Growth prospects for the non-oil middle-income countries, 1977-85: A favorable forecast, beyond the present period of inflation and adjustment, depending on suitable internal policies

The non-oil middle-income developing countries have so far been remarkably successful in cushioning the effects of both the recession and their worsened terms of trade through increased international borrowing. This article suggests that they have the ability to maintain a reasonably high rate of growth over the medium term, while progressively reducing their reliance upon external borrowing as their exports expand. Success will depend heavily upon internal policies in these countries, as well as upon trends in the world economy.

Abstract

The non-oil middle-income developing countries have so far been remarkably successful in cushioning the effects of both the recession and their worsened terms of trade through increased international borrowing. This article suggests that they have the ability to maintain a reasonably high rate of growth over the medium term, while progressively reducing their reliance upon external borrowing as their exports expand. Success will depend heavily upon internal policies in these countries, as well as upon trends in the world economy.

John A. Holsen

The non-oil middle-income developing countries achieved annual growth rates of real output that averaged 7.4 per cent in 1969-73. These countries have been able to cushion the economic shocks from adverse external developments since 1974 by high levels of external borrowing. Thus, the average growth rate of their output is expected to fall to only 5.4 per cent in 1974-78 (which roughly coincides with the period these economies are expected to require to adjust to the changed circumstances). As the adjustment period comes to an end, there are good prospects that these countries will increase their growth rates. Between 1979 and 1985 they should be able to maintain average annual growth rates of gross domestic product (GDP) of 6.6 per cent. They will be in a position to give increasing attention to problems of regional imbalances and income distribution, and to improving the social and economic infrastructure upon which long-term development depends‑areas which in some cases have been rather neglected as attention was concentrated on rapid growth in total output.

The non-oil middle-income countries are defined for the purpose of this article as those that are not significant net exporters of petroleum products, and have average per capita annual incomes over $200 and under $2,000 (at 1973 prices). They are a highly varied group (see Table 1) and their averages conceal great differences between countries and even within the larger ones. The largest bloc is in Latin America; the second largest bloc is in East Asia. The remainder of these countries are in southern Europe, the Middle East, North Africa, and a few in Sub-Saharan Africa. Despite their many differences, however, it is useful to look upon them as a group because of their many common concerns and, in contrast to the poorer non-oil developing countries their comparatively rapid historical and prospective rates of economic growth.

Table 1.

Principal non-oil middle-income countries

(Selected indicators for 1975 in millions of U.S. dollars)

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Not applicable.

Notes: Data on current account deficits, long-term capital inflows, and gross international reserves (at year-end) are from the IMF’s International Financial Statistics. Per capita GNP figures are from the 1976 edition of the World Bank Atlas, External debt data cover debts of or guaranteed by government agencies, including undisbursed amounts, and are from World Bank sources.

A number of non-oil middle-income countries are excluded from the above list because their international financial transactions are comparatively small or, in a few cases, because the relevant data are not available. Estimates for these countries are, however, included in the accompanying study when totals are given for the non-oil middle-income countries. These additional countries are: Afars and Issas, Angola, Bahamas, Barbados, Belize, Botswana Cameroon Cape Verde, Congo, Peoples Republic, Cyprus, Equatorial Guinea, Falkland Islands, Fiji, French Guiana French Polynesia, Gilbert Islands, Grenada, Guadeloupe, Guinea-Bissau, Guyana, Hong Kong Lebanon, Liberia, Macao, Martinique, Mauritius, Mozambique, Namibia, Nauru, Netherlands Antilles New Caledonia, New Hebrides, Pacific Islands (U.S.), Papua New Guinea, Reunion Rhodesia’ St. Helena, Sao Tome and Principe, Senegal, Seychelles, Solomon Islands (British) Surinam Swaziland, Tonga, Western Samoa.

These favorable prospects are, however contingent upon a number of factors. As: the present period of recession and adjustment comes to an end, the growth of: these middle-income countries will depend increasingly on their own policies. Over: the medium term, a dominant feature of: these policies must be export expansion The adjustment period saw extraordinary levels of foreign borrowing by many of these countries. Although this is expectecd to continue on a substantial scale for several years, their reliance on debt will need to be progressively replaced by closing their trade balances.

This article is based on a World Bank staff study. The projections of growth in output, trade, and capital flows are taken from the “base case” projection, which assumed that real output in the industrial countries would grow at an average rate of 4.9 per cent annually in 1976-85, while world prices (expressed in U. S. dollars) would increase at about 7 per cent annually.

The share of investment in GDP is expected to continue to increase, while dependence upon foreign savings is likely to be reduced from the abnormally high level of over 4.5 per cent of GDP in 1975 to 1.5 per cent in 1985. An improvement in the terms of trade from the very adverse terms of 1975 is expected, but it will by no means be enough to restore the level of 1967-69 prices. It is mainly for this reason that it will be necessary to have a trade surplus, when exports and imports are measured in 1967-69 prices, instead of a trade deficit. The principal trends are shown in Table 2.

Table 2

Trends in investment, savings, and capital requirements in the non-oil middle-income countries

(As per cent of GDP) 3

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Based on data in 1967-69 dollars.

In this table exports and imports are valued at 1967-69 prices. As a result of changes in the relative prices of exports and imports, however, the trade flows may be significantly different when expressed in the current prices of each year. The “terms of trade loss” (in this case expressed as a per cent of GDP) is the decrease in a country’s international purchasing power due to changes in the relative prices of its exports and imports.

Equals current account deficit.

Most of these developing countries should experience a sharp improvement in their export earnings in the next few years simply as business conditions recover in the industrial countries. What is required, however, is a sustained expansion of economic growth. The projected average growth rate of 7.3 per cent per annum in export volume between 1978 and 1985 (see Table 2) is not possible for many of the traditional exports of this group of developing countries because of their limited markets. The needed increase in export earnings must, therefore, be obtained largely through the expansion of nontraditional exports. This cannot be expected to take place unless the developing countries concerned adopt export-promotion policies and unless they receive progressively greater access to the markets of the industrial countries.

A great deal has already been accomplished in the creation of a greater international division of labor. Exports of manufactured goods by these developing countries have increased very rapidly over the past 15 years, although the increases were concentrated in only a few countries. Processing of primary products within the developing countries is expanding, although this activity is often held back by discriminatory tariffs. Among the middle-income developing countries, specialization and diversification are gradually taking place; Brazil is an outstanding example‑it has reduced its role as a supplier of coffee while increasing its exports of manufactured goods.

The “success stories” in the expansion of nontraditional exports provide numerous illustrations of both the possibilities and the problems involved. Outward-looking policies have been effective in increasing export earnings and local employment in export-related activities. However, incentives for exports of manufactured goods must be carefully designed; excessive incentives for such exports combined with overvalued exchange rates are the economic equivalent of a tax on agricultural exports and will adversely affect this important sector. The export-promotion efforts of these developing countries will need to be complemented by liberalization and adjustment measures on the part of the industrialized countries. The willingness of the latter to accept growing imports of manufactured goods from the developing countries will, of course, depend heavily upon the success of the industrialized countries in achieving satisfactory levels of employment and output.

Capital flows

The net inflow of medium-term and long-term capital to the non-oil middle-income countries rose from an average of $7 billion in 1969-73 to $16 billion in 1974 and to an estimated $24 billion in 1975. Over the next several years this inflow is expected to stay in the $20‑22 billion range. These figures are in projected current prices, assuming world inflation of about 7 per cent annually. Thus, in real terms, the net inflow is expected to decline. In relation to the growing trade of the non-oil middle-income countries, the decline is even sharper. By 1978 the net inflow‑expressed in relation to exports (or to imports)‑ is expected to be below the average level of 1969-73 (see Table 3).

Table 3

Net capital inflow (medium-term and long-term loans plus official grants) of non-oil middle-income countries, 1969-85

(In billions of current U. S. dollars)

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Figures in this column do not total those under “Official” and “Private” due to rounding.

Deflated by the index of import prices for non-oil developing countries.

However, these projections of net capital inflow by no means imply an easy balance of payments situation. During the period up to 1980 the situation will be particularly tight. The projections in this article assume that these developing countries will strengthen their creditworthiness through export expansion and careful financial management. They also assume that private financial institutions will be willing and able to expand their lending to developing countries that meet satisfactory standards of creditworthiness. To the extent that either of these assumptions is not realized, imports and output in the non-oil middle-income developing countries will be restricted to levels lower than those projected.

The current account deficits and capital inflows of the non-oil middle-income countries are largely the counterpart of the surpluses of the major oil exporting countries. These surpluses must necessarily be balanced by deficits in other sectors of the world economy. The poorer of the non-oil developing countries can offset only a small part of this surplus; their deficits must be financed largely by scarce concessional assistance. In addition, their absorptive capacity is limited. Some of the economically stronger industrial countries have successfully avoided current account deficits; other industrial countries are seeking to reduce the deficits they have been running. In these circumstances the non-oil middle-income countries have, in effect, been assigned most of the role of offsetting the surpluses of the oil exporters. So far this process has worked with fewer difficulties than had been anticipated. As the surpluses of the oil exporters are expected to continue for some time, facilitating the necessary capital flows is of interest to all participants in the increasingly interdependent world economy. Reactivation of the growth of the economically stronger industrial countries is important, partly because it will help to keep the share of the surplus of the Organization of Petroleum Exporting Countries that must be offset by the non-oil middle-income countries within manageable limits.

The projected relationships between trade and capital flows shown in Table 1 are considerably influenced by the inclusion of some countries that have substantial trade, but only small capital inflows (for example, Hong Kong, Singapore, and the Netherlands Antilles). A more realistic view of the debt problem can be obtained by a closer look at a selected group of 25 non-oil middle-income countries that accounted for about 83 per cent of external debt (outstanding and disbursed) at the end of 1974, but for only about 60 per cent of the exports and imports of all non-oil middle-income countries in that year.

The aggregate debt service ratio of these 25 countries is expected to rise from 18 per cent of exports in 1973 to a peak of almost 25 per cent in 1979; a modest decline is projected in the 1980s (see Chart 2). The growth of the debt service burden in the next few years is largely a result of what has already happened or now seems inevitable; the reversal after 1979 will take place only if trade deficits in relation to GDP are reduced to below their pre-1974 levels. Even so, the projected debt service ratio would be about 21 per cent in 1985. These average figures obviously conceal some of the problems of individual countries. However, if exports and imports grow as projected, many of the non-oil middle-income developing countries would be able to opt for somewhat higher levels of growth and external indebtedness by the mid-1980s if they so wished.

The increase in the conventionally calculated debt service ratio overstates the increase in the real debt burden of the middle-income countries because this ratio fails first, to distinguish between interest and amortization obligations; and second, to reflect the characteristics of much of the recent increase in their borrowing. Since roughly two thirds of future debt service (see Chart 2) represents amortization payments, there is considerable scope for reducing the debt service burden through longer maturities or measures that facilitate rollovers. Financial credits with floating rates, which make up a large part of the recent increase in indebtedness, should be comparatively easy to roll over as long as interest service is maintained and creditors take a favorable view of the borrowers’ financial management and prospects. Some loans, which the debt records show as financial credits, represent transactions between parent companies and their subsidiaries; these are alternatives to direct investment and, under normal circumstances, are expected to be rolled over. The fact that disbursements of financial credits are not linked to particular imports or to progress in project implementation eases the borrowers’ problems of debt management.

The interest component of the debt service ratio also overstates the real burden arising from external debt. The average interest rate on debt outstanding and disbursed is less than 1 per cent above the assumed global inflation rate of 7 per cent. This is an average of a moderately negative real rate on loans from official sources and a moderately positive real rate on loans from private sources. It partly reflects the lower interest rates that prevailed some years ago, when much of the present debt was incurred. But in real terms the rates on commercial loans are likely to be considerably below the yield from potential investments. It will make good sense for the non-oil middle-income countries to continue borrowing relatively large amounts at commercial interest rates until their exports expand further.

Chart 1
Chart 1

Total medium-term and long-term external debt of 25 non-oil middle-income countries

(In billions of current U.S. dollars)

Citation: Finance & Development 0014, 002; 10.5089/9781616353292.022.A008

Source: World Bank

The needs for amortization must not place an excessive strain on the cash flow of the borrowers, nor should the latter become too dependent upon sources of finance that might substantially reduce their lending for reasons related to developments in the creditor country rather than the position of the borrower. In these circumstances, capital from private financial institutions and capital from official development agencies are complements rather than substitutes. If development financing from official sources falls short of the projected level, borrowers will have difficulty in maintaining an appropriate balance between longer-term official debt and medium-term borrowing from financial institutions, except at the cost of reduced economic growth.

High debt service ratios are a matter of concern because they reduce a country’s ability to counter unpredictable variations in export earnings and import requirements. A country’s own foreign exchange reserves are its normal first line of defense, but the comfortable levels of a few years ago have been rapidly eroded by rising import prices. Commodity agreements to help stabilize export demand, and expanded compensatory financing arrangements can reduce the risks of comparatively high debt service ratios, and thus strengthen the creditworthiness of the middle-income countries for loans from private financial institutions. More generally, the creation of new measures to reduce such fluctuations or to provide readily available resources to meet unexpected needs would greatly benefit both the non-oil middle-income countries and the international community.

Internal policy improvements

Growth depends more upon the effectiveness with which a country mobilizes and utilizes its own resources than upon the capital inflows from abroad. By far the larger share of investment financing in these middle-income countries is mobilized internally: their net capital inflow in the 1969-73 period (defined as the deficit on current account) averaged less than 2 per cent of their combined GDP, and financed less than 10 per cent of investment and less than 13 per cent of imports. The events of 1974 and 1975 temporarily made the lack of foreign exchange the dominant concern, but more recently internal policy issues have been reassuming their normal importance.

Priorities for internal policy improvements will vary from country to country, but a great many of the common problems fall under the general heading of financial management. Exchange rate policies too frequently fail either to encourage the best use of the country’s limited import capacity or to provide reasonable incentives for exports. Budgetary and pricing policies may leave essential services and public sector investment activities inadequately financed; excessive government dependence upon domestic credit adds to inflationary pressures and also pre-empts credit resources needed elsewhere in the economy. Frequently a combination of tax measures and the establishment of expenditure priorities and controls is required. In most developing countries the public sector takes responsibility for a substantial range of directly productive activities. Often the pricing policies in these areas are inadequate to generate a cash flow to cover a reasonable share of new investment requirements. The implicit subsidies that result commonly prove to be poorly directed in terms of either economic or social objectives.

Chart 2
Chart 2

Debt service on medium-term and long-term loans for 25 non-oil middle-income countries

(As per cent of exports, including net factor services)

Citation: Finance & Development 0014, 002; 10.5089/9781616353292.022.A008

Source: World Bank

An aspect of financial management of increasing importance is concerned with external debt. The degree to which it is feasible and desirable to establish control over private capital movements will vary from country to country, but in all cases an explicit policy regarding public sector indebtedness should be implemented. It is necessary to see that borrowing terms are consistent with debt management objectives and that the limited external capital is appropriately allocated. The planning and control of foreign borrowing may also help to coordinate the expenditures of those public sector agencies that escape normal budgetary control, since their larger projects typically involve some foreign financing.

The development of an efficient system of financial markets is a concern in practically all middle-income developing countries. The prevailing level and structure of interest rates, however, frequently conflict with this objective. Rates paid to depositors may be too low for the financial intermediaries to attract private savings; sub sidies to borrowers through low interest rates frequently have questionable effects on resource allocation and may run counter to employment objectives.

Effective resource use

Over the longer run, the effectiveness with which each developing country’s own resources are mobilized and allocated will be the most important determinant of its success or failure in accomplishing its growth objectives. The international economic environment, however, will also affect this process. The success of the major industrial countries in establishing and maintaining high levels of output and demand is of the greatest importance in this regard. In addition to the direct effect of increased demand for developing countries’ exports, there is an indirect effect of high growth rates in the industrial countries; the latter are more likely to adopt policies facilitating the nontraditional exports of the developing countries when their own output and employment levels are expanding satisfactorily.

The non-oil middle-income developing countries will require, in addition to effective internal policies and a favorable international economic environment, substantial continuing inflows of capital from both official and private sources. If their growth potential is to be realized, the net inflow should continue (during 1977-80) at about the 1976 level in nominal terms; this implies, of course, a decline in real terms and an even sharper decline relative to their output and exports. This level of borrowing should not give rise to a generalized “debt problem” in the middle-income countries. As has always been the case, of course, individual countries with unsatisfactory financial policies may get themselves into balance of payments difficulties. But, for the group as a whole, the prospects are favorable, and debt service ratios are expected to decline after 1979.

The middle-income developing countries have attained a position in the world economy where, in aggregate, they are a major market for the industrial nations. By accomplishing the projected 6.6 per cent annual average growth rate, they will contribute significantly to the level of economic activity in the industrial nations. Thus the generally favorable prospects for the middle-income developing countries bode well for the world economy as a whole. As trade and financial links intensify, it is increasingly important to all countries that the evolving international economic order adequately reflects the needs of the middle-income developing countries.

Finance & Development, June 1977
Author: International Monetary Fund. External Relations Dept.
  • View in gallery

    Total medium-term and long-term external debt of 25 non-oil middle-income countries

    (In billions of current U.S. dollars)

  • View in gallery

    Debt service on medium-term and long-term loans for 25 non-oil middle-income countries

    (As per cent of exports, including net factor services)