|Terms of trade||3.2||–3.1||–1.5||–0.1|
|(Annual averages, in billions of U.S. dollars)|
|Current account balance||–34.4||20.5||–20.9||–26.9|
|Total net external credit||42.7||21.5||27.9||24.9|
|Net official credit2||9.8||21.4||30.3||21.4|
|Net bank credit3||…||–0.3||–18.2||–3.7|
|(As percent of exports of goods and services, period averages)|
|Total external debt4||221.8||251.6||230.9||181.0|
|Of which: interest payments||9.8||19.3||16.1||12.9|
|Countries without debt-servicing difficulties|
|(Annual changes in percent or percent of GDP)|
|Terms of trade||0.7||–0.8||–1.4||0.6|
|(Annual averages, in billions of U.S. dollars)|
|Current account balance||–14.7||–13.5||–12.8||–4.5|
|Total net external credit||19.0||21.4||30.6||29.9|
|Net official credit2||6.1||7.6||10.7||11.8|
|Net bank credit3||…||6.3||6.9||7.3|
|(As percent of exports of goods and services, period averages)|
|Total external debt4||107.5||92.3||87.3||73.3|
|Of which: interest payments||6.1||7.4||5.5||4.7|
The strongest growth performance in the first half of the 1990s is once again projected for the Asian developing countries, led by continued strong export growth. The developing countries of the Western Hemisphere are projected to match the growth of the Asian economies after 1992, although their export growth would not be as rapid. Growth in the group of net debtor countries in the Middle East (which includes Iraq) could also reach 5½ percent in the 1992–95 period, on the assumption (hat oil production returns to normal patterns. A substantial recovery is also projected for the developing countries of Europe, reflecting in part efficiency gains resulting from market-oriented reforms in Eastern Europe. Medium-term projections of output growth for Africa have been revised slightly upward since the May 1990 World Economic Outlook, but per capita income growth would still be very weak.
The current account deficit of the net debtor developing countries is projected to narrow from around $34 billion a year in 1990–91 to $31½ billion in 1992–95, representing about 2¾ percent of the total value of exports of goods and services. Inflows of foreign direct investment are projected to rise by $2 billion a year over the same period, and reserve accumulation is projected to fall by $5 billion annually. Changes in other non-debt-creating flows, asset transactions, and errors and omissions largely offset each other so that average net external borrowing is projected to decline by about $9 billion between 1990–91 and 1992–95. Much of the decline is accounted for by a projected turnaround in net credit from the Fund as the expected profile of purchases and repurchases shifts to repayments falling due under existing programs. Net external borrowing from other creditors (including official lenders and commercial banks) is projected to fall by about $4 billion a year between 1990–91 and 1992–95. but borrowing would be higher on average than in 1983–89.
The pattern of balance of payments transactions differs for countries with and without debt-servicing difficulties. Countries in the former group would continue to run a higher deficit relative to exports of goods and services and their aggregate deficit would show a substantial increase between 1991 and 1995. Countries in the latter group have easier access to external finance but generally less need to borrow as their current account deficit is projected to decline. However, there is a significant change in the medium-term external financing position of countries without recent debt-servicing difficulties. A few of these countries are now expected to experience more rapid growth of domestic demand, with higher inflation, slower export growth, and some increase in outward private capital flows. Partly as a result, and partly due to the impact of higher oil prices, borrowing from both commercial banks and official creditors by this group of countries is expected to increase somewhat compared with recent experience. Additional borrowing by these countries would account for much of the increase projected to occur between the 1983–89 and 1992–95 periods in total net external credit extended to developing countries. This would add to the pressure on world savings, which has already increased as a result of developments in Eastern Europe and Germany.
Chart 24.Net Debtor Developing Countries; Ratio of Debt to Exports
External debt and debt-service ratios for net debtor developing countries are projected to decline significantly over the medium term as a result of the continued expansion of exports, relatively little change in net borrowing, and the projected impact of debt-reduction operations (Chart 24). Between 1989 and 1995, the debt-export ratio for countries that have experienced debt-servicing difficulties would fall by about 70 percentage points to 181 percent, the lowest level since before the onset of the debt crisis in 1982. However, there would still be a wide dispersion in debt ratios, with almost one third of all net debtor countries (mainly, although not exclusively, in Africa) still having a debt-export ratio in excess of 300 percent in 1995. Average debt-service ratios are also projected to decline significantly, but they would still be nearly twice as high in countries with debt-servicing difficulties as in other net debtor countries. In Africa and the Western Hemisphere, debt-service payments would continue to absorb almost one fourth of all earnings from exports of goods and services. Therefore, despite the effects of general trade expansion and debt-reduction operations in reducing debt burdens, much remains to be done to ensure a sustainable balance of payments position in all net debtor countries.
The medium-term projections are, as usual, subject to a number of risks. The future course of world interest rates, the availability and distribution of savings, the stability of exchange rates, and the growth of world economic activity and trade will all have a profound influence on developing countries’ economic prospects. Most important at this juncture, a sustained rise in oil prices would also have implications for the future pattern of current account flows and growth rates of developing countries. Aside from the external environment, considerable risks to the medium-term projections also arise from uncertainties about the orientation of domestic economic policies in some developing countries.
A Scenario Based on Alternative Policy Assumptions
While a number of developing countries have made substantial progress with macroeconomic stabilization and structural reform in recent years, slippages in the implementation of adjustment measures have been widespread. As a result, in the past several years, medium-term projections in the World Economic Outlook have tended to overestimate growth and, in particular, to underestimate inflation in the developing countries.72 This section therefore reviews the policy assumptions underlying the medium-term projections and considers a scenario that allows for less-than-full program implementation.
The role of policy improvements in the marked recovery of growth projected in the medium-term baseline can be illustrated using a simple growth-accounting framework that decomposes growth of potential GDP into the contributions of factor inputs and total factor productivity. In this framework, the structural reforms initiated in many developing countries to enhance economic efficiency should be reflected in a larger contribution of total factor productivity to growth. Also, after several years of weak investment activity, successful macroeconomic stabilization can be expected to result in higher saving and investment ratios, and thus a larger contribution of capital to output growth. The results obtained from the decomposition of potential GDP growth in the net debtor countries during 1975–89 and 1992–95 are illustrated in Table 15.73 In view of severe data constraints, these results should be interpreted as broad orders of magnitude.
In order to assess the contribution of policy improvements to the projected strengthening of output growth over the medium term, it is instructive to review the sources of growth in the developing countries in recent years. In the years prior to the debt crisis, most developing countries were able to sustain strong investment activity, in part financed by foreign capital inflows. In the countries that avoided debt-servicing difficulties, the rapid expansion in the capital stock was accompanied by significant increases in total factor productivity, which accounted for more than one fourth of the growth of potential GDP in that period. However, the economies of the countries that later encountered debt-servicing problems appear to have been far less efficient. In these countries, capital formation alone accounted for more than three fourths of potential GDP growth in 1975–82, but the contribution of total factor productivity was negative. After the onset of the debt crisis, investment fell sharply in these countries while the contribution of total factor productivity remained negative. By contrast, in the countries that avoided debt-servicing difficulties, investment ratios were maintained and the growth of potential output accelerated markedly, with total factor productivity accounting for more than one third of the growth in productive capacity during 1983–89.
On the basis of the policy assumptions underlying the staff’s medium-term baseline projections, growth of potential output in countries with recent debt-servicing problems is expected to strengthen significantly in 1992–95. A recovery of investment is expected to contribute to this improvement, but partly because of continuing foreign financing constraints, the average contribution of capital formation to growth of potential GDP would remain smaller than before the debt crisis. The projected strengthening of investment is concentrated mainly in the developing countries in the Western Hemisphere and, to a lesser extent, in Africa; in the developing countries in Europe and in the Middle East, the contribution of capital formation to growth is expected to remain broadly unchanged. A recovery of growth in many developing countries depends to an even greater extent on improvements in efficiency reflected in the development of total factor productivity. For the countries with recent debt-servicing difficulties, the baseline projections assume a marked turnaround in total factor productivity from an average negative contribution of about ½ of 1 percent to the growth of potential GDP during 1983–89 to a positive contribution of 1½ percent in 1992–95. Significant productivity gains are projected in all regions, except Asia and the Middle East. In Asia, the growth rates of potential GDP and total factor productivity are expected to slow after several years of very rapid expansion.
The considerable strengthening of investment and the efficiency gains implicit in the baseline projections require substantial progress in macroeconomic stabilization and structural reform in many countries with recent debt-servicing problems. In particular, the projected recovery of investment in the Western Hemisphere is unlikely to materialize if policy slippages prevent the rapid reduction of inflation and the large improvement in fiscal positions assumed in the baseline. The successful implementation of structural reforms—which itself requires a stable macroeconomic environment—is also essential to achieve the projected increase in total factor productivity in most developing regions, particularly in Africa and in the Western Hemisphere.
The medium-term outlook for the debtor countries clearly would be much less favorable if the adjustment measures assumed in the baseline projections were not fully implemented. The alternative medium-term scenario in Table 15 is based on the assumption that, in those countries where the medium-term baseline projections presuppose adjustment measures, planned stabilization policies and structural reforms will not be implemented in full. Specifically, it is assumed that in countries with adjustment programs, only half of the increase in the contribution of capital and total factor productivity to growth projected for 1992–95, compared with 1983–89, will be realized.
|Net debtor countries|
|By analytical criteria|
|Countries with recent debt-servicing problems|
|Countries without recent debt-servicing problems|
Under the policy assumptions of the alternative scenario, growth of potential GDP in 1992–95 in the group of countries with recent debt-servicing difficulties would fall short of the baseline projections by more than 1 percentage point. The shortfall would be particularly pronounced in the developing countries in the Western Hemisphere and, to a lesser extent, in Africa and in the developing countries in Europe. In Africa, the assumed partial failure of adjustment policies would be sufficient to erode the modest gains in per capita GDP implicit in the baseline projections. The medium-term outlook for the group of countries without recent debt-servicing difficulties remains unaffected by the modified policy assumption because this group includes only a few, small countries where the baseline projections assume the implementation of comprehensive adjustment programs.
Although the alternative scenario would imply a considerably more moderate recovery of growth over the medium term in countries with adjustment programs, it would still involve a marked increase, compared with 1983–89, in the average contribution to growth of both capital and total factor productivity. This improved economic performance therefore also presupposes considerable progress in macroeconomic stabilization and structural reform.
Fiscal Adjustment and Macroeconomic Stabilization
The experience of the indebted countries during the 1980s illustrates the importance of a stable macroeconomic environment for sustained growth. As noted above, countries that have avoided debt-servicing difficulties have generally pursued more cautious financial policies than countries with debt-servicing problems. This difference in policy stance dates back to the years prior to the debt crisis and probably played a critical role in the debt-servicing problems subsequently encountered by many debtor countries. In 1981, central government deficits as a percent of GDP averaged 7 percent and money growth averaged 48 percent in the countries that experienced debt-servicing difficulties, while the average fiscal deficit amounted to 3½ percent of GDP, and broad money grew at an average rate of 24½ percent in the countries that avoided such difficulties.
The reduced availability of foreign financing after the onset of the debt crisis forced most countries facing debt-servicing difficulties to tighten fiscal policy, but the reductions in fiscal imbalances were generally not sufficient to avoid increased monetization of government deficits. Moreover, the initial improvement in fiscal conditions was not always sustained. Fiscal deficits in countries with debt-servicing difficulties began to widen again in the mid-1980s and reached an average of 11¼ percent of GDP in 1989, while monetary expansion accelerated to an average annual rate of 281 percent. In contrast, the developing countries that were able to avoid debt-servicing difficulties succeeded in containing fiscal imbalances and monetary expansion during the 1980s.
Unsustainable fiscal positions contributed to the marked widening of macroeconomic imbalances and the sharp acceleration of inflation in many countries with debt-servicing difficulties during the 1980s.74 For the most part, the renewed deterioration of fiscal balances in these countries in the latter half of the 1980s reflected the lack of a sustained effort to consolidate public sector finances, even though unfavorable external developments—such as the decline in prices for primary commodities, notably oil—contributed to widening fiscal imbalances. Moreover, fiscal management was complicated by the large debt-service burden itself, owing in part to the increase in the public sector’s responsibility for servicing external debt, and by the impact of accelerating inflation on revenues and expenditures.
In the initial adjustment phase that followed the onset of the debt crisis, improvements in fiscal balances were, in large part, achieved by cutting public investment expenditure. Although inefficiencies were widespread and not all of the investment in previous years had enhanced productive capacity, the cuts in investment may have weakened the basis for future growth. Moreover, it soon became evident in many countries that selective expenditure cuts and revenue measures would not be sufficient to achieve a viable fiscal position over the medium term.
The experience with fiscal adjustment in many developing countries during the 1980s has shown that a sustained improvement in fiscal positions generally requires a comprehensive effort to address deep-seated structural weaknesses in public sector finances. On the revenue side, reforms in the tax system that broaden the revenue base and minimize distortions, and improvements in tax administration that reduce tax evasion, are needed. On the expenditure side, systems of expenditure control need to be improved, subsidies to enterprises and households need to be reduced or eliminated, and public sector employment needs to be streamlined. In the public enterprise sector, restructuring or privatization is generally required to reduce transfers and improve economic efficiency.
Several debtor countries, such as Chile, Ghana, Mexico, and Nigeria, have made considerable progress in some of these areas. As a result, fiscal balances in these countries have improved significantly and there is increasing confidence in the authorities’ commitment to sustained fiscal consolidation. In many other countries, however, the record of fiscal adjustment has been patchy and policy slippages have been frequent. While a number of these countries have recently strengthened adjustment measures, the stabilization of macroeconomic conditions will depend critically on a sustained and comprehensive effort to consolidate public sector finances.
Structural Reform and Growth
In many developing countries, the functioning of markets is severely hampered and relative prices are highly distorted as a result of exchange, trade, price and interest rate controls, direct government intervention in key sectors such as agriculture, and distortionary tax and subsidy systems. These rigidities and distortions limit growth through disincentives to saving and investment and through an inefficient allocation of resources that reduces the output gains that can be obtained from a given increase in factor inputs. Structural reforms that reduce market imperfections and bring relative prices more in line with relative scarcities can therefore have a significant impact on potential output and growth. This section examines the implications of rigidities and distortions for economic growth, and the experience with structural reform in three areas that have been the focus of structural policies in a large number of developing countries in recent years: exchange and trade systems, agricultural pricing and marketing, and financial intermediation.
Liberalization of Exchange and Trade Systems
Exchange and trade restrictions—such as multiple exchange rates, import licenses and quotas, highly protective tariffs, and export taxes—severely distort the relationship between international and domestic prices and limit trade flows in a large number of developing countries. The costs of these policies, which generally imply strong protection for domestic enterprises and a severe anti-export bias, are well known but difficult to quantify. Trade restrictions entail direct costs in terms of forgone consumption and production because they prevent efficient resource allocation based on a country’s comparative advantage. They also involve indirect efficiency costs because they encourage unproductive rent-seeking activities, prevent the exploitation of economies of scale, and limit exposure to foreign competition, thus fostering inefficiencies and monopolistic structures in the protected sectors. While estimates of the direct static costs of inefficient resource allocation are often low, estimates of the costs of trade restrictions that take account of indirect efficiency costs are in the neighborhood of 5 percent of GDP or more for countries such as Turkey and the Philippines.75 More recently, it has been argued that the costs of protection are likely to be even higher since countries with highly restrictive and inward-looking trade systems forego the gains from technology transfer that would be associated with a fuller integration into the international economy.
While the precise costs of trade and exchange restrictions are difficult to gauge, there is considerable empirical evidence suggesting that outward-oriented trade policies have significant positive effects on growth.76 Outward orientation is usually defined as a trade regime that does not entail a bias against exports and maintains, on average, equality between the “effective” exchange rates (that is, exchange rates adjusted for tariffs, surcharges, and premia associated with quantitative restrictions) that apply to exports and imports. Small deviations from this benchmark can be viewed as compatible with moderate outward orientation while larger deviations, implying varying degrees of bias in favor of production for the domestic market, are generally identified with inward orientation.77
Table 16 compares the growth performance of a sample of 41 developing countries classified by trade orientation on the basis of the growth-accounting framework described earlier.78 The results broadly agree with previous analyses of the relationship between trade orientation and growth. During 197589, the outward-oriented countries achieved, on average, significantly higher growth rates of potential GDP and of total factor productivity than the inward-oriented countries. In the strongly outward-oriented countries, total factor productivity accounted for one third of potential GDP growth in 1975–82 and for about one half in 1983–89; by contrast, its contribution was, on average, negative in the inward-oriented countries.79
|Strongly outward-oriented countries|
|Moderately outward oriented countries|
|Moderately inward-oriented countries|
|Strongly inward-oriented countries|
While there is little disagreement that outward-oriented trade regimes support growth, views differ on the precise policy implications that should be drawn from the empirical evidence. It has been argued that complete trade liberalization is not a necessary condition for outward orientation, and that several outward-oriented countries maintain numerous forms of intervention in their trade and exchange systems. While it is true, in theory, that a broadly neutral system of incentives can be achieved by balancing restrictions on imports that favor production for the domestic market with incentives for exports, such balancing is difficult in practice and is likely to entail significant costs. Since the required export incentives, and hence their budgetary costs, are positively related to the degree of import restriction, highly restrictive trade and exchange regimes are generally characterized by a strong anti-export bias. While outward-oriented countries have not always pursued trade and exchange policies that amount to complete “laissez-faire,” they have generally avoided pervasive quantitative restrictions, high and strongly differentiated effective rates of protection, and persistently overvalued exchange rates.
A number of traditionally inward-oriented developing countries such as Ghana, Madagascar, Mexico, and Senegal have recognized the importance of a more open trading environment for efficient resource allocation and growth and have substantially liberalized their trade and exchange systems in recent years. Trade liberalization has also figured prominently in the adjustment programs of many other developing countries, including Jamaica, Nigeria, Pakistan, and Sri Lanka. Reforms of trade and exchange systems have typically included the establishment of a more market-oriented system of exchange rate determination, the reduction and eventual elimination of quantitative import controls, simplification or elimination of licensing requirements, reduction and simplification of tariffs, reduction of the dispersion of tariff rates, easing of export restrictions, and measures to enhance competition in export marketing. The experience with these reforms has shown that although the gains are not always immediate and depend on the scope of the reform program, comprehensive liberalization of exchange and trade systems in countries such as Chile in the 1970s and Turkey in the 1980s—and more recently Ghana, Madagascar, Mexico, and Nigeria—has stimulated export activity and growth and has led to a marked diversification of exports.
Structural Reform in Agriculture
Because of its importance in terms of output, employment, and foreign exchange earnings, the agricultural sector has been a principal target of government intervention in many developing countries, notably in sub-Saharan Africa. Such intervention ranges from explicit taxes on output and sub-sidies on inputs to direct government involvement in the marketing of major crops and the procurement of major inputs. Government action in this area has been motivated by a variety of objectives, including generation of fiscal revenue, stabilization of agricultural incomes, and income redistribution through implicit subsidization of basic consumer goods. As a result, the structure of incentives in the agricultural sector in many developing countries is highly distorted.
While it is difficult to assess the net effect of these distortions, the evidence suggests that in most cases they have resulted in incentives biased against agricultural production, with effective rates of protection for agriculture well below those for manufacturing and heavy explicit or implicit taxation of agricultural output. In a significant number of developing countries, domestic farmgate prices for major crops have frequently been less than 50 percent of the corresponding border prices.80 Subsidization of agricultural inputs has somewhat mitigated the impact of heavy output taxation, but it has also led to an inefficient use of inputs and a distorted mix of outputs. Many developing countries adopted such policies on the presumption that the cost in terms of output forgone would be negligible because agricultural production was thought to be insensitive to price incentives. A number of studies, however, indicate that supply responses to changes in agricultural prices are stronger than previously believed. Evidence for the developing countries indicates that a 10 percent increase in real farmgate prices would raise aggregate agricultural output by 3–9 percent in the long run.81 Supply responses at the lower end of the range are typically observed in low-income countries with limited infrastructures such as India and the countries in sub-Saharan Africa, while supply elasticities appear to be considerably higher in middle-income developing countries such as Argentina. In addition, there is considerable evidence that in many developing countries, strong growth in the agricultural sector is positively related to growth in the rest of the economy. These results suggest that incentive systems with a bias against agriculture are likely to involve significant costs in terms of forgone total output.
Recognizing the cost of severe distortions in the agricultural sector, many developing countries, particularly in sub-Saharan Africa, have undertaken structural reforms in recent years to improve incentives for agricultural production. Measures have ranged from discretionary adjustments of producer prices to the liberalization of pricing and marketing arrangements, as, for example, in Malawi, Mali, Nigeria, and the Philippines. While in the early 1980s two thirds of the countries in sub-Saharan Africa had fixed prices and legal state monopolies for marketing major food crops, by the late 1980s, two thirds of the countries in the region had incentives based on market-determined prices. Some countries also have taken steps to reduce subsidies on inputs. Although the results of these reforms have not always been as spectacular as those of the agricultural liberalization in China in the early 1980s and, more recently, in Viet Nam, the measures have generally stimulated production in the agricultural sector and, indirectly, in other sectors as well.
Financial Sector Reform
Financial market imperfections are pervasive in many developing countries, and, to some extent, attributable to a weak institutional infrastructure. However, in the majority of countries, government intervention is a major source of rigidities and distortions. The most common forms of intervention in financial markets are interest rate controls and regulations influencing the size and allocation of bank credit. While composite measures of financial sector distortions are difficult to define, real interest rates are widely used as indicators of financial repression because interest rate controls frequently lead to negative real interest rates. On the basis of annual data for 1975–89, almost two thirds of the developing countries for which interest rate data are available had negative real interest rates in at least five years.82
Financial intermediaries play a critical role in mobilizing and allocating funds for investment, and there is considerable empirical evidence suggesting that financial sector distortions resulting in negative real interest rates are associated with relatively low average rates of economic growth.83 Financial sector distortions can influence growth in three ways. First, they can affect the overall level of saving. Given that national saving and investment ratios are strongly correlated in the developing countries, distortions that discourage saving are likely to limit investment and hence growth.84 Second, financial sector distortions can affect the proportion of savings that is available for productive investment. Third, they can affect the allocation of savings among different investment projects and hence the efficiency of investment. The empirical evidence concerning the relationship between interest rates and saving suggests that increases in the real interest rate generally have a positive, but relatively small, impact on saving. However, this evidence should be interpreted with caution. Saving data are very weak in many developing countries and the limited variability of interest rates that results from interest rate controls greatly complicates time series analysis. There is stronger evidence that negative real interest rates tend to discourage investment in domestic financial assets and encourage nonfinancial forms of saving as well as investment abroad. More important, the financial sector distortions that are typically associated with negative real interest rates hamper the efficient allocation of available funds, thereby lowering the efficiency of investment.85
A comparison of the growth performance of a subsample of 33 developing countries with different levels of real interest rates as indicators of financial repression confirms these results (Table 17).86 Growth of potential GDP during 1975–89 was significantly faster in countries with positive real interest rates than in countries with negative real interest rates. Differences in the growth of total factor productivity were particularly large, suggesting that investment efficiency is negatively affected by financial repression.87
The evidence on the cost of financial sector distortions constitutes a strong argument in favor of structural reforms that allow market forces to play a greater role in financial intermediation. However, the experience with financial sector liberalization in developing countries has been mixed. In Argentina, Chile, and Uruguay in the 1970s and in the Philippines and Turkey in the early 1980s, rapid liberalization under conditions of macroeconomic instability and high inflation exacerbated macro-economic imbalances and contributed to financial crises. Lack of adequate banking regulation and supervision added to the difficulties. Also, financial liberalization in the presence of large distortions in other markets did not lead to a more efficient allocation of resources but rather contributed to reinforce these distortions. By contrast, countries such as Korea, Taiwan Province of China, and Tunisia, which proceeded more gradually with financial sector reforms, removed severe distortions in other sectors, and maintained a reasonable degree of macroeconomic stability, were able to avoid the disruptions experienced in other countries. In recent years, many other developing countries, including Ghana, Kenya, Madagascar, Mexico, and Nigeria, have allowed interest rates to reflect market conditions and have begun to reduce credit controls. Senegal and other countries in the West African Monetary Union have undertaken comprehensive financial sector reforms, In many instances, financial liberalization required supporting measures to strengthen the institutional infrastructure of the financial sector. The empirical evidence on the effects of such reforms indicates that, although the impact on saving was generally small, the measures succeeded in channeling a larger proportion of savings through the domestic banking system toward productive investment, including savings that had previously been invested abroad.88
|Countries with positive real interest rates|
|Countries with moderately real interest rates1|
|Countries with strongly negative real interest rates2|
Lessons from the Experience with Structural Reforms
Developing countries also have introduced structural reforms in several other areas in recent years, notably in the public enterprise sector, government finances, and in pricing policies in key industrial sectors such as energy. Many of these reforms are still at an early stage and are primarily motivated by fiscal considerations, but they are likely to have implications for resource mobilization and allocation. For example, measures that strengthen public sector finances and eliminate disincentives for private saving in the tax system help to increase national saving. Reform or privatization of public sector enterprises could enhance efficiency and competition in the industrial sector, while pricing of key inputs on the basis of opportunity cost helps to improve resource allocation.
The experience with structural reforms in the developing countries provides a number of important lessons. First, stable macroeconomic conditions, cautious financial policies, and a competitive real exchange rate have proven to be essential for sustainable structural reforms, particularly in the external and financial sectors. Second, when rigidities and distortions are pervasive, isolated measures in a few sectors are unlikely to yield significant benefits and may actually reinforce distortions in other areas. Third, although structural reform generally requires a comprehensive approach, careful sequencing can play an important role; sequencing of reforms should take into account different speeds of adjustment in goods and financial markets and the limited administrative capacity of most developing countries. Fourth, abandoning direct government controls and interventions in markets often requires the strengthening of indirect policy tools and other steps that ensure a smooth functioning of markets (for example, by removing monopolistic structures). In many developing countries that have undertaken structural reforms in recent years, these conditions were not always met and slippages occurred in numerous instances. Nonetheless, the benefits of sustained structural adjustment are evident in a number of countries, for example, Ghana and Madagascar.
After years of declining output and widening internal and external imbalances. Ghana and Madagascar embarked on comprehensive programs of macroeconomic stabilization and structural reform in the early 1980s. Initial measures focused on the reduction of macroeconomic imbalances but included a number of important structural reforms, such as the adjustment of agricultural producer prices, the establishment of a more market-oriented exchange rate, and a reduction of price controls. In subsequent years, stabilization efforts continued while structural reforms were stepped up significantly in the exchange and trade system and in the agricultural, enterprise, and financial sectors. These policies were accompanied by a sustained effort to strengthen the infrastructure and resulted in a marked improvement in macroeconomic conditions and growth.
Following a cumulative decline in real GDP of 20 percent and in export volumes of 40 percent between 1974 and 1983, output and exports in Ghana expanded at average annual rates of 6 percent and 12 percent, respectively, during 1984–89. At the same time, inflation dropped from an average annual rate of nearly 70 percent to less than 30 percent. In Madagascar, economic conditions did not improve as rapidly as in Ghana and output growth continued to lag behind population growth during most of the 1980s. More recently, however, exports and output growth have strengthened significantly in spite of unfavorable external conditions. While structural reforms do not always lead to a quick revival of growth, the experience in Ghana and Madagascar and in many other developing countries has shown that they are a critical element of adjustment programs aimed at restoring the potential for sustainable growth, particularly when accompanied by a redirection of government efforts toward improving the infrastructure, fostering development of human capital, and providing essential social services.
Developing Countries and the Uruguay Round
Domestic structural reforms and macroeconomic stability are essential ingredients of a strategy to improve developing countries’ medium-term economic performance. But the prospects of success will be greatly enhanced if the reforming countries also face a favorable external economic environment. The Uruguay Round of trade negotiations offers an opportunity to improve the external conditions facing developing countries through a significant liberalization of world trade. The advantages to developing countries of liberalizing their own trade regimes, whether unilaterally or in the context of multilateral negotiations, have already been discussed. In addition, there is the prospect of important gains for developing countries in terms of improved access to the markets of the industrial countries and those of other developing countries.
It is too early to assess the impact of the Uruguay Round on the developing countries, and precise quantification of the effects of trade liberalization is in any case difficult. The effects would vary from country to country and some countries—for example, those losing existing trade preferences—might benefit only in the long run. It may be useful, however, to indicate the order of magnitude of the potential effects to illustrate the kinds of benefits that could accrue from the successful completion of the Round. The analysis concentrates on the effects of industrial country liberalization on developing countries, in view of the size and importance of the industrial country market. Substantial gains would also be realized, however, if the developing countries reduced their own tariffs as well as other measures that act as barriers to trade between developing countries.
Current trade policies in industrial countries affect developing countries’ exports in a number of ways.89 First, the tariffs applied to trade with developing countries are on average higher than those on trade between industrial countries. Following completion of the Tokyo Round of tariff cuts, the average tariff applied by industrial countries against imports of manufactures from other industrial countries was less than 4 percent, but it was over 6 percent for imports from developing countries, even after allowing for the impact of arrangements favoring developing countries, such as the Generalized System of Preferences. Second, tariffs are generally higher on processed products than on raw materials, with the result that developing countries’ processing industries face high rates of effective protection in industrial countries’ markets. Third, the rapid growth of nontariff barriers over the last two decades has tended to be more pronounced for products exported by developing countries. For manufactures as a whole, the incidence of nontariff barriers in the industrial countries is estimated to be 50 percent higher for the exports of developing countries than those of industrial countries.90 The incidence of nontariff measures is particularly high in agriculture and textiles, both sectors of major importance to many developing countries. Countervailing and antidumping investigations are also being increasingly used by industrial countries against the exports of developing countries, often as a form of administered protection.91 Finally, developing countries face a number of other hidden barriers in industrial countries’ markets, such as public procurement practices, domestic subsidies, and national product standards. Of course, protection in many of these areas is also high in many developing countries, imposing costs on other countries as well as on the domestic economy.
Success in the Uruguay Round, the first GATT negotiation in which developing countries have been closely involved, would help to reduce some of these adverse effects. The objectives of the Round, and the progress to date, are described in detail in Supplementary Note 3. Over and above the traditional objectives of tariff reductions and tariff reform, the Round also seeks, among other things, to bring agriculture and textiles within the GATT framework, to tackle the growing use of voluntary export restraints and other nontariff barriers, and to implement effective safeguards and dispute-settlement mechanisms. Progress in these areas is of particular interest to developing countries. The industrial countries, on the other hand, are looking for better access to developing countries’ markets through, for example, lower tariffs and greater discipline in the use of trade restrictions for balance of payments reasons, as well as progress in the “new areas,” including trade in services and trade-related aspects of investment and intellectual property.
The negotiations taking place in Geneva are quite complex and the eventual outcome is still uncertain. Nevertheless, the potential benefits for developing countries from the successful conclusion of the Uruguay Round could be quite large. For example, it has been estimated that the elimination of the industrial countries’ tariff and nontariff restrictions could raise the level of GDP in developing countries by almost 3 percent.92 This is equivalent to about twice the amount that industrial countries currently devote to overseas development assistance. Another study suggests that the present value of exports of the heavily indebted countries could rise by an amount equal to one half of their total external debt, as a result of trade liberalization in industrial countries.93
The effect of a cut in tariffs can be illustrated using the models designed for medium-term analysis in the World Economic Outlook. The results shown in Table 18 illustrate the impact on developing countries of a 5 percentage point reduction in the average tariff on manufactured imports by all industrial countries.94 Such a reduction, which would correspond approximately to the removal of all tariffs on manufactured goods,95 would have macro-economic effects in industrial countries through lower prices, lower interest rates, higher imports, and temporarily faster growth of domestic demand.96 In addition, efficiency gains would result from improved resource allocation. In the simulation, it is assumed that the efficiency gains in industrial countries amount to an increase in productivity of about 1 percent, which is in line with estimates obtained from general equilibrium trade models. The main effects on developing countries, shown in the table, are higher exports, particularly from the relatively outward-oriented East Asian economies, and a significant decline in debt-service and debt-export ratios. Overall, net debtor countries could register GNP gains averaging about 1 ½ percent a year in this scenario. Moreover, this estimate probably understates the potential gains as it ignores tariff escalation and other biases in the tariff structure.
Nontariff barriers are particularly prevalent in the textiles and clothing sectors, where many developing countries have a comparative advantage. Trade in these goods is regulated by the Multifiber Arrangement (MFA), a framework of bilateral quotas that protect developed country producers, discriminate against new entrants, and generate large rents for quota holders. Recent research suggests that developing countries would realize efficiency gains of almost $8 billion (0.3 percent of their combined GDP) if MFA tariffs and quotas were eliminated.97 With the exception of Hong Kong and Macao, which would register very small income losses, all exporters would benefit, as improved market access would more than offset any loss of quota rent.
Together with textiles, protection for temperate agricultural products in the industrial countries represents one of the major distortions to the international trading system. Farm support costs consumers and taxpayers in industrial countries more than $200 billion annually and farmers receive subsidies equivalent to about 40 percent of the value of their output.98 If this support were removed, food prices on international markets could rise by 15–30 percent on average and the instability of prices could fall by about one third.99 This would be of direct benefit to major exporters of beef, sugar, cereals, and rice among the developing countries, including Argentina, Brazil, China, the Philippines, and Thailand. Overall, net exporters’ foreign exchange earnings from agricultural trade could rise by as much as $52 billion.100 However, the first-round effects of higher prices would be adverse for food-deficit countries, such as Egypt, Jamaica, Morocco, and Peru. There would also be shifts in income distribution within developing countries away from urban consumers and in favor of agricultural producers. Over the longer term, the pattern of gains and losses would depend on the wider consequences of agricultural liberalization in industrial countries. For example, economy-wide efficiency gains from agricultural reform in industrial countries would indirectly yield other benefits for developing countries, such as cheaper imports of manufactured goods and faster-growing markets. Moreover, if agricultural support in industrial countries were permanently reduced, developing countries would have greater incentive to liberalize their own agricultural policies, which (as indicated in the previous section) typically penalize agriculture. Domestic reform would substantially increase the gains to developing countries from agricultural liberalization.
(Differences from the baseline scenario in percent 2)
|Net debtor countries||By predominant export|
|Current account balance||1.2||0.9||0.2||Primary products exporters|
|Debt ratio||–7.1||–8.6||–7.2||Current account balance||3.5||2.9||1.0|
|Debt-service ratio||–1.1||–1.3||–1.1||Debt ratio||–23.3||–26.2||–19.5|
|Real GNP||1.3||1.6||1.6||Debt-service ratio||–2.6||–2.9||–2.1|
|Export volume||3.6||4.5||+.6||Real GNP||2.4||2.9||2.5|
|Import volume||2.9||4.2||5.0||Export volume||4.7||5.9||5.7|
|Africa||Exporters of manufacturers|
|Current account balance||1.0||0.8||—||Current account balance||0.9||0.6||0.2|
|Debt ratio||–9.2||–11.3||9.5||Debt ratio||–4.2||–5.3||–5.2|
|Debt-service ratio||–1.5||–1.7||–1.4||Debt-service ratio||–0.7||–0.9||–0.8|
|Real GNP||1.2||1.6||1.6||Real GNP||1.4||1.7||2.0|
|Export volume||2.6||3.4||3.3||Export volume||4.6||5.9||6.7|
|Import volume||3.0||4.1||4.5||Import volume||3.2||4.7||6.0|
|Current account balance||1.2||0.8||0.4||Current account balance||1.5||1.0||0.1|
|Debt ratio||–4.1||–5.1||–5.3||Debt ratio||–8.4||–9.5||–5.7|
|Debt-service ratio||–0.7||–0.7||0.8||Debt-service ratio||–1.5||–1.8||–1.1|
|Real GNP||1.5||1.8||1.9||Real GNP||1.2||1.6||1.6|
|Export volume||5.1||6.3||6.5||Export volume||2.6||3.4||3.5|
|Import volume||3.4||5.0||5.8||Import volume||2.4||3.8||4.6|
|Europe||Service and remittance countries|
|Current account balance||0.5||0.3||–0.1||Current account balance||2.5||1.7||0.5|
|Debt ratio||–3.7||–4.4||–1.1||Debt ratio||–12.9||–15.7||–13.9|
|Debt-service ratio||–0.7||–0.8||–0.1||Debt-service ratio||–1.2||–1.5||–2.0|
|Real GNP||0.9||1.1||1.1||Real GNP||0.7||1.0||1.0|
|Export volume||1.7||2.1||2.1||Export volume||2.0||2.6||2.8|
|Import volume||1.6||2.0||2.9||Import volume||0.9||2.2||3.2|
|Non-oil Middle East||Diversified exporters|
|Current account balance||1.0||1.1||0.2||Current account balance||1.1||0.9||0.2|
|Debt ratio||–11.3||–15.1||–12.9||Debt ratio||–5.3||–6.9||–5.6|
|Debt-service ratio||–1.3||–1.7||–2.0||Debt-service ratio||–0.9||–1.1||–0.9|
|Real GNP||1.3||1.8||1.8||Real GNP||1.5||2.0||2.0|
|Export volume||2.6||3.3||3.3||Export volume||2.9||3.7||3.8|
|Import volume||1.3||2.2||3.0||Import volume||2.5||3.7||4.2|
|Western Hemisphere||By miscellaneous criteria|
|Current account balance||2.1||1.4||–0.6||Fifteen heavily indebted countries|
|Debt ratio||–12.5||–13.6||–7.3||Current account balance||1.5||1.2||–0.5|
|Debt-service ratio||–2.0||–2.4||–1.4||Debt ratio||–10.6||–12.0||–6.9|
|Real GNP||1.3||1.6||1.4||Debt-service ratio||–1.8||–2.1||–1.3|
|Export volume||2.8||3.6||3.6||Real GNP||1.3||1.6||1.4|
|Import volume||3.0||4.7||5.5||Export volume||2.7||3.4||3.4|
|By financial criteria|
|Countries with recent debt-servicing problems||Small low-income countries|
|Current account balance||1.3||1.0||–0.3||Current account balance||2.0||1.4||0.6|
|Debt ratio||–9.2||–10.8||–6.9||Debt ratio||–16.8||–16.6||–12.5|
|Debt-service ratio||–1.3||–1.7||–1.2||Debt-service ratio||–1.3||–1.2||–0.9|
|Real GNP||1.1||1.4||1.2||Real GNP||0.8||0.8||0.8|
|Export volume||2.3||2.9||2.9||Export volume||1.8||2.1||2.0|
|Import volume||3.2||3.3||3.7||Import volume||2.2||2.7||3.0|
|Countries without recent debt-servicing problems||Four newly industrializing Asian economies3|
|Current account balance||1.1||0.8||0.3||Current account balance||0.9||0.4||0.2|
|Debt ratio||–4.8||–5.9||–5.5||Debt ratio||–0.9||–1.1||–1.3|
|Debt-servicing ratio||–0.9||–1.0||–0.8||Debt-service ratio||–0.2||–0.2||–0.2|
|Real GNP||1.5||1.9||2.0||Real GNP||4.9||6.6||7.8|
|Export volume||4.7||5.9||6.1||Export volume||7.7||10.1||11.8|
|Import volume||3.2||4.7||5.7||Import volume||5.3||8.3||10.8|
Reduction or elimination of industrial countries’ tariff and nontariff barriers to trade in tropical products also would benefit many developing countries. Estimates suggest that the export revenues of the main suppliers of coffee, cocoa, and tea could rise by 2½ percent as a result of liberalization in industrial countries; exports in processed form would rise by even more. Significant gains in export revenue would also be likely for other tropical products such as fruit, tobacco, and some tropical oils. However, the gains from liberalization in tropical products would not be evenly distributed. For example, Brazil and other Latin American exporters of coffee and cocoa could gain substantially but some countries currently benefiting from preferential access under the HC’s Lomé Convention might suffer some loss of export revenue.101
In areas where the industrial countries are seeking “concessions,” some developing countries have expressed concern about the impact of liberalization on the domestic economy and on their development goals. However, a number of considerations suggest that such concerns may be overstated. The advantages of a more outward-oriented trade strategy have already been emphasized, and the arguments for general trade liberalization appear to be gaining increasing acceptance. As regards the balance of payments provisions of the GATT, which allow countries to apply trade restrictions for balance of payments reasons, many developing countries now recognize that a lasting solution to external payments difficulties lies in appropriate exchange rate and macroeconomic policies and access to adequate external finance rather than trade restrictions. Many of the arguments for liberalization of trade in goods also apply with equal force to services, where access to cheap and high-quality service inputs (for example, transport, telecommunications, and financial services) is essential for developing countries wishing to promote efficient and competitive agricultural and industrial sectors. In some cases, other developing countries may be the most efficient providers of these services. Countries wishing to attract foreign direct investment, particularly in the face of competition from Eastern Europe, could improve their chances of success by reducing or eliminating trade-related investment measures (such as local content rules and minimum export requirements), allowing greater freedom for the right of establishment for service providers, and offering better protection for intellectual property.
It is one of the paradoxes of trade negotiations that the countries making “concessions’ are often the ones to gain most from the reduction in trade barriers. The reforms sought by industrial countries in the new areas of services, intellectual property, and investment involve measures that developing countries should find to be in their own interests. Conversely, although the potential gains to developing countries from tariff cuts and reform in the agriculture and textiles sectors are large, most studies suggest that the protecting countries would benefit even more. These examples illustrate that trade liberalization is not a zero-sum game. The benefits of economic liberalization are increasingly widely recognized. This has been reflected not only in the adoption of domestic structural reforms in the industrial countries, but also in the unilateral relaxation of trade restrictions in a number of developing countries in the last few years and in the market-oriented reforms currently under way in Eastern Europe. The challenge now is to build on this widespread support for liberalization and use it as a foundation for a successful multilateral agreement in the Uruguay Round.
Recent progress in implementing the debt strategy has been encouraging, but wider application of its essential elements will be needed to ensure its ultimate success. Since 1986, there has been a general decline in debt ratios in most groups of countries, with the notable exception of the low-income countries. In several cases where stabilization measures and structural reforms have been implemented, debtor countries have received substantial support from external creditors. In addition, debts owed to official creditors have been restructured under increasingly favorable terms, significant progress has been achieved in restructuring the commercial bank debts of some heavily indebted middle-income countries, and there has been some evidence of a return to market access by a few highly indebted countries. Nonetheless, in many other countries progress in restoring growth, correcting fiscal imbalances, and containing inflation has been insufficient to assure balance of payments viability over the medium term and to ensure the necessary financial support. The success of the debt strategy appears to require the right combination of macroeconomic stabilization, structural reforms, and, when necessary, external debt relief.
Paris Club creditors have continued to reschedule developing country debts, offering increasingly extended consolidation and repayment periods. In addition, the strategy of subordination of claims through the use of cut-off dates has been implemented to enable Paris Club creditors to provide new loans—including export credits—to countries that have rescheduled official debt and introduced strong adjustment programs. In the case of low-income countries, since late 1988 official creditors have agreed to reschedule the debt of 18 debtors by applying the menu of options agreed upon at the Toronto Summit in 1988. The reschedulings of nonconcessional debt according to the Toronto terms have incorporated an average grant element of about 20 percent.
So far, ten donor OECD countries have announced plans to cancel or convert into grants bilateral debt owed by low-income countries, mainly in Africa. Since 1980 the total amount of debt forgiven or converted is estimated at $5 billion (5 percent of the total debt of severely indebted low-income countries). In addition, resources have been mobilized under the Special Program of Assistance (SPA) for low-income countries in sub-Saharan Africa to support adjustment efforts. The supplemental IDA adjustment credit program has been launched by the World Bank, and the Fund has provided support under special concessional lending programs (the structural adjustment facility and the enhanced structural adjustment facility) for low-income countries with severe balance of payments difficulties. (For additional details see Chapter I.)
As regards commercial bank debt, over the past year Costa Rica, Mexico, and the Philippines have completed significant debt restructurings under the new debt initiative, while Chile has continued with its program of market-based debt reduction. Morocco and Venezuela have reached preliminary agreements with their creditor banks, and Uruguay and Jamaica have been granted waivers for buy-back operations.
A number of developing country borrowers have maintained access to international capital markets, where they have raised approximately $24 billion over the past year and a half. Furthermore, in Chile, Mexico, and Venezuela, private borrowers have been able to obtain foreign credits on a limited but voluntary basis, which indicates that international investors and private financial institutions do respond positively to constructive policies in indebted countries. Mexico and Chile also have registered significant inflows of private capital, including foreign direct and portfolio investment, as well as a reversal of short-term capital flows. The example of these countries illustrates the potential benefits resulting from a combination of debt restructuring and strong adjustment and structural reform programs.
The experience of those few countries that have consistently demonstrated their commitment to adjustment and reform and have maintained good relations with their creditors contrasts with that of other debt-distressed countries that have either postponed adjustment or have not persisted in implementing the required reforms. Indeed, over the last few years several developing countries with debt problems have received debt relief (mostly reschedulings and other forms of relief that ultimately increase external debt) and have initiated stabilization programs, and yet have been unable to service external debt obligations on a sustained basis. To some extent, the failure to achieve long-term balance of payments viability can be attributed to the fact that, unlike those that have avoided debt-servicing difficulties, these countries were unable to attain the degree of economic stability necessary to encourage saving and investment and to maintain the confidence of the domestic private sector and that of external creditors.102
The importance of domestic stabilization and adjustment has been consistently at the forefront of the debt strategy. Attention has focused on the large fiscal imbalances that have been at the root of macroeconomic instability in many developing countries. With the expansion in the public sector’s responsibility for managing external debt and meeting debt-service payments, external debt management and fiscal policy issues have become closely intertwined.103 In many countries the lack of success of stabilization programs reflects the government’s internal transfer problem, and thus the lack of viability of the fiscal position is at the core of the external payments problems of a large number of low-and middle-income highly indebted countries.104
Faced with an unsustainable fiscal situation, the government’s first priority must be to adopt the domestic policy measures needed to deal with the imbalance. The policies required, which typically include a mix of expenditure-cutting and revenue-raising measures, have been discussed above. In some cases, even after these fiscal initiatives have been implemented, full debt servicing may conflict with stabilization objectives. Additional taxes may be difficult to collect, while increased domestic borrowing to service external debt will tend to bid up interest rates and crowd out the private sector, thereby jeopardizing economic stability and growth and undermining the government’s ability to service debt. In extreme cases, when the contractual value of the government’s debt-service payments exceeds its expected debt-servicing capacity, even continued reschedulings, while providing cash-flow relief, may not restore fiscal viability in the long run.105
In cases where the mobilization of the public sector’s resources to service external debt in full is difficult, the fiscal benefits stemming from the reduction of debt and debt service could help ensure the success of the stabilization program. There are also other important benefits from debt relief, apart from the direct reduction in budgetary expenditures, such as an improvement in the investment climate as the disincentive effects arising from the debt overhang are removed and as uncertainties associated with repeated debt renegotiations diminish.106 Moreover, because of lower levels of external indebtedness, the impact of future fluctuations in world interest rates on the developing country economies should be reduced.
The preceding discussion suggests a number of important policy implications. First, the resolution of the debt problem may take considerable time, as the restoration of fiscal balance—the core policy issue—and the realization of the benefits of stabilization programs will require an extended commitment on the part of the government. Second, in cases of debtors’ insolvency, reducing debt and debt-service payments will need to be given serious consideration. Finally, principles of burden sharing, including contributions to the debt-relief effort, will need to be agreed by all the parties involved.
For their part, developing countries will need to implement stabilization programs that are consistent with external viability and are likely to gain the support of their creditors. Persistent efforts will be required to improve the government’s fiscal position by trimming unnecessary expenditures, selling assets and privatizing public sector companies, and reforming tax systems. Such efforts to put the government’s finances on a sound footing are essential to achieve macroeconomic stabilization and enhance the efficiency of resource use.
The continued commitment of the international community is crucial for the success of the strengthened debt strategy. Commercial banks will need to show flexibility to expedite the negotiation process in cases where new financing or debt and debt-reduction packages are necessary. Official creditors will need to continue to provide flexible financial support that addresses the specific needs of individual countries, when comprehensive reorientation of economic policies is under way. However, as recognized by the Houston Summit, Paris Club creditors will also need to continue reviewing additional options to address debt burdens, including the lengthening of repayment periods for lower middle-income countries implementing strong adjustment programs. More flexible approaches in the form of generous cash-flow relief may be required to give investors additional assurances about the continued support of official creditors, and thereby enhance conditions for restoring growth and investment. Recent initiatives announced by Canada, France, and the United States to reduce official debt and debt-service obligations in Africa and Latin America appear to recognize the severity of the problem of excessive indebtedness in severely indebted middle-income countries. For some low-income countries making serious adjustment efforts, assistance in addition to debt restructurings based on the Toronto terms may also be required. Moreover, the international donor community needs to continue to provide essential support and concessional economic assistance to the poorest countries whose development is highly dependent on external resources.
Finally, the international financial institutions must continue to provide both policy advice and financial assistance to countries demonstrating strong commitment to stabilization and reform. The central focus of international financial institutions’ support is the debtor country’s commitment to a strong adjustment program aimed at achieving sustained growth and internal and external financial viability. This support can enhance the credibility of economic programs, even in situations where debtors are not able to service fully their external obligations. An important aspect of the Fund’s involvement is helping to normalize members’ relations with their external creditors, while assuring that the financing provided is consistent with the requirements of the economic programs and with the safeguarding of Fund resources. To help these efforts, the Fund will need to continue to catalyze other sources of external financing consistent with the country’s progress toward external viability.