Private capital flows into developing nations fall sharply

Net private capital inflows to developing countries fell to $707 billion (Dh2.5 trillion) in 2008, a sharp drop from a peak of $1.2trn in 2007. International capital flows are projected to fall further in 2009 to $363bn, World Bank said in a report.

The report – Global Development Finance 2009: Charting a Global Recovery – warned that the world is entering an era of slower growth that will require tighter and more effective oversight of the financial system. Developing countries are expected to grow by only 1.2 per cent this year, after 8.1 per cent growth in 2007 and 5.9 per cent growth in 2008. When China and India are excluded, GDP in the remaining developing countries is projected to fall by 1.6 per cent, causing continued job losses and throwing more people into poverty. Global growth is also expected to be negative, with an expected 2.9 per cent contraction of global GDP in 2009.


Rebound in growth

Global GDP growth is expected to rebound to two per cent in 2010 and 3.2 per cent by 2011. In developing countries growth is expected to be higher, at 4.4 per cent in 2010 and 5.7 per cent in 2011, albeit subdued relative to the robust performance prior to the current crisis.

"The need to restructure the banking system, combined with emerging limits to expansionary policies in high-income countries, will prevent a global rebound from gaining traction," said Justin Lin, World Bank Chief Economist and Senior Vice-President, Development Economics.

"Developing countries can become a key driving force in the recovery, assuming their domestic investments rebound with international support, including a resumption in the flow of international credit."

Lin said though the extraordinary policy responses by a number of big economies have prevented systemic collapse, a concerned effort is required while the crisis is still under way.

"To prevent a second wave of instability, policies have to focus rapidly on financial sector reform and support for the poorest countries," said Hans Timmer, Director of the Bank's Prospects Group. Global integration and the expanding role of private actors in international finance have brought huge benefits, but have also widened the scope for turmoil. Today, developing countries rely heavily on private flows and many countries are being hit by a collapse in corporate finance, with big companies and banks that were powering growth now in distress.

"Many corporations will be hard pressed to service their foreign currency liabilities with revenues earned in depreciating domestic currencies at the same time that export demand has plummeted," said Mansoor Dailami, Manager of International Finance in the Prospects Group and lead GDF author.

The risk of balance-of-payments crises and corporate debt restructurings in many countries warrant special attention, the report cautions.

Charting a worldwide recovery will require quick implementation of detailed reforms and an eventual shift away from governments having high stakes in the financial system to a resumption of private sector control of the banking system, the report says. In addition, the big expansion of the money supply in advanced countries will need to be unwound and fiscal deficits will need to be cut in the medium term, to maintain debt sustainability and avoid another debt crisis as seen in the 1970s and 1980s.


East Asia and Pacific

The East Asia and Pacific region has felt the full brunt of the crisis because of its close trade links with high-income countries and because of declining investment as well as a drop in exports and industrial production. Growth for the region is projected to be five per cent this year, although several countries are projected to see GDP decline. Recovery across the region is expected to begin in the second half of 2009 and into 2010, reflecting substantial fiscal stimulus in China and a modest recovery of export demand in rich countries

Looking beyond 2009, scope for faster recovery in the region will be helped by China but will ultimately depend on the pace of recovery in the advanced economies. Even under the assumption that a pickup in growth in developed countries begins in 2010, a sizable output gap will remain for several years, including high unemployment and weak consumption and imports, sustaining downward pressure on prices for manufactured products.

A pickup in 2010 is likely to be relatively subdued, at 6.6 per cent, up from the five per cent trough of 2009, as consumers in developed countries adjust to lower wealth levels and banks complete the deleveraging process.

Prospects for lower global growth – contrasted with the average of the past decade – increase the importance of China's rebalancing its growth pattern, by moving away from reliance on export-led manufacturing, boosting the role of services, and stimulating domestic consumption and, inevitably, imports.

The region's contribution to global GDP will remain the largest, equal in dollar terms to the sum of the contributions from the other three regions with positive impacts: South Asia, the Middle East and North Africa, and Sub-Saharan Africa. Given that developing East Asia's nominal GDP is barely a tenth of global output, the region's contribution to incremental global GDP will only partially offset the collapse in output in developed countries.


CIS and Europe

Europe and Central Asia has been the region most adversely affected by recent developments, in large part because many countries in the region entered the crisis period suffering from substantial imbalances. Large current account deficits and domestic overheating made many countries vulnerable to the abrupt reversal of capital flows and weaker export demand that the crisis generated.

Financing requirements across the region are projected to remain substantial, due in part to large current-account deficits.

The region's large external financing requirements in 2009 also reflect more than $283bn in short-term debt coming due. Among the countries with high short-term debt levels, only Russia could foot the bill from reserves or its current-account surplus if external finance were not forthcoming.

The aftershocks from the initial crisis in global financial and product markets will continue to exact a painful toll on the growth outlook across Europe and Central Asia. As many countries are facing balance-of-payments difficulties and in some cases adjustments to the real side of their economies, the region will see the sharpest contraction among all developing regions.

GDP is projected to fall by 4.7 per cent in 2009, recovering to grow by about 1.6 per cent in 2010.

The sharpest downturn will be felt in the Baltic states. The CIS area is expected to face a deep recession in 2009, with real GDP contracting by 6.2 per cent from growth of 8.6 per cent in 2007 and 5.6 per cent in 2008. The slowdown stems to a considerable extent from the projected 42 per cent decline in international energy prices in 2009 (relative to the 2008 average). For the group of CIS oil-exporting countries, the decline in terms of trade represents a loss of some 7.9 per cent of their 2008.


Latin America

Latin America and the Caribbean entered the crisis supported by stronger fiscal, currency, and financial fundamentals than in the past. However, it too is feeling the crisis in part because of falling commodity prices, but also on the financial side as foreign funds were withdrawn quickly. Flexible exchange rates in many countries in the region were able to absorb much of the initial shock and avoid systemic problems even as equity markets tumbled. Regional GDP is expected to decline by 2.3 per cent in 2009, and to reach two per cent growth in 2010.

Brazil is more resilient to external demand shocks than many other economies in the region, given the smaller share of trade in its overall GDP, and has somewhat more room for monetary expansionary policies. Output is projected to contract by 1.1 per cent in 2009 after growth of 5.1 per cent in 2008 and to bounce back to 2.5 per cent in 2010 as external demand recovers and credit growth resumes, and domestic demand remains resilient.

The principal danger facing the economies of Latin America and the Caribbean is a deeper and more prolonged recession in advanced economies than presently anticipated. The region's external financing needs are estimated at $268bn in 2009.


South Asia

South Asia has witnessed considerably diminished capital inflows and a falloff in investment growth. GDP is projected to expand 4.6 per cent in 2009, down from 6.1 per cent in 2008. Regional output is then expected to increase by seven per cent in 2010 and 7.8 per cent in 2011. However, threats to long-term growth include the possibility of heightened fiscal pressures if the global recession is prolonged, and large fiscal deficits.

The outlook for regional growth remains highly uncertain, given the synchronised nature of the slowdown in growth across the globe. There are significant uncertainties tied to potential negative feedback loops between the real and financial sectors within and among countries and about how massive swings in commodity prices and exchange rate will ultimately affect different industries.
Given the region's strong underlying growth dynamics, the negative impacts of the crisis are expected to begin to unwind in 2010 and 2011, with a projected rebound in GDP growth to 7.1 per cent and 7.7 per cent, respectively.