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MACROECONOMIC DEVELOPMENTS AND SELECTED ISSUES IN SMALL DEVELOPING STATES

May 2015

IMF staff regularly produces papers proposing new IMF policies, exploring options for reform, or reviewing existing IMF policies and operations. The following documents have been released and are included in this package:

  • The Staff Report on Macroeconomic Developments and Selected Issues in Small Developing States, prepared by IMF staff and completed on March 9, 2015 to brief the Executive Board on March 20, 2015. The Executive Directors met in an informal session, and no decisions were taken at this meeting.

The policy of publication of staff reports and other documents allows for the deletion of market-sensitive information.

Electronic copies of IMF Policy Papers are available to the public from http://www.imf.org/external/pp/ppindex.aspx

International Monetary Fund

Washington, D.C.

© International Monetary Fund

Front Matter Page

MACROECONOMIC DEVELOPMENTS AND SELECTED ISSUES IN SMALL DEVELOPING STATES

March 9, 2015

Executive Summary

This report builds on the work in the 2013 Board paper on Fund Engagement with Small States, the 2013 background papers on Asian and Pacific small states and Caribbean small states, and the 2014 staff guidance note. It provides a deeper analysis and policy recommendations in respect of three challenges identified in these papers. Looking ahead, the paper also analyses the impact and possible policy responses to two global economic trends—lower oil prices and diverse movements in major currencies.

Macroeconomic trends and outlook. Vulnerabilities for many small states remain high. The outlook for small states is for generally sluggish growth, higher fiscal deficits after a temporary narrowing in 2013, and an upward drift in already relatively high public debt ratios, even after taking account of lower oil prices which represent an economic windfall for the majority of small states.

Fiscal management. Expenditure rigidity and revenue volatility in the face of limited fiscal buffers often results in procyclical fiscal policy, requiring efforts to streamline and prioritize recurrent spending to create fiscal space for capital spending. The quality of expenditure could be improved through fiscal anchors and public financial management reforms.

Exchange rate devaluation. Several analytical approaches find that the effects of devaluation are not significantly different between small and large states—including its impact on growth—although the transmission channels are different. Devaluation results in lower consumption and higher investment in small states and its effectiveness can be strengthened by complementary wage and anti-inflation policies.

Financial inclusion. Access to financial services is a challenge in many small states, as the banking sector is typically small and highly concentrated and the lack of competition constrains the delivery of financial services. For lower-income small states in particular, weak financial inclusion limits access to credit, with consequences for investment and growth. Where possible, small states should foster competition as a way to develop financial inclusion.

Approved By Peter Allum, Hoe Ee Khor, Adrienne Cheasty, and Anne-Marie Gulde-Wolf

Project coordinated by Wendell Samuel (WHD). Prepared by Xavier Maret, Mai Farid, Sarwat Jahan, and Calixte Ahokpossi, (all SPR under the guidance of Peter Allum); Patrizia Tumbarello, Ezequiel Cabezon, Antoinette Kanyabutembo, and Yiqun Wu (all APD); Sebastian Acevedo, Aliona Cebotari, Kevin Greenidge and Geoffrey Keim (WHD); and Marshall Mills, Valeria Fichera, Albert Touna-Mama, Pietro Dallari, Naly Carvalho and Graham Campbell (all AFR) with statistical support from Zhe Liu (SPR) and editorial support from Eneshi Kapijimpanga and Edward Moreno (WHD).

Contents

  • ABBREVIATIONS AND ACRONYMS

  • INTRODUCTION

  • BOX

  • 1. Definition of Analytical Groupings of Small States

  • TABLES

  • 1. Selected Macroeconomic Indicators, Small States and the Rest of the World, 2013

  • 2. Profile of Developing Small States

  • MACROECONOMIC TRENDS

  • A. Recent Macroeconomic Performance and Near Term Outlook

  • B. Vulnerabilities and Structural Issues

  • BOXES

  • 1. Effects of Commodity Price Decline

  • 2. Diversification in Small States

  • FIGURES

  • 1. Impact on 2015 Projections of Lower Oil Prices and Other Factors

  • 2. Vulnerability Profile for Small States

  • APPENDIX FIGURES

  • STRENGTHENING FISCAL FRAMEWORKS AND IMPROVING THE SPENDING MIX IN SMALL STATES

  • A. Introduction

  • B. Improving the Mix of Public Spending

  • C. Coping with Revenue Volatility

  • D. Policy Reform Options

  • BOXES

  • 1. Pacific Islands: Quantifying the Opportunity Cost of Building Fiscal Buffers

  • 2. From Best Practice to Best Fit: Lessons from Small States

  • FIGURES

  • 1. Small States: Spending Mix and Infrastructure Gap

  • 2. Measures of Efficiency of Public Spending and Population Dispersion

  • 3. Health, Education Expenditure, and Selected Human Development Indicators

  • 4. Small States: Sources of Revenue Volatility

  • 5. Small States: Revenue Volatility Across Different Groups

  • 6. Small States: Procyclical Bias in Fiscal Policy

  • APPENDIX

  • I. Econometric Analysis

  • ANNEX

  • I. Fiscal Anchors in Small Developing States

  • EXTERNAL DEVALUATIONS: ARE SMALL STATES DIFFERENT?

  • A. Introduction

  • B. Results

  • C. Conclusion and Policy Implications

  • BOXES

  • 1. Exchange Rate Regimes in Small States

  • 2. Two Cases of Devaluations in Small States

  • FIGURE

  • 1. Event Study: Growth Outcomes in Large Devaluation Episodes

  • ANNEX

  • I. Literature Overview and Methodological Notes

  • FINANCIAL INCLUSION IN SMALL STATES

  • A. Introduction

  • B. Access to and Use of Financial Services

  • C. The Banking Sector and Financial Inclusion

  • D. Other Barriers to Financial Access

  • E. Conclusions and Policy Recommendations

  • BOXES

  • 1. Determinants of Interest Rate Spreads in Pacific Island Countries

  • 2. Promoting Financial Access by SMEs: The cases of Mauritius and Seychelles

  • FIGURES

  • 1. Individual/Household Use of Financial Services

  • 2. Households Use of Financial Services

  • 3. Physical Access to Financial Services, 2013

  • 4. Households Use of Nonbank Financial Institutions

  • 5. Firms Access to Financial Services by Income Level

  • 6. Firms Access to Financial Services by Country Grouping

  • 7. Bank Competition, Concentration and Financial Access

  • 8. Other Barriers to Financial Access

  • TABLE

  • 1. Determinants of Financial Access

  • APPENDICES

  • I. Empirical Specification of the Panzar-Rosse Model

  • II. Panel Regressioin Specification and Estimation

  • ISSUES FOR DISCUSSION

  • REFERENCES

  • STATISTICAL APPENDIX

Abbreviations and Acronyms

AFR

African Department

APD

Asia and Pacific Department

CPIA

Country Policy and Institutional Assessment

DSA

Debt Sustainability Analysis

ECCU

Eastern Caribbean Currency Union

EMDCs

Emerging Market and Developing Countries

EUR

European Department

HIPC

Heavily-Indebted Poor Countries

LICs

Low-Income Countries

MIC

Middle Income Country

MFI

Microfinance Institution

M-LML

Micro Lower-Middle and Low Income

M-UMH

Micro Upper-Middle and High Income

PICs

Pacific Island Countries

PRGT

Poverty Reduction and Growth Trust

OFC

Offshore Financial Centers

S-LML

Small Lower-Middle and Low Income

S-UMH

Small Upper-Middle and High Income

SPR

Strategy, Policy and Review Department

WEO

World Economic Outlook

WHD

Western Hemisphere Department

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Macroeconomic Developments and Selected Issues in Small Developing States
Author:
International Monetary Fund