On November 13, 2019, the Executive Board of the International Monetary Fund (IMF) discussed an IMF staff paper on recent economic developments and near-term prospects in low-income developing countries (LIDCs). The paper also examines the challenges faced by LIDCs in the implementation of a value-added tax system and how financial safety nets can be appropriately tailored to the specific circumstances of these countries.

Background

LIDCs are a group of 59 IMF member countries primarily defined by income per capita level below a certain threshold (set at $2,700 in 2016). This group of countries contain one fifth of the world’s population—1.5 billion people—but account for only 4 percent of global output.

LIDCs are expected to record average annual growth of some 5 percent in 2018–19, a reasonably robust performance against the backdrop of loss of momentum in the global economy. Commodity-dependent economies continue to fare less well than countries reliant on other export sectors, a pattern in place since the drop of commodity prices from mid-2014; experiences vary markedly within these groups, with countries in fragile situations typically recording weaker-than-average performance. Looking ahead, growth is expected to pick up marginally in 2020 and beyond, although risks to the global economy threaten this outlook.

An analysis of the drivers of longer-term growth patterns in LIDCs highlights the importance of investment levels in contributing to growth, but also the drag on growth stemming from inefficient use of resources, weak business climates, and low levels of human capital.

Public debt accumulation in LIDCs has slowed significantly since 2017, having risen markedly in the preceding four years, but debt levels continue to drift upward in about half of the countries.

Progress in boosting domestic revenue mobilization over time has been mixed, with the median tax-GDP ratio in LIDCs, at about 13 percent of GDP, remaining broadly unchanged from the levels recorded in 2013. But one-quarter of the countries have succeeded in increasing this ratio by at least 2 percentage points over this period, showing that sustained progress can be achieved with well-designed reforms.  

The value-added tax (VAT) can be a very effective instrument for boosting tax revenues, but many LIDCs have faced significant challenges in building the institutional capacity to execute the provision of VAT credits in a timely manner and to manage VAT registration in a cost-effective manner. As these challenges are addressed, the VAT can be expected to deliver higher revenues with in an efficient and cost-effective manner.

Recent experience with bank failures in some LIDCs has highlighted weaknesses in financial sector safety nets that contribute to financial sector instability. These include the absence of effective bank resolution regimes, of well-designed emergency liquidity assistance frameworks, and of a financially sound deposit insurance system. Upgrading safety nets, including by targeted adaptation of international standards to suit local conditions, can enhance the overall stability of the financial system while bolstering depositor confidence in the security of their savings. 

Executive Board Assessment[1]

Executive Directors broadly endorsed the assessment of macroeconomic developments in low-income developing countries (LIDCs) and the policy priorities outlined in the staff report. They also welcomed the discussions of the experience with implementing VAT in LIDCs and how financial safety nets can be appropriately tailored to the specific circumstances of these countries.

Directors noted the solid growth of output in LIDCs in 2018-19, despite slowing global growth, while underscoring that there was large variation in experiences across countries. Commodity exporters are still recovering from the large drop in commodity prices from mid-2014, whereas many diversified exporters have been recording strong growth for several years. Within these broad groupings, several countries, often fragile or conflict-affected, have been falling behind, recording little if any sustained growth in GDP per capita. Directors noted the broadly favorable medium-term outlook, while recognizing the sizeable downside risks to this outlook, both external and domestic.

Directors welcomed the examination of longer-term drivers of growth across LIDCs, noting that the poor performance of total factor productivity growth had acted as a significant drag on economic performance in many countries. They underscored the importance of improving public investment management capacity to strengthen the quality, efficiency, and prioritization of public investments, enhancing governance frameworks, as well as strengthening the key role of the business climate in influencing both the scale of and returns to private sector investment. They agreed on the importance of building human capital for longer-term growth and welcomed the improvement in access to education across LIDCs, while noting the need to strengthen its quality. To better understand the inclusive nature of growth in LIDCs, Directors encouraged more analysis of poverty dynamics and the evolution of per capita incomes.

Directors were encouraged by the improvement in fiscal balances in a majority of commodity exporters, helped by a pick-up in revenues. In the context of generally low fiscal revenues in most LIDCs, mobilizing domestic revenue, by broadening the tax base and strengthening tax administration, is essential. While welcoming the significant progress made in boosting revenues in some of the countries, Directors expressed concern that the median tax-GDP ratio across LIDCs had not changed significantly since 2013. They called for more analysis to identify the key factors contributing to success or failure in boosting tax revenues across LIDCs.

Directors agreed that the VAT is an efficient and productive instrument for building a strong tax base. However, they saw a need for renewed efforts to tackle the implementation challenges faced in many LIDCs, notably the handling of VAT credits and the management of VAT registration. Directors called on the Fund and other providers of technical assistance to help build the relevant institutional capacity in LIDCs.

Directors agreed that the distributional impact of the VAT needs to be viewed as part of the wider mix of fiscal policy, including both tax and expenditure policies. They noted that, while concerns about the regressivity of the VAT are relevant, governments have other instruments to address distributional objectives, with new possibilities for well-designed benefit programs being opened up by digitalization.

While growth of public debt levels in LIDCs has slowed markedly since 2017, Directors noted that public debt vulnerabilities remain a serious cause of concern in many LIDCs, with more than two-fifths of countries assessed to be at high risk of, or already in, debt distress. They emphasized the importance of strengthening debt management capacity and improving data quality and transparency, to be supported by implementation of the joint Bank-Fund multi-pronged approach to tackle debt vulnerabilities.

Directors expressed concern that financial sector stress remains significant in many LIDCs, with elevated levels of nonperforming loans, and that the loss of correspondent banking relationships (CBRs) continues to be a challenge in many countries. They called for proactive oversight by the regulatory authorities to contain financial stress, along with sustained efforts to substantially strengthen financial sector regulation and supervision frameworks, supported by the international community and the Fund. They also encouraged the Fund to continue to work with authorities and financial regulators to better understand the drivers, impact, and potential solutions with regard to the withdrawal of CBRs.

Directors concurred with the need to strengthen financial sector safety nets in many LIDCs, particularly in developing a robust bank resolution regime, a soundly-designed emergency liquidity assistance framework, and an appropriately funded deposit insurance scheme. They were encouraged by ongoing reform efforts in several countries and welcomed the Fund’s broad engagement with LIDCs on these topics. Directors underscored that reform measures should be properly prioritized and tailored to country-specific circumstances and implementation capacity.

Directors looked forward to receiving regular reports on macroeconomic developments and policy issues in LIDCs. To enhance traction, they encouraged staff to explore ways to develop further the thematic focus of the report. Directors also noted that the timeline for Board discussions could be better aligned with the cycle of the Spring and Annual Meetings.