The International Monetary Fund has introduced an analytical framework for assessing vulnerabilities and emerging risks in low-income countries (LICs) arising from changes in the global economy. The proposed Vulnerability Exercise for Low-Income Countries is intended to enable Fund staff to spot vulnerabilities and assess member countries’ resilience to emerging risks before they materialize, and thus help guide policy responses.

Previous internal IMF Vulnerability Exercises for advanced and emerging market economies have focused on capital account or systemic financial sector crises and growth recessions that have the potential to trigger significant contagion or dislocation on a regional or global scale. By contrast, the LIC exercise focuses on LICs’ vulnerabilities to sharp growth declines arising from external shocks—such as sharp swings in terms of trade and volatile external financing flows. These shocks can spark fiscal and external instability, debt distress, banking system stress, and steep output drops, all of which can generate substantial welfare losses and even social dislocation.

The results of the LIC Vulnerability Exercise, which would be conducted on an annual basis, will bolster IMF surveillance of LICs by strengthening risk assessments of individual countries and providing the basis for cross-country comparisons and analyses. Assessments of emerging external risks relative to existing policy buffers will help identify areas where buffers would need to be strengthened, and highlight the scope for pre-emptive policy action. The information generated from this exercise will also provide members with early warning of pertinent global tail risks and allow policymakers to design contingency plans.

The Vulnerability Exercise is part of a broader program of IMF work aimed at helping LICs to manage volatility and mitigate external shocks. The program also includes a forthcoming paper discussing the role of contingent financing instruments in managing volatility in LICs, and a separate paper reviewing the macroeconomic and policy challenges of LICs facing fragilities, including those arising from fragile political environments and weak institutional capacity.