2010 Crisis, Finance, and Growth 2010 Global Economic Prospects Global Economic Prospects Global Economic Prospects 2010 Global Economic Prospects Crisis, Finance, and Growth © 2010 The International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org E-mail: feedback@worldbank.org All rights reserved 1 2 3 4 13 12 11 10 This volume is a product of the staff of the International Bank for Reconstruction and Development / The World Bank. The findings, interpretations, and conclusions expressed in this volume do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: pubrights@worldbank.org. ISBN: 978-0-8213-8226-4 eISBN: 978-0-8213-8227-1 DOI: 10.1596/978-0-8213-8226-4 ISSN: 1014-8906 Cover photos: © iStockphoto.com/burakpekakcan (sky); © iStockphoto.com/mikeuk (sea) Cover design: Critical Stages The cutoff date for the data used in this report was January 8, 2010. Dollars are current U.S. dollars unless otherwise indicated. Foreword xi Acknowledgments xiii Abbreviations xv Overview 1 The acute phase of the crisis is over 1 Impact of the boom period on developing-country potential 4 Medium-term implications of the bust for finance in developing countries 8 Medium-term impact on the supply potential of developing countries 12 Conclusion 14 References 14 Chapter 1 Prospects for Developing Economies 15 Recent developments in financial markets 18 Global growth 22 Prospects for high-income countries 23 Prospects for developing economies 25 Regional outlooks 26 Commodity markets 31 Inflation 35 World trade 36 Narrowing global external payment imbalances 38 Uncertain prospects 39 The impact of the crisis on the very poor 41 Policy implications for developing countries 42 Notes 43 References 44 Chapter 2 The Impact of the Boom in Global Finance on Developing Countries 45 Financial innovation, high-income finance, and the liquidity boom 47 Novel channels for credit creation 50 Developing-country finance during the boom 53 v Contents Real-side consequences of the surge in global finance 61 Concluding remarks 70 Notes 71 References 72 Chapter 3 Medium-Term Impacts of the Crisis on Finance and Growth in Developing Countries 75 The impact of post-crisis regulatory and structural changes 77 Implications of a potential developing-country retreat from financial integration 88 The impact of higher borrowing costs 94 Strategies for dealing with a weaker international finance system 104 Implications for the global balance between savings and investment 107 Conclusion 108 Notes 109 References 112 Appendix: Regional Economic Prospects 117 East Asia and the Pacific 117 Europe and Central Asia 123 Latin America and the Caribbean 131 Middle East and North Africa 139 South Asia 146 Sub-Saharan Africa 154 Notes 163 References 164 Figures O.1 Financial conditions have stabilized 2 O.2 Developments in high-income countries have driven the industrial production cycle 2 O.3 The downturn in developing countries has been deeper and more broadly based than during previous recessions 3 O.4 Selected indicators of macroeconomic stability in developing countries, 2007 5 O.5 The cost of risk in high-income countries fell sharply during the boom 6 O.6 Developing-country potential output growth was boosted by low borrowing costs 7 O.7 Foreign participation in selected emerging equity markets 9 O.8 FDI as a share of investment in developing countries, 1995−2008 10 O.9 Very volatile external debt flows pose serious macroeconomic challenges 10 O.10 Indicators of regulatory quality 12 O.11 Private credit provision is strongly correlated with per capita incomes 12 O.12 Higher borrowing costs result in a permanent decline in developing-country GDP 13 1.1 Financial markets’ stabilization has partially restored pre-crisis financial conditions in developing countries 19 1.2 Syndicated bank lending by region, 2008 and 2009 20 1.3 FDI flows to developing countries 21 1.4 External financing needs as a share of GDP, 2010 22 C o n t e n t s vi 1.5 Growth in industrial production 23 1.6 Change in stock building as a contribution to GDP growth in G-3 countries 24 1.7 Dispersion of GDP growth results in the first quarter of 2009 25 1.8 China’s stimulus program yielded a pickup in import demand 27 1.9 Nonperforming loans rise across much of Europe and Central Asia 28 1.10 In Latin America EMBI-stripped spreads retreat as investor confidence returns 28 1.11 Lower oil prices and production yield sharp decline in oil revenues during 2009 30 1.12 South Asia’s external position improves in most countries on lower oil prices and decline in domestic demand 30 1.13 Quarterly GDP data point to output stabilization in Sub-Saharan Africa 31 1.14 Real commodity price indexes 32 1.15 OPEC spare capacity 33 1.16 Global stock-to-use ratio of key agricultural markets (excluding China) 34 1.17 Real commodity prices 35 1.18 Inflation in low-, middle-, and high-income countries 35 1.19 Core inflation in high-income countries 35 1.20 Food prices in low-income countries 36 1.21 World trade is recovering 36 1.22 International tourist arrivals 37 1.23 An easing of global imbalances 39 1.24 U.S China imbalances have diminished markedly 39 1.25 Comparison of 2015 poverty forecast, GEP 2009 versus GEP 2010 43 2.1 Since the early 2000s, credit expansion has grown more than twice as fast as nominal GDP 49 2.2 High-income GDP and trade growth do not explain the acceleration in developing- country economic activity 50 2.3 Notional value of derivative transactions, 2002–08 52 2.4 Share of commercial bank and securitized assets in total credit held by U.S. financial sector, 1995–2008 52 2.5 The cost of risk in high-income countries fell sharply during the boom 55 2.6 Developing-country interest rates fell substantially during the boom period 56 2.7 Total capital inflows to developing economies 58 2.8 Portfolio equity flows to developing countries 59 2.9 FDI inflows to developing countries, 1980–2008 60 2.10 Distribution of capital flows as a percentage of GDP in 2007 61 2.11 The determinants of private finance 62 2.12 Private credit from banks and other financial institutions relative to per capita income, 2007 63 2.13 Rising investment rates contributed to an acceleration in potential output 70 3.1 Foreign participation in selected emerging equity markets 84 3.2 Debt financing of M&A transactions, 1995–2008 85 3.3 FDI as a share of investment in developing countries, 1995−2008 86 3.4 Net external debt flows from private sources, 1980–2008 88 3.5 The recent buildup in reserves was concentrated in East Asia and among oil exporters 89 3.6 Developing countries’ average financial openness, 1990–2006 91 C o n t e n t s vii 3.7 The global synthetic price of risk versus the portion explained by economic fundamentals 95 3.8 Yields on selected U.S. government securities 97 3.9 Government debt is projected to rise in high-income, but not developing, countries 97 3.10 Falling capital costs were reflected in rising capital-output ratios 99 3.11 Impact of 110-basis-point shock on the capital-output ratio of a typical country 102 3.12 Higher borrowing costs result in a permanent decline in developing-country GDP 102 3.13 The effect of higher borrowing costs on the ratio of private-source debt to gross national income 104 3.14 Higher intermediation costs will reduce the risk-free interest rate relevant to savings decisions 108 A1 East Asian exports and production hard hit by downturn in capital goods demand 118 A2 Malaysia: A profile of recovery 119 A3 China’s stimulus program supports exports from regional partners 119 A4 Equity markets have nearly recovered from earlier declines 120 A5 East Asian currencies continue to recoup against U.S. dollar 120 A6 Stimulus measures yield widening fiscal shortfalls across the region 121 A7 East Asia will enjoy a moderate rebound in 2010–11 122 A8 Gross capital flows to Europe and Central Asia picked up in mid-2009 125 A9 Many European and Central Asian economies post sharp current account adjustments 125 A10 Pace of contraction in industrial production moderates in Europe and Central Asia 126 A11 Nonperforming loans rise across much of developing Europe and Central Asia 130 A12 Industrial production and trade volumes are gaining momentum in Latin America and the Caribbean 132 A13 Central banks across Latin America eased monetary policy aggressively 134 A14 Real effective exchange rates depreciated in more integrated economies 134 A15 Quarterly GDP points to output stabilization in Latin America 134 A16 Capital flows return to Latin America 135 A17 Equity markets in the Middle East dropped quickly, and GCC recovery has been muted 140 A18 Oil prices, 2004–09 141 A19 Lower oil prices and lower Middle Eastern output yield sharp decline in oil revenues in 2009 141 A20 Reduced oil revenues reduce current account surplus positions in 2009 142 A21 Middle Eastern exports declined sharply as European demand fell 142 A22 Worker remittances fell by a moderate 6.3 percent in 2009 143 A23 Tourism receipts fall from record 2008 performance, but modest recovery likely 143 A24 Oil price and export revival hold key to recovery in the Middle East and North Africa 144 A25 Gross capital inflows to South Asia are recovering but remain below pre-crisis levels 147 A26 Local equity markets have generally returned to pre-crisis levels 147 A27 Recovery in industrial production has taken hold in South Asia ahead of most other regions 148 C o n t e n t s viii A28 Current account balances improve across much of South Asia in 2009 149 A29 International flows to South Asia 149 A30 Budget deficits in most South Asian countries outstrip developing-country average 150 A31 Interest payments represent a significant burden in South Asian economies 153 A32 Middle-income and oil-exporting countries of Sub-Saharan Africa hit hardest by global crisis 154 A33 Private consumption and trade contracted markedly in South Africa 155 A34 Current account balances of middle-income and oil-exporting countries deteriorated the most, while low-income countries remained aid-dependent 155 A35 EMBI-stripped spreads retreat as investor confidence returns 156 A36 Inflation in Sub-Saharan Africa down to low single digits on lower food prices 156 A37 Quarterly GDP readings point to output stabilization in Sub-Saharan Africa 157 A38 Growth in middle-income and oil-exporting countries in Sub-Saharan Africa will accelerate faster 162 Tables O.1 A modest recovery 3 O.2 Regional distribution of changes in financing conditions, 2000–07 6 O.3 Decomposition of increase in potential output growth directly attributable to capital deepening 7 O.4 Contribution of private-source debt inflows to external finance of developing countries with current account deficits, average 2003–07 9 1.1 The global outlook in summary 17 1.2 Prospects remain uncertain 40 1.3 Poverty in developing countries by region, selected years 42 2.1 Interest rates and inflation in industrial countries, January 2002–June 2007 49 2.2 Changes in domestic intermediation, 2000–07 56 2.3 Net capital inflows by region 60 2.4 Intertemporal changes in financial variables mainly reflected the cost of capital, but across countries institutional quality was most important 63 2.5 Regional distribution of changes in financing conditions, 2000–07 65 2.6 Rising investment rates by region 66 2.7 Intertemporal and cross-country influences on investment 67 2.8 Decomposition of increase in potential output growth directly attributable to capital deepening 70 3.1 Credit growth by foreign banks versus total credit growth, developing countries 82 3.2 Contribution of private-source debt inflows to external finance of developing countries with current account deficits, average 2003–07 88 3.3 Indicators of the quality of domestic financial systems 93 3.4 Historical and prospective costs of capital for developing countries 98 3.5 Possible impact of tighter financial conditions on developing-country capital costs 99 3.6 Impact on potential output of a return to normal pricing of risk and higher base rates 101 3.7 Higher borrowing costs and slower population growth imply slower growth in potential output over the longer term 103 3.8 The crisis could increase poverty by 46 million in the long term 104 3.9 Selected indicators of banking sector efficiency 105 C o n t e n t s ix [...]... long-term growth prospects    106 East Asia and Pacific forecast summary    118 East Asia and Pacific country forecasts    123 Europe and Central Asia forecast summary    124 Europe and Central Asia country forecasts    129 Latin America and the Caribbean forecast summary    131 Latin America and the Caribbean country forecasts    137 Middle East and North Africa forecast summary    141 Middle East and. .. on social and humanitarian assistance precisely when it is most required In addition to analyzing the immediate challenges for developing countries posed by the crisis, this year’s Global Economic Prospects describes some of the longer-term implications of tighter financial conditions for developingcountry finance and economic growth While necessary and desirable, tighter regulation in high-income countries... reabsorbed This year’s Global Economic Prospects examines the consequences of the crisis for both the short- and medium-term growth prospects of developing countries It concludes that the crisis and the regulatory reaction to the financial excesses of the preceding several years may have lasting impacts on financial markets, raising borrowing costs and lowering levels of credit and international capital... significant domestic and external imbalances and ultimately unstable macroeconomic conditions Economic policies are critical to understanding cross-country differences in intermediation Lower borrowing costs were the largest identifiable factor behind the increase in Developing Middle-income Low-income East Asia and Pacific    (excluding China) China Europe and Central Asia Latin America and the    Caribbean... investment activity and potential growth rates, higher borrowing costs going forward will tend to reduce investment rates and result in lower levels of potential output than would have been observed otherwise Firms can be expected to react to higher capital costs by employing less capital and more labor and natural resources per unit of output, so economy-wide capital-to-output and investment-to-GDP ratios... rates) As a result, employment growth will remain weak and unemployment is expected to remain high for many years The overall strength of the recovery and its durability will depend on the extent to which household- and business-sector demand strengthens over the next few quarters While the baseline scenario projects that global growth will firm to 2.7 percent in 2010 and 3.2 percent in 2011 after a... Bank, Washington, DC   1 Prospects for Developing Economies T he ­­­­­­­­­ acute phase of the financial crisis has passed and a global economic recovery is under way Moreover, the recovery is fragile and expected to slow in the second half of 2010 as the growth impact of fiscal and monetary measures wane and the current inventory cycle runs its course Indeed, industrial production growth is already slowing... taken by the U.S Federal Reserve Bank and other central banks, medium (1-year) and long-term (10-year) interest rates on U.S government securities are 0.4 and 3.8 percentage points, respectively—some 290 and 60 basis points lower than during the boom period Similarly, developing-country risk premiums have fallen and appear to have stabilized at close to their pre-crisis levels or about 150 basis points... into increased investment and, as a result, increased long-term supply potential Inflows of foreign direct investment and domestic credit creation were associated with larger investment and growth effects than were equity or debt-creating inflows Medium-term implications of the bust for finance in developing countries T he short-term costs of the financial crisis have been severe and discouraging In many... Luca, and Angel Palerm Chapter 3 was written by Andrew Burns and William Shaw, with written contributions from Dilek Aykut, Jean-Pierre Chauffour, and Mariem Malouche Both chapters 2 and 3 benefited from the expert research assistance of Augusto Clavijo, Yueqing Jia, Eung Ju Kim, Irina Kogay, Sergio Kurlat, Sabah Mirza, and Nadia Islam Spivak The accompanying online publication, Prospects for the Global . 2010 Crisis, Finance, and Growth 2010 Global Economic Prospects Global Economic Prospects Global Economic Prospects 2010 Global Economic Prospects Crisis,. USA; fax: 20 2-5 2 2-2 422; e-mail: pubrights@worldbank.org. ISBN: 97 8-0 -8 21 3-8 22 6-4 eISBN: 97 8-0 -8 21 3-8 22 7-1 DOI: 10.1596/97 8-0 -8 21 3-8 22 6-4 ISSN: 101 4-8 906 Cover