CHAPTER 4 How Fast Can Countries Return to a Path of Sustained Growth?
- International Monetary Fund
- Published Date:
- December 2009
Spillover Effects in the Recovery
To what extent will a change in the global environment lead to a recovery, and how quickly? The global economy would seem to be on its way to provide a more supportive environment for countries in the region in coming years:
- Global output is projected to recover by about 2.5 percent in 2010 and 2011, helped by fiscal stimulus, monetary easing, and financial sector measures in major economies. Foreign demand for goods and services in the region is expected to follow suit (Figure 15).
- Capital flows to emerging and developing economies are projected to regain momentum over the next few years, after a sharp drop in 2009. Net flows to the region will continue to depend heavily on foreign direct investment. Countries are expected to regain access to market financing.
- Non-fuel commodity prices are expected to rise modestly in 2010 as the global recovery gets underway, consistent with pricing in forward markets.
Figure 15.Driving the Recovery: Foreign Demand and Commodity Export Prices
Source: IMF, World Economic Outlook.
Estimates of moderate, positive spillover effects seem to justify expectations that the recovery will be mild for countries in the region (Figure 16). The expected spillovers account for part of the projected growth in the coming years, partly because the region will still be feeling the lagged effects of the global downturn. Thus, the projected recovery assumes that at least in the first few years, domestic demand will be a key driver of growth. In any case, an eventual return to the growth path observed in the years before the global financial crisis will require a continued effort to pursue good and sound economic policies that fashion an environment conducive to sustained growth.
Figure 16.Spillover Effect on the Expected Recovery, 2010-11 GDP Growth
Catching Up to Precrisis Growth: How Fast?
Growth in the region is expected to rebound, helped by a turnaround in trade as well as domestic stimulus (Figure 17). The recovery for the region as a whole, however, masks a very diverse set of country circumstances:
- Kenya is the only country with an expected V-shaped recovery in the region. Having been greatly impacted by both domestic and external shocks, the economic deceleration is expected to be largely reversed in the coming two years, as the shocks are not expected to impart permanent effects on growth.
- In Tanzania, growth is expected to recover only gradually in the coming years, with only a mild rebound to precrisis levels.
- In Uganda, the slowdown in growth is expected to be more protracted, reflecting not only the impact of the crisis but likely also some convergence to longer-term growth. The growth rates experienced precrisis were the highest in the region and likely above potential.
- In Rwanda, where growth rates appear to have been the least affected so far, projections suggest the economy will be affected with some lags, as growth is projected to decline in the coming years. As for Uganda, the growth rates experienced precrisis were likely above potential.
Figure 17.The Expected Recovery
The catch-up is partly supported by the fact that the EAC economies have been quite resilient to the external shocks. This resilience reflects favorable developments in the years prior to the crisis, when countries attained high growth rates while keeping their current account and fiscal deficits manageable, kept inflation stable or in decline, reduced debt, increased foreign reserves, and strengthened policy frameworks.
Although the precise pace of the projected recovery remains highly uncertain, it seems that it might take some time, at least few years, for growth to catch up to precrisis levels (Figure 18).2 For some countries such as Uganda and Rwanda, growth will not return to precrisis levels simply because growth then was above potential. For other countries, this reflects a number of forces at play:
- The resumption in global growth is not expected to significantly ease the financing pressures facing countries in the region.
- World trade is projected to remain subdued, implying a loss of potential markets for countries in the region.
- Except for Kenya, the strength of the recovery will depend on aid prospects, a key financing source for most of the EAC.
Figure 18:Growth Prospects in EAC
Source: IMF, World Economic Outlook and Staff Calculations
As economic activity picks up, adjustments to macroeconomic policy stances may be needed to foster a sustained strong recovery. Strong policies over the past decade have created room in the EAC countries for countercyclical policies in the face of the global slowdown. However, as growth recovers, part or all of the stimulus may need to be withdrawn in order to preserve macroeconomic stability. In particular, a tightening of the monetary and fiscal stances is likely to be necessary to avoid the emergence of inflation pressures or the buildup of external or financial sector vulnerabilities. At the same time, the unwinding of the stimulus will also help create room for maneuver to counter future possible shocks.
The unwinding of the fiscal stimulus will have to be conducted while preserving and possibly creating additional fiscal space for infrastructure spending. In EAC countries, as elsewhere in Africa, there is no doubt that the infrastructure gap is acting as a constraint on growth and development. Creating fiscal space for stepped-up infrastructure spending should therefore remain a priority. In the first place, efforts should be made to create fiscal space without incurring any debt. Further improving domestic revenue mobilization through tax policy and administration reforms is therefore paramount. Then, additional borrowing could be envisaged in countries where debt sustainability is not at risk. In this case, the various possible financing options should be compared with a view to limiting risks and safeguarding resources. Encouraging greater private participation either through direct investment or public-private partnership arrangements is also an option.
The policies implemented in reaction to the crisis should not derail the reform momentum of the past decade. Progress in liberalizing EAC economies, in opening up to the world economy, and in the areas of public financial management, financial sector reform, and the business environment have started to bear fruit. Sustaining the reform effort will be crucial to boost growth over the medium term.
In addition to the domestic policy and reform agendas, accelerating regional integration could also help foster progress in these areas and boost growth. Regional integration can accelerate the pace of economic growth by fostering efficient cross-border investment and trade flows. It can also help create economies of scale and boost productivity and domestic and foreign investment. Progress has been made in the EAC toward a custom union, but more can be done to reduce tariff and non-tariff barriers, create a single market, and develop harmonized regional financial markets.
Enhanced policy coordination across EAC countries could be particularly valuable in the following areas:
- Infrastructure. The development of regional infrastructure could help generate economies of scale.
- Food security and agricultural policies. Enhanced cooperation would also facilitate dealing with food crisis, and implementing policies to enhance agricultural productivity in the region could help. By contrast, unilateral export bans such as those put in place in some countries in the past couple of years risk exacerbating food shortages in some countries while reducing incentives for investment in those experiencing excess supply.