Financial Crisis Year 2008

The global financial crisis has spread rapidly since the fall of 2008, leading to a global downturn of uncertain severity and duration. The impact of financial sector turmoil on real activity has become increasingly evident, propagating beyond its initial epicenters to affect other advanced economies, emerging markets, and LICs. This paper analyzes the impact of the global financial crisis on LICs.
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It provides an overview of the possible impact of the crisis on the short-term macroeconomic outlook. To assess the magnitude of the effects, the paper compares current (January 2009) projections with those made before the crisis. In addition, simulations illustrate the heavy downside risks to these projections.While for many LICs the effects of the crisis have lagged the rest of the world, its eventual impact may be severe, especially given their often limited scope for countercyclical policies. Many LICs have made great strides in strengthening their policy frameworks and robustness to shocks, reducing poverty, and reforming their financial systems. But many remain highly vulnerable to a deep global downturn that so closely follows the 2007/08 food and fuel price shocks. Financial market linkages are generally weak, but second-round effects of the economic slowdown on the financial system could be particularly severe. Without additional aid, the scope for countercyclical policies is limited for most LICs due to binding financing constraints and fragile debt positions. This could both deepen and prolong the crisis in LICs, and set back the fight against poverty. Against this background, the paper provides policy advice on how best to address the impact of the crisis on LICs and describes the Fund support.The Fund assists countries in designing policies to support growth and mitigate risks to the financial system. The Fund is also deploying its own financing facilities for LICs, while making efforts to sustain and catalyze additional assistance from other institutions and donors.The paper is structured as follows. Section II discusses the outlook for global economic growth and commodity prices, while Section III provides an overview of the changes in economic projections associated with the crisis. The various financial channels and spillovers from the global downturn are discussed in Section IV. Section V analyzes the fiscal and debt sustainability implications of the crisis. Country vulnerabilities are investigated in Section VI. Policy recommendations to help countries weather the crisis are considered in Section VII, with LICs’ potential additional financing needs assessed in Section VIII. Finally, Section IX concludes with a review of ways in which the Fund can assist its LIC membership.
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Generally, references to LICs in Fund documents relate to all 78 PRGF-eligible countries. However, because of data limitations, and unless indicated otherwise, data for LICs reported in this paper refer to the more limited set of 71 countries listed in Appendix I.