This Time Is Different—Fiscal Policy in Low-income Countries

By Carlo Cottarelli

When it comes to the crisis, most of the media attention is focused on advanced and emerging market countries. But low-income countries have been badly hit too, reflecting their growing integration in the world economy. We can see sharp declines in exports, FDI, tourism, and remittances. Output growth in 2009 will be less than half of the pre-crisis rate of over 5 percent. Sub-Saharan Africa is the worst affected, with a contraction of real per capita GDP of almost 1 percent.

This is the bad news. But there is some good news in all of this. Low-income countries have been able to use fiscal policy as a countercyclical tool this time around, far more than in the past. Fiscal deficits are expected to increase in three-quarters of low-income countries in 2009, with an average expansion of 3 percent of GDP. Revenues have grown slower than GDP, reflecting the disproportionate impact of the crisis on trade and commodity revenues, as well as weakening tax compliance. Expenditures are expected to increase by about 2 percentage points of GDP.

The crisis has also confirmed the importance of debt relief and donor assistance in creating fiscal space, and in supporting the fight against poverty (photo: Zohra Bensemra/Reuters)

Almost one-third of the low-income countries are augmenting their automatic fiscal loosening with a discretionary stimulus, mostly through current spending. Many low-income countries have sought to preserve or increase social spending, and IMF-supported programs have shown flexibility by allowing automatic stabilizers to work and by accommodating fiscal stimulus.

 Room for larger deficits

The fiscal easing has been more prevalent in countries with low or moderate risk of debt distress prior to the crisis. The combination of debt relief and sound policies led to falling debt ratios before the crisis, providing room to accomodate larger deficits during the crisis. We can see this in both Central America and sub-Saharan Africa. Countries with higher risks of debt distress had more limited room to expand deficits because of financing constraints—and many of these countries tightened fiscal policy by cutting non-social spending.

This experience confirms the importance of following prudent fiscal policies in good times, to be able to use fiscal policy to cushion shocks in bad times. And so, as the global economy recovers, countries will need to rebuild their fiscal space.

The crisis has also confirmed the importance of debt relief and donor assistance in creating fiscal space, and in supporting the fight against poverty. But major donor countries now face large deficits and rising debt of their own. In these circumstances, they could scale back support to low-income countries, in spite of Gleneagles commitments to double aid to sub-Saharan Africa.

Continued support to low-income countries must remain a priority. These countries still face daunting social and infrastructure challenges. Some still have elevated risks of debt distress that predate the crisis—I’m thinking here of countries like the Democratic Republic of Congo, Tajikistan, or Togo. Let’s face it—support to low-income countries is still a small fraction of total spending in advanced countries (a mere 1 percent of expenditures, on average).

While the advanced countries will need to tighten fiscal policy in the future, cutting funds for aid would cause severe harm to low-income countries, without making a significant difference to their own fiscal problems. At the same time, the onus is on low-income countries to continue improving the way foreign aid is spent, through strengthening public financial management, fighting corruption, and better prioritizing expenditure. 

2 Responses

  1. It probably helps to get some philosophy behind money and banking by reading a book like “The Ethics of money production” by Guido Hulsmann. (amazon : http://www.amazon.com/gp/product/1933550090/ref=pd_sim_b_1&tag=prezr-21 ).

  2. I think most governments have a “fear” of fiscal stimulus because they can see the possible inflationary consequences. But, with this large employment crisis, they should allow higher inflation rates and take adantage of the situation to beef up social policies, as Obama is doing in the U.S. with health reform. Don´t fear inflation; to grow and to generate wellbeing is the main duty of government.

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