LIDCs: Macroeconomic Trends and Outlook

Economic growth in most LIDCs has been strong over the past 15 years, faster than in previous decades and on par with growth performance in emerging markets. This performance was helped by external factors but domestic factors also played a central role, with sound macroeconomic management and wide-ranging market-oriented reforms providing the building blocks for sustained growth even as the global economy stalled in 2009. The impressive resilience of LIDCs during the global economic crisis was facilitated by the limited direct linkages between domestic financial systems and international financial markets.

The positive growth performance for the group as a whole masks a number of more problematic developments. For one, almost one-fifth of LIDCs failed to increase the level of output per capita over the period—mainly countries affected by conflict and weak states, but, in some cases, reflecting flawed economic policies. Second, growth has generally not been very deep or transformative, driven largely by factor accumulation rather than productivity gains. Thirdly, progress in reducing extreme poverty and reaching other Millennium Development Goals has been mixed.

Looking ahead, LIDCs may face continued economic headwinds in the form of mediocre growth in many trading partner countries. Nevertheless, growth is projected to remain generally strong, with a number of the larger economies (such as Bangladesh and Kenya) showing significant dynamism and with improved political conditions and/or policy reforms contributing to growth in other cases (such as Myanmar and Democratic Republic of Congo). The Ebola outbreak, if not contained rapidly, could have acute macroeconomic and social consequences on several already fragile economies in West Africa. Over the medium term, maintaining growth at the pace needed to employ fast-growing labor forces will be difficult without achieving structural transformation and associated strong productivity growth.

How vulnerable are LIDCs to adverse shocks?

Although LIDCs have been resilient in recent years, their still-limited export diversification and weakened policy buffers leave them less well-positioned to handle these shocks than prior to the global crisis. The share of LIDCs that are assessed to be highly vulnerable is easing slightly (to around 10 percent of the total); most of these countries are fragile states. Weak fiscal positions are typically the most important source of vulnerability across countries. Analysis of selected shock scenarios, drawing on the World Economic Outlook, flags the significant adverse impact on LIDCs of a protracted period of slower growth in advanced and emerging market economies. Temporary global oil price shocks have relatively modest output effects on LIDCs, but sizeable fiscal effects on those oil-importing countries that currently subsidize fuel products. Frontier market economies, expanding their links to the global financial system, face new risks; rapid credit growth and the expansion of foreign credit warrant close monitoring in some cases.

To enhance resilience, policy actions to rebuild fiscal buffers are a priority in many countries—through a country-specific mix of enhanced revenue mobilization and improved prioritization of public expenditures—as is the strengthening of fiscal institutions including public administration. Foreign reserve levels are insufficient in a sizeable number of LIDCs and need to be given higher priority in framing macroeconomic policies in these cases. The modernization of monetary frameworks underway in many countries will strengthen the effectiveness of monetary and exchange rate policies in responding to shocks. Over the medium term, policies to promote economic diversification would strengthen resilience in the face of shocks, including natural disasters, but will take time to deliver results.

What do we learn from recent debt trends in LIDCs?

Public debt levels are now at relatively low levels in the majority of LIDCs, helped by strong economic growth, low interest rates, and the provision of comprehensive external debt relief to some 34 countries under the Heavily Indebted Poor

Countries/Multilateral Debt Relief Initiative (HIPC/MDRI). Some three-quarters of LIDCs are currently assessed as being at low or moderate risk of experiencing external debt distress under the joint Bank-Fund Debt Sustainability Framework. Nevertheless, debt levels are high and/or have increased significantly in recent years in a third of LIDCs.

Looking at debt developments since 2007, most countries that had benefited from debt relief prior to that point (“early HIPCs”) have seen public debt levels (as a share of GDP) rise over time, although it is only in a few cases that debt accumulation has become a significant cause for concern. External borrowing (both concessional and non-concessional) has typically accounted for the preponderance of the debt build-up, but domestic debt levels have also risen significantly in a handful of cases (such as Ghana and Malawi). There has been no clear trend in debt levels among non-HIPCs (countries that have not benefited from HIPC/MDRI). However, the supportive conditions that helped stabilize debt ratios in LIDCs since 2007—notably easy global financing conditions—will likely fade away in the period ahead, flagging the need to avoid complacency.

The changing external financial landscape has enabled an increasing number of LIDCs to access international financial markets; non-traditional official creditors have also significantly expanded their provision of project finance. New borrowing options open the opportunity to increase development spending but borrowed funds cover their costs only if used to augment development spending on projects that yield appropriately high rates of return. Countries tapping new sources of funding thus need to give due attention to where the incremental funds go and how efficiently they are used. With new risks, such as bunching of repayments and rollover risk, efforts to strengthen public debt management are an imperative, supplemented by the development of a medium-term debt strategy on which new borrowing decisions can be grounded.

Approved By

Siddharth Tiwari and Vitor Gaspar