Information about Asia and the Pacific Asia y el Pacífico

2 Economic Growth in Developing Countries

International Monetary Fund
Published Date:
May 2011
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Information about Asia and the Pacific Asia y el Pacífico
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In chapter 1, economic growth is seen as critical to attaining the Millennium Development Goals (MDGs). Prospects for further progress on the MDGs should be seen in light of macroeconomic developments in emerging and developing economies, and in the global economic environment they face.

Economic recovery is proceeding along two tracks. Advanced economies are experiencing subdued growth with high unemployment, while many fast-growing emerging economies are seeing inflation pressures build amid some signs of overheating. Projections put annual global growth at about 4.5 percent in 2011 and 2012. But sustaining the global recovery demands divergent policy responses: in the advanced economies, redressing fiscal imbalances and repairing and reforming financial systems; in the emerging economies, facilitating external rebalancing and checking overheating pressures, in many cases allowing further exchange rate appreciation, and in some, more ambitious fiscal tightening.

Good policies among low-income countries contributed to strong growth before the crisis. The policy buffers established then also allowed for active countercyclical policies that softened the impact of the crisis and drove a relatively rapid return to pre-crisis growth rates. To substantially reduce poverty and meet the MDGs, however, low-income and other developing countries need to grow faster and to rebuild buffers so as to guard against future shocks. In addition to strong, well-designed policies in the countries themselves, international cooperation is required to restore a global economic environment conducive to poverty reduction and development and to provide adequate assistance, with special attention to the most vulnerable countries.

Economic recovery

Global economic activity has gathered pace, unevenly

The World Economic Outlook of the International Monetary Fund (IMF) estimates that after contracting by 0.5 percent in 2009, global GDP expanded by 5.0 percent in 2010, compared with the projection of 4.2 percent a year ago (table 2.1). The recovery is markedly uneven, however, with rates of growth in advanced market economies several percentage points less than those in emerging market and developing economies.1 Although below the levels existing immediately before the crisis, per capita real growth rates in low-income countries remained positive even in the depths of the economic crisis in 2009, and they strengthened further in 2010 (figure 2.1).

TABLE 2.1Global output, 2007-14annual percentage change
World output5.42.9-
Advanced economies2.70.2-
Emerging and developing economies8.
Central and Eastern Europe5.53.2-
Commonwealth of Independent States9.05.3-
Developing Asia11.
Middle East and North Africa6.
Sub-Saharan Africa7.
Western Hemisphere5.74.3-
Emerging economies9.
Other developing economies7.
Least developed countries (LDCs)a9.
Source: World Economic Outlook.

United Nations classification, a subset of developing countries.

Source: World Economic Outlook.

United Nations classification, a subset of developing countries.

FIGURE 2.1Low-income economies’ per capita growth remained positive in 2009, in contrast to elsewhere

Sources: World Economic Outlook; IMF 2010a; IMF staff estimates

Spurred by expanding inventories and fixed investments, global merchandise trade rose 13 percent in 2010, while industrial production also rebounded. Household spending firmed in many emerging market economies and in other countries with strong precrisis fundamentals. But in many advanced market economies, lower property values and stubbornly high unemployment reduced household wealth and incomes, while weaknesses in the financial system still constrain credit; together, these factors are restraining consumption. Exceptional policy stimulus helped advanced market economies achieve 3 percent growth in 2010—still a modest rate, considering that they are emerging from a deep recession.

Price inflation remains low in advanced economies, where unemployment is high and excess capacity is considerable, but is becoming a policy concern in some emerging market economies. Inflation rates in emerging market and some developing economies average about 6 percent, reflecting rising commodity prices and other factors. Most low-income countries do not yet seem to have experienced an increase in inflation.

Commodity prices have rebounded, leading to concerns over food price inflation

Together with other factors, economic recovery brought sharp increases in metals, food, and other commodity prices in 2010 (figure 2.2). This helped support a strong growth rebound among low-income commodity exporters. However, surging food prices are again sparking concerns over the affordability of food for the poorer segments of the population in some low- and lower-middle-income countries (box 2.1).2 Food price increases are also adding to inflationary pressures in many emerging market economies, while in parts of Sub-Saharan Africa good harvests have muted food price increases. With continued economic recovery in 2011, overall commodity prices may rise further—though food price levels will depend greatly on weather patterns during the year.

FIGURE 2.2Economic recovery has taken many commodity prices sharply higher

Sources: World Economic Outlook; IMF staff estimates.

Note: Indexes are in U.S. dollars. Data for 2011 are projected.

Policy challenges remain for global financial stability, but most low-income countries weathered the crisis well

In advanced economies, leverage is still high, and balance sheet restructuring and regulatory reform are incomplete. The heightened sensitivity of financial markets to fiscal outlooks is leading to funding pressures in some markets. Differences in interest rates and growth prospects have spurred strong capital flows from advanced to emerging (and some developing) economies.

Emerging and developing countries’ access to international financial markets has returned broadly to precrisis levels. After an uptick in mid-2010, the fall in international bond spreads toward 2006-07 levels suggests largely restored market access for sovereign borrowers and investment-grade corporations (figure 2.3). Market access for subinvestment-grade borrowers has also been substantially restored, though high-yield spreads remain well above those before the crisis—even if yields are now lower. Share prices have also increased (figure 2.4). Bank financing has continued to recover, notably to emerging markets in Asia and Latin America. With the protracted economic problems of emerging Europe, bank lending to them contracted modestly in 2010 (figure 2.5).

FIGURE 2.3Bond spreads and international bond issuance are virtually back to precrisis levels in emerging and developing countries

Sources: Dealogic; Bloomberg; IMF staff estimates.

FIGURE 2.4Share prices, too, have bounced back

Sources: International Financial Statistics; IMF staff estimates.

Note: Prices are presented in local currency.

FIGURE 2.5Emerging market bank financing continues to recover

Sources: Bank for International Settlements; IMF staff estimates.

Note: Liabilities to BIS-reporting banks, adjusted for exchange rate changes. Changes are calculated as flow adjusted for exchange rate changes as a share of the stock in the previous quarter.

Improved financial regulation and crisis policy measures helped banking systems in most emerging and developing countries withstand the crisis well. The share of nonper-forming loans did, however, increase somewhat further in 2010, as it did in advanced economies (figure 2.6). Banking sectors have also benefited from financial market resilience, including somewhat more stable exchange and interest rates. Even so, lingering concerns about systemic risks to bank and corporate solvency highlight the need to further strengthen the financial supervisory and institutional framework. To safeguard financial stability, the problems of impaired assets need to be addressed.

FIGURE 2.6Nonperforming loans in emerging and developing countries, 2003-10

Sources: Global Financial Stability Report; IMF staff estimates.

BOX 2.1The global food price surge in 2010—causes and prospects

The IMF food price index has increased sharply since the middle of 2010 and has surpassed its prerecession peaks (left figure). (For the index’s definition and methodology, see “IMF Primary Commodity Prices” at Price increases have been broad based and led by a surge in grain prices by 80 percent. Prices of key grains, including corn and wheat, have risen sharply to close to their 2008 peaks. For more income-elastic food groups, such as vegetable oils, meat, and seafood, prices are pushing past previous highs (right figure).

The catalyst for the recent food price rise has been a series of weather-related supply shocks to major grains. Wheat prices were the first to surge, as the improving supply picture reversed sharply in mid-2010. Drought and wild fires in the Russian Federation and Kazakhstan and heavy rain in Ukraine led to significant downward revisions in global production estimates. Corn prices began to rise as estimates of the 2010/11 U.S. harvest were progressively downgraded because of adverse weather during the summer months.

La Nañi has contributed to adverse weather conditions around the Pacific Rim. Recent satellite evidence indicates that this is among the most intense La Nina episodes of the last 50 years and that its effects are likely to be close to their peak during the southern hemisphere summer. This has already affected rice harvests across Asia and food products typically not traded globally, such as local fruits and vegetables.

While supply has disappointed, demand for major food crops has remained robust, largely reflecting growth in emerging economies but also demand for biofuel feedstock. Many important food items are relatively income inelastic, but previous global recessions have been associated with lower demand growth. During the most recent recession, however, demand growth remained steady and has now risen to around 2.5 percent a year for the major crops. China and other emerging market economies account for 70-80 percent of demand growth during the past three years. The U.S. corn ethanol sector has rebounded from the 2008-09 crisis. Almost 40 percent of the 2010 U.S. corn crop is estimated to have been used as ethanol feedstock, an increase of 5 percentage points over the previous year.

Low global inventories and trade restrictions have exacerbated the price response to supply disappointments in recent quarters. Global food inventories were run down to very low levels in 2002-08 as demand picked up and the global supply response lagged. That response has now begun, most evident in the increase in acreage harvested; but stocks will likely only recover gradually. The imposition and extension of grain export restrictions by Russia and Ukraine in 2010 added to price volatility.

Output should recover quickly from recent supply shocks, and increased global acreage indicates that more normal weather conditions will bring large harvests in 2011. Weather-related supply shortfalls tend to be followed by sharp recoveries in output for many major crops, including wheat. This would ease market tightness and allow prices to decline modestly over the next 12 months, although they will remain high compared with 10-15-year averages. One important risk is that the La Niña weather pattern may adversely affect southern hemisphere harvests. More generally, food markets will remain vulnerable to more widespread supply shocks for as long as inventories are low. (See also related discussion in the trade section of chapter 5.)

IMF food price index, 2005-11a

Source: International Monetary Fund.

a. U.S. dollar price index rebased at 2005 = 100. Data for 2011 are current as of February 2011.

IMF food price index groups, 2005-11a

a. U.S. dollar price index rebased at 2005 = 100. Data for 2011 are current as of February 2011.

Trade and capital flows have bounced back, into a changed picture

Globally, current account imbalances widened in 2010 after narrowing considerably in 2009 in the midst of the crisis (figure 2.7). They remain below the levels of 2004-08. A number of emerging market economies that experienced renewed surges in capital inflows in 2010 accumulated more foreign exchange reserves; the size of their current account surpluses did not fall and may have widened somewhat. After large swings in 2009, terms-of-trade changes in 2010 seem to have been relatively benign (figure 2.8). In emerging and low-income countries in 2010, levels of official reserves roughly kept pace with the rebound in trade, with only modest declines in the median ratio of reserves to imports and, for emerging economies, increasing somewhat relative to short-term external debt (figure 2.9).3

FIGURE 2.7Global current account imbalances, 2000-11

Sources: World Economic Outlook; IMF staff estimates.

Note: The global statistical discrepancy is not shown.

a. projected.

FIGURE 2.8Annual changes in terms of trade, by quintile group

Sources: World Economic Outlook; IMF staff estimates.

Note: Quintile groups are based on the average (mean) of terms-of-trade changes in 2009 and 2010.

FIGURE 2.9Reserve levels broadly kept pace with the rebound in trade

a. Reserves, in months of exports

Sources: World Economic Outlook; IMF staff estimates.

Note: Bars represent the range between the 25th and 75th percentiles.

FIGURE 2.9b. Reserves, in terms of the stock of external short-term debta

Sources: World Economic Outlook; IMF staff estimates.

a. The median ratio is shown. Stock of short-term external debt Includes amortization paid to official creditors.

The crisis affected low-income countries mainly through export demand, foreign direct investment (FDI), and remittances, more than global interest rates or the terms of trade.4 Exports from low-income countries contracted very sharply in late 2008 and early 2009. Critically, though, relative to previous crises, these countries had entered this crisis with lower external debt, narrower fiscal and current account deficits, and higher external reserves (figure 2.10). (See also chapter 1, regarding growth and these countries’ progress toward reaching the MDGs.) These proved to be important policy buffers that could be drawn upon to help cushion the shock (see lower external debt, narrower fiscal and current account deficits, and higher external reserves below). By late 2010, monthly exports to the Group of Twenty (G-20) countries approached their peak precrisis levels—but with interesting compositional shifts (box 2.2).

FIGURE 2.10Low-income countries’ precrisis macroeconomic policy buffers were stronger than in earlier years

Sources: World Economic Outlook; IMF staff estimates.

Despite important signs of a recovery in financial flows, the picture for emerging and developing countries is mixed. In aggregate, there was a sharp recovery in trade credit and strengthening in portfolio equity and bond flows in 2010, and modest increases in FDI flows.5 However, (simple average) net financial inflows, expressed relative to GDP, actually fell farther in 2010—suggesting that many recipient countries may not yet be sharing in these increases (table 2.2). Net financial flows to developing countries in 2011 are projected to reach 13 percent of GDP, near the average for 2007-08.

TABLE 2.2Net financial flowspercent of GDP
Flows20072008200920102011 projection
Emerging market economies12.
Private capital flows, net8.
of which: private direct investment5.
private portfolio flows1.2-0.9-
Private current transfers4.
Official capital flows and transfers (net)-
Memorandum item:
Reserve assets-3.9-1.7-2.4-2.0-1.7
Developing countries13.913.211.710.513.2
Private capital flows, net3.41.60.8-0.10.6
of which: private direct investment7.
private portfolio flows-1.9-1.6-1.6-1.5-1.3
Private current transfers3.
Official capital flows and transfers (net)
Memorandum item:
Reserve assets-4.3-2.3-3.4-2.9-3.5
Least developed countriesa12.910.58.29.311.8
Private capital flows, net-0.5-4.3-3.6-3.2-4.1
of which: private direct investment6.
private portfolio flows-2.5-2.4-2.6-2.5-2.4
Private current transfers1.
Official capital flows and transfers (net)11.412.99.610.013.5
Memorandum item:
Reserve assets-4.3-2.2-5.0-4.5-4.8
Fragile statesb14.
Private capital flows, net-1.5-7.4-8.8-8.7-6.4
of which: private direct investment6.
private portfolio flows-1.2-0.9-0.9-1.4-1.8
Private current transfers1.
Official capital flows and transfers (net)14.312.06.57.513.7
Memorandum item:
Reserve assets-4.3-2.8-7.6-7.0-9.9
Sources: World Economic Outlook; IMF staff estimates.Note: Unweighted simple averages.

United Nations classification, a subset of developing countries.

World Bank classification, a subset of emerging and developing countries.

Sources: World Economic Outlook; IMF staff estimates.Note: Unweighted simple averages.

United Nations classification, a subset of developing countries.

World Bank classification, a subset of emerging and developing countries.

Inflows of FDI are lagging other signs of recovery, both in emerging market and developing countries (table 2.2),6 although increases in workers’ remittances to precrisis levels have partly offset this (table 2.3).7

TABLE 2.3Inflows of international remittancesUS$, billions
Source of inflows2003-07

annual average




Emerging market economies150.2233.2224.1238.3252.5
Developing countries28.955.453.156.860.9
Least-developed countriesa12.822.924.225.927.9
Fragile statesb9.015.614.215.717.0
Sources: World Bank; IMF staff estimatesNote: Remittances include workers’ remittances, compensation of employees, and migrant transfers.

United Nations classification, a subset of developing countries.

World Bank classification, a subset of emerging and developing countries.

Sources: World Bank; IMF staff estimatesNote: Remittances include workers’ remittances, compensation of employees, and migrant transfers.

United Nations classification, a subset of developing countries.

World Bank classification, a subset of emerging and developing countries.

BOX 2.2Low-income-country exports during the exit from the crisis: early evidence

Exports from low-income to G-20 countries recovered steadily in 2010, after a sharp fall in the second half of 2008 and early 2009.a Using three-month moving averages (non-seasonally adjusted), their exports grew from US$15 billion in January 2007 to US$25 billion in August 2008, fell to US$13 billion a month in early 2009, then reached US$22 billion in October 2010 (figure below, left).

Low-income country exports, by destination

Sources: Global Trade Atlas; IMF staff estimates.

Note: Based on three-month backward moving averages of imports reported by Argentina, Australia, Brazil, Canada, China, EU-27, India (estimated for July–October 2010), Indonesia, Japan, Republic of Korea, Mexico, Russian Federation, South Africa, Turkey, and the United States;

Direction of trade

Of total low-income-country exports to G-20 countries, about two-thirds go to advanced market economies and one-third goes to emerging market economies (figure below, right).b But low-income-country exports to emerging market economies were growing more quickly before the crisis, fell less abruptly during the crisis, and in 2010 accounted for more than 40 percent of their export growth. Among exports to emerging market economies, however, China accounted for about one-third prior to the crisis, but nearly half by late 2010. While China accounted for about one-sixth of low-income-country export growth in the precrisis period, it accounted for one-quarter in 2010.

Contribution to export growth, by destination

Sources: Global Trade Atlas; and IMF staff estimates.

Product composition

Minerals constituted about two thirds of low-income-country exports prior to the crisis, followed by light manufactures such as textiles and clothing (figure below and at top right).c Exports of other (“heavy”) manufactures were under 10 percent before the crisis but close to 15 percent by end-2010 (figure at bottom right). Minerals exports were the source of the greatest changes in exports and remain the largest export category. They accounted for three-quarters of precrisis low-income-country export growth (mainly fuel exports by oil exporters), but were also highly vulnerable in the downturn—nearly 90 percent of the export contraction in 2009 was in minerals. Minerals exports remained the largest export item with the highest contribution to export growth in the postcrisis period: in 2010, about two-thirds of low-income-country export growth was in mineral products.

Interestingly, the exit from the crisis is also seeing increased exports of heavy manufactures. These rose from March 2009, driven by exports to China. This reflects exports of chemical products, plastics, rubber, and metal products, mainly from Asian low-income-countries.

Aggregate low-income-country exports will remain sensitive to demand for minerals and other commodities, an area where continued strong growth in emerging markets will be important. But there is also tentative evidence that emerging market growth may be helping some low-income countries diversify their export composition.

Low-income country exports, by product type

Sources: Global Trade Atlas; IMF staff estimates.

Note: Based on three-month backward moving averages of imports reported by Argentina, Australia, Brazil, Canada, China, EU-27, India (estimated for July-October 2010), Indonesia, Japan, Republic of Korea, Mexico, Russian Federation, South Africa, Turkey, and the United States.

Contribution to export growth, by product type

Sources: Global Trade Atlas; IMF staff estimates.

Low-income country exports: heavy manufacturing

Sources: Global Trade Atlas; IMF staff estimates.

Note: Based on three-month backward moving averages of imports reported by Argentina, Australia, Brazil, Canada, China, EU-27, India (estimated for July-October 2010), Indonesia, Japan, Republic of Korea, Mexico, Russian Federation, South Africa, Turkey, and the United States.

a. The analysis in this box is based on detailed bilateral monthly trade statistics provided for 19 of the G-20 countries under subscription by the Global Trade Information Service’s Global Trade Atlas.b. Countries are classified as follows: advanced markets refer to 32 countries included in World Economic Outlook classification 110; low-income countries refer to 71 countries eligible for the Poverty Reduction and Growth Trust; and emerging markets refer to all the countries in the sample that are neither advanced markets nor low-income countries.c. Products are classified as follows: agriculture (HS codes 01-05 [animal and animal products] and 06-15 [vegetable products]), minerals (25-27 [mineral products]); light manufactures (16-24 [foodstuffs], 50-63 [textiles], and 64-67 [footwear/headgear]); heavy manufactures (28-38 [chemicals and allied industries], 39-40 [plastics/rubbers], 72-83 [metals], 84-85 [machinery/electrical], and 86-89 [transportation]); and others.

Twin-track macroeconomic policies reflect the uneven economic recovery

In advanced and some emerging market economies, as the impact of fiscal stimulus wanes and active fiscal adjustment begins, highly supportive monetary policy remains important for a more vigorous recovery. But policy makers must address the social costs of continued high unemployment (including high youth unemployment in some countries) at the same time.8 Most emerging economies face different challenges, including incipient inflationary pressures and, often, a need to rebalance growth toward domestic sources. Accordingly, among developing countries and particularly among emerging market economies, the macroeconomic policy mix shifted notably in 2010. Following the combined monetary and fiscal loosening by most emerging market economies in the face of contracting global output in 2009, one-third undertook both monetary and fiscal tightening in 2010 (figure 2.11). As global conditions improved, developing countries also began to reverse their countercyclical policies.

FIGURE 2.11Macroeconomic policy responses to the crisis vary

Sources: International Financial Statistics; IMF staffestimates.

Note: Fiscal conditions are defined based on annual change in government balance as a percent of GDP in 2008, 2009, and 2010. Monetary conditions are based on the change in the monetary conditions index; changes are calculated Q4 over Q4, except for 2010, which uses Q3. The monetary conditions index s a linear combination of nominal short-term interest rate and the nominal effective exchange rate (with a one-third weight for the latter).

Continued accommodative monetary policy in most advanced economies has been critical to alleviating the financial crisis and recession. In contrast, monetary conditions in most emerging and developing countries began to normalize in 2010, but remained too accommodative in many cases. While some 80 percent of emerging market economies undertook monetary policy loosening in 2009, only about one-third did so in 2010. Many developing countries continued with some monetary loosening (figure 2.12). Resumed strong growth in emerging market economies underpinned declining measures of excess liquidity (such as growth of the money supply relative to nominal GDP), even as monetary aggregates expanded (figure 2.13).

FIGURE 2.12Monetary policy loosening

Sources: World Economic Outlook; IMF staff estimates.

Note: MCI = monetary conditions index. Monetary policy loosening is based on MCI calculations. MCI is a linear combination of nominal short-term interest rate and the nominal effective exchange rate (with a one-third weight for the latter).

FIGURE 2.13Average year-on-year growth in money and the money gap in emerging market economies

Sources: International Financial Statistics; IMF staff estimates.

Note: The money gap is the difference between year-on-year growth rates of the monetary aggregate M2 and nominal GDP. The sample includes emerging market economies that have data on both for the whole sample period shown.

Fiscal policy has begun to shift from supporting recovery to cutting deficits.9 The average deficit among advanced economies fell by about 1 percentage point of GDP in 2010. But because this mainly reflected better growth and reduced financial sector support rather than narrower cyclically adjusted balances, the need remains for robust, specific fiscal consolidation plans. Among major emerging market economies, deficits fell modestly and cyclically adjusted deficits were broadly unchanged, suggesting that easy credit conditions may be discouraging the more rapid consolidation that could help dampen currency appreciation and inflationary pressures (figure 2.14).10

FIGURE 2.14Fiscal deficit, 2008-11

Sources: World Economic Outlook; IMF staff estimates.

Note: General government balance data from World Economic Outlook based on Government Finance Statistics Manual 2001 definitions of fiscal balance.

Low-income countries have also begun to reverse the unprecedented countercyclical fiscal response that helped soften the impact of the crisis. As in past downturns, fiscal revenue declined during the crisis. This time, however, most of these countries did not curtail spending—indeed, about half of them accelerated growth of real primary expenditures in 2009, undertaking a vigorous countercyclical fiscal response that required additional financing (figure 2.15).11 As revenues grew in 2010, fiscal deficits declined by about 1 percentage point of GDP (more among Asian low-income countries), and low-income countries began to rebuild policy buffers, even as they broadly sustained rates of expenditure growth (figure 2.16).

FIGURE 2.15Low-income countries: fiscal balances and economic crises

Sources: World Economic Outlook; IMF 2010a; IMF staff estimates

FIGURE 2.16Real primary expenditure in low-income countries has increased in favor of public investment and social sectorsa. Real primary expenditurea

Sources: World Economic Outlook; IMF 2010a; IMF staff estimates.

a. Median.

FIGURE 2.16b. Real growth rate of primary expenditureb

b. Median

The quality of low-income-country macroeconomic policies in 2010 was broadly in line with that in recent years

Monetary policy, fiscal policy, access to foreign exchange, and the consistency of macro-economic policies are areas that IMF country desks judged strong in most countries in 2010 (figure 2.17).12 Expenditure composition and public sector governance are seen as areas of relative weakness. Whether the result of an actual deterioration or because the global crisis has enhanced awareness of the inherent risks, IMF teams appear to have become more concerned with the adequacy of low-income countries’ financial sector governance.

FIGURE 2.17Macroeconomic policy quality in low-income countries remained little changed

Source: IMF staff estimates.

a. Available from 2005.

Exiting from the crisis: achieving sustainable growth

Meeting the policy challenges in emerging market economies

Despite their impressive growth and declining poverty rates, emerging market economies remain home to many of the world’s poor people. A continued strong and stable economic performance, complemented by targeted poverty-reduction policies, will help these countries meet the MDGs. In addition, as these economies have become important trade and financial partners for low-income countries, this performance will also contribute to those countries’ MDG progress.

Fiscal balances improved in most emerging market economies in 2010, driven in part by higher growth. Their overall budget deficit in 2010 is projected at about 4 percent of GDP (around 0.75 percent of GDP lower than in 2009), in some cases partly the result of one-off receipts. Cyclically adjusted balances in the six largest economies were only marginally tighter in 2010, but an adjustment of around 0.5 percent of GDP is expected in 2011. Government debt rose during the crisis (especially in emerging Europe), but on average remains at less than 40 percent of GDP (below the average in advanced economies).

The policy challenges of the emerging economies involve overheating and strong capital inflows—issues quite different from those of other countries. (The advanced market economies, for example, must formulate and implement detailed fiscal consolidation plans to avoid unsustainable fiscal situations, even while they face sluggish growth and job creation.) For these economies, growth is generally strong and debt is manageable,13 although many are at risk of overheating pressures associated with rapid credit growth, inflation, and possible asset price bubbles. Robust domestic demand and the recovery of global output are leading to a rapid closure of output gaps, even as food and commodity prices have returned to precrisis peaks.14 Inflationary expectations are rising and policy targets have been exceeded in a number of Asian and Latin American countries. Inflationary pressures could threaten some otherwise sound policy frameworks, but some countries’ concerns about further currency appreciation are slowing their monetary policy responses. Strong capital inflows that exacerbate overheating pressures are complicating the policy response.

Timid policy responses to overheating would pose risks to the real economy and could derail growth prospects, especially in the large economies. Inadequate responses to large capital inflows could result in asset price overvaluations and an increased risk of a hard landing in credit and property markets, possibly triggering broader macroeco-nomic and financial instability (box 2.3). To lower risks of a hard landing, many emerging economies will need to tighten policies. This may include a further removal of monetary accommodation, further macroeconomic prudential tightening, and, often, exchange rate appreciation. Some will also need to tighten fiscal policies.

Tackling obstacles to growth in low-income countries

The crisis has set back progress toward the MDGs in many low-income countries, after an extended period of strong economic growth that had made substantial inroads into poverty. Although growth has since picked up and poverty rates are falling again, recovery at the projected pace will not make up the progress lost because of the crisis. To regain momentum, action is needed to boost growth, emphasizing growth patterns that benefit subnational regions and sectors where poor people are most numerous—and pushing ambitious microeconomic and sectoral reforms to promote access to social services and basic infrastructure.15 Economic growth in low-income countries must also be made more resilient so that progress is not derailed by future shocks.

BOX 2.3Emerging market capital inflows: experience and challenges

Capital flows to emerging market economies have rebounded with the ebbing of the global financial crisis. The largest recipients are Asian and Latin American emerging market economies, South Africa, and Turkey. In several countries, net inflows are close to all-time highs; on a gross basis, however, total inflows to emerging markets have yet to reach their precrisis peak. Compared with other waves of inflows, the current episode is characterized by a predominance of volatile portfolio inflows. Gross inflows have reached 6 percent of GDP in only three quarters since the postcrisis trough; it took three years to reach a similar magnitude in the surge that preceded the global crisis. Portfolio inflows account, on average, for almost one-half of inflows (Brazil and the Republic of Korea are the top two recipients), much more than in the previous wave. Direct investment and cross-border bank lending are less predominant this time, reflecting lagging economic performance and impaired financial intermediation in advanced market economies.

The main pull and push factors behind the recent acceleration of capital flows from advanced to emerging economies are improved fundamentals and growth prospects in emerging market economies and loose monetary policy in advanced economies. From a structural perspective, the global crisis and the more recent jitters in Europe have exposed balance sheet vulnerabilities in advanced economies and appear to have triggered a gradual shift in the portfolio allocation of institutional investors toward emerging market economies, many of which are enjoying low debt, proven resilience to shocks, and improved ratings. From a cyclical perspective, the two-speed nature of the ongoing global recovery will likely keep interest rate differentials between emerging market and advanced economies wide for a prolonged period. Surging commodity prices are an additional cyclical force pushing capital toward commodity exporters, such as Brazil and Peru. In relative terms, more-liquid emerging markets are attracting larger inflows. All things considered, the stage seems set for the ongoing wave of inflows to be both large and persistent, bringing important investment and growth benefits to emerging market economies. However, inflows have tended to reverse suddenly and in a synchronized manner in the past, causing sharp currency depreciation and severe balance sheet dislocations. Emerging market economies therefore face the challenge of absorbing the benefits of capital inflows while limiting the attendant macroeconomic and financial stability risks.

A close look at selected countries that have received large capital inflows provides useful insights regarding the effects of and policy responses to the recent episode of inflows (see the figure on the next page). These countries are facing large capital inflows mainly in the form of long-term portfolio debt flows, although commodity exporters also continue to enjoy large direct investment inflows. Despite significant accumulation of international reserves, real exchange rates in most cases have appreciated back to precrisis levels—although the degree of nominal appreciation has been less pronounced and more varied across countries. Surging portfolio inflows helped propel stock and bond prices especially in countries with shallower capital markets. While there are limited signs of bubbles so far, cyclical pressures are emerging, with credit to the private sector picking up strongly in some cases.

Macroeconomic policy responses to the current inflow episode have varied. On the monetary policy side, most countries have begun clawing back the easier monetary policy stance adopted during the global crisis. That said, countries have refrained from tightening aggressively, despite emerging inflationary pressures, out of fear that tightening would pull in more capital. The fiscal stance has also varied widely across countries, but most countries have yet to fully unwind the structural loosening adopted during the crisis, despite closing output gaps, implying a procy-clical stance in many cases.

The countries under review have generally complemented macroeconomic policy with other measures to manage capital inflows. Such measures include taxes on certain inflows, minimum holding periods, and currency-specific reserve requirements. Recourse to these measures has been motivated by concerns about export competitiveness, financial stability, sterilization costs, and political constraints on fiscal policy. Many measures were designed to address specific risks associated with certain types of flows, such as their impact on certain asset markets or their short-term nature; and to guard against the risk of flow reversal. Evidence to date on their effectiveness in reducing targeted inflows is mixed, though in most cases currency appreciation has slowed or halted around the time of the introduction of the measures. Market participants have expressed concerns about policy and regulatory uncertainty and distortions from measures that go beyond macroeconomic policies. Even so, they consider the measures implemented so far to be “at the margin” and are likely to continue investing in countries where the positive structural story dominates.

The variety of policy responses adopted—and their potential multilateral implications—suggests the importance of developing a broadly accepted framework for countries with open or partially open capital accounts on policies to deal with capital inflows. Choosing appropriate responses can be challenging given the uncertainties associated with the causes and effects of the inflows and with possible policy reactions. Even so, a framework for considering appropriate macroeconomic and other policy responses to inflows can be beneficial. Primacy should be given to structural measures that increase the capacity of the economy to absorb capital inflows and prudential measures that enhance the resilience of the financial system. Beyond this, when confronted with surging inflows, macroeconomic policies are appropriate tools—namely allowing the currency to strengthen, accumulating reserves, and/or rebalancing the monetary and fiscal policy mix.

Because they can potentially be used to avoid the necessary macroeconomic policy adjustments, measures designed to influence capital inflows (capital flow management measures or CFMs) could be used when appropriate macroeconomic conditions are in place—when the exchange rate is not undervalued, reserves are more than adequate, and the economy is overheating so that lowering policy rates would not be advisable. If these conditions exist but fiscal policy is pro-cyclical, CFMs could be used temporarily to complement fiscal tightening plans that are already in place, in view of the lags associated with the macro-economic impact of fiscal consolidation. If CFMs are adopted, residency-based measures generally should be given lower priority, consistent with the general standard of fairness that countries expect from their participation in a multilateral framework.

Capital Flows and Policy Responses in Selected Emerging Markets

Sources: International Financial Statistics; Haver Analytics; GDS; IMF staff calculations.

a. Net inflows are defined as the sum of foreign direct investment, portfolio, and other investment balances. Calculations are made for the last wave of capital inflows (2009Q3-2010Q2).

b. Capital flow management measures (CFMs) refer to certain administrative, tax, and prudential measures that are part of the policy tool kit to manage inflows.

Note: This box presents the main messages from IMF (2011b).

MAP 2.1GDP: Economic growth in 2009 and 2010 has been uneven

Source: World Economic Outlook.

MAP 2.2Fiscal balance: Countries are diverging in their responses to fiscal challenges

Source: World Economic Outlook.

To achieve accelerated and sustained growth, low-income countries will require much higher investment in infrastructure. By raising productivity and encouraging private investment, closing the present large infrastructure gap could substantially increase rates of per capita income growth.16 The cost of addressing Sub-Saharan Africa’s infrastructure needs is estimated at around $93 billion a year, equivalent to 15 percent of the region’s GDP (or 22 percent of GDP for the region’s low-income countries).17 This raises the twin challenges of investing efficiently in infrastructure to get the biggest possible growth dividend and financing that investment in a sustainable manner.

Effective public investment management is critical to efficient investing. It begins with establishing strategic guidance to anchor government thinking and inform sector-level decisions, and with independent review and analysis of the feasibility of prospective projects. In later stages, project selection processes, budgeting, implementation, project evaluation, and audit are key.18 A new index of the capacity of 71 developing countries (including 40 low-income countries) to appraise, select, implement, and evaluate infrastructure projects can guide public investment management reforms to areas in which they are needed most.19 Although the index scores for many low-income countries indicate weak capacity throughout the process, this is not universal: Rwanda, for example, scores better than many lower-middle-income countries.

Financing more infrastructure spending presents its own challenges, beginning with debt sustainability. Infrastructure competes with existing priorities (such as social spending) and with the new demands of adapting to climate change.20 Ongoing needs for large-scale grants and highly concessional loans for investment underscore the importance of donors meeting aid commitments, even as they face fiscal constraints at home. (See Chapter 5 for more discussion.) Given scarce concessional financing, however, low-income countries with moderate debt vulnerabilities and effective public finance institutions would be justified in borrowing on market terms to finance productive investments, within the limits of a sound debt management strategy.

Stronger domestic revenue mobilization has a key role in sustainable infrastructure financing. Tax revenue collections in low-income countries lag behind those of lower-middle-income countries by 6-8 percentage points of GDP. While low-income countries have large shares of hard-to-tax informal and small-scale agricultural sectors, such structural factors account for only part of the difference. Closing this gap will require long-term efforts. Experience suggests that vigorous reforms to tax policy and tax administration can raise revenue ratios by 1 percentage points in the first year and, if consistently pursued, by up to 5 percentage points over 10 years. Individual country circumstances vary, but tax policy reforms for a typical low-income country would emphasize broadening tax bases (such as for value added and corporate income taxes), increasing rates of certain environmental and excise taxes, and improving regional coordination on matters such as corporate taxes.21 Tax policy reforms should be complemented by efforts to secure taxes from large and medium enterprises and wealthy individuals, and by other tax administration reforms.

Enhanced market access for low-income-country exports would also support higher growth and help meet the MDGs. Multilateral trade reform—especially by concluding the World Trade Organization Doha Round (see Chapter 5)—would spur global trade and growth and foster a development-friendly global macroeconomic environment. Most critically for low-income countries, which need a stable global trading environment to export and to attract investment, the Doha Round would bring the added security of tightened World Trade Organization trade rules. Further actions by advanced countries and major emerging market economies to expand and improve trade preferences for the least-developed countries could further boost growth in the poorest countries.22

Making growth resilient in low-income countries

With policy buffers drawn down because of the global financial crisis, low-income countries now face the task of shoring up these buffers to boost resilience to future adverse shocks. A gradual consolidation of low-income countries’ macroeconomic positions over the medium term is projected, with improving fiscal and current account balances, moderate inflation, generally adequate reserve positions, and declining debt paths. Almost three-fourths of low-income countries are seen improving their fiscal buffers over the next four years. But doing so will require disciplined fiscal and monetary policies, together with vigorous financial and real sector reforms.

One-third of the projected improvement in the primary balance would come from a cyclical recovery in revenues. The balance would come mainly from measures to boost underlying revenue performance and trim nonpriority spending, some of which are part of longer-term reform efforts initiated before the crisis. Additional donor support to countries with larger projected adjustments could help ease the burden of rebuilding fiscal buffers. With low-income countries’ revenue-to-GDP ratios below potential, substantial and sustained increases in fiscal revenues (as outlined above) are critical to rebuilding buffers while making room for priority investments (figures 2.18 and 2.19).

FIGURE 2.18The overall debt outlook in low-income countries seems favorable as fiscal buffers are being rebuilt along with the recovery

Source: IMF 2010a.

FIGURE 2.19Low-income countries projected to cut real spending tend to have high deficits and debt

Source: IMF 2010a.

Note: The average for 2010 is shown.

For most low-income countries, medium-term debt dynamics are not a major concern as they rebuild fiscal buffers along the recovery path. For example, the median improvement in the primary balance is projected at 1.3 percentage points of GDP over five years. The share of countries with fiscal deficits in excess of 5 percent of GDP is projected to drop from almost half in 2009 to one-tenth by 2014. At the other end of the spectrum, almost half the low-income countries are expected to have fiscal deficits of below 2 percent of GDP by 2014, compared with one-quarter in 2009. As growth recovers and fiscal situations improve, the median public debt ratio would decline again: half the low-income countries would see public debt fall below 40 percent of GDP by 2015, while one-fifth would have debt exceeding 65 percent of GDP.

The global recovery is projected to boost demand for exports and strengthen current account balances, helping bolster reserve cushions. The projected improvement in the external environment would help maintain median reserve coverage at around the equivalent of four months of imports over the medium term, although country experience would differ: one in seven low-income countries would have reserve coverage exceeding six months of imports, while one in 20 would have less than two months.

Exchange rate policies should continue to be used to cushion the effect of future volatility where possible. Many low-income countries with fixed exchange rate regimes could benefit from somewhat faster accumulation of reserves. Conversely, some with floating rates appear to have built more than adequate reserve cushions; they could afford to raise spending (figures 2.20 and 2.21).

FIGURE 2.20The current account balance is projected to improve gradually in low-income countries as exports rebound

Source: IMF 2010a

FIGURE 2.21Reserve cushions would not improve much among low-income countries with relatively low reserves

Source: IMF 2010a.

Note: “Low” is defined as having less than three months of reserves coverage; “medium” as having more than three but less than four months of reserves coverage.

Most low-income countries can continue using monetary policy to support the recovery if the present moderate rates of inflation continue, but they must closely monitor the effects of commodity prices on their domestic inflation rates, given the risks associated with rising world prices for food and fuel. If these global shocks persist and feed through to local prices, monetary policy should accommodate the direct impact; however, it may need to be tightened in some cases to counter second-round effects.

The crisis has underscored the importance to low-income countries of adequate financial regulatory frameworks, effective supervision, and sound financial institutions. Supervisory authorities will need to ensure that credit standards do not deteriorate during times of strong credit growth. Regulatory frameworks should focus on the risks assumed by banks and the sources of their business growth to ensure that these are sustainable. Closer supervision is required to ensure that banks are complying with prudential regulations. In banks where financial strains have been significant, the balance sheet cleanup should proceed quickly—recognizing losses and having shareholders inject needed capital.

Developing domestic debt markets would help mobilize national savings and increase low-income country policy buffers, helping cushion the impact of the crisis. Low-income countries also have enormous investment needs that require financing. Although external financing has to remain a significant part of the financing mix, policies to mobilize domestic savings and develop domestic debt markets would broaden the range of available options.

Reforms that promote economic diversification also have an important role to play in managing macroeconomic volatility and fostering durable growth.23 Such diversification is likely to involve further trade integration, which will require both low-income countries and their trading partners to undertake further reforms of their trade regimes. Barriers in labor and product markets also impede the emergence of new sectors and the entry of new firms; addressing these barriers would promote diversification. To the extent that transformation in economic structures leads to social dislocation, it would be important to ensure that effective social safety nets are in place to protect vulnerable groups (see the discussion of indigenous peoples and socially excluded groups in chapter 4). Fragile states face special challenges (box 2.4; also see figure 1.7 and box 1.4 in Chapter 1 and box 5.4 in Chapter 5).

BOX 2.4Fragile states—experience and implications’a

Fragile states are generally off target to meet the MDGs. They are typified by poor initial conditions (left figure below), slow GDP growth (right figure below), and macroeconomic instability. These characteristics contribute to a cycle of underdevelop-ment that reinforces political instability and conflict, with negative regional spillovers.

Initial conditions

Source: IMF staff calculations.

Note: CPIA = Country Policy and Institutional Assessment; PIMI = public investment management index.

Growth of real GDP and consumption, fragile states and nonfragile states, 1970-2009

Source: IMF staff calculations.

The quality of institutions (measured by the Country Policy and Institutional Assessment and by the index of public investment management mentioned above) tend to be considerably weaker in fragile states than in other low-income countries.b Fragile states are also characterized by lower levels of development and a much higher incidence of conflict.c

Slow real GDP growth

  • During 1970-2009, average real GDP growth in fragile states was about one-fifth that of other low-income countries. The difference in the growth performance is especially apparent since the early 1990s.
  • While the number of growth upswings was broadly similar, growth downswings are twice as frequent in fragile states.
  • Output losses that follow economic and political shocks are larger and persist longer than in other low-income countries.

Macroeconomic instability

  • Measured by high inflation, large debt-to-GDP ratios, and low international reserves, macroeconomic instability has been much higher in fragile states than in other low-income countries.

Implications for global policy

International organizations and development partners have recognized that the problems of fragile states present distinct challenges and warrant well-targeted approaches. Concerned about preserving peace and security in these countries and aware of the risk of spillovers to neighbors, they have made considerable efforts to develop effective paradigms for engagement.

Their key challenge for effective engagement is to devise strategies that recognize these states’ capacity constraints, their large financing needs, and the need for prolonged engagement. Furthermore, given their multidimensional needs, fragile states would benefit from a well-coordinated and comprehensive strategy of assistance from the international community. This strategy should emphasize the paramount need to secure peace and security; the need to rebuild capacity and strengthen institutions through a common technical assistance strategy; and the design, scale, and timing of macroeconomic adjustment that can secure a virtuous cycle of development.

a. The IMF does not maintain a formal list of fragile states, and the analysis here uses the World Bank list.b. The average Country Policy and Institutional Assessment score for fragile states in 2008 was 2.82, compared with 3.57 for nonfragile low-income countries.c. This is indicated by lower per capita GDP and investment ratios and by weaker health and education indicators.

Boosting the impact of international support

To regain momentum toward the MDGs, international cooperation will be required on three fronts. First, low-income countries in particular will need a strong and stable global economic environment in which to continue growing. To secure such an environment, the advanced market economies need to repair and reform their financial systems and address their fiscal imbalances, and emerging market economies should adjust their macroeconomic policies to reorient growth domestically and to avoid possible overheating.

Second, actions are needed to help low-income countries achieve and sustain more rapid economic growth and restore their policy buffers. Inadequate infrastructure is one major challenge for growth. Addressing the infrastructure gap requires stronger public investment management systems and enhanced domestic revenue mobilization—areas where international organizations can offer policy advice and technical assistance. It also requires large-scale, highly concessional finance, underscoring the need for donors to meet aid commitments and to strengthen the overall effectiveness of aid. Another major challenge is to expand trade opportunities, particularly for the poorest countries. Key steps include completing the Doha Round and expanding and improving Aid for Trade.24

Third, fragile states lag farthest behind in reaching the MDGs, and they require additional support to help build institutions and move toward a virtuous circle of development, peace, and security.


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Except where otherwise noted, this chapter distinguishes “advanced” and “emerging and developing” economies according to the IMF World Economic Outlook country classification. Within the latter group, “emerging economies” are those not eligible for the IMF Poverty Reduction and Growth Trust (PRGT) (see and “low-income countries” (or “developing economies”) are those eligible for the PRGT. The analysis in box 2.4 is based on the World Bank definition of fragile states. Least-developed countries are a subset of low-income countries, as defined by the United Nations.


The January 2011 Global Economic Prospects (World Bank 2011a) examines the poverty implications of higher food prices (box 6 of that volume) and explores links between financial markets and food prices, finding little evidence that investment-based demand has driven up prices (box 7).


In 2009, increases in the ratios of reserves to imports reflected the IMF special drawing rights (SDRs) allocation (see the factsheet on SDRs at and 2009’s sharp contraction in global trade.


IMF 2010a.


World Bank 2011a.


World Bank 2011b, table 2.


World Bank 2011b.


In addition to immediate income loss from not working—loss for society and for the individ-ual—the considerable human costs of unemployment include long-lasting income loss, increased illness and mortality, and reduced educational achievement and social cohesion (ILO-IMF 2010). Policy makers can take the following steps to improve employment opportunities (including where young adult unemployment runs high): establishing more flexible labor market regulations together with effective social safety nets; implementing programs to upgrade skills and better match them with the demands of labor markets; and strengthening the business environment (IMF 2010d).


IMF 2011c.


In addition to facilitating greater price stability, there is evidence that fiscal adjustment in emerging economies has typically helped promote income equality in the longer term. See IMF (2010b), appendix 3.


More than half of the additional deficit was financed domestically, including borrowing in domestic debt markets, central bank financing, or drawing down government deposits. External borrowing accounted for much of the rest, with the IMF financing a significant component.


IMF country desks were asked in January 2011 to assess the quality of macroeconomic policies in 2010 as unsatisfactory, adequate, or good.


Recovery has been very strong in emerging Asia and Latin America and more restrained in the Middle East and emerging Europe, where output in some countries remains well below precrisis levels.


Emerging and developing economies’ export volumes grew 13 percent in 2010 and are expected to remain buoyant in 2011.


IMF 2010c.


Calderon (2009) estimates that by increasing the stock and quality of their infrastructure to that of Mauritius, Sub-Saharan low-income countries would raise their annual per capita income growth by more than 2 percentage points.


Brumby and Verhoeven (2010) note that though government investment spending among low-income countries accelerated in 2009-10, fiscal consolidation pressures may reduce its growth over the next few years.


IMF 2011a.


Hoekman and Wilson 2010; see chapter 5 of this volume.

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