83687 Coping with policy normalization in high-income countries Volume GLOBAL 8 ECONOMIC 2014 PROSPECTS January Coping with policy normalization in high- income countries GLOBAL ECONOMIC PROSPECTS | January 2014 Overview and Latin America & Caribbean regions, as economies in these regions have already recovered from the main messages crisis and are growing at potential. In the East Asia & the Pacific region, GDP growth is projected to remain flat at about [7.1-7.2] percent over the projection horizon, partly reflecting a trend slowing of growth China as it rebalances its economy. In After several years of extreme weakness, high Latin America & the Caribbean, a strong rebound income economies appear to be finally turning the in Mexico following very weak growth in 2012, corner, contributing to an acceleration in global coupled with more modest firming of growth growth from 2.3 percent last year to [3.1] percent elsewhere is projected prompt a pick up in growth this year and to [3.4] and [3.5] percent in each of from [2.6] percent in 2013 to around [3.3] percent 2015 and 2016 (table 1). in 2014 and around [3.5] percent in 2016. Most of the acceleration is expected to come from Trade and financial linkages with high-income high-income countries, as the drag on growth from Europe and a reduced pace of domestic household, fiscal consolidation and policy uncertainty eases fiscal, and banking sector consolidation are and private-sector recoveries gain firmer footing. expected to boost GDP growth in developing High-income growth is projected to strengthen Europe & Central Asia from [3.1] percent in 2013 from only [1.2] percent in 2013 to [2.2] percent this to [3.7] percent in 2014, rising further to [4.6] year and 2.4 percent in each of 2015 and 2016. The percent in 2016. In the Sub-Saharan Africa region strengthening of output among high-income relatively robust domestic demand, notably countries marks a significant shift from recent years resource-sector investments, should help support when developing countries alone pulled the global regional growth of about [5.4] percent in 2015 and 2016. In South Asia, very weak growth in India – economy forward. following several years of rising inflation and current account deficits – has opened up a large Activity and sentiment in developing countries has negative output gap, which is projected to gradually turned up since mid-year bolstered by close as the economy slowly recovers. Better Indian strengthening high-income demand and a policy performance will be heavily reflected in a regional induced rebound in China. These positive growth that is expected to strengthen from [4.7] developments were partly offset by tighter financial percent in 2013 to [5.6] percent in 2014 and about conditions and reduced capital flows as long-term [6.6] percent in 2016. interest rates in the U.S. ticked up in response to expectations of the gradual withdrawal of Many of the economies of the Middle East and quantitative easing that will. Other major North Africa region remain in turmoil nearly three headwinds included declining commodity prices for years after the Arab Spring uprisings first began. commodity exporters. Nascent recoveries have repeatedly faltered due to the flaring up of political and social tensions. These Overall, growth in developing countries is tensions and their economic consequences are projected to pick up modestly from [4.8] percent in assumed to persist in the baseline forecast — 2013 to [5.3] percent this year and [5.5] and [5.7] holding back a more vigorous rebound. Regional percent in each of 2015 and 2016. Developing GDP is estimated to have remained flat in 2013 GDP growth will be about 2 .2 percentage points and to expand by [2.7] percent in 2014 before weaker than it was during the pre-crisis boom rising to [2.8] percent in 2016. Of course should period. However, the slower growth is not cause tensions ease more quickly than anticipated (or for concern. More than two-thirds of the deteriorate) outcomes could be substantially better slowdown reflects a decline in the cyclical (worse). component of growth and less than one third is due to slower potential growth. Prospects will be sensitive to the pace at which Growth accelerations are projected to be particularly muted in both East Asia & Pacific and extraordinary monetary support measures in 1 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 1. The global outlook in summary (percentage change from previous year, except interest rates and oil price) GEP 13b Forecast (Jun 2013) Change 2012 2013e 2014f 2015f 2016f 2012 2013 2014 2015 2012 2013 2014 2015 Global conditions World trade volume (GNFS) 2.4 3.1 4.6 5.1 5.2 2.7 4.0 5.0 5.4 -0.3 -0.9 -0.4 -0.3 Consumer prices G-7 Countries 1,2 1.8 1.3 1.8 1.9 2.0 United States 2.1 1.5 1.7 2.0 2.2 2.1 2.4 2.5 2.5 0.0 -0.9 -0.8 -0.5 Commodity prices (USD terms) Non-oil commodities -8.6 -8.3 -0.2 -0.3 0.1 -9.5 -4.7 -1.1 -1.5 0.9 -3.6 0.9 1.2 Oil price (US$ per barrel) 3 105.0 105.0 105.7 102.0 100.7 105.0 102.4 101.0 101.0 0.0 2.6 4.7 1.0 Oil price (percent change) 1.0 0.0 0.7 -3.5 -1.3 1.0 -2.5 -1.3 -0.1 0.0 2.5 2.0 -3.4 4 -1.3 -1.6 2.3 1.0 1.4 -2.1 2.4 2.2 1.9 0.8 -4.0 0.1 -0.9 Manufactures unit export value Interest rates $, 6-month (percent) 0.7 0.4 0.4 0.7 1.3 0.5 0.7 1.1 1.4 0.2 -0.3 -0.7 -0.7 €, 6-month (percent) 0.8 0.3 0.3 0.5 0.8 0.2 0.5 1.2 1.5 0.6 -0.2 -0.9 -1.0 International capital flows to developing countries (% of GDP) Developing countries Net private and official inflows 5.1 4.7 4.3 4.3 4.2 5.0 4.7 4.4 4.3 0.1 0.0 -0.1 0.0 Net private inflows (equity + debt) 5.0 4.6 4.2 4.2 4.1 4.9 4.7 4.4 4.3 0.1 -0.1 -0.2 -0.1 East Asia and Pacific 4.7 4.4 4.0 3.9 3.7 4.6 4.2 3.9 3.8 0.1 0.2 0.1 0.1 Europe and Central Asia 7.8 6.6 6.0 6.2 6.3 5.7 6.5 6.1 6.0 2.1 0.1 -0.1 0.2 Latin America and Caribbean 5.7 5.3 5.0 5.1 4.9 6.4 5.9 5.5 5.3 -0.7 -0.6 -0.5 -0.2 Middle East and N. Africa 2.1 1.5 1.1 1.6 1.7 1.4 1.1 1.4 1.7 0.7 0.4 -0.3 -0.1 South Asia 4.1 3.7 3.6 3.7 3.9 4.0 3.6 3.4 3.3 0.1 0.1 0.2 0.4 Sub-Saharan Africa 4.8 5.3 4.3 4.2 4.1 3.5 3.8 3.9 4.2 1.3 1.5 0.4 0.0 Real GDP growth 5 World 2.5 2.3 3.1 3.4 3.5 2.3 2.2 3.0 3.3 0.2 0.1 0.1 0.1 Memo item: World (2010 PPP weights) 2.9 2.9 3.6 3.9 4.0 2.9 3.1 3.8 4.1 0.0 -0.2 -0.2 -0.2 High income 1.5 1.2 2.2 2.4 2.4 1.3 1.2 2.0 2.3 0.2 0.0 0.2 0.1 OECD countries 1.4 1.1 2.1 2.2 2.3 1.2 1.1 1.9 2.2 0.2 0.0 0.2 0.0 Euro Area -0.6 -0.5 1.1 1.5 1.5 -0.5 -0.6 0.9 1.5 -0.1 0.1 0.2 0.0 Japan 1.9 1.8 1.6 1.2 1.3 2.0 1.4 1.4 1.3 -0.1 0.4 0.2 -0.1 United States 2.7 1.7 2.6 2.9 3.0 2.2 2.0 2.8 3.0 0.5 -0.3 -0.2 -0.1 Non-OECD countries 3.5 2.5 3.3 3.7 3.8 2.8 3.1 3.7 3.9 0.7 -0.6 -0.4 -0.2 Developing countries 4.8 4.8 5.3 5.5 5.7 5.0 5.1 5.6 5.7 -0.2 -0.3 -0.3 -0.2 East Asia and Pacific 7.4 7.2 7.2 7.1 7.1 7.5 7.3 7.5 7.5 -0.1 -0.1 -0.3 -0.4 China 7.7 7.7 7.7 7.5 7.5 7.8 7.7 8.0 7.9 -0.1 0.0 -0.3 -0.4 Indonesia 6.2 5.6 5.3 5.5 5.5 6.2 6.2 6.5 6.2 0.0 -0.6 -1.2 -0.7 Thailand 6.5 3.2 4.5 5.0 5.2 6.5 5.0 5.0 5.5 0.0 -1.8 -0.5 -0.5 Europe and Central Asia 2.0 3.4 3.5 3.7 3.8 2.7 2.8 3.8 4.2 -0.7 0.6 -0.3 -0.5 Kazakhstan 5.0 5.8 5.9 6.0 6.0 5.0 5.0 5.3 5.5 0.0 0.8 0.6 0.5 Turkey 2.2 4.3 3.5 3.9 4.2 2.2 3.6 4.5 4.7 0.0 0.7 -1.0 -0.8 Romania 0.7 2.5 2.5 2.7 2.7 0.7 1.7 2.2 2.7 0.0 0.8 0.3 0.0 Latin America and Caribbean 2.6 2.5 2.8 3.1 3.7 3.0 3.3 3.9 3.8 -0.4 -0.8 -1.1 -0.7 Brazil 0.9 2.2 2.4 2.7 3.7 0.9 2.9 4.0 3.8 0.0 -0.7 -1.6 -1.1 Mexico 3.9 1.4 3.4 3.8 4.2 3.9 3.3 3.9 3.8 0.0 -1.9 -0.5 0.0 Argentina 1.9 4.9 2.8 2.5 2.5 1.9 3.1 3.0 3.0 0.0 1.8 -0.2 -0.5 Middle East and N. Africa 1.5 -0.1 2.8 3.3 3.4 3.5 2.5 3.5 4.2 -2.0 -2.6 -0.7 -0.9 Egypt 6 2.2 1.5 1.7 2.0 2.4 2.2 1.6 3.0 4.8 0.0 -0.1 -1.3 -2.8 Iran -2.9 -1.5 1.0 1.8 2.0 -1.9 -1.1 0.7 1.9 -1.0 -0.4 0.3 -0.1 Algeria 3.3 2.8 3.3 3.5 3.5 2.5 2.8 3.2 3.5 0.8 0.0 0.1 0.0 South Asia 4.2 4.6 5.7 6.3 6.7 4.8 5.2 6.0 6.4 -0.6 -0.6 -0.3 -0.1 India 6,7 5.0 4.8 6.2 6.6 7.1 5.0 5.7 6.5 6.7 0.0 -0.9 -0.3 -0.1 Pakistan 6,7 4.4 3.6 3.4 4.1 4.5 3.7 3.4 3.5 3.7 0.7 0.2 -0.1 0.4 Bangladesh 6 6.2 6.0 5.7 6.1 6.0 6.2 5.8 6.1 6.3 0.0 0.2 -0.4 -0.2 Sub-Saharan Africa 3.6 4.8 5.4 5.4 5.4 4.4 4.9 5.2 5.4 -0.8 -0.1 0.2 0.0 South Africa 2.5 1.9 2.7 3.4 3.5 2.5 2.5 3.2 3.3 0.0 -0.6 -0.5 0.1 Nigeria 6.6 6.7 6.7 6.8 6.8 6.5 6.7 6.7 7.0 0.1 0.0 0.0 -0.2 Angola 5.2 5.1 8.0 7.3 7.0 8.1 7.2 7.5 7.8 -2.9 -2.1 0.5 -0.5 Memorandum items Developing countries excluding transition countries 4.8 5.0 5.4 5.6 5.8 5.0 5.3 5.8 5.9 -0.2 -0.3 -0.4 -0.3 excluding China and India 2.9 3.2 3.6 3.9 4.2 3.3 3.5 4.2 4.4 -0.4 -0.3 -0.6 -0.5 Source: World Bank. Notes: PPP = purchasing power parity; e = estimate; f = forecast. 1. Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. 2. In local currency, aggregated using 2010 GDP weights. 3. Simple average of Dubai, Brent, and West Texas Intermediate. 4. Unit value index of manufactured exports from major economies, expressed in USD. 5. Aggregate growth rates calculated using constant 2010 dollars GDP weights. 6. In keeping with national practice, data for Bangladesh, Egypt, India, and Pakistan are reported on a fiscal year basis in table 1.1. Aggregates that depend on these countries are calculated using data compiled on a calendar year basis. 7. Real GDP at factor cost, consistent with reporting practice in Pakistan and India. 2 GLOBAL ECONOMIC PROSPECTS | January 2014 high-income countries are withdrawn Developing countries responded to the 2007/08 The strengthening of growth in the U.S.A. has global financial crisis by deploying fiscal and already prompted the Federal Reserve to announce monetary stimulus. However, with government plans to begin reducing the extent of support it deficits and current account balances some [3] or provides to the economy on January. In the more percent of GDP higher in most countries the baseline, the withdrawal of quantitative easing (and scope for such reactions has declined greatly. its effect on the long-end of US interest rates) is assumed to follow a relatively slow orderly More to the point, for most developing countries trajectory as the US economy improves. improved growth will have tro come from supply- side reforms that increase underlying growth The corresponding increase in global interest rates potential. is expected to weigh on investment and growth in Given the risks that developing countries are developing countries as capital costs rise and facing, policy makers need to give thought bnow to capital flows recede in line with a rebalancing of how they would respond to a sharp deterioration in global asset portfolios. So far, market reactions external conditions. Appropriate policy responses have been subdued. If, however, the taper is met will vary from country to country, but may include with a sharp adjustment in portfolios as occurred in tightening monetary policy to reduce vulnerabilities the summer of 2013, capital flows could weaken and attract capital, allowing a controlled sharply — placing renewed stress on vulnerable depreciation (particularly for economies with developing economies. In a scenario where long- flexible exchange regimes and overvalued exchange term interest rates rise rapidly by 100 basis points, rates, and the prudent use of capital controls and capital flows could decline by as much as [30] macro-prudential regulations. These measures may percent for several quarters ([80] percent in the less need to be supplemented by policy reforms—for likely scenario of a sudden 200 basis point example, of the kind being adopted in Mexico and increase). Impacts on developing countries under China. By improving the longer term growth such scenarios are likely to be concentrated among outlook, credible reform agendas can go a long way middle-income countries with deeper financial towards boosting investor and market confidence markets and domestic imbalances. and potentially set in motion a virtuous cycle of stronger investment, including foreign investment, Especially in the scenarios where interest rates and output growth over the medium term. adjust rapidly and capital flows weaken, financial conditions in many developing countries could Older risks include fiscal policy uncertainty in tighten sharply. The ability to withstand these such the US and rebalancing in China. shocks will depend crucially on domestic If upcoming debt ceiling debates in the US prove vulnerabilities and policy buffers, with some better as tense as in October, these could hobble the placed to navigate these headwinds. recovery underway through negative confidence and spending impacts and, at worst, could spark an Risks will be most pronounced among developing acute global crisis in case of a debt default. In economies where short-term and/or foreign debt China, policy makers attempts to steer the represents a large proportion of overall debt, or economy to a more sustainable path are raising where credit has been expanding rapidly in recent concerns about the ability of firms and banks to years. Policy makers in these economies should be continue to service loans contracted during the taking steps now to restructure debt holdings investment boom. The structural shift in China’s toward longer-term issues, and requiring banks to growth patterns also poses commodity price risks, stress-test their loan books and begin provisioning so that producers in sub-Saharan Africa and Latin now (before they go bad) loans that might be at America could suffer further negative terms of risk. trade shocks on top of those already experienced from the sharp falls in food and metals prices over Rebalancing, retrenchment and reforms will the past year. prove much harder to deliver than stimulus 3 GLOBAL ECONOMIC PROSPECTS | January 2014 Recent Developments In Japan, the economy has responded to strong fiscal and monetary stimulus with robust growth, rising inflation and a depreciation of the currency. Partly as a result, output has now reached [98] High income economies are finally percent of its pre-crisis levels. Although growth emerging from the crisis nearly halved in the third quarter, indications are that activity has rebounded with momentum After years of feeble growth or outright recessions, gaining additional strength in the fourth quarter as a recovery appears to be taking hold in high consumers frontload spending ahead of the income economies (figure 1). Among the three upcoming consumption tax increase in April 2014. major high-income economies (the United States, the Euro Area and Japan), the recovery is the most Finally in the Euro Area, growth turned positive in advanced in the US, with GDP having been the second quarter. However, headline growth growing for [10] quarters now, and having reached slowed in the third quarter reflecting weaker a level [5] percent higher than in the pre-crisis growth in Germany and a decline in France. In period (although only 1 percent above in per capita contrast, output in the periphery continued to terms) (figure 2). strengthen. Three of the five high-spread economies have now exited recession (Ireland, In the US, headwinds from higher long-term Portugal and Spain) helped by strong export interest rates, fiscal uncertainty and the government growth, while the recession is easing in the other shutdown have delayed but not derailed the two (Italy and Greece). Nevertheless, Euro Area recovery. A rebound in consumer and business output remains well below pre-crisis levels and 10 sentiment in the fourth quarter reflected in rising or more percent below pre-crisis levels in some of household spending, industrial output and the hardest hit countries of the area. employment gains indicate continued firming in growth after a strong acceleration in growth in the third quarter. Meanwhile a recent budget Surveys in all three major high-income economic compromise that puts an end to protracted budget regions are pointing to further firming in business negotiations and eases “sequester” cuts that have activity and to an upturn in investment spending weighed on activity in recent years should also over the coming year. Manufacturing Purchasing should boost confidence and help unleash pent up Managers Indices (PMIs) rebounded to their demand by households and businesses over the highest level in 2013 in November the US as drags medium term. Partly as a result, the Federal from the October government shutdown faded, Reserve has announced that it will begin and rose to a 50-month high in Japan. Euro Area withdrawing quantitative easing stimulus beginning PMIs indicated a fifth consecutive month of in January. expansion, signaling the durability of the ongoing Figure 1. Growth is slowly improving in high income Figure 2. GDP in most high-income economies re- economies mains below pre-crisis levels GDP, GDP per capita as % 140 135 132 130 GDP GDP per capita 124 125 120 115 110 106 105 102 105 101 102 99 98 99 100 97 95 96 97 92 95 93 93 91 91 92 91 90 89 90 85 77 80 76 75 Germany France Italy Developing United States Japan Euro area United Kingdom Spain Ireland Portugal Greece Other High Income Source: World Bank. Source: World Bank. 4 GLOBAL ECONOMIC PROSPECTS | January 2014 Figure 3. Manufacturing surveys are pointing to ex- Figure 4. Core inflation is sliding sharply in the Euro panding output levels Area reflecting significant spare capacity Source: World Bank, Markit. Source: World Bank, Haver. recovery (figure 3). PMIs for the service sector — In the US, any missteps as the US Federal Reserve which accounts for nearly two-thirds of total gradually exits from extraordinary monetary output — have also strengthened in the US and support measures could undermine the recovery Germany, indicating a broadening of the recovery. underway, as could politically charged negotiations in February over raising the debt ceiling. While the outlook is brightening, significant Furthermore, although unemployment at 7 percent challenges remain in all three economies: including of the labor force is at its lowest level since 2008, the weak levels of activity compared to pre-crisis employment rates remain well below pre-crisis years, burdensome debt levels, and risks that crisis levels — partly because of withdrawal from the fatigue and improving economic conditions slow labor force of retirees, but also reflecting large the pace of reforms. In Japan, structural reforms numbers of part-time workers. unveiled by the government—arguably the most important of the “three arrows” of “Abenomics”—have disappointed thus far , raising Activity has strengthened in doubts about whether the improvement in developing countries after a weak economic performance can be sustained over the medium to longer term. start to 2013... In Europe, a return to growth is not yet a signal of Activity in the developing world strengthened in a return to health. Although labor markets are the second and third quarters of 2013, despite showing signs of stabilizing, long-term and youth financial market tensions and slightly weaker unemployment remain endemic spreading concerns momentum in high income countries. This about the potentially permanent employability followed a period of weakness that set in toward effects of extended joblessness. At the same time, the end of 2012. The firming of growth is broadly- significant spare capacity has opened up — based, with activity rebounding particularly strongly contributing to a sharp slide in core inflation in India and China (figure 5). Overall, developing (figure 4) and fears that a pernicious debt-deflation country industrial production grew at a [13.8] cycle could begin. Banks are holding a rising share percent annualized pace during the three months of sovereign debt in the troubled economies, and ending October ([8.9] percent excluding China). continue to face deleveraging pressures ahead of Meanwhile the aggregate PMI for developing asset quality reviews due in 2014. Any delays in the countries moved into the above 50-zone in August development of credible banking union also carry and has continued to strengthen through the potential for renewed bout of financial market November improving in 4 of 5 regions where data turmoil or further deleveraging pressures if are available (figure 6). adequate backstops for the banking sector are not found. 5 GLOBAL ECONOMIC PROSPECTS | January 2014 Box 1. Recent Regional Economic Developments (The regional annexes to this volume contain more detail on recent economic developments and outlook, including country -specific forecasts.) 2013 marked the third consecutive year of easing growth in East Asia & the Pacific with the regional growth moderating from 7.4 percent in 2012 to an estimated [7.2 percent in 2013]. This reflected slower growth in Indonesia, Malaysia and Thai- land, where weak revenues related to declining commodity prices, combined with policy tightening aimed at addressing do- mestic vulnerabilities, cut into \activity in the first quarter of 2013 when global demand was still subdued. Regional currencies and asset prices came under pressure later in the year, as global portfolios started to shift in anticipation of a tapering in the US. Despite the mid-year financial turbulence regional output growth has strengthened in the second half of the year sup- ported by improved external demand, lower imports and policy stimulus in China. Excluding China, regional industrial produc- tion and exports remain weak, especially in Indonesia and Thailand, reflecting on -going domestic adjustment exacerbated by pressures related to tightening of external financing conditions and also due to on -going political tensions in Thailand. Output in the developing Europe & Central Asia region has continued to firm through 2013, growing at a 4.8 percent annu- alized pace in the three months ending September. The improvement has been led by Central and Eastern European coun- tries whose exports have been lifted by strengthening demand in the Euro Area as well as by continued strength in energy commodity-exporting Central Asian countries. Hungary, Serbia, Turkey, and Ukraine were the most affected in the region by global financial market volatility during the summer, with currencies and equities coming under pressure. Commonwealth of Independent States countries are exposed to the slowdown in Russia although remittances and exports have held up so far. Non-energy commodity exporters have suffered a negative terms of trade shock over the past year reflecting the decline in metal and agricultural commodity prices. Several countries are struggling to lower fiscal deficits (Albania, Macedonia, Serbia, and Ukraine). Current account deficits are also elevated in a number of countries (Bosnia, Kyrgyz Republic, Montenegro, and Turkey). The slowdown in global trade in 2012 followed by tighter financing conditions and less supportive commodity markets in 2013 has left many countries in the Latin America & Caribbean region struggling with relatively weak and volatile growth patterns. Regional merchandise exports from January to September grew less than 4 percent compared to over 8 percent over the same period in 2012. Domestic demand growth is also moderating from cyclical highs and there are only modest signs of improvement in Q4, notably in Brazil where industrial activity is currently contracting, in part reflecting monetary tight- ening along with foreign exchange rate interventions during the summer that successfully stemmed currency pressures. Activity is starting to recover in Mexico, after weakening due to fiscal consolidation and hurricane related damage earlier i n the year. Bumper harvests in Argentina have supported growth and export revenues in the face of headwinds from weak growth in Brazil, a continued lack of access to international debt markets and restrictive currency, capital and price controls. Exports are rebounding in Central American economies, partly supported by the expansion of the Panama Canal. Two years after the Arab Spring, the economies of the Middle East and North Africa region remain depressed. Political turmoil in Egypt and Tunisia and an escalation of the civil war in Syria with spillovers to neighboring Lebanon and Jordan have weakened activity in the developing oil importing countries. Meanwhile, security setbacks, strikes, infrastructure prob- lems, and in the case of Iran, international sanctions, have negatively affected developing oil exporting countries. Growth for the region is estimated at just 0.1 percent in 2013—down from a weak growth of 1.4 percent in 2012, with growth in both oil - exporting and oil-importing countries weakened relative to 2012. If Syria is removed from the regional aggregate, the growth slowed to 1 percent, down from 2.6 percent in 2012. In addition, fiscal and external balances have worsened and macroeco- nomic vulnerabilities have deepened. Meanwhile, the persistent structural problems of high youth unemployment and poor service delivery remain unaddressed two years after the Arab Spring. South Asia's GDP rose an estimated [4.6] percent in 2013 on a market price -calendar year basis vs. [4.2] percent in 2012. Growth was, however, subdued compared to average growth over the past decade, reflecting a combination of domestic imbalances and weak external environment. Regional exports and industrial activity experienced a cyclical recovery in Q3, reflecting both strengthening external demand and currency depreciation in India (the latter resulting from a sharp withdrawal of capital flows during mid-year on apprehensions of tapering of U.S quantitative easing). Despite the cyclical rebound, in- dustrial activity for the full year was very weak, growing an estimated 1.5 percent (y/y). Lower international commodity prices helped ease inflation in Bangladesh and Sri Lanka, but inflation remains stubbornly high in India. Despite a moderation in Q1, remittances rose an estimated [6.8] percent in 2013—while India was the largest recipient by size, flows were more im- portant for Bangladesh, Nepal, Pakistan, and Sri Lanka as a share of their GDP. Economic growth picked up in Sub-Saharan Africa in 2013, supported by strong domestic demand, notably resource -based investments. Real GDP growth strengthened to an estimated [4.8] percent for the region, up from 3.6 percent in 2012; ex- cluding South Africa, its largest economy, average GDP growth accelerated to [6.1] percent from 4.1 percent. The recovery in during the first half of 2013 remained weak among oil exporters (Angola, Gabon, and Nigeria), partly because of domestic challenges in Nigeria. Industrial output in South Africa contracted at an 8 percent annualized pace in Q3 partly reflecting the impacts of labor strikes. Overall in the region, strong investment spending– notably large public infrastructure programs - have exacerbated current account deficits, which widened further in 2013. However, these were financed to a large extent with official transfers and FDI flows which rose to an estimated US$44 billion in 2013 from US$37 billion in 2012, flowing into both mining and non-mining sectors. Lower food prices and prudent monetary policies helped push inflation lower in many countries, which combined with a [6.5] percent increase in remittances has helped to support private consumption. However fiscal balances deteriorated further in 2013, especially among oil exporters in part reflecting weak commodity revenues. 6 GLOBAL ECONOMIC PROSPECTS | January 2014 Figure 5. Industrial output growth has rebounded in Figure 6. PMI’s are rising in 4 of 5 regions where data China and India are available Manufacturing Jan-13 Feb-13 Mar-13 Apr-13 PMI, May-13 Jun-13 Jul-13 Aug-13 +50=expansion Sep-13 Oct-13 Nov-13 54 52 50 48 46 E. Asia & Pacific South Asia L. America & Developing Dev. Ex. China Europe & C. Asia Sub-Saharan Caribbean Africa Source: World Bank, Thomson Datastream. Source: World Bank, Markit. The improvement partly reflects strengthening high periods was due to cyclical factors rather than any -income economies and rising demand in China significant slowing in potential growth. where growth accelerated to 9.3 percent annualized pace in the third quarter from just 6.9 percent in Overall, developing country growth has slowed by the first, helped by a “mini-fiscal stimulus” earlier 2.4 percentage points, with cyclical factors in the year. As a result (and boosted by currency accounting for 2.0 percentage points of the total depreciations in some countries during the (table 2). Slower potential growth accounted for summer) developing country exports (excluding the remainder (0.4 percentage points), with almost China) grew at a [12.2] percent pace during the 3 all of the slowing reflecting weaker productivity months ending October the fastest in 7 months. growth (a slight increase in the contribution from capital accumulation was offset by an equally At the regional level, strengthening was most modest decrease in the contribution from increased visible in East Asia, notably China but also labor supply). Thailand and Malaysia where GDP growth accelerated in Q3. In other regions, a sharp These trends are broadly visible across most recession in Ukraine has tempered a broader developing regions. Indeed in the majority of improvement in industrial activity in developing developing countries actual growth remains broadly Europe and Central Asia region. In Latin America in line with potential. Although, the slower growth and the Caribbean region, activity is recovering in of the past year or so in these countries has served Mexico following a sharp slowdown earlier in the to unwind some of the overheating pressures that year, but has weakened in Brazil. Activity in the had built up earlier (notably in East Asia), negative Middle-East & North Africa is weak reflecting output gaps in most of these economies are small – unsettled political conditions among oil importers despite growth rates below potential. in the region, and production setbacks among its oil exporters. The exceptions are Europe & Central Asia where potential growth slowed to a larger extent Slower growth in recent years mainly (accounting for half of the 3.4 percentage point reflecting an easing in the cyclical growth deceleration and reflecting steep component of growth contractions in investment during the crisis) and the Middle East & North Africa, where Cyclical factors have played a large role in productivity growth has slowed sharply due to developing countries’ GDP growth during both the severe political turmoil. pre-crisis and post-crisis periods. A decomposition of the sources of developing countries’ growth In many middle income economies, spare capacity suggests that most of the slowdown between the has remained limited. For Brazil, Turkey and pre-crisis (2003-07) and post-crisis (2010-13) Russia, output gaps remain either positive or only 7 GLOBAL ECONOMIC PROSPECTS | January 2014 slightly negative – suggesting that the recent but this has begun to narrow as growth rebounded slowdown has been helping to alleviate some of the in the third quarter. excess demand pressures that have contributed to a build up of imbalances and vulnerabilities in these countries (box 2). The main exception is India Tighter international financial where the sharp slowdown in the first half of 2013 conditions pose a headwind for opened up a relatively larger negative output gap, developing countries Financial conditions in developing countries over Table 2. Contributions to Potential Growth in Devel- the past 6 months, were roiled by a portfolio oping Countries (percentage points) adjustment that was set into motion by speculation 2003-07 2007-10 2010-13 2013-16 All Developing Countries over the timing as to when the US Federal Reserve GDP growth 7.7 5.5 5.3 5.5 would begin to withdraw some of the extraordinary Cyclical Component growth 1.5 -0.6 -0.5 0.0 measures have been put in place to support growth POT growth 6.2 6.2 5.8 5.6 during the post-crisis period. Despite no actual --of which TFP growth 2.6 2.5 2.2 2.1 --of which capital growth 2.2 2.5 2.4 2.2 change in the long-term asset purchases of the --of which labor growth 1.3 1.2 1.1 1.2 United States Federal Reserve (it merely indicated East Asia and the Pacific that it might begin reducing the extent of its long- GDP growth 10.2 8.5 7.6 7.2 term interventions toward the end of the calendar Cyclical Component growth 1.3 -0.2 -0.6 -0.4 year), financial markets rapidly priced in a POT growth 8.9 8.7 8.2 7.6 --of which TFP growth 4.7 4.5 4.0 3.8 significant increase in long-term yields. The yield --of which capital growth 3.0 3.4 3.3 2.8 on 10-year United States Treasury bills rose by 100 --of which labor growth 1.0 0.8 0.8 0.8 basis points, increasing US mortgage rates by 1.2 Europe and Central Asia percentage points and causing spreads on GDP growth 7.3 1.3 3.9 4.1 developing country sovereign bonds to rise by Cyclical Component growth 2.0 -2.6 0.3 0.3 POT growth 5.3 3.9 3.6 3.8 some 80 basis points between early May and end --of which TFP growth 2.0 1.3 1.3 1.4 August (figure 7). --of which capital growth 2.5 1.8 1.7 1.7 --of which labor growth 0.7 0.7 0.6 0.7 The increase in long-term U.S. yields sparked a Latin America and Caribbean significant portfolio readjustment. Previously, GDP growth 5.4 2.9 3.0 3.3 unprecedentedly low interest rates on United States Cyclical Component growth 1.9 -0.8 -0.3 0.2 POT growth 3.5 3.7 3.4 3.0 Treasury bills had induced investors to place their --of which TFP growth 1.3 1.2 0.9 0.6 money into riskier higher-yielding assets – --of which capital growth 1.0 1.3 1.4 1.4 including developing country bonds and equities. --of which labor growth 1.2 1.1 1.0 1.0 Partly as a result, over the past 5 years the share of Middle East and North Africa developing country bond markets (net of Brady GDP growth 5.4 4.0 0.8 2.5 Cyclical Component growth 0.9 0.4 -2.0 0.1 POT growth 4.5 3.6 2.8 2.4 Figure 7. U.S treasury yields and emerging market --of which TFP growth 1.1 0.4 -0.1 0.0 spreads rose rapidly during the summer --of which capital growth 1.5 1.8 1.4 1.0 --of which labor growth 1.9 1.4 1.5 1.5 (Percent) US Treasury 10-year yields (LHS) (Basis points) 5.5 Emerging market bond spreads (RHS) 1000 South Asia 5.0 900 GDP growth 8.4 6.9 5.2 6.3 4.5 2013 800 Cyclical Component growth 1.3 -0.1 -1.0 0.4 market 4.0 turmoil 700 POT growth 7.1 7.0 6.3 5.9 --of which TFP growth 2.9 2.7 2.4 2.3 3.5 600 --of which capital growth 2.7 2.8 2.5 2.2 3.0 500 --of which labor growth 1.5 1.4 1.3 1.3 2.5 2004 Fed 400 hikes 2008 2.0 global 300 Sub-Saharan Africa crisis GDP growth 7.2 5.3 5.1 6.3 1.5 2011 Euro- 200 zone crisis Cyclical Component growth 1.5 -0.8 -0.7 0.3 1.0 100 Jan-04 Jan-06 Jan-11 Jan-13 Oct-04 Aug-05 Sep-07 Feb-08 Dec-08 Oct-09 Oct-11 Jun-04 Jun-06 Aug-10 Aug-12 Mar-05 Nov-06 Jul-08 Jun-11 Jun-13 Apr-07 Mar-10 Mar-12 May-09 POT growth 5.7 6.1 5.8 6.0 --of which TFP growth 2.1 1.8 1.6 1.6 --of which capital growth 1.6 2.3 2.3 2.4 --of which labor growth 2.0 2.0 1.8 1.9 Source: World Bank. 8 GLOBAL ECONOMIC PROSPECTS | January 2014 Box 2. Slower growth in major middle-income countries reflects a closing of output gaps from above Growth dynamics in developing countries over the past several years have been heavily influenced by capacity constraints. Among several large middle-income countries, capacity constraints appear to have stymied efforts of policy makers to boost GDP growth through fiscal and monetary policy stimulus -- yielding increased fiscal deficits, larger current account deficits and higher inflation rather than faster growth. Several of these economies entered the great recession with demand levels well above capacity following several years of unusual fast growth during the boom period 2003 -07. While the crisis caused output in these economies to slow (as else- where in the world), the slowing occurred from positions of significant excess demand or strongly positive output gaps (the difference between the level of actual demand and supply capacity/potential output expressed as a percent of potential out- put, (table 1.1). Initially growth in these economies bounced back from the crisis very quickly – in part because of fiscal and monetary stimulus. As a result, by 2010 they had regenerated positive output gaps (Brazil and India) or closed them signifi- cantly (Turkey). Box 2 Table 1.1 Source: Bloomberg. However, growth during 2010-12, was held back by supply constraints and slowed significantly (relative to 2003 -07) despite further fiscal and monetary stimulus. In the case of Brazil, India and South Africa GDP grew much less quickly than potential output growth. As a result, by 2012 the large positive output gaps of 2010 had been closed. For Russia and Turkey, growth was also much slower than during the boom years, but was still stronger than potential output growth so in these countries output gaps closed from below by 2012. For 2013 as a whole, GDP growth for these countries is below potential, with large negative output gaps having been opened up in four of the five countries under consideration. However, quarterly growth has rebounded and currently exceeds or is equal to potential in Brazil, Turkey, and South Africa. bondsFN1) in global allocations have increased from As yields on 10 year US Treasury bills nearly a broadly stable 7 percent share in the last decade doubled, investors quite naturally decided to to more than [10] percent in the first half of 2013, increase the share of now higher-yielding US bonds the highest level observed since 1998 (figure 8). in their overall portfolios. This portfolio adjustment caused a temporary but significant reversal in capital flows from developing countries to the United States. On a cumulative basis, investors withdrew a net total of US $ 64 billion Figure 8. Developing countries have been active issu- from developing country mutual funds between ers in international bond markets June and August. Gross capital flows to developing 14 countries fell by half and the currencies and stock 12 markets of several major developing economies 10 Brady bonds declined by as much as 15 percent. Share of global bonds Markets are increasingly 8 6 4 differentiating between countries on 2 the basis of macroeconomic risks 0 Financial market pressure was much more focused Source: World Bank. on a few developing countries than is broadly 9 GLOBAL ECONOMIC PROSPECTS | January 2014 Figure 9. Currency depreciations were concentrated Figure 10. Downward pressure on currencies began in a few middle-income economies to ease in mid-August as portfolio adjust- ments drew to a close Source: World Bank. Source: World Bank. recognized. Rather than depreciating, the adjustment in asset markets. Negative pressures currencies of the vast majority (62 percent) of eased on currencies in the middle-income developing countries were stable or appreciated economies that had been hit hardest by the capital during the May through September period (Figure outflows during the summer accompanied by a 9). recovery in stock market valuations and some narrowing in developing country bond spreads. The impact of the portfolio adjustment on This recovery in levels was bolstered further by the developing-country financial assets and currencies late September announcement by the Federal was most pronounced among middle income Reserve that it would delay the beginning of its economies notably Brazil, Turkey, South Africa, tapering operations (figure 10). Initial financial India, Mexico, Malaysia and Indonesia. In part market reactions have also remained muted [thus these economies were hit, because they have far] after following the December 18th relatively deep financial markets, and therefore the announcement that the Federal Reserve would investors seeking to rebalance their portfolios curtail its $85 billion bond purchasing program by actually had money in these economies to about $10 billion starting in January 2014. withdraw. But other economies, like Peru, Mexico, and China have also received large inflows but However gross capital flows have remained volatile were much less affected. What distinguishes those in recent months (figure 11). A sharp drop in economies that were most affected from those that October fully reversed the rebound in September, were not is the extent to which they had been with the decline led by a steep fall in syndicated characterized by growing external and domestic imbalances (including current account deficits, Figure 11 Developing country gross capital flows government deficits, and rising inflation). With remain volatile markets re-pricing risk, those economies with $ billion weaker domestic reform agendas and poorer 80 macroeconomic fundamentals came under more 70 Equity issuance Bond Issuance pressure than others (Box 3). 60 Syndicated bank loans 50 Although financial market tensions 40 have eased, capital flows remain 30 volatile 20 10 Financial market conditions began to improve in 0 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 mid-August, likely reflecting an end to the portfolio Source: World Bank. 10 GLOBAL ECONOMIC PROSPECTS | January 2014 Box 3. Why some middle-income countries fared better than others during the mid-summer sell-off International financial market developments during the summer of 2013 are a stark reminder of the vulnerability of developing economies to rapid changes in global financial conditions. Currency and equity market declines that followed after expecta- tions of a tapering of US monetary policy began to build in May were concentrated mostly in middle -income economies with relatively deep capital markets. But even among these there were clear differences, with some experiencing sharper declines than others. Despite policy action from local central banks working mostly through foreign exchange interventions and domestic monetary tightening, the currencies of Brazil, India, Indonesia and Turkey fell by 10 percent or more between late May and September in trade weighted terms. In contrast, currency declines were significantly smaller in Mexico, Malaysia and South Africa (about 7 percent), and Chile (about 3 percent). The degree to which countries were hit reflected a combination of three factors: namely degree of market liquidity, domestic vulnerabilities and growth prospects. In part the stress reflected an unwinding of sizable carry trades that had built up in re- cent years. As investors started to rethink prospects for US interest rates, funding for carry trade flows into large middle - income economies also fell back. However market reassessments of their growth prospects and the size of domestic and external imbalances also likely played a role. For example, despite news that growth contracted in Mexico by 2.9 percent (saar) in Q2 compared to an acceleration to 6 percent in Brazil, currency declines were smaller in Mexico likely reflecting greater market confidence in light of strong progress on an ambitious structural reforms in energy and labor markets and fiscal retrenchment which has helped to contain fiscal deficits. Chile meanwhile has benefited from decades of prudent macroeconomic management: despite strong domestic demand, capital inflows, and ample liquidity, there are no signs of gen- eralized asset or credit bubbles, inflation remains below tar- Box Figure 2.1 Nominal effective exchange rates and get current account balances, selected econ- and growth robust with ample fiscal space to boost the omies economy in case of adverse external shocks. Malaysia has percent % change in Neer (May 21- Sept 1) continued to run large current account surpluses (to the 10 % change in Neer (Sept 1- YTD) order of 7 percent of GDP) and a newly elected government CA Balance (% of GDP 2012) has unveiled an ambitious structural reform agenda to im- 5 prove rural infrastructure, education and tackle corruption. 0 In Brazil in contrast, investor and consumer confidence has weakened on poor macroeconomic management and inter- -5 ventionist government policies at the same time as terms of trade have deteriorated in line with declining agricultural -10 and metal prices since 2012. In India, currency and equity Nominal effective exch. rate pressures only began to subside on indications of an im- depreciation proving trade balance in August and a strengthening of its -15 central bank’s inflation credibility and regulatory changes to encourage the repatriation of capital. Indonesia’s currency -20 Mexico Brazil Chile Indonesia India Turkey S. Africa Malaysia has however fallen by a further 6 percent since early Sep- tember, mainly reflecting poor incoming news on current Source: World Bank. account imbalances and rising domestic inflation. Figure 12 bank lending flows which tend to trail equity and Bond issuance by un-rated sovereign and corporate borrowers in developing coun- bond flows, and which had remained resilient tries have dropped sharply since May 2013 during the summer turmoil. Much of the decline in total bond volume ($bn) bond flows since September reflects a decline in 45 Investment grade corporates Investment grade sovereigns flows to un-rated borrowers. In the first half of the 40 Non-investment grade corporates year these borrowers sold about half of all bonds. 35 Since September that share has fallen to only 16 Non-Investment grade sovereigns 30 25 percent (figure 12). Bond issuance by investment 20 grade sovereigns and corporates appear to have 15 recovered the levels of the first half of the year. 10 5 The bulk of adjustment to the normalization of monetary policy in 0 Source: World Bank. high income economies lies ahead 11 GLOBAL ECONOMIC PROSPECTS | January 2014 Figure 13. The increase in long term rates has only Figure 14. Food and metal commodity prices have unwound about a third of the effects of QE fallen sharply since 2011 % of GDP Federal Reserve - Total Assets % 16 ECb - Total Assets 6 Bank of Japan - Total Assets Bank of England - Total Assets 14 Yield 10 year US T-bills, RHS 5 12 4 10 8 3 6 2 4 1 2 0 0 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Source: ECB, World Bank. Source: World Bank. Although the U.S. authorities have postponed the The USD price of internationally traded food and beginning of the tapering of quantitative easing, base metal commodities have declined by nearly 25 they are likely to begin the process sometime percent since January 2011 (figure 14), boosting during the course of 2014, in line with the expected incomes in commodity importers, but hurting strengthening of growth in the U.S. economy. As exporters. Energy prices are up [13] percent over active intervention at the long end of the yield the same period, although oil prices oil prices have curve eases, some further increase in yields on 10 eased most recently due to growing supply in the year U.S. Treasuries can be expected that should US and the easing of tensions surrounding Iran. reduce capital flows to developing countries (figure 13). When that occurs there is likely to be a further The decline in metals prices has been steady tightening of global financial conditions and throughout this period, reflecting both moderate additional portfolio adjustment. demand growth in China and a strong supply response to earlier price increases that have Although some financial adjustment has taken attracted a 5-fold increase in long-term investments place (the average long term cost of bond financing in new mines over the past few years. for developing countries is up some 50 basis points since early May), based on pre-crisis yields U.S. In contrast to metals prices, much of the decline in yields could have a further 100 basis points to rise food prices has occurred more recently, with a [16] (figure 13) and could increase even more and [20] percent fall in rice and maize prices since depending if the markets demand an additional June of 2013 due to improved maize harvests and return given the increase in the U.S. debt to GDP the release of Thai rice stocks. While prices have ratio from 64 percent in the pre-crisis period to an declined they remain [110] and [53] percent higher estimated 107 percent of GDP in 2014. than their January 2005 levels. Wheat prices have Developing country yields are likely to rise by not eased nearly as much and risks remain to the more, possibly 200 basis points or higher, on upside due to relatively low stocks. average in the medium-term as spreads over US benchmark yields also increase (Kennedy 2013). Price risks remain generally weighted to the downside in commodity markets. In metal markets, prospects hinge on China, which accounts for 45 Internationally traded food and metal percent of global metal consumption. If robust supply trends continue and Chinese demand commodity prices have weakened remains weaker than in recent years, the sharp price over the past 18 months falls over the past two years could extend further. In agricultural markets, weather-related supply disruptions could push prices higher (especially for wheat where stocks remain relatively low), but 12 GLOBAL ECONOMIC PROSPECTS | January 2014 Figure 15. The US is now the largest non-OPEC pro- Figure 16. Commodity exporters have suffered large ducer of liquid hydrocarbons* terms of trade shocks as commodity prices have fallen Liquid hydrocarbon production* million b/d 12 % of GDP Thailand 10 Benin Jamaica Brazil 8 Uruguay Vietnam Decline in commodity price: 6 Indonesia December 2012 vs latest obs. In Uganda 2013 South Africa 4 Laos PDR Decline in commodity prices: Argentina Guatemala average 2013 vs average 2012 2 Ethiopia Botswana Tanzania 0 Bolivia Aug-08 Belize Aug-09 Zambia Aug-10 Peru Aug-11 Honduras Aug-12 Gambia Aug-13 Kyrgyzstan Nicaragua Mali 2 Paraguay Ghana Guyana Source: KBC, World Bank.* includes crude oil condensate, natural gas Papua New Guinea -5.5 -5.0 -4.5 -4.0 -3.5 -3.0 -2.5 -2.0 -1.5 -1.0 -0.5 0.0 liquids (NGLs) and ethanol. OPEC data includes NGLs which are not subject to quota. Source: World Bank. upside risks are limited on account of rising Comparing average prices in 2013 with average production and adequate stocks, notably for rice. prices in 2012 – suggest that since 2012 commodity producers in Sub-Saharan Africa and Latin In energy markets, downside risks include weak oil America and the Caribbean have suffered on demand if growth prospects in emerging average terms-of-trade losses of over 1 percent of economies (where most of the demand growth is GDP and over 2.5 percent in some cases. Income taking place) deteriorate. However, changing declines in major middle-income commodity supply patterns also mark a structural shift. Surging producers are smaller but not insignificant: about US production due to advancements in shale 0.4-0.6 percent of GDP in Indonesia, South Africa extractive technologies has allowed the US to and Vietnam and nearly 0.2 percent in Brazil surpass Russia (figure 15) as the largest non-OPEC (figure 16). producer of liquid hydrocarbons.FN2 This is reducing its oil import demand, putting downward Estimates of the year-to-date fall in commodity pressure on global markets. It has also increased its prices show much larger impacts for agricultural potential to become a major energy exporter for commodity producers (reflecting the sharper natural gas – which is also putting downward declines in prices in the second half of the year), pressure on global natural gas prices, notably in amounting to 0.7 percent in major producers such Europe. Over the long term, oil demand is likely to as Thailand and Indonesia and 3.5 percent or more be dampened further as substitution between crude of GDP in smaller economies, which should weigh oil and natural gas intensifies (a slow and expensive on growth during 2014. process due to a lack of infrastructure to support wider use of natural gas in vehicle transport). Improvements in global trade should ... generating a large negative terms provide an important tailwind to of trade shock for food and metals developing countries producers Global trade growth has weakened markedly in the post-crisis period. During the period 1990-2007, The sharp fall in global food and metal prices has global trade tended to grow twice as quickly as led to a steady worsening in the terms of trade of global GDP, with the share of trade in developing commodity producers hurting export and fiscal country GDP steadily rising as developing revenues. In addition to impacting outturns this countries increased their share in both final and year, continued price declines in the second half of intermediate goods markets. 2013 should continue to weigh on growth in 2014. 13 GLOBAL ECONOMIC PROSPECTS | January 2014 However, in the post-crisis period 2010-13 global Looked at from the perspective off value-chains, trade has grown at about the same speed as the this is equivalent to saying that during the post- global economy – sparking speculation as to crisis period the average amount of gross trade to whether the period of rapid trade deepening by value added trade has declined due to a shift away developing countries may have come to an end, from products that involve many intermediate and with it whatever contributions it may have steps towards those that involve fewer steps. An made to growth. analysis of the OECD’s TiVA database is consistent with this hypothesis noting that the National accounts data suggest that that import share of goods like automobiles, which tend to elasticities for high income economies have fallen have long value chains and a low share of final from around 2.6 in the pre-boom period (2003-05) exporter value added to total value added ratio, has to 2.1 in the post crisis period (2010-13),FN3 and in declined while that of goods with short product developing countries from 2.28 to 1.25. Detailed chains and final-exporter high value added ratios trade data suggests that much of the decline in the has increased. elasticity of trade relative to GDP (the ratio of the trade growth rate and GDP growth rate) reflects a Based on this result, assuming that the composition change in the composition of global demand away of global final demand evolves as in the forecast from goods and services with heavy import content period a relatively stronger acceleration in high- and toward products that tend to have a higher income country investment and final demand, then domestic component in value added (and therefore trade can be expected to accelerate and the average less gross trade per unit of final demand). trade elasticity reach around [2.4] . Nevertheless, this should be lower than in the pre-crisis period, Data from the World Input Output Data Tables reflecting a slow recovery in private domestic suggests that on average the import content of demand – notably consumption- in both Europe private demand is much higher than the important and Japan (see below). content of government consumption (and highest for private investment) (table 3). These results hold for both developing and high income economies, although on aggregate import intensities are higher Prospects are for a for the latter. The financial crisis has cut sharply into activity and growth in high-income countries, and weak private demand has translated into slow acceleration in weakness in import demand. global economic Mathematically the change in trade elasticities can be decomposed into a part reflecting changes in the growth driven by high composition of final demand, and a part due to changes in the partial elasticities of trade to income economies different types of demand.FN4 World Bank computations suggest that some 30 percent of the recent decline in trade elasticities can be attributed to changes in the composition of final demand. Global GDP growth is projected to accelerate gradually from 2.3 percent in 2013 to 3.5 percent Table 3. Import Intensities* by Component of Aggregate Demand in High Income and Developing Countries Government Consumption Export Investment Developing 0.12 0.22 0.24 0.34 High-Income 0.14 0.33 0.33 0.38 Average 0.14 0.31 0.31 0.37 Source: World Bank, World Input-Output Database Project.* These indicate the increase in imports for a unit increase in aggregate demand component 14 GLOBAL ECONOMIC PROSPECTS | January 2014 by 2016, mainly reflecting a slow but steady Developing country growth should improvement in outturns among high income economies and the developing countries of Europe remain weaker than in pre-crisis and Central Asia. years, but in line with potential Growth in high income economies is expected to rise to [2.1] percent in 2014 from [1.3] percent in 2013, increasing Developing country GDP in 2013 is estimated to to about [2.4] percent by 2016. The recovery in Europe have grown about [4.9] percent, roughly the same and the United States is expected to be supported by still pace as in 2012, reflecting weakness at the start of very loose monetary policy; a diminished drag on growth the year. However, as discussed earlier, growth from government and household budget consolidation accelerated in the second half of 2013. This has efforts; and pent-up demand for consumer durables and generated a positive carry over for 2014, with GDP investment goods. The baseline projection assumes a expected to expand by 5.3 percent, broadly in line timely resolution to the debt ceiling debate in the US, with potential (figure 17). steady progress in economic rebalancing in the Euro Area, and some additional fiscal stimulus in Japan that helps Going forward, developing countries face offset a drag from higher consumption taxes in 2014. significant headwinds as monetary policy returns to “normal” in high income economies. Higher The pace of recovery in Europe is projected to be interest rates — U.S. long term rates are expected slow, reflecting the long and deep private sector to rise by a 100 basis points by 2016 in line with balance sheet adjustments. However, the drag from forward market expectations, with short rates these adjustments is expected to ease over time, as expected to start rising in 2015 and to increase rise balance sheets improve. In particular the drag from by 150 basis by end 2016 — can be expected to fiscal consolidation is expected to ease from about boost the cost of capital and further add to 0.8 percentage points of GDP in 2013 to 0.4 headwinds. Capital flows to developing countries percentage points in 2014. This gradual healing are meanwhile projected to decline by about [0.6] process is expected to allow growth to improve to percent of developing country GDP by 2016 (see around 1.5 percent in each of 2015 and 2016. Chapter 3 for more), as global asset portfolios are rebalanced towards high income economies. For In the US, overall growth for 2014 is projected to commodity producers, slower demand for their accelerate sharply to [2.6] percent from a relatively products from China as it rebalances its economy subdued at [1.7] percent in 2013. A main driver of are also expected to weigh on export and fiscal revenues. this improvement is a reduction in the drag on growth from fiscal consolidation, which in 2013 However the tightening of global financial conditions will amounted to 1.8 percent of GDP and is projected be accompanied by strengthening of growth in high to decline to less than [0.5] percent of GDP in income economies. Consequently, better import 2014. The pick up in growth will also reflect an demand from high-income countries (high-income acceleration in residential investment, which as a percent of GDP remains nearly [2] percentage Figure 17. Developing countries are expected to grow points lower than its long-term average (business in line with potential investment rates are closer to their long-term average). In Japan, aggressive fiscal and monetary easing have sparked a strong cyclical recovery, but in the absence of structural reforms that boost productivity growth and wages, particularly in the relatively low- productivity domestic service sector, this is unlikely to be sustained. In addition, in contrast to other high income economies, fiscal tightening is expected to weigh on growth in 2014. Accordingly, the economy is projected to grow broadly in line with potential growth, expanding by 1.5 percent in 2014, and slowing to about 1.3 percent in 2016. Source: World Bank. 15 GLOBAL ECONOMIC PROSPECTS | January 2014 import growth is projected to rise from 2.4 but growth in commodity exporters should suffer percent in 2013 to 4.2 percent by 2016)FN5 is (especially in 2014) as a result of the decline in expected to partly offset negative impacts from commodity prices over the past year (see earlier higher interest rates and weaker capital flows to discussion of terms of trade effects). developing countries. Barring structural reforms that boost supply In addition, a weakening of developing country capacity and productivity, growth in East Asia and currencies as capital flows to developing countries the Pacific (excluding China) — which is broadly in ease will be an essential part of the rebalancing in line with potential—is unlikely to accelerate much these economies. As figure 19 shows, this process further without hitting supply side constraints and has already begun—although it has yet to fully generating overheating pressures. Overall growth unwind the significant currency appreciations since is projected to rise mildly from about [5.2] percent 2003 in major middle-income economies that in 2013 and 2014 to reach about [5.6] percent in reflected strong capital inflows and elevated 2016 with output gaps projected to turn positive by commodity prices for commodity exporters. 2015. Similarly, growth in the Latin America and Further depreciations should help improve the the Caribbean region is expected to remain broadly competitiveness of the traded sectors and for stable at or just below [3.5] percent annually in the commodity exporters, help reverse some of the projection period, up from [2.6] percent in 2013. Dutch Disease impacts associated with elevated China’s GDP is expected to grow about [7.5] commodity prices over the past decade. percent growth over the projection horizon (in line with potential) as the economy shifts to slower but more sustainable consumption-led growth. Accordingly, aggregate developing country growth In developing Sub-Saharan Africa, continued is expected to accelerate modestly to about [5.7] robust investment in resource sectors is projected percent in 2016. Although broadly in line with to lift growth from about 4.8 percent in 2013 to 5.3 potential, this would be nearly 2 percentage points percent in 2013 and about 5.4 percent in 2015 and lower than average growth of 7.3 percent during 2016 despite the negative income effects of lower the pre-crisis boom years (figure 19). commodity prices. Regional growth is projected to With its close trade and financial ties to the Supply side constraints remain a dominant factor in Euro Area, growth in developing Europe is the outlook for developing East Asia and the expected to benefit from the recovery in high- Pacific (excluding China) and Latin America and income Europe, which will transition from being a the Caribbean keeping growth broadly in line with serious negative factor for growth in the region to a potential (figure 18). Growth for manufacturing small positive one. However, growth in developing intensive economies in both regions should benefit Central Asia will be held back by weakness in from stronger demand in high income economies, Russia (now classified as a high-income country), a Figure 18. Strong real currency appreciations over the Figure 19 Output is expected to remain supply con- past decade in developing countries have strained in East Asia and Latin America begun to unwind % of potential GDP 4 % change in Real Effective Exchange Rate (+ appreciation) Paraguay 3 Mexico Senegal Colombia 2 Thailand Pakistan Lebanon 1 Ecuador Hungary Lesotho 0 Mauritius Algeria since 2010 Jamaica -1 Honduras Since 2003 Cameroon Romania -2 Jordan Bulgaria Ghana Morocco -3 Gabon Belize Armenia -4 2010 2011 2012 Indonesia Albania India -5 2013 2014 2015 Namibia S. Africa Egypt -6 2016 Congo Madagascar Cape Verde -7 Brazil Europe & C. E. Asia & L. America & South Asia Sub-Saharan M. East & N. -60 -40 -20 0 20 40 60 80 Asia Pacific (ex. Caribbean Africa Africa China) Source: World Bank. Source: World Bank. 16 GLOBAL ECONOMIC PROSPECTS | January 2014 Box 3. Regional Economic Outlook (The regional annexes to this volume contain more detail on recent economic developments and outlook, including country -specific forecasts.) Growth in the East Asia & the Pacific region is likely to remain supply constrained over the forecast period in the absence of structural reforms that boost supply potential and productivity. Tighter global financial conditions and lower capital flows are also expected to weigh on investment in the region. Growth in China is projected to slow to 7.5 in 2015 from 7.7 percent in 2013 and 2014 reflecting policy efforts to rebalance its economy. In the rest of the region, growth is projected to stay flat at around 5.3 percent in 2014 and to settle around 5.5 percent in 2016 as external demand solidifies and adjustment is com- pleted. Regional risks relate to the potential for a disorderly unwinding in Chinese investment as it rebalances and weaker contribution from net-exports than assumed under the baseline. A rapid increase in global interest rates could also expose vulnerabilities, notably current account financing pressures (Indonesia, Mongolia), low foreign exchange reserves (Cambodia, Indonesia, Lao PDR, Mongolia, Vietnam and the Pacific Islands) or high levels of non-government debt in China, Malaysia and Thailand. Commodity exporters (Indonesia, Malaysia, PNG, Mongolia, Vietnam) could suffer if commodity prices fall more sharply than projected. A potential escalation of political tensions is an added risk to the regional outlook. The overall outlook for the Europe & Central Asia region remains positive. Growth is expected to accelerate to 3.1 percent in 2013 from 1.9 percent in 2012 and to gradually lift to 4.6 percent in 2016. However, the outlook remains divergent across countries within the region. Those with close trade and financial links Europe are expected to benefit further from the latter’s recovery. Prospects are considerably weak for some countries, notably Belarus and Ukraine where rising fiscal and current account deficits look increasingly unsustainable. The region continues to face considerable risks, including prolonged weak- ness in the Euro Area and Russia (although by the same token, stronger than expected growth would be an upside); risks of a disorderly adjustment to tighter global financial conditions once tapering of US monetary policy begins particularly in coun- tries with weak banking sectors, high current account deficits financed by portfolio inflows, and high levels of private external debt; and further sharp declines in commodity prices. . With global economic conditions expected to improve in 2014 and beyond, the economic outlook in the Latin America and the Caribbean in the medium term is positive, with regional growth picking up from 2.5 percent in 2013, to 3.2 percent in 2014 and 3.2 percent in 2015. Strong export growth along with a steady consumption growth is expected to nudge Brazil’s growth higher from 2.4 percent in 2014 to 3.7 percent in 2016. Argentina and Paraguay will be moderating from their bumper harvest booms in 2013 to grow at average rate of 2.6 percent and 4.0 percent, respectively, for the remainder of the forecast- ing period. Hinging on the pickup in the United States, Mexico is expected to see a growth rate of 3.4 percent in 2014, accel- erating to 4.2 percent in 2016. The outlook for the Central American economies is generally positive with growth accelerating in Belize, El Salvador, Honduras and Nicaragua. Downside risks for the region include a disorderly jump in global interest rates due monetary tightening, which would hike financing costs and threaten investment, and a prolonged and deeper slump in commodity prices which could further substantially cut export revenues. Growth in the Middle East and North Africa region is expected to remain weak during the forecast period. The outlook for the region is shrouded in uncertainty and subject to a variety of risks, mostly domestic in nature, and linked to political insta- bility and policy uncertainty. Under the baseline scenario for the forecast period, marked improvement in the political uncer- tainty that has plagued the region is not expected. Consequently, aggregate growth for the region is expected to slowly pick up to about [3.3] percent in 2016, but remain well below it’s potential growth. In developing oil importing countries, consump- tion will be underpinned by large public outlays on wages and subsidies, while public investment will likely be constrained in the forecast period by large fiscal deficits, while growth in developing oil exporters will strengthen as the oil prices remain relatively high and infrastructure problems and security setbacks are resolved and mitigated. GDP growth in South Asia is projected to improve to [5.7] percent in 2014, rising gradually to [6.7] percent in 2016, led mainly by a recovering high income import demand and regional investment. The pickup in investment, however, depends critically on macroeconomic stability, sustained policy reforms, and progress in reducing supply -side constraints (particularly in energy and infrastructure) -- and is therefore subject to significant downside risks. India's growth is projected to rise to just over [6] percent in FY2014-15, and to [6.6] and [7.1] percent by the 2015 -16 and 2016-17 fiscal years. Pakistan's growth is expected to moder- ate to about [3.5] percent in FY2013 -14, reflecting necessary fiscal tightening, and then rise to about [4.5] percent in the medi- um term. A projected decline in international commodity prices will help reduce inflation and current account pressures, and -- together with normal harvests and sustained remittance flows -- support consumption demand in the region. The main regional risks to the outlook are fiscal and policy reforms going off -track; uncertainties related to national elections in Afghanistan, Bangladesh and India; and a possible disorderly adjustment of portfolio capital flows to tapering of U.S quantitative easing Robust domestic demand, relatively resilient FDI flows and slower pace of inflation that boosts real income are expected to continue to support growth in Sub-Saharan Africa in the medium term, despite tighter global financial conditions to which countries in the region are relatively insensitive. A modest fiscal consolidation is expected to start in 2014 and current ac- count deficits are expected to narrow in 2016 as export capacity rises and import growth slows. Significant external risks relate to sharper than projected declines in commodity prices, and spillovers from U.S. monetary tapering to South Africa where rising domestic and external imbalances render it vulnerable to rapid capital flow movements. For frontier countries that have been raising funds in international bond markets, currency depreciations could raise repayment costs. Domestic risks relate to weather shocks to local harvests and food prices, security risks in Northern Nigeria, and pirate attacks along the gulf of Guinea, which could raise shipment costs and disrupt regional trade 17 GLOBAL ECONOMIC PROSPECTS | January 2014 major trading partner and major source of and banks have gone a long way to remittances. In addition, debt overhang from the restructuring themselves, but there is still a 2008/09 crisis will impede a strong pickup in long road ahead before all of the problems that growth, which for Europe and Central Asia as a the global financial crisis laid bare are fully whole is projected to accelerate from 3.1 percent in resolved. In order for the large output gaps 2013 to about 4.6 percent by 2016. that have opened up to close, a strong acceleration in growth will be necessary, and Growth in South Asia is estimated to have been a the drivers of such growth remain unclear. very weak [4.6] percent in 2013, mainly reflecting Moreover with the banking sector still weak weakness in India following several years of rising and details on a fully-fledged banking union inflation and current account deficits, and high still being worked out, the currency bloc government deficits. Growth appears to be remains susceptible to shocks, including a recovering toward the end of this year, and tightening of policy in the US. regional GDP on a calendar basis is projected to slowly accelerate to [about [6.6] percent in 2016, mainly reflecting stronger growth in India, and a  Meanwhile significant amounts of spare capacity gradual implementation of structural reforms have opened up. On the one hand ,pervasive youth throughout the region. and long-term unemployment are raising concerns about a permanent deterioration in Prospects for developing countries in the Middle job skills and employability of the jobless. At East remain extremely poor, reflecting continued the same time, continued sharp credit social and political tensions that have sapped contractions raise the specter of deflation, macroeconomic conditions and have exacerbated which could exacerbate debt overhang the severe structural challenges inherited from the problems and result in a much more muted period prior to the Arab Spring. Growth in the recovery than considered in the baseline. baseline is predicated on is expected to pick up to [3.1] percent by 2016, up from [1.6] percent in  In the United States the general government 2013, worse than average growth in the pre-Arab deficit has also come down significantly – Spring period. However the baseline is predicated mainly due to heavy spending cuts imposed by on an improvement in political conditions the sequester and rising tax revenues as the necessary to lift confidence and activity and create economy recovers. Nevertheless, little progress the room for necessary reforms, but this is has been made to agree to a medium-term plan increasingly looking optimistic. In the absence of a for bringing the debt-to-GDP ratio under control political consensus, the balance of risks remains and the risk of additional brinksmanship and an weighed to the downside. excessive and disruptive tightening of policy remains. The outlook is subject  In China concerns persist over the scale of to significant investments being made, their medium-term profitability and the viability of the loans taken uncertainties out to finance them. Chinese policy makers face formidable challenges in reorienting the economy away from an export/investment led model, with reforms required across a range of sectors While the baseline forecast remains the most likely if private consumption is to underpin future outcome, the outlook is subject to significant growth. Meanwhile past high levels of investment uncertainties. While the main tail-risks that have have generated significant vulnerabilities, which preoccupied the world economy over the past 5 could generate significant banking and fiscal years have subsided, the underlying challenges that risks. An abrupt unwinding of investment in underpinned them – though less acute — remain. China as it deleverages could sharply reduce GDP by 3 percent or more (see World Bank,  In the Euro Area much has been achieved Global Economic Prospects 2013a for more) 18 GLOBAL ECONOMIC PROSPECTS | January 2014 with significant knock on effects in the region and and its negative impacts on investment and growth other economies with close trading linkages are incorporated into the baseline.FN6 (including commodity producers). Gross capital flows to developing countries While disappointments along any of these fronts are also expected to recede in the baseline as could slow growth there are also potential upside asset portfolios are rebalanced (see the risks. A forceful reinforcement of the structural extensive discussion in Chapter 3), with flows component of Japanese policy, a multi-year expected to taper off by 0.6 percent of agreement on fiscal policy in the United States and developing country GDP to about [4.0] additional progress toward a banking union and percent of GDP by 2016 (about a 10 percent recapitalization of European banks would all likely relative to current levels). boost confidence and clear the way for a more forceful recovery in high-income countries. However, should market reactions to the withdrawal of extraordinary monetary measures in A stronger than expected recovery in high income high-income countries be less orderly than assumed economies could provide considerable support to in the baseline, then a much more disruptive path external demand in developing countries, helping toward the new equilibrium can be envisaged offset downward adjustments in domestic demand where long term interest rates in “G-4” economies triggered by rising global interest rates. Finally, rise rapidly by 200 basis points (figure 20). lower food prices should also reduce inflation pressures and contain food import costs, although Simulations based on econometric work discussed they are a negative for food exporters. in more detail in Chapter 3 suggest that a more precipitous adjustment of interest rates and In the near term, the transition to investor portfolios could inflict significant damage on developing economies, raising domestic and higher global interest rates is likely to external costs of debt servicing. Those most at risk be bumpy would include those that are more integrated into the global financial system, those that have large external imbalances. In addition countries with Over the medium term, the gradual return of long- large amounts of external debt and those that have term interest rates in both high–income and experienced large credit expansions in recent years developing countries to more normal levels should could also be at risk. help reduce the excesses and vulnerabilities associated with a persistently low interest rate In a disorderly adjustment scenario, gross flows to environment from building up further. The higher developing countries could decline by as much as cost of capital implied by a gradual normalization 70 percent for several months, falling to about 0.6 percent of developing country GDP (figure 21). In Figure 20 Long term interest rates in G4 countries Figure 21. Gross capital inflows to developing coun- under different normalization scenarios tries under different scenarios G4 long term interest rates Capital inflows developing countries (percent of GDP) 6.0 Percent Percent 14 5.5 12 Baseline Baseline 5.0 Fast normalization 10 Fast normalization 4.5 Overshooting 8 Overshooting 4.0 6 3.5 4 2 3.0 0 2.5 -2 2.0 -4 1.5 -6 Source: World Bank. Source: World Bank. 19 GLOBAL ECONOMIC PROSPECTS | January 2014 the event, nearly a quarter of developing countries …and comes at a time when policy could experience sudden stops in their access to global capital, substantially increasing the probability of space has been significantly eroded economic and financial instability. World Bank and macroeconomic imbalances simulations suggest that in such a scenario, GDP in middle income countries could fall by a cumulative have deteriorated 1.2 percent relative to the baseline by 2016, and roughly 0.4 percent in low income economies, While the resilience that developing countries reflecting the different degrees of global financial displayed in the face of the great recession is and trade integration of these economies (Box 4). comforting, and symptomatic of their much improved fundamentals and macroeconomic For some countries, the effects of a rapid management, they are much more vulnerable now adjustment in global interest rates and pull back in than they were then. Currently, fiscal deficits are capital flows could trigger balance of payments or over 4 percentage points of GDP higher 2007 in domestic financial crisis. As research in Chapter 3 nearly half of developing countries (figure 22), with shows, more than a third of past crises (over the the deterioration having been particularly marked last 20 years) were either preceded by a sharp in the Middle East, but also among commodity surges or accompanied by a sharp stops. Global producers in Sub-Saharan Africa and East Asia, and domestic factors seem equally important and in South Asia and the smaller economies in triggers, with the probability of crisis rising Latin America. significantly after periods of low global interest rates, low risk aversion, high commodity prices and Monetary policy is also loose in most developing rapid domestic credit growth. countries, leaving little room for additional stimulus were it to be required (figure 23). Since Box 4. Potential impacts from a disorderly unwinding of capital flows and rapid increase in global interest rates associated with an unwinding of quantitative easing policies in high income economies World Bank simulations of the potential impacts of a disorderly adjustment to the unwinding of quantitative easing policies in high income economies – which triggers a rapid increase of 200 basis points in long term interest rates in the US– suggest that gross flows to developing countries could decline by as much as 70 percent for several months, falling to about 0.6 Box Figure 4.1 Impact of a rapid 200 basis points in- percent of GDP before recovering gradually after (figure 22). crease in global interest rates on real Results derived from VAR simulations integrated into the GDP in developing countries World Bank’s multi-country econometric model show that In Difference Relative to Baseline(% of GDP) such a scenario, growth in medium income countries would 0.20 be most affected, with rapid increases in global interest rates and temporary capital pullbacks subtracting a cumula- 0.00 tive 1.3 percentage points from GDP levels over the fore- -0.20 cast period (see Figure 23) compared to the baseline. The impact of a rapid tightening of global financing conditions on -0.40 high income countries would be around half the effect esti- mated for medium income countries, as rising long -term -0.60 interest rates would itself reflect signs of a sustained recov- -0.80 ery in high income countries while a reversal of capital flows would support their resilience. -1.00 -1.20 Low income countries that are less dependent on interna- "High Income" "Middle Income" "Low Income" tional capital flows or less integrated in global financial mar- -1.40 kets, are mainly affected through trade channels (as weak- 2013 2014 2015 2016 er import demand from medium and high income countries sap export growth and activity). Simulations indicate that a Source: World Bank. rapid tightening of global financial conditions in medium and high income countries would lower real GDP levels in low income countries by 0.4 percent compared to the baseline fore- cast. This should be considered as a lower bound impact, as the multi -country model does not cover financial market spillo- vers that could impact financing costs for many low income economies that had begun to enter international debt markets in recent years. 20 GLOBAL ECONOMIC PROSPECTS | January 2014 Figure 22. Fiscal balances have deteriorated in most Figure 23. Central banks have yet to unwind cuts im- developing countries plemented in recent years so that mone- tary policy remains loose Bot, Camer. Tha, Moz., Pan, Kyr, Ven Egy, Jor, Jam, Nigeria,, Tanz, ALgeria, Dom. R. , S Africa, Haiti, C. Rica Number of changes 16 Increases Cuts 20 14 No of countries Namibia, Mongolia, Cape Verde 12 15 10 8 10 Papua New Guinea 6 Swaziland 4 5 Morocco Congo 2 0 0 Nov-11 Nov-12 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Mar-13 Jan-13 May-13 Jul-13 Sep-13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Change in fiscal balance, 2007-2012 (% of GDP) Source: World Bank. Source: World Bank. November 2011, the number of rate cuts have As a result, developing countries will be more outnumbered rate increases by a ratio of 4FN7. vulnerable to a deterioration in external financing Loose policy has translated into rising or conditions like that expected. For commodity persistently high inflation in many countries. exporters, whose current account surpluses have Developing country inflation has continued to mostly been wiped out (compared to surpluses accelerate over the past year despite sharp declines approaching 10 percent of GDP in 2006), in food commodity prices in recent months financing pressures could be further exacerbated if suggesting that wage pressures and limited spare there are sharp falls in commodity prices during capacity (along with currency depreciations and this period., more than projected in the baseline. other factors) are sustaining higher prices (figure 24). Financial sector risks have increased With demand stimulus keeping import demand across developing countries, but are relatively strong despite a sharp easing in exports, the aggregate developing countries current account most pronounced in East Asia balance has swung from a surplus of nearly 3 percent of developing country GDP in pre-crisis The stock of credit as a share of GDP in several years to a small but growing deficit since 2011 developing countries has increased very rapidly (figure 26 and figure 27). over the past 5 years (figure 27), reflecting policy stimulus at home and spillovers from loose global Figure 24. Developing country inflation has contin- Figure 25. Current account balances have deteriorated ued to rise despite a sharp declines in for most developing countries... international food prices % of GDP 12 Price indexes, % year-on-year Resource Rich 50 8 10 All Developing 40 7 Oil importing 8 Oil Exporting 30 6 Developing ex China 6 20 5 4 10 4 2 0 3 0 -10 -20 2 -2 -30 1 -4 10M09 11M01 11M05 11M09 12M01 12M05 12M09 13M1 13M5 13M9 2006 2007 2008 2009 2010 2011 2012 2013 International Energy International Food Developing CPI (RHS) Hign income country CPI Source: World Bank. 21 GLOBAL ECONOMIC PROSPECTS | January 2014 financial conditions. This indicates the potential for debt servicing difficulties among untested/first- Figure 26. …… but particularly sharply in several mid- dle-income economies time borrowers and a possibly significant increase in the exposure of existing borrowers, with risks to 20 Change in Current Account Balance, 2007 - 2012 (% of GDP) financial stability if economic cycles worsen. 15 Among major middle income economies, the stock 10 of credit has increased by 20 percent or more of Turkey 5 Mexico Thailand GDP since 2007 in Brazil, Turkey, Malaysia, South Africa 0 Vietnam, Thailand, Indonesia and China. In China, -20 -15 -10 -5 0 Brazil 5 10 15 20 25 Current Account Balance (% -5 credit stock has increased by over 60 percentage China of GDP, 2012 points since 2007 to 210 percent of GDP in Q4 India -10 Indonesia Malaysia 2013 (if credit that has originated from the under- -15 EAP ECA regulated shadow banking sector is included). -20 LAC MNA SAS SSA -25 Public sector indebtedness is also high, in excess of -30 60 percent of GDP in many developing economies Source: World Bank. (figure 28). Moreover, given implicit guarantees to banking sectors in many developing economies and the use of state owned banks to stimulate domestic credit growth (Brazil, China, India), public debt Figure 27 Domestic credit to GDP ratios have in- levels could rise rapidly in case of rising loan creased sharply Change in bank credit, 2007- Credit stock in 2012 (% of 12 % of GDP GDP) 40 180 Business-as-usual is no longer a 160 35 Change 2007-12, LHS Stock as of 2012 140 policy option for developing countries 30 120 100 25 80 With developing countries entering a potentially 20 60 disruptive period of global financial tightening, 40 maintaining a business-as-usual policy stance is no 15 20 longer an option. Policy complacency risks a 10 Mozambi… 0 Yemen,… Papua… further accumulation of domestic vulnerabilities Lao PDR Ukraine Bhutan Morocco Venezuela Togo Botswana Armenia China Vietnam Malaysia Gambia Turkey Lesotho Cambodia Paraguay Kosovo Brazil Tunisia Colombia Nepal India Angola Bulgaria Kenya Macedonia Nigeria Swaziland Mauritius Guinea Thailand Serbia Malawi Romania Russia likely requiring larger adjustments down the road, and at greater economic cost given the closer Source: World Bank. scrutiny of domestic risks by financial markets. However, the already daunting political challenge represented by implementing necessary measures – Figure 28. Public debt levels are in excess of 60% of both short term to boost macroeconomic stability GDP in many developing economies during the transition to higher global interest rates General Government Gross Debt (% of GDP, 2012) and longer term reforms to raise growth potential – Ghana Mauritius Vietnam may be made even more difficult given upcoming Montenegro Lao P.D.R. Guinea-Bissau elections in several of those countries that were Malawi El Salvador Malaysia most tested during the summer, including South Uruguay Zimbabwe Africa, Thailand, Turkey, Indonesia, Brazil and Morocco Albania Bhutan India. Serbia Pakistan Guyana India Brazil Belize Furthermore indications of policy complacency The Gambia Jordan Egypt also appeared once financial market pressure Cape Verde Sudan subsided after the summer sell-off. Although there Mauritania Eritrea Lebanon have been positive developments, credit continues Jamaica 0 20 40 60 80 100 120 140 160 to expand too quickly in several of the countries Source: IMF, World Bank. hardest hit by markets during the summer, which 22 GLOBAL ECONOMIC PROSPECTS | January 2014 ready to respond to financial market pressures Figure 29. While private external debt is also consider- including through tighter monetary policy, ably high in some countries exchange rate adjustment supported by central banks’ reserve management policies, macro- prudential policies and capital controls (see Chapter 3 for more discussion). These measures helped limit spillovers to domestic activity during the summer sell-off, and remain relevant in the current environment for reducing external financing dependencies; bringing down domestic imbalances, and ensuring the viability of existing loans to a hike in interest rates. However, even during May-September episode policy actions were complicated by domestic Source: World Bank. vulnerabilities and imbalances. Notably the usefulness of exchange rate as a “first line of may be adding to vulnerabilities. For example in defense” or “shock absorber” was constrained by Brazil, despite rate hikes, lending by state-owned risks that rising import costs would add to cost- banks and quasi-sovereign institutions continues to push inflation (India, Indonesia and Brazil) or remain strong and may be adding to vulnerabilities. budgetary pressures in countries with large (imported) fuel subsidies (India and Indonesia). In Similarly, although inflation expectations remain addition, some policy measures, notably trade entrenched, the Indian central bank is only restrictions deployed by India, may prove gradually tightening policy – raising its main policy counterproductive over the long term while having rate by a cumulative 50 basis points to 7.75 percent a relatively limited impact in the short term. since September, so that real rates remain firmly in the red at [2.3] percent currently. Meanwhile, the ratio of restructured advances to gross advances 2)… and to supplement these efforts by plus the non-performing asset ratio reached 9.4 rebuilding policy buffers and implementing percent of loans in March 2013. This prompted the Reserve Bank of India to warn recently of the structural reforms stress on banks' asset books, in particular from lending to iron, steel and infrastructure sectors The resilience of developing countries to the which have the highest levels of stressed assets. 2008/09 global financial crisis was underpinned The authorities’ recent decision to allow increased partly by strong macroeconomic fundamentals and foreign participation and private-sector partly by strong growth potential. However, as competition in the sector is a good initial step in discussed earlier, buffers have eroded considerably the right direction. since then as growth eased and stimulus was deployed. The experience of high-income In Turkey, although credit is growing at close to a countries, where fiscal sustainability unraveled and 30 percent annual rate the authorities have not yet monetary buffers were quickly exhausted (even raised interest rates. Mexico has eased policy, among countries that started from a position of cutting rates (by 25 basis points) recently but this is relative strength) serves as an object lesson of the easier to justify in light of reforms that have already importance of possessing sufficient policy room to been initiated that address some of the structural absorb the impact of financial and economic stress. issues in that economy. Meanwhile, for most developing countries a further acceleration of growth (or even sustaining current 1) Developing countries need to stand ready to growth levels which are broadly in line with respond to financial market pressures potential) cannot be assured without constant efforts to expand capacity and increase With tapering at hand, policy makers need to stand productivity. In middle-income economies 23 GLOBAL ECONOMIC PROSPECTS | January 2014 structural reforms are needed if they are to escape effects and improve the functioning of automatic the so-called “middle income trap” and boost per fiscal stabilizers. capita incomes further. As productivity gains associated with shifting workers out of low- Policy steps that would stimulate the supply side productivity agriculture towards manufacturing include addressing energy bottlenecks that are diminish, growth will increasingly have to be driven particularly prominent across the South Asia by rising productivity and innovation within region, and infrastructure bottlenecks that are manufacturing and services instead. significant for all developing regions but are a particularly binding constraint in Sub-Saharan Policy actions that address the rebuilding of policy Africa and the Middle East and North Africa. buffers and boost supply capacity and productivity However, solutions for boosting infrastructure are growth are intertwined, with some measures complex and not a macro but a micro problem for yielding pay-offs both in the near term and over a most developing countries, with policy makers longer horizon. In fiscal policy, relatively easy short needing to pay close attention to improving the -term “wins” include subsidy cuts. Although quality of investment and infrastructure spending. precise numbers are hard to obtain, the cost of Arguably levels of investment are already quite high food and fuel subsidies can be disproportionate in in countries such as China and India and are at developing countries compared to other priority historically high levels in most of Sub-Saharan public spending areas. For instance, agricultural Africa (figure 31) where public investment has in subsidies are estimated at close to over 2 percent of recent years (rightly) been geared toward the GDP in Indonesia, China and Turkey (OECD, provision of basic infrastructure, particularly power 2013). Fuel subsidies alone in several economies in generation, and roads and port facilities (World the Middle East and North Africa region amount Bank, 2013b). to more than 6 percent of GDP (IMF, 2012). Other policies that could help boost longer term Scaling back such subsidies would also potentially productivity growth include reducing regulatory yield benefits over the medium term to the current impediments to business and trade which are account through the rationalization of (imported particularly severe in Sub-Saharan Africa and to a goods) prices, and longer term benefits to fiscal lesser extent in the Middle East and North Africa sustainability and potential growth if they create and South Asia regions (World Bank, 2013c). room to raise spending on priority areas such as Although local conditions and therefore infrastructure, health and education that relieves recommendations differ, such policies are likely to supply side constraints. Explicitly combining a generate the largest dividends, and are more likely reduction in subsidies with targeted social also to attract long-term stable FDI flows. assistance of the very poor can make such reforms more acceptable, minimize the negative poverty Figure 30. …Agricultural subsidies are quite high as a Figure 31. Investment levels are at historical highs in share of GDP in some developing countries China, India and Sub-Saharan Africa Total Agricultural Support Estimates, % of GDP, 2012 Investment as % of GDP 4.0 50 China 3.5 East Asia ex China 45 Europe & C. Asia 3.0 L. America & Car. 40 South Asia 2.5 Sub-Saharan Africa 35 2.0 30 1.5 1.0 25 0.5 20 0.0 15 Kazakhsta Indonesia China Turkey Japan US OECD Russia EU Mexico Ukraine Chile South Brazil Africa n 10 1980 1985 1990 1995 2000 2005 2010 Source: World Bank , OECD (2013). Source: World Bank. 24 GLOBAL ECONOMIC PROSPECTS | January 2014 absence of an explicit deposit insurance system and Figure 32. Developing countries have more cumber- resolution frameworks. some custom clearances than high income economies In India, regulations mandating that a portion of 120 bank lending be directed towards priority sectors such as agriculture have limited the availability of credit for industry forcing it to seek debt funding 100 Number of Days to Import 80 from overseas, and increasing the vulnerability of 60 domestic firms to changes in risk sentiment and funding conditions overseas. In Brazil state owned 40 banks accounted for 50 percent of all outstanding 20 credit in mid-2013, up from 33 percent in 2008— the first time they passed the halfway mark since a 0 0 10000 20000 30000 40000 50000 60000 70000 80000 90000 wave of bank privatizations in 1999. GDP per capita (constant USD) Source: World Bank. Accordingly, further progress on financial reforms is needed to fully mobilize domestic savings and push them towards their most productive use. The heavy involvement of the state needs to be rolled Trade facilitation reforms represent particularly low back in order to increase exposure to market -hanging fruit that could yield substantial benefits discipline and to improve governance, the for developing countries. It takes about thrice as efficiency of capital allocation and risk much time and twice as much documents and cost management. to import goods in developing countries compared to high-income OECD countries (World Bank, Among major middle income economies, China 2013c). Reducing these costs could yield gains of and Mexico stand out as having the most ambitious nearly $120 billion in additional global GDP per and advanced reform agendas. However progress annum, most of which should accrue to developing on the credible implementation of reform measures countries (Hufbauer et al, 2013). In this context, is critical not only for reinvigorating growth over the recently negotiated Agreement on Trade the medium to longer term, but in the short term Facilitation (as part of the Doha Development can also help to limit the vulnerability of domestic Agenda) is an important step in facilitating greater economies to tighter, or more volatile, global merchandise trade, although facilitation of trade in financing conditions. In this context, by boosting services and agricultural goods continues to be a investor confidence, they can also help to support a thorny issue. sustainable virtuous cycle of strong investment, including foreign investment, and output growth over the medium term. In many developing economies, financial sectors tend to be bank-centric and heavily dominated by the state, and local debt markets relatively underdeveloped. This is also true in middle-income economies despite significant capital market deepening efforts in recent years. For instance, in Malaysia, government controlled or influenced investment entities hold nearly a third of market capitalization in listed companies, while in Indonesia, the largest three state-owned commercial banks account for a third of the banking sector asset and deposit base (IMF, 2010). Meanwhile, both the ownership and the client base of the banking sector in China are dominated by the state, which provides implicit guarantees in the 25 January GLOBAL ECONOMIC PROSPECTS | June 2014 2013 Notes 1. Brady bonds were dollar-denominated bonds, issued mostly by Latin American countries beginning in 1980 as a debt-reduction and restructuring agreement in order to convert bank loans into a variety or "menu" of new bonds after many of those countries defaulted on their debt in the 1980s . 2. Crude oil, condensate, biofuels and liquid natural gas . 3. The analysis excludes the years 2008 and 2009, when trade and GDP first declined sharply and then bounced back and focuses instead on the relatively calm pre - and post-crisis years . 4. Mathematically, the growth of global imports can be expressed as the weighted average of the growth rate if imports due to increased consumer consumption, government consumption, investment and exports (in many countries exports tend to have a high import content). Taking the total derivative gives and dividing by imports in the previous period gives the following expression for the growth rate of imports, and dividing by GDP growth on both sides gives an expression for the trade elasticity of GDP. Using econometric estimates of the partial elasticity of imports to different components of demand and the change in the various components of final demand (C, G, I, X) we can calculate the contribution to the change in imports from changes in demand, leaving the contribution to be explained by changes in the elasticities as a residual . 5. Despite the firming, global trade growth rates are not expected to regain pre -crisis levels in large part because global growth – though strengthening – will be almost [2] percentage points slower than during the pre -crisis boom period . 6. Impacts have been estimated to be as high as 0.6 percentage points per annum in the medium term (World Bank, 2010) , although this does not take into account potential productivity gains from capital being used more efficiently . 7. Since November 2011, here have been some 200 policy rate cuts by central banks in developing countries, compared to less than 60 rate increases . 26 GLOBAL ECONOMIC PROSPECTS | January 2014 References World Bank. 2013A. Global Economic Prospects: Assuring Growth Over the Medium Term. World Bank. Washington DC. OECD. 2013A. Agricultural Policy Monitoring and Evaluation, OECD IMF 2012. Energy Subsidy Reform – Lessons and Implications. IMF. Washington DC. World Bank. 2013B. Africa Pulse. World Bank. Washington DC. World Bank. 2013C. Doing Business, 2014 Report. World Bank. Washington DC. 27 GLOBAL ECONOMIC PROSPECTS | January 2014 Despite a weak start and mid-year turbulence, output growth in the region strengthened in the second half of 2013 supported by better net exports and a modest stimulus in China. Regional output is projected to stay flat in 2014 and pick up in 2015 & 2016 when benefits from stronger global trade outweigh the impact of tighter financing conditions. The region is vulnerable to risks of disorderly unwinding in Chinese investment and abrupt tightening in global financing conditions. Recent Developments of the 2008-09 crisis, domestic policy induced quick rebound from the economic slowdown in 2009, left output in the region close to or above capacity. Continued fiscal and monetary stimulus in the post-crisis period combined with the strong 2013 marked another year of weakening foreign inflows exacerbated imbalances leading to a growth in the East Asia and the Pacific region. rapid expansion of credit, deteriorating current Growth moderated to 7.2 percent in 2013 from 7.4 account positions, and growing asset price percent in 2012. Growth in China unchanged from pressures, in several countries between 2007-2012 the 7.7 percent recorded in 2012. A one percentage (Figure 2.1). Domestic credit expanded by more point slowdown in growth in the rest of the region than 20 percentage points of GDP in Malaysia, reflects a moderation of economic activity in Thailand, China, Vietnam, Cambodia and Lao Indonesia, Malaysia and Thailand, and sharp during this period. In several countries, including slowdown in Papua New Guinea due to a Mongolia, Papua New Guinea, Lao and Vietnam, a completion of construction of the Liquid Gas large part of the debt was foreign financed (World facility. Despite the damage caused by the natural Bank, GEP 2012b, 2013a, 2013b, East Asia & disasters, output in the Philippines is estimated to Pacific economic updates 2013, 2014). expand at a 6.9 percent rate in 2013 reflecting an ongoing construction boom. Beginning toward the end of 2012, authorities in the region tightened policies to unwind Weakening of regional growth reflects imbalances, contributing to sharp decline in unwinding of imbalances accumulated during economic activity in the first quarter of 2013. the years of above potential growth. As output Policy tightening along with still weak external in the region was capacity constrained at the onset demand contributed to the sharp decline in real 31 GLOBAL ECONOMIC PROSPECTS | January 2014 economic activity in the first part of 2013, when financial conditions in the second quarter of regional quarterly GDP growth fell from an 8. 3 2013. Speculation about the timing of tapering in percent annualized rate in Q4 2012 to 5.3 percent the US, provoked a global portfolio adjustment in Q1 2013 (8.2 percent to 2.7 percent for the toward US assets, whose yields had nearly doubled, region excluding China). The decline was most and cut sharply into the regional financial flows and pronounced in Indonesia, Malaysia and Thailand, asset prices. Net capital flows to the region declined where investment growth slowed sharply. Significant by 20 percent between May and September 2013. fiscal policy tightening measures taken include a Hardest hit were those economies where prolonged reduction of domestic stimulus in China and a 33 expansionary policies had increased domestic percent increase in fuel prices in Indonesia. Monetary vulnerabilities (current account deficits, high debt). policy on hold and then tightening was a major Sovereign spreads increased by 200 basis points in contributing factor in Indonesia, but also played Indonesia and 130 basis points in Vietnam, compared role in broadly unchanged in Malaysia, China (since with a developing country average of around 100 July of 2012), and in the Philippines (since October basis points. Despite interest rate hikes, Indonesia’s of 2012) -- although China has sought to actively currency declined by about [9 percent] in nominal guide credit flow within the economy. Only trade weighted terms reflecting a deteriorating Thailand, where the decline in economic activity current account and rising inflation, and Thailand’s was most marked, continued to ease policy throughout currency dropped by about 7 percent (Figure 2.2). 2013, including a rate cut implemented in November. Stock markets fell by between 20 (Thailand and the Philippines) and 35 percent (Indonesia) versus a 12 Declining commodity prices have cut into fiscal percent decline on average for developing countries. revenues among commodity exporting countries complicating the process of adjustment. World Despite the mid-year financial turbulence, metal and mineral prices have declined nearly 30 growth in the region has been strengthening percent, agricultural food prices eased by over 24 since Q1 supported by improved external percent, and raw materials have weakened by demand, lower imports and policy stimulus in almost [40] percent from their post-crisis high in some countries. The weaker than expected growth February 2011 hurting the regional food, metal and in China in Q1 (5.9 percent saar) prompted authorities raw material exporters. Deteriorating terms of trade to deploy a relatively modest stimulus package. are estimated to have reduced incomes by as much This, in combination with recovering import as 3.4 percent of GDP in Papua New Guinea, 2.5 demand from high income countries, pulled Chinese percent of GDP in Mongolia, and 0.5-0.6 percent quarterly GDP growth up to a 9.3 percent annualized of GDP in Lao, Indonesia and Vietnam (about 0.5- rate in the third quarter. Outside of China quarterly 0.6 percent of GDP). GDP growth also accelerated to [5.2] percent annualized rate in Q3, mainly benefitting from The impact of domestic adjustment was also better net exports due to lower imports (Figure exacerbated by tightening of international 2.3). Quarterly GDP growth in Thailand Figure 2.1 Loose policies domestically and globally Figure 2.2 Downward pressure on currencies began helped sustain a period of rapid credit to ease in mid-August, except of Indone- growth sia and to some extent Thailand Source: Source: 32 GLOBAL ECONOMIC PROSPECTS | January 2014 leading to a 0.2 percentage point fall in annual growth Figure 2.3 Imports are contracting at an accelerated rate in 2013). rate Since August 2013, capital inflows to the region have rebounded leading to decline in bond yields, which nevertheless remain elevated, partial recovery of asset prices, and easing pressures on local currencies. Pressures on current accounts have considerably eased from May-September tightening episode, but remained present, particularly in Indonesia reflecting ongoing adjustment to external balance pressures. Despite earlier losses, regional reserve positions have remained stable in excess of 5 months of import coverage in most countries, with Source: the notable exception of [Vietnam, Lao, Cambodia and some Pacific Islands]. Increased revenue from accelerated to 5.2 percent annualized rate in Q3 tourism and remittances, fueled by recovering following two previous quarters of disappointing economic activity in high-income countries, played outcomes. In Indonesia, growth remains robust, some role in easing pressures on regional current but quarterly GDP growth has eased to 4.9 percent in accounts. Remittances to the region grew an Q3 relative to its recent trend. In Malaysia, output has estimated 7.4 percent in 2013 (to US$115.3 billion). coped relatively well recovering from contraction In the Philippines remittances, continued to in the first quarter to a strong 6.8 percent expand by an estimated 5.8 percent in 2013, and annualized rate expansion in Q3. In the will likely accelerate in the wake of typhoon. Philippines, the impact of typhoon Haiyan, has Buoyant revenue from tourism have benefitted caused large humanitarian impact, and has cut Thailand, and smaller economies of the region deeply into activity in the central islands, but its including the Pacific Islands. impact on the country’s overall economic growth is likely to be limited and growth is estimated to be Sentiment has turned up and both industrial 6.9 (about a 0.9 percent decline in growth in Q4 2013 production and exports started to firm but performance remains uneven across the region. Table 2.1 Net capital flows to East Asia and the Pacific ($billions) 2008 2009 2010 2011 2012 2013e 2014f 2015f 2016f Capital Inflows 208.2 259 529.6 546.4 485.8 495.7 505.9 536.1 560.6 Private inflows, net 208.6 255.1 525.6 546.8 482.5 495.3 506.0 537.4 562.5 Equity Inflows, net 203.6 184.7 331.5 346.6 351.6 335.3 350.8 369.1 386.5 Net FDI inflows 211.2 154.5 291.1 339.9 313.7 320.0 326.0 337.0 348.0 Net portfolio equity inflows -7.6 30.2 40.3 6.7 37.9 15.3 24.8 32.1 38.5 Private creditors. Net 5.0 70.4 194.1 200.2 130.9 160.0 155.2 168.3 176.0 Bonds 2.7 9.5 28.1 30.6 45.7 56.0 41.3 38.1 39.5 Banks 17.8 -4.2 16.0 28.9 31.9 41.0 38.2 41.3 43.3 Other private -2.3 0.1 1.1 -4.5 -3.3 0.2 0.4 0.6 1.0 Short-term debt flows -13.3 65.0 148.9 145.1 56.7 62.8 75.3 88.3 92.2 Official inflows, net -0.4 3.9 4.0 -0.4 3.3 0.4 -0.1 -1.3 -1.9 World Bank 1.2 2.2 2.7 0.9 1.0 0.2 .. .. .. IMF 0.0 0.1 0.0 0.0 -0.1 -0.3 .. .. .. Other official -1.5 1.6 1.3 -1.3 2.3 0.5 .. .. .. Source: The World Bank Note: e = estimate, f = forecast 33 GLOBAL ECONOMIC PROSPECTS | January 2014 Figure 2.4 Regional exports excluding China and the Figure 2.5 Business sentiment is improving Philippines continue to be weak Source: Source: Sentiment has turned up, helped by strengthening portfolio flows represent large share of total capital high-income demand and the growth rebound in flows (53 percent in the region excluding China China. Business surveys in the region, which compared with about 10 percent developing dropped below the 50 growth/no growth line in country average). Bond issuance in the region will May, have improved most recently and the divergence be disproportionately affected and is estimated to within the region has also narrowed (Figure 2.5). decline by about 30 percent over the forecast Export performance in Indonesia (double digit rate period from present record high level (about $ 56 contraction since August) and Thailand (2.9 billion in 2013) (table 2.1). percent annualized rate growth in October following six month period of contraction) remains At the same time, the recovery in import weak, but continue to firmed up in China, demand from high-income countries should Malaysia, Philippines and Vietnam (Figure 2.4). contribute to acceleration in global trade and Industrial production firmed up in China (about 12 regional exports. Global gross domestic product percent quarterly growth since September), growth is expected to gradually firm from [2.3] Malaysia, Philippines and Indonesia but continues percent to [3.5] percent in 2016. Global trade flows to contract in Thailand and showed some signs of are also projected to recover from current low weakening in Malaysia most recently. levels [3.1] percent to 5.2 percent by 2016. Increased trade will particularly benefit exporters of Outlook manufacturing products and services (China, Malaysia, Thailand, the Philippines, Pacific Islands), and economies with relatively low unit labor costs and competitive exchange rates (Lao, Vietnam, Cambodia, Myanmar). Declining commodity prices Economic prospects for the region will reflect are however projected to weigh on outturn for several counterbalancing factors, including the commodity exporters (Indonesia, Malaysia, impact of normalization of long-term interest Mongolia and Papa New Guinea). rates, which is projected to weigh on prospects for several middle-income countries in the region Overall growth in the region is expected to stay (Indonesia, Malaysia, and Thailand). broadly flat at around 7.2 percent throughout the projection period. This is about 2 percentage Higher borrowing costs are expected to weigh on points slower than during the pre-crisis boom years investment, while reduced capital inflows but broadly in line with potential. Full year growth (projected to decline from estimated 4.7 to 3.7 for China is expected to remain at around [7.7] percent of regional GDP between 2013 and 2016). percent in 2014, but the quarterly pace should slow This will impact countries’ ability to access external somewhat toward the second half of the year and financing (see Chapter 3 for more), especially when growth is projected to stabilize at around 7.5 34 GLOBAL ECONOMIC PROSPECTS | January 2014 percent in 2015 and 2016. Growth in the rest of the challenge related to effective management of region should also be broadly stable in 2014, but is resource boom in the environment of declining projected to pick up in 2015 [5.7] reflecting modest commodity prices. Mongolia’s economy is acceleration in Indonesia and Thailand, expected to continue to register double-digit reconstruction efforts in the Philippines and start growth rates in 2014 and 2015 with growth rate of production of Papua New Guinea Liquefied Gas easing to 7.7 percent in 2016 with completion of before settling at [5.5] percent in 2016 (table 2.2). new production facilities. The start of liquid gas exports will significantly raise the level of GDP in Aligning growth with potential rate in several Papua New Guinea in 2015, but output growth is major middle-income economies in 2014 will estimated to decline to 5 percent rate in 2016. help alleviate domestic vulnerabilities generated Timor-Leste’s growth outlook, while favorable, has during the years of expansionary policies. In moderated in line with lower planned growth in Indonesia, the current slowdown is projected to public spending. run its course during 2014 allowing overheating Risks pressures to ease and economy to adjust to lower commodity price environment and permitting a modest acceleration in 2015. Outturns for Malaysia, Thailand and Vietnam will depend on the ability of the authorities to effectively implement policy tightening to contain further increase in domestic The outlook is subject to significant domestic debt, contain potential price pressures and boost and external risks. An abrupt tightening of international competitiveness to take full advantage international financing conditions could reduce of recovering global trade flows. In Thailand, the capital flows, exerting financing pressures in the weak growth of the past year is projected to give region. The baseline assumes a gradual adjustment way to acceleration on the back of recovering of global financial conditions, but a more external demand. Political conditions however disorderly reaction of financial markets to a could see outturns disappoint if investors take a normalization of conditions in the United States wait and see attitude. and elsewhere cannot be excluded (see discussions in Chapters 1& 3). In such a scenario, capital flows Outturns for the Philippines, Cambodia, Lao could decline briskly by as much as 60 percent and Myanmar, will depend on the effective within for a period of several months placing balance of competing needs. The strong credit extreme pressure on countries with large current and construction boom presents elements of an account deficits (Cambodia, Lao, PDR, Indonesia, asset-price bubble in Cambodia, Lao, the Malaysia and Mongolia), overvalued real effective Philippines and Myanmar, that could unwind in a exchange rate overvaluation (Mongolia), large short disorderly fashion if not managed prudentially. The -term debt exposures (China, Malaysia, Thailand sustained increase in remittances and FDI flows Indonesia) and/or limited reserves (Cambodia, also continue to put upward pressure on the Lao, Fiji, PNG, Mongolia and Vietnam). currencies of the region especially in the Philippines, which is likely to hurt competitiveness. Countries where years of expansionary policies In the Philippines, there is increasing need to have contributed to domestic vulnerabilities are undertake structural reforms and rebalance particularly at risk. In such scenarios those economies from its excessive dependence on countries that have had a significant credit consumption, while at the same time prioritizing expansion in 2007-2012 (China, Malaysia, investment, to rebuild the typhoon stricken Mongolia, Thailand, Vietnam) would experience a portions of the economy. This may require a spike in debt servicing costs, a sharp rise in non- careful management of fiscal levers to direct performing loans and pressure on the balance spending towards the affected areas and away from sheets of banks, which would quickly transmit to the overheating sectors elsewhere. lending and investment activity – and in extreme cases could undermine financial stability leading to Growth outlook is favorable for Mongolia, a banking crisis (see Chapter 3). Although public Papua New Guinea and Timor-Leste, but tall sector indebtedness is relatively low in most three countries are facing the formidable economies in the region, given implicit guarantees 35 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 2.2 East Asia and the Pacific forecast summary (annual percent change unless indicated otherwise) Est. Forecast 00-09a 2010 2011 2012 2013 2014 2015 2016 b GDP at market prices 8.0 9.6 8.3 7.4 7.2 7.2 7.1 7.1 (Sub -region totals-- countries with full NIA + BOP data) c GDP at market prices c 8.0 9.6 8.3 7.4 7.2 7.2 7.1 7.1 GDP per capita (units in US$) 7.3 8.9 7.6 6.7 6.5 6.6 6.5 6.5 PPP GDP 8.1 9.6 8.3 7.4 7.2 7.2 7.1 7.1 Private consumption 6.0 7.4 7.9 7.3 7.3 7.7 7.7 7.8 Public consumption 7.4 9.6 8.9 8.4 8.5 8.5 8.0 7.7 Fixed investment 10.7 11.4 8.9 10.3 7.0 6.7 6.5 6.1 Exports, GNFS d 10.0 23.3 8.6 3.0 5.3 7.2 8.0 8.2 Imports, GNFS d 9.6 19.4 6.2 4.7 5.5 7.2 8.1 8.2 Net exports, contribution to growth 0.4 1.7 1.1 -0.4 0.2 0.3 0.3 0.3 Current account bal/GDP (%) 4.6 3.8 1.9 1.9 1.9 1.9 1.9 1.9 GDP deflator (median, LCU) 5.4 6.2 5.1 2.1 2.9 5.1 3.9 4.0 Fiscal balance/GDP (%) -1.8 -1.6 -1.7 -1.8 -1.9 -1.9 -1.9 -1.9 Memo items: GDP East Asia excluding China 4.4 6.9 4.7 6.2 5.2 5.3 5.7 5.5 China 9.4 10.4 9.3 7.7 7.7 7.7 7.5 7.5 Indonesia 4.6 6.2 6.5 6.2 5.6 5.3 5.5 5.5 Thailand 3.5 7.8 0.1 6.5 3.2 4.5 5.0 5.2 Source : World Bank. a. Growth rates over intervals are compound weighted averages; average growth contributions, ratios and deflators are calculated as simple averages of the annual weighted averages for the region. b. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. c. Sub-region aggregate excludes Fiji, Myanmar and Timor-Leste, for which data limitations prevent the forecasting of GDP components or Balance of Payments details. d. Exports and imports of goods and non-factor services (GNFS). to banking sectors in countries and reliance on significant knock on effects in the region and other state owned banks to stimulate domestic credit economies with close trading linkages (including growth (China, Vietnam), public debt levels could commodity producers). Recognition of such risks rise rapidly in case loan defaults if economic cycles may have underpinned recent decisions to focus turn. reform on land ownership and use, restructuring of state-owned enterprises and the financial sector. Although major tail-risks have subsided, they The implementation of this agenda is likely to lead have not been eliminated and include to more balanced growth in the medium-term but rebalancing in China, protracted recovery in the the risks in case of a falloff remain formidable. In EU and fiscal policy uncertainty in the US. In Euro Area much has been achieved, but protracted China policy makers face formidable challenges in recession remains a downside risk due to the reorienting the economy away from an investment remaining formidable challenges. Setbacks in led model, with reforms required across a range of sustainable resolution of debt and fiscal issues in sectors if private consumption is to underpin the US could spark an acute global crisis in case of future growth. Past high levels of investment have a debt default. In addition, although currently generated significant vulnerabilities, which contained, an escalation of country level (e.g. in represent risks to banking sector. An abrupt Thailand) as well as bilateral and/or geo-political unwinding of investment in China, as it tensions may undermine regional growth prospects. deleverages, could sharply reduce GDP, with 36 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 2.3 East Asia and Pacific Country forecasts Est. Forecast 00-09a 2010 2011 2012 2013 2014 2015 2016 Cambodia GDP at market prices (% annual growth) b 7.4 6.0 7.1 7.3 7.0 7.0 7.0 7.0 Current account bal/GDP (%) -4.5 -6.9 -7.9 -10.1 -9.6 -12.0 -11.8 -10.0 China GDP at market prices (% annual growth) b 9.4 10.4 9.3 7.7 7.7 7.7 7.5 7.5 Current account bal/GDP (%) 5.0 4.0 1.8 2.3 2.4 2.4 2.3 2.3 Fiji GDP at market prices (% annual growth) b 1.3 0.1 1.9 2.3 2.4 2.1 2.2 2.3 Current account bal/GDP (%) -7.7 -4.4 -5.5 -1.4 -17.4 -5.5 -6.3 -7.8 Indonesia GDP at market prices (% annual growth) b 4.6 6.2 6.5 6.2 5.6 5.3 5.5 5.5 Current account bal/GDP (%) 2.5 0.7 0.2 -2.8 -3.5 -2.6 -2.3 -2.1 Lao PDR GDP at market prices (% annual growth) b 5.5 8.5 8.0 8.2 8.0 7.7 8.1 8.1 Current account bal/GDP (%) -2.6 -10.0 -10.3 -15.3 -20.8 -20.0 -18.9 -17.0 Malaysia GDP at market prices (% annual growth) b 3.9 7.2 5.1 5.6 4.5 4.8 4.9 4.9 Current account bal/GDP (%) 12.6 11.1 11.0 6.1 4.3 4.3 4.1 4.0 Mongolia GDP at market prices (% annual growth) b 5.8 6.4 17.5 12.4 12.5 10.3 10.0 7.7 Current account bal/GDP (%) -6.3 -14.3 -31.5 -32.7 -25.6 -16.8 -10.7 -9.2 Myanmar GDP at market prices (% annual growth) b 9.7 5.3 5.9 6.5 6.8 6.9 6.9 6.9 Current account bal/GDP (%) -0.7 -1.3 -2.6 -4.1 -4.2 -4.8 -5.1 -5.1 Papua New Guinea c GDP at market prices (% annual growth) b 3.0 7.7 10.7 8.1 4.0 8.5 20.0 5.0 Current account bal/GDP (%) 2.4 -21.4 -23.5 -51.0 -27.0 -2.0 12.3 9.3 Philippines GDP at market prices (% annual growth) b 4.0 7.6 3.6 6.8 6.9 6.5 7.1 6.5 Current account bal/GDP (%) 1.5 4.5 3.2 2.9 2.0 0.6 0.7 1.0 Solomon Islands GDP at market prices (% annual growth) b 2.8 7.0 10.7 4.8 4.0 3.5 3.7 4.0 Current account bal/GDP (%) -20.5 -30.8 -6.7 -0.1 -2.0 -6.5 -5.3 -7.6 Thailand GDP at market prices (% annual growth) b 3.5 7.8 0.1 6.5 3.2 4.5 5.0 5.2 Current account bal/GDP (%) 3.3 4.1 2.8 1.7 1.1 1.1 1.3 1.4 Timor-Leste b GDP at market prices (% annual growth) b 3.3 9.5 12.0 8.3 8.1 8.0 7.7 8.6 Current account bal/GDP (%) 17.1 39.8 40.4 43.5 34.3 32.1 27.0 27.7 Vietnam GDP at market prices (% annual growth) b 7.1 6.8 6.2 5.2 5.3 5.4 5.4 5.5 Current account bal/GDP (%) -10.8 -3.8 0.2 5.9 5.1 3.0 0.6 0.5 Source : World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not significantly differ at any given moment in time. Samoa; Tuvalu; Kiribati; Democratic People's Republic of Korea; Marshall Islands; Micronesia, Federated States; N. Mariana Islands; Palau; and Tonga are not forecast owing to data limitations. a. GDP growth rates over intervals are compound average; current account balance shares are simple averages over the period. b. GDP measured in constant 2010 U.S. dollars. c. The start of production at Papua-New-Guinea-Liquefied Natural Gas (PNG-LNG) is expected to boost PNG's GDP growth to 20 percent and shift the current account to a 9 percent surplus in 2015. PNG's GDP deflators are expected to be updated in 2014 and the new GDP series is expected to be significantly different from the existing one. d. Non-oil GDP. Timor-Leste's total GDP, including the oil economy, is roughly four times the non-oil economy, and highly volatile, subject to global oil prices and local production levels. 37 GLOBAL ECONOMIC PROSPECTS | January 2014 Regional growth strengthened in 2013, due to higher demand from Europe and strong growth in energy commodity-exporters. Non-energy commodity exporters suffered declines in metal and agricultural prices. Strong growth in high-income Europe will benefit most countries with strong trade ties. Prospects are weaker for those struggling with high fiscal and external deficits. A sharper slowdown in Russia and tighter global finance are key downside risks. Recent Developments notwithstanding an estimated contraction in Ukraine. -1.1 percent A moderate pick-up in external demand boosted regional economic activity. The return to growth in the Euro Area in the second quarter of 2013 supported real side activity in the region, Economic activity strengthened in the Europe particularly in the Central and Eastern European and Central AsiaFN1 region in 2013 countries due to strong trade linkages.FN2 On a year supported by strengthening external demand. After sub-par growth in 2012 (2.0 percent) Figure 2.6 Growth is picking up in East Central Asia economic activity in the region is estimated to have region accelerated to 3.4 percent in 2013, albeit, with divergent performances across countries (figure 2.6). The pick-up was strongest in the Central and Eastern European sub-region where output increased by 1.6 percent in 2013 (up from -0.1 percent in 2012), supported by strengthening demand in the Euro Area. In Turkey, the largest economy in the region, buoyant domestic demand underpinned acceleration in growth to 4.3 percent in 2013 from 2.2 percent in 2012. Growth in the remainder of the region was broadly stable at an estimated 3.4 percent in 2013 (3.4 percent in 2012), Source: Datastream and the World Bank 39 GLOBAL ECONOMIC PROSPECTS | January 2014 Figure 2.7 Exports are recovering led by the CEE Figure 2.8 Performance of industrial production var- countries ies across countries Source: The World Bank Source: Datastream and the World Bank -to-date basis, exports in the sub-region grew by reflecting strong domestic demand bolstered by 8.8 percent during the first nine months of 2013 accommodative monetary policies, particularly in compared with the same period in 2012 reflecting the first half of the year. particularly strong growth in the third quarter (14.4 percent annualized) (figure 2.7). In contrast Performance among the Commonwealth of Turkish exports were some 0.6 percent lower than Independent States has been mixed. Among a year before during the first 9 months of 2013, energy-exporting countries (Azerbaijan, reflecting weak global growth during the first half Kazakhstan, and Uzbekistan), activity has remained of the year and tighter sanctions on Iran (which strong reflecting relative strength in energy-related cut sharply into gold exports). As elsewhere commodity prices, expansion of production in stronger global growth in Q3 and the 10.9 percent extractive sectors, and robust growth in domestic depreciation of the Lira since May has contributed demand supported by government spending and so to an annualized 7.6 percent increase in Q3 far stable remittance inflows (see below). In exports, with new foreign orders up (fastest pace in contrast, political disturbances have dampened 22 months according to November business economic activity and domestic demand in sentiment indicators). Recent monthly data for the Ukraine, where industrial production contracted at Commonwealth of Independent States is not a 2.9 percent annualized pace in the three months available, but given strong trade links with Russia ending October, a fifteenth consecutive month of and falling Russian import demand (-24.1 and -4.5 contraction. Among metal and mineral exporting percent in Q2 and Q3) non-commodity exports of countries in the sub-region, a 30 percent decline in these countries are likely to have been weak during this period. In contrast, oil production and exports Figure 2.9 Estimated impact of commodity price in Kazakhstan and Azerbaijan have shown changes on trade balance (% GDP, 2013) continued strength, supporting their above regional -average GDP growth rates. 5.0 4.0 Regional industrial production strengthened, 3.0 but performance differed across economies. For 2.0 the region as an aggregate, industrial production 1.0 accelerated to 2.3 percent growth during the first 0.0 nine months of 2013 compared with a 0.9 percent in 2012. In the Central and Eastern European sub- -1.0 region industrial production accelerated to an -2.0 annualized pace of 5.7 percent in Q3 2013 on -3.0 stronger exports. (figure 2.8). In Turkey industrial -4.0 Azerbaijan Kazakhstan Albenia Georgia Armenia Uzbekistan Ukraine Hungary Bulgaria Belarus Kyrgyz Republic activity has grown at a 3.1 percent year-to-date Source: The World Bank 40 GLOBAL ECONOMIC PROSPECTS | January 2014 Figure 2.10 Remittances (% GDP, 2013) Figure 2.11 Non Performing Loans remain elevated in the region 60 45 40 50 35 30 40 25 20 30 15 10 20 5 10 0 Egypt, Arab Rep. Macedonia, FYR Bulgaria Serbia Ukraine Albania Kazakhstan Romania Moldova Ghana Pakistan Sierra Leone Tajikistan Nigeria Senegal Hungary Montenegro Bosnia & Herzegovina Kyrgyz Republic Russia 0 Tajikistan Kyrgyz Moldova Armenia Georgia Bosnia & Montenegro Serbia Albania Ukraine Republic Herzegovina Source: The World Bank Source: The World Bank metals and mineral prices since 2011 has cut into of an end of quantitative easing sparked an incomes and activity. Agricultural food prices are adjustment in global portfolios away from down 24 percent and raw materials have declined developing countries. As a result, average monthly by almost 37 percent (energy prices are up 8 capital flows to developing Europe and Central percent). Kyrgyz Republic, Belarus and Ukraine Asia fell by 60 percent between June and October experienced the most negative terms of trade as compared with the first 5 months of the year. impacts —as lower export prices and higher energy Within the region, Turkey felt the most immediate import prices are estimated to have reduced impacts. The country’s large current account incomes by some 2.7 percent, 1.5 percent, and 0.6 deficits funded by relatively large share of short- percent of GDP, respectively (figure 2.9). term loans and volatile portfolio flows were seen as being particularly vulnerable to outflows and a rise The negative impact of deteriorating terms of in global interest rates. Hungary, Serbia and trade was partially mitigated by strong Ukraine were also hard-hit by the sudden reversal remittance inflows. On account of strengthening in capital flows, but other countries, including activity in the Euro Area as well as resilient flows Georgia and Kazakhstan, where the stock of from Russia (despite its growth deceleration in the private external debt is particularly high, also came second half of 2013) remittances to the region under considerable pressure, resulting in increases rebounded by an estimated 11 percent in 2013, in long term interest rates. The weakness in capital helping to support household consumption. The inflows caused currencies to depreciate (by 3.7 rebound was strongest in Tajikistan, with an percent on average for the region in nominal estimated 23 percent increase in 2013. Remittances effective terms, stock markets to depreciate by 10.5 are particularly important to the economies of percent in June and by 4.3 percent between June Tajikistan where they represent 48 percent of and September), while efforts to resist depreciation GDP, Kyrgyz Republic (31 percent of GDP) and in some countries was reflected in a significant Moldova (24.1 percent of GDP) (figure 2.10). decline in reserves (e.g., Hungary, Romania, Turkey) when expressed as a percent of monthly Capital inflows to the region began strong, but imports. Since August, capital inflows to the region declined with speculation about the timing of have rebounded and local currencies appreciated, an end to US quantitative easing. Overall, net equity prices have recovered earlier losses and capital inflows to the region are estimated to have bond yields declined, but remain elevated slightly decreased by $1.9 billion or –1.6 percent compared to pre-May levels. This episode which year on year in 2013, mainly reflecting strong flows led to the tightening of financing conditions is a during the first 5 months of the year being offset stark reminder of the vulnerabilities of economies by mid-year weakness and ensuing volatility since in the region (see risk section). then. The higher interest rates on US government debt that accompanied speculation as to the timing 41 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 2.4 Europe and Central Asia forecast summary (annual percent change unless indicated otherwise) Est. Forecast 00-09a 2010 2011 2012 2013 2014 2015 2016 b GDP at market prices 3.9 6.0 6.3 2.0 3.4 3.5 3.7 3.8 (Sub -region totals-- countries with full NIA + BOP data) c GDP at market prices c 3.9 6.1 6.3 2.0 3.4 3.5 3.6 3.8 GDP per capita (units in US$) 3.5 5.3 5.5 1.2 2.7 2.8 3.0 3.1 PPP GDP 3.9 5.8 6.1 1.9 3.2 3.4 3.5 3.6 Private consumption 4.3 4.5 7.0 2.2 3.7 3.9 3.9 4.0 Public consumption 3.7 -0.7 2.9 4.1 2.5 2.3 2.8 2.8 Fixed investment 5.0 12.7 9.5 -0.7 4.3 5.1 5.2 4.8 Exports, GNFS d 5.1 8.5 8.6 4.6 2.6 4.2 4.8 5.2 Imports, GNFS d 5.4 12.5 11.1 1.3 4.9 4.9 5.8 5.7 Net exports, contribution to growth -0.2 -1.7 -1.3 1.2 -1.1 -0.5 -0.6 -0.4 Current account bal/GDP (%) -3.7 -3.3 -4.3 -3.5 -4.0 -4.0 -4.0 -3.9 GDP deflator (median, LCU) 9.3 8.5 8.7 3.4 4.3 4.2 4.6 4.3 Fiscal balance/GDP (%) -4.4 -2.2 0.7 -1.1 -1.0 -1.0 -0.7 -0.7 Memo items: GDP ECA including high income countries 3.9 4.7 4.9 2.3 2.1 2.8 3.1 3.3 Transition countries e 4.8 3.4 4.2 1.7 2.6 3.5 3.4 3.5 Central and Eastern Europe f 3.1 0.3 2.0 -0.1 1.5 2.1 2.2 2.6 g Commonwealth of Independent States 6.5 6.1 6.0 3.4 3.4 4.6 4.3 4.2 Turkey 3.0 9.2 8.8 2.2 4.3 3.5 3.9 4.2 Romania 3.8 -0.9 2.3 0.7 2.5 2.5 2.7 2.7 Source: World Bank. a. Growth rates over intervals are compound weighted averages; average growth contributions, ratios and deflators are calculated as simple averages of the annual weighted averages for the region. b. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. c. Sub-region aggregate excludes Bosnia and Herzegovina, Kosovo, Montenegro, Serbia, Tajikistan and Turkmenistan. Data limitations prevent the forecasting of GDP components or Balance of Payments details for these countries. d. Exports and imports of goods and non-factor services (GNFS). e. Transition countries: CEE and CIS (f + g below). f. Central and Eastern Europe: Albania, Bosnia and Herzegovina, Bulgaria, Georgia, Kosovo, Lithuania, Macedonia, FYR, Montenegro, Romania, Serbia. g. Commonwealth of Independent States: Armenia, Azerbaijan, Belarus, Kazakhstan, Kyrgyz Republic, Moldova, Tajikistan, Turkmenistan, Ukraine, Uzbekistan. Across the region, the banking sector remains including widespread use of state-directed credit weak, saddled with overhang of non- and subsidized lending to priority sectors including performing loans (NPLs). Fourteen of the the state-owned enterprises in commodity sectors. twenty developing countries with the highest share of non-performing loans are in Europe and Central Asia (led by Kazakhstan, Serbia, Albania, Bulgaria, and Romania) (figure 2.11). In Central and Eastern Outlook European countries, high NPLs partly reflect the deep recession and the tepid economic recovery. Slow growth has delayed the recovery in asset prices, discouraging banks from actively writing-off loans and disposals. High NPLs in turn have After expanding by an estimated 3.4 percent in weakened credit creation by the banks hampering 2013, GDP growth for the region is projected to potentially productive investments. In the steadily rise from 3.5 percent in 2014 to 3.8 percent Commonwealth of Independent States sub region, by 2016. This pick-up in activity, though generally the profitability of banks has generally recovered broadly-based, will be most marked in the Central since the crisis, but the conditions underlying the and Eastern European economies, where there is vulnerabilities in the banking sector remain, currently the most spare capacity. 42 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 2.5 Net capital flows to Europe and Central Asia ($ billions) 2008 2009 2010 2011 2012 2013e 2014f 2015f 2016f Capital Inflows 324.9 101.3 85.3 137.3 121.2 119.3 116.6 133.1 149.9 Private inflows, net 300.3 52.3 57.3 130.4 128.1 114.2 111.6 124.1 137.9 Equity Inflows, net 165.5 54.8 27.6 75.1 72.4 55.4 54.1 59.3 65.1 Net FDI inflows 166.0 51.1 23.8 75.8 64.4 55.0 51.0 55.0 60.0 Net portfolio equity inflows -0.4 3.7 3.7 -0.7 8.0 0.4 3.1 4.3 5.1 Private creditors. Net 134.8 -2.5 29.7 55.3 55.7 58.8 57.5 64.8 72.8 Bonds -3.2 -6.8 7.1 8.2 38.7 29.7 22.7 20.6 19.7 Banks 133.2 14.4 -19.0 33.1 8.1 15.3 14.7 18.6 22.5 Other private -0.9 -0.2 0.1 -0.1 -0.1 0.7 0.6 1.1 0.2 Short-term debt flows 5.7 -9.9 41.6 14.1 9.0 13.1 19.5 24.5 30.4 Official inflows, net 24.6 49.0 28.0 6.9 -6.9 5.1 5.0 9.0 12.0 World Bank 1.2 3.4 3.9 2.9 2.0 3.1 .. .. .. IMF 12.8 25.5 9.0 -1.0 -13.0 -4.0 .. .. .. Other official 10.6 20.2 15.1 5.1 4.0 6.0 .. .. .. Source: The World Bank Note: e = estimate, f = forecast GDP growth in the Central and Eastern European Commonwealth of Independent States, a sub region is expected to reach 2.9 percent by strengthening outlook will be supported by a pick- 2016, up from an estimated 1.5 percent in 2013, up in remittances and exports as the global supported by strengthening economic activity in economy strengthens. Sub-region remittances are the European Union. Despite stronger growth, projected to increase by 10.3 percent in 2014 domestic demand, is expected to remain sluggish benefitting from an economic recovery in the EU due to ongoing banking-sector restructuring and countries and strengthening growth in Russia (from tighter international financial conditions, which will x percent in 2013 to y percent in 2014–16), the weigh on investment and consumer durable demand. destination for a large number of migrants from Ongoing or planned fiscal consolidation in some Central Asian economies. On the downside, countries (e.g. Albania, Macedonia and Serbia), will weaker metal and agricultural prices are likely to also serve to partly offset the growth impetus from weigh on export revenues and government stronger exports. While conditions are projected to spending. improve, growth will not be strong enough to make a substantial dent in regional unemployment Growth in Turkey, the region’s largest economy, is and spare capacity over the forecast horizon. expected to stabilize around its potential growth rate of about 3.9 percent over the 2014–16 Growth in the Commonwealth of Independent period—well below its pre-crisis rate of 6.8 percent States is projected to pick-up from an estimated 3.3 (2002–2007 average). As a significant beneficiary of percent in 2013 to 4.2 percent in 2016. Among international capital flows in recent years, Turkey resource rich Commonwealth of Independent will be impacted by the tighter global financial States, this will be supported by the expected markets. Gross capital flows to the region are coming on stream of new export capacity following expected to decline by 0.3 percent of regional GDP years of investment in the energy sectors. The to about 6.3 percent of GDP by 2016 as global strengthening of the global economy should be asset portfolios are rebalanced (see the extensive supportive of increased energy demand, although discussion in Chapter 3). While tighter financial technological developments will continue to weigh conditions should temper growth in Turkey, these on medium to long-term prices. Oil prices are effects are expected to be partially offset by projected to remain stable in nominal terms relatively strong private consumption and through 2014 ($105.7) before declining marginally investment and higher government consumption in in 2015 and 2016. Among non-energy the run up to elections in 2014. 43 GLOBAL ECONOMIC PROSPECTS | January 2014 Risks High levels of external private sector debt levels are a challenge in the region. Particularly high debt levels in some countries in the region (e.g., Bulgaria, Kazakhstan, Moldova, and Latvia) increase their susceptibility to changes in external While the baseline forecast remains the most financing conditions and currency mismatch. likely outcome, the outlook is subject to Added to this, banks in many countries remain downside risks. Although the main tail-risks of weak due to high levels of non-performing loans the past 5 years have subsided, the underlying left over from the previous crisis. Ukraine is the challenges that underpinned them—though less most vulnerable on account of a de-facto peg acute — remain. In the Euro Area much has been against the US dollar which has come under achieved and banks have gone a long way to pressure over the past year due to a severe restructuring themselves, but the recovery will take recession. Risks in Turkey reflect rising leverage in time and considerable effort. Protracted recession the corporate sector with large amounts of foreign in the Euro area is therefore a downside risk to the exchange liabilities (intermediated through the outlook especially for countries with stronger trade banking sector), relatively low reserve coverage of and financial links with the area (in particular, short term external debt (compared to other major Central and Eastern European economies). middle-income economies), and a reliance on short Further, slower than projected growth in China, term capital flows to cover its current account perhaps provoked by a quicker than anticipated deficits. decline in investment, could slow global growth by as much as 0.3 percent but with more marked On the upside, stronger growth than envisaged effects on regional industrial commodity producers in the baseline could provide additional boost to (e.g. Belarus and Ukraine). A sharper than expected the regional economies. A stronger recovery in slowdown in Russia would be a key downside risks high income economies could provide considerable for many Commonwealth of Independent States, support to external demand, notably in Central and especially those that are heavily dependent on East European developing countries, helping offset Russia for import demand, remittance flows, and downward adjustments in domestic demand foreign investment (e.g., Tajikistan, Moldova, the triggered by rising global interest rates. Declining Kyrgyz Republic, Armenia, and Uzbekistan). global food prices should also reduce inflation pressures and food import costs, although they are Further tightening in global finance conditions a negative development for food exporters. is a downside risk to the outlook especially for countries with high refinancing needs. Over the medium term, the gradual return of long-term interest rates in both high income and developing countries to more sustainable levels should help reduce the excesses and vulnerabilities that can accumulate in a persistently low interest rate environment. However, in the near term, the transition to higher global interest rates could be volatile. Should market reactions to the withdrawal of extraordinary monetary measures in high- income countries be less orderly than assumed in the baseline, simulations based on econometric work discussed in more detail in Chapter 3, suggest that capital flows to developing countries could decline by 80 percent or more for several months—potentially sparking local crises in countries with large external imbalances and those that have experienced large credit expansions in recent years (e.g., Albania, Bosnia, Kyrgyz Republic, Montenegro, Serbia, and Turkey). 44 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 2.6 East Central Asia Country forecasts Est. Forecast 00-09a 2010 2011 2012 2013 2014 2015 2016 Albania b GDP at market prices (% annual growth) 4.9 3.8 3.1 1.6 1.3 2.1 3.0 3.0 Current account bal/GDP (%) -8.6 -11.5 -13.0 -10.8 -8.2 -7.1 -6.3 -6.7 Armenia b GDP at market prices (% annual growth) 7.7 2.2 4.7 7.2 3.2 5.0 5.0 5.0 Current account bal/GDP (%) -7.4 -14.8 -11.0 -11.2 -10.6 -10.0 -9.2 -8.0 Azerbaijan b GDP at market prices (% annual growth) 14.1 5.0 0.1 2.2 4.9 5.3 4.5 3.9 Current account bal/GDP (%) 2.9 29.3 25.4 21.2 17.7 15.9 14.3 12.5 Belarus b GDP at market prices (% annual growth) 6.6 7.7 5.5 1.5 1.0 1.5 2.0 1.5 Current account bal/GDP (%) -4.6 -15.0 -9.0 -2.8 -8.9 -8.1 -9.2 -8.4 Bosnia and Herzegovina b GDP at market prices (% annual growth) 4.0 0.7 1.3 -1.1 0.8 2.0 3.5 3.5 Current account bal/GDP (%) -13.3 -5.6 -8.8 -9.6 -7.5 -6.6 -6.3 -6.1 Bulgaria b GDP at market prices (% annual growth) 4.0 0.4 1.8 0.8 0.6 1.7 1.8 2.0 Current account bal/GDP (%) -11.3 -1.5 0.3 -1.3 2.1 -0.5 -0.9 -1.0 Georgia b GDP at market prices (% annual growth) 5.6 6.3 7.0 6.0 2.5 6.3 6.3 6.5 Current account bal/GDP (%) -12.6 -10.2 -12.7 -11.7 -7.5 -7.1 -7.0 -6.3 Hungary b GDP at market prices (% annual growth) 1.8 1.3 1.6 -1.7 0.7 1.7 1.5 2.7 Current account bal/GDP (%) -6.8 1.1 0.9 1.6 2.3 2.2 2.1 3.2 Kazakhstan b GDP at market prices (% annual growth) 7.5 7.3 7.5 5.0 5.8 5.9 6.0 6.0 Current account bal/GDP (%) -2.0 0.9 5.4 0.3 -0.3 -1.3 -1.7 -1.8 Kosovo b GDP at market prices (% annual growth) 5.8 3.9 5.0 2.7 3.0 4.0 4.2 4.2 Current account bal/GDP (%) -7.3 -12.0 -13.8 -7.6 -10.7 -8.7 -8.3 -8.6 Kyrgyz Republic b GDP at market prices (% annual growth) 4.2 -0.5 6.0 -0.9 7.8 6.5 5.4 5.3 Current account bal/GDP (%) -6.0 -6.4 -6.0 -15.3 -10.4 -11.7 -11.0 -10.9 Moldova b GDP at market prices (% annual growth) 4.4 7.1 6.4 -0.8 4.2 3.8 4.0 4.0 Current account bal/GDP (%) -8.4 -9.6 -12.4 -7.9 -8.4 -8.7 -9.6 -8.0 Macedonia, FYR b GDP at market prices (% annual growth) 2.3 2.9 2.9 -0.4 2.5 3.0 3.5 3.7 Current account bal/GDP (%) -6.1 -2.1 -2.5 -3.1 -3.2 -4.5 -5.7 -6.1 Montenegro GDP at market prices (2005 US$) b - 2.5 3.2 -2.5 1.8 2.5 2.7 2.9 Current account bal/GDP (%) -11.4 -22.9 -17.7 -18.7 -15.0 -15.0 -15.0 -15.0 Romania b GDP at market prices (% annual growth) 3.8 -0.9 2.3 0.7 2.5 2.5 2.7 2.7 Current account bal/GDP (%) -7.5 -4.6 -4.8 -3.8 -1.5 -1.8 -2.5 -2.7 Serbia b GDP at market prices (% annual growth) 3.6 1.0 1.6 -1.7 2.0 1.0 2.2 2.5 Current account bal/GDP (%) -9.7 -6.7 -9.2 -10.5 -6.0 -6.0 6.3 6.5 45 GLOBAL ECONOMIC PROSPECTS | January 2014 Est. Forecast 00-09a 2010 2011 2012 2013 2014 2015 2016 Tajikistan GDP at market prices (% annual growth) b 7.7 6.5 7.4 7.5 7.0 6.0 6.0 6.0 Current account bal/GDP (%) -4.8 -1.2 -4.7 -1.9 -2.2 -2.4 -2.5 -2.5 Turkey GDP at market prices (% annual growth) b 3.0 9.2 8.8 2.2 4.3 3.5 3.9 4.2 Current account bal/GDP (%) -3.2 -6.2 -9.7 -6.1 -7.3 -7.1 -6.8 -6.5 Turkmenistan GDP at market prices (% annual growth) b 12.6 9.2 14.7 11.1 10.1 10.7 10.5 10.1 Current account bal/GDP (%) 7.4 -10.6 2.0 0.0 -3.4 -1.7 -1.5 -1.5 Ukraine GDP at market prices (% annual growth) b 3.9 4.2 5.2 0.2 -1.1 2.0 1.0 0.7 Current account bal/GDP (%) 2.2 -2.2 -5.5 -8.4 -8.1 -5.7 -5.6 -5.5 Uzbekistan GDP at market prices (% annual growth) b 6.1 8.5 8.3 8.2 7.4 7.0 6.7 6.7 Current account bal/GDP (%) 5.2 0.8 0.5 -2.8 -2.7 -2.5 -1.9 -1.3 Source : World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not significantly differ at any given moment in time. Bosnia and Herzegovina, Turkmenistan are not forecast owing to data limitations. a. GDP growth rates over intervals are compound average; current account balance shares are simple averages over the period. b. GDP measured in constant 2010 U.S. dollars. Notes 1. For the purposes of this report, the Europe and Central Asia region concerns only the low - and middle-income countries of the geographic region. As such it excludes from the aggregate Russia . 2. CEE refers to Albania, Bosnia and Herzegovina, Bulgaria, Hungary, Kosovo, Macedonia, Montenegro, Romania, Serbia, and Turkey 46 GLOBAL ECONOMIC PROSPECTS | January 2014 The slowdown in global trade, less supportive commodity markets, and domestic challenges weakened the region’s growth in 2013. However, with global economic conditions expected to improve, the regional economic outlook is positive, with growth picking up to an average of 3.2 percent over the medium term from 2.5 percent in 2013. Downside risks include a disorderly rise in global interest rates and a prolonged and deeper slump in commodity prices. Recent Developments Despite a strong H1 2013, overall exports growth for 2013 was relatively subdued. Consistent with developments in the strength of global import demand during 2013, the region’s merchandise exports saw solid growth in the first Amid a sluggish global recovery and lower half of 2013, but fizzled out towards the end of commodity prices, economic activity in the Latin Q3. Global import demand expanded at an average American and the Caribbean region fell annualized rate of 6.1 percent in the first half of marginally in 2013. Weakening consumption 2013 but contracted by -0.7 percent in Q3, partly and export growth led regional growth to edge reflecting uncertainty sparked by speculation about downwards to [2.5] percent in 2013, from 2.6 the future of United States monetary policy. percent in 2012. With GDP growing below its Similarly, the region’s merchandise exports grew at potential rate (estimated at 3.3 percent), the an average annualized rate of more than 9 percent negative output gap that opened in 2012 further through June before receding to 0.4 percent in Q3. widened in 2013. Underlying the regional trend, Overall, merchandise exports growth slowed growth in developing Central and North America, dramatically in 2013. Indeed, for the ten months to and the Caribbean slowed considerably, from 4.0 to October, exports advanced by only [4.3] percent, [1.7] percent, and from 2.9 to [2.2] percent, compared with the 8.1 percent expansion observed respectively. Growth in South America was more over the same period in 2012. Bolivia, Colombia, diverse with countries such as Argentina and Costa Rica, Jamaica, and Mexico all saw marked Paraguay surging ahead, Venezuela slowing down decelerations in export growth, while export considerably, and Bolivia and Colombia growing at volumes contracted in 2013 in Honduras, around the same speed as in 2012. Nicaragua and Peru. In contrast, thanks to a bumper harvest, Argentina’s export volumes were 47 GLOBAL ECONOMIC PROSPECTS | January 2014 Figure 2.12 Industrial production decelerates in Latin Figure 2.13 Effect of Lower commodity prices on American Countries the terms of trade (% of GDP) DOM DMA GTM HND MEX GUY ARG JAM PAN VEN BRA SUR ECU BOL COL PRY VCT PER LCA SLV BLZ NIC HTI CRI 1.0 0.4 0.5 0.7 0.1 0.2 0.0 0.0 0.0 0.0 -0.2 -0.2 -0.1 -0.4 -0.3 -1.0 -0.8 -0.6 -0.6 -1.3 -1.3 -1.2 -1.2 -2.0 -2.4 -3.0 -2.6 -3.1 -4.0 -5.0 -6.0 -6.0 Source: Datastream, Haver Analytics. Source: World Bank. up by [23] percent through the first ten months of decline in prices severely dented the region’s value 2013. of exports, and consequently led to a fall in export revenue, and in many cases, government revenue as A short-lived upturn in industrial production well. Our calculations suggests that the income gave way to broad-based weakness in H2 effect of the negative terms-of-trade shock led to a 2013. Regional industrial production accelerated deterioration of the region’s trade balances by in H1 2013 and peaked at an annualized pace of 3.6 some 0.3 percent of GDP. Suriname, where percent in June from -1.6 percent in January (figure commodities constitute 97.5 percent of exports in 2.12). However, industrial activity has since then 2010, experienced a terms of trade hit of almost 6 decelerated with output contracting at a 1.4 percent percent of GDP, leading to a substantial increase in annualized pace in Q3. This pattern was most its current account deficit (figure 2.13). In contrast, pronounced in Brazil where industrial activity rose in Haiti, where primary commodities make up only in H1 2013 riding on strong investment and 3 percent of exports, the terms of trade changes exports. However, monetary tightening since April, were favorable as reflected in an improving trade partly as a reaction to the reversal of capital flows balance and an easing of its current account deficit and exchange rate depreciation following in 2013. Similarly, other Central American and speculation about U.S. tapering, and associated Caribbean countries with low commodity export uncertainty took a toll on industrial production and shares, such as Costa Rica, St. Lucia, Dominica, GDP after June. Similarly, boosted by expansionary and St. Vincent and the Grenadines observed policies and a good harvest and consequently varying degrees of improvement to their current agricultural exports, Argentina’s industrial account balances. For the region as a whole, lower production peaked in June, before retreating in H2 commodity prices, together with the slowdown in 2013. Largely due to the delayed effects of weak export volumes, led the current account deficit as a export demand, developments among Central share of GDP to increase from 1.7 in 2012 to [2.5] American economies took on a different path with percent in 2013. industrial activity contracting until July, and early signs of a recovery being observed in August and Gross capital flows to the region increased September where industrial production grew at an overall for 2013, despite a H2 slump in equity annualized 1.2 percent. issues. Gross capital flows to the region, consisting of the new equity issues, new bond A deterioration in the terms-of-trade widened issues and syndicated bank lending, totaled $147 current account balances in the region’s billion during the first ten months of 2013, an economies. In 2013, the USD prices of agriculture, increase of 16.4 percent compared with the $127 metals and precious metals commodities fell 7.8, billion over the same period in 2012 (table 2.7). 8.0 and 19.2 percent, respectively. Given the Boosted by strong flows to Brazil and Mexico, commodity intensity of the region’s exports, the equity flows jumped 80 percent, reaching $26 48 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 2.7 Gross capital flows to Latin America and Figure 2.14 Regional currencies depreciate on pro- the Caribbean region spect of QE tapering (US$/LCU ex- Total Gross Equity Bond Bank change rate index, May 2013 = 100) Billions of US$ Capital Flows Issue Issue Lending $/LCU 110 Total Jan - Oct 2012 126.4 14.4 83.5 28.5 PER MEX COL BRA ARG Total Jan - Oct 2013 147.1 26.0 86.6 34.5 105 % change 16.4 80.9 3.7 21.3 100 Average Jan - May 2012 11.6 1.2 8.6 1.9 95 Average Jul - Oct 2012 15.1 1.9 8.9 4.4 % change 29.7 61.1 3.5 128.5 90 Average Jan - May 2013 15.1 3.4 9.4 2.4 85 Average Jul - Oct 2013 16.5 1.8 9.9 4.9 % change 9.3 -48.2 5.7 106.9 80 2013M01 2013M03 2013M05 2013M07 2013M09 2013M11 Source: World Bank. Source: World Bank. billion compared with $14 billion in 2012. After trend, the Argentine peso has however continued posting robust flows in the first five months of to depreciate, even past September, in part 2013, capital flows to the region fell sharply in June reflecting loose monetary policy and weak investor on the prospect of QE tapering. Flows then sentiment. The broad depreciation in regional rebounded in July, and with the unexpected non- currencies has however been supportive of a tapering announcement by the U.S. FED in nascent pick-up in regional exports starting in September, capital flows to the region surged to [October]. $22 billion as region’s borrowers sold a record high of $20.6 billion worth of bonds in the month with Outlook Mexico accounting for $12 billion. While total flows to the region did strengthen substantially overall in 2013, average monthly equity issues for July to October amounted to only $1.8 billion, nearly half the average amount of monthly issues from January to May of $3.4 billion. However, Central American and Caribbean economies, on The economic outlook for the Latin America account of being less financial integrated, observed and Caribbean region is projected to strengthen less turbulences from a reduction in capital inflows. over the medium term, growing around potential – but below the boom years before the Regional currencies depreciated after May on crisis. Regional GDP growth is forecast to tapering announcement. With the sell-off in strengthen from [2.5] percent in 2013 to [2.8] emerging market assets following mid-year percent in 2014, and subsequently to [3.1] and [3.7] expectations on QE tapering, regional currencies percent in 2015 and 2016 ( table 2.8). depreciated, in particular those that benefitted the most from earlier capital inflows and had relatively Strengthening global demand should be larger domestic imbalances. Between May and supportive of the region’s growth over the August, the Brazilian real, Colombian peso, forecast horizon. The baseline assumes that global Peruvian Nuevo sol and Mexican Peso depreciated economic activity will pick-up over the projection by some 13.0, 2.7, 5.6 and 4.7 percent respectively horizon, supported in particular by a moderate (figure 2.14). However, as expectations of the acceleration of growth in high-income countries tapering waned in September, regional currencies (see chapter one). Indeed, from a weak 2.3 percent regained some of its depreciated value, although in 2013, global GDP is projected to gradually they still remain below their May 2013 levels. For strengthen – reaching 3.5 percent in 2016. As a the Brazilian real, the Central Bank did intervene in result, global trade growth will pick-up from 3.1 the currency market over the summer months that percent in 2013 to 5.2 percent in 2016. The led to its appreciation in September. Bucking this recovery in global trade, albeit it being subdued 49 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 2.8 Latin America and the Caribbean forecast summary (annual percent change unless indicated otherwise) Est. Forecast 00-09a 2010 2011 2012 2013 2014 2015 2016 b GDP at market prices 2.7 6.0 4.1 2.6 2.5 2.8 3.1 3.7 c (Sub -region totals-- countries with full NIA + BOP data) GDP at market prices c 2.7 6.0 4.1 2.6 2.5 2.9 3.2 3.7 GDP per capita 1.5 4.8 2.9 1.4 1.3 1.7 2.1 2.7 PPP GDP 2.6 6.1 4.5 2.9 2.7 3.1 3.3 3.8 Private consumption 3.1 5.6 4.9 3.8 2.6 2.8 2.9 3.2 Public consumption 2.7 4.3 2.8 3.7 2.2 2.3 2.6 2.7 Fixed investment 3.6 13.1 8.3 1.7 2.7 2.6 3.4 4.1 Exports, GNFS d 2.8 11.3 6.1 2.5 2.2 4.0 4.8 5.4 Imports, GNFS d 3.6 21.6 10.1 3.8 3.7 3.1 3.6 3.7 Net exports, contribution to growth -0.1 -1.9 -0.9 -0.4 -0.4 0.1 0.1 0.3 Current account bal/GDP (%) -0.4 -1.4 -1.4 -1.7 -2.5 -2.5 -2.3 -2.0 GDP deflator (median, LCU) 6.5 5.1 6.9 5.8 4.6 4.8 4.8 5.0 Fiscal balance/GDP (%) -2.6 -3.1 -2.6 -3.9 -3.1 -3.1 -2.5 -2.4 Memo items: GDP LAC excluding Argentina 2.6 5.8 3.7 2.7 2.2 2.9 3.2 3.8 e Developing Central & North America 1.5 5.1 4.0 4.0 1.7 3.5 3.8 4.2 Caribbean f 3.2 4.4 3.9 2.9 2.2 3.4 3.9 4.1 Brazil 2.9 7.5 2.7 0.9 2.2 2.4 2.7 3.7 Mexico 1.2 5.3 3.9 3.9 1.4 3.4 3.8 4.2 Argentina 2.9 9.2 8.9 1.9 4.9 2.8 2.5 2.5 Source : World Bank. a. Growth rates over intervals are compound weighted averages; average growth contributions, ratios and deflators are calculated as simple averages of the annual weighted averages for the region. b. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. c. Sub-region aggregate excludes Cuba and Grenada, for which data limitations prevent the forecasting of GDP components or Balance of Payments details. d. Exports and imports of goods and non-factor services (GNFS). e. Developing Central & North America: Costa Rica, Guatemala, Honduras, Mexico, Nicaragua, Panama, El Salvador. f. Caribbean: Belize, Dominica, Dominican Republic, Haiti, Jamaica, St. Lucia, St. Vincent and the Grenadines, and Suriname. compared to pre-crisis levels, will be supportive of commodity export share of more than 70 percent exports from the Latin American and Caribbean of exports, and Ecuador a major exporter of region. We project that the region’s export bananas and crude oil, will see a deterioration of volumes will be expanding by over 5 percent in export revenues and trade balances, and quite 2016, up from the below 3 percent growth possibly their current account balances as well. observed in both 2012 and 2013. Depreciated exchanges rates will mitigate to some extent the effects of the lower commodity prices Continued decline in commodity prices will on the trade and current account balance with the moderate export revenues. With few exceptions, net effect being determined on a country specific commodity prices are projected to continue their basis. downward trend in the medium term, yielding negative terms-of-trade developments for the Global financing conditions are expected to majority of the region’s commodity exporters along tighten further thus moderating capital flows to with decreases in export and government revenue, the region. In the baseline, the tapering of and ceteris paribus worsening of the trade and quantitative easing in the United States is assumed current account balances. Countries such as Belize to commence in H1 2014, as a result long-term with a commodity export share of more than 80 interest rates on U.S. Treasuries will rise further percent of total exports, Colombia with a leading investors to demand higher yields on 50 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 2.9 Net capital flows to Latin America and the Caribbean ($billions) 2008 2009 2010 2011 2012 2013e 2014f 2015f 2016f Capital Inflows 163.1 160.4 303.4 267.7 312.1 296.2 285.3 303.8 313.8 Private inflows, net 156.7 143.2 280.8 262.8 300.3 289.9 277.8 294.5 308.4 Equity Inflows, net 109.9 112.5 150.1 147.5 170.5 172.7 162.3 177.7 189.2 Net FDI inflows 121.5 71.2 110.9 145.0 150.3 158.0 144.0 152.0 160.0 Net portfolio equity inflows -11.6 41.2 39.3 2.6 20.2 14.7 18.3 25.7 29.2 Private creditors. Net 46.8 30.7 130.7 115.3 129.8 117.2 115.5 116.8 119.2 Bonds 9.1 43.3 65.6 75.6 79.8 76.3 71.2 62.5 60.1 Banks 35.6 -4.2 18.3 46.1 28.0 23.4 20.1 35.4 36.2 Other private -0.5 -0.5 0.9 -0.4 9.6 2.1 1.5 0.8 2.4 Short-term debt flows 2.6 -7.9 45.9 -5.9 12.3 15.4 22.7 18.1 20.5 Official inflows, net 6.4 17.2 22.6 4.9 11.8 6.3 7.5 9.3 5.4 World Bank 2.5 6.2 8.3 -2.9 3.6 2.2 .. .. .. IMF 0.0 0.4 1.3 0.2 -0.1 0.4 .. .. .. Other official 3.9 10.6 13.0 7.5 8.4 3.7 .. .. .. Source: The World Bank Note: e = estimate, f = forecast developing country debts. Increased capital costs steadily accelerate from [1.4] percent in 2013 to will slow debt flows to developing countries, [4.2] percent in 2016. Similar to Mexico, other including to the Latin American and Caribbean Central & North American countries with tight region, which has been one of the largest trade links to the strengthening U.S. are also beneficiaries of the increased capital flows to expected to see growth rising to [3.5] percent in developing countries observed in recent years 2014, and to [4.2] percent in 2016. The Caribbean (table 2.9). Overall, total net capital flows to the economies are also expected to strengthen from region will decline by about 3.7 percent in 2014, on [3.4] percent in 2014 to [4.1] percent in 2016, on top of the 5.0 percent decline saw in 2013. The stronger tourism income. In contrast, the weaker growth in capital flows will thus temper the Venezuelan economy is projected to undergo a contribution of domestic demand to overall GDP drawn-out adjustment and weak growth in the growth, an effect that should be partially offset by medium term, as goods shortages and supply stronger exports. bottlenecks persist and inflation is high. Performance across individual countries will vary. Riding on strong exports growth, together with public investments for the upcoming World Risks Cup in 2014 and summer Olympics in 2016, Brazil, the largest economy in the region, is expected to see a modest but sustained growth over the forecasting horizon from [2.4] percent in 2014 Potential for a disorderly adjustment to long- accelerating to [3.7] in 2016 (Latin America and the term higher interest rates. Prospects will be Caribbean forecast table). Driven by broad public sensitive to the pace at which accommodative transportation investment program that includes monetary policy in high-income countries are the expansion of the canal, Panama will continue to withdrawn. In the baseline, the withdrawal of be an outlier, with high growth rates exceeding [7] quantitative easing, and its effect on long-term percent for 2014, and moderating to around [6] interest rates in United States, is assumed to follow percent for 2015 and 2016. Mexico is also expected a relatively gradual trajectory in line with improving to post a relatively robust performance, economic conditions in the United States. If predominantly benefiting from a maturing recovery however markets react sharply to signs of a taper in the United States, and will see GDP growth then capital flows to developing countries could 51 GLOBAL ECONOMIC PROSPECTS | January 2014 decrease by as much as 60 percent or more, However, this recovery still remains hesitant, and is destabilizing current account balances, and leading subject to a number of downside risks. For to disorderly depreciations of exchanges rates, and instance, outturns in Central and North American quite possibly increasing imported inflation. These and Caribbean developing economies are likely to would compel local governments to tighten be particularly sensitive to the U.S. economy and in monetary policies and further reduce growth particular the evolution of fiscal policy discussions prospects. The Latin America region will not be in that country. Similarly in the Eurozone, although immune to such developments, particularly so as it growth has encouragingly turned positive in recent is one of the developing regions that has benefitted quarters, the recovery is in early stages and much the most from higher capital flows arising from needs to be done before the region regains loose monetary policies in high-income countries. sustained levels of strong growth. As earlier observed, reflecting the mid-2013 perturbations in global financial markets, equity Sharper-than-expected decline in commodity issuances slumped by nearly 50 percent, and prices. Although the baseline assumes a moderate regional currencies depreciated by up to 13 percent decline in commodity prices, this is not guaranteed. over the same time period. Econometric analysis Indeed, given China’s importance in global (see chapter 3) suggests that because investors tend commodity markets (particularly in metal markets) to discriminate among countries those with poorer a sharper-than-expected slowdown in China is macroeconomic fundamentals (e.g. high current likely to impact commodity exporters in the region, account and fiscal deficits) are likely to see larger thereby eroding export and government revenues adjustments on the prospects of a disorderly and potentially aggravating current account tapering process. imbalances Weaker than expected growth in the global economy. The baseline forecast assumes the continued improvement of advanced economies namely, the United States and the Eurozone. 52 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 2.10 Latin America and the Caribbean country forecasts Est. Forecast 00-09a 2010 2011 2012 2013 2014 2015 2016 Argentina GDP at market prices (% annual growth) b 2.9 9.2 8.9 1.9 4.9 2.8 2.5 2.5 Current account bal/GDP (%) 2.7 0.4 -0.6 0.0 -0.8 -0.9 -0.8 -0.2 Belize GDP at market prices (% annual growth) b 5.0 2.7 1.9 5.3 2.0 2.5 3.3 3.8 Current account bal/GDP (%) -12.7 -2.9 -1.1 -2.2 -1.1 -1.3 -1.2 -0.3 Bolivia GDP at market prices (% annual growth) b 3.4 4.1 5.2 5.2 5.3 4.7 4.0 3.6 Current account bal/GDP (%) 3.9 4.6 2.3 7.7 7.1 5.9 4.5 3.0 Brazil GDP at market prices (% annual growth) b 2.9 7.5 2.7 0.9 2.2 2.4 2.7 3.7 Current account bal/GDP (%) -0.7 -2.2 -2.1 -2.4 -3.6 -3.7 -3.5 -3.2 Colombia GDP at market prices (% annual growth) b 3.7 4.0 6.6 4.2 3.8 4.2 3.8 3.8 Current account bal/GDP (%) -1.4 -3.1 -2.9 -3.3 -3.5 -3.6 -3.3 -3.0 Costa Rica GDP at market prices (% annual growth) b 3.8 5.0 4.4 5.1 3.3 4.3 4.2 4.1 Current account bal/GDP (%) -5.0 -3.5 -5.4 -5.6 -5.1 -4.8 -4.6 -4.2 Dominica GDP at market prices (% annual growth) b 2.4 1.2 1.0 0.4 1.1 1.7 1.8 2.0 Current account bal/GDP (%) -18.4 -17.5 -13.8 -10.2 -9.8 -9.6 -9.2 -8.1 Dominican Republic GDP at market prices (% annual growth) b 4.5 7.8 4.5 3.9 2.5 3.9 4.6 4.9 Current account bal/GDP (%) -2.6 -8.4 -8.2 -6.8 -4.8 -4.0 -3.2 -2.7 Ecuador GDP at market prices (% annual growth) b 4.2 3.5 7.8 5.1 4.0 4.1 4.2 4.3 Current account bal/GDP (%) 1.0 -2.3 -0.3 -0.3 -0.9 -0.8 -0.6 -0.5 El Salvador GDP at market prices (% annual growth) b 2.0 1.4 2.0 1.6 1.9 2.3 2.6 2.9 Current account bal/GDP (%) -3.8 -2.7 -4.7 -5.1 -4.3 -3.5 -2.6 -1.1 Guatemala GDP at market prices (% annual growth) b 3.4 2.9 4.1 3.0 3.3 3.4 3.3 3.2 Current account bal/GDP (%) -4.8 -1.6 -3.6 -2.9 -3.0 -2.8 -2.8 -2.9 Guyana GDP at market prices (% annual growth) b 2.1 3.6 5.2 3.9 4.5 4.1 4.0 4.0 Current account bal/GDP (%) -10.0 -7.0 -10.2 -13.7 -17.1 -16.9 -16.3 -18.9 Honduras GDP at market prices (% annual growth) b 3.8 3.7 3.7 3.3 2.9 3.4 3.8 3.9 Current account bal/GDP (%) -6.7 -5.4 -9.0 -9.7 -11.2 -8.2 -6.9 -6.0 Haiti GDP at market prices (% annual growth) b 0.6 -5.4 5.6 2.8 3.4 4.2 3.9 3.9 Current account bal/GDP (%) -6.8 -29.4 -24.3 -17.3 -15.6 -15.0 -14.5 -27.0 53 GLOBAL ECONOMIC PROSPECTS | January 2014 Est. Forecast 00-09a 2010 2011 2012 2013 2014 2015 2016 Jamaica GDP at market prices (% annual growth) b 1.0 -1.5 1.7 -0.5 0.2 0.8 1.0 1.3 Current account bal/GDP (%) -10.1 -7.1 -14.6 -12.7 -10.8 -6.9 -3.3 0.4 Mexico GDP at market prices (% annual growth) b 1.2 5.3 3.9 3.9 1.4 3.4 3.8 4.2 Current account bal/GDP (%) -1.6 -0.2 -0.9 -0.9 -1.5 -1.5 -1.4 -1.4 Nicaragua GDP at market prices (% annual growth) b 2.8 3.6 5.4 5.2 3.8 4.2 4.4 4.3 Current account bal/GDP (%) -17.3 -10.0 -13.2 -12.8 -13.6 -13.2 -12.2 -11.2 Panama GDP at market prices (% annual growth) b 5.6 7.6 10.6 10.5 7.6 7.3 6.1 6.2 Current account bal/GDP (%) -4.8 -10.8 -12.8 -9.1 -8.5 -8.4 -8.0 -7.4 Peru GDP at market prices (% annual growth) b 4.8 8.8 6.9 6.3 4.9 5.5 5.9 5.8 Current account bal/GDP (%) -0.7 -2.5 -1.9 -3.6 -4.9 -4.4 -3.8 -3.2 Paraguay GDP at market prices (% annual growth) b 2.0 13.1 4.3 -1.2 12.7 3.7 4.2 4.0 Current account bal/GDP (%) 2.0 -0.4 1.4 0.6 4.5 2.3 0.8 0.8 St. Lucia GDP at market prices (% annual growth) b 2.1 3.2 0.6 -0.2 1.2 1.7 2.0 3.8 Current account bal/GDP (%) -19.6 -18.9 -21.7 -15.4 -13.2 -11.2 -9.4 -17.2 St. Vincent and the Grenadines GDP at market prices (% annual growth) b 2.8 1.0 1.5 3.1 1.9 2.5 3.0 -3.5 Current account bal/GDP (%) -18.8 -29.0 -26.4 -26.5 -25.4 -24.7 -23.8 -14.4 Suriname GDP at market prices (% annual growth) b 4.4 4.1 4.7 4.5 3.9 4.1 3.5 3.5 Current account bal/GDP (%) 9.8 6.4 5.8 4.2 0.5 3.7 4.4 4.5 Venezuela, RB GDP at market prices (% annual growth) b 3.3 -1.5 4.2 5.5 0.7 0.5 1.7 2.3 Current account bal/GDP (%) 9.7 2.6 7.5 2.5 1.7 2.1 2.2 2.2 Source : World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not significantly differ at any given moment in time. Cuba, Grenada, St. Kitts and Nevis, are not forecast owing to data limitations. a. GDP growth rates over intervals are compound average; current account balance shares are simple averages over the period. b. GDP measured in constant 2010 U.S. dollars. 54 GLOBAL ECONOMIC PROSPECTS | January 2014 Political turmoil has weakened activity in the developing oil importing countries while security setbacks have negatively affected developing oil exporting countries, with deterioration of fiscal and external accounts across the board. Growth for the region is expected to remain weak and to remain below it’s potential in the forecast period, picking up to [3.3] percent by 2016. The outlook is subject to significant downside risks which are mostly internal to the region, while external risks are more balanced. Recent Developments have deepened. Meanwhile, the persistent structural problems remain unaddressed. Activity has weakened on account of political instability in oil importing countries.FN1 Three years after the Arab Spring, the Political turmoil in Egypt, stalemate in Tunisia and economies of the Middle East and North an escalation of the civil war in Syria with spillovers Africa region remain depressed. In the decade to neighboring Lebanon and Jordan have prior to the uprisings in 2011, the region averaged weakened activity in the developing oil importing solid growth of about [4] percent with countries. Rising social and political tensions in the macroeconomic stability underpinned by fiscal and run up to and after the overthrow of the Morsi external accounts that were broadly in balance. government weighed heavily on confidence in However, that growth was accompanied by Egypt, causing investment and industrial output to persistent structural problems —high youth plummet in the second and third quarters. Egypt’s unemployment, poor service delivery and unequal GDP contracted by [3.1] percent (saar) in 2013Q2, access (of firms and households) to economic and growth for the fiscal year (ending in the same opportunities — which contributed to the quarter) amounted to a meager [1.5] percent, down discontent that led to the uprisings of the Arab from an already modest [2.2] percent in 2012. Since Spring. Three years since, political turbulence, and 2011, Egypt has experienced four separate episodes in some cases violence, continues while the political of a sharp deceleration or contraction in activity as transition remains far from complete and its political and social tensions erupted, punctuated by outcome uncertain. Not surprisingly, economic ultimately short-lived rebounds in activity. Two growth has slowed, fiscal and external balances separate political assassinations in Tunisia have worsened and macroeconomic vulnerabilities contributed to the delay of the political transition 55 GLOBAL ECONOMIC PROSPECTS | January 2014 Figure 2.15 Developing oil importers—industrial pro- Figure 2.16 Developing oil importers—Exports and duction tourist arrivals Source: Datastream, World Bank. Source: Datastream, UN World Tourism Office, World Bank. towards the new constitution with GDP expanding developing oil exporting countries—accounting for by just [2.1] percent (saar) in 2013Q3, versus nearly a third of the region’s oil output—has fallen growth of [4.5] percent in 2012. over the past year by nearly 7 percent (year to date) in 2013, reflecting security setbacks, strikes, Industrial production in the oil importing countries infrastructure problems (Algeria, Iraq and Libya), contracted by [43] percent (saar) in three months to and in the case of Iran, international sanctions. By September, led mainly by sharp declines of over the end of September 2013, the aggregate [50] percent in Egypt (figure 2.15). However, production of developing oil importers averaged Purchasing Managers Index (PMI) surveys just 7 mb/d, down from 8.5 mb/d at the beginning exceeded the 50 threshold in November 2013 for of 2013 and 9.5 mb/d at the end of 2010 (figure the first time in 13 months, signaling an 2.17). Meanwhile, the developed oil exporters (Gulf improvement in manufacturing output. Momentum Cooperation Countries or GCC) continue to make in industrial production growth has strengthened up the loss in oil production, and, in some cases, recent months in Jordan and Tunisia as well. providing financial support to the region’s transition economies. Similar to industrial production, data for the third quarter indicate that exports contracted by [16] Security setbacks affected oil production in percent (saar) in the three months to September, several countries. For example, Libyan production led by contractions in Egypt, Morocco and plunged to a post-war low of 0.3 mb/d in Lebanon. Overall, exports—which have been September 2013 as labor disputes, political turmoil, contracting since the start of 2013—have bottomed out in July and have recovered since led Figure 2.17 Developing oil exporters— Production by gains in Tunisia and Jordan. of crude oil Tourism arrivals to the oil importing countries rebounded strongly in the first quarter of 2013, but plunged dramatically due to security uncertainties in the wake of the overthrow of Morsi government in Egypt and due to the Syrian civil war, affecting Lebanon and Jordan (figure 2.16). Tourist arrivals dropped by 48 percent (saar) in three months to September in the oil importing countries of the region. Oil production is declining in developing oil exporting countries.FN2 Oil production in Source: Bloomberg, Energy Intelligence Group. 56 GLOBAL ECONOMIC PROSPECTS | January 2014 and infighting among local militias crippled the financing have led to a reduction in reserves, which country’s output. Output was on the decline in had fallen to 3.5 months of imports as of end- August, falling to 0.6 mb/d, less than the average September 2013. After a challenging 2012, Jordan’s output of 1.4 mb/d in 2012 and 1.6 mb/d in 2010. external balance improved in 2013 due to a decline Similarly, in Iraq—who surpassed Iran as the in energy imports in response to the subsidy second largest oil producer in OPEC at the end of reforms and an increase in official transfers. As 2012—production peaked at 3.2 mb/d and fell to external financing in the form of grants and loans 2.8 mb/d in September reflecting militant attacks from international financial institutions filled the on the Kirkuk to Ceyhan pipeline in the north financing gap in 2013, the pressure on the currency (with volumes cut in half from March 2013) as well and foreign exchange reserves subsided. as planned maintenance disruptions in the south. Crude oil production in Syria collapsed some 57 With only a few exceptions, fiscal imbalances percent in 2013—after falling 50 percent in 2012— have worsened across the Middle East and and is virtually non-existent as the on-going civil North Africa region, especially in oil importing war brought it to a standstill. countries. Deterioration reflects weaker revenues due to slow growth, rising public sector spending International sanctions affected Iran’s crude oil on wages and subsidies for food and fuel in the production in 2012, but it has been stable in 2013. wake of the Arab Spring and in some cases, The International Energy Agency (IEA) estimates increased debt servicing charges. With limited that Iran’s oil production was about 2.5 mb/d in external financing, deficits have been financed September, of which some 1.2 mb/d were mostly from the domestic banking sectors and, exported. Prior to sanctions introduced in 2011, more recently, with loans and grants from the GCC Iran used to produce about 3.5 mb/d and export countries. about 2.5 mb/d of crude oil. The interim deal on Iran’s nuclear program reached in November 2013 Subsidies have historically played an important role is expected to have a very limited impact and not in the economies of the region. Governments to lift Iran’s exports much above current levels. provided price subsidies on energy products and food to provide a social safety net in the oil External imbalances have worsened across the importing countries and to share the oil revenues in developing countries of the Middle East and the oil exporting countries. According to IMF North Africa region. Current account deficits estimates, pretax energy subsidies in 2011 have widened in the oil importing countries—hurt amounted to over 8 percent of regional GDP and particularly by the steep decline in tourism nearly 50 percent of all subsidies in the world. receipts—while current account surpluses have Attempts to reduce general energy subsidies are shrunk for the oil exporting countries as oil exports underway in Egypt, Morocco, Jordan and Tunisia. have declined. Oil importers have experienced However, rising political uncertainty and lower difficulty financing current account deficits as economic growth pose challenges for foreign investment flows declined and access to implementation of these reforms. traditional capital markets became more limited in the midst of political turmoil. Fiscal policies have remained expansionary. For example, in Egypt, the new government has In Egypt, balance-of-payments pressures eased in announced a stimulus package equivalent to 1.6 2013 thanks to exceptionally high bilateral percent of GDP on the back of the financing borrowing from the Gulf counties, increased provided by the GCC countries. One of the key exchange rate flexibility, and weak economic provisions of the new stimulus package is a 64 activity. The current account deficit also narrowed percent public sector wage increase beginning in in response to high inflows of remittances and a January 2014. Rising fiscal deficits have led to smaller non-oil trade deficit. In Tunisia, the current growing public sector debt and concerns about account deficit is expected to persist despite lower debt sustainability. As a share of GDP, government imports because of stagnating tourism receipts and debt rose in most developing countries in the remittances, and weak exports. Interventions to region. In Egypt, spending pressures exacerbated sustain the currency in the face of a worsening by rising borrowing costs have pushed interest current account and lower-than-expected official expenditures to about 8.4 percent of GDP or 25 57 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 2.11 Net capital flows to Middle East and North Africa ($ billions) 2008 2009 2010 2011 2012 2013e 2014f 2015f 2016f Capital Inflows 23.9 30.9 31.4 10.2 32.7 28.9 21.3 28.8 32.1 Private inflows, net 25.6 28.4 30.1 9.0 27.9 19.8 15.2 23.7 27.7 Equity Inflows, net 30.0 27.5 24.2 13.0 18.0 14.8 12.9 19.5 21.8 Net FDI inflows 29.6 26.3 22.3 13.7 19.3 15.5 13.1 18.4 20.3 Net portfolio equity inflows 0.4 1.2 2.0 -0.6 -1.3 -0.7 -0.2 1.1 1.5 Private creditors. Net -4.4 0.9 5.9 -4.0 9.9 5.0 2.3 4.2 5.9 Bonds -0.8 0.1 3.2 -0.6 5.8 1.2 0.2 2.3 3.4 Banks -0.4 -1.2 -1.0 -0.1 0.4 -0.4 -0.1 0.7 1.1 Other private -1.3 -1.0 -0.8 -0.7 -0.3 -0.1 -0.1 -0.2 0.3 Short-term debt flows -1.9 3.0 4.5 -2.6 4.0 4.3 2.3 1.4 1.1 Official inflows, net -1.7 2.5 1.3 1.2 4.8 9.1 6.1 5.1 4.4 World Bank -0.3 0.9 0.8 0.9 0.8 0.8 .. .. .. IMF -0.1 -0.1 0.0 -0.1 0.5 0.0 .. .. .. Other official -1.4 1.6 0.5 0.3 3.5 8.3 .. .. .. Source: The World Bank Note: e = estimate, f = forecast percent of total expenditures in fiscal year 2012 account of political turmoil. Overall net FDI levels (figure 2.18). To finance its revenue shortfall Egypt remain well below pre-Arab Spring inflows and are has relied heavily on domestic borrowing, not projected to recover to those levels in the increasing the exposure of the banking sector to forecast period (table 2.11). A strong official sovereign risk, crowding out private sector inflows in form of aid from the Gulf countries borrowing and pushing domestic interest rates have helped the region buffer the drop off in higher. The quality of government spending private flows. In addition, sovereigns that have deteriorated in some cases too: in Morocco, for the successfully accessed international markets have first time the government spent more on subsidies done so with external assistance. Jordan issued a than on public investment in 2012. U.S. government-backed $1.25 billion Eurobond while Tunisia successfully issued a $230 million Capital flows to the developing countries of the with a Japanese guarantee. region fell in 2013 to an estimated $28.9 billion after recovering to $32.7 billion in 2012. The Remittance inflows to the region are moderating deterioration reflected a decrease in net FDI flows as well and have grown by 3.6 percent in 2013 (down 14.5 percent) to Egypt and Tunisia on to about US$49 billion. The growth in remittances is easing from the 12 percent average annual growth recorded in 2010 to 2013 and is Figure 2.18 Debt service in Egypt expected to be in the 5-6 percent range annually between 2014 and 2016. With about US$20 billion in remittances anticipated in 2013, Egypt is the sixth largest beneficiary in the developing world, and receives about 40 percent of remittances sent to the region (remittances are more than three times larger than receipts from the Suez Canal, and are equivalent to about 165 percent of Egypt’s official reserves). Egypt accounted for much of the expansion in earlier years, as well as the slowing expected in 2013. Remittances to Lebanon and Morocco, two other large recipients in the region, have recovered in 2013, after flat or negative Source: Egyptian Ministry of Finance. growth in 2012. 58 GLOBAL ECONOMIC PROSPECTS | January 2014 Outlook political uncertainty that has plagued the region is not expected. Among developing oil exporters, growth has been the most volatile and is estimated to have Growth in the Middle East and North Africa contracted in 2013 by [1.5] percent reflecting region is expected to remain weak during the production setbacks in Libya and Iraq, sanctions in forecast period. Given the persistent bouts of Iran and civil war in Syria. Going forward growth is political instability and policy uncertainty, expected to firm to [3.4] percent by the end of the economic growth has contracted by [0.1] percent in forecast period as the oil prices remain relatively 2013—down from already weak growth of [1.5] high and infrastructure problems and security percent in 2012. If Syria is removed from the setback are resolved and mitigated. This should regional aggregate, the growth slowed to [0.8] underpin domestic demand and lead to a gradual percent, down from [2.7] percent in 2012. The improvement in fiscal and current account deficits. outlook for the region is shrouded in uncertainty Importantly, the baseline outlook for Iran assumes and subject to a variety of risks, mostly domestic in a partial easing of the sanctions in line with steps nature and linked to political instability and policy taken to date. uncertainty. Under the baseline scenario for the forecast period, marked improvement in the Aggregate growth in oil importers is expected to remain weak and below potential at [2.5] Table 2.12 Middle East and North Africa forecast summary (annual percent change unless indicated otherwise) Est. Forecast 00-09a 2010 2011 2012 2013 2014 2015 2016 b, c GDP at market prices, geographic region 4.0 4.2 2.3 3.4 1.8 3.6 4.0 4.0 c GDP at market prices, developing countries 4.1 4.4 -0.7 1.5 -0.1 2.8 3.3 3.4 d (Sub -region totals-- countries with full NIA + BOP data) c GDP at market prices, developing countries 4.3 4.6 1.6 -1.1 0.0 1.8 2.7 2.8 GDP per capita (units in US$) 2.8 3.0 0.0 -2.6 -1.5 0.3 1.3 1.4 PPP GDP e 4.3 4.6 1.5 -1.1 0.0 1.8 2.7 2.8 Private consumption 4.0 2.0 1.2 2.3 1.4 3.1 3.7 2.9 Public consumption 3.5 3.3 2.7 1.8 3.5 3.4 3.2 3.1 Fixed investment 6.9 5.1 3.4 -0.2 -1.0 0.6 1.2 2.3 Exports, GNFS f 4.3 6.9 -0.8 -2.5 1.4 2.9 4.8 4.7 Imports, GNFS f 7.5 4.0 1.2 4.1 3.3 4.4 5.2 4.0 Net exports, contribution to growth -0.6 0.8 -0.6 -2.0 -0.6 -0.6 -0.4 0.0 Current account bal/GDP (%) 5.2 1.7 2.0 -1.6 -3.4 -3.7 -3.7 -3.7 GDP deflator (median, LCU) 6.0 8.4 7.0 8.7 4.4 4.1 4.2 6.0 Fiscal balance/GDP (%) -0.5 -1.7 -1.7 -7.6 -7.2 -6.4 -5.9 -5.8 Memo items: GDP Developing countries, ex. Syria 4.0 4.5 -0.5 2.7 0.8 3.2 3.4 3.4 Selected GCC Countries g 3.8 3.8 6.4 5.7 4.1 4.6 4.7 4.7 Developing Oil Exporters 3.8 4.8 -2.4 1.4 -1.5 3.0 3.4 3.4 Developing Oil Importers 4.5 3.7 2.3 1.5 2.5 2.6 3.2 3.3 Egypt 4.4 3.5 2.0 0.5 1.8 2.3 2.7 2.5 Fiscal Year Basis 4.3 5.1 1.8 2.2 1.5 1.7 2.0 2.4 Iran 4.6 5.9 2.2 -2.9 -1.5 1.0 1.8 2.0 Algeria 3.4 3.6 2.6 3.3 2.8 3.3 3.5 3.5 Source : World Bank. a. Growth rates over intervals are compound weighted averages; average growth contributions, ratios and deflators are calculated as simple averages of the annual weighted averages for the region. b. Georgaphic region includes the following high-income countries: Bahrain, Kuwait, Oman, Saudi Arabia, United Arab Emirates and Qatar. c. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. d. Sub-region aggregate excludes Iraq and Libya, for which data limitations prevent the forecasting of GDP components or Balance of Payments details. e. GDP measured at PPP exchange rates. f. Exports and imports of goods and non-factor services (GNFS). g. Selected GCC Countries: Bahrain, Kuwait, Oman, Saudi Arabia and United Arab Emirates. 59 GLOBAL ECONOMIC PROSPECTS | January 2014 percent in 2013, but performance will not improve Economic, social and fiscal pressures are high for dramatically in the forecast period unless there is a these countries and could be exacerbated further credible restoration of political stability and return should the civil war in Syria intensify. of confidence. Aggregate growth for the region is expected to slowly pick up to about [3.3] percent in Countries in political transition have benefited 2016, closer to—but still well below—the region’s from large official transfers from the Gulf potential growth. Consumption will be economies. While these are expected to continue, underpinned by large public outlays on wages and they nonetheless pose refinancing risk for the subsidies, while public investment will likely be recipients. In addition, public debt levels have constrained in the forecast period by large fiscal increased significantly in the last three years and deficits. could be approaching unsustainable levels as debt service takes a ever larger share of the The global economic environment will remain expenditures, especially in the domestic debt challenging for the recovery in the region. On the markets. one hand, the real-side recovery in the high-income countries anticipated during the forecast period Setbacks in political transitions and further should lea to stronger exports. On the other hand, escalation of violence in Egypt, Tunisia, Libya and a normalization of the extraordinary monetary Iraq would further undermine confidence and delay stimulus introduced in the wake of the global the structural reforms or reduce oil output. On the financial crisis in 2008 will raise interest rates and upside, restoration of political stability and policy slow investment. While the region does not rely certainty that would lead to sustained addressing of heavily on the portfolio capital flows, it is expected structural reforms could substantial boost to continue to underperform in attracting FDI. Of confidence and return growth to the long-run course, these effects would be more than potential. counterbalanced if the domestic political and security situation were to improve. External risks are more balanced. European growth could disappoint the already modest recovery projected, but it could also do better. Risks Exports from the countries in North Africa, tourism, remittances, capital flows and external balances would all be sensitive to differences in the outturn in Europe. In addition, risks from tightening of global financial conditions could lead The region’s outlook is subject to significant to a rise in risk premiums for developing countries downside risks which are mostly internal to the and lead to lower FDI. Furthermore, a sharper region. A further escalation of violence in Syria and than expected decline in commodity prices than spillovers on the rest of the region, namely those currently projected will lead to a significant Lebanon, Jordan and Iraq can adversely affect the deterioration in external and fiscal accounts of the region. Over 2.1 million Syrian refugees are hosted oil exporting countries although benefiting more in the region and refugees in Lebanon and Jordan vulnerable importers in the region. amount to 19 and 8 percent of populations there. Notes  Oil importing countries are: Egypt, Jordan, Lebanon, Morocco and Tunisia. Djibouti and West Bank and Gaza are not included due to data limitations.  Developing oil exporters are: Algeria, Iran, Iraq, Libya, Syria and Yemen. 60 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 2.13 Middle East and North Africa Country forecasts Est. Forecast 00-09a 2010 2011 2012 2013 2014 2015 2016 Algeria GDP at market prices (% annual growth) b 3.4 3.6 2.6 3.3 2.8 3.3 3.5 3.5 Current account bal/GDP (%) 22.3 7.3 8.9 5.9 2.7 1.2 0.1 0.0 Egypt, Arab Rep. GDP at market prices (% annual growth) b 4.4 3.5 2.0 0.5 1.8 2.3 2.7 2.5 Fiscal Year Basis 4.3 5.1 1.8 2.2 1.5 1.7 2.0 2.4 Current account bal/GDP (%) 1.1 -2.0 -2.3 -2.7 -3.5 -3.1 -2.8 -2.7 Iran, Islamic Rep. GDP at market prices (% annual growth) b 4.6 5.9 2.2 -2.9 -1.5 1.0 1.8 2.0 Current account bal/GDP (%) 6.3 7.0 9.2 2.8 -0.9 -1.6 -1.9 -2.2 Iraq GDP at market prices (% annual growth) b -1.0 0.8 8.5 8.4 4.2 6.5 6.6 8.3 Current account bal/GDP (%) 0.0 3.0 12.5 7.0 1.0 1.2 1.5 1.9 Jordan GDP at market prices (% annual growth) b 6.1 2.3 2.6 2.8 3.0 3.1 3.3 3.8 Current account bal/GDP (%) -4.4 -7.1 -12.0 -17.7 -14.9 -14.0 -13.0 -11.6 Lebanon GDP at market prices (% annual growth) b 4.4 7.0 3.0 1.4 0.7 2.0 2.7 4.2 Current account bal/GDP (%) -16.8 -20.4 -12.1 -13.5 -14.1 -13.3 -12.3 -11.3 Libya GDP at market prices (% annual growth) b 3.8 3.5 -53.9 104.5 -6.0 23.0 12.2 9.0 Current account bal/GDP (%) 0.0 19.5 9.1 29.1 3.2 5.4 4.4 5.5 Morocco GDP at market prices (% annual growth) b 4.6 3.6 5.0 2.7 4.5 3.6 4.4 4.7 Current account bal/GDP (%) 0.2 -4.6 -8.4 -9.7 -7.8 -7.3 -6.6 -5.7 Syrian Arab Republic GDP at market prices (% annual growth) b,c 4.6 3.2 -3.4 -21.8 -22.5 -8.6 1.7 1.7 Current account bal/GDP (%) 2.7 -0.6 -19.7 -19.0 -20.5 -15.5 -11.7 -9.1 Tunisia GDP at market prices (% annual growth) b 4.2 3.0 -2.0 3.6 2.6 2.5 3.3 3.6 Current account bal/GDP (%) -2.7 -4.7 -7.3 -8.3 -8.9 -7.8 -7.5 -7.3 Yemen, Rep. GDP at market prices (% annual growth) b 3.5 7.7 -12.6 2.4 3.0 3.4 3.9 3.9 Current account bal/GDP (%) 1.1 -5.4 -5.4 -3.1 -5.1 -5.2 -4.6 -4.4 Source : World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not significantly differ at any given moment in time. Djibouti, West Bank and Gaza are not forecast owing to data limitations. a. GDP growth rates over intervals are compound average; current account balance shares are simple averages over the period. b. GDP measured in constant 2010 U.S. dollars. c. The estimates for GDP decline in Syria in 2012 and 2013 are subject to significant uncertainty. 61 GLOBAL ECONOMIC PROSPECTS | January 2014 South Asia’s GDP growth rose to an estimated [4.6] percent in 2013 from [4.2] percent in 2012, but was well below its average in the last decade, reflecting both rising domestic imbalances and a challenging external environment. Regional GDP growth is projected to improve to [5.7] percent in 2014, and then rise further to [6.3] and [6.7] percent in 2015 and 2016. The projected pickup will depend critically on ensuring macroeconomic stability, sustaining reforms, and reducing supply-side constraints. Recent Developments countries, which together account for close to [90] percent of regional GDP, reflect a combination of domestic imbalances (large fiscal deficits, high inflation), weakening investment rates, and a more challenging external environment (see Rajan 2013a Regional GDP growth is estimated to have and 2013b for a discussion on India). Among the picked up modestly in 2013, but was weak smaller countries, Bangladesh’s growth slowed to when compared to past performance. South [6.0] percent in FY2012-13 from [6.2] percent in Asia’s GDP growth rose to an estimated [4.6] FY2011-12, while growth in Afghanistan weakened percent in 2013 in calendar year-market price terms sharply to an estimated [3.1] percent in 2013 from from [4.2] percent growth recorded in 2012. GDP an exceptionally high [14.4] percent in 2012. By growth, however, remained well below its pre-crisis contrast, growth in Sri Lanka picked up to an pace. For instance, in India, the largest regional estimated [7.0] percent in 2013 from [6.4] percent, economy, GDP growth measured on a factor cost with strengthening manufacturing and services basis is estimated to have moderated to [4.8] activity, and a rebound in agriculture in Q3. percent in the 2013-14 fiscal year (similar to the [5] percent rate in the previous fiscal year)—but well A cyclical improvement in activity in the second below the close to [8] percent average growth half of 2013 was led by a rapid expansion of achieved during the past decade. GDP growth in exports. Activity in South Asia registered a Pakistan, South Asia’s second largest economy, has cyclical recovery during the second half of 2013, also been relatively weak, averaging [3.5] percent in following a mid-year slump. Regional export factor cost terms since 2010, below the nearly [5] volumes expanded by a robust annualized [53] percent average growth during the previous decade. percent in the three months to October (3m/3m The relatively weak GDP growth rates in these two saar), reflecting a gradual recovery in global 63 GLOBAL ECONOMIC PROSPECTS | January 2014 demand and currency depreciation in India (see consumption growth. Lower international figures 2.19 and 2.22). Export volumes in South commodity prices has helped inflation momentum Asia excluding India also rose robustly in Q3. to weaken in South Asia, with Bangladesh and Sri Despite the strong momentum in the second half, Lanka experiencing significant declines during the regional export growth slowed in 2013. Nevertheless, course of 2013. But in India, despite a negative the regional current account deficit fell by [1] output gap, consumer price inflation remained percentage point of GDP—mainly due to weaker elevated at close to [10] percent (y/y), reflecting import growth from weak domestic demand, stable persistent food price inflation, currency crude oil prices relative to 2012, and restrictions on depreciation, fuel price adjustments, and supply- import of gold in India. Even with a cyclical side constraints. In Pakistan, both monetization of rebound in Q3, full-year industrial output growth large fiscal deficits and structural constraints have for South Asia was very weak at an estimated [1.5] contributed to inflationary pressures. Lower percent (y/y), although industrial activity picked up international commodity prices in 2013, together at a decidedly faster pace in Pakistan. with normal agricultural harvests, helped to marginally raise relatively weak regional Investment growth in South Asia is estimated consumption growth. to have improved in 2013, but was still weak. Regional investment growth is estimated to have The pace of increase in migrant remittances improved from a decade-low [1.1] percent recorded moderated in 2013. Growth in remittances to in the 2012 calendar year to a still relatively South Asia is estimated to have moderated to [6.8] lackluster [3.5] percent in 2013. India’s investment percent in 2013 from [9.7] percent the previous growth slowed sharply in FY2012-13, but year, according to World Bank estimates (World improved in the second half of 2013. In Pakistan, Bank 2013a). Flows to India dipped in the first investment as a share of GDP has been falling quarter, but with the depreciation of the rupee, (albeit at a slowing pace) in recent years. Generally they rebounded to reach an estimated $71 billion in weak regional investment reflects subdued, albeit 2013. Remittance flows to Nepal and Sri Lanka improving, business sentiment in India (figure (where they are [25] and [10] percent of GDP) are 2.20), as well as structural bottlenecks (including in estimated to have experienced double-digit growth electricity provision), policy uncertainties, and high in the 2013 calendar year. After rising [12.4] inflation. In Bangladesh, disruptions and violence percent in FY2012-13, remittance inflows to in the run-up to national elections slowed private Bangladesh fell [9.2] percent (y/y) in the first five sector investment growth, although compensated months of the current fiscal year, reflecting both to some extent by public investment. weak labor exports and political unrest. Flows to Pakistan, however, rose [7.1] percent (y/y) in the Weaker international commodity prices and same period, compared to the [5.6] percent increase normal harvests supported a stabilization of in FY2012-13. Figure 2.19 Regional exports surged with strengthen- Figure 2.20 Business sentiment improves in India in ing recovery in external demand and INR second half depreciation Source: Datastream, Haver Analytics, World Bank Source: Markit, Haver Analytics, World Bank 64 GLOBAL ECONOMIC PROSPECTS | January 2014 Fiscal deficits remain high reflecting subsidy Capital flows to the South Asia region expenditures and weak revenue mobilization. experienced a sharp correction during mid-year. Fiscal positions have improved marginally across India, with large current account and fiscal deficits the South Asia region, but deficits remain elevated and slowing growth, was hit particularly hard by a (figure 2.21), with the regional deficit close to [7] withdrawal of portfolio capital and steep currency percent of GDP. India’s central government fiscal depreciation during mid-year (figure 2.22) on deficit at [4.9] percent of GDP in FY2012-13 was concerns of tapering of US quantitative easing below target. But since April, the government’s (QE). The rupee subsequently appreciated (in part deficit target for FY2013-14 came under pressure, due to policy interventions to support foreign reaching [84] percent of the target by October as exchange markets), and capital flows and equity compared to [43] percent in the previous fiscal markets rebounded as QE tapering was delayed to year. Pakistan’s fiscal deficit was [8] percent of December. Nevertheless, net private capital flows GDP in the 2012-13 fiscal year, although planned to South Asia weakened to an estimated $85 billion fiscal consolidation (including tax administration in 2013 from $92 billion in 2012 (table 2.14). reforms) is expected to reduce this gradually. Sri Lanka’s deficit has fallen in recent years, but is Reserve buffers in the region have been depleted estimated to be nearly 6 percent of GDP in 2013. in recent years, but external debt ratios are relatively modest. International reserves as a share Weak GDP growth has adversely affected tax of imports have been drawn down in several South revenues, already among the lowest (as a share of Asian countries in recent years, due to slower pace GDP) compared to developing countries at similar of increase in exports, capital inflows, and levels of economic development (see World Bank remittances. International reserves have fallen 2013b). Subsidies on fuel and other items below 2 months of imports in Pakistan. Nepal and (including food and fertilizers) were [2.6] percent Maldives both have trade deficits exceeding a of GDP in India and [3.1] percent in Bangladesh, quarter of GDP. The former’s is mostly offset by while energy subsidies are close to [2] percent in remittances, but in the Maldives, it has resulted in a Pakistan, according to the IMF estimates and current account deficit of [28] percent of GDP and national sources. South Asian countries have made weakening reserves. External debt as a share of some progress in fuel subsidy reforms. For GDP is modest in most South Asian countries. But instance, India has increased regulated diesel prices in Sri Lanka, they are close to 80 percent of GDP. at monthly intervals. More decisive action, Sri Lanka’s large current account deficit, high including eventually deregulating fuel prices while foreign debt, and openness to capital flows suggest protecting the poor through targeted assistance, that it remains especially vulnerable to tightening of may be needed to lower subsidy burdens. Lowering international financial conditions – alongside India subsides will help to reduce fiscal deficits or, whose current account deficit narrowed in Q3 alternatively, to raise productivity-enhancing 2013, but was still elevated for the full year. expenditures in a fiscally neutral manner. Figure 2.21 Fiscal positions are improving but remain Figure 2.22 Sharp currency depreciation in India, under stress Nepal and Pakistan since mid-year Source: Datastream, Haver Analytics, World Bank Source: Datastream, Haver Analytics, World Bank 65 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 2.14 South Asia capital flows ($ billions) 2008 2009 2010 2011 2012 2013e 2014f 2015f 2016f Capital Inflows 64.7 90 106.9 84.7 96.1 90.6 92.8 101.4 113.5 Private inflows, net 55.8 79.0 96.1 78.1 92.1 84.7 87.7 96.7 109.7 Equity Inflows, net 35.1 63.6 61.1 36.1 50.8 50.3 54.4 59.5 70.0 Net FDI inflows 50.9 39.5 31.2 40.4 27.4 32.0 35.3 38.1 43.6 Net portfolio equity inflows -15.8 24.1 29.9 -4.3 23.4 18.3 19.1 21.4 26.4 Private creditors. Net 20.7 15.4 35.0 42.0 41.3 34.4 33.3 37.2 39.7 Bonds 1.7 1.9 10.1 0.7 5.1 6.2 5.3 4.7 4.1 Banks 11.2 10.9 13.2 18.6 23.0 15.2 12.5 15.7 16.2 Other private -0.1 -0.1 0.0 0.0 -0.2 -0.1 0.1 0.1 0.2 Short-term debt flows 7.9 2.6 11.7 22.7 13.4 13.1 15.4 16.7 19.2 Official inflows, net 8.9 11.0 10.8 6.6 4.0 5.9 5.1 4.7 3.8 World Bank 1.4 2.4 3.3 2.0 0.9 0.5 .. .. .. IMF 3.2 3.6 2.0 0.0 -1.5 0.5 .. .. .. Other official 4.3 4.9 5.6 4.6 4.6 4.9 .. .. .. Source: The World Bank Note: e = estimate, f = forecast Outlook macroeconomic stability (including reducing fiscal deficits and inflation), making sustained progress on policy reforms, and reducing structural and regulatory constraints to production (particularly in the provision of energy and infrastructure). For South Asia’s regional GDP growth is projected to instance, moving towards market-based pricing and improve to [5.7] percent in 2014 in market price- dealing with losses and debts of state-owned calendar year terms, and rise further to [6.3] and companies in the electricity and petroleum sectors [6.7] percent in 2015 and 2016 (table 2.15). A will not only be important for reducing subsidies gradual improvement in regional growth over the and fiscal deficits, but also for creating incentives forecast period will be led mainly by a projected for provision of reliable energy supplies for the recovery in global demand and domestic private sector. investment, although the latter remains subject to significant downside risks. Regional export growth Relatively stable or declining international is expected to gradually rise over the forecast commodity prices during the forecast period will horizon together with a projected strengthening of contribute to reducing inflationary and current demand in the Euro Area and U.S (the two largest account pressures, and – together with normal destinations of South Asian exports) and robust harvests and sustained remittance flows – support growth in developing-country markets. Developing consumption in the region. Normal agricultural countries have become increasingly important trade production and a gradual decline in inflation partners for South Asian countries, accounting for expectations (provided structural reforms to release over a third of regional exports. production bottlenecks are accelerated) will contribute to stronger consumption growth. In the Regional investment activity is expected to firm in near term, however, planned fiscal consolidation in 2014, with a further increase projected for 2015 Pakistan (and to a lesser extent in India) are likely and 2016. Despite slowing of US quantitative to result in subdued government spending growth. easing, investment rates in India are projected to experience a cyclical recovery. After declining for Private capital flows to the South Asia region are several years, the investment-to-GDP ratio in projected to rise marginally by [3] percent to [$88] Pakistan is also expected to improve over the billion in 2014 - led mainly by a [10] percent medium term. The projected increase in investment increase in FDI flows (partly reflecting easing of rates, however, will depend critically on ensuring regulations on foreign investment in India). 66 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 2.15 South Asia forecast summary (annual percent change unless indicated otherwise) Est. Forecast 00-09a 2010 2011 2012 2013 2014 2015 2016 GDP at market prices b,e 5.9 9.9 7.2 4.2 4.6 5.7 6.3 6.7 GDP per capita (units in US$) 4.4 8.4 5.8 2.7 3.2 4.3 4.9 5.3 PPP GDP c 5.9 10.0 7.3 4.1 4.6 5.7 6.3 6.7 Private consumption 5.3 7.7 7.0 3.8 4.1 5.3 6.0 6.4 Public consumption 5.5 7.1 7.4 4.5 4.0 5.2 5.9 6.3 Fixed investment 8.9 16.7 6.2 1.1 3.5 6.2 7.7 7.9 Exports, GNFS d 11.5 14.9 16.1 8.2 6.5 7.7 7.8 8.1 Imports, GNFS d 9.4 16.2 16.9 9.9 3.4 6.2 7.7 7.9 Net exports, contribution to growth -0.2 -1.2 -1.3 -1.1 0.5 -0.1 -0.5 -0.5 Current account bal/GDP (%) -0.6 -2.6 -3.1 -4.1 -3.0 -2.7 -2.6 -2.5 GDP deflator (median, LCU) 6.5 9.6 8.5 7.6 7.5 6.5 6.3 6.0 Fiscal balance/GDP (%) -7.3 -8.0 -7.9 -7.5 -6.7 -6.8 -6.4 -6.0 Memo items: GDP at market prices e South Asia excluding India 4.5 4.9 5.2 4.9 4.8 5.1 5.2 5.3 India at factor cost 7.6 9.3 6.2 5.0 4.8 6.2 6.6 7.1 Pakistan at factor cost 4.9 2.6 3.7 4.4 3.6 3.4 4.1 4.5 Bangladesh 5.2 6.1 6.7 6.2 6.0 5.7 6.1 6.0 Source: World Bank. a. Growth rates over intervals are compound weighted averages; average growth contributions, ratios and deflators are calculated as simple averages of the annual weighted averages for the region. b. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. c. GDP measured at PPP exchange rates. d. Exports and imports of goods and non-factor services (GNFS). e. National income and product account data refer to fiscal years (FY) for the South Asian countries, while aggregates are presented in calendar year (CY) terms. The fiscal year runs from July 1 through June 30 in Bangladesh, Bhutan, and Pakistan, from July 16 through July 15 in Nepal, and April 1 through March 31 in India. Due to reporting practices, Bangladesh, Bhutan, Nepal, and Pakistan report FY2010/11 data in CY2011, while India reports FY2010/11 in CY2010. Portfolio equity flows are projected to rise 2015-16 and 2016-17 fiscal years. Growth will be marginally in 2014, while private debt flows led by recovery in global demand and increase in contract. Despite tapering of U.S quantitative domestic investment, subject to downside risks easing and eventual normalization of interest rates outlined below. Growth in Pakistan is expected to in high income countries, private capital flows to moderate to [3.4] percent in FY2013-14, reflecting South Asia are projected to rise to [$98] billion and necessary fiscal tightening, but rise to [4.5] percent [$110] billion respectively in 2015 and 2016— in the medium term. Political uncertainty and together with improvement in regional GDP disruptions in the run-up to elections in growth and firming global activity. Remittance Bangladesh will contribute to growth slowing to an inflows are also projected to pick up, and reach estimated [5.7] percent in the 2013-14 fiscal year. [$145] billion by 2016 (World Bank 2013a). Coupled with earlier safety problems in garment factories, election-related disruptions could slow a Country GDP growth forecasts (table 3) broadly recovery in Bangladesh’s GDP and exports. reflect the above regional trends, but are also influenced by country-specific factors. Growth Growth in Nepal is projected to pick up after rates in India are projected to rise to just over [6] delayed budget approval and weak agricultural percent in FY2014-15 (from an estimated [4.8] performance in the 2012-13 fiscal year resulted in a percent in the current fiscal year), and then deceleration in growth. Sri Lanka’s growth is gradually increase to [6.6] and [7.1] percent by the projected to accelerate to [7.4] percent in 2014, 67 GLOBAL ECONOMIC PROSPECTS | January 2014 mainly as a result of infrastructure spending, and expectations in India (RBI 2013a) could reduce consumption and services activity buoyed by space for monetary easing, and adversely affect remittance inflows. However, over the medium investment. Lack of progress in reducing supply- term, Sri Lanka’s growth is projected to slow side constraints (particularly in electricity, towards a more sustainable rate of around [6.5] infrastructure and agricultural sectors) could also percent. The gradual withdrawal of international pose significant downside risk to the outlook. forces will affect Afghanistan, as previously donor- financed expenditure will need to be financed from Disorderly adjustment of capital flows. The budget expenditure. Afghanistan’s GDP growth is tapering of U.S quantitative easing is expected to projected at [3.5] percent for 2014 (a slight proceed gradually, but a disorderly adjustment of improvement upon an estimated [3.1] percent in capital flows could result in currency depreciation 2013), before rising gradually to around [5] percent pressures, and put further stress on the private as the security situation stabilizes and mining sector. Weak GDP growth has already taken a toll projects come online. As the presence of on corporate and bank balance sheets in India, as international forces in Afghanistan winds down, gross non-performing and restructured loans rose reductions in Coalition Support Funds for Pakistan to [9.4] percent of loans in the 2012-13 fiscal year, are likely to be offset by continued disbursements with India’s central bank warning of stress on asset under the IMF’s extended fund facility and robust quality in the iron, steel, and infrastructure sectors inflows of remittances. (RBI 2013b). Further strains from a sharp withdrawal of foreign capital could increase risk of corporate debt distress, while one-off costs of bank Risks recapitalization can put pressure on fiscal positions. Fragile global growth. Prolonged weakness in the Euro Area, U.S fiscal policy brinkmanship, and Risks to the outlook for the South Asia region are geopolitical risks in the Middle East are additional tilted to the downside, on balance. Some potential sources of external risk. A relatively subdued upside risks include better than anticipated global recovery in the Euro Area, reflecting unresolved growth, and lower crude oil prices than projected. financial fragilities and structural problems, would Domestic risks are particularly relevant for a act as a drag on global trade and affect South Asian sustained revival of investment and for medium- exports. The risks from brinkmanship on U.S fiscal term growth prospects. policy have diminished, but a recurrence could affect global activity through negative confidence Domestic risks. The main domestic risk includes effects. Tensions in the Middle-East have subsided current and planned reforms in South Asian recently, but a resurgence and associated supply countries going off-track and the inability to shocks could result in a spike in international crude maintain fiscal discipline. A stalling or reversal of oil prices, and threaten the gains made in stabilizing policy reforms could see investment and growth current account positions in South Asia. significantly lower than that projected in the baseline. Limited fiscal space in South Asian South Asian policymakers must continue the countries compared to the immediate pre-2008 urgent task of rebuilding domestic and external crisis period has already made it difficult to policy buffers and reducing imbalances to deal with respond forcefully to intensification of crises. An potential intensification of external pressures, as inability to maintain fiscal discipline and to reduce well as accelerate productivity-enhancing reforms subsidies could adversely affect sovereign and improve their business environment to raise creditworthiness. Political uncertainties related to growth rates on a sustained basis. Given already national elections in Bangladesh in early 2014 and large fiscal and current account deficits, high in India in mid-2014 could hamper a sustained inflation, and weak reserve positions (or a revival of business confidence and investment. In combination of these) in some South Asian Afghanistan, the combination of political transition countries, policymakers need to maintain an and withdrawal of international forces in 2014 appropriately tight macroeconomic stance so as not could pose risks to the country’s fiscal sustainability to exacerbate external vulnerabilities and domestic and growth. Entrenchment of inflation inflationary pressures. 68 GLOBAL ECONOMIC PROSPECTS | January 2014 References IMF (2013). Various Article IV consultation reports for South Asian countries. Rajan, Raghuram (2013a). “Why India Slowed.” Project Syndicate, April 30 th. ________ (2013b). “Filtering Out the Real India.” Leatherbee Lecture at Harvard Business School, October 15 th. RBI (2013a) “Inflation Expectations Survey of Households (Round 33).” Reserve Bank of India. RBI (2013b) “Trend and Progress of Banking in India 2012 -13.” Reserve Bank of India. World Bank (2013a). Migration and Development Brief 21. World Bank (2013b). South Asia Economic Focus: “A Wake Up Call”, October. 69 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 2.16 South Asia country forecasts Est. Forecast 00-09a 2010 2011 2012 2013 2014 2015 2016 Calendar year basis b Afghanistan c GDP at market prices (% annual growth) 11.9 8.4 6.1 14.4 3.1 3.5 4.3 5.1 Current account bal/GDP (%) -0.3 2.8 3.1 3.9 2.5 1.8 0.5 -0.3 Bangladesh c GDP at market prices (% annual growth) 5.2 6.4 6.5 6.1 5.8 5.9 6.1 6.0 Current account bal/GDP (%) 0.6 2.0 0.2 1.5 1.7 1.6 1.3 1.0 Bhutan c GDP at market prices (% annual growth) 7.7 9.6 9.5 8.3 7.9 8.4 8.6 8.6 Current account bal/GDP (%) -0.1 -19.1 -25.5 -20.7 -20.9 -19.2 -18.4 -18.4 India GDP at factor cost (% annual growth) c 7.4 9.1 7.0 5.3 4.9 5.8 6.5 7.0 Current account bal/GDP (%) -0.5 -3.2 -3.4 -5.0 -3.5 -3.2 -3.1 -2.9 Maldives c GDP at market prices (% annual growth) 6.3 7.1 7.0 3.4 4.3 4.2 4.1 4.1 Current account bal/GDP (%) -1.1 -9.2 -21.4 -27.1 -28.0 -26.0 -25.0 -25.0 Nepal c GDP at market prices (% annual growth) 3.4 4.4 4.3 4.1 3.7 4.1 4.8 5.2 Current account bal/GDP (%) -0.9 -2.6 0.2 1.4 1.5 1.0 0.6 0.1 Pakistan GDP at factor cost (% annual growth) c 4.9 3.1 4.0 4.0 3.5 3.8 4.3 4.5 Current account bal/GDP (%) -1.4 -0.7 -1.1 -0.9 -1.7 -1.6 -1.4 -1.2 Sri Lanka c GDP at market prices (% annual growth) 4.4 8.0 8.2 6.4 7.0 7.4 6.5 6.3 Current account bal/GDP (%) -3.7 -2.3 -7.9 -6.4 -5.1 -4.4 -3.8 -3.2 Fiscal year basis b Bangladesh GDP at market prices (% annual growth) c 5.2 6.1 6.7 6.2 6.0 5.7 6.1 6.0 Bhutan GDP at market prices (% annual growth) c 7.7 9.3 10.0 9.0 7.6 8.1 8.6 8.6 India GDP at factor cost (% annual growth) c 7.6 9.3 6.2 5.0 4.8 6.2 6.6 7.1 Nepal GDP at market prices (% annual growth) c 3.4 4.8 3.9 4.6 3.6 3.8 4.4 5.2 Pakistan GDP at factor cost (% annual growth) c 4.9 2.6 3.7 4.4 3.6 3.4 4.1 4.5 Source: World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not significantly differ at any given moment in time. a. GDP growth rates over intervals are compound average; current account balance shares are simple averages over the period. b. National income and product account data refer to fiscal years (FY) for the South Asian countries with the exception of Sri Lanka, which reports in calendar year (CY). The fiscal year runs from July 1 through June 30 in Bangladesh, Bhutan, and Pakistan, from July 16 through July 15 in Nepal, and April 1 through March 31 in India. Due to reporting practices, Bangladesh, Bhutan, Nepal, and Pakistan report FY2010/11 data in CY2011, while India reports FY2010/11 in CY2010. GDP figures presented in calendar years (CY) terms for Bangladesh, Bhutan, Nepal, India and Pakistan are calculated taking the average growth over the two fiscal year periods to provide an approximation of CY activity. c. GDP measured in constant 2010 U.S. dollars. 70 GLOBAL ECONOMIC PROSPECTS | January 2014 Sub-Saharan Africa’s real GDP growth picked up to [4.8] percent in 2013 supported by robust domestic demand, notably investment growth. Strengthening external demand is expected to support growth over the forecast horizon, with regional GDP growth projected to rise to [5.4] percent in 2014-16. However, a protracted decline in commodity prices, tighter global financing conditions, and domestic risks including rising fiscal pressures, and adverse weather conditions could weaken growth prospects. Recent Developments Strong investment demand continues to support growth in the region. Gross fixed capital formation continued to increase rapidly in the region, expanding an estimated [7.8] percent in 2013, reaching [23.2] percent of GDP. Net foreign direct investment inflows to the region grew [16] Economic activity remained robust in much of percent to $43 billion in 2013 (table 2.16). Much of Sub-Saharan Africa, with GDP growth in the the investment has flowed to the natural resource region picking up in 2013. After an increase of 3.6 percent in 2012, GDP growth in the region Figure 2.23 Real GDP growth in Sub-Saharan Africa strengthened to 4.8 percent in 2013, supported by strengthened in 2013 robust domestic demand – notably investment growth. In South Africa, the region’s largest economy, structural bottlenecks and tense labor relations combined with weak external demand contributed to keep growth slow at [1.9] percent. Excluding South Africa, the average growth for the rest of the region was 6.1 percent (figure 2.23). About a third of countries in the region grew by 6 percent or more in 2013 (figure 2.24), boosting real per capita incomes. However, in many of these countries, poverty remains widespread and unemployment is high. Source: World Bank. 71 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 2.17 Net capital flows to Sub-Saharan Africa ($billions) 2008 2009 2010 2011 2012 2013e 2014f 2015f 2016f Capital Inflows 46.5 56.5 59.5 62.9 73.6 86.1 66.9 73.2 79.8 Private inflows, net 41.5 46.3 46.0 50.1 62.6 74.5 66.9 73.2 79.8 Equity Inflows, net 38.7 48.2 40.4 39.0 46.4 52.6 51.7 57.6 62.0 Net FDI inflows 44.3 37.7 32.2 40.0 37.0 43.0 41.0 44.2 47.8 Net portfolio equity inflows -5.6 10.5 8.2 -1.0 9.4 9.6 10.7 13.4 14.2 Private creditors. Net 2.8 -1.9 5.6 11.1 16.2 21.9 15.2 15.6 17.8 Bonds -1.6 2.0 1.4 6.0 3.6 7.3 4.1 4.7 5.2 Banks 2.6 0.8 0.7 3.4 4.0 6.4 5.1 6.1 6.8 Other private -0.1 0.8 0.5 0.1 0.6 1.0 0.8 0.7 1.3 Short-term debt flows 1.9 -5.5 3.0 1.6 8.0 7.2 5.2 4.1 4.5 Official inflows, net 5.0 10.2 13.5 12.8 11.0 11.6 World Bank 1.9 3.1 4.0 3.2 3.9 3.5 .. .. .. IMF 0.7 2.2 1.2 1.4 0.9 0.6 .. .. .. Other official 2.5 4.9 8.3 8.2 6.2 7.5 .. .. .. Source: The World Bank Note: e = estimate, f = forecast sector, supporting exploration and production in After more than doubling in 2012, fiscal deficits in oil, gas, and mining. However, FDI flows to the the region are estimated to have deteriorated a non-resource sector also increased. This is further [0.5] percentage points in 2013, with the particularly the case of the service sector where largest deterioration occurring among oil exporters rising consumer incomes are buoying activity in and low-income countries (figure 2.25). In telecommunications, finance, retail, and Cameroon and Chad, fiscal deficits as a share of transportation. Consumer-oriented FDI projects in GDP are estimated to have doubled in 2013; and in manufacturing and services have expanded rapidly Malawi, the overall fiscal deficit is expected to in recent years. As a result, their share in the total widen to about [19] percent of GDP in 2013 after value of FDI greenfield projects in the region has rising to 16.6 percent of GDP in 2012. Among risen from about [7] percent in 2008 to about [23] middle-income countries, Ghana’s fiscal deficit percent in 2012. jumped to 11 percent of GDP in 2012 and remained high in 2013; and in South Africa, the Fiscal deficits widened in 2013 and debt-to- fiscal deficit has not declined as expected, GDP ratios continued to rise across the region. remaining unchanged at [4.2] percent of GDP in Figure 2.24 Sub-Saharan Africa was the second fast- Figure 2.25 The overall fiscal deficit (% of GDP) deteri- est growing region in 2013 orated in oil-exporting countries % 4.0 South Sudan 17.1% Sierra Leone 3.0 Gambia 2.0 Dem. Rep.… Cote d'Ivoire 1.0 2011 2012 2013e Chad 0.0 China Ghana -1.0 Angola -2.0 Mozambique -3.0 Burkina Faso Zambia -4.0 Tanzania -5.0 India Sub-Saharan Africa Oil importers Oil exporters 0 5 10 15 20 Source: World Bank. Source: IMF Data. 72 GLOBAL ECONOMIC PROSPECTS | January 2014 2013. Ambitious public investment programs and Malawi, Burundi and Guinea. Central banks in increases in public wages coupled with weak many countries in the region have maintained an revenues contributed to the deterioration of fiscal accommodative monetary policy stance in an effort balances in many of these countries. The increase to stimulate domestic demand. Central Banks in of fiscal deficits despite the acceleration of Kenya and South Africa have kept monetary policy economic activity suggests rising structural unchanged; and, in the CFA franc zone, the two imbalances, which falling commodity prices and regional central banks cut their benchmark reduced access to concessional resources could discount rates. Remittance inflows to the region exacerbate. remained robust and are estimated at $33 billion in 2013, up from $31 billion in 2012. These inflows, Partly as a result, the debt to GDP ratio for the combined with lower food prices, supported region as a whole has risen from 29 percent in 2008 household incomes and demand. High frequency to an estimated [34] percent in 2013. These consumption data is not available for much of the averages, however, reflect significant differences region. However, the annualized 6 percent growth across countries. Debt-to-GDP ratios range from in total imports for the first half of 2013, despite a as low as [8] percent of GDP in Equatorial Guinea, 1.7 percent decline in capital equipment imports, to as high as [126] percent of GDP in Eritrea. suggests that private consumption, which accounts Some middle-income countries saw a sharp rise in for over 60 percent of regional GDP, remained their debt ratios, the latter exceeding [50] percent robust in 2013. of GDP in Ghana and [90] percent of GDP in Cape Verde in 2013. The rising debt ratios and The region’s export performance was adversely widening fiscal deficits suggest rising fiscal impacted by the decline in commodity prices. vulnerabilities that may hamper potential growth. The World Bank’s commodity price indices show For most countries in the region fiscal that in the first 9 months of 2013 the USD prices consolidation is needed not only to help create of agricultural goods and metals and minerals fiscal space for development spending but also to declined by [12.8] and [1.6] percent respectively start rebuilding fiscal buffers to minimize exposure while the price of oil remained stable, compared to external headwinds. with the same period a year ago. The fall in commodity prices dampened export receipts in the Supported by decelerating inflation and rising region, even though on a volume basis exports remittances household consumption demand has went up in many countries. Year-to-date, export been expanding robustly. Inflation eased in the receipts fell an estimated [2.4] percent in the region. region, declining to 7.1 per cent in September 2013 Meanwhile, supported by the coming on stream of from 9.8 percent the previous year (figure 2.26). new mines and wells, export volumes for oil, However, currency depreciations, wage increases minerals and metals rose in several countries. and infrastructure bottlenecks have kept inflation in double digits in many countries, including Tourism, an increasingly important driver of growth in several Sub-Saharan African Inflation eased in Sub-Saharan Africa in countries, continues to grow at a robust pace. Figure 2.26 2013 Data from the UN World Tourism Organization (UNWTO) shows that tourist arrivals to the region grew by 4 percent in the first half of 2013, a faster pace compared with the same period a year ago. Among the Sub-Saharan African destinations for which quarterly data is available, the strongest performers were Cape Verde (+18%), Seychelles (+13%), South Africa (4%), Swaziland (+2%), and Mauritius (+1%). International tourist arrivals in the region are expected to remain robust in the second half of 2013. UNWTO estimates tourist arrivals to the region will expand by up to [6] percent in 2013. Source: World Bank. 73 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 2.18 Sub-Saharan Africa forecast summary (annual percent change unless indicated otherwise) Est. Forecast 00-09a 2010 2011 2012 2013 2014 2015 2016 b GDP at market prices 4.4 5.1 4.6 3.6 4.8 5.4 5.4 5.4 (Sub -region totals-- countries with full NIA + BOP data) c GDP at market prices c 4.4 5.1 4.6 3.6 4.8 5.4 5.4 5.4 GDP per capita (units in US$) 2.1 2.6 2.0 1.0 2.2 2.8 2.9 2.9 PPP GDP c 4.6 5.2 4.7 2.1 5.6 6.0 5.7 5.5 Private consumption 5.1 8.9 4.9 4.3 5.6 5.3 5.1 5.1 Public consumption 5.4 5.8 7.9 5.5 5.4 5.7 3.8 5.0 Fixed investment 8.9 0.1 8.8 6.9 7.8 6.5 7.4 6.2 Exports, GNFS d 4.2 5.5 6.2 0.2 5.4 6.2 6.2 5.8 Imports, GNFS d 4.5 8.7 10.1 4.6 7.6 6.5 5.7 5.1 Net exports, contribution to growth -0.4 -1.0 -1.3 -1.6 -0.9 -0.3 0.0 0.1 Current account bal/GDP (%) 0.0 -1.3 0.2 -1.5 -3.0 -3.3 -3.3 -3.1 GDP deflator (median, LCU) 6.5 7.3 7.8 6.0 5.8 5.7 5.5 5.6 Fiscal balance/GDP (%) -0.4 -3.5 -1.2 -2.6 -2.9 -2.6 -2.5 -2.5 Memo items: GDP SSA excluding South Africa 5.1 6.1 5.1 4.1 6.1 6.5 6.3 6.2 Oil exporters e 5.6 6.0 4.3 2.9 6.3 6.8 6.4 6.2 CFA countries f 3.6 4.0 2.6 5.5 4.6 5.3 5.0 5.3 South Africa 3.2 3.1 3.5 2.5 1.9 2.7 3.4 3.5 Nigeria 5.6 8.0 7.4 6.6 6.7 6.7 6.8 6.8 Angola 10.7 3.4 3.9 5.2 5.1 8.0 7.3 7.0 Source : World Bank. a. Growth rates over intervals are compound weighted averages; average growth contributions, ratios and deflators are calculated as simple averages of the annual weighted averages for the region. b. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. c. Sub-region aggregate excludes Liberia, Chad, Somalia and São Tomé and Principe. Data limitations prevent the forecasting of GDP components or Balance of Payments details for these countries. d. Exports and imports of goods and non-factor services (GNFS). e. Oil Exporters: Angola, Cote d Ivoire, Cameroon, Congo, Rep., Gabon, Nigeria, Sudan, Chad, Congo, Dem. Rep. f. CFA Countries: Benin, Burkina Faso, Central African Republic, Cote d Ivoire, Cameroon, Congo, Rep., Gabon, Equatorial Guinea, Mali, Niger, Senegal, Chad, Togo. Outlook reflects anticipated higher growth notably in high- income countries. In this environment, foreign direct investment flows are projected to remain an important driver of growth for many countries in the region. Although commodity prices have Medium-term growth prospects for Sub- eased, they remain high and investment Saharan Africa are strong. Regional GDP opportunities in the region are profitable. As a growth is projected to strengthen to 5.4 percent result, FDI flows, which are less sensitive to global during 2014-16 from 4.8 percent in 2013 (table interest rates hikes than short-term portfolio flows, 2.17). Excluding South Africa, the rest of the are projected to rise to US$[44.2] billion in 2015 region is projected to grow at 6.3 percent on and reach U$[47.8] billion in 2016. average in 2014-16. Private consumption in the region is expected to remain strong in 2014-16. Reduced imported Domestic demand, associated with investment inflation, helped by a benign global inflationary in infrastructure and household consumption, environment, stable exchange rates, and adequate will remain the main driver of growth for most local harvests are expected to help contain countries in the region. The expected inflationary pressures, which should allow for improvement in growth relative to 2013 also further interest rate cuts. Combined with steadily 74 GLOBAL ECONOMIC PROSPECTS | January 2014 rising remittances, these effects should stimulate countries where production is stagnating. In metal- demand and permit a continued rapid expansion of exporting countries, increased output will mitigate domestic demand. the weakness of metal prices. On the import side, the demand for capital goods is projected to remain Government spending is projected to continue strong, but as investments mature and construction rising at a moderate pace, as governments expand projects approach completion in many countries, spending on pro-poor projects in health, education imports are expected to grow at a slower pace. and social services in an effort to reach the Reflecting these trends and the weakening of millennium development goals by 2015. After commodity prices, the current account deficit in rising by a robust 5.4 percent in 2013, public the region is projected to increase from an consumption is projected to increase by [4.8] estimated [3.0] percent of GDP in 2013 to an percent on average in 2014-16. Reflecting this average of [3.3] percent of GDP in 2014 and 2015, slowdown, fiscal deficits are expected to decline; before narrowing to [3.1] percent of GDP in 2016. however, fiscal space will remain depleted for most For most countries in the region net exports will be countries in the region. less of a drag on GDP growth during 2014-16 Growth in the region is expected to be driven by Risks resource as well as non-resource rich countries. Oil exporters, led by Angola, are projected to grow at 6.4 percent on average during 2014-16. Growth is also projected to remain robust in many mineral- exporting countries including Burkina Faso, Ghana, and Mozambique, driven by FDI flows in The main risks that threaten the region’s economic the natural resource sector and increased outlook include a protracted decline in commodity production from projects coming on stream. In prices brought on by increased output and weaker several non-resource rich countries, notably demand, second-round effects from the tightening Ethiopia and Rwanda, real GDP growth is of monetary conditions as the Federal Reserve projected to exceed the regional average supported begins to taper its asset purchases; and domestic by robust growth in agriculture, services, and risks from political unrest, security problems and investments in infrastructure. Elsewhere, growth is weather shocks. forecast to remain moderate. While real GDP growth in many countries in the region is expected to remain stronger than in many other developing Long-term structural decline in commodity countries, poor physical infrastructure limits the prices: Simulation results of a one-standard region’s growth potential. Unreliable electricity deviation decline in the price of oil from the supply and poor road conditions will continue to baseline in 2014 show that growth in the region impose high costs on business, reduce efficiency, will decline by about 1.3 percentage points and and impede intra-regional trade. current account balances will deteriorate by 4.5 percentage points compared to baseline Net exports are projected to make a marginal projections. Oil exporters, especially the less contribution to GDP growth in the region over diversified ones such as Angola and Gabon, would the forecast horizon. Following a sharp be hit the hardest, with a GDP decline relative to contraction in 2012, exports rebounded with an the baseline of 3.8 percentage points and the estimated [5.4] percent annual increase in 2013; but current account deficit worsening by 10.8 massive imports of capital and construction goods percentage points (figure 2.27), which underscores saw net exports subtract an estimated 1.0 the need for structural reforms to foster economic percentage point off GDP growth. Export capacity diversification. In contrast, the region’s oil is expected to strengthen during 2014-16, importers would benefit from the decline in oil providing a boost to economic growth. The prices, with GDP rising by some 0.61 percentage contributions of net exports will be somewhat points and current account balances improving by constrained, however, by lower commodity prices, 0.77 percentage points (figure 2.28). which will be exacerbated by low output in some countries, notably the oil-exporting Central African 75 GLOBAL ECONOMIC PROSPECTS | January 2014 Figure 2.27 A one-standard deviation shock to oil Figure 2.28 Less diversified oil exporters would be hit prices will affect Sub-Saharan Africa the hardest most %ch, GDP growth 2.0 % Ethiopia Malawi 0.0 Kenya Sierra Leone Rwanda -2.0 Togo Comoros -4.0 Mauritius Namibia -6.0 Cape Verde Botswana -8.0 Cote d'Ivoire Real GDP Growth Current Account (% GDP) Congo, Dem. Rep. -10.0 Nigeria Gabon -12.0 Angola Sub-Sahran Europe and Middle East All Oil Latin America EAP Oil Africa Oil Central Asia Oil and North exporters Oil exporters exporters -10.0 -8.0 -6.0 -4.0 -2.0 0.0 2.0 4.0 exporters exporters Africa Oil exporters Source: World Bank. Source: World Bank. Tighter monetary conditions: The tapering of problem that might adversely affect economic asset purchases by the Federal Reserve is expected activity in the sub-region. to lead to a rise in base interest rates and spreads. A 100-basis point increase in high-income country Risks from food price spikes at the global level base rates is likely to be associated with a 110 to appear contained for now. Yet, while short-term 157 basis point increase in developing-country forecasts of weather conditions are broadly yields (World Bank), implying an increase in the favorable, most countries in the region remain cost of raising capital, which could lead to lower highly vulnerable to changing weather conditions investment and growth. South Africa, which has given the importance of rain-fed subsistence strong links with global financial markets, is agriculture for their economies and the livelihoods particularly vulnerable to sudden stops of capital of their populations. Inadequate rainfalls could inflows given its reliance on portfolio inflows to affect growth prospects in many of these countries. finance its current account deficit; but frontier The resulting lower local harvests might raise the countries such as Kenya and Nigeria, which have risk of food insecurity and push food prices higher, seen significant portfolio inflows in local securities dampening household consumption which has markets, will also be affected by the reversal of been an important driver of growth in the region capital flows; and countries that are planning to tap in recent years. the international bond markets are likely to face higher coupon rates. Domestic risks associated with social and political unrest as well as emerging security problems remain a major threat to the economic prospects of a number of countries in the region. For example, political instability in the Central African Republic, which has added to the impoverishment of its population, could deteriorate further with spillovers to neighboring countries. Piracy attacks in the Gulf of Guinea, which increased sharply in 2012 both in their number and intensity, could escalate and impose greater security spending on government budgets, push up shipments costs higher and disrupt trade in the sub-region. Ongoing conflicts in Northern Nigeria are also emerging as an important security 76 GLOBAL ECONOMIC PROSPECTS | January 2014 Table 2.19 Sub-Saharan Africa Country forecasts Est. Forecast 00-09a 2010 2011 2012 2013 2014 2015 2016 Angola GDP at market prices (% annual growth) b 10.7 3.4 3.9 5.2 5.1 8.0 7.3 7.0 Current account bal/GDP (%) 4.9 9.1 12.6 10.4 10.6 9.2 9.5 10.1 Benin GDP at market prices (% annual growth) b 3.6 2.6 3.5 5.4 4.2 4.1 4.2 4.0 Current account bal/GDP (%) -8.3 -9.4 -13.2 -11.6 -9.8 -9.8 -9.2 -8.9 Botswana GDP at market prices (% annual growth) b 3.5 8.1 6.1 4.3 4.6 5.0 5.2 5.2 Current account bal/GDP (%) 7.4 -7.4 -1.4 -4.5 -0.2 -1.2 -1.9 -2.4 Burkina Faso GDP at market prices (% annual growth) b 5.2 7.9 4.2 10.0 7.0 7.0 7.0 7.0 Current account bal/GDP (%) -13.2 -5.8 -4.8 -6.8 -4.9 -4.3 -3.4 -1.2 Burundi GDP at market prices (% annual growth) b 2.9 3.8 4.2 4.0 4.3 4.5 4.1 3.5 Current account bal/GDP (%) -17.5 -15.9 -16.3 -17.2 -17.9 -16.3 -16.0 -15.6 Cape Verde GDP at market prices (% annual growth) b 5.6 1.5 4.0 2.5 2.6 2.9 3.3 3.6 Current account bal/GDP (%) -11.3 -14.5 -17.4 -12.4 -9.9 -8.1 -8.8 -8.9 Cameroon GDP at market prices (% annual growth) b 3.0 3.3 4.1 4.7 4.8 5.0 5.1 5.1 Current account bal/GDP (%) -2.4 -3.8 -5.8 -6.4 -5.7 -5.9 -6.1 -6.4 Central African Republic GDP at market prices (% annual growth) b 0.7 3.3 3.1 4.1 -18.0 -1.8 1.1 2.5 Current account bal/GDP (%) -8.6 -13.3 2.5 2.5 -1.1 -0.1 1.7 1.6 Comoros GDP at market prices (% annual growth) b 1.8 2.1 2.2 3.0 3.3 3.5 3.5 3.2 Current account bal/GDP (%) -11.9 -27.4 -32.1 -16.9 -14.1 -13.5 -13.1 -11.9 Congo, Dem. Rep. GDP at market prices (% annual growth) b 4.2 7.2 6.9 7.2 7.5 7.5 7.4 6.7 Current account bal/GDP (%) 0.6 -16.6 -8.2 -12.3 -8.2 -5.3 -4.8 -4.6 Congo, Rep. GDP at market prices (% annual growth) b 3.8 8.8 3.4 3.8 5.6 5.4 5.5 5.5 Current account bal/GDP (%) -2.0 -28.0 31.2 1.8 1.8 0.4 0.4 -0.3 Cote d Ivoire GDP at market prices (% annual growth) b 0.8 2.4 -4.7 9.5 8.7 8.2 8.1 7.6 Current account bal/GDP (%) 1.9 2.1 1.4 -2.2 -3.5 -4.5 -4.3 -4.7 Equatorial Guinea GDP at market prices (% annual growth) b 15.0 -1.7 4.9 2.5 -1.5 -0.5 -1.6 2.1 Current account bal/GDP (%) 10.9 -24.7 -16.4 -14.9 -13.9 -12.9 -9.5 -7.4 Eritrea GDP at market prices (% annual growth) b 0.7 2.2 8.7 7.0 6.0 3.5 3.0 3.0 Current account bal/GDP (%) -20.9 -5.5 3.2 22.5 23.5 27.6 28.8 29.3 Ethiopia GDP at market prices (% annual growth) b 7.5 8.6 7.9 7.7 7.0 7.1 7.0 7.1 Current account bal/GDP (%) -5.0 -1.2 -2.0 -6.2 -6.4 -6.4 -6.5 -6.5 77 GLOBAL ECONOMIC PROSPECTS | January 2014 Est. Forecast 00-09a 2010 2011 2012 2013 2014 2015 2016 Gabon GDP at market prices (% annual growth) b 1.3 6.7 7.0 6.1 4.2 4.2 3.9 3.9 Current account bal/GDP (%) 14.8 5.8 11.4 14.4 9.6 9.1 7.3 6.9 Gambia, The GDP at market prices (% annual growth) b 3.2 6.5 -4.3 5.3 6.5 7.5 6.4 5.5 Current account bal/GDP (%) -3.6 2.2 5.3 -7.3 -12.7 -13.1 -13.5 -10.3 Ghana GDP at market prices (% annual growth) b 5.0 8.0 15.0 7.9 7.4 7.4 7.3 6.7 Current account bal/GDP (%) -6.5 -9.6 -8.9 -12.5 -11.7 -11.7 -10.2 -9.9 Guinea GDP at market prices (% annual growth) b 2.4 1.9 4.3 3.9 4.0 4.7 5.0 6.0 Current account bal/GDP (%) -7.2 -7.0 -23.8 -35.4 -25.5 -46.3 -43.5 -38.7 Guinea-Bissau GDP at market prices (% annual growth) b 2.3 1.7 5.7 -1.5 3.0 2.7 2.7 2.9 Current account bal/GDP (%) -9.0 -11.9 -6.1 -7.0 -5.8 -5.0 -4.5 -3.4 Kenya GDP at market prices (% annual growth) b 3.6 5.8 4.4 4.6 5.0 5.1 5.2 5.3 Current account bal/GDP (%) -2.5 -7.7 -10.3 -9.8 -9.5 -8.6 -7.5 -7.5 Lesotho GDP at market prices (% annual growth) b 3.3 7.9 3.7 4.0 4.6 5.1 4.5 4.4 Current account bal/GDP (%) 2.9 -19.9 -20.5 -21.4 -14.5 -13.1 -12.0 -11.5 Madagascar GDP at market prices (% annual growth) b 3.0 0.5 1.9 3.1 4.1 4.8 5.4 5.4 Current account bal/GDP (%) -12.4 -10.2 -10.4 -11.8 -13.6 -18.1 -20.3 -16.3 Malawi GDP at market prices (% annual growth) b 3.8 6.5 4.3 1.9 4.4 4.8 5.5 5.5 Current account bal/GDP (%) -10.7 -16.8 -13.6 -15.0 -18.4 -15.9 -14.7 -15.6 Mali GDP at market prices (% annual growth) b 4.2 5.8 2.7 -1.2 4.0 5.2 4.5 4.6 Current account bal/GDP (%) -8.3 -14.1 -7.0 -4.4 -9.6 -10.1 -10.0 -9.7 Mauritania GDP at market prices (% annual growth) b 4.5 5.1 4.0 7.6 5.7 4.6 4.0 3.3 Current account bal/GDP (%) -10.8 -6.0 -1.9 -25.3 -25.5 -21.5 -17.0 -16.9 Mauritius GDP at market prices (% annual growth) b 3.4 7.7 3.8 3.2 3.7 4.1 4.3 4.2 Current account bal/GDP (%) -2.7 -10.3 -13.4 -11.2 -9.6 -8.4 -7.7 -10.5 Mozambique GDP at market prices (% annual growth) b 7.1 7.1 7.3 7.4 7.0 8.5 8.5 8.5 Current account bal/GDP (%) -14.0 -16.4 -23.8 -35.4 -40.3 -40.9 -39.2 -37.9 Namibia GDP at market prices (% annual growth) b 3.9 6.0 4.9 5.0 4.2 4.3 4.4 4.4 Current account bal/GDP (%) 3.5 -2.1 -4.7 -3.4 -2.0 -2.3 -3.8 -3.8 Niger GDP at market prices (% annual growth) b 3.6 -8.0 2.3 11.2 5.6 6.2 6.0 5.8 Current account bal/GDP (%) -9.7 -21.3 -24.6 -19.6 -17.9 -17.7 -17.6 -16.8 Nigeria GDP at market prices (% annual growth) b 5.6 8.0 7.4 6.6 6.7 6.7 6.8 6.8 Current account bal/GDP (%) 14.4 6.3 12.2 13.7 7.2 5.2 3.5 1.7 Rwanda GDP at market prices (% annual growth) b 7.2 7.2 8.2 8.0 7.0 7.5 7.2 7.0 Current account bal/GDP (%) -6.0 -7.5 -7.4 -11.2 -8.4 -8.2 -8.5 -8.8 Senegal GDP at market prices (% annual growth) b 3.6 4.1 2.6 3.7 4.0 4.5 4.6 4.6 78 GLOBAL ECONOMIC PROSPECTS | January 2014 Est. Forecast 00-09a 2010 2011 2012 2013 2014 2015 2016 Current account bal/GDP (%) -8.0 -4.7 -7.4 -9.2 -8.3 -7.2 -6.7 -5.9 Seychelles b GDP at market prices (% annual growth) 1.5 7.1 5.0 2.9 3.5 3.9 3.5 3.0 Current account bal/GDP (%) -13.9 -19.5 -21.3 -23.8 -24.8 -21.7 -17.1 -22.2 Sierra Leone b GDP at market prices (% annual growth) 6.0 5.4 6.0 15.2 17.0 14.1 12.1 12.1 Current account bal/GDP (%) -11.1 -25.0 -40.6 -37.1 -19.3 -10.6 -7.8 -7.4 South Africa b GDP at market prices (% annual growth) 3.2 3.1 3.5 2.5 1.9 2.7 3.4 3.5 Current account bal/GDP (%) -3.0 -2.8 -3.4 -6.3 -6.9 -6.5 -6.4 -6.3 South Sudan b GDP at market prices (% annual growth) 4.4 3.9 4.7 -42.0 33.9 23.9 8.7 4.0 Current account bal/GDP (%) 10.7 30.1 17.2 -25.4 -14.3 8.8 12.9 15.4 Sudan b GDP at market prices (% annual growth) 5.6 3.5 -3.3 -10.1 2.9 2.9 3.0 3.2 Current account bal/GDP (%) -5.9 -0.6 -0.4 -0.5 -5.3 -4.5 -4.0 -2.1 Tanzania b GDP at market prices (% annual growth) 6.2 7.0 6.4 6.9 7.3 7.4 7.6 7.8 Current account bal/GDP (%) -9.3 -12.0 -19.3 -14.8 -17.2 -16.6 -16.0 -15.5 Togo b GDP at market prices (% annual growth) 1.7 4.0 4.8 5.6 5.0 4.5 4.5 4.4 Current account bal/GDP (%) -9.2 -6.3 -4.1 -6.3 -9.2 -8.4 -8.7 -7.9 Uganda GDP at market prices (% annual growth) b 6.9 6.2 5.0 4.6 6.2 6.6 7.0 7.1 Current account bal/GDP (%) -4.0 -7.9 -9.3 -5.5 -5.1 -4.6 -3.5 -3.2 Zambia GDP at market prices (% annual growth) b 4.8 7.6 6.8 7.3 6.0 6.5 6.0 5.8 Current account bal/GDP (%) -10.8 6.0 2.9 2.7 2.8 2.4 2.2 2.2 Zimbabwe GDP at market prices (% annual growth) b -5.9 9.6 9.4 4.4 2.2 3.3 3.4 3.5 Current account bal/GDP (%) -12.2 -10.3 -23.0 -19.7 -21.9 -17.6 -14.7 -18.6 Source : World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not significantly differ at any given moment in time. Liberia, Somalia, Sao Tome and Principe are not forecast owing to data limitations. a. GDP growth rates over intervals are compound average; current account balance shares are simple averages over the period. b. GDP measured in constant 2010 U.S. dollars. 79 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Introduction the increase in overall capital flows to developing countries between 2009 and 2013 could be accounted for by global factors with the remainder explained by country-specific developments. Assuming a smooth recovery consistent with the The past two decades have seen dramatic changes baseline projection of Chapter 1, the model is then in international capital flows to developing used to evaluate the likely impact on capital flows countries, characterized by a substantial increase in developing countries of a normalization of high- both in absolute terms and as a share of developing income country growth and policy conditions. country GDP — but also by surges and stops in With the aid of a second multivariate vector response to changes in global financial and autoregression model focusing on the short-term economic conditions. adjustment dynamics between capital flows and their main external drivers, two disorderly Thus during the boom years 2003-07 capital flows adjustment scenarios are also presented. surged peaking at more than 12 percent of developing country GDP in 2007Q3, before A second shorter section concentrates on crisis crashing to negative territory in 2008 with the risks and domestic vulnerabilities in the event of a global financial crisis. They partly recovered in the disorderly adjustment, focusing on an evaluation of post-crisis period — averaging [6] percent between banking crisis probabilities at the individual country 2010 and 2013.FN1 level. It proposes a classification of country risks in relation to domestic credit, external debt, exchange Capital flows eased in the second half of 2013 due rate and current account imbalances. to market expectations that the strengthening of growth in high-income countries would prompt an A final section discusses policy options in the face end to the extraordinary macroeconomic policies of capital retrenchment risks, including capital flow that brought global interest rates to historically low management instruments, macro, prudential and levels, pushing capital toward faster growing and structural reforms. higher-yielding developing countries. Capital flows: past and As the recovery in high-income countries continues (see Chapter 1), the global conditions of recent years will also evolve. Fiscal policies are being tightened, growth differentials between high- income and developing countries are narrowing, expected trends and monetary policy interventions for countering the recession will be gradually withdrawn. This normalization of external conditions will have Since the 1990s, when they represented an average important ramifications for developing countries, of 4 percent of developing-country GDP, gross including for capital inflows. capital inflowsFN2 to developing countries increased markedly, averaging 9 percent of GDP between This chapter examines in greater detail the recent 2005Q1 through 2008Q3. The financial crisis saw pattern of capital flows to developing countries them drop precipitously before recovering again, to with a view to better understanding the possible 6 percent of GDP between 2010Q1 and 2013Q2 impacts that a normalization of activity and policy (see figure 1). in high-income countries may have. It is organized into three sections. For the most part, strong capital inflows to The first section describes the evolution of capital developing countries during the pre-crisis period flows in recent years and presents econometric contributed to higher investment rates and evidence outlining the relative importance of facilitated capital deepening and technological changing global and country-specific conditions in transfer, all of which had positive effects on that evolution. It finds that about 60 percent of growth potential and level of development (World 83 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Figure 1. Gross capital inflows to developing Figure 2. Gross capital inflows to developing coun- countries tries by region and type 20 Percent of GDP 12 Percent of GDP 18 Credit inflows Credit Inflows 16 Portfolio inflows 10 FDI inflows Portfolio inflows 14 FDI inflows Total inflows 8 12 Total gross inflows 10 6 8 4 6 4 2 2 0 0 06Q1-08Q2 08Q3-09Q3 09Q4-11Q2 11Q3-13Q2 06Q1-08Q2 08Q3-09Q3 09Q4-11Q2 11Q3-13Q2 06Q1-08Q2 08Q3-09Q3 09Q4-11Q2 11Q3-13Q2 06Q1-08Q2 08Q3-09Q3 09Q4-11Q2 11Q3-13Q2 06Q1-08Q2 08Q3-09Q3 09Q4-11Q2 11Q3-13Q2 06Q1-08Q2 08Q3-09Q3 09Q4-11Q2 11Q3-13Q2 06Q1-08Q2 08Q3-09Q3 09Q4-11Q2 11Q3-13Q2 -2 -2 -4 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Dev. East Asia & East Europe Latin America Middle East South Asia Sub-Sah. Countries Pacific & Cent. Asia & Carib. & N. Africa Africa Source: World Bank, based on IMF Balance of payments statistics. Source: World Bank, based on IMF Balance of payments statistics. Bank, 2010a). In most cases, the rise in capital recovery in financial flows to developing countries. inflows during the pre-crisis years did not cause As demonstrated throughout this Chapter, excessively large current account imbalances or exceptionally loose monetary policy in high income domestic vulnerabilities in developing countries. countries also contributed significantly to the vigorous resurgence of financial inflows to Developments in central Europe were a notable developing countries in the post crisis period exception. Massive cross-border lending flows (peaking at 8 ½ percent of their combined GDP by (bank flows alone represented 6 percent of regional mid-2011), increasing the probability of a reversal GDP in the 2003-07 period, see figure 2), fueled of inflows once conditions normalize. credit and asset price bubbles in the pre-crisis period, contributing to a boom in private This post-crisis upsurge was initially driven by a consumption, mounting current account deficits recovery in cross-border lending and later by a and indebtedness problems similar to those persistent rebalancing of portfolio investments, observed in high-income countries during the same both largely influenced by global interest rates and period. As a result, unlike other regions developing risk aversion. As a result, the weight of developing Europe has gone through an extended period of country bonds in global fixed income portfolios restructuring and deleveraging similar to that of reached before the summer 2013 levels last seen in high-income countries. the late-1990s (see Chapter 1). While the remarkable increase in gross financial Portfolio investments (bond and equity flows) have flows to developing countries implied investment and growth opportunities in “normal” times, it also Figure 3. Institutional investor rating for developing amplified the transmission of global financial countries (relative to US and EU) shocks, as starkly illustrated during the 2008-09 financial crisis, when gross flows to developing 70 Africa (Sub-Saharan) Asia/Pacific (South & East) countries fell abruptly to about [-1] percent 65 Eastern Europe/Central Asia Latin America/Caribbean (negative inflows are possible because they are 60 North Africa/Middle East 55 counted net of repayment of past liabilities and 50 thus can be negative). 45 40 Most developing regions exited from the crisis 35 relatively quickly, in part because of counter-cyclical 30 stimulus they deployed. Their rapid growth, 25 improving relative fundamentals (reflected in the 20 credit ratings see figure 3), and a gradual thawing of 2000 2001 2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010 2011 2011 2012 2012 2013 global financial conditions, contributed to a rapid Source: Institutional Investor, World Bank. 84 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY been robust in most regions since 2009 (see figure capital flows to a recovery in high-income growth, 2). In contrast, bank lending has moderated – and the tightening of macroeconomic policy likely particularly in emerging Europe – due to continued to accompany it, followed a two pronged strategy. deleveraging and balance sheet adjustments by banks in high income countries. In a first step, a panel regression was used to assess the relative importance of global and domestic Foreign direct investment (FDI) has been most factors in determining the equilibrium level of stable overall, although at the regional level the capital inflows. While useful to understand the long picture is more mixed. In Sub-Saharan Africa, FDI -term reaction (after all adjustment has occurred) to inflows have increased steadily in the post-crisis a change in global (or domestic) conditions, the period, reaching 6 ½ percent of the region’s GDP panel regression cannot map out the short-term most recently. This contrasts with South Asia and interaction and interplay between global factors the Middle-East & North Africa where FDI flows (interest rates, uncertainty, high-income country have been declining (to 1.3 and 0.8 percent of regional GDP) and capital flows. To capture the short-term GDP) respectively during the period 2011-13. dynamics of capital flows in relation to changes in interest rates, market volatility and GDP growth, a Over the last two years, capital inflows have multivariate vector autoregression model was moderated and stabilized at around 4.5 percent of estimated in a second step. developing-country GDP. The slowdown was also associated with stagnant international reserves, rising Accounting for global “push” and domestic capital outflows and a deterioration of current account “pull” factors balances in a number of countries and regions. As discussed in Chapter 1, since May 2013, The economic literature suggests that capital flows expectations of a gradual unwinding of quantitative to individual developing countries are determined easing by the US Federal Reserve led to a by both global external conditions (“push” factors) significant portfolio adjustment on the part of and domestic factors (“pull” factors).FN2 global investors away from emerging developing countries. Issuances of developing-country bond, The model outlined in Box 1 was designed to equity and syndicated bank loans dropped initially control for the impacts on capital flows of changes by around 30 percent — imposing significant in observable global conditions, including real adjustment pressures on the currencies, asset prices (growth and growth expectations) and financial and foreign exchange reserves of several middle- (interest rates and interest rate differentials) income countries. incentives, access to liquidity (global money supply), and global risk aversion. It also accounts Modeling capital flows to developing for domestic pull factors (credit ratings, local interest rates, GDP levels) that can influence the countries volumes of gross capital flows to developing economies. The remainder of this section presents the results of an econometric evaluation of the main Importantly, the model does not attempt to tease determinants of capital inflows to developing out the full influence that extraordinary monetary countries, including both the role of domestic and policy measures undertaken in high-income global conditions on capital flows to developing countries had on capital flows. To do this would countries. In addition it explores the likely impact require determine the extent to which quantitative on capital flows to developing countries to the easing itself influenced the various drivers of recovery in growth and normalization of policies in capital flows (interest rates, liquidity, risk, and high-income countries — examining both a growth) — an question that is under active scenario where financial markets react in an orderly discussion in the literature, but over which there is fashion as well as two scenarios where the little consensus as yet.FN3 Instead, the model simply adjustment is less orderly. uses a series of dummy variable to test whether extraordinary monetary measures may had an effect Analysis of the sensitivity of developing country on capital flows that went over and above those 85 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Figure 4. Impact of global and country-specific vari- Figure 5. Estimated contribution to increase in capi- ables on capital flows tal flows in the post-crisis period (impact of 1 std. dev. change in explanatory variable on std. dev. of log capital flows) Increase in gross capital flows to developing countries between 2009H1 and 2013H1 accounted for by changes in: Institutional investor rating (Percent of total change) Developing GDP growth 25.7 Growth differential 20.1 QE* 12.8 VIX Global factors Yield curve Developing-country variables 3.8 US short-term rate -0.15 -0.1 -0.05 0 0.05 0.1 0.15 US short-term rates QE-specific effect US yield curve Risk (VIX) * Non-standardized coefficient Source: World Bank. Source: World Bank. coming through the modeled channels. accounting for about 60 percent of the increase in The results obtained from the model are broadly capital flows between 2009 and 2013, with the consistent with the existing literature on observable remaining 40 percent explained by domestic factors factors associated with gross financial inflows such as countries’ institutional investor rating, and (Alfaro, Kalemli-Ozcan & Volosovych 2008; developing country growth and growth Bruno and Shin 2013; Gelos, Sahay and Sandleris differentials. 2011; Forbes and Warnock 2012; Fratzscher, 2011). Capital flows to individual developing countries About thirteen percent of the total variation in correlate with country ratings, and a number of capital flows during this period is picked up by the global financial conditions—in particular the short- quantitative easing dummy, suggesting that capital term interest rate, the yield curve, and the VIX flows were larger in the post-crisis period than index—also play an important role. The evidence would have been expected given the levels of other for the effect of several other country-specific and variables. These effects appear concentrated on global factors—such as growth differentials relative earlier rounds of quantitative easing. When the to the US, and aggregate developing-world quantitative easing indicator is split into separate growth—is somewhat weaker, and a number of episodes corresponding to QE1, 2 and 3, the factors, such as real interest rate differentials, turns impact on inflows diminishes between successive out to be statistically indistinguishable from zero. episodes. Indeed, when broken out, the QE3 variable is statistically insignificant — implying that The various effects are summarized in Figure 4 by that time all of the impact of quantitative easing which shows the response of gross inflows to a one on capital flows has been accounted for by its standard deviation change in each of the affect (if any) on the traditional drivers of capital explanatory variables. The response of risk taking/ flows. uncertainty appears to be relatively small over the full sample (figure 4). However, because of its very Implications for capital flows as global large changes during the crisis and post-crisis periods, its variation between the first half of 2009 conditions normalize and the first half of 2013FN4 is estimated to have had the largest impact on capital flows during this The preceding analysis confirms previous research period (figure 5). suggesting that global economic conditions play a major role in determining capital flows to Both domestic and global factors appear to be developing countries. important determinants of capital flows to developing countries, with global factors (US As conditions in high-income countries improve interest rates, risk and the additional unmodeled (as output gaps are closed and growth realigns with influence of quantitative easing) together underlying potential output) monetary policy can 86 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Box 1. Modeling the influence of high-income policy (including quantitative easing) and domestic factors on capital flows to developing countries The results reported in the main text of Chapter 3 are based on a panel econometric analysis designed to illuminate how global and domestic economic conditions influence the volume of capital flows to individual developing countries. The study uses an unbalanced panel of available quarterly gross financial inflows data for 60 developing countries for the 2000Q1 - 2013Q2 period, thus spanning 8 years of non-crisis year capital flows, and 5 years of post-crisis flows. These gross finan- cial inflows comprise bond and equity portfolio flows, foreign direct investment, and cross -border bank lending, and were derived from the IMF Balance of Payments statistics and the Bank for International Settlements’ Locational Banking Statis- tics, supplemented by national sources drawn from the Datastream and Haver Analytics databases. The model allows for the influence on individual -country capital inflows of global economic variables (“push factors”) that have been identified in the capital flows literature as affecting the propensity to invest as well as country -specific “pull fac- tors” that capture time-varying characteristics of individual countries that may affect the allocation of funds across countries. The observable pull and push factors include measures used to capture:  Global financial conditions, such as the US Federal Funds rate, the US money supply (M2), and the yield curve (the difference between the US long-term interest rate and short-term policy rates). The role of global uncertainty and risk aversion was proxied for by the VIX index.  Real-side global conditions, such as high -income and developing world GDP growth, and the global composite pur- chasing managers index (PMI), which proxies for growth expectations.  Domestic pull factors, including country GDP levels and institutional investor ratings, a country -specific (lagged) GDP growth differential (relative to the United States), and the interest rate differential between the developing country vis -à- vis the United States.FN5 The extraordinary measures taken by central banks, in the United States, Europe and Japan are likely to have influenced several of the global variables: short-term interest rates would have been affected by conventional monetary policy; the structure of the yield curve would have been affected due to the Federal Reserve’s purchase of mortgage -backed securities and long-term debt on secondary markets; and market uncertainty along with U.S. and global growth may have benefited from stimulatory monetary and fiscal policies. To the extent that such measures may have influenced these drivers, their influence on capital flows will have been captured in the regression. To account for the possibility that extraordinary monetary measures have operated through other unobservable channels (or through conventional channels over and above these observable measures), a series of dummy variables covering the different episodes of quantitative easing were also included. Several alternative specifications were experimented with, including: a single QE dummy variable for all episodes of quantitative easing; separate indicator variables for each of the three episodes; and a continuous measure of QE interventions based on QE -related assets on central bank balance sheets. A non-zero coefficient on these dummies can be interpreted as indicating that there were additional influences on capital flows to developing economies due to quantitative easing that are not directly attributable to observable measures. The baseline estimation employs econometric techniques that address the influence of time -invariant unobserved country effects, a time trend, and the possibility of bias due to the inclusion of a lagged dependent variable. In addition to the base- line, several additional variations were explored. To ascertain whether quantitative easing may have altered the magnitude of the influence of the conventional transmission channels (say by making flows more sensitive to interest rate develop- ments), a specification that allowed for interactions between the indicator and the observable global variables was consid- ered. However, this specification was not retained as there was little evidence in favor such interaction effects. Further- more, specifications that included market expectations of future interest rate changes were considered, but not retained because these expectations variables were not statistically significant. Alternative specifications with additional controls, alternative measures of the main controls, and different estimation techniques were also considered, with little change to the baseline results.FN6 More details including benchmark regression results and the regression results for the constituent components of gross flows are provided in Annex 1 (see also Lim, Mohapatra and Stocker forthcoming). Additional results on interactions, ex- pectations and robustness tests are described in an additional annex available online at www.worldbank.org/gep. be expected to normalize, and the extraordinary are shown in Table 1. These simulations are monetary policy measures that have been undertaken conditioned on the following underlying will be withdrawn. In this context, capital flows to assumptions: developing countries should adjust to a new equilibrium.  Developing and high-income country GDP growth gradually strengthens in line with the Simulations based on the panel regression results projections presented in Chapter 1. 87 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY modest decline in capital inflows — although at Table 1. Baseline results: a modest decline in capi- more than 4 percent of GDP broadly in line with tal flows as global conditions normalize their average level between 1990-2003. History Baseline 2012 2013 2014 2015 2016 Developing GDP growth 5.0 5.4 5.5 5.8 5.9 Looking a bit deeper G4 GDP growth 1.4 1.1 2.2 2.4 2.4 The above results refer to the sum of all capital Yield curve 1.7 2.1 2.5 2.6 2.3 flows (portfolio flows, international bank lending, G4 10 Y Bond Yields 2.2 2.4 2.9 3.2 3.5 and foreign direct investment). When flows are G4 3 m interest rates 0.4 0.2 0.3 0.6 1.2 decomposed into their constituent components, VIX Index 18 15 16.9 18.2 18.9 portfolio flows are both the most volatile and the Deviation in gross capitals from a "no change" scenario most sensitive to the external drivers associated % of flows -3.7 -7.4 -10.0 with global financial conditions. % of developing country GDP -0.22 -0.42 -0.56 Note: Tan background implies an exogenously given variable Estimates of the capital flow model performed on blue background shows VIX simulations derived from the VAR model each of these flows individually suggest that gold background denotes results from the panel regression equilibrium portfolio flows are sensitive to changes Source: World Bank. in short-term interest rates, the yield curve, and global risk aversion, as well as to the QE indicator. Equilibrium foreign direct investment, in contrast, tends to be  QE Tapering by the US Federal Reserve starts relatively insensitive to the effects of global push in 2014Q1 and has a very gradual effect. It factors, although such flows are much more responsive adds 50bp to US long term interest rates by the to country specific credit ratings, a result consistent end of 2015 and a cumulative 100bp by the with the literature (Alfaro, Kalemli-Ozcan & end of 2016. Policy rates in the US start to Volosovych 2008, Dailami, Kurlat and Lim 2012). increase in 2015Q2, from 0,25% to 2% by the end 2016. Cross-border bank lending falls into an intermediate category. In particular, the coefficient  The ECB, Bank of Japan and Bank of on the QE dummies was the largest for bank England, start to unwind their own lending—suggesting that more so than for the quantitative / qualitative policies in the course other flows QE operated through channels other of 2015/16, adding 50bp to their long term than those modeled to boost bank lending. On the yields by the end of the forecast horizon, and other hand, bank lending was also much less tighten policy rate later than the US Fed. sensitive to the observable fundamental factors. This suggests that the response of overall gross Based on the above baseline assumptions, the VAR flows to global risk conditions and QE-specific model described in Box 2, which maps out the effects are driven to a large extent by the behavior inter-temporal relationships between GDP growth of portfolio capital flows (see figure 6). When flows in high income and developing regions, global into developing-country bond and equity mutual interest rates and uncertainty / risk taking, suggests funds (a subset of portfolio flows) are considered, that the VIX index will gradually rise back toward the sensitivity of these flows to changes in both the its long-term average of close to 20 by 2016, some short-term interest rate and yield curve is much 25 percent above current low levels. higher than for overall portfolio flows, and for other types of capital flows. Feeding these global “push factors” into the earlier panel regression results points to a baseline decline To the extent that this historical pattern between of capital flows (relative to a “no change” scenario) different flows persists over future tapering of about 10 percent by 2016 (see Table 1), or a 0.6 scenarios, portfolio flows are estimated to decline percent of developing country GDP decline in in the first year by 33 percent, while bank lending capital flows by 2016. falls to a much smaller extent, and FDI flows hardly move at all (under the gradual tightening These results confirm that a gradual normalization scenario). Partly as a result, the impact on regional of global conditions would be accompanied by a capital flows may turn out to be very different. 88 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Figure 6. Estimated decline in capital flows relative to Figure 7: Estimated decline in regional capital flows no policy change baseline by type relative to no policy change baseline FDI Bank lending Portfolio Investment Mutual Fund Flows East Asia & EAP excl. Europe & Latin 0 0.0 Pacific China Central Asia America & MNA SAS SSA 0.0 -5 -0.1 -0.1 -10 -0.2 -0.2 -15 -0.3 -0.3 -20 -0.4 -0.4 -25 -0.5 -0.5 -30 Percent change -0.6 -0.6 Percent of GDP change [Right] -0.7 -35 -0.7 -0.8 -40 -0.8 -0.9 -45 -0.9 -1.0 -50 -1.0 Percent of GDP change Percent Percent Source: World Bank. Source: World Bank. For regions such as East Asia & Pacific (excluding suggests that such a smooth market reaction to an China) and Europe and Central Asia—where portfolio eventual tapering of quantitative easing is not flows represent 53 and 45 percent of total flows assured. The next set of results considers the respectively—enduring declines in inflows may be impacts on both global push variables and capital significantly larger than the declines in regions like flows under two alternative scenarios: Latin America, the Middle-East and North Africa, or South Asia where portfolio flows are a much  “Fast normalization”: long-term interest rates smaller proportion of total flows (see figure 7). snap up by 100 basis points in the first half of 2014, before gradually converging back to Sub-Saharan Africa is the third largest in terms of baseline levels over the subsequent two years; impact. While in other regions the large overall impact is due to the disproportionate share of  “Overshooting”: market reactions are assumed portfolio flows in overall flows, in Sub-Saharan to be more abrupt, resulting in a sharp (200 bp) Africa these floes are relatively small (outside of increase in long term interest rates in first half South Africa FDI is the dominant type of gross of 2014, followed a more protracted inflows —72 percent of the total). However, both adjustment back to the baseline; capital flows and portfolio are a particularly large share of Sub-Saharan Africa’s GDP (See earlier To assess dynamic adjustments and risks of figure 2) and as a result the impact of reduced disorderly impacts on capital flows, the VAR portfolio flows is a relatively large share of Sub- model described in Box 2 was used to explore the Saharan GDP. inter-temporal behavior of both global drivers and actual capital flowsFN9. Tracking the dynamic behavior of capital flows Figure 8 illustrates the adjustment path for three of the co-determined variables (gross capital flows to and overshooting risks developing economies; long-term interest rates and market volatility, the VIX) in the VAR system The above results assume that monetary authorities under the three scenarios. In the baseline, the in high income countries are able to engineer a capital flow projections resulting from the VAR gradual increase in long-term interest rates as simulations are very similar to those drawn from quantitative easing is withdrawn in line with the panel regression, with the share of capital improved growth conditions. inflows to GDP in developing countries declining by 0.5 percent over the projection horizon. However, the experience of the summer of 2013— when the yield on 10-year US Treasury bills jumped In the two more extreme scenarios, deviations by some 100 basis points in a just a few months— from the baseline are pronounced. In the “fast 89 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Box 2. Modeling the inter-temporal adjustment path Inter-temporal interactions between global “push” factors, capital inflows and GDP growth in developing countries are mod- eled using a six-dimensional Vector Auto-Regressive model (VAR), estimated over the period 2000Q1 to 2013Q2 (see Appendix 2 for a detailed description). The VAR jointly models aggregate gross capital flows to developing countries as a share of their combined GDP; real GDP growth in both developing and “G4” countries (US, euro area, Japan and UK); “G4” short term interest rates; the G4 yield curve (10 year government bond yields minus 3 month interest rates), and the VIX index of implied stock market volatility, a popular measure of the pricing of financial market risks. The impulse response of aggregate capital inflows in developing countries to one standard deviation shock in the other four variables is presented on Figure B2.1. At first sight, changes in growth patterns between developing and G4 countries seem to be dominant drivers, with the effect of shocks persisting for about 1 ½ year. Rising risk aversion (increase in the VIX) and a steepening of the G4 yield curve are both associated with lower capital inflows (as a share of GDP), with peak effects after about 4 quarters. The direct impact of changes in short -term interest rates in the G4 region is small. Further investigation shows more complex interactions between global factors and highlights the central role of uncertainty and changes in risk assessments in the transmission of monetary shocks. In particular, an increase in VIX leads within 4 quarters to lower short term interest rates, a steepening of the yield curve and weaker growth in the G4 and developing countries. The impact of market distress on global growth and the slope of the yield curve serve to amplify the initial effect of increased uncertainty on capital inflows. Box Figure 2.1 Response of developing-country Capital Box Figure 2.2 Share of variance explained by VIX and inflows (% of GDP) to one S.D. shock in: G4 interest rate shocks (after 2 years) 1.2 1.2 35 Percent G4 GDP G4 GDP growth growth 1.0 1.0 GDP growth Dev GDP growth 30 Dev 0.8 VIX index G4 Interest Rate shocks 0.8 VIX index G4 short term rates 25 VIX Index shocks 0.6 G4 short term rates 0.6 G4 yield curve G4 yield curve 20 0.4 0.4 0.2 15 0.2 0.0 10 0.0 -0.2 -0.2 5 -0.4 -0.4 0 -0.6 -0.6 -0.8 -0.8 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 Source: World Bank. Source: World Bank. For the sample period 2000Q1 to 2013Q2, the model suggests that changes in risk aversion explain around 10 percent of the variance of GDP growth in both G4 and developing regions, 20 percent of changes in the yield curve and 25 percent of changes in short term rates. In addition, the VIX index is itself the variable in the model most sensitive to changes in monetary conditions, with lower interest rates reflected within two to three quarters in lower risk aversion. About 8 percent of the variance of VIX is ex- plained in the model by such change in monetary conditions. These results are consistent with recent studies, which tend to assign an even bigger role of interest rate shocks in determining the price of risk. For instance, Bruno and Shin (2013) find that US Federal Fund Rates explain almost 30 percent of the variance of the VIX at horizons longer than 10 quarters while Bekaert et al (2012) find that monetary policy shocks account for 20 percent. Rey (2013) presents estimates compa- rable to ours (between 5 and 10 percent). normalization” scenario, the resulting increase in adjustments observed during May-September 2013, market volatility and rising risk aversion leads to a a period that lies mainly outside of the estimation sharper but partially temporary correction in flows. period of the model. In this context, foreign capital inflows drop by an average 30 percent in 2014 with a peak impact of In the “overshooting” scenario, where long term 50 percent towards the end of the year. As interest rates spike by 200 bp in 2014, flows would discussed in Box 3, the magnitude of these then drop by 45 percent in 2014 as whole, and up simulated effects is broadly consistent with the to 80 percent at the peak impact. 90 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Figure 8. Normalization scenarios, overshooting risks and capital flow projections Capital inflows developing countries (percent of GDP) G4 long term interest rates VIX index / financial risk 6.0 60 14 Percent Percent Percent 5.5 55 12 Baseline Baseline 50 Baseline 10 Fast normalization 5.0 Fast normalization Fast normalization Overshooting Overshooting 45 Overshooting 8 4.5 40 6 4.0 4 35 3.5 2 30 3.0 0 25 2.5 20 -2 -4 2.0 15 -6 1.5 10 Source: World Bank. Such a correction in capital flows, albeit temporary, macroeconomic scenarios. This is being addressed would have important bearing on the probability of in the last section of this Chapter. isolated or more diffused crisis under different Box 3. A live experiment: tapering expectations and capital flows during the summer of 2013 The simulations derived from the Vector Auto-Regressive (VAR) model can be compared with actual developments after the Fed tapering announcement in May 2013. Following the Congressional testimony of the Federal Reserve Bank’s chair- man on May 22 2013, laying down the conditions for a gradual unwinding its asset purchase program, the US long term interest rates increased suddenly by 100bp and the VIX index initially rose from 15 to 20. Emerging market bond spreads increased significantly, issuances of developing -country bond, equity and syndicated bank loans dropped by around 30 percent during the summer (see Box Figure 3.1). Although the aggregation of bond, equity and syndicated bank flows is conceptually different from the Balance of Payment data gross flow data used in our modeling strategy, the observed deceleration of flows during the Summer of 2013 is large- ly consistent with the elasticities estimated in the VAR model. Counterfactual simulations show that a more gradual decline predicted by the VAR model but of broadly similar magnitude (see Box Figure 3.1). As presented in the “fast adjustment” scenario above, a 100bp shock to the yield curve generally translates within 2 quarters into a drop in inflows by around 50 percent, with the VIX index predicted to increase by 6 points . The observed impact of financial market tensions during the summer was also reflected in a deteriorated outlook for many developing economies, particular among those considered most vulnerable (see Figure B3.2). Box Figure 3.1 Gross capital inflows to developing coun- Box Figure 3.2 2014 real GDP growth consensus fore- tries cast revisions from May to Sept 2013 Equity issuance 1.0 Percent Bond Issuance Syndicated bank loans 70 Billion USD, VAR counter. Simulations Percent 3.1 0.5 3m avg US 10y bond yields - RHS 60 2.9 2.7 0.0 50 2.5 40 -0.5 2.3 30 2.1 -1.0 20 1.9 10 1.7 -1.5 Thailand Turkey Ukraine China Malaysia Canada India Brazil Uruguay Poland Euro zone New Zealand Hungary Argentina Philippines Switzerland UK Russia South Africa Vietnam Indonesia Chile Mexico Bulgaria USA Romania Sweden Japan Kazahkstan Saudi Arabia Ecuador Colombia 0 1.5 Oct-13 Feb-13 Apr-13 Jun-13 Aug-13 Sep-13 Dec-13 Jan-13 Mar-13 May-13 Jul-13 Nov-13 Source: World Bank. Source: Consensus Economics, World Bank 91 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Disequilibrium risks banking crises much more common occurrences than sovereign debt crises. The clustering suggests that crises are either being caused by common factors or that there are important contagion effects. The preceding analysis suggests that in the long run, the withdrawal of quantitative easing and a Crises in developing countries tend to occur return to a tighter stance of monetary policy in high following a capital surge episodes, but at the same -income countries will have a relatively small time as sudden stops in capital flows (see figure impact on gross capital flows reducing them from 10). While the sudden stop relationship is clear, the 4.6 percent of developing country GDP in 2013Q3 causality is less soFN9 FN10. Does the stop in capital to 4.0 by the end of 2016. However, the path to flows precipitate the crisis, or do the flows stop this new normal level of flows will matter. once a crisis has begun? What is clear is that banking crises tend to be more common following If market reactions to tapering decisions are a capital surge. Thirty-four percent of banking precipitous, developing countries could see flows crises occurred within two years after a surge in decline by as much as 80 percent for several capital inflows to the country, versus only 20 months. This would raise the likelihood of abrupt percent for currency crisis and 17 percent for stops at the individual country level, with as many sovereign debt crisis FN11. Moreover, the evidence as 25 percent across the developing world suggests that having had a banking crisis in the experiencing such episode (see Box 4). preceding two years increases the likelihood of a sovereign debt or currency crises, whiles these While this adjustment period might be short-lived, other kinds of crises do not increase the likelihood it is likely to inflict serious stresses on the financial of later banking crises to the same extentFN12. and economic conditions in certain countries – potentially heightening crisis risks. A more formal look at banking crises A brief history of crises in developing An econometric analysis of the factors countries. associated with an increased probability of crises in developing countries tends to confirm the linkages According to data compiled by the IMF (laeven between the incidence of these crises, global and valencia, 2012), between 1970 and 2009 there factors and individual country characteristics and were some [147] financial crises globally (figure 9). vulnerabilities (see Box 5). Of these [123] occurred in what are now classified as developing countries, and 95 developing There is a very large empirical literature on banking countries had at least one crisis. These crises have crisesFN13. While early work typically focused on tended to occur in clusters, with currency crises and domestic causes of banking crisis, especially in a Figure 9. Frequency of sovereign, currency and Figure 10. Capital inflows surges, stops and frequen- banking crisis cy of financial crises in developing coun- 40 tries Number of crisis Sovereign debt crisis 40 Percent 35 Currency crisis 35 Banking crisis 30 30 25 Banking crisis 25 Currency crisis 20 Sovereign debt crisis 20 15 15 10 10 5 5 0 0 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Capital inflow surge in past 2 years Capital inflow stop in same year Source: laeven and Valencia (2012), World Bank. Source: laeven and Valencia (2012), World Bank. 92 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Box 4. Capital surges, stops and aggregate capital flows As discussed, in the main text, capital flow surges tend to precede financial crises, and crises tend to occur at the same time as sudden stops. The surge in capital flows in the pre -crisis period was typical (see Box Figure 4.1), and some 80 percent of developing countries suffered a sudden stop in flows in its aftermath (of which xx percent had a crisis). The post -crisis rebound, which also classifies as a surge, was also followed by an increased incidence in stops, with 15 percent enduring such episode during 2012 -13. The methodology used here to identify surge and stop episodes at the individual country level is based on Forbes and Warnock (2012), with the threshold being defined changes in flows being larger than one standard deviation around a 5 year rolling mean. Box Figure 4.1 Gross capital inflow episodes in devel- Box Figure 4.2 Frequency of stop episodes: impulse oping countries response to changes in aggregate flows 90 Proportion of 6.0 countries affected, minus 2 SE 80 Stops Surges Cumulated impulse response Percent 4.0 plus 2 SE 70 2.0 60 50 0.0 40 -2.0 30 -4.0 20 -6.0 10 0 -8.0 2000Q1 2002Q1 2004Q1 2006Q1 2008Q1 2010Q1 2012Q1 1 2 3 4 5 6 7 8 9 10 Source: World Bank, Source: World Bank. The link between aggregate capital flows to developing countries and the proportion of these countries going through ei- ther surge or stop episodes can be approximated empirically using a simple Vector -Autoregressive Model approach. Over the period 2000Q1 to 2013Q2, the relationship can be summarizes with the following accumulated impulse response (based on a 4 lags VAR selected through the HQ and AIC criteria). Overall, a one standard deviation decline in the ratio of aggregate capital flows to GDP in developing countries in the course of a quarter (about a 2.7 percent of GDP decline), tends to increase the proportion of countries experiencing sud- den stops to 22 percent after 4 quarters. In the “overshooting” scenario presented in the previous section, capital flows are predicted to decline by 3 percent of GDP, implying that more than a quarter of developing countries could experience sud- den stops in such scenario . context of developing countries, more recent work global monetary conditions that have suppressed has focused on the effects of outside forces, such global risk aversion and increased liquidity. Risk is as global monetary and financial developments and further heightened if global agricultural prices are contagion, on the likelihood of a crisis in a given high – which may be a reflection of the strong countryFN14. correlation between capital flows and high commodity prices (Reinart and Rogoff, 2009). Somewhat counter-intuitively, the model suggests Relative importance of global, contagion, and that high energy prices in previous years reduce the likelihood of a crisis in any given year perhaps domestic factors because high oil prices cause oil importing countries to retrench and reduce vulnerabilities. The regression results (see Annex Table xx) generally confirm the influence of both global and Among the contagion variables examined, only the domestic factors in determining the onset of trade linkages variable (the share of trade with banking crisis. The modeling strongly suggests that other countries in crisis) was consistently the risk of a banking-crisis rises following an statistically significant. As expected domestic extended period of low interest rates and loose factors play a critical role in determining whether 93 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Box 5. The banking-crisis regression model To assess the role of all three concepts (global, contagion, and domestic factors) on the likelihood of a crisis in a given developing country, an unbalanced pooled probit model is estimated (see Appendix 3 for a detailed description) the proba- bility that a country will suffer a banking crisis is modeled as a function of global factors, contagion factors, and domestic factors. The modeling work focusses on banking crises in developing countries using crisis data developed by Laeven and Valen- cia (2012) as the determinants of banking causes in developing countries may be distinct from those of high income coun- tries (Eichengreen et al., 1996, 1998, 2000). To avoid sample selection problems, explanatory data for the 67 developing countries that did not have banking crisis are added to the 95 developing countries in the Laeven and Valencia data set, all of which had banking crisis during the sample period. Observations for the three years following a crisis are dropped from the panel, so that the explanatory power of domestic factors that may have triggered a crisis are not diminished by inclu- sion of their post-crisis period when the binary crisis variable would be zero. All explanatory variables are entered with a one period lag, in order to minimize endogeneity problems. FN16 Global factors Seven measures of capture global effects were tested for the model, covering global risk appetite, global interest rates, global growth, global liquidity, global bank leverage, and global commodity prices.FN17 Global risk appetite was proxied by the Chicago Board of Trade Volatility Index (VXO), a measure commonly used to capture risk appetite in the global finan- cial markets.FN18 [Need to check FN18 and revise.] Global growth is measured by the first principal component of real GDP growth in the US, Japan, UK, and Germany. Global liquidity is proxied by M2 as a share of GDP in the United States. Global interest rates are measured by the first principal components of rates on long -term government bonds in the G4.FN19 [Need to check the FN19 and revise.] Global commodity prices are measured by agricultural commodity index and energy commodity index.FN20 Contagion factors Following Forbes and Warnock (2011) and IMF (2013), but giving precedence to variables that allowed for a wider country coverage, four variables were included to capture contagion effects: trade openness, trade linkage, financial linkage, and regional contagion. Trade openness is measured by a country’s trade with the rest of the world scaled by its GDP. Trade linkage is defined by a bilateral trade volume between two countries (scaled by each country’s total trade with the rest of the world) and multiplied by an indicator variable defined as equal to 1 if the trading partner is experiencing a banking cri- sis, and to 0 otherwise. Financial linkage is defined by the total bank claims between a country and BIS reporting banks scaled by GDP to capture the country’s degree of integration with the global financial markets and hence exposure to fi- nancial contagion. Regional contagion is defined as the number of countries in the same region experiencing a banking crisis.FN21 Domestic factors Ten separate variables were considered to capture country -specific factors: current account and fiscal balance, total exter- nal debt and a share of short term debt, domestic credit growth, inflation, per capita GDP growth, ratio of M2 to re- serves,FN22 and a measure of real exchange rate overvaluation.FN23 The definition of each variable is shown in Table x in the appendix . an individual country enters into crisis. High-levels Figure 11. Estimated in-sample contribution to of foreign and short-term debt, an earlier period of changes in banking-crisis risk rapid domestic credit growth (measured as the change in credit to GDP rates over the previous 5 REER overvaluation years), low levels of international reserves, and an Fiscal balance Ratio of M2 to reserves overvaluation of the real exchange all increase the Import cover of risk of banking crises. Credit growth Short term debt Change in current account balance Figure 12 reports the estimated sensitivity of External debt Trade linkage banking crises to the different variables identified Energy Commodity Index in the econometric work. It shows the absolute Agricultural Commodity Index Global liquidity value of the relative importance of each identified Global growth factor in contributing to an increase or decrease in Global LTR, Change Global risk the likelihood of a crisis. Empirically, between 0.0 0.5 1.0 1.5 2.0 2000 and 2010 the global variables have played the Source: World Bank. 94 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Box 6. Monetary policy, domestic credit growth and country-specific vulnerabilities The “imported” easing of monetary conditions through large capital inflows in recent years has contributed to rapid credit expansion, widening current account deficits and increasing banking sector vulnerabilities in some cases. The surge of capital flows in the post crisis period has contributed to lenient domestic credit conditions, directly through cross-border intermediation channels and indirectly through exchange rate and monetary policy spillovers. Regarding the latter, a simple Taylor predicting the monetary policy stance of central banks in developing countries on the basis of do- mestic conditions (deviation of consumer price inflation from the policy target and the level of slack in the economy) sug- gests that policy rates were kept lower than normally suggested during periods of large capital inflows (Figure xx and He & McCauley (2013). In this context, domestic credit has grown very rapidly in several developing countries in recent years, increasing the vul- nerability of some economies to a rapid tightening of financing conditions. Outstanding credit exceeds 100 percent of GDP in 15 developing economies, and rose as a share of GDP by 15 or more percentage points in about 40 developing econo- mies between 2007 and 2012. The sharpest upsurge was recorded in Thailand, Armenia, China, Malaysia, Morocco and Turkey. Robust real credit growth continued during 2012 and 2013 in Cambodia, Argentina, Armenia, Indonesia and Para- guay. Monetary, fiscal and regulatory tightening in several countries, including China, Brazil, India, and Indonesia, has helped contain a further build-up of credit risks but banks’ exposure to rising interest rates as become an increase source of concern since the start of QE tapering expectations Box Figure 5.1 Policy rates and “Taylor rule” rates in Box Figure 5.2 Domestic credit growth in selected devel- emerging and developing countries oping countries 40 Percent Change since 2007 in percent of GDP 40 35 Monthly real credit growth (average 2012-2013) 35 30 30 25 25 20 20 15 15 10 10 5 5 0 0 China Armenia Malaysia Turkey Nigeria Paraguay Ukraine Thailand Russia India Kenya Brazil Argentina Morocco Cambodia Indonesia Colombia Source: World Bank, IFS largest role – explaining about 58 percent of the these bleed through into the domestic economy changes in country level banking-crisis risk. (see following discussion on policy). Domestic factors – particularly an increase in credit to GDP ratios over the previous 5 years, short- Model prediction term debt and overall money supply are also important contributors to risk. Changes in these Probability models like that used here to estimate variables explain 35 percent of all the variation in the sensitivity of banking crises to external, risk over the sample period. domestic and contagion factors tend to have low predictive power because the events they model are That said, it should be recognized that domestic low-probability events. One measure of the variables are not entirely independent of external adequacy of such models is the proportion of variables. In particular, as discussed in Box 6 loose threshold events it correctly predicts (and the financial market conditions at the global level can proportion of non-events that it correctly predicts). feed through to rapid credit growth, exchange rate By these measures, the model outlined in column 5 changes and fluctuations in reserves at the of Annex Table A3.3 does a reasonable job in domestic level. The main difference being that predicting banking crises in developing countries— while developing economies do not have the policy a conclusion supported by the AUROC statistic of levers with which to affect global financial conditions, more than 80 percent in the preferred model they can influence the extent and manner in which specification. 95 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Figure 12. Model predictions for 2008/9 banking crisis 12 30 6 10 Kazakhstan 25 Latvia 5 Nigeria 8 20 4 crisis crisis crisis 6 15 3 Kazakhstan Latvia Nigeria 4 10 2 Average Average Average 2 5 1 0 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2000 2001 2002 2003 2004 2005 2006 2007 2008 2000 2001 2002 2003 2004 2005 2006 2007 2008 3.0 14 20 2.5 Mongolia 12 Ukraine Russia 15 2.0 10 crisis crisis crisis 8 1.5 10 Mongolia 6 Ukraine Russia 1.0 Average 4 Average 5 Average 0.5 2 0.0 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2000 2001 2002 2003 2004 2005 2006 2007 2008 2000 2001 2002 2003 2004 2005 2006 2007 2008 Note: The figures show the predicted risks for the countries that experienced systemic banking crisis (blue) vis -à-vis the average predicted risk for the non-crisis sample (red) based on the econometric model reported in Chart 2. Another measure is to compare the prediction of regional level. the model with actual events (within-sample prediction). Figure 13 plots the estimated  In the East Asia & Pacific region rapid credit probability of a crisis for six of the eight countries expansions over the past 5 years, coupled with that had banking crises in 2008–09 compared to a rising ratio of short-term debt in total debt the average predicted risk for all countries during are common areas of concern. the same period. In all cases, the model suggests an above average risk of crisis for those countries that  In Europe & Central Asia a high external debt did have a crisis. Moreover, for all countries the to GDP ratio, which exposes countries to predicted risk of crisis increased rapidly prior to exchange rate and roll-over risk, is an issue in and including the year of crisis. However, in the several Central and Eastern European cases of Mongolia and Nigeria, the predicted economies, with a heightened share of short likelihood of banking crisis was only marginally term debt in that total being a further concern higher than the average for all countries . in several others. High-short term debt ratios makes a given level of debt much more Assessing current risks sensitive to short-term swings in investor sentiment or capital flows as might occur in Given current conditions, empirical analysis of the fast tightening and overshooting banking crisis risks suggests that several countries scenarios discussed in the previous section. might be subject to heightened vulnerabilities. Rapid credit growth is a further issue of common concern in the region with credit to Figure 13 presents key domestic risk factors in GDP ratios have risen sharply over the past 5 those countries. Countries are arranged by region years in a number of economies – increasing and in alphabetical order. The shaded areas in the the sensitivity of loan quality (and bank table indicate dimensions where current levels are solvency) to the kind of sharp rise in interest above the 75th percentile of countries for which rates discussed above. data are available. Although conditions on the ground will vary and these kinds of gross indicators  In Latin America & the Caribbean risks fewer need to be interpreted with a great deal of caution, countries appear to be at immediate risk, with the results are instructive and point to areas of rapid credit growth combining with significant vulnerability that individual countries may need to short-term debt ratios and exchange rate address if they are to reduce risks of a crisis as overvaluation as the main sources of risk. external conditions tighten.  In the Middle-East & North Africa, where While results vary widely across countries within political turmoil has cut deeply into economic regions, some commonalities can be seen at the growth in recent years (see Chapters 1 and 2), 96 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Figure 13. Domestic sources of risk by region East Asia and Pacific Europe and Central Asia External External debt debt Import Short-term Short-term Import cover cover debt debt REER REER Real credit Real credit overvaluatio overvaluati growth growth n on Latin America and Caribbean Middle East and North Africa External External debt debt Short-term Short-term Import cover Import cover debt debt REER REER Real credit Real credit overvaluatio overvaluatio growth growth n n Sub-Saharan Africa South Asia External External debt debt Short-term Short-term Import cover Import cover debt debt REER REER Real credit Real credit overvaluatio overvaluatio growth growth n n Source: World Bank. Note: Radar charts summarize areas of elevated risk in each region. Each segment corresponds to domestic risk factors from the regression analysis. The center is the least risky area, and the further away from the center, the greater the risk. The thick line in each region represents the average value of each indicator among the countries whose predicted crisis risk is particularly elevated (one standard deviation above the average predicted risk of the entire sample). The grey area represents the average values of each indicator for the region as a whole. There are no countries whose predicted risk is more than one standard deviation above the average predicted risk in Sub -Saharan Africa and South Asia. Indicator values are standardized using percentile ranks. 97 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY banking-sector risks stem mainly from rapidly  Use of international reserves to support deteriorating current accounts, which increase domestic currencies and smooth the reliance on external capital flows, and rapid adjustment process; increase in credit to GDP ratios.  Implementation or exploitation of temporary  Based on existing data risks in South Asia swap arrangements with other central banks to appear low, but there are concerns that non- increase access to liquidity and foreign performing loans in India are being under- currencies; reported and there too there has been a significant deterioration in current account  Use of monetary policy to raise benchmark balance. interest rates and increase the attractiveness of assets denominated in national currencies  In Sub-Saharan Africa, only a few countries appear to have elevated risk, with rapidly  Imposition of prudential measures such as deteriorating current account positions in a limiting the foreign exchange positions that common thread, along with high exposure to investors can take, or adjusting capital short-term external debt in a few. requirements of banks  Putting in place of temporary capital controls on outward financial flows, while removing Policy response to impediments to capital inflows for foreign direct investments and institutional investors weaker capital flows  Trade measures designed to conserve foreign currency, such as temporary import restrictions in the form of quantitative limits for commodity importers, tariffs, taxes and export The preceding analysis suggests that in a benign support measures; scenario combining a gradual recovery in advanced economies and an orderly normalization of global  Budgetary consolidation policies, cutting financial conditions consistent with the baseline subsidies and raising taxation; forecast of Chapter 1, the risk of a sharp decline in global capital flows is modest.  Reforms aimed at bolstering the investment climate, in particular for foreign investors. However, events around the summer of 2013 illustrate the difficulties in managing market Some of these measures worked by helping to expectations as major central banks plan their exit smooth adjustment, or by restoring market from unprecedented market interventions. As confidence and thereby reduce short-term discussed above, an abrupt adjustment in global pressures. Others such as trade restriction, may interest rates and increased financial market have helped reduce pressures in the short run, but volatility could have significant impacts for capital could have important distortionary effects and flows, growth prospects and financial stability in does not address underlying sources of developing countries, with effects likely being vulnerability. concentrated among those more financially integrated and with the largest vulnerabilities. Figure 14 attempts to summarize the range of policy options available to countries for dealing If a disorderly adjustment occurs, authorities have a with a sudden deceleration in capital inflows. range of polices at their disposal to deal with Which policy response is right for which country financial market pressures, bearing in mind that the will depend on country specific factors, including appropriate mix will vary depending on the the exchange rate regime, the degree of capital individual country situation and policy regime. openness, the structure of external and banking Steps that were taken developing countries during sector liabilities, and the existing state of fiscal and the recent May-September period included: other macroeconomic imbalances. 98 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Figure 14. Policy options to cope with a sudden deceleration in capital inflows Source: World Bank In general, countries with fully floating exchange attention to specific contagion channels. Finally, rates should be able to rely more on market the size of the country will matter, with small open absorption mechanisms (like exchange rate economies having less room for autonomous depreciation) and counter-cyclical macro- macro and prudential policies. stabilization - when sufficient buffers are available. Countries with less flexible exchange-rate regimes, From an operational perspective, the design of the large external liabilities and foreign denominated most appropriate response will essentially be credit may have to focus more on prudential country specific, should involve multi-stakeholders policies and temporary capital controls. Although and be transparent. No single solution will fit all. limited capital account openness may shelter an The rest of this section explores issues associated economy from capital flight, these economies with individual policy options in greater detail. could still be vulnerable through the exposure of financial sector balance sheets, requiring particular 99 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Allowing currency depreciation Such a policy is likely to be most effective in countries facing domestic inflationary pressures and excessive credit growth, but could be Relying on exchange rate depreciation in order to counterproductive in countries facing severe absorb adverse external shocks is appropriate if the economic headwinds – if the induced slower depreciation does not itself exacerbate existing growth exacerbates net outflows. vulnerabilities (say from currency mismatch in the loan books of firms, banks or the sovereign) and is warranted by the fundamentals of the economy. Using capital controls as part of a Particularly in cases where currencies are already crisis mitigation strategy overvalued, currency depreciations could stimulate external competitiveness, reduce current account Maintaining an independent monetary policy and pressures and eventually lead to stronger domestic stable exchange rate in the face of fully liberalized activity. capital accounts can be very complicated because large capital movements will either be met by large Such orderly adjustment would only operate in the exchange rate developments or undesirable cycles presence of a flexible exchange rate regime and a in domestic credit and money supply. credible macro-economic policy framework. The shift of many developing countries towards The “impossible trinity” of achieving monetary inflation-targeting central bank objectives, fully policy autonomy, stable exchange rates and full floating currencies and the “de-dollarization” of capital account openness is often cited as a reason their economies have arguably moved a number of for imposing some form of controls on capital countries in this camp over the years. flows and relying more on counter-cyclical prudential and fiscal policies. Capital controls may be particularly attractive for countries with less Pursuing more active exchange rate flexible currency regimes and large foreign currency denominated debt, where a sudden drop in gross and monetary policies capital inflows would more rapidly translate into financial stability risks. However, for countries with overvalued currencies and large current account deficits, a sudden decline As repeatedly emphasized by the IMF and the in capital inflows could generate a disruptively World Bank, capital flow management instruments rapid depreciation. are part of the relevant short term stabilization instruments to be used in a crisis situation. In such cases, temporary interventions in currency However, they should be used with caution given markets (leaning against the wind) by spending potential adverse effects on the level and cost of international reserves or invoking currency swap or future financing and their mixed record in other arrangements to reduce liquidity risks and regulating large capital flow movements in the past slow the pace of adjustment towards a new (their effects seem to be most visible in changing equilibrium may be warranted. Swap facilities have the structure of foreign assets and liabilities rather gained particular prominence recently, with a than affecting overall fluctuations). growing number of bilateral agreements between central banks to improve liquidity conditions and Countries have used both price-based controls limit strains on foreign exchange markets in times such as taxes, as well as quantity restrictions. of financial stress. Evidence on which of these categories have been most efficient and least distortionary, and under However, exchange rate interventions tend to be what circumstances, is not yet conclusive. effective only in the short-term, and a country’s ability to engage in them will depend on the size of Although discussions on capital controls as part of reserves that it has accumulated in the past. crisis mitigation strategies generally focus on Central banks may also be able to defend their managing capital outflows, the importance of currencies by tighten monetary policy and counter-cyclical controls on inflows, where increasing the rate of return on domestic assets. controls are tightened during an inflow cycle and 100 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY loosened during an outflow cycle, should be emphasized. Figure 15. Main policy pillars to restore confidence Capital controls also seem most effective when they are implemented as part of a broad policy package that includes sound macroeconomic policies as well as robust financial regulation. They should be temporary, being lifted once crisis conditions abate, and may need to be adjusted on an ongoing basis in order to remain effective. Implementing targeted prudential measures Source: World Bank Tighter prudential rules on lending, stricter capital requirement and new regulatory initiative to rein excesses in the shadow banking sector are still a dynamic recovery in most developing regions in the priority in some countries in order to limit the immediate aftermath of the global financial crisis in further accumulation of credit risks and prevent a 2008-09, their resilience was significantly damaging credit crunch. underpinned by a combination of a strong growth potential and an accumulation of substantial policy In those countries facing more immediate external buffers. financing pressures, the focus should be on containment strategies. Targeted prudential Tighter liquidity standards, counter-cyclical fiscal measures aimed in particular at reducing foreign and prudential rules are essential to build-up exchange exposure in the financial sector and sufficient policy buffers and “lean against the foreign currency lending could be effective in wind” of disruptive cycles in capital flows. This certain circumstances, but affect by definition only requires a credible rule-based approach to those flows intermediated through the domestic macroeconomic and macro-prudential policies. financial sector and could have negative consequences for access to finance, in particular Developing countries should further enhance for small and medium size companies. policies supporting private savings and domestic financial markets to intermediate it, hence reducing As bond and equity flows, in particular from exposures to volatile external capital flows. These foreign institutional investors, will arguably be include long term measures focusing on education, most affected by rising global interest rates and the pension and health care reforms and the unwinding of quantitative easing policies, measures development of better regulated domestic bond aimed at lifting barriers to such investments should and equity markets. In this process, authorities be considered, along with targeted policies should closely monitor the composition of both intended to open up new opportunities for foreign domestic and foreign liabilities, adjusting regulation direct investments. to the ever changing nature of financial stability risks. Restoring confidence through Reforms aimed at promoting growth and financial domestic reforms stability should not loose sight of the need for protecting the most vulnerable and developing Eventually, reforming domestic economies by social protection mechanism to better cope with improving the efficiency of labor markets, fiscal global shocks. management, the breadth and depth of institutions, governance and infrastructure will be the most effective way to restore confidence and spur stability (see figure 15). As emphasized by the 101 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Reinforcing global coordination Finally, the framework for global policy coordination should be further strengthened in the context of the G20, better recognizing large cross- border spillovers from high income country policies, and the mutual benefits of greater financial and economic stability in the developing world. Over the past five years, G20 members have made significant progress but a certain reform fatigue is apparent. Important gaps in building a more resilient global financial system, improving international oversight and limiting the propagation of systemic risks still need to be filled. Regarding the G20 developments agenda, tangible progress in areas such as economic growth, financial regulation, trade, financial inclusion, infrastructure and climate change financing could make a significant contribution to promoting development and reducing poverty. Erecting trade barriers to solve financial and economic headwinds would be counterproductive, and should be resisted in both high income and developing countries. The momentum created by the World Trade Organization agreement last December on trade facilitation, food security, development and access of least developed countries, could lead to new opportunities for growth and development and should be followed up with further multilateral efforts to open up trade in goods and services and strengthen disciplines for investment. 102 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Technical note: Panel data model of global and domestic factors that can influence Appendix 1. capital flows to developing countries Data Sources The analysis of capital flows relies on an unbalanced panel of available quarterly gross capital flows data for up to 60 developing countries for the 2000Q1–2013Q2 period, thus spanning 8 years of non-crisis year capi- tal flows, and 5 years of post-crisis flows (see country list in Annex table A.1). Aggregate gross financial in- flows (GFIit) are defined as the sum of changes in foreign holdings of three categories of assets (portfolio, FDI, and loans) in the developing economy, net of their own disinvestment in each of these three flows. Gross portfolio and FDI inflows were drawn primarily on balance of payments data from the International Monetary Fund's International Financial Statistics (IFS). These were supplemented by data from national sources drawn from Haver Analytics and Datastream (where gaps exist), and with bank lending data from the Bank of International Settlements’ Locational Banking Statistics (LBS).FN32 We also draw on EPFR Global's Global Fund Flows and Allocations Data—which compiles secondary market transactions of bond and equi- ty purchases in emerging market mutual funds—to obtain a complementary fund inflow measure. The main explanatory and control variables were obtained from IFS, World Development Indicators (WDI), and cen- tral banks, supplemented with Datastream and Haver where gaps exist (see specific sources in Annex table A.2). Both capital flows and explanatory variables in the model are measured in real terms, in constant 2010 exchange rates and prices. Table A1.1 Country list for panel data model of capital flows Albania Honduras Nicaragua Argentina India Nigeria Armenia Indonesia Pakistan Azerbaijan Jordan Panama Bangladesh Kazakhstan Paraguay Belarus Kyrgyz Republic Peru Belize Lao PDR Philippines Brazil Latvia Romania Bulgaria Lebanon Russian Federation Cape Verde Lesotho Seychelles Chile Lithuania South Africa China Macedonia, FYR Sri Lanka Colombia Malaysia Suriname Costa Rica Mauritius Thailand Dominican Republic Mexico Turkey Ecuador Moldova Uganda Egypt, Arab Rep. Mongolia Ukraine El Salvador Morocco Uruguay Georgia Mozambique Venezuela, RB Guatemala Namibia Vietnam Notee: The baseline sample is the largest available sample for the parsimonious and extended benchmark specifications Model The main dependent variable of interest, gross financial inflows (GFIit), and its component parts (portfolio investment flows, foreign direct investment, and cross-border bank lending) are each modeled as a function of variables meant to proxy for various factors associated with the movement of cross-border flows.FN29 103 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Table A1.2 Variable list for panel data model of capital flows Variable Source Gross financial inflow IMF International Financial Statistics, Datastream, Haver, Bank for International Settlements Portfolio investment IMF International Financial Statistics, Datastream, Haver Foreign direct investment IMF International Financial Statistics, Datastream, Haver Bank lending Bank for International Settlements’ Locational Banking Statistics Mutual fund flows (equity and bonds) EPFR Global US 3-month T-bill rate US Federal Reserve; Datastream US 10-year government bond yield US Federal Reserve; Datastream US money supply (M2) US Federal Reserve; Federal Reserve Bank of St. Louis VIX Chicago Board Options Exchange, Datastream GDP & GDP growth Datastream, Haver, World Development Indicators Global Purchasing Managers’ Index JP Morgan; Markit (PMI) Central bank balance sheet expansion US Federal Reserve; European Central Bank, Bank of Japan, Bank of England; Federal Reserve Bank of St. Louis. Developing-country interest rates IMF International Financial Statistics, Datastream Country rating Institutional Investor Ratings Global savings World Development Indicators Trade/GDP Haver, Datastream, IMF IFS, World Development Indicators External debt/GDP World Development Indicators, Datastream, BIS Private sector credit/GDP IMF International Financial Statistics Notee: All variables are at quarterly frequency, unless indicated otherwis = −1 + + + + ′ + + + + + Measures used to capture relevant global financial conditions (GFCt) include the US Federal Funds rate; the US money supply (M2); the yield curve (the difference between the US long-term interest rate and short-term policy rates); and the VIX index. Increased short-term treasury yields raise the opportunity cost of alternative investments—including that of developing world assets—such that, ceteris paribus, capital inflows can be expected to fall, suggesting a negative coefficient a priori. The US M2 serves as a quantity-based measure of available liquidity: an increase in M2 indicates an increase in available financing, which reduces the liquidity premium (raises yields on liquid assets) and substitutes away from financial investments in developing coun- tries, thus also suggesting a negative coefficient.FN30 The yield curve captures the effect that quantitative easing (QE) can have on long-term yields, and hence of temporal rebalancing toward higher-risk asset classes, of which developing-country investments are one (Powell 2013); this relationship between a flatter yield curve and greater investment in riskier asset thus implies an a priori negative coefficient. The role of global uncer- tainty and risk aversion was proxied for by the VIX index (Rey 2013): greater uncertainty is likely to be associ- ated with weaker flows (again, a negative coefficient). The measures used to capture global real side conditions (GRCt) include high-income country GDP growth (proxied by weighted-average growth rates of the G4 economies – U.S, Euro Area, U.K and Japan) and the global composite purchasing managers index (PMI) which proxies for growth expectations. Overall develop- ing country growth was included to account for a combined pull factor for developing countries. Stronger real-side activity is likely to translate into greater investment opportunities overall and increased flows to de- veloping countries; in general one would expect these coefficients to be positive.FN31 Taken together, these global factors can be regarded as “push” factors. The extraordinary measures taken by central banks, in the United States, Europe and Japan are likely to have influenced several of the global financial and real-side variables: by affecting short-term interest rates through conventional monetary policy; by affecting the term-structure of interest rates due to the Federal Reserve’s 104 GLOBAL ECONOMIC PROSPECTS | January 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY purchase of mortgage-backed securities and long-term debt on secondary markets (Christensen, & Rudebusch 2012; Gagnon et al. 2011; Krishnamurthy and Vissing-Jorgensen 2011); by reducing uncertainty over the fu- ture stance of central bank policy by serving as a credible commitment to low future rates (Bauer & Rude- busch 2013); and by the influence of these factors on US and global growth (Chen, Curdia and Ferrero 2012). To the extent that these policies have influenced these drivers, their influence on capital flows will have been captured in the regression. To account for the possibility that extraordinary monetary measures have operated through other channels — or if QE may have any additional, unobservable effect over and above these standard, observable variables — a series of dummy variables covering the different episodes of quantitative easing (QEt) were also included. A non-zero coefficient on these dummies can be interpreted as indicating that over and above the (unidentified) influence of quantitative easing on the fundamental drivers included in equation (1), quantitative easing had an additional impact on capital flows to developing countries that are not captured by observables variables. We consider three alternative measures for the additional effects of QE programs: a single QE variable that corresponds to all episodes of U.S quantitative easing; separate indicator variables for each of the three dis- tinct episodes; and a continuous measure of QE interventions based on expansions in the size of the central bank's balance sheet. For the indicator variables, our coding scheme for the start/end quarters defines a quar- ter as belonging to the implementation window if the total number of implementation days exceeded half the days in any given quarter (e.g. QE1 operations, which began on December 16, 2008, is coded as starting 2009Q1, while QE2, which came into effect on November 3, 2010, is coded as beginning 2010Q4). The base- line specification includes QE operations by the U.S. Federal Reserve, while robustness tests took into ac- count QE operations in other major advanced-economy central banks. The vector Xit captures the influence of domestic “pull” factors and includes the log of country GDP vol- umes, country institutional investor ratings, country-specific lagged GDP growth differential (relative to the United States), the interest rate differential between the developing country vis-à-vis the United States, and aggregate developing-country GDP growth. The interest rate differential relative to the US captures spatial rebalancing that arbitrages cross-country differences in yields. The lagged growth differential captures the relative attractiveness of investing in a particular developing country. Lagged ratios of private credit as a share of GDP (financial depth), trade/GDP (trade openness), external debt/GDP, and real exchange rate apprecia- tion were included in alternative specifications, but were not retained in the benchmark as they were not sta- tistically significant across most specifications and are instead presented in robustness specifications. Country fixed effects αi and a time trend τt were included in all specifications. An indicator for crisis and post -crisis were included to account for the large decline in capital flows during 2008-09, and the possibility of a “new normal” in financial flows thereafter. Given that the equation is a dynamic panel model with fixed ef- fects and subject to bias, the coefficients were estimated using bias-corrected Least Squares Dummy Variables estimator (Bruno 2005) under the strictest condition for bias approximation (up to O(1/NT2)), with boot- strapped standard errors. Results for benchmark specification The results for the benchmark regression for gross financial inflows (GFIit) are presented in Annex table A.3. Columns B1–B3 present a parsimonious specification, while columns B4–B6 present an extended specifica- tion with a larger number of independent variables. The results suggest that global financial conditions (short interest rate, the yield curve, and the VIX index) play an important role in determining the level of capital flows, are signed according to a priori expectations, and are consistent with the findings of Chuhan, Claessens, and Mamingi (1996), Fernandez Arias (1996), Reinhart and Reinhart (2008), Forbes and Warnock (2012), Bruno and Shin (2013), among others. Among global real side indicators, whereas some factors may have had a modest impact on flows (developing country growth rates is marginally significant (at 10 percent) in some specifications, but global PMI and high-income country growth did not prove to be significantly as- sociated with country-level capital flows). 105 GLOBAL ECONOMIC PROSPECTS | June January 2013 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Table A1.3 Benchmark regressions for gross financial inflows (GFI) B1 B2 B3 B4 B5 B6 Lagged inflows 0.473 0.477 0.481 0.466 0.473 0.473 (0.02)*** (0.02)*** (0.02)*** (0.02)*** (0.02)*** (0.02)*** All QE 0.031 0.026 episodes (0.01)*** (0.01)*** QE1 episode 0.041 0.049 (0.01)*** (0.01)*** QE2 episode 0.031 0.035 (0.01)*** (0.01)*** QE3 episode 0.025 0.006 (0.01)*** (0.00) QE-related 0.003 0.002 expansion (0.00)*** (0.00)*** Global financial-side conditions 3M T-bill -0.010 -0.012 0.001 -0.016 -0.017 -0.006 rate (0.00)*** (0.00)*** (0.00) (0.01)* (0.01)** -0.01 Yield curve -0.014 -0.017 -0.001 -0.018 -0.025 -0.007 (0.00)*** (0.01)*** (0.00) (0.01)** (0.01)*** -0.01 VIX -0.002 -0.002 -0.002 (0.00)*** (0.00)*** (0.00)*** Money supply -0.105 0.144 -0.097 (M2) (0.22) (0.26) (0.22) Global real-side conditions Global PMI -0.001 -0.001 -0.002 (0.00) (0.00) (0.00) Developing 0.003 0.002 0.002 0.004 0.000 0.004 GDP growth (0.00)** (0.00) (0.00) (0.00)** (0.00) (0.00)** High-income 0.001 0.001 0.001 0.000 0.001 0.000 GDP growth (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) Country-specific controls Interest rate 0.000 0.000 0.000 0.000 0.000 0.000 differential (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) Growth 0.001 0.001 0.001 differential (0.00)* (0.00)* (0.00) GDP 0.132 0.130 0.130 0.129 0.125 0.128 (0.03)*** (0.03)*** (0.03)*** (0.03)*** (0.03)*** (0.03)*** Country insitutional 0.002 0.001 0.001 0.002 0.002 0.002 rating (0.00)*** (0.00)*** (0.00)*** (0.00)*** (0.00)*** (0.00)*** Other controls Crisis period -0.046 -0.052 -0.050 -0.022 -0.026 -0.026 (0.01)*** (0.01)*** (0.01)*** -0.01 (0.01)* (0.01)* Post-crisis -0.016 -0.025 -0.052 0.002 -0.010 -0.027 period (0.00) (0.01)* (0.02)*** (0.01) (0.01) (0.02) Adj. R2 0.360 0.360 0.358 0.368 0.371 0.367 R2 (within) 0.364 0.365 0.362 0.374 0.377 0.372 R2 (between) 0.525 0.527 0.528 0.526 0.529 0.528 N (countries) 1,938 (60) 1,938 (60) 1,938 (60) 1,925 (60) 1,925 (60) 1,925 (60) Notee: All level variables are in logarithmic form, but rates, indices, and indicator variables are untransformed. Bootstrapped standard errors (with 100 replications) are reported in parentheses. A time trend, country fixed effects, and constant term were included in the regressions, but not re- ported. * indicates significance at 10 percent level, **indicates significance at 5 percent level, and *** indicates significance at 1 percent level. 106 GLOBAL ECONOMIC PROSPECTS | June January 2013 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY The indicator for quantitative easing episodes has positive and statistically significant relationship, which sug- gests that over and above the other modeled channels, quantitative easing induced additional capital inflows. Consistent with the literature on the impact of quantitative easing on the US economy (Curdia & Ferrero 2013; Krishnamurthy & Vissing-Jorgensen 2013), these effects are diminishing with each new QE interven- tion: when the QE indicator is split into separate indicators for each of QE1, QE2 and QE3, the magnitude and significance diminishes between successive episodes (and for QE3 the coefficient is statistically insignifi- cant). Consistent with the existing literature (Alfaro, Kalemli-Ozcan & Volosovych 2008; Fratzscher, 2011; Gelos, Sahay and Sandleris 2011), the results suggest that capital flows to individual countries are strongly influenced by a number of country-specific pull factors: changes in investor country ratings, which represent the per- ceived quality of policies and institutions, as are changes in country-specific growth differentials relative to the US (at the 10 percent level), which is consistent with growth performance being a proxy for the relative at- tractiveness of a country for international investors. Real interest rate differentials are not statistically signifi- cant, although this is consistent with the existing literature (e.g. Bruno and Shin 2013). Interactions of QE episode dummy with global financial and real -side conditions and additional robustness tests In order to ascertain whether quantitative easing may have altered the influence of the conventional transmis- sion channels of capital flows (say by making flows more sensitive to interest rate developments), a specifica- tion that allowed for interactions between the QE indicator and the observable global financial and real-side variables was also explored. These are presented in a detailed version of this annex available online at www.worldbank.org/gep The main message one receives from this set of results is that there is little evidence that supports the argument that the sensitivity of transmission channels for unconventional monetary policy changed as a result of QE. Several alternative specifications were also examined, including a host of additional controls and alternative measures. These additional controls include the global level of saving (to account for the quantity of investable funds), the (lagged) ratio of trade to output, the (lagged) ratio of private credit to output, the (lagged) ratio of debt to GDP, the inflation differential, and the (lagged) real exchange rate. Note that including these additional variables does not alter the qualitative message from our baseline results nor do the coefficients for these controls generally enter with significant coefficients. A measure of the third QE episode that includes an additional indicator for the period where there were an- ticipations of a tapering of QE in 2013Q2were associated with a significant reduction in inflows: the coeffi- cient on the variable is almost twice as large as average effects over all prior QE episodes. Substituting the baseline interest rate differential with the interest rate spread computed from a richer array of fixed income instruments does not change the main qualitative conclusions. An alternative set of measures allows for the fact that unconventional monetary policies were more or less simultaneously pursued by the Bank of England (via the Asset Purchase Facility), the Bank of Japan (via its Asset Purchase Program), and the European Central Bank (through its Securities Market Program and Out- right Monetary Transactions.FN34 This expanded QE indicator has a similar sign and significance as the benchmark specification. Given that the VIX, interest rates and GDP growth tend to be codetermined (Albuquerque, Loayza & Serven 2005; Kose, Otrok & Whiteman 2003) a common factor (the principal com- ponent of the three variables) was derived to proxy for global conditions.FN36 Using this single factor did not affect other coefficients significantly, although it did reduce the overall power of the regression. Decompositions To obtain greater insight into whether specific channels may be more operative then others, depending on the financial flow, we break down our dependent variable—aggregate gross inflows—into portfolio, loans, and FDI. Estimates of the capital flow model performed on each of these flows individually suggests present- ed in columns (D1)-(D3) of Annex table A.6 suggest that portfolio flows are the most sensitive to the exter- nal drivers associated with monetary conditions in high-income countries. The sensitivity of portfolio flows to 107 GLOBAL ECONOMIC PROSPECTS | June January 2013 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY changes in the yield curve is almost double that of overall gross capital flows, as is the response to the QE indicator. Foreign direct investment tends to be relatively insensitive to the effects of global push factors, and is much more responsive to country specific characteristics, consistent with the literature (Alfaro, Kalemli- Ozcan & Volosovych 2008, Benassy-Quere, Coupet & Mayer 2007; Dailami, Kurlat and Lim 2012).FN38 Cross-border bank lending appears to fall into an intermediate category. In particular, the coefficient on the QE dummies are much larger for bank lending, suggesting that more so than for the other flows, QE operat- ed through channels other than those modeled to boost bank lending. On the other hand, bank lending was much less sensitive to liquidity or portfolio rebalancing factors. Columns D4-D6 present measures of flows into emerging market mutual funds, a subset of portfolio inflows. The statistically significant coefficients in columns D4 are broadly comparable to overall portfolio inflows (D1). It is notable that while bond flows appear to react to more transmission channels than equity flows — debt is associated with changes in the VIX as well as the global PMI,FN39 while equity is not—the magni- tude (and standard errors) of the coefficients on equity are generally larger than those for debt. Alternatively, although bond flows are liable to react to a wider range of possible QE transmission channels, equities react more strongly to the few channels to which they do react to 108 GLOBAL ECONOMIC PROSPECTS | June January 2013 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Table A1.4 Decomposition of gross financial inflows D1 D2 D3 D4 D5 D6 Portfolio Loans FDI Gross fund Bonds Equity Lagged inflows 0.261 0.307 0.597 -0.088 0.294 -0.011 (0.02)*** (0.02)*** (0.02)*** (0.04)** (0.03)*** -0.03 All QE 0.018 0.021 -0.003 0.061 0.015 0.044 episodes (0.01)*** (0.01)*** -0.01 (0.02)*** -0.02 (0.03)* Global financial-side conditions 3M T-bill -0.015 -0.004 0.004 -0.080 -0.089 -0.053 rate (0.01)** (0.01) (0.01) (0.02)*** (0.02)*** (0.03)** Yield curve -0.020 -0.002 0.005 -0.090 -0.065 -0.064 (0.01)*** (0.01) (0.01) (0.03)*** (0.02)*** (0.03)** VIX -0.002 0.000 0.000 -0.002 -0.006 0.000 (0.00)*** (0.00) (0.00) (0.00) (0.00)*** (0.00) Money supply 0.015 -0.071 0.056 -1.110 -2.120 -0.589 (M2) (0.19) (0.16) (0.26) (0.65)* (0.45)*** (0.66) Global real-side conditions Global PMI -0.001 -0.001 -0.001 0.008 0.003 0.004 (0.00) (0.00) (0.00) (0.01) (0.00) (0.01) Developing 0.004 0.000 -0.001 0.014 0.023 0.007 GDP growth (0.00)*** (0.00) (0.00) (0.01)*** (0.00)*** (0.01) High-income -0.001 0.002 0.004 -0.011 -0.017 -0.007 GDP growth (0.00) (0.00) (0.00) (0.01) (0.01)*** (0.01) Country-specific controls Interest rate 0.000 0.000 0.000 -0.001 -0.002 0.000 differential (0.00) (0.00) (0.00) (0.00) (0.00)* (0.00) Growth 0.001 0.001 0.000 0.001 0.000 -0.001 differential (0.00)* (0.00) (0.00) (0.00) (0.00) (0.00) GDP 0.009 0.110 0.070 -0.060 0.020 0.039 (0.03) (0.02)*** (0.04)* (0.09) (0.07) (0.08) Country insitutional 0.001 0.001 0.002 0.002 0.001 0.000 rating (0.00)*** (0.00)*** (0.00)** (0.00) (0.00) (0.00) Other controls Crisis period -0.002 -0.043 -0.005 0.024 -0.043 0.032 (0.01) (0.01)*** (0.02) (0.04) (0.03) (0.05) Post-crisis 0.024 -0.025 -0.010 0.038 -0.061 0.050 period (0.01)* (0.01)** (0.02) (0.05) (0.04) (0.05) Adj. R2 0.157 0.032 0.399 0.054 0.193 0.005 R2 (within) 0.164 0.037 0.403 0.07 0.203 0.018 R2 (between) 0.572 0.209 0.854 0.45 0.562 0.042 N (countries) 1,925 (60) 3,460 (85) 2,419 (63) 974 (31) 1,220 (39) 1,185 (37) Source: 109 GLOBAL ECONOMIC PROSPECTS | June January 2013 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Data description and technical note for the Vector Autoregressive analysis of capital Appendix 2. inflows to developing countries Model specification Inter-temporal interactions between global “push” factors, capital inflows and GDP growth in developing countries are modeled using a six-dimensional Vector Auto-Regressive (VAR) system, estimated over the pe- riod 2000Q1 to 2013Q2. The vector of endogenous variables consist of:  aggregate gross capital flows to developing countries as a share of their combined GDP - source: IFS / Bal- ance of Payment data;  Quarterly real GDP growth in both developing and “G4” countries (US, euro area, Japan and UK) - source Haver/ Datastream / National Statistical Offices;  “G4” short term interest rates (3 month money market rates) – source: Datastream  G4 yield curve (10 year government bond yields minus 3 month interest rates) - source: Datastream  The VIX index measuring the implied volatility of S&P 500 options - source: Datastream / Chicago Board Options Exchange Market Table A2.1 Descriptive statistics Regarding the lag selection procedures for the VAR, the Hannan and Quinn information criterion (HIC) and Schwartz bayesian information criterion (BIC) suggested one lag (Hannan-Quinn 1979, Schwarz 1978), but the Final Prediction Error and Likelihood Ratio test Statistics recommended two, while the Akaike infor- mation criterion (AIC) recommended four. A two period lag structure was decided upon, with all eigenvalues being significant less than one. A formal Johansen Test rejects the presence of co-integration, so the system was estimated the model was estimated as an unrestricted VAR. Table A2.2 VAR lag order selection criteria Sample 2000 Q1—2013 Q2 To compute impulse responses and variance decompositions, a structural identification was derived by im- posing a Cholesky decomposition on the covariance matrix. The Cholesky restrictions were imposed by or- dering the variables so that the first variable cannot respond to contemporaneous shocks (in the same quar- ter) of any other variables, the second one responds to contemporaneous shocks affecting only the first varia- ble, and so on. The following order was suggested by expected time lags in the reaction of “real” variables to financial shocks: ”G4” GDP growth, developing countries’ GDP growth, developing countries capital in- flows (in percent of GDP), the VIX index, G4 short-term interest rates and the yield curve (potentially re- sponding to all other variables in real time). 110 GLOBAL ECONOMIC PROSPECTS | June January 2013 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Figure A2.1 Impulse response Table A2.3 Variance decomposition 111 GLOBAL ECONOMIC PROSPECTS | June January 2013 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Interest rate assumptions and alternative scenarios Baseline scenario: QE Tapering by the US FED starts in 2014Q1 and has a very gradual effect. It adds 50bp to US long term interest rates by the end of 2015 and a cumulative 100bp by the end of 2016 (assuming that anticipation has already taken out half of the overall QE effect from May to November 2013). The ECB, Bank of Japan and Bank of England, start to unwind their own quantitative / qualitative policies in the course of 2015/16, adding 50bp to their long term yields by the end of the forecast horizon. Only the US Fed starts to increase policy rates by 2015Q2, from 0,25% to 2% by the end 2016. The ECB, Bank of Japan and Bank of England follow broadly the same tightening path, but a full year later. As a result, G4 long term interest rates are expected in the baseline to increase from 2.5% in 2013Q4 to 3.7% by end 2016. The corresponding “add factor” in the VAR equation under this baseline scenario is presented in Figure A2.2m, showing slightly positive residuals from the purely model-based prediction over the projec- tion horizon (10 to 15bp). “Fast normalization” and “overshooting” scenarios: "Fast normalization" is a scenario in which the unwinding of QE specific effects on the yield curve (100bp) is front loaded and happens within the first two quarters of 2014. The add factor to the yield curve equation is adjusted upwards in 2014Q1 and 2014Q2 by a cumulative 100bp, but is lowered back to zero afterwards. This assumes that only the timing of the adjustment is affected, but with an unchanged cumulative impact. The model is run on the alternative add factor series and simulations for all six endogenous variables reported as the “fast normalization” scenario. "Overshooting" is a scenario in which the yield curve steepens by a further 200bp compared to the baseline. In this context, the add factor to the yield curve is shifted upwards by a cumulative 200bp from the baseline, the model is run on the alternative add factor series and simulations for all six endogenous variables reported as the “overshooting” scenario Figure A2.2 G4 yield curve equation: residual / add factor under different normalization scenarios 1.4 1.2 Percent 1.0 "GEP" baseline 0.8 Fast normalization 0.6 Overshooting 0.4 0.2 0.0 -0.2 -0.4 -0.6 Source: World Bank 112 GLOBAL ECONOMIC PROSPECTS | June January 2013 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Appendix 3. Data description and technical note for Crisis risks in developing countries Data sources and coverage The analysis is based on the banking crisis data compiled by Laeven and Valencia (2012), which identifies 147 banking crisis in 162 countries for the period 1970–2011. The analysis focuses on the banking crisis in devel- oping countries by excluding the OECD country observations. Table A3.1 reports country and time coverage statistics. The primary data source for the explanatory variables are World Bank’s World Development Indi- cators (WDI) and Global Economic Prospects (GEP), the IMF’s World Economic Outlook (WEO), Interna- tional Finance Statistics (IFS), and Direction of Trade Statistics (DOTS), and the Bank of International Settle- ments (BIS) datasets. Table A2.1 reports the definition of the variables and data sources. Table A3.1 Countries in estimation samples (Number of time-series observations on the right) Country Name Obs. Country Name Obs. Country Name Obs. 1. Albania 10 41. Guinea-Bissau 5 81. Rwanda 20 2. Algeria 4 42. Guyana 17 82. Senegal 20 3. Angola 9 43. Haiti 10 83. Seychelles 23 4. Argentina 11 44. Honduras 23 84. Sierra Leone 20 5. Armenia 10 45. India 20 85. Solomon Islands 22 6. Azerbaijan 10 46. Indonesia 20 86. South Africa 14 7. Bangladesh 20 47. Jamaica 17 87. Sri Lanka 20 8. Belarus 10 48. Jordan 20 88. St. Lucia 23 9. Belize 21 49. Kazakhstan 9 89. St. Vincent and the Grenadines 23 10. Benin 20 50. Kenya 18 90. Sudan 23 11. Bolivia 14 51. Kyrgyz Republic 8 91. Syrian Arab Republic 23 12. Botswana 23 52. Lao PDR 12 92. Tanzania 16 13. Brazil 13 53. Latvia 10 93. Thailand 20 14. Bulgaria 10 54. Lebanon 3 94. Togo 20 15. Burkina Faso 11 55. Lesotho 20 95. Tunisia 20 16. Burundi 17 56. Lithuania 11 96. Turkey 14 17. Cambodia 11 57. Macedonia, FYR 9 97. Uganda 13 18. Cameroon 17 58. Madagascar 17 98. Ukraine 7 19. Cape Verde 20 59. Malawi 23 99. Uruguay 14 20. Central African Republic 6 60. Malaysia 20 100. Vanuatu 23 21. Chile 23 61. Mali 20 101. Venezuela, RB 20 22. China 20 62. Mauritania 2 102. Vietnam 9 23. Colombia 16 63. Mauritius 9 103. Yemen, Rep. 10 24. Comoros 9 64. Mexico 20 104. Zambia 14 25. Congo, Dem. Rep. 4 65. Moldova 10 26. Congo, Rep. 19 66. Mongolia 9 27. Costa Rica 17 67. Morocco 15 28. Cote d'Ivoire 20 68. Mozambique 15 29. Dominica 22 69. Nepal 20 30. Dominican Republic 20 70. Nicaragua 13 31. Ecuador 20 71. Niger 23 32. Egypt, Arab Rep. 23 72. Nigeria 20 33. El Salvador 14 73. Pakistan 23 34. Ethiopia 23 74. Panama 13 35. Gabon 20 75. Papua New Guinea 19 36. Gambia, The 14 76. Paraguay 15 37. Georgia 8 77. Peru 17 38. Ghana 17 78. Philippines 20 39. Guatemala 23 79. Romania 8 40. Guinea 11 80. Russian Federation 7 113 GLOBAL ECONOMIC PROSPECTS | June January 2013 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY Table A3.2 List of Variables Used in the Regression Analysis Variable Definition Source Dependent Variable Banking crisis Indicator variable that equals 1 if the country Laeven and Valencia experiences a systemic banking crisis for the first year (2012) Explanatory Variables Global Variables Global risk Volatility Index (VXO) calculated by the Chicago Datastream Board Options Exchange, in annual inter-quartile range Global interest rate Change in global interest rate give by the first IFS principal component of the G4 (US, UK, Japan, and EU) long-term interest rates Global liquidity M2 as a share of GDP in US Datastream Global growth First principal component of G4 real GDP growth Datastream Agricultural Commodity Price index Global commodity price index GEP Energy commodity price index Global commodity price index GEP Contagion Variables Openness Exports plus imports as a share of GDP WDI Trade linkage Bilateral trade (export plus import) as a share of DOT total exports, mulitplied by a dummy variable that equals =1 if the trade partner experiences a banking crisis Financial linkage External position vis-à-vis BIS Reporting Banks as BIS a share of GDP Regional contagion Dummy variable that equals 1 if the country in the WDI same region experiences a banking crisis Domestic Variables External debt Total external debt as a share of GDP WDI Current account balance Change in current account balance as a share of GDP WDI, WEO over last 5 years Short term debt Short term external debt plus amortization due WDI, WEO, IFS within a year as a share of total external debt Domestic credit growth Change in domestic credit as share of GDP over last WDI 5 years Inflation Cchange in the consumer price index WDI, WEO Per capita GDP growth Growth rate of real per capita GDP WDI Import cover Reserves as a multiple of monthly imports WDI, WEO, IFS, GEP Ratio of M2 to reserves M2 as a share of total reserves WDI, IFS Fiscal blance Net borrowing/ lending by the government as a WDI, WEO share of GDP REER overvaluation Real effective exchange rate minus long term trend WDI, GEP (estimated by 10 year moving average) Empirical methodology In line with the literature, we estimate the relationship between the onset of banking crisis and the global, contagion, and domestic factors using a pooled probit model: PCrisisit Wt 1 , X it 1 , Z it 1   F  Wt 1   X it 1   Z it 1  where P(.) is the probability that a country i will be in banking crisis in time t, conditional on global factors W, contagion factors X, and domestic factor Z. F (.) is the standard normal distribution function that transforms a linear combination of the explanatory variables into the [0,1] interval. A pooled regression involves pooling observations across country- and time-dimensions such that a unit of 114 GLOBAL ECONOMIC PROSPECTS | June January 2013 2014 PRELIMINARY DRAFT: DO NOT CITE AND DO NOT COPY observation becomes a country-year, not a country. To allow for the fact that same countries are repeatedly observed in the sample, such that errors in the model are not iid, we use robust standard errors with clusters, where the cluster is defined as a country, to allow errors of a given country to be correlated over time. We exclude observations three years following each crisis observation for a given country to avoid double counting and endogeneity. In all estimations, we also use lagged explanatory variables to reduce endogeneity concern. Similar approach has been used by Eichengreen et al (1996, 1998, 2000) and Forbs and Warnock (2011). The general to specific approach is applied to arrive at the final probit specifications. Results are re- ported in Table [A3.3]. Column 4 in Table [A3.3] evaluates the relative importance of all three sets of factors. The results generally confirm the strong influence of both global and domestic factors in the onset of banking crisis found in the separate models (columns 1–3), although not all factors remain significant in the combined model. A consoli- dated model, applying the general-to-specific method to eliminate the insignificant variable for later analyses, is reported in column 5. The general-to-specific modeling refers to the process of simplifying initially general (over-parameterized) model that adequately characterizes the empirical evidence within a theoretical frame- work and reducing the number of variables and parameters to be estimated to achieve greater statistical effi- ciency without causing significant problems of model misspecifications and omitted variable bias. Central aspects of this approach includes the model selection procedures based on across-model comparison and parameter constancy, as well as evaluation of selection criteria such as adjusted pseudo-R squares, Akaike In- formation Criterion (AIC), and Bayesian Information Criterion (BIC), all of which are reported in the bottom of Table [A3.3]. Given two models, a higher adjusted pseudo-R2, or a smaller AIC or BIC indicates a better- fitting model. In the final version of the model (column 5), all the significant impact of global and domestic variables re- mains. Among the global factors, we continue to find the strong influence of low global risk aversion, high global liquidity, and rising global interest rates. The positive coefficient on the global liquidity and long term interest rate and the negative coefficient on the global risk variable are all consistent with a view that crises in individual developing countries tend to be preceded by periods of ample liquidity and suppressed risk. The positive coefficient on the agricultural commodity prices is consistent with the argument by Reinart and Rogoff (2009) who find that commodity booms tend to increase the likelihood of a crisis, while the negative and significant coefficient on energy price remains a puzzle—possibly relating to the relative persistent of momentums in energy price compared to year-on-year volatility in agricultural commodity prices as discussed as discussed earlier. Most contagion variables are not statistically significant, although the trade linkages varia- ble (the share of trade with other countries that are in crisis) remain significant. Among the domestic factors, a high external and short-term debt, rapid growth in domestic credit, low levels of international reserves, and overvaluation in real exchange are all significantly associated with heightened risk of banking crisis, with ex- pected signs. Bottom of Table [A3.3] reports alternative measures of predictive accuracy of the models: Percent of Correct Positive – Let pj be the predicted probability of a positive outcome and yj be the actual outcome (0 or 1). Let c be the cutoff value which we specify as equal to the observed risk of positive outcome in the estimation sample. A prediction is classified as “positive” if pj >= c, and classified as “negative” other- wise. Percent of Correct Positive is the fraction of yj=1 observations that are correctly classified as “positive” (pj>=c). This is also known as “sensitivity” of the model. Percent of Correct Negative – This is the fraction of yj=0 observations that are correctly classified as “negative” (pj