What low-income countries can do about the commodity crisis

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By Seán Nolan, Hans Weisfeld and Klaus Hellwig

Almost three years into the sharp drop of global commodity prices that started in mid-2014, economic conditions have become very difficult for many of the world’s 60 poorest countries — a group the International Monetary Fund refers to as “Low-Income Developing Countries” (LIDCs).

As discussed in a recent report by the IMF, the situation is particularly challenging for commodity-dependent countries, which have seen tax and export revenues shrink markedly in response to lower commodity prices.

With commodity prices expected to remain subdued over the medium term, more decisive policy changes will be needed to restore macroeconomic stability.

But policies must be designed to reduce the pain for the population and preserve longer-term growth prospects.

Fuel commodity exporters have been the hardest hit by the commodity price decline — with the effects being more marked where exchange rate adjustment has either been resisted (by central banks) or is ruled out as an option (because currencies are tied to the US dollar or the euro).

On average, for fuel exporters, the large drop in oil prices, together with spill-overs into the non-oil economy, has pushed countries into recession and more than halved fiscal revenues.

Non-fuel commodity exporters have suffered less severely — both because export prices have fallen by much less than the price of oil and because they have benefited from lower oil import bills — but they are experiencing strains as well, with growth having dropped below 4 per cent, from 4.5 per cent previously.

While such performance seems solid when compared with more advanced economies, it is too slow to lift large numbers of people out of poverty and provide jobs for young and rapidly growing populations.

Doing substantially better, economies less dependent on commodities (so-called diversified exporters) have generally maintained their growth momentum at some 6 per cent per year. But some have felt the adverse effects of the end of the commodities boom through declining worker remittances and a drop in exports to oil-exporting countries.

The reversal in commodity exporters’ growth momentum, coupled with only limited adjustment of macroeconomic policies so far, has resulted in significant weakening in fiscal positions, particularly fuel exporting countries.

Thus, many of these countries are now seeing sharp increases in public debt. In diversified exporters, where fiscal deficits have remained elevated due in part to high outlays for public investment, debt is rising as well, from already elevated levels. With this, risks of debt distress are intensifying in many LIDCs.

Banking sector stresses are further compounding the growing vulnerabilities.

With weak growth and rising government arrears, indebted firms are facing loan-servicing difficulties, imposing strains on national banking systems.

Such stresses have already emerged in one-fifth of LIDCs, with most commodity exporters facing elevated risks of banking sector stress over the next one to two years. Addressing these stresses will be a challenging task for banking supervisors.

Beyond these broad trends, the story of economic developments in LIDCs over the past year is far from uniform.

For example, it has been a very difficult period for countries suffering from armed conflict and for countries hit by drought in East and Southern Africa. Millions of people are at risk of famine and starvation in the worst hit countries.

The challenge for policymakers, particularly in commodity exporting countries, is to restore macroeconomic stability while containing the burden imposed on the most vulnerable and preserving longer-term growth prospects.

This requires fiscal adjustments to put budget positions on a sustainable path while continuing to invest in people and infrastructure.

While the specific priorities depend on country circumstances, policies will typically need to include efforts to raise fiscal revenue by broadening the tax base and to cut back on low-priority and wasteful spending; if budget deficits are not reduced, public debt levels will soon become increasingly difficult to sustain.

Development partners can assist by providing more grant aid and concessional financing, and quickly providing humanitarian relief in regions threatened by famine.

The sharp decline in commodity prices has depressed growth and fiscal accounts in commodity exporters, most notably fuel exporters, leading to rising public debt levels. Many diversified exporters are also seeing risks from elevated debt.

With careful design, the budget adjustments needed to put the public finances on a sustainable path can be implemented in a manner that limits the burden on the poorest segments of the population while protecting growth-critical outlays.

Policymakers now need to act quickly and decisively. And for their part, development partners need to stand ready to provide more support.

Seán Nolan is a deputy director in the Strategy, Policy and Review Department of the IMF; Hans Weisfeld is deputy division chief, Strategy, Policy and Review Department of the IMF; Klaus Hellwig is an economist with the Strategy, Policy and Review Department of the IMF

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