‘The global economy is limping along’

Whether there was any good economic news in the IMF’s forecast very much depends on whether you are a glass half-full or a glass half-empty type of person. While ‘the global economy continues to recover from the pandemic’ and ‘resilience has been remarkable’, it’s ‘limping along, not sprinting’. The IMF is forecasting that economic growth will slow in 2023 and 2024 and is pessimistic about the medium term: ‘Global growth prospects are weak, especially for emerging market and developing economies. The implications are profound: a much slower convergence toward the living standards of advanced economies, reduced fiscal space, increased debt vulnerabilities and exposure to shocks, and diminished opportunities to overcome the scarring from the pandemic and the war.’

The World Bank estimates that, although poverty is now at similar levels to before the pandemic, it is still above pre-Covid rates in low-income countries and increased slightly between 2022 and 2023. This is driven by countries in the Middle East and North Africa, as well as those classified by the World Bank as being in ‘fragility, conflict, and violence (FCV)’. In slightly better news, forecasts suggest that poverty in South Asia and sub-Saharan Africa is now below pre-pandemic levels.

Debt developments

Ethiopia, having requested debt restructuring under the G20 Common Framework in early 2021, has agreed to suspend debt service payments on its Chinese debt in the 2023/24 fiscal year. It has reached a similar arrangement in principle with its official bilateral creditors and will start talks to restructure its Eurobond next year. It is finalising a programme with the IMF, but this is being held up by discussions over exchange rate reforms.

ODI Senior Research Associate Ganeshan Wignaraja writes on six lessons from Sri Lanka’s default, highlighting the long-term trends that ultimately led to default, including a lack of political consensus on development strategy, macroeconomic stress due to weak fiscal performance, an anti-export bias in the trade regime and an overvalued exchange rate, lack of independence of the central bank, an inefficient welfare system and low agricultural productivity.

Zambia’s Eurobond restructuring has been blocked by the official creditor committee on the basis that bondholders are not offering comparable debt relief to that given by official creditors. Brad Setser and Theo Maret highlight the lessons from that earlier deal. While several are important for understanding how China is approaching debt restructuring, they emphasise that Zambia’s experience is not going to be generalisable to other cases: ‘A deal was done; nothing significant was settled’.

Setser also analyses the state of sovereign debt restructuring after Marrakech. He highlights what the Common Framework has and has not delivered after three years, challenges with debt sustainability analysis and a lack of consensus on how to deal with domestic debt, and argues that too few countries have sought to restructure their debt.

The World Bank’s South Asia Development Update has a useful spotlight on what it takes for a debt restructuring to sustainably reduce debt. It notes that more than a third of defaults fail to reduce the debt-to-GDP ratio or the interest rate on debt, despite their length (taking an average of three years to resolve) and their associated social costs, including higher poverty and worse health outcomes. It highlights above-median debt restructurings, domestic or global growth accelerations, fiscal consolidations and IMF-supported policy programmes as factors behind successful restructurings. But the Bank also warns that slowing global growth places even greater importance on domestic policies to boost growth and ensure the fiscal position is sustainable.

How were Special Drawing Rights used?

The largest-ever issuance of Special Drawing Rights – SDG 456 billion, equivalent to $650 billion – was made in August 2021 to help countries cope with the impact of the Covid-19 pandemic. A new IMF report looks at how countries used this allocation. As the report states, the policy question for governments is whether to retain SDRs as reserves or convert them to finance fiscal or external needs.

The findings are largely unsurprising, reflecting countries’ financing constraints: advanced economies used their allocation to increase foreign exchange reserves; most emerging markets used some or all of their SDR allocation to boost their reserves, but a third also used them for fiscal support or for meeting other financing needs. Only just over half of LICs used some of their SDR allocation to boost reserves and over 70% used them to finance fiscal or external needs. Fifty-five countries used SDRs to repay IMF programmes, mostly to the PRGT. Unsurprisingly, countries with an IMF programme tended to use a much higher proportion of their SDR allocation for financing compared to non-programme countries, who allocated more to their reserves.

To me this is evidence that the SDR issuance was an effective tool (albeit not a well targeted one – hence the need for SDR ‘re-channelling’) to alleviate financing constraints suffered by many low-income economies and emerging markets (or as the IMF says ‘The 2021 SDR allocation had significant benefits for the global economy’). The report does, however, note concerns from some IMF mission chiefs that the SDR allocation may have adversely affected central bank independence (in 12 countries), and led to delays in needed policy adjustments and reforms (in 20% of LICs and 12% of emerging markets), including in 12 cases delaying a needed debt restructuring.

Green fiscal policy

The IMF’s Fiscal Monitor explores ‘Fiscal Policies in a Warming World’. It argues that governments face a trilemma between meeting climate goals, fiscal sustainability and political feasibility – pursuing any two of these objectives comes at the cost of partially sacrificing the third. This is because relying mostly on more popular spending measures to deliver climate goals will be too costly for most countries with rising interest rates and slowing growth, carbon pricing will generate revenues, but can be politically unpopular, and ‘business-as-usual’ will not meet the Paris Agreement goals on net zero.

This challenge is particularly acute for emerging economies as, despite having larger carbon revenue potential, they also have greater investment needs and higher borrowing costs. The report argues that, while each country will have to choose its own policy mix, a combination of revenue- and spending-based mitigation instruments including carbon pricing, together with transfers, green subsidies and investments and regulatory measures, can meet climate goals at acceptable costs. The report presents illustrative combinations of policies that limit the increase in debt-to-GDP ratios to the range of 10–15 percentage points of GDP by 2050. It also highlights that, for countries with rising debt costs and other large spending needs on climate adaptation and other development goals, increasing revenue mobilisation and improving spending efficiency will be crucial. In short, improvements in public financial management are going to be an essential part of the climate response.

For many lower-income countries with low emissions, adaptation to a changing climate is a much more urgent concern than mitigation. Commentary from the World Resources Institute raises concerns about a climate debt trap, where debt constraints limit a country’s ability to invest in protection and adaptation, in turn worsening the fiscal and debt impacts of climate change. Such concerns led the Kenyan president, AU chairman and AfDB president to put out a New York Times op-ed calling for a pause in African debt repayments so that countries can invest in climate adaptation, more and cheaper finance and innovations such as debt for nature swaps. For countries facing more frequent disasters as a result of climate change, the IMF has provided guidance on how to incorporate these risks, as well as long-term adaptation investment needs, into fiscal rules.

Spending reviews

Spending reviews – exercises to identify unproductive or wasteful expenditure that can be cut back or to identify where productivity improvements can be made – are an important tool for governments seeking to improve spending efficiency. An IMF blog from Robert Allen and Richard Clifton identifies six lessons from 30 years of experience in designing and implementing spending reviews.

The key takeaways are that the most successful spending reviews are analytical and draw in specialists from other parts of government and the private sector. Different specific approaches suit different countries, but all require trust between the actors involved, which can only be developed incrementally over time, and as such many low- and middle-income countries lack the political cohesion and technical capacity to mirror advanced countries’ processes. This can be solved by focusing on smaller-scale problems that are manageable (as in South Africa), or by focusing on laying the groundwork for more effective spending reviews by strengthening PFM foundations, such as credible annual budgets and reliable finance reporting. It also highlights that the technical or analytical aspects of a spending review are the easy part; more challenging is putting findings into practice via negotiations with other departments and passing legislation. Carrying out reviews too often may lead to reform fatigue, so careful consideration is needed about when and how spending reviews are done.

On the question of the scope of the issues spending reviews should cover, Holger van Eden argues that they should focus on finding savings, rather than enhancing the effectiveness of spending. He suggests that the job of a finance minister is to support fiscal consolidation via cutbacks on ineffective and low-priority spending, not to also be overseeing policy management, which is the job of line ministries. He also argues that spending reviews are a crucial instrument for finance ministers to locate and weed out policies that reflect past priorities, so they do not need to rely on across-the-board cuts to reduce expenditure.

The subversive advisor?

We finish with a call from Stefan Dercon, former Chief Economist of the UK Department for International Development and Development Policy Advisor at the Foreign, Commonwealth and Development Office, for ‘subversive policy advice’. He calls for policy advice to take political constraints seriously, and distinguishes between different types of advisor and different forms of advice. His first category is politically-uninformed ‘first-best advisers’, who assume that governments want to maximise economic or development outcomes, but whose advice, at best partly implemented given political economy constraints, may not improve economic or development outcomes, and might even make them worse. The second group, ‘mercenaries’, give advice that maximises the objectives of the government, including non-developmental aims. Third is ‘politically-informed second best economic advisors’, who provide advice to promote economic and development objectives, but take the non-development objectives of those in power as a constraint. Lastly, ‘politically-subversive economic advisors’ do not take the objectives as given, but treat the government’s current objectives as endogenous to the advice, encouraging economic policies that may steer governments away from non-developmental objectives.

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