Frameworks to support IMF policy advice to low-income countries

18 April 2013 | Minutes

Financial Sector Surveillance in Low Income Countries – Financial Deepening and Macro-stability
Financial Deepening and Macro-Stability


Paul Mathieu, Monetary and Capital Markets Department, African regional TA coordinator IMF
Felipe Zanna, Felipe Zanna, IMF Research Department
Catherine Patillo, IMF Strategy and Policy department

CP: Arguing today that the IMF does not take a one size fits all approach to policy advice. We have sought to strengthen the analytical foundation of policy advice to LICs, through annual surveillance and programmes.

Three core objectives: to ensure policy advice is related to the current interests and policy questions of the authorities, the issues they are concerned with. Hence today’s discussion of issues such as natural resources, strengthening financial sectors.

Secondly, that we recognise the particular characteristics of low income countries – economic structure remains different, they have unique characteristics and thus policy advice take particular and unique aspects into account.

Thirdly, we wish to ensure that we recognise the heterogeneity of LICs, ranging from fragile post-conflict, alternatively there are advanced, frontier markets with deep financial markets, similarly concerning size, or natural resource endowment, and so on.

Paul Mathieu – Financial Deepening

Financial market shallowness – issues related to it.

2011 Triennial Surveillance Review called for deeper coverage, more work on financial stability, and in October first financial surveillance strategy was approved, in particular with regard to LICs, there is a May 2012 initiative to enhance surveillance and LICs, analysing the interplay of financial deepening and stability, highlighting impediments to growth.  See doc with id = 4649

Financial shallowness and macro policy, argues that it reduces macro policy choices, impedes monetary policy effectiveness, makes household consumption smoothing challenging, and limits vehicles for saving and sources of funding for private investment t, while impeding opportunities for agents to manage risk

Undeveloped financial markets impeded governments’ ability to manage need for cash, e.g. liquidity problems, especially in order to smooth government expenditure patterns. Argues that the higher private credit to GDP ratio, the more counter cyclical fiscal policy is feasible. Also imposes a constraint on the financing of public investment.

Exchange regime – while the choice of regime reflects various considerations, financial shallowness constrains options, and those without a deep sector are more likely to adopt fixed rate regimes. LICs also often claim to have floats while adopting de facto pegs

Monetary policy – shallowness limits choice of policy instruments, as financial markets are necessarily more efficient. Additionally pervasive excess liquidity in the banking system and thin credit and government securities markets limit the effectiveness and efficiency of monetary policy moves. Thus changes in the money market are significantly less correlated with changes in policy rates in LICs. Hence shallow markets result in the ineffectiveness of indirect monetary policy, such as interest rate or inflation targeting.

Risk factors of shallowness –  the narrow range of formal economic actors leads to a concentration of bank’s exposure

Shallow markets lead to higher volatility and lower growth.

Lessons to improve financial deepening

  1. Encourage competition
  2. Develop information and market infrastructure
  3. Address collateral issues
  4. Limit intrusive public sector intervention and dominance


Not to replace FSAP, but to focus on macro growth and stability. These pilots are intended to ‘sharpen financial aspects of bilateral surveillance and stability’

Senegal, Benin, regional WAEMU and Haiti completed. Ghana underway, Bhutan to follow

Experience to date that this is “useful value added “to promote financial deepening

Benin findings:

Constraints on banks found to be weak property fights, weak creditor rights, unpredictable judiciary, lack of financial education.

Regarding role to play of financial markets

The shocks that pertain to financial markets in developed countries shows that the role of the financial market is significant – we are not makings arguments about opening up capital account or liberalisation of local financial systems, nor indeed that every state needs a stock market, but rather the access of local firms and individuals to financial products – and those that get their strategy right do much better. This is a key problem of macroeconomic management – e.g. to run a counter cyclical fiscal policy many developing countries cannot do so, and with these structural reforms.