The Implications of the Global Financial Crisis for Low-Income Countries

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Description

The global financial crisis is expected to have a major impact on low-income countries (LICs), especially in sub-Saharan Africa—and urgent action is required by LIC policymakers and the international community. The crisis is projected to increase the financing needs of LICs by at least US$25 billion in 2009, and much larger needs are possible. Twenty-six LICs appear particularly vulnerable to the unfolding crisis. Additional external assistance and foreign financing will be essential to mitigate the impact of the crisis on LICs. The Fund is deploying its own financing facilities for LICs, while making efforts to sustain and catalyze additional assistance from other institutions and donors. Fund financing to LICs has already increased significantly; new financing arrangements jumped from 5 in 2007 to 23 in 2008, representing an increase in total (GRA and PRGF/ESF) disbursements from US$0.6 billion to US$5.4 billion. The Fund has also launched a broad examination of its LIC facilities and financing framework to ensure its financial assistance meets the diverse needs of its lowincome members.

The global economy is in the midst of a deep downturn, affecting the real and financial sectors, that is taking its toll both in advanced and in emerging and developing countries. All major advanced economies are in recession, while activity in emerging and developing economies is slowing abruptly.

LICs are exposed to the current global downturn more than in previous episodes, as they are more integrated than before with the world economy through trade, FDI, and remittances.

The crisis significantly impacts these countries through reduced demand for their exports. Since many are commodity exporters, they will be hard hit by the sharp decline in demand for commodities and in their prices. Many LICs are also hit by lower remittances and foreign direct investment (FDI) while aid flows are under threat. Growth of remittances was flat in the second half of 2008, and is expected to be negative in 2009. A sharp slowdown in FDI is expected in about half of all LICs. Prospects for higher aid to offset these effects are particularly uncertain, given budgetary pressures faced by many donor countries.

LICs’ financial systems have so far not been strongly affected by the global crisis. Their banks have little, if any, exposure to complex financial instruments. However, those LICs that had begun to access international financial markets have seen this access come virtually to an end. Foreign lenders may become more reluctant or unable to roll over sovereign and private debt falling due. Domestic banks may be hit by second-round effects, as the economic downturn increases the number of borrowers unable to repay their loans.

The global financial crisis will worsen the budgetary position of many LIC governments. Government revenues are expected to suffer as economic activity slows and commodity prices fall. Potential declines in donor support and tighter financing conditions will likely impose further pressures on LICs’ budgets. At the same time, many countries will need to increase spending to protect the poor, and additional spending pressures may arise from currency depreciation and rising interest rates, which could raise debt service costs.

Author

IMF. March 2009