Global economic growth reached 3.8 percent in 2004, the fastest rate in four years. Developing countries outgrew high-income countries, and the gains were widespread all developing regions grew faster in 2004 than their average over the last decade. But global growth momentum has peaked, and developing countries gains are vulnerable to risks associated with adjustments to ballooning global imbalances, especially the $666-billion US current account deficit, says the World Bank's annual Global Development Finance 2005 report which was launched in Islamabad on Thursday.
South Asia's GDP is estimated to have grown at a robust 6.6 percent in 2004. "While this is down from the 7.8 percent growth posted in 2003, the deceleration mainly reflects a poor crop in India," says Shanta Devarajan, the World Bank's Chief Economist for the South Asia Region. "India's growth rate this year is lower than last year but still a healthy 6.9 percent. Outside India, regional growth increased from 5.7 percent in 2003 to 5.9 percent in 2004. The more balanced growth that characterised the region in 2004 is expected to continue with domestic consumption and investment providing the largest contributions to growth."
The strong global performance was underpinned by solid US growth and rapid expansion in China, India, and Russia. Record expansion of 6.6 percent in developing countries was encouraged by favourable global conditions and supported by years of domestic policy improvements. As a result, financial flows to developing countries during 2004 reached levels not seen since the onset of the financial crises of the late 1990s.
Net private capital flows, including debt and equity to developing countries, increased by $51 billion to $301.3 billion in 2004. Of this, net foreign direct investment (FDI) totalled $165.5 billion, up by $13.7 billion in 2004. In South Asia, net private capital flows increased from $11.2 billion in 2003 to a record $16.8 billion in 2004. Foreign direct investment rose modestly from $5.2 billion in 2003 to $6.5 billion in 2004.
FDI outflows from developing countries rose to an estimated $40 billion in 2004, up from $16 billion in 2002; these outflows are coming, for the most part, from the same countries receiving the bulk of private capital inflows, namely Brazil, China, Mexico and Russia.
"This recovery of financial flows is a welcome sign of renewed market interest in developing countries and a tribute to the substantial strengthening in economic fundamentals achieved in many countries, "said François Bourguignon, the World Bank's Senior Vice President for Development Economics and Chief Economist. "But we should also keep in mind that current global financial imbalances pose risks - of disorderly exchange rate movements, or of interest rate increases - that could threaten these gains. Developing countries need to prepare themselves for adjustments, some of which could be sudden."
The report, Mobilising Finance and Managing Vulnerability, points to a baseline scenario in which tightening of US fiscal policy and higher interest rates along with strong growth among developing countries - starts to redress global imbalances and reduce the US current account deficit.
But it also highlights the risks to this outlook, and argues that developing countries need to reduce their vulnerability to shifts in market sentiment prompted by higher-than-expected interest rate hikes, or a greater-than-expected depreciation of the US dollar.
"History has shown, time and again, that financial crises often take markets and policymakers by surprise, "said Hans Timmer, who is among the lead authors of this year's GDF. "There is a tendency for financial markets and policymakers to miss the warning signs and overshoot, making the necessary adjustment larger when it does occur. For developing countries, the key question is whether the pickup in flows witnessed over the last two years can survive under less favourable and less stable global conditions."
TIGHTENING GLOBAL CONDITIONS WILL TEST DEVELOPING COUNTRIES RESILIENCE: Features of the current global recovery have contributed to some of the risks facing developing countries going forward. The dramatic increase in the US current account deficit now equivalent to 5.6 percent of US GDP - has meant that developing countries as a whole are running larger and larger current account surpluses, equivalent to two percent of their GDP in 2004.
For most developing countries, these surpluses have been directed in part towards increasing foreign reserve accumulation in 2004. Foreign reserves held by developing countries grew by $378 billion in 2004, to an estimated $1.6 trillion - an all-time high. China held $610 billion, India, $125 billion, and the Russian Federation, $114 billion.
For most countries, reserve accumulation is part of a sensible strategy to reduce external vulnerability and improve creditworthiness. For a few countries that have accumulated excess reserves, there are also risks, arising from the possible impact of changing exchange rates, and fiscal costs, from the need to borrow in local currency to offset higher reserves. As a result, high-reserve countries may need to re-evaluate the desirability and sustainability of continued reserve accumulation.
Tightening global conditions also highlight the vulnerability posed by increased debt burdens, which have been at the heart of the financial crises over the last decade. The GDF notes good news in that, as aggregate external debt indicators are down, many developing countries have improved their capacity to manage debt, and acted aggressively to address the weaknesses that contributed to previous crises.
But external debt burdens have risen in more than half of emerging market economies, and, in many, domestic borrowing has risen dramatically as well. Although the shift from external to domestic borrowing can reduce vulnerability to external shocks, it also carries risks from possible over-borrowing or inadequate supervision.
The report notes that the encouraging economic performance in developing countries in 2004 coincides with sound policies in those countries, namely openness to trade and investment, prudent fiscal stances, and exchange rate flexibility, all of which have improved the countries' credit quality. These policies, it argues, have served developing countries well, and should be sustained.
PRESSURES ON AID FLOWS POSE BIGGEST RISK FOR POOREST COUNTRIES: For low-income countries, risks from the current global environment are linked less to the evolution of interest rates and exchange rates (since they have only limited access anyway) and more to the possible impact on aid flows (from both bilateral and multilateral sources) and other financing sources. While the challenge of generating sufficient ODA to help these countries reach the MDGs remains large, there are some encouraging signs of progress, as a number of donors have increased their commitment levels and ODA flows have turned upwards. But there remain concerns about the increase in 'net' flows, and whether adequate flows are being directed towards crucial regions, such as Africa. ODA levels remain well below those reached in the early 1990s.
The GDF also highlights growing evidence that non-aid flows are becoming more important financing sources for poor countries' - from rapid expansion in FDI outlined above, to grants from NGOs, which rose by $5 billion between 1990 and 2003, up from 10 to 17 percent of official development aid. Workers' remittance flows also rose, from $116 billion in 2003 to $125.8 billion in 2004.
More broadly, South-South linkages are emerging as a key factor in poorer countries - in terms of FDI, remittances, and even development assistance. Such flows cannot and should not substitute for sustained and targeted official aid, they nonetheless highlight the growing options and opportunities open to low-income countries.
SOUTH ASIA AND THE WAY FORWARD: The external debt burden in South Asia has declined substantially over the past few years, falling from 29 percent of GDP in 1998 to 22 percent in 2004. Despite that, there is a risk that public debt burdens could increase significantly given the sizeable fiscal imbalances in some countries. Central governments in the region as a whole recorded a budget deficit equal to 8.3 percent of GDP in 2004, up from 7.9 percent in 2003.
The GDF 2005 forecasts that global growth will slow down to 3.1 percent in 2005, as a result of increases in US interest rates, fiscal tightening, and the effects of the 25-percent real effective appreciation of the Euro. A reduction in demand for developing-country exports is expected to slow growth among them to 5.7 percent in 2005, which still remains above recent growth trends. This comparatively buoyant growth among developing countries is led by East Asia, South Asia, and Eastern Europe and Central Asia, where regional GDP grew respectively by 8.3, 6.6 and 6.8 percent in 2004.
The Islamabad launch of the GDF 2005 was chaired by Abid Hasan, Acting Country Director of the World Bank for Pakistan. Hans Timmer made a detailed presentation on the salient features of the report. Government officials, members of the civil society and media attended the launch at the Bank's office.
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Global and Regional Growth Trends and Forecasts
2003 2004e 2005f 2006f 2007f
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World 2.5 3.8 3.1 3.1 3.2
High income 1.9 3.2 2.4 2.6 2.6
OECD Countries 1.8 3.1 2.3 2.5 2.6
Euro Area 0.5 1.8 1.2 2.2 2.6
Japan 1.4 2.6 0.8 1.9 1.9
United States 3.0 4.4 3.9 3.0 2.6
Developing countries 5.3 6.6 5.7 5.2 5.4
East Asia & Pacific 8.0 8.3 7.4 6.9 7.2
Europe and
Central Asia 5.9 6.8 5.5 4.9 5.0
Latin America &
Caribbean 1.7 5.7 4.3 3.7 3.7
Middle East &
N. Africa 5.8 5.1 4.9 4.3 4.3
South Asia 7.8 6.6 6.2 6.4 6.7
Sub-Saharan Africa 3.4 3.8 4.1 4.0 4.1
Developing countries
excluding transition
countries 5.2 6.7 5.7 5.3 5.5
excluding China
and India 3.9 5.8 4.8 4.4 4.4
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