OREANDA-NEWS. December 22, 2015. The paper also examines the experience of LIDCs with capital inflows over the past decade and it builds on a similar paper produced in 2014 that focused on longer-term economic developments.

The sharp decline in international commodity prices over the past 18 months has significantly affected many LIDCs. Countries heavily reliant on commodity exports (such as oil and minerals) experienced a significant slowing of growth in 2015 that is expected to carry over into 2016. In most cases, countries with more diversified export revenues are continuing to record robust economic growth. Natural disasters and internal conflicts have disrupted economic activity in several countries, while a few others have been affected by adverse spillovers from economic difficulties in Russia. In some cases, weak domestic policies have also contributed to poor growth outcomes.

Weakening fiscal and external positions have left many commodity exporters increasingly vulnerable to adverse shocks, underscoring the need for policies to adjust to what is expected to be a sustained period of less favorable export prices. Some diversified exporters that have benefited from improved terms of trade over the past two years also face elevated vulnerabilities, usually due to weakened fiscal positions.

The paper also examines the implications of the ongoing process of climate change on LIDCs over the longer term. It notes that most LIDCs are especially vulnerable to the projected effects of climate change and will need significant external assistance to adequately finance adaptation efforts.

Capital inflows to LIDCs have increased sharply in recent years, with some easing expected ahead, given lower mineral prices and tightening global financial conditions. While favorable external factors contributed to the surge in capital flows, strong economic performance and improved macroeconomic fundamentals in many LIDCs also provided a strong “pull” factor. Capital inflows have contributed to higher domestic expenditure levels, with the split between additional consumption and higher investment depending on both the type of capital inflow and on domestic policy settings.

Executive Board Assessment1

Executive Directors appreciated the focus of the staff paper on the impact of the sizeable declines in international commodity prices on LIDCs, coupled with the review of economic vulnerabilities and analysis of trends and drivers of growing capital flows to LIDCs. Directors also welcomed the effort to differentiate between LIDC sub-groupings, which should provide useful guidance for tailored policy advice, financial support, and technical assistance, while noting country-specific circumstances, even within sub-groups.

Directors broadly agreed with the assessment of recent economic developments in LIDCs against the backdrop of a more challenging external environment. They noted that the impact of the sharp fall in commodity prices has varied across LIDCs. Many commodity-dependent exporters, especially oil producers, have been hit hard, whereas countries less dependent on commodity exports have gained from falling import prices, notably through lower oil import bills. While growth has slowed in many commodity-dependent exporters, economic performance has typically remained robust in countries with more diversified trade structures. Moreover, several LIDCs have been badly hit by domestic supply shocks, including from natural disasters (such as Ebola) and worsening security conditions. Directors noted that security concerns have come to pose serious challenges that can affect the outlook for several LIDCs.

Directors noted that commodity price levels will likely remain low for the foreseeable future, requiring commodity exporters to adjust policies. Past debt relief and strong reform efforts have helped create policy space in many countries; in order to sustain this space, promote growth and poverty reduction and avoid further recourse to debt relief, it will be important over the medium-term to strengthen fiscal positions, including by improving domestic revenue mobilization and public financial management, and to push ahead with reforms to enhance competitiveness. Directors emphasized the importance of economic diversification and structural transformation to increase LIDCs’ resilience to adverse shocks and sustain growth. International financial institutions, including the Fund, have a role in helping countries improve institutional capacity and design adjustment programs, and in providing financing to smooth the adjustment process in line with their respective mandates.

Directors noted that, while several diversified exporters have maintained strong fundamentals, short-term economic vulnerabilities have increased across a significant number of LIDCs. In part this reflects the economic shocks experienced by commodity exporters but also the erosion of policy buffers in some countries less dependent on commodity exports. Directors underscored the importance of using good times to build the fiscal and external buffers needed to allow countries handle future adverse shocks effectively.

Directors noted that LIDCs, particularly small states, are especially vulnerable to the effects of natural disasters. In most cases, they are particularly at risk to the adverse effects of climate change, reflecting geographical location as well as the relative weight of agriculture in national GDP. They agreed that LIDCs will need significant concessional climate finance by the international community, along with capacity building and sound policies to strengthen resilience and effectively handle adaptation to climate change without compromising on achieving development goals.

Directors noted that, in recent years, portfolio inflows to LIDCs have risen markedly alongside foreign direct investment. They recognized that, while global financial conditions have provided a supportive environment, improved domestic fundamentals have played an essential role in attracting inflows. Noting that rising yields could be a source of concern for countries with higher current account and fiscal deficits, Directors stressed the need to ensure that these inflows are used wisely to boost investment and growth. They also highlighted the importance of sound debt management strategies, strengthened financial systems, and efforts to deepen domestic debt markets.

Directors saw merit in having an annual formal Board discussion of macroeconomic developments in LIDCs while stressing the importance of consistent messages, avoiding overlap across the range of IMF products covering these developments, and not imposing new resource demands on the IMF budget. They looked forward to the next such discussion around the time of the 2016 Annual Meetings.

1 At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.