significantly related in LICs. This paper builds on those results by identifying the specific shortcomings in DeM in LICs and providing the basis for targeted reform programs to increase their DeM performance. Much literature exists on the importance of DeM in developing countries as well as the links between DeM and financial crises.<sup>9</sup> This paper builds on this literature by introducing new data on DeM in LICs that identifies vulnerabilities and highlights areas for improvement. The structure of the paper is as follows: Section II gives a brief overview of the current crisis, with particular attention paid to its effects on LICs. Section III looks at the unique challenges developing countries, and LICs in particular, face with regard to DeM. Section IV focuses on the results of the DeMPA and MTDS tools and what they tell us about the current state of DeM in LICs. This section identifies priority areas for improvement and highlights potential pitfalls in the current environment. Section V concludes.

# **II. Setting the Stage: The Global Financial Crisis and Developing Countries**

The global financial and economic crisis of 2008‐09 has significantly altered the economic landscape for developing countries. The effects of the crisis on developing countries and regions were diverse and a function of both developmental and structural factors. Many Eastern European economies, which were highly integrated with and reliant upon Western European capital markets, most notably, were hard hit by financial contagion and the sudden stop in capital flows. LIC’s on the other hand, with financial sectors that were largely not integrated with the global markets, were insulated from the financial market contagion that spread from advanced economies. LICs, however, were severely affected by the decline in exports and falling commodity prices. In either case, developing countries as a whole now face a new and more precarious post‐crisis environment, the major consequence of which will be potential reductions in trend growth over the medium term (see Figure 4).

<!-- Start of picture text --> Figure 2: Private Capital Flows to Central and Figure 3: Total Private Capital Flows to<br>Eastern Europe 2005 – 2009, by instrument Developing Asian Countries, 2005‐2009<br>500 300<br>Bond<br>450<br>Loan 250<br>400<br>350 Equity<br>200<br>300<br>250 150<br>200<br>100<br>150 China<br>100 India<br>50<br>50 Indonesia<br>Other Developing Asia<br>0 0<br>2005 2006 2007 2008 2009 2005 2006 2007 2008 2009<br>Source: IMF Financial Stability Report 2010, Index: 100 = 2005 Source: IMF Financial Stability Report 2010, Index: 100 = 2005<br><!-- End of picture text --> With the exception of some large emerging markets that came into the crisis with strong fundamentals and large external surpluses, capital inflows have declined sharply for most developing countries. For example, while China, India and Indonesia have for the most part recovered their pre‐crisis levels, the rest of developing Asia has not (see Figure 3). Similarly, Central and Eastern Europe, with larger current

> 9 Notably, see World Bank (2003), World Bank (2009), Anderson and Togo (2009), Melecky (2007), Jaimovich and Panizza (2006), and Panizza (2008)

4