46820 Global Economic Prospects Commodities at the Crossroads 2009 Global Economic Prospects Global Economic Prospects Commodities at the Crossroads 2009 © 2009 The International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org E-mail: feedback@worldbank.org All rights reserved 1 2 3 4 12 11 10 09 This volume is a product of the staff of the International Bank for Reconstruction and Development / The World Bank. The findings, interpretations, and conclusions expressed in this volume do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: pubrights@worldbank.org. ISBN: 978-0-8213-7799-4 eISBN: 978-0-8213-7801-4 DOI: 10.1596/978-0-8213-7799-4 ISSN: 1014-8906 Cover photos: Oil platform worker in Urucu, Brazil by Hervé Collart/Corbis (left); Molten steel being poured in Tangshan, China by Yang Liu/Corbis (top right); Farmers in Kenya by Curt Carnemark/The World Bank (bottom right) Cover design: Critical Stages The cutoff date for the data used in this report was November 20, 2008. Dollars are current U.S. dollars unless otherwise indicated. Contents Foreword xi Acknowledgments xiii Abbreviations xv Overview 1 Chapter 1 Prospects for the Global Economy 15 Financial markets 19 Outlook for high-income OECD countries 24 Outlook for the developing countries 27 World Trade 36 Commodity markets 39 Key risks and uncertainties 45 Long-term prospects and poverty forecast 46 Chapter 2 The Commodity Boom: Longer-Term Prospects 51 Characteristics of the current commodity price boom 53 The roots of the boom in commodity prices 57 Long-term demand prospects 64 Long-term supply prospects 74 Projections 85 Conclusions 89 Chapter 3 Dealing with Changing Commodity Prices 95 Commodity dependence and growth 98 Managing primary commodity booms 102 Poverty impacts of higher commodity prices 113 Dealing with high food and fuel prices 121 The international response to high commodity prices 127 Conclusions 131 Technical Annex: Sensitivity Analysis 132 v C O N T E N T S Appendix: Regional Economic Prospects 141 East Asia and the Pacific 141 Europe and Central Asia 147 Latin America and the Caribbean 153 Middle East and North Africa 159 South Asia 166 Sub-Saharan Africa 171 Figures O.1 The recent commodity boom was the largest and longest of any boom since 1900 4 O.2 Real commodity prices in local currency units increased by between 75 and 150 percent but have fallen since 4 O.3 Slower growth should ease commodity demand 5 O.4 Technological progress has reduced the quantity of commodities used per unit of GDP 5 O.5 Oil prices are having a direct impact on food prices 8 O.6 On average, poor countries are dependent on commodities but relatively resource poor 9 O.7 Primary commodity exporters are exhibiting fewer signs of the behaviors linked to the “resource curse” 10 O.8 Exchange rates, inflation, and government expenditures in new versus established oil exporters, 2001–06 10 1.1 GDP growth 18 1.2 Emerging market equities are hit hard as turbulence evolves to crisis 22 1.3 Emerging-market bond spreads widen, especially for corporates 22 1.4 Private debt and equity flows decline by a third in 2008 23 1.5 Change in GDP in the United States, Europe, and Japan 25 1.6 The contribution of U.S. domestic demand to GDP growth 25 1.7 U.S. household wealth falls sharply in the last quarters 26 1.8 GDP to decline across the OECD 26 1.9 East Asian countries show steep falloff in output growth 27 1.10 Output growth in Latin America, South Asia, and Europe and Central Asia is fading 28 1.11 Investment was the driving force for growth in developing countries 28 1.12 Developing-country GDP growth is expected to fall below 5 percent in 2009 30 1.13 Headline inflation is easing across industrial countries 30 1.14 Inflation in emerging markets surged on higher food and energy prices 30 1.15 Key developments in 2008 for East Asia and the Pacific 33 1.16 Sovereign bond spreads widen across Europe and Central Asia 33 1.17 In Latin America and the Caribbean, current accounts of largest economies diverge 34 1.18 Oil revenues, recovery from drought underpin growth in the Middle East and North Africa in 2008 35 1.19 South Asian production slips in the last months 36 1.20 In Sub-Saharan Africa, primary commodity exports increased as prices surged 36 1.21 World trade is expected to decline in 2009 for the first time since 1982 37 vi C O N T E N T S 1.22 Decline in high-income import growth affects developing-country exports 37 1.23 Developing-country exports have been strong, even outside China 37 1.24 Developing-country current account surpluses to wane after 2008 38 1.25 Current account balances for commodity-exporting and -importing developing-country groups (excluding China) 39 1.26 Almost all currencies have depreciated against the dollar 39 1.27 Commodity prices surged before retreating in the second half of 2008 40 1.28 Crude oil prices correct sharply after unprecedented run-up 40 1.29 Grains prices show sharp declines from recent peaks 43 1.30 Most vulnerable countries will benefit from the decline in grains and oil prices 45 1.31 First-round income impact of lower commodity prices will be positive in more than half of developing countries 45 1.32 Revised poverty estimates following from new price survey 49 2.1 The recent commodity boom was the largest and longest of any boom since 1900 55 2.2 The real local currency price of commodities rose much less than the real dollar price 56 2.3 Oil and metal prices led this boom, with food prices rising only much later 56 2.4 Global growth lasted longer and was stronger during the recent commodity boom than in earlier ones 57 2.5 Dormant capacity helped keep oil prices low in the 1990s 59 2.6 Real spending by major American multinational oil companies declined by 60 percent in the 1980s 59 2.7 Global metal demand also fell during the transition 59 2.8 Real food prices were broadly stable in developing countries until mid-2007 61 2.9 Most of the decline in global grain stocks reflects lower stocks in China 63 2.10 Outside of China, only wheat stocks are unusually low 63 2.11 Demand for most commodities has grown less rapidly than GDP but more rapidly than population 64 2.12 The quantity of most commodities used per unit of GDP was declining until recently 65 2.13 Metal intensities have declined steadily in high-income countries but have reversed in China since 1993 69 2.14 Metal intensities in China are much higher than elsewhere 70 2.15 Weaker population growth should slow demand for food 71 2.16 Per capita grain demand tends to stop rising when income reaches around $5,000 72 2.17 Demand for edible oils grew much faster than population in Asia 72 2.18 Food crop prices have become sensitive to oil prices 73 2.19 Output of virtually all commodities has increased since 1965 74 2.20 Almost all of the additional oil supply since the 1970s has come from nontraditional sources 75 2.21 Rather than declining, known oil reserves keep rising 75 2.22 Gas reserves are almost as large as oil reserves 76 2.23 Agricultural productivity has been rising rapidly over the past 20 years 80 2.24 For key crops, most of the increase in output was due to increased yield, not increased area planted 81 2.25 Yield growth has decelerated recently 81 vii C O N T E N T S 2.26 The stock of unused but potentially arable land is enormous 82 2.27 Developing countries spend less on agricultural R&D than high-income countries 83 3.1 More-diversified developing countries grew more rapidly from 1980 to 2006 98 3.2 Poorer countries are more dependent on nonfuel primary commodities 98 3.3 On average, poor countries are dependent on commodities but relatively resource poor 99 3.4 Government spending by primary commodity exporters responded less to export booms in this decade than in the 1980s 103 3.5 Public expenditures in Sub-Saharan Africa grew much less quickly in the 2000s than in the 1980s 103 3.6 Oil-exporting countries with large reserves spent a smaller portion of their revenue from the recent boom in oil prices, 2000–06 105 3.7 Imports and current account positions suggest more savings from commodity revenues by oil exporters than by nonfuel commodity exporters 106 3.8 Primary commodity exporters limited the real appreciation of their currencies during the recent boom 107 3.9 Many oil exporters are suffering significantly higher inflation 107 3.10 New oil exporters are experiencing more macroeconomic volatility than established producers 108 3.11 Commercial bank lending to commodity-dependent economies in Sub-Saharan Africa is rising 108 3.12 Corruption is highest among fuel exporters, although the difference has narrowed 109 3.13 The increased grain bill could exceed 5 percent of GDP in more than 20 countries 116 3.14 Real food prices in developing countries rose less than prices of internationally traded foods 119 3.15 Developing countries have responded to rising food prices with a variety of policies 122 3.16 Countries have tended to expand cash transfers and school feeding programs when responding to higher food prices 122 3.17 After India banned rice exports, international prices rose 124 A1 GDP growth eases in several East Asian economies 142 A2 Export growth in East Asia turns down on falling OECD demand 143 A3 Exchange rates decline sharply as carry trades unwind 144 A4 Gross capital inflows to East Asia contracted 40 percent in 2008 144 A5 Deepening global financial crisis affects Europe and Central Asia 148 A6 Core inflation is rising in several countries of Europe and Central Asia 152 A7 Contributions to GDP growth in Latin America and the Caribbean 153 A8 Bond spreads have increased sharply for many Latin American countries 155 A9 Exchange rates in Latin America and the Caribbean fell sharply against the dollar in late 2008 155 A10 Inflation still high in Latin America and the Caribbean despite sharp falloff in food and fuel prices 156 A11 Current account positions in the Middle East and North Africa set to shift dramatically 161 A12 Markets in the Middle East and North Africa are hard hit by financial crisis 161 viii C O N T E N T S A13 Inflation rises across the Middle East and North Africa 162 A14 Notable slowing of growth across the Middle East and North Africa in 2009 166 A15 Key international finance links in South Asia, 2007 169 A16 Bond spreads for African countries jumped after mid-September 173 A17 African headline inflation jumps as food prices skyrocket 174 A18 Economic growth to slow in Sub-Saharan Africa 178 Tables O.1 Food price hikes and consumption shares vary by region 11 O.2 Higher food prices have increased both the incidence and severity of poverty worldwide 12 1.1 The global outlook in summary 17 1.2 High-income OECD countries: growth and related indicators 25 1.3 Developing regions: growth and related indicators 29 1.4 Forecast of commodity prices 40 1.5 Poverty in developing countries by region, selected years 47 2.1 Principal characteristics of major commodity booms 55 2.2 Comovement among major commodity prices, 1960–2007 60 2.3 Impact of a 10 percent increase in incomes on commodity demand 65 2.4 Modern goods make less intensive use of commodities 65 2.5 Fundamental economic factors drive future commodity demand 66 2.6 Energy demand is projected to slow in the baseline scenario 69 2.7 Energy demand could decline further under more aggressive climate change policies 69 2.8 Developing countries will account for most of the projected demand for various foods, 2000–30 72 2.9 Historically, estimates of oil reserves have kept pace with production 76 2.10 Increased investment has stabilized reserve-to-production ratios for some commodities 77 2.11 Oil’s share in global energy supply is projected to decline 78 2.12 Potential gains from extending the green revolution remain large 82 2.13 With some exceptions, yield growth for key agricultural commodities has been highest in South and East Asia 83 2.14 Agricultural sector simulation results, 2005–30 86 2.15 Energy sector simulation results, 2005–30 87 3.1 Non-oil or resource-rich countries have higher per capita incomes than resource- dependent countries, 2006 99 3.2 Ratios of reserves to production vary greatly among oil exporters 105 3.3 Assets in sovereign wealth funds grow in commodity-exporting countries 107 3.4 Country studies suggest that high oil prices have large poverty impacts 115 3.5 Higher food prices raise poverty more in urban areas than in rural areas 117 3.6 Observed real price shocks and food shares of consumption vary across developing regions 119 3.7 Poverty effects of the changes in relative food prices 120 3.8 Fiscal costs of selected antipoverty measures vary widely 122 3.9 Increasing rice self-sufficiency can be more costly than relying on imports 124 3A.1 Sensitivity analysis 132 A1 East Asia and Pacific forecast summary 142 ix C O N T E N T S A2 East Asia and Pacific country forecasts 146 A3 Europe and Central Asia forecast summary 148 A4 Europe and Central Asia country forecasts 151 A5 Latin America and the Caribbean forecast summary 154 A6 Latin America and the Caribbean country forecasts 158 A7 Middle East and North Africa forecast summary 160 A8 Middle East and North Africa country forecasts 164 A9 South Asia forecast summary 168 A10 South Asia country forecasts 170 A11 Sub-Saharan Africa forecast summary 172 A12 Sub-Saharan Africa country forecasts 176 Boxes 1.1 Chronology of recent developments in the financial crisis 20 1.2 Commodity prices and inflation in developing countries 31 1.3 Impact of commodity prices on external balances and capital flows 41 1.4 The impact of the new price survey on poverty estimates 48 2.1 Commodity price cycles 54 2.2 Developing-country growth and global commodity demand in the recent past 58 2.3 The historical link between crude oil and other commodity prices 62 2.4 Alternative fuels for transportation 68 2.5 Understanding the rise in Chinese metal intensities 70 2.6 Declining costs of resource extraction 75 2.7 The rise of biofuel production 79 2.8 State-owned firms and output efficiency 80 2.9 Genetically modified crops—the next green revolution? 84 3.1 The impact of severe shocks on economic progress 100 3.2 Efforts to capture a larger share of windfall commodity revenues 104 3.3 Combating the corrupting influence of high commodity revenues 109 3.4 Successful sovereign wealth funds 110 3.5 National and international marketing strategies 111 3.6 Malawi government hedging of maize price and supply risks, 2005–08 113 3.7 Critical assumptions underlying the estimation of the poverty impact of food price increases 118 3.8 Conditional cash transfers are most effective in getting money to the poor 126 3.9 Removing fuel subsidies in Ghana 127 3.10 The international response to rising food prices 128 x Foreword E ACH YEAR, Global Economic Prospects developing countries and the possibility that explores critical “here and now” eco- serious crises may emerge. nomic developments relevant to low- While the measure of that slowdown and its and middle-income countries. Past editions near-term implications for growth and incomes have examined the sustainability of developing- are important, governments in developing country growth over the long term, importance countries also need to be mindful of the longer- for developing countries of international and term implications of their policy response. regional trade liberalization, and migration Thus, while countercyclical policy may help re- and remittances. Last year’s report looked at duce the short-term costs of the slowdown, the pace and determinants of technological care must be exercised to react prudently so as diffusion in developing countries. not to endanger longer-term fiscal sustainabil- This year’s Global Economic Prospects ity and growth prospects. For as serious as the finds the global economy at a crossroads, coming slowdown may be, developing-country transitioning from a sustained period of very growth is expected to recover after the crisis is strong developing country–led growth to one over. of substantial uncertainty as a financial crisis Commodity markets have seen spectacular rooted in high-income countries has shaken fi- swings over the past 24 months as enormous nancial markets worldwide. Commodity mar- tensions first built up and were then released. kets too are at a crossroads with the very high The extended and sharp rise in commodity prices of 2007 and early 2008 having fallen by prices prompted concerns that the world was more than half in many instances. transitioning into a new phase of commodity Great uncertainty surrounds the implica- scarcity—a concern that the recent dramatic tions of this crisis for developing countries. Ini- drop in commodity prices has only partially tially, the repercussions for developing coun- alleviated. Long-term supply and demand tries of the financial turmoil that characterized prospects for commodities suggest that while 2007 and the first half of 2008 were limited. commodity prices are likely to be higher than However, since September 2008, the intensifi- they were during the 1990s and early 2000s cation of the banking crisis, the collapse of sev- (when they were depressed by excess supply), eral global financial players, and the sharp in- the recent peaks that have been observed are crease in emerging market bonds spreads have unlikely to be the new norms. Over the long dramatically altered the outlook for develop- run, demand for commodities is not expected ing countries. These events constitute the kind to outstrip supply. Even though per capita in- of disorderly adjustment that has been dis- comes in developing countries are expected to cussed in previous reports as a risk. continue rising rapidly, population growth is Materialized, it implies a sharp slowdown for slowing and with it global GDP growth. As a xi F O R E W O R D result, the pace at which commodity demand global growth) have declined. However, expands should also ease. Assuming that effi- countries with new-found commodity wealth ciency with which commodities are both em- or newly independent commodity-rich states ployed and produced continues to improve as have not shown similar restraint and may it has done over the past few decades, supply encounter more difficulties during the current should keep pace with demand. downturn. However, policy will need to be supportive Higher food prices are estimated to have if such a positive result is to materialize. In increased global poverty by some 130–155 particular, agricultural yields have declined in million people. Most countries responded to recent years. Unless governments in develop- the food crisis by expanding existing social ing countries and aid agencies take concrete safety net programs, which made good sense steps to increase investment in rural infra- given the profound and long-term conse- structure, agricultural research and develop- quences that increased malnutrition could ment, and agricultural extension services, it is generate. However, in many instances the re- possible that global agricultural productivity sponse was poorly targeted and expensive. growth will slow. Higher food prices would Now that food prices are declining, countries follow and many countries that are now self- need to take steps to revamp their social wel- sufficient in food (notably those that still have fare systems so that they are better targeted fast growing populations) would become large and that the next time a similar crisis comes net importers of food. On the energy side, along, additional spending will be more effec- policies to combat carbon emissions would tive in limiting poverty impacts. help slow the depletion of hydrocarbon re- At the international level, steps need to be sources, by speeding both demand-side and taken to prevent producing countries from ex- supply-side substitution toward cleaner energy acerbating shortfalls by introducing export sources. If successful in slowing global warm- bans or by withholding stocks from the global ing, these could also help prevent the very market. An international scheme to share in- large agricultural productivity losses predicted formation about private and public stocks and by some in the second half of this century. coordinate their management during times of The recent boom in commodity prices has crisis is worth pursuing. Similarly, funding for challenged policy makers in both producing international food aid programs should be and consuming countries. Encouragingly, made more predictable and agencies should be commodity producers appear to have man- endowed with a line of credit that would aged their windfall revenues more prudently allow them to respond rapidly to future food than in the past. Instead of expanding spend- emergencies in a way they cannot at present. ing programs in line with increased revenues, many have saved a much larger share of these Justin Yifu Lin revenues—reducing the likelihood that they Senior Vice President and will need to cut back spending in a procyclical Chief Economist manner now that commodity prices (and The World Bank xii Acknowledgments T HIS REPORT WAS produced by staff from the World Bank’s Development Prospects Group. Andrew Burns was the lead author and manager of the report, with direction from Uri Dadush. The principal authors of the report were John Baffes, Donald Mitchell, Elliot (Mick) Riordan, Shane Streifel, Hans Timmer, and William Shaw. The report was produced under the general guidance of Justin Yifu Lin. Several people contributed substantively to chapter 1. Elliott (Mick) Riordan and Hans Timmer were its main authors. The Global Trends Team, under the leadership of Hans Timmer, was responsible for the projections. The projections and regional write-ups were produced by Teng Jiang, Annette De Kleine, Elliot (Mick) Riordan, Cristina Savescu, and Ani Silwal in coordina- tion with country teams and the offices of the regional Chief Economists and PREM directors including Luca Barbone, Marcello Guigale, August Kouame, Ernesto May, Vikram Nehru, Ritva Reinikka, Sudir Shetty, and Augusto de la Torre. The short-term commodity price forecasts were produced by John Baffes, Betty Dow, Donald Mitchell, and Shane Streifel. The remittances fore- casts were produced by Sanket Mohapatra, while Shaohua Chen from the Development Research Group and Dominique van der Mensbrugghe generated the long-term poverty forecast. John Baffes, Andrew Burns, William Shaw, and Shane Streifel were the main authors of Chap- ter 2, with written contributions from Donald Mitchell, Marian Radetzki, Varun Kshirsagar, Denis Medvedev, and Dominique van der Mensbrugghe. Chapter 3 was written by Donald Mitchell and William Shaw with written contributions from Ataman Aksoy, Margaret Grosh, and Rafael de Hoyos Navarro. Both Chapters 2 and 3 benefited from the expert research assistance of Varun Kshirsagar and Teng Jiang. The accompanying online publication, Prospects for the Global Economy (PGE), was produced by a team led by Cristina Savescu and comprised of Sarah Crow, Betty Dow, Kathy Rollins, Ani Silwal, Cybele Arnaud, and Ying Yu with technical support from Gauresh Rajadhyaksha. The translation process was coordinated by Jorge del Rosario (French and Spanish) and Li Li (Chinese). A companion pamphlet highlighting the main messages of the commodities section of the report was prepared by Kavita Watsa and Roula Yazigi. Several reviewers offered extensive advice and comments throughout the conceptualization and writing stages. These included Charles Blitzer, Christopher Delgado, Sebastien Dessus, Christopher Gilbert Sheldon, Santiago Herrera, Justin Yifu Lin, William Maloney, William Martin, Celestin Monga, Vikram Nehru, Marian Radetzki, Ana Revenga, Alexander Sarris, Katherine Sierra, Luiz Pereira da Silva, Claudia Paz Sepulveda, and Daniel Villar. Marty Gottron edited the report. Hazel Macadangdang managed the publication process and Merrell Tuck-Primdahl managed the dissemination activities. Book design, editing, and production were coordinated by Aziz Gökdemir of the World Bank’s Office of the Publisher, along with Stephen McGroarty, Denise Bergeron, Andrés Meneses, and Susan Graham. xiii Abbreviations ASEAN Association of South Eastern Asian Nations CEE Central and Eastern European countries CIS Commonwealth of Independent States CPI consumer price index EMBI Emerging Markets Bond Index EMBIG Emerging Markets Bond Index Global EU European Union FDI foreign direct investment FSU former Soviet Union GCC Gulf Cooperation Council GDP gross domestic product GFRP Global Food Crisis Response Program GIDD Global Income Distribution Dynamics Model IDA International Development Association (World Bank) IEA International Energy Agency IMF International Monetary Fund IPO initial public equity offering LSMS Living Standards Measurement Survey MSCI Morgan-Stanley Composite Index OECD Organisation for Economic Co-operation and Development OPEC Organization of Petroleum Exporting Countries PPP purchasing power parity PCSC Programme Complémentaire de Soutien à la Croissance RIGA Rural Income-Generating Activities saar seasonally adjusted annualized rate toe tonne of oil equivalent UAE United Arab Emirates USD U.S. dollar WFP World Food Programme xv Overview T he release of this year’s Global Economic Prospects finds the world economy at a crossroads. Markets all over the world are en- The global financial crisis threatens short- term prospects in developing countries The banking crisis that erupted in September gulfed in a global economic crisis, with stock 2008, following more than a year of less acute markets sharply down and volatile, almost all financial turmoil, has substantially reinforced currencies having depreciated substantially the cyclical downturn that was already under against the dollar, and risk premiums on a wide way. Following the insolvency of a large num- range of debt having increased by 600 or more ber of banks and financial institutions in the basis points. Commodity markets too have United States, Europe, and the developing turned a corner. Following several years of in- world, financial conditions have become crease, prices have plummeted, and although much tighter, capital flows to developing well above their 1990s levels, they have given countries have dried up, and huge amounts of up most of the increases of the past 24 months. market capitalization have evaporated. Chapter 1 of this report examines the The crisis began in high-income countries, medium-term implications of this crisis for but developing countries have been caught up developing-country growth, inflation, and in its wake. As of mid-November, developing- world trade. Chapter 2 looks at longer-term country equity markets had given up almost all supply and demand prospects in commodity of their gains since the beginning of 2008 and markets. It takes into account the long-term initial public offerings had disappeared. Risk growth prospects of developing countries premiums, which had risen to more than 800 and their rising share in world GDP (gross basis points on sovereign bonds and 1,000 on domestic product), the declining quality of commercial debt, have declined but remained new pools of resources, and the influence well above 600 basis points in every of technology on both demand and supply. developing region. As corporate bonds had Finally, chapter 3 reports on the poverty im- been one of the most important source of pacts of high commodity prices and examines developing-country finance, these developments the effectiveness of policies in both produc- suggest that a sharp slowing in developing- ing and consuming countries in dealing with country investment growth is to be expected. the challenges posed by periodic bouts of Bank lending and foreign direct investment in- high commodity prices. flows were also down, but less dramatically. This report does not deal with water, fish, The increased volatility and losses emanating or timber, all commodities of critical impor- from the banking sector have caused investors tance to developing countries and the globe worldwide to sell stocks and increase their but which fall outside the scope of this report holdings of less risky assets, notably U.S. trea- either because of their public-goods character suries. As a result, the currencies of virtually or, in the case of timber, because of its treat- every developing country in the world has de- ment in a recent report (World Bank 2007). preciated vis-à-vis the dollar. 1 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Following a series of efforts by central banks At the same time, rising commodity prices and governments to resolve the growing crisis and tight capacity in many countries (following through liquidity injections and various ad years of very fast growth fueled by ample liq- hoc measures, policy makers have now acted uidity) caused both headline and core inflation forcefully to restore confidence in the interna- to pick up throughout the world, with headline tional banking system, including the partial inflation rising by some 5 percentage points nationalization of nine banks and trillions of among developing countries. Weaker growth dollars in rescue plans introduced by govern- and falling commodity prices have already ments in the United States and Europe and caused inflationary pressures to ease in some recent multilateral meetings to address weak- countries. However, the significant losses in real nesses in the global financial architecture. At income endured by many people in developing the time of this writing (November 20, 2008), countries and the still overheated state of some it is too soon to judge the effectiveness of these of their economies could generate second- measures in restoring confidence in the bank- round price increases that either push inflation ing system. However, they do constitute the higher or stabilize expectations at high levels. kind of forceful and credible action that has The combination of a relatively strong been needed, and interbank lending rates have first half and a much weaker second half is fallen substantially and although they remain expected to cause GDP growth to slow to 1.3 volatile, stock and bond markets have greeted percent in high-income countries and to 6.3 per- these measures favorably. cent in developing countries in 2008. The slow- Notwithstanding these steps, growth down is projected to intensify in 2009 because prospects for both high-income and develop- most of the real-economy side effects of the ing countries have deteriorated substantially, banking crisis will be felt in the final months of and the possibility of a very deep global reces- 2008 and the first two quarters of 2009. sion cannot be ruled out. The main mechanism for the slowdown in Even before the emergence of a full-blown both developing and high-income countries financial crisis in September 2008, global will be through investment, which for 2009 is growth showed significant weakening. Eco- expected to decline 3.1 percent in high-income nomic growth slowed sharply in Europe and countries. In developing countries, investment Japan and in many developing countries in growth is projected to slow sharply to 3.4 per- the second quarter of 2008. In the United cent in 2009 from more than 13 percent in States, the continued disruption in financial 2007. Because low-income countries have less markets and the fall in housing prices caused access to international capital markets, the domestic demand to fall in 6 of the past 12 slowdown will affect them mainly through in- quarters. However, strong export growth— direct mechanisms, including slower global driven in part by developing-country import growth, lower commodity prices, slackening demand—spared the U.S. economy from re- remittance receipts, and partial scaleback in cession until recently when its GDP declined aid flows. 0.3 percent in the third quarter of 2008. In Overall global GDP growth is projected to developing countries, overall GDP growth decline to 0.9 percent in 2009, with develop- also remained robust in the first half of the ing economies expanding by 4.5 percent—well year. However, slower growth in high-income below the 7.9 percent growth rate recorded in countries and the weakening of capital inflows, 2007. International trade should decelerate in combination with commodity-price- sharply, with global export volumes declining induced losses in real income, generated a for the first time since 1982. As a result, both sharp deceleration in industrial production, commodity prices and inflation are projected investment, and international trade beginning to ease, with oil prices averaging about $75 a in the third quarter. barrel in 2009 and food prices projected to 2 O V E R V I E W decline by about 23 percent compared with very serious. Global financing conditions their average for 2008. would deteriorate rapidly, and apparently This financial crisis and the expected sound domestic financial sectors could find abrupt slowing of global growth come at a themselves unable to borrow or unwilling to moment when developing countries consid- lend—both in international and domestic mar- ered as a whole are more vulnerable than they kets. Such a scenario would be characterized have been in the recent past. Higher commod- by a long and profound recession in high- ity prices have raised the current account income countries and substantial disruption deficits of many oil-importing countries to and turmoil, including bank failures and cur- worrisome levels (they exceed 10 percent of rency crises, in a wide range of developing GDP in about one-third of developing coun- countries. Sharply negative growth in a number tries), and after having increased substantially, of developing countries and all of the attendant the international reserves of oil-exporting repercussions, including increased poverty and developing countries are now declining as a unemployment, would be inevitable. share of their imports. Moreover, inflation is Although a receding concern, high inflation high, and fiscal positions have deteriorated in developing countries, remains a problem, es- both for cyclical reasons and because govern- pecially if the financial turmoil is resolved rela- ment spending has increased to alleviate the tively quickly. While global growth would still burden of higher commodity prices. slow in 2009 under such a scenario, the sub- Thus, even in the baseline scenario, where stantial policy stimulus that has been introduced the rapid equity declines of September and could cause growth in both developing and de- October are assumed to end and where credit veloped countries to surge in 2010, reigniting in- begins to thaw as recent policy actions im- flationary pressures and forcing a subsequent prove financial market confidence, a number tightening of policy and a second bout of slow- of developing countries are likely to be sub- ing growth. Policy in countries that currently jected to substantial strains, possibly including have large current account deficits and high in- bank failures and currency crises. In these very flation needs to be particularly vigilant. These uncertain circumstances, policy makers must economies continue to be vulnerable and in- place a premium on reducing the likelihood vestors skittish; under these conditions, their of domestic turmoil, by reacting swiftly and currencies are likely to remain particularly sen- forcefully to emerging difficulties, including, if sitive to changing market perceptions. necessary, seeking assistance from the Interna- tional Monetary Fund (IMF). The commodity market boom has come to an end Uncertainty continues to cloud the outlook The sharp rise in commodity prices over the While this sober outlook represents a likely past five years, like the earlier booms of the last outcome, a wide range of outcomes remains century, was associated with a period of strong possible. The financial turmoil could intensify economic growth (partly fueled by relatively further, sparking a prolonged credit crunch loose fiscal and monetary policy) and a period and global recession. A milder downturn is of global uncertainty, and it has generated also possible, if credit conditions do not dete- significant inflationary pressures. This most riorate as much as anticipated in the baseline. recent boom has been the most marked of the At the time of this writing, the possibility past century in its magnitude, duration, and that the situation in high-income countries will the number of commodity groups whose prices deteriorate substantially cannot be ruled out. have increased (figure O.1). Should credit markets fail to respond to the ro- The strength and duration of the boom bust policy interventions taken so far, the con- mainly reflected the resilience of GDP growth sequences for developing countries could be between 2003 and 2008. 3 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 two-thirds of the global increase in maize pro- Figure O.1 The recent commodity boom was duction went to biofuels. Although the initial the largest and longest of any boom since 1900 impact was confined to the maize market, as farmers switched land away from wheat and Real non-energy commodity prices, index (1977–79 5100) 380 soybean production to grow maize, the price of 1917 (just prior to WW I) these commodities also began to rise. Higher oil 330 1974 (first oil crisis) and fertilizer prices also increased food produc- 1951 (postwar rebuilding) 280 tion costs, especially in high-income countries 2008 (forecast) 230 where they can account for as much as 30 per- 180 cent of overall costs. This factor, plus biofuel de- mand for grains, has made the price for these 130 products much more sensitive to changes in oil 80 1900 1920 1940 1960 1980 2000 prices. Finally, a series of poor wheat crops in Australia compounded the situation, driving Source: Grilli and Yang (1988) for 1900 to 1947; World Bank for 1948 to 2008. down stocks and contributing to the price rise. In addition to these fundamental drivers, agricultural prices have been influenced both by In the oil and metals sector, the supply pres- increased investor interest in these commodities sures that built up over the past five years and as an asset class and by government policies, in- which drove prices to record heights stemmed cluding the decision by several countries to im- mainly from slow-growing supply capacity. pose export bans. All of these factors are driven That slow growing supply capacity resulted by forward-looking expectations and may have because for much of the 1990s rising demand exacerbated both the upward rise in prices dur- in the rest of the world was met by the slow reabsorption of idle capacity created follow- ing 2007–08 and their more recent decline. ing the 1980 oil shock and the collapse of demand in the former Soviet bloc when these Commodity prices are declining in formerly communist countries began to allo- response to slower GDP growth cate resources according to market signals. As Like earlier commodity booms, this one has a result of this idle capacity, prices remained come to an end. Prices in all commodity markets low in the oil and metals sectors and firms did have fallen sharply since July 2008 (figure O.2), not have the economic incentives to increase productive capacity. Furthermore, because of low prices and be- cause incremental demand was being met by this Figure O.2 Real commodity prices in local capacity, investment in the oil and metals indus- currency units increased by between 75 and 150 percent but have fallen since tries plummeted, and the sectors that supplied the inputs necessary for exploration and ex- Real local currency commodity price indexes, CPI-deflated (Jan. 2000 5 100) ploitation atrophied. That in turn created a mis- 300 Energy match between the underlying rate of growth of 250 supply capacity and demand. When the spare ca- pacity was exhausted in the early 2000s, supply 200 was no longer able to keep pace with strength- 150 Food ening demand, and prices began to rise. 100 The story in agricultural markets is different. Metals and minerals 50 Food-based demand for agricultural crops has Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. been relatively stable. However, diversion of 2000 2001 2002 2003 2004 2005 2006 2007 2008 food crops toward biofuel production has Source: World Bank. increased sharply. Between 2003 and 2007, 4 O V E R V I E W reflecting slower GDP growth, increased sup- Figure O.3 Slower population growth should plies and revised expectations. Because com- result in weaker GDP and commodity demand modity prices reflect forward-looking Growth of GDP, annual average (percent) expectations, the sharp slowing of growth that 6 is expected over the next year has caused Developing prices to decline rapidly even though the un- countries 5 Contribution High-income derlying supply and demand tensions are little 4 to GDP countries growth from Contribution changed from just a few months ago when population to GDP 3 growth these prices were close all-time highs. growth from per Some metals prices have already fallen to 2 capita incomes pre-boom levels and the dollar price of many 1 internationally traded foods has fallen back to their 2006 levels. While much weaker GDP 0 1990s 2000s 2015–30 growth is projected to cause commodity prices to ease further in the short run, they should Source: World Bank LINKAGES model. nevertheless remain higher than they were dur- ing the 1990s. Real food prices are projected to decline by 26 percent between 2008 and 2010, manufactured goods) has reduced the quantity energy prices to fall by 27 percent, and metals of metals and energy required to produce a prices to decline by 32 percent. unit of GDP by an average of 0.9 and 0.8 per- cent a year respectively (figure O.4). The food In the longer term, growth in the demand intensity of GDP has also declined as an in- for commodities should ease creasing share of the world’s population has The strength, breadth (in terms of the number of reached income levels where per person de- commodities whose prices have increased), and mand for basic food commodities is stable. duration of the current commodity boom have Beginning in the middle 1990s, the decline prompted speculation that the global economy in metals intensities began to reverse. That re- is moving into a new era characterized by rela- versal is explained almost entirely by increas- tive shortage and permanently higher (and even ing metal intensities in China, which began permanently rising) commodity prices. This outcome does not appear likely. Over Figure O.4 Technological progress has the next two decades, slower population reduced the quantity of commodities used growth and weaker (though still strong) income per unit of GDP growth are projected to cause trend global GDP Commodity intensity of demand index (1971 5 1.00) growth to ease (figure O.3) and, with it, the de- 1.10 mand for commodities. As discussed later, the 1.05 1.00 extent to which commodity demand does slow 0.95 and how easily supply is able to keep pace with 0.90 demand will very much depend on the policy 0.85 environment, the pace of technological change, 0.80 and external factors such as climate change. 0.75 0.70 Moderating demand for metals depends 1971 1977 1983 1989 1995 2001 critically on increased efficiency in China Energy Metals Over the past 50 years, a combination of con- Metals (excluding China) Food servation measures, technological change, and Source: World Bank calculations, using data from the World changes in the structure of global GDP (ser- Bureau of Metal Statistics, the IEA, and the FAO. vices tend to be less commodity-intensive than 5 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 in 1995 and grew even more sharply at the 75 percent in developing countries by 2050, beginning of the 2000s. The uptick in metals substantially reducing private transportation’s intensities was associated with the investment, dependency on liquid fuels. manufacturing, and export booms in that In the baseline scenario, demand for oil is country. Currently, metal intensity in China is expected to continue rising to around 114 mil- four times higher than in developed countries lion barrels a day (mb/d) by 2030 (compared and twice as high as in other developing coun- with 87 mb/d today). Energy demand is pro- tries. China’s metal intensities are expected jected to grow somewhat more quickly as coal, to stabilize in coming years and then begin to natural gas, and non-fossil-fuel energy sources fall as the country’s very high investment rate increase their share in total energy supply. The declines and the transitional shift in global extent to which this shift occurs will depend manufacturing capacity from high-income importantly on the policy environment. A countries to China slows. more proactive stance toward restraining car- Assuming China’s metal intensity stabilizes bon emissions could speed the pace at which and then falls in coming years, global demand alternative energies become economically for metals—which has outpaced GDP in recent viable and reduce the expected increase in years—should first realign itself with GDP reliance on coal-powered electrical plants. growth over the next few years and then decline further during the next decade, reaching about Over the next 20 years, supplies of 2.7 percent a year in the period 2015–30. extracted commodities are likely to remain ample Future energy demand depends on The pace at which the growth in supply capac- improving automobile efficiency ity in the oil and metals sectors catches up to Demand in the energy sector will depend demand will depend on how quickly capacity in critically on the pace at which energy effi- the heavy and specialized equipment and labor ciency continues to improve, especially in the supply sectors can be restored. Years of low transport sector. Since 1970 conservation ef- prices and weak investment have reduced forts and technological progress have reduced capacity in these sectors, and as a result, energy demand by 56 percent, compared with delivery times and costs of inputs have more a no-change scenario (IEA 2006). With some than quadrupled in many instances. High prices 75 percent of future energy demand expected for these components are speeding the allevia- to come from the transport sector, especially tion of these constraints. With the expected from developing countries, the pace of future slowing of global GDP growth and lower energy demand growth (and its composition) commodity prices, investment demand has will depend heavily on future efficiency gains eased and prices for these specialized investment in car technology. goods are expected to fall further. Nevertheless, Prospects for such improvements are good, deliveries are projected to continue trailing if policy continues to be supportive of both demand for some time, and prices will remain conservation and efficiency measures. Already relatively high for the next several years. existing technologies—available either in ini- Over the longer run, the price of extracted tial rollout phases or as prototypes (flex-fuel commodities should fall—although they are and hybrid cars, plug-in hybrids, and electric not expected to fall to their levels in the and hydrogen-powered vehicles)—could help 1990s. Higher prices than in the past will be to more than double fuel efficiency. An ambi- required to ensure that firms continue to in- tious (and successful) policy to speed the de- vest in new capacity. velopment and diffusion of these technologies Although the absolute quantity of fossil could see the share of these vehicles rise to fuels and metals in the earth’s crust is declin- 90 percent in the high-income world and to ing and the quantity that is extracted each 6 O V E R V I E W year is rising, there appears little likelihood demand for most primary food commodities that the world will run out anytime soon. His- no longer rises with income, demand for food is torically, proven reserves of both metals and expected to slow—broadly in line with weaker oil have tended to rise even more rapidly than population growth. However, the potential production, remaining surprisingly constant in role of biofuel demand for food crops greatly the case of oil at about 40 years of production. complicates the picture. Given today’s tech- In part, that is because measured reserves, nology, maize can be profitably transformed rather than being an accurate count of the re- into ethanol at oil prices in excess of $50 a sources remaining in the ground, bear a closer barrel. Above that price, every percentage resemblance to the inventory of product that point increase in the barrel price of oil causes firms can readily bring to the market. So long maize price to rise by 0.9 percent (figure O.5), as firms have ample “known reserves” for ex- which means the maize market is effectively pected future demand, they have little incen- tied to the oil market (this relationship is not tive to find more. statistically significant when oil is below $50 a As production increases and more known barrel). Moreover, because farmers have re- reserves are brought into service, additional sponded to high maize prices by increasingly reserves will likely be discovered. In general, growing maize in fields where they once grew these newer reserves tend to be of lower qual- wheat and soybeans, prices of these (and ity and higher cost than existing ones. How- other) commodities have also become increas- ever, historically improvements in extraction ingly sensitive to oil prices. technology have advanced quickly enough to Given that the energy market is much keep the cost of exploiting new sources stable larger than the market for maize (if all the or even falling, despite increased remoteness world’s maize were used to produce biofuels, and poorer quality. The projected long-term it would only meet 8 percent of energy de- price of a barrel of oil of $75 (real 2005 dol- mand), biofuel demand has the potential to lars) is based on the expectation that such a change permanently the nature (and price) price will be sufficient to incite additional of agricultural commodities. The International output from high-cost sources such as the Energy Agency (IEA), for example, suggests Canadian oil sands. that biofuel demand for grains could increase Even if certain resources do become scarce, by 7.8 percent a year over the next 20 years ample alternatives exist. For example, if the (compared with 1.2 percent annual increases pace at which new oil reserves are discovered for food demand). If this prognosis is borne declines, the rising price for oil will make out, 40 percent of global grain production alternative sources of energy (including coal, could be going to biofuels by 2030. natural gas, nuclear, and renewable alterna- It is probably premature to argue that the tives) more competitive and induce increased nature of these markets is permanently conservation and technological change. Simu- changed. On the one hand, technological im- lations suggest that if oil production fails to provements are likely to lower the cost of rise between now and 2030, oil prices might producing ethanol from maize (and sugar), double but most of the energy shortfall would which in turn will lower the threshold oil be met by increased coal and natural gas con- price above which these food crops become sumption—albeit at higher cost. sensitive to oil prices. However, technological change may also give rise to alternative Food demand will slow with lower sources of energy that make ethanol produc- population growth, but biofuels could tion from food crops uneconomic. Such expand crop demand very rapidly alternatives might include biofuels made from Because an increasing share of the world’s cellulose or other nonfood sources, solar population has reached income levels where power, or hydrogen-based systems. In these 7 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 cases, the new, stronger connection that has Figure O. 5 Oil prices are having a direct been created between the energy market and impact on food prices the grain markets would be broken, and food Oil price per barrel versus food price per ton prices would likely fall significantly. a. Soybeans vs. Crude Oil Prices Soybeans ($/ton) Strong productivity growth and unused 700 crop land should ensure adequate food 600 supply at the global level Food supplies are unlikely to fall short of de- 500 mand. Over the past 30 years, agricultural 400 productivity has improved much faster than 300 demand; as a result, agricultural output has 200 increased rapidly even as the share of agricul- tural workers in total employment has steadily 100 declined and prices fallen. 0 Longer-term prospects are somewhat 0 20 40 60 80 100 120 140 clouded by the gradual exhaustion of the easy Crude oil ($/bbl) productivity gains offered by the green revolu- b. Wheat vs. Crude Oil Prices tion. In addition, climate change threatens Wheat ($/ton) yields in many developing countries, although 500 most of this effect is not likely to be felt until after 2030. Assuming that policies are put 400 in place to expand infrastructure and facili- tate the diffusion of the new technologies 300 (including biotechnologies) that have sustained agricultural productivity in high-income coun- 200 tries, agricultural output should more than keep pace with food demand over the long term. 100 However, if developing countries are not 0 successful in combating recent trends for yields 0 20 40 60 80 100 120 140 to decline by increasing investment in rural Crude oil ($/bbl) agriculture and through the spread and adop- c. Maize vs. Crude Oil Prices tion of more productive seed varieties and farming techniques, there is a real risk that Maize ($/ton) many countries, notably in Africa (where pop- 350 ulation growth is expected to be faster), will 300 move from a position of being broadly self- 250 sufficient in food to being net food importers. 200 Most of the shortfall would be met by produc- tion from high-income countries, where pro- 150 ductivity growth has not slowed. 100 Even if biofuel demand increases substan- 50 tially, enormous potential exists for bringing additional (albeit lower productivity) land into 0 0 20 40 60 80 100 120 140 cultivation. That said, if biofuel-related de- Crude oil ($/bbl) mand for crops is much stronger or productivity Source: World Bank. performance disappoints, future food supplies may be much more expensive than in the past. 8 O V E R V I E W Simulations suggest that under these unfavor- for resource dependence to generate poor able circumstances, food crop prices could be as growth outcomes. These include: much as 30 percent higher than in the baseline scenario. • The tendency for government spending in resource-dependent countries to rise Commodity-producing countries are in booms and fall procyclically during managing the revenue windfall better than busts; they have in the past • The tendency for strong revenue inflows Historically, countries whose economies are to cause an excessive real appreciation heavily dependent on commodities exports of the currency that hurts the competi- have tended to grow less quickly than those tiveness of the nonresource sectors of with more diverse economies. This tendency the economy; and mainly reflects low GDP and underdevelop- • The tendency for large commodity- ment of their nonresource sectors rather than based revenues to foster rent-seeking the actual quantity of resources held by these behavior, corruption, and even political countries. Indeed, measured by per capita violence. value-added from resources, high-income countries tend to be more resource rich than Encouragingly, during the course of the re- developing countries, while their large nonre- cent commodity boom, fiscal spending in source sectors mean they are also less resource resource-dependent developing countries has dependent (figure O.6). been much more prudent than during earlier Resource dependence need not result in booms. Partly as a result, the currencies of slow growth. But to realize the potential of most countries have appreciated by less than resource wealth, governments need to avoid in the past. Moreover, corruption among com- following policies that exacerbate the tendency modity exporters has improved relative to diversified exporters (figure O.7), suggesting that perhaps this mechanism for reducing the Figure O.6 On average, poor countries are development potential of resource wealth has dependent on commodities but relatively been weakened as well. resource poor Exceptions include newly independent Value of per capita primary Share of primary commodity exporters or states with newly commodities in exports commodities in total (US$ thousands) merchandise exports (%) found resource wealth. Government spending 70 70 in these countries has kept pace with or even 60 60 exceeded export revenues, and their currencies 50 50 have appreciated much more strongly than 40 40 those with more experience of commodity booms (figure O.8). With prices now sharply 30 30 lower, such countries may be encountering 20 20 additional fiscal pressures. In addition, oil ex- 10 10 porters with relatively low reserves are not 0 0 saving significantly more than those with high Primary exports per capita Primary exports/exports (left axis) (right axis) reserves and, as a result, may be exacerbating the competitiveness problems of their non-oil Low-income Lower-middle-income countries countries sectors. That, in turn, could be creating a High-income Upper-middle-income future problem, because these countries, unlike countries countries those with ample reserves, will have to rely on Source: World Bank. their non-resource-based sectors to generate most of the growth in coming years. 9 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Figure O.7 Primary commodity exporters are Figure O.8 Exchange rates, inflation, and exhibiting fewer signs of the behaviors government expenditures in new versus linked to the “resource curse” established oil exporters, 2001–06 a. Government expenditures have increased by much less % change than export revenues 60 Percentage change in the share of GDP 50 New producers 8 40 Change in 30 6 exports/GDP Established producers 4 20 10 2 0 0 Ϫ10 Ϫ2 Real exchange Percentage Change in Change in government rate with US$ change in government Ϫ4 expenditures/GDP CPI, 2008 expenditure/ GDP, 2001–07 Ϫ6 1980s 2000s Source: World Bank and IMF data. Source: World Bank. Note: New producers are defined as countries dependent on oil that began production after 1985 or were established as a country b. The currencies of commodity exporters have appreciated after 1985, including Azerbaijan, Chad, Equatorial Guinea, modestly Kazakhstan, Sudan, and the Republic of Yemen (Turkmenistan lacks data for inflation and the real exchange rate). The Percentage change in trade-weighted real effective established producers include Algeria, Angola, Republic of Congo, exchange rate Gabon, Islamic Republic of Iran, Libya, Nigeria, Oman, and República Bolivariana de Venezuela. The real exchange rate with 10 the United States (rather than the trade-weighted real exchange rate as in figure 3.5) is reported here to include sufficient countries 5 for a useful comparison between the two groups. 0 a. Real exchange rate with the U.S. dollar, where increase Ϫ5 Recent boom indicates appreciation. Data for Equatorial Guinea are for 2001–04. Ϫ10 b. Percentage change in consumer price index in 2008. 1980s boom Ϫ15 c. Change in ratio of government expenditure to GDP from 2001 to 2007. Ϫ20 Non-oil exporters Oil exporters Source: IMF data; World Bank staff calculations. Note: Increase indicates appreciation. commodities, such as agricultural producers, where the benefits of high prices are less con- c. Corruption in commodity exporting countries has declined centrated. Encouragingly, much of the spend- ing appears to be directed toward investment Index goods, which should contribute to future 0.0 Better production potential. In a number of African Ϫ0.2 countries, however, investment spending has been financed by heavy bank borrowing, Ϫ0.4 which may pose significant problems as loans Ϫ0.6 Diversified exporters become due, now that commodity prices have Agricultural exporters declined and access to credit has become Ϫ0.8 much more difficult. Worse Oil and mineral exporters Ϫ1.0 1996 2006 High commodity prices pose challenges for Source: Kaufmann, Kraay, and Mastruzzi 2007; World Bank data. the poor, especially in consuming nations For consuming nations, high commodity In addition, spending from resource rev- prices pose a number of challenges. In the case enues in the private sector remains high. This of heavily traded commodities such as oil, is especially true for exporters of non-oil sharp price hikes can pose serious balance of 10 O V E R V I E W payment difficulties and increase the vulnera- Not all foods prices have risen by as much as bility of net importers. In the case of food the prices for rice, maize, and wheat, however. commodities, which are mainly consumed in Moreover, during 2007 and the first half of the same country in which they are pro- 2008, the dollar was depreciating so that local duced, the issue for most countries is one of a currency prices rose by less than the dollar transfer of wealth between producers and prices. As a result, the real-local-currency in- consumers. That said, some countries are sig- crease in the price of food actually consumed in nificant net importers of food and have suf- developing countries was much less than the fered significant balance of payment impacts 54 percent increase observed in internationally from high food prices as well. Both fuel and traded and dollar-denominated food prices food prices have boosted inflation and cut into (table O.1). Moreover, not all food consumed in real incomes in developing countries. poor countries is traded and the share of non- In general, economic policy should not re- traded foods in total consumption varies across sist changes in relative prices but should seek regions. In Africa, for example, real food prices to assist adjustment to changing circum- rose by an average of 8.3 percent, compared stances. However, the magnitude of the with 19.8 percent in the Middle East, which re- changes over the past several years has been lies much more heavily on imported foods. unusually large with important implications Overall, the rise in food prices between 2005 for inflation, balance of payments, and poverty and the beginning of 2008 is estimated to have in developing countries. Moreover, because increased the share of the population of East high food prices can increase malnutrition Asia, the Middle East, and South Asia living among the very poor, resulting in permanent in extreme poverty by 1 or more percentage cognitive and physical damage, even a tempo- points. Impacts in Africa were less pronounced rary but large hike in food prices demands a because food prices rose by less on average and prompt and well-targeted policy response. At the global level, the cost of higher food Table O.1 Food price hikes and consump- and fuel prices to consumers in developing tion shares vary by region countries during 2008 is estimated to have Food been about $680 billion. The price increases Price share among Region shock the poor had major macroeconomic effects. High oil prices increased current account deficits in a (percent) number of countries by as much as 5 percent Rural population of their GDP. Both food and fuel price in- East Asia and Pacific 12.4 71.5 Europe and Central Asia Ϫ0.2 63.4 creases have led to a sharp uptick in inflation. Latin America and the Caribbean 6.9 51.2 In addition, by increasing costs, the food and Middle East and North Africa 25.9 64.5 fuel increases have increased the number of South Asia 5.0 65.3 Sub-Saharan Africa 9.6 68.0 poor and the extent of their poverty. In gen- Developing world 6.7 66.1 eral, higher food prices have had a more pro- nounced effect on poverty, because households Urban Population in poor countries spend 50 percent or more of East Asia and Pacific 13.8 67.5 their income on food and only 10 percent on Europe and Central Asia Ϫ0.5 57.8 Latin America and the Caribbean 1.6 44.1 fuel. Moreover, for very poor households, food Middle East and North Africa 12.5 57.1 tends to claim an even higher share in expen- South Asia 4.8 64.4 ditures, and fuel a much lower share. Finally, Sub-Saharan Africa 4.9 53.0 the poverty impacts are likely to be more sig- Developing world 4.1 60.4 nificant because the demand for food is more Source: World Bank. Note: Price shocks differ between the rural and urban popu- inelastic than household demand for fuels, be- lations because of differing degrees of urbanization among cause the former can be replaced by biomass. countries included in the aggregates. 11 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 because a much larger share of the population the poverty line) increased by $38 billion, or 0.5 lives in rural areas. In general, rural dwellers percent of developing-country GDP. have been less seriously affected because, in ad- For the very poor, reducing consumption dition to being consumers, many are producers from already very low levels, even for a short and benefit from higher revenues. The impact period, can have important long-term conse- on the urban poor was much higher, increasing quences. Already, higher food prices during the incidence of poverty by more than 1.5 per- 2008 may have increased the number of centage points in East Asia, the Middle East, children suffering permanent cognitive and South Asia, and Sub-Saharan Africa (table O.2). physical injury caused by malnutrition by Overall the number of extremely poor is esti- 44 million. It is therefore critical that coun- mated to have increased by between 130 and tries react to higher food prices by increasing 155 million, and the poverty deficit (the annual the assistance they make available to those cost of lifting the incomes of all of the poor to most at risk. Most countries have reacted to the hike in Table O.2 Higher food prices have food and fuel prices by some combination of increased both the incidence and severity increased government spending on existing of poverty worldwide social safety net programs, be they subsidies, January 2005–December 2007 conditional transfer systems, or food distribu- Initial levels: Change in: tion schemes. Others have responded by seek- ing to hold domestic prices down by reducing Poverty Income Poverty Income Region headcount gap ratio headcount gap ratio taxes or instituting restrictions on exports. Such programs have been relatively expen- (percent) (percentage points) sive, increasing government expenditures by Urban population as much as 2–4 percent of GDP. Moreover, in East Asia and Pacific 13.2 20.3 6.3 2.7 Europe and many cases poor targeting means that much of Central Asia 2.5 8.7 0.0 0.2 this spending does not benefit those most in Latin America need. And, by interfering with market prices, and the Caribbean 3.7 37.6 0.1 Ϫ0.7 Middle East these programs often impede adjustment, re- and North Africa 2.7 17.8 2.4 5.7 ducing producers’ incentives to increase out- South Asia 32.3 25.0 2.0 0.5 put and consumers’ incentives to conserve. As Sub-Saharan Africa 34.1 38.1 1.7 0.3 such they likely exacerbated the extent of price Developing world 15.3 27.1 2.9 0.5 rises and extended their duration. Rural population Going forward, policy makers need to East Asia and Pacific 31.9 23.2 4.9 0.7 restructure their support so that it is better Europe and Central Asia 8.2 6.6 0.0 0.0 targeted on the very poor. Doing so will help en- Latin America sure that the next time food (or energy) prices and the Caribbean 18.6 43.9 0.1 0.1 spike, assistance programs will be both more Middle East and North Africa 15.4 22.9 0.7 0.9 affordable and more effective at delivering assis- South Asia 43.3 24.0 0.8 0.3 tance to those most in need. Of the options Sub-Saharan Africa 54.9 41.5 0.3 0.0 available, targeted cash transfers tend to succeed Developing world 37.1 28.2 2.1 0.1 best because they have relatively low adminis- Source: World Bank, using the Global Income Distribution trative requirements and minimize the diversion Dynamics model. of benefits toward less needy population Note: The per capita poverty line equals 1.25 international 2005 dollars a day. The ratio of food in total consumption groups. Unfortunately, these programs may also among the poor is computed as described in De Hoyos and exclude the many poor who are either unable or Lessem (2008). East Asia excludes China, and the Middle East comprises Jordan, Morocco, and the Republic of Yemen. unwilling to meet the conditions attached to the The income gap ratio expresses, as a percent of the poverty program, which are designed to dissuade all but line, how much the income of the average poor person is lower than the poverty line. the most needy from participating. In-kind 12 O V E R V I E W programs, such as school feeding and the distri- alternative to building stocks and restricting bution of fortified weaning food for toddlers, exports. Such contracts can reduce both price can be effective, especially in fiscally constrained and quantity uncertainty by providing for countries. Subsidies, even targeted ones, tend to guaranteed delivery of fixed quantities of be much less efficient, with as little as one-fifth grains at fixed prices. They can even be writ- of the money spent benefiting the poor. Public ten conditionally, providing an option to sell works programs rarely provide sufficient cover- or buy that can be exercised depending on age to meaningfully target poor families. What- market conditions. ever policies are adopted, it is critical that the Trade reform will necessarily form part of offsetting income support be clearly presented the solution as well. Steps are required to as temporary and include phaseout strategies to sanction effectively countries that use export avoid creating an unnecessary longer-term fiscal restrictions as a mechanism to control domes- burden. tic prices. Not only do such restrictions interfere with the domestic supply response, The role for international policy they also tend to exacerbate the price hikes Ultimately, given the scope of the costs in- and shortages in the rest of the global econ- volved, neither individual governments nor in- omy. Although a successful conclusion to the ternational agencies are in a position to offset World Trade Organization’s Doha Round of the costs of higher food and fuel prices en- multilateral trade negotiations might result in tirely. However, well-targeted programs are higher prices in the short run, it would likely much more affordable. For the poorest coun- prove beneficial to developing countries by tries, these too may be beyond reach fiscally, improving the competitiveness of their agri- and in these cases, the international commu- cultural sectors and reducing their reliance on nity has a role. imported food. Steps so far have concentrated on reallocat- ing existing funds toward those most in need and on strengthening both the financial and References De Hoyos, R., and R. Lessem. 2008. “Food Shares infrastructural capacity of emergency food aid in Consumption: New Evidence Using Engel agencies such as the World Food Programme Curves for Developing Countries.” World Bank, (WFP). Further steps that might be considered Washington, DC. include providing the WFP with a more stable Grilli, Enzo R., and Maw Cheng Yang. 1988. “Primary source of financing and affording it a line of Commodity Prices, Manufactured Good Prices, credit so that it is able to act quickly in in- and the Terms of Trade of Developing Countries: What the Long Run Shows.” World Bank Eco- stances where food prices are unusually high. nomic Review 2: 1–47. Policy makers might also examine IEA (International Energy Agency). 2006. Energy prospects for improving the coordinated man- Technology Perspectives: Scenarios & Strategies agement of grain reserves so that they can be to 2050. Paris: OECD/IEA. more easily brought to the aid of those in Kaufmann, D., A. Kraay, and M. Mastruzzi. 2007. need. Steps might include the construction Governance Matters VI: Aggregate and Individ- of storage facilities in strategic parts of the ual Governance Indicators for 1996–2006. World Bank Policy Research Working Paper 4280, world and the creation of a management Washington, DC. system perhaps along the lines of that used World Bank. 2007. At Loggerheads: Agricultural by the IEA for oil. Individual food-importing Expansion, Poverty Reduction, and Environment and -exporting nations may wish to explore in the Tropical Forests. Washington, DC: World the use of market-based future contracts as an Bank. 13 1 Prospects for the Global Economy modest. However, as the crisis intensified in T he stresses in the financial markets of the United States that first emerged in the summer of 2007 transformed themselves into a 2008 and especially since mid-September, risk aversion (the absence of which had been the full-blown global financial crisis in the fall of hallmark of the preceding boom) has in- 2008: credit markets froze; stock markets creased, and capital flows to developing coun- crashed; and a sequence of insolvencies threat- tries have seized up. As a result, the currencies ened the entire international financial system. of a wide range of developing countries depre- Massive liquidity injections by central banks ciated sharply, and developing-market equity and a variety of stopgap measures by govern- prices have given up almost all of their gains ments proved inadequate to contain the crisis since the beginning of 2008. Initial public eq- at first. uity offerings have disappeared, and risk pre- The initially hesitant policy response has miums have increased to more than 700 basis become increasingly robust. The United States points on sovereign bonds and to more than government introduced a $700 billion rescue 1,000 basis points on the debt of developing- package and has taken equity positions in nine country firms. Very recent data on bank lend- major banks and several large regional banks. ing and foreign direct investment inflows are Various debt and deposit guarantees have also not available, but indications are that these in- been introduced. At the same time, European flows have also declined, but less dramatically. governments have announced plans for equity Virtually no country, developing or high- injections and purchases of bank assets worth income, has escaped the impact of the widening some $460 billion, along with up to almost crisis, although those countries with stronger $2 trillion in guarantees of bank debt. At the fundamentals going into the crisis have been time of this writing, November 20, 2008, mar- less affected. The deterioration in financing kets remain volatile despite the forcefulness of conditions has been most severe in countries these measures and signs that credit condi- with large current account deficits, and in tions are improving somewhat in high-income those that showed signs of overheating and countries. Both private-sector and sovereign unsustainably rapid credit creation before the interest rate spreads for developing countries financial crisis intensified. Of the 20 develop- have spiked even higher, and a growing list of ing countries whose economies have reacted countries have been forced to seek assistance most sharply to the deterioration in conditions from the International Monetary Fund (IMF). (as measured by exchange rate depreciation, During the initial phases of this financial increase in spreads, and equity market de- crisis in 2007, the effects of the financial tur- clines), 6 come from Europe and Central Asia, moil on developing countries were relatively and 8 from Latin America and the Caribbean. 15 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Much tighter credit conditions will see is projected to decelerate sharply, with global investment and GDP growth slow sharply export volumes falling by 2.1 percent in In this climate, growth prospects for both 2009—the first time they have declined since high-income and developing countries have de- 1982 and eclipsing the 1.9 percent falloff that teriorated substantially, and the possibility of a occurred in 1975. Export opportunities for serious global recession cannot be ruled out. developing countries will fade rapidly because Even if the waves of panic that have inun- of the recession in high-income countries and dated credit and equity markets across the because export credits are drying up and ex- world are soon brought under control, the port insurance has become more expensive. crisis is likely to cause a sharp slowdown in Slower growth in high-income countries is activity stemming from the deleveraging in estimated to have reduced remittance flows financial markets that has already occurred into developing countries from 2 to 1.8 per- and that is expected to continue. In the baseline cent of recipient country GDP between 2007 forecast presented in this chapter, much tighter and 2008. At the country level, the extent of credit conditions, weaker capital inflows to further slowdown will depend critically on ex- middle-income countries, and a sharp reduc- change rate developments, with recent swings tion in global import demand are expected to in bilateral exchange rates dwarfing the ex- be the main factors driving the slowdown in pected changes in remittances denominated in developing countries. Import demand is pro- host-country currencies. jected to decline by 3.4 percent in high-income The global growth recession is projected to countries during 2009, while net private debt cause both commodity prices and inflation to and equity flows to developing countries are ease further, with oil prices averaging about projected to decline from $1 trillion in 2007 $75 a barrel (bbl) in 2009, and food and metal to about $530 billion in 2009, or from 7.7 to prices projected to decline by about 23 and 3 percent of developing-country GDP. As a re- 26 percent, respectively, compared with their sult, investment growth in developing countries average levels in 2008. Nevertheless, com- is projected to slow dramatically, rising only modity prices will remain well above the very 3.5 percent in middle-income countries, com- low levels of the 1990s. pared with a 13.2 percent increase in 2007. Lower commodity prices should reduce the A pronounced recession is believed to have burden on some segments of the poor (notably begun in mid-2008 in Europe, Japan, and most urban dwellers), whose purchasing power has recently, the United States. This recession is pro- declined because of high food and fuel prices jected to extend into 2009, yielding a decline in (see chapter 3). Lower prices should also help high-income country GDP of 0.1 percent that dampen headline inflation. Indeed, the rapid year (table 1.1). In developing countries, rise of food and energy prices over the course growth is projected to slow to 4.5 percent in of 2007 and the first half of 2008, coupled with 2009, down from 7.9 and 6.3 percent in 2007 tight capacity in many countries (following and 2008. Overall, global GDP is projected to years of very fast growth fueled by ample liq- expand only 0.9 percent in 2009 (figure 1.1)— uidity) caused headline and core inflation to below the rate recorded in 2001 and 1991 and pick up throughout the world. Headline infla- indeed, the weakest since records became tion increased by 5 percentage points or more in available beginning in 1970. most developing countries, and more than half Because low-income countries have less ac- of developing countries had an inflation rate in cess to international capital markets, the slow- excess of 10 percent by the middle of 2008. down will affect them mainly through indirect This financial crisis and the expected abrupt mechanisms, including reduced demand for slowing of global growth comes at a moment their exports, lower commodity prices, and when developing countries considered as a reduced remittance inflows. International trade whole are more vulnerable than they have been 16 P R O S P E C T S F O R T H E G L O B A L E C O N O M Y Table 1.1 The global outlook in summary (percentage change from previous year, except for interest rates and oil prices) Indicator 2006 2007 2008* 2009† 2010† Global conditions World trade volume 9.8 7.5 6.2 Ϫ2.1 6.0 Consumer prices G-7 countriesa,b 2.2 1.7 3.3 1.6 1.8 United States 3.3 2.6 4.5 2.5 2.8 Commodity prices (US$) Non-oil commodities 29.1 17.0 22.4 Ϫ23.2 Ϫ4.3 Oil price (US$ per barrel)c 64.3 71.1 101.2 74.5 75.8 Oil price (percent change) 20.4 10.6 42.3 Ϫ26.4 1.8 Manufactures unit export valued 1.6 5.5 9.0 2.1 1.3 Interest rates $ LIBOR, 6-month (percent) 5.2 5.3 3.3 1.9 2.5 € EURIBOR, 6-month (percent) 3.1 4.3 4.9 3.8 4.2 Real GDP growthe World 4.0 3.7 2.5 0.9 3.0 Memo item: World (PPP weights)f 5.0 4.9 3.6 1.9 3.9 High-income countries 3.0 2.6 1.3 ؊0.1 2.0 OECD countries 2.9 2.4 1.2 Ϫ0.3 1.9 Euro Area 2.9 2.6 1.1 Ϫ0.6 1.6 Japan 2.4 2.1 0.5 Ϫ0.1 1.5 United States 2.8 2.0 1.4 Ϫ0.5 2.0 Non-OECD countries 5.5 5.6 4.3 3.1 5.3 Developing countries 7.7 7.9 6.3 4.5 6.1 East Asia and the Pacific 10.1 10.5 8.5 6.7 7.8 China 11.6 11.9 9.4 7.5 8.5 Indonesia 5.5 6.3 6.0 4.4 6.0 Thailand 5.1 4.8 4.6 3.6 5.0 Europe and Central Asia 7.5 7.1 5.3 2.7 5.0 Poland 6.2 6.6 5.4 4.0 4.7 Russian Federation 7.4 8.1 6.0 3.0 5.0 Turkey 6.9 4.6 3.0 1.7 4.9 Latin America and the Caribbean 5.6 5.7 4.4 2.1 4.0 Argentina 8.5 8.7 6.6 1.5 4.0 Brazil 3.8 5.4 5.2 2.8 4.6 Mexico 4.9 3.2 2.0 1.1 3.1 Middle East and North Africa 5.3 5.8 5.8 3.9 5.2 Algeria 1.8 3.1 4.9 3.8 5.4 Egypt, Arab Rep. of 6.8 7.1 7.2 4.5 6.0 Iran, Islamic Rep. of 5.9 7.8 5.6 3.5 4.2 South Asia 9.0 8.4 6.3 5.4 7.2 Bangladesh 6.6 6.4 6.2 5.7 6.2 India 9.7 9.0 6.3 5.8 7.7 Pakistan 6.2 6.0 6.0 3.0 4.5 Sub-Saharan Africa 5.9 6.3 5.4 4.6 5.8 Kenya 6.1 7.1 3.3 3.7 5.9 Nigeria 5.2 6.5 6.3 5.8 6.2 South Africa 5.4 5.1 3.4 2.8 4.4 Memo items Developing countries excluding transition countries 7.8 7.9 6.3 4.6 6.2 excluding China and India 6.0 6.1 5.0 2.9 4.7 Source: World Bank. Note: PPP ϭ purchasing power parity; * ϭ estimate; † ϭ forecast. a. Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. b. In local currency, aggregated using 2000 GDP weights. c. Simple average of Dubai, Brent, and West Texas Intermediate. d. Unit value index of manufactured exports from major economies, expressed in U.S. dollars. e. GDP in 2000 constant U.S. dollars, 2000 prices, and market exchange rates. f. GDP measured at 2000 PPP weights. 17 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Prudent and vigilant policies are key Figure 1.1 GDP growth as uncertainty continues to cloud the Real GDP, percentage change Asian Dot-com outlook crisis crisis Forecast 8 Although this sober outlook represents a High-income countries 6 likely outcome, the situation remains unsta- 4 ble, and a wide range of outcomes are possi- 2 ble, including a scenario where the rebound of growth in 2010 is weaker, held back by 0 continuing banking sector restructuring, and Ϫ2 negative wealth effects resulting from lower 1980 1984 1988 1992 1996 2000 2004 2008 housing and stock market prices. Developing countries, excluding China and India An even sharper recession is also possible. Developing countries If the freeze in credit markets does not thaw as anticipated in the baseline, the consequences Source: World Bank. for developing countries could be cata- strophic. Financing conditions would deterio- rate rapidly, and apparently sound domestic in the recent past. Higher commodity prices financial sectors could find themselves unable have widened current account deficits of many to borrow or unwilling to lend—in both inter- oil-importing countries to worrisome levels national and domestic markets. Such a sce- (they exceed 10 percent of GDP in about one- nario would be characterized by a long and third of developing countries), and after hav- profound recession in high-income countries ing increased substantially, the international and substantial disruption and turmoil, in- reserves of oil-exporting developing countries cluding bank failures and currency crises, in a are now declining as a share of their imports. wide range of developing countries. Sharply Moreover, inflation is high, and fiscal positions negative growth in a number of developing have deteriorated both for cyclical reasons and countries with all of the attendant repercus- because government spending has increased to sions, including increased poverty and unem- alleviate some of the burden of higher com- ployment, would be inevitable. modity prices. Although it is a receding concern, high infla- Although the global recession is likely to be tion in developing countries remains a problem, protracted, some elements of an eventual re- especially if the impact from the current crisis covery can already be discerned. These include on developing-country investment demand is early movement toward stabilization in the less pronounced, and the stimulus provided by housing sector in the United States; continued various rescue and fiscal packages in high- progress on debt workouts and a strengthen- income and developing countries feeds a rapid ing of balance sheets among both banks and expansion in demand. Under such a scenario, households; a gradual easing of credit condi- global growth would still slow in 2009, which tions as government rescue packages take hold would tend to dampen inflationary pressures and investors begin to return to heavily dis- initially, but growth could be expected to snap counted equity markets; increases in real in- back much more sharply in 2010. Countries comes (stemming from lower food and fuel that now have large current account deficits prices) among individuals with relatively high and high inflation could suffer from a renewed marginal propensities to consume; and in- overheating of their economies. Policies would creased space for fiscal and monetary policies have to be very prudent in these circumstances, as inflationary pressures ease and government because the currencies of these countries are outlays on food and fuel subsidies decline in likely to remain sensitive to changing market tandem. perceptions and increased risk aversion. 18 P R O S P E C T S F O R T H E G L O B A L E C O N O M Y The challenge for policy makers is not only Earlier in the year major banks were still to prevent an escalation of the crisis and to mit- able to attract new equity investors in an effort igate the downturn but also to ensure a good to rebuild their capital bases, which were starting position once the rebound sets in. For eroded by significant losses stemming from developing countries, this means responding large write-downs on mortgage-backed securi- rapidly and forcefully to signs of weakness in ties and other assets. However, investor confi- domestic banking sectors, including resorting dence was shaken by the March collapse of to international assistance where necessary. It Bear Sterns, the seventh largest securities firm also means pursuing a prudent countercyclical in the world in total assets. In September and policy, relying on automatic stabilizers, social October, authorities in the United States and safety nets, and infrastructure investment that Europe had to respond with extraordinary addresses bottlenecks that have become bind- steps, including large injections of liquidity; co- ing constraints on long-term sustainable ordinated reductions in policy interest rates; growth in many countries. the takeover of major financial institutions; en- In the current circumstances of heightened hancements in deposit guarantees; and plans to risk aversion and investor skittishness, policy purchase impaired financial assets (such as the makers need to be especially wary of taking U.S. Troubled Asset Repurchase Program, or on excessive levels of debt or creating the con- TARP), to take equity positions in commercial ditions for an inflationary bubble by reacting banks, and to intervene in the commercial too aggressively to the global slowdown. paper markets (box 1.1). Although it is important for policy makers to react quickly to emerging problems, it is also The turmoil has had a dramatic essential that steps and conditions attached to impact on emerging market assets assistance be well focused on overcoming Although financial institutions in developing some of the fundamental sources of weak- countries are believed to have limited direct ness. Otherwise there is a risk that govern- exposure to U.S. subprime assets and related ments lose the support of markets and tax- securities, the financial turmoil has affected payers in their efforts to limit the extent of virtually all emerging-market economies as near-term disruptions. high-income-country banks and investment funds withdrew from emerging markets and converted a broad range of risky assets into Financial markets more liquid holdings. The rapid increase in risk aversion has also led to a forceful unwind- The deterioration in financial ing of the carry trade. The sell-off in risky as- conditions accelerated markedly sets carried a dramatic impact on equity prices, in September 2008 bond spreads, and currencies in virtually all T he protracted turmoil that has plagued global financial and credit markets since mid-2007 escalated in September 2008, with emerging-market economies and has also con- tributed to tighter domestic credit conditions in larger countries, including India, the Russian the sudden collapse of major financial insti- Federation, and Brazil, and smaller countries, tutions, first in the United States and subse- including Thailand and the Philippines. These quently in Europe. The crisis has spread developments were reinforced as local in- rapidly to emerging markets and has raised vestors also moved out of equity markets, and fears of systemic risk to the international more generally, out of investments denomi- financial system. Growing concerns about nated in local currencies. counterparty risk have disrupted credit mar- Countries with large current account kets, especially the interbank and commercial deficits, and therefore most dependent on for- paper markets. eign capital, were hit hardest by the substantial 19 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Box 1.1 Chronology of recent developments in the financial crisis F inancial stress escalated in the United States and the BENELUX countries were later sold to the Europe over the course of 2008, beginning with French commercial bank, BNP Paribas. the takeover of Bear Stearns by JP Morgan in March, The German government, together with commer- and culminating in September when several major cial banks and federal regulators, provided $50 bil- institutions came under severe distress. lion in credit guarantees to Hypo Real Estate. Week of September 7 Citigroup agreed to buy the banking operations The U.S. government seized control of Fannie of Wachovia. Mae and Freddie Mac, institutions that own or guar- France, Belgium, and Luxembourg injected antee about one-half of all mortgage assets in the $9.2 billion into the French-Belgian bank Dexia. United States. The Icelandic government took a 75 percent equity Week of September 14 stake in Glitnir, the country’s third-largest bank. The U.S. investment bank Lehman Brothers filed The Swedish central bank announced that it for bankruptcy and Merrill Lynch was taken over by would lend up to $700 million to the Swedish unit the Bank of America for $50 billion. of the Icelandic bank Kaupthing. The U.S. government seized control of American Ireland announced unlimited guarantees on retail, International Group Inc., providing an $85 billion commercial, and interbank bank deposits. Similar emergency loan and taking a 79.9 percent equity measures were adopted in Austria, Denmark, stake in the firm. Germany, Greece, Iceland, Italy, and Portugal. Britain’s largest mortgage lender, HBOS, agreed to Sweden, the United Kingdom, and the United States be purchased by Lloyds TSB in an $18.9 billion deal. raised limits on deposit guarantees. On October 3, The Russian government pledged to provide European finance ministers agreed to raise the mini- $120 billion to support financial markets and banks mum guarantee on bank deposits to €50,000 across (the amount was increased by $50 billion on all EU member states. October 7). Week of October 5 U.S. Treasury Secretary Henry Paulson introduced The Icelandic government loaned $683 million to the Troubled Asset Relief Program, a key element of Kaupthing, and seized control of Landsbanki, and which enables the government to buy up to $700 bil- sought a $5.5 billion loan from Russia. lion of mortgage-backed securities. An amended The Spanish government established a $40 to version was signed into law on October 4th. $68 billion emergency fund to purchase assets held Week of September 21 by Spanish banks. Goldman-Sachs and Morgan Stanley became The U.S. Federal Reserve intervened in the bank holding companies. commercial paper market for the first time since the The U.K. government nationalized the mortgage Great Depression. bank Bradford and Bingley (a loan portfolio of The British government made available $87 bil- $90 billion). lion in emergency loans to the banking system and Week of September 28 offered to purchase capital in eight of the largest Washington Mutual became the largest bank banks. The package includes guarantees of £250 mil- failure in U.S. history, with assets valued at lion for new debt and the same for liquidity $328 billion. provisions. The Belgian, Dutch, and Luxembourg govern- The central banks of the United States, the Euro ments each took a 49.9 percent equity stake in the Zone, Canada, Sweden, and Switzerland each cut operations of the banking and insurance company their benchmark rates by half a percentage point in Fortis within their respective borders, each injecting an unprecedented coordinated effort. Separately, $16.4 billion in capital. One week later, the Dutch China’s central bank lowered its key one-year lend- government took full control of the company’s ing rate by 27 basis points, the second reduction in operations in the Netherlands. Fortis’ operations in three weeks. 20 P R O S P E C T S F O R T H E G L O B A L E C O N O M Y The Icelandic government placed Glitnir into re- The Belarusian authorities requested financial as- ceivership, seized control of Kaupthing Bank, and sistance from the IMF under a program that could abandoned its attempt to peg the krona at 131 per be supported by a Stand-By Arrangement. euro, established one day earlier, after it touched 340 The Pakistani authorities requested discussions against the euro. with the IMF on an economic program supported by California, the most populous U.S. state, asked financial assistance from the IMF. federal authorities for a $7 billion emergency loan as Week of October 26 it was unable to obtain financing in the wake of the IMF staff agreed with the Hungarian and Ukrain- bankruptcy of Lehman Brothers. ian authorities’ economic programs supporting loans The British government announced a $685 billion of $15.7 and $16.7 billion, respectively. plan to restore confidence in financial institutions, The European Union stood ready to provide a which included insuring up to $438 billion in new loan of $8.1 billion to Hungary and the World Bank debt issued by banks, along with providing as much agreed to provide $1.3 billion. as $88 billion in equity capital. The IMF announced the Short-Term Liquidity The National Bank of Ukraine seized control of Facility designed to channel funds quickly to emerg- Prominvestbank, the country’s sixth-largest bank. ing markets that have a strong track record, but that Week of October 12 need rapid help during the current financial crisis to European governments announced financing get them through temporary liquidity problems. packages totaling over $2.5 trillion. The packages in- Week of November 9 clude recapitalizing the banking sectors, credit guar- The Leaders of the Group of Twenty agreed to a antees on interbank lending, and direct loans. plan of action to restore global growth and achieve The British government injected $60 billion in eq- needed reforms of the world’s financial systems. uity capital into the country’s three largest banks. IMF staff and Pakistani authorities reached agree- The United States announced that it would com- ment on an economic program supported by a $7.6 mit $250 billion of the $700 billion rescue package billion loan. The Executive Board of the IMF was to recapitalize the banking sector. expected to discuss the program shortly under the Week of October 19 IMF’s Emergency Financing Mechanism procedures. The IMF agreed with Iceland on an economic Week of November 16 recovery program supported by a two-year loan IMF staff and Serbian authorities agreed on an of $2.1 billion. economic program supported by a $0.5 billion loan. tightening of credit conditions in international $3.1 billion in Turkey, and $2.1 billion in markets. One-third of developing countries are Ukraine (comparing January through Septem- running current account deficits in excess of ber 2008 with the same period in 2007). 10 percent of GDP, many of which may be All middle-income countries, even with forced to restrict domestic demand severely as current account surplus positions, have come capital inflows dry up. During 2007, for ex- to be substantially affected by the financial ample, several countries were the recipients of crisis. A Revealed Vulnerability Index indi- vigorous increases in private debt flows that cates the extent to which financial conditions fueled credit growth to the domestic private for developing countries have deteriorated sector and intensified inflation pressures. A since September 15, 2008 (upon the failure of year later private debt flows to the banking Lehman Brothers). The vulnerability index sector declined dramatically in a number of averages the standardized depreciation of cur- cases: by $13.2 billion in Kazakhstan, $6.6 bil- rencies, domestic equity market losses, and in- lion in Russia, $3.7 billion in South Africa, creases in risk premiums, as well as the decline 21 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 South African rand depreciated by nearly 60 Figure 1.2 Emerging market equities are hit percent against the dollar (38 percent against hard as turbulence evolves to crisis the euro) from late October 2007 to mid- MSCI equity price indexes (January 2005 5 100) November 2008. Similarly, the Turkish lira 250 depreciated by over 40 percent against the Emerging markets 200 Euro Area dollar (20 percent vis-à-vis the euro) from late October 2007 to mid-November 2008, but 150 the currency has appreciated by 6 percent in 100 real effective terms between January 2007 and Oct. 2007 United States October 2008. 50 Jan. Jan. Jan. Jan. The banking crisis that erupted in September 2005 2006 2007 2008 2008 is restricting credit to developing coun- Source: Morgan-Stanley, Standard & Poor’s. tries, and in particular to the least creditworthy borrowers. Sovereign bond spreads widened to a peak of 1,100 basis points in late October in gross capital flows to a country over the 2008 from 330 points in late August—well preceding 12 months. The index shows that above the record 150 basis points registered in virtually all middle-income countries are expe- June 2007—before recovering to just over 700 riencing financial stress. basis points by mid-November. At that time, Emerging-market equity prices—as cap- sovereign bond spreads exceeded the “dis- tured by the Morgan-Stanley Composite tressed debt” threshold of 1,000 basis points in Index (MSCI)—tumbled by over 60 percent 14 of 38 emerging market economies currently (in dollar terms) from their peak of October part of JPMorgan’s EMBI Global Index. 2007, bringing prices back to levels attained at Corporate bond spreads jumped by still more the beginning of 2005 (figure 1.2).1 The mas- than sovereign spreads (figure 1.3). Spreads on sive correction in equity prices was wide- risky non-investment grade (BB-rated) emerg- spread across emerging market economies, ing market corporate bonds widened to 1,750 with the largest declines found in a number of basis points in mid-November, up more than European and Central Asian economies— 1,450 points since mid-2007. Ukraine (80 percent), Romania (75 percent), Bulgaria (75 percent), and the Russian Feder- ation (73 percent). Other large emerging mar- ket economies, including Brazil, China, and Figure 1.3 Emerging-market bond spreads widen, especially for corporates India, experienced corrections of over 60 per- cent. Despite the declines of the past year, eq- Spreads in basis points 1200 uity prices in emerging markets remain above those in mature markets from a longer-term 1000 perspective, albeit characterized by much 800 Corporate higher volatility. CEMBI composite 600 The selloff in emerging market assets trig- gered a marked depreciation of exchange rates 400 in a large number of countries, reversing much 200 Sovereign of the appreciation of the past two years. For EMBIG composite 0 example, the Brazilian real dropped by 40 per- Jan. May Sep. Jan. May Sep. cent against the dollar (20 percent against the 2007 2007 2007 2008 2008 2008 euro) from early August to mid-November Source: JPMorgan-Chase. 2008, but the currency stands only 8 percent Note: CEMBI ϭ Corporate Emerging Markets Bond Index; EMBIG ϭ Emerging Markets Bond Index Global. below its January 2007 dollar value. The 22 P R O S P E C T S F O R T H E G L O B A L E C O N O M Y The rise in spreads was only partially offset down from a record high of $200 billion by a 1.3 percentage point decline in the bench- achieved at the start of 2008. mark yield on 10-year U.S. Treasury notes be- Even assuming a restoration of market con- tween June 2007 and November 2008, so the fidence and a thawing of credit markets and yield on dollar-denominated sovereign bonds capital movements, overall credit conditions issued by emerging markets reached 10.5 per- for emerging markets will remain substan- cent, the highest in four years. tially tighter than in the recent past. As a con- sequence, net private debt and equity flows to Private capital flows expected to developing countries are anticipated to decline continue decline from the record-high $1.03 trillion (7.6 per- Even before the intensification of the financial cent of developing-country GDP) set in 2007 crisis, tighter credit conditions were curtailing to about $530 billion (3 percent of GDP) in gross private debt and equity flows to devel- 2009. Although net foreign direct investment oping countries (figure 1.4). Cross-border syn- should be moderately more resistant to the dicated bank loan commitments declined to downturn (as in past episodes), tighter credit $315 billion over the 12-months ending may cause high-income firms to reduce their October 2008, down from a record $400 bil- foreign direct investment by much more than lion a year earlier (but still above levels they did during earlier financial crises, which recorded over 2005–06). Bond issuance by de- were centered in developing countries. veloping countries decreased to $72 billion over the year to October, down from a record Tightening of credit sharply reduces high of just over $170 billion at mid-2007. domestic growth prospects Corporate bond issuance declined sharply, Before the financial turmoil developed into a with large falloffs in South Africa (by $15.6 crisis of global proportions, developing coun- billion), India ($12.8 billion), and Russia tries were affected mainly by slowing demand in ($9.4 billion). Indeed, non-investment-grade high-income countries through the export chan- bonds by corporations located in emerging nel. Many developing countries had shown markets accounted for about 40 percent of strong resilience in the face of the gradually de- total issuance from January to October 2008, teriorating external environment, because their compared with 60 percent over 2005–06. And economies were supported by strong investment equity issuance plummeted along with falling growth and shielded by large amounts of inter- equity prices to total $90 billion in the period, national reserves. This situation has changed dramatically since September 2008. Unlike gradual adjustments in markets for Figure 1.4 Private debt and equity flows goods and services, adjustments in financial decline by a third in 2008 markets come fast and suddenly, and they US$ billions often tend to “overshoot.” More importantly, 400 Bank loan the escalation of the crisis directly affects the commitments engine for domestic growth in many develop- Equity 300 issuance ing economies, because obtaining finance for capital spending has become abruptly more 200 difficult. Moreover, the crisis is placing strong 100 pressure on foreign exchange reserves and, at Bond issuance the same time, can reveal dangerous currency 0 mismatches in private sector balance sheets. Jan. Jan. Jan. Jan. Jan. 2004 2005 2006 2007 2008 During the global boom of the past five Source: Dealogic Analytics. years, local banks and private companies whose local currencies were appreciating 23 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 found it attractive to borrow abroad in the United States, Europe, and Japan during dollars. With the sudden turnaround in cur- the third quarter, OECD growth dropped to rency movements, the currency mismatch on Ϫ0.5 percent. private sector balance sheets has likely led to Industrial production slipped to negative substantial losses across firms and banks and ground across all major OECD economies in even for households. To the extent that this both the second and third quarters of the year, development results in loan defaults, it may as fading overseas demand combined with a strain domestic banking systems and place lack of domestic orders tied to sluggish condi- pressure on banks to find alternative sources tions in housing and autos in a number of of funding at a time when global financing countries (table 1.2, first and second panels). conditions have deteriorated markedly. Stress Growth of export volumes dropped from 14.6 induced by currency movements thus carries percent in 2007 to 2.5 percent during the third the potential to further degrade prospects for quarter (saar), as intra-OECD trade (especially investment spending in developing countries. within Europe) softened at the same time as developing-country demand slowed. During the second quarter, conditions in Outlook for high-income Europe and Japan deteriorated sharply. OECD countries Japan’s GDP declined at a steep 3.7 percent T he intensification of the financial crisis in the United States, and its widening to major European countries in the autumn of seasonally adjusted annualized rate (saar), and Euro Area GDP fell 0.7 percent (figure 1.5 and table 1.2, first panel). A falloff in household 2008, is expected to exact a significant toll on spending tied to the effects of much higher in- economic activity across the high-income flation, a decline in investment, and countries belonging to the Organisation for a dramatic shift in the growth contribution Economic Co-operation and Development of trade all contributed to the turnaround. In (OECD). Even if confidence in global credit Europe, increased sluggishness in export mar- markets is restored quickly, reductions in the kets and the long bout of euro appreciation finance available for firms and consumers, pressured exports and imports into negative coupled with a slowdown in developing- territory in the second quarter, with contribu- country import demand, have set the stage for tions to overall growth slipping to nil from 1.4 a recession in the United States, Europe, and points in the final quarter of 2007. Japan beginning in the second half of 2008 and In the United States, conversely, GDP lasting into 2009. picked up 2.8 percent (saar) in the second quarter, as fiscal stimulus and looser monetary A movement to joint recession across key policy boosted consumption spending. More- OECD countries over, the pace of decline in residential invest- Through the first quarter of 2008, the slow- ment slackened, while contributions from down among the OECD countries was fairly trade—still benefiting from the weak dollar— moderate (although industrial production increased to a large 1.6 percentage points of stagnated in the quarter): exports benefited growth (figure 1.6). U.S. domestic demand has from strong import demand from developing been depressed since the final quarter of 2006, countries and from oil exporters, while falling as a rise in domestic savings helped to unwind imports served to boost the contribution of the global imbalances that were of such net trade to GDP growth. But GDP fell to concern a couple of years ago. As financial 0.3 percent growth (at an annual rate) in the dislocations heightened in the third quarter, second quarter for the key advanced including unprecedented declines in equity mar- economies, down from 2.4 percent in 2007; kets in Europe, Japan, and the United States, and as GDP growth moved to decline across consumer spending came under increasing 24 P R O S P E C T S F O R T H E G L O B A L E C O N O M Y Table 1.2 High-income OECD countries: growth and related indicators Seasonally adjusted Growth year-over-year annualized growth Growth year-over-year Indicator, country 2006 2007 Q108 Q208 Q308 H108 Q308 GDP growth (percent) High-income OECD 2.9 2.4 1.5 0.3 ؊0.5 1.9 0.5 United States 2.8 2.0 0.9 2.8 Ϫ0.3 2.3 0.8 Japan 2.4 2.1 2.5 Ϫ3.7 Ϫ0.4 1.0 0.0 Euro Area 3.0 2.6 2.6 Ϫ0.7 Ϫ0.8 1.7 0.3 Germany 3.2 2.6 5.7 Ϫ1.7 Ϫ2.1 2.2 0.8 France 2.4 2.1 1.6 Ϫ1.1 0.6 1.6 0.6 United Kingdom 2.8 3.0 1.1 0.0 Ϫ2.0 1.9 0.3 Industrial production High-income OECD 2.9 2.4 0.1 ؊3.2 ؊3.8 1.4 ؊2.2 United States 2.2 1.7 0.4 Ϫ3.2 Ϫ5.9 1.0 Ϫ4.5 Japan 4.1 2.9 Ϫ1.7 Ϫ3.5 Ϫ4.3 1.8 Ϫ1.9 Euro Area 3.4 2.8 1.3 Ϫ4.5 Ϫ2.6 1.2 Ϫ1.8 Germany 5.9 6.1 4.9 Ϫ3.2 Ϫ4.7 4.2 Ϫ2.3 France 0.9 1.2 0.1 Ϫ6.1 Ϫ2.6 0.7 Ϫ1.9 United Kingdom 0.7 0.4 Ϫ1.7 Ϫ2.9 Ϫ5.8 Ϫ0.2 Ϫ3.0 Consumer pricesa High-income OECD 2.3 2.0 3.1 3.2 4.0 3.2 4.0 United States 3.2 2.9 4.3 4.0 4.9 4.2 4.9 Japan 0.3 0.1 0.7 1.2 2.1 1.0 2.1 Euro Area 1.9 2.3 3.3 3.5 3.9 3.4 3.9 Germany 1.7 2.3 2.8 3.1 2.9 3.0 2.9 France 1.7 1.5 2.8 3.2 3.0 3.0 3.0 United Kingdom 2.3 2.3 2.2 2.4 5.0 2.3 5.0 Export volumes High-income OECD 13.9 14.6 9.2 2.8 2.5 6.7 4.8 United States 10.5 6.9 5.3 14.7 21.9 9.8 11.2 Japan 8.1 5.9 4.0 2.1 Ϫ12.9 7.1 Ϫ1.6 Germany 13.0 6.2 11.0 0.4 Ϫ5.9 6.4 3.9 France 9.9 3.7 32.6 Ϫ14.6 Ϫ0.1 5.1 4.2 United Kingdom 11.7 Ϫ10.4 0.7 Ϫ1.3 4.2 Ϫ0.8 0.2 Source: National statistical agencies through Haver Analytics and Thomson/Datastream. Note: CPI inflation for high-income OECD countries is GDP weighted. a. Year-over-year growth rates. Figure 1.5 Change in GDP in the United Figure 1.6 The contribution of U.S. domestic States, Europe, and Japan demand to GDP growth GDP growth (percentage change) Percentage points (4-quarter moving average) 6 6 Contribution of Q2, 2008 domestic demand 4 Q1, 2008 4 Q4, 2007 Q3, 2008 2 0 2 U.S. GDP ؊2 0 ؊4 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 United States Euro Area Germany Japan 2000 2001 2002 2003 2004 2005 2006 2007 2008 Source: World Bank, national statistical agencies. Source: U.S. Department of Commerce; World Bank calculations. 25 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 decline in GDP would have been much more Figure 1.7 U.S. household wealth falls sharply in the last quarters severe save for the contribution of net trade. Notwithstanding that GDP is projected to de- US$ billions cline more sharply in the fourth quarter of 2,000 2008, growth for the year is expected to regis- Q3, 2007 1,500 ter 1.4 percent, because of the strong contribu- 1,000 tions of trade in the first half of the year. An Q1, 2008 500 abrupt decline in investment and a 1 percent falloff in consumer spending are expected to 0 Q2, 2007 cause GDP to fall in both the first and second Q2, 2008 ؊500 Q4, 2007 quarters of 2009, with a shallow recovery be- ؊1,000 ginning in the second half of the year. GDP is ؊1,500 projected to decline by 0.5 percent for all of 2009 but to recover to a still below-par 2.0 per- ؊2,000 Total Household Financial Equities, cent in 2010 (figure 1.8). assets real estate assets mutual funds Financial conditions in the Euro Area are Source: Federal Reserve. now also perilous. After having fallen 0.7 per- cent in the second quarter (saar), GDP dropped 0.8 percent during the third quarter pressure (figure 1.7).2 And with export per- and is expected to register modest declines in formance for OECD economies fading on the coming quarters before picking up steam to- back of sputtering global demand, the Euro ward the end of 2009. Growth is expected to Area and Japan fell into technical recession in register a weak 1.1 percent increase for 2008 the quarter, while growth in the United States as a whole and a 0.6 percent decline in 2009, reverted to decline. before strengthening in 2010 to a still below- trend advance of 1.6 percent. The depth of re- Financial crisis places outlook under cession in Europe should be comparable to exceptional uncertainty that in the United States, in part because cor- Given the dramatic developments over Sep- porate finance in Europe is more reliant on the tember to November 2008, the depth of the banking sector but also because lower com- coming recession is difficult to gauge. Should modity prices will dampen import demand in credit markets remain frozen and asset prices continue to fall, then the decline in output over the next year could be extreme. However, Figure 1.8 GDP to decline across the the extraordinary measures now being taken OECD by fiscal and monetary authorities are ex- Real GDP growth (percentage change) pected to eventually restore confidence so that 4 Dot-com United States Forecast banks will no longer hoard cash, and busi- recession 3 nesses can obtain the finance essential for nor- mal operations. Nevertheless, the outlook for 2 OECD countries remains grim. A common Japan element is a falloff in domestic demand— 1 Euro Area increasingly deep in business capital spending— 0 no longer offset by support from net trade because of a coincident marked slowdown in Ϫ1 growth among the developing countries. 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 With U.S. private consumption dropping an Source: National statistical agencies, World Bank. unprecedented 3.1 percent in the quarter, the 26 P R O S P E C T S F O R T H E G L O B A L E C O N O M Y the Middle East and North Africa, a region Slowing growth in the high-income economies, that has been an important origin of export falling equity markets, and reduced interna- demand for Europe. The rapid decline in out- tional capital flows cut into investment in de- put, plus the drop in commodity prices should veloping countries, while a sharp acceleration alleviate inflationary pressures in Europe. But in inflation linked to the surge in commodity the recent depreciation of the euro measured prices constrained consumer spending. against the dollar may continue, as investors’ Industrial production (outside of China) continue to perceive U.S. government securities had been robust but began to slow in mid- as safe-haven assets. 2008. In the rest of East Asia, the downward Aside from sharp equity market declines, shift in production growth has been sharp, Japan’s financial markets have been less af- dropping from 20 percent in January (saar) to fected (through mid-November 2008) by a decline of 5 percent by May 2008, before re- fallout from the global financial and banking covery to nil by September (figure 1.9). crisis. Nevertheless, the macroeconomic land- More dramatic has been the steep recent scape is surprisingly similar to that in the falloff in China’s industrial production growth, United States and Europe. Household spend- from 20 percent in July to a decline of 0.2 per- ing has retrenched, higher inflation has com- cent in September (saar). Softening export pressed purchasing power, and consumer sen- growth, together with tightening microman- timent has plummeted to 17-year lows. The agement of inventories—given uncertain sales Tankan survey of business investment inten- prospects—have underpinned this develop- tions has been marked down steeply, in line ment. This, in turn, has carried aggregate pro- with a downward shift in expectations for duction growth in East Asia to zero as of the Japan’s export prospects. Slumping import de- third quarter. mand in emerging Asia has been amplified by Output growth also faded in India and else- a tightening of policy interest rates in countries where in South Asia, while production in Hun- such as India, Indonesia, the Philippines, and gary, Poland, Turkey, and the Baltic states began Thailand to stem inflation pressures. During to decline more recently. Output dynamics have the third quarter, Japan’s GDP dropped by also faltered in Latin America, as production in 0.4 percent (saar) and for the remainder of Chile, Colombia, and Mexico have dropped to 2008, creeping spillover from the credit crunch negative ground, while that in Brazil has slowed and falling exports will cause Japan’s GDP to recede further, coming to register 0.5 percent growth for the year. Recession in Japan is ex- pected to be less pronounced than elsewhere, Figure 1.9 East Asian countries show steep falloff in output growth with output declining by 0.1 percent in 2009 before picking up to 1.6 percent in 2010 as Industrial production (percentage change, saar) 30 global investment demand revives and stimu- 25 East Asia & Pacific China lates Japanese exports. 20 15 Outlook for the developing 10 countries 5 0 (A deeper discussion of developments in each Ϫ5 of the six developing regions may be found in East Asia, excluding China Ϫ10 the Regional Appendix in this book.) Jan. Jun. Nov. Apr. Sep. Feb. Jul. E ven before international credit channels froze, there were increasing signs of slow- ing economic activity in developing countries. 2006 2006 2006 Source: World Bank data. 2007 2007 2008 2008 27 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 prospects. The effects of the global financial Figure 1.10 Output growth in Latin America, crisis on developing countries will differ by re- South Asia, and Europe and Central Asia is fading gion and by the ability of individual countries to offset adverse effects on domestic banking Industrial production (percentage change, saar) sectors and the broader financial market. 20 Emerging-market corporate borrowers al- 15 South Asia ready are seeing a sizable widening of spreads and are increasingly being shut out of interna- 10 tional bond markets (see discussion above). A pullback in syndicated bank lending is emerg- 5 ing (as commercial banks and other financial 0 institutions in the high-income countries shore up balance sheets by limiting new lending or Latin America Ϫ5 & Caribbean Europe & by calling in existing lines of credit), and ini- Central Asia tial public equity offerings from key emerging Ϫ10 markets have dried up. Even before the freez- Jan. Jun. Nov. Apr. Sep. Feb. Jul. 2006 2006 2006 2007 2007 2008 2008 ing of credit flows that has accompanied the Source: World Bank data. banking crisis, overall capital inflows to devel- oping economies were down 35 percent over the first nine months of 2008 from the same period a year earlier. sharply (figure 1.10 and table 1.3, second The slowdown is likely to be more panel). Imports across developing regions are pronounced in 2009 also showing signs of easing, reflecting a soften- Looking forward, recent adverse trends are ing of domestic demand. And export volumes anticipated to intensify, driven by an especially from emerging markets displayed fading mo- sharp decline in investment growth in devel- mentum over the first three quarters of 2008, oping countries, weaker exports as import de- notably in Latin America, as import demand in mand from high-income economies declines, the OECD countries declined sharply. Overall and lingering and in some cases still-escalating GDP growth for the developing countries slowed from the 7.9 percent advance recorded in 2007 to 5.3 percent (annualized) during the Figure 1.11 Investment was the driving force second quarter of 2008 (see table 1.3 and asso- for growth in developing countries ciated notes). Contribution to real GDP growth (percentage points) Financial turmoil likely to curb 4 investment 3 Fixed investment has been a powerful driving force for growth across developing countries Investment 2 over the last decade, particularly in East Asia and the Pacific and in Europe and Central 1 Asia, increasing its contribution to overall growth to almost 4 percentage points in recent 0 Net exports years, and well outstripping contributions Ϫ1 from trade (figure 1.11). But the intensification 1992 1994 1996 1998 2000 2002 2004 2006 2008a of the credit crisis in the United States has se- Source: World Bank data. verely constrained finance to developing coun- a. Projected. tries, with ominous implications for growth 28 P R O S P E C T S F O R T H E G L O B A L E C O N O M Y Table 1.3 Developing regions: growth and related indicators Growth Seasonally adjusted Growth year-over-year annualized growth year-over-year Indicator 2006 2007 Q108 Q208 Q308 H108 Latest GDP growth (percent) Developing countries 7.7 7.9 7.5 5.3 — 6.9 — East Asia and the Pacific 10.1 10.5 9.4 9.2 — 9.0 — South Asia 9.0 8.4 11.3 2.9 — 8.3 — Europe and Central Asia 7.5 7.1 8.8 Ϫ1.2 — 5.9 — Latin America and the Caribbean 5.6 5.7 4.4 5.4 — 5.3 — Middle East and North Africa 5.3 5.8 4.0 3.8 — 4.0 — Sub-Saharan Africa 5.9 6.3 4.9 5.2 — 4.5 — Industrial production Developing countries 8.8 9.7 10.6 9.6 ؊2.4 9.2 5.0 East Asia and the Pacific 13.0 15.0 18.3 17.1 0.2 14.7 10.2 South Asia 10.6 9.1 9.5 1.1 Ϫ4.1 6.1 1.0 Europe and Central Asia 7.6 6.9 5.9 3.3 Ϫ9.8 5.1 0.3 Latin America and the Caribbean 4.3 4.3 0.2 0.4 3.6 3.4 2.2 Middle East and North Africa Ϫ0.8 Ϫ0.5 8.6 3.5 Ϫ0.2 3.6 3.5 Sub-Saharan Africa 3.9 5.8 Ϫ2.1 15.6 Ϫ9.3 6.5 4.7 Consumer pricesa Developing countries 6.2 6.1 8.6 10.4 9.9 9.5 9.9 East Asia and the Pacific 5.1 5.3 7.7 9.5 8.2 8.6 8.2 South Asia 7.6 7.6 10.1 11.0 22.0 10.6 22.0 Europe and Central Asia 5.6 8.0 11.0 11.3 11.0 11.2 11.0 Latin America and the Caribbean 5.6 6.5 8.8 9.7 7.5 9.3 7.5 Middle East and North Africa 5.1 7.2 11.2 10.8 12.7 11.0 12.7 Sub-Saharan Africa 6.2 6.0 8.2 10.4 11.3 9.3 11.3 Export volumesa Developing countries 13.9 14.6 14.0 13.8 — 14.0 — East Asia and the Pacific 19.2 18.7 16.2 17.0 17.1 16.2 19.2 South Asia 4.8 9.0 13.8 9.4 12.8 13.8 10.5 Europe & Central Asia 11.8 11.8 14.3 10.3 — 14.3 — Latin America and the Caribbean 6.9 4.5 0.7 Ϫ2.5 Ϫ11.4 Ϫ0.7 Ϫ5.4 Source: National Statistical Agencies through Haver Analytics. Note: Growth rates at annual or annualized rates, unless otherwise indicated. Consumer prices for regions are medians. Quarterly 2008 growth for developing regions is based on data available for key economies. No data on export volumes for South Asia and Sub-Saharan Africa are available. East Asia and Pacific: China, Indonesia, Malaysia, the Philippines, and Thailand. South Asia: India. Europe and Central Asia: Czech Republic, Hungary, Poland, Russian Federation, and Turkey. Latin America and the Caribbean: Argentina, Brazil, Chile, Colombia, and Mexico. Middle East and North Africa: Arab Republic of Egypt. Sub- Saharan Africa: Nigeria, and South Africa. a. Quarterly data, year-over-year growth. inflation. Developing-country GDP growth is Growth outcomes for 2009 are anticipated projected to decline to 4.5 percent in 2009, to vary significantly across developing coun- more than 3 percentage points below the av- tries and regions, depending on their reliance erage of the past five years (figure 1.12). No on external flows and bank lending to finance region or country is likely to escape this investment, trade links to deeply affected growth recession. Recovery in 2010 to a 6.1 high-income countries, direct and indirect ex- percent advance is predicated upon a relatively posures to the subprime mortgage crisis, and quick improvement in financial and growth the degree of participation of foreign banks in conditions among the high-income countries, a the domestic financial sector. Moreover, policy prospect currently subject to a high degree of responses to the crisis will play a large role in uncertainty. shaping the near-term economic outlook. 29 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Figure 1.12 Developing-country GDP growth Figure 1.13 Headline inflation is easing is expected to fall below 5 percent in 2009 across industrial countries Real GDP (percentage change) Percentage change (saar) 8 9 Forecast United States 7 a 6 Euro Area (HICP) 6 3 5 0 4 Japan 3 Ϫ3 Jan. Jan. Jan. 2 2006 2007 2008 Source: World Bank data. 1 a. Year-over-year. 0 Note: HICP ϭ Harmonized index of consumer prices. 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: World Bank. despite substantial increases in oil and metals prices since 2003 (box 1.2). However, the Inflation has been rising but is now sharp rise in food and fuel prices in the first set to decline half of 2008 pushed median inflation in the The projected global growth recession and developing world to 12 percent by July 2008, much lower commodity prices should help and more than 30 countries were facing ease the surge in inflation observed over 2007 double-digit inflation rates. and 2008. Headline consumer price inflation In a welcome development, median infla- among the OECD countries increased from a tion has since retreated to below 10 percent in modest 2 percent in 2007 to a 4 percent year- September, as falling commodity prices have over-year pace in the third quarter of 2008, improved CPI developments across a wide led by increases in the United States (4.9 per- range of developing countries. cent), the Euro Area (3.9 percent), and the United Kingdom (5 percent). Although the peak in commodity prices appears to have Figure 1.14 Inflation in emerging markets passed, the momentum of headline inflation surged on higher food and energy prices during August picked up to 8.5 percent in the Median inflation rates (%) United States before easing in September, 12 while falling to 2.3 percent in Japan and to 3.6 percent in Europe (figure 1.13). Developing countries 9 Consumer price inflation accelerated much more quickly in developing countries than in the advanced economies (figure 1.14, and 6 table 1.3, third panel). In the majority of de- veloping economies, most of the increase in 3 headline inflation was attributable to the direct effects of higher commodity prices; increases High-income OECD countries 0 in core inflation (which excludes food and Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. energy) were limited. Indeed, inflation in 2000 2001 2002 2003 2004 2005 2006 2007 2008 developing countries has remained relatively Source: World Bank data. low over the past five years of rapid growth, 30 P R O S P E C T S F O R T H E G L O B A L E C O N O M Y Box 1.2 Commodity prices and inflation in developing countries S trong growth in developing countries during the 1960s coincided with a low-inflation environ- ment, while high inflation during the subsequent two Box figure 1.2b How do international commodity prices explain inflation in developing countries? decades coincided with low average growth (box fig- Log scale ure 1.2a). The recent sharp pickup in GDP growth 0.20 occurred in an environment of low and stable infla- tion. Although the causality is always difficult to un- Dynamic simulation tangle, the potential adverse impact of high inflation 0.15 on the ability to interpret price signals, on disciplined fiscal management, and on savings and investment 0.10 are well understood. These negative effects underscore the importance 0.05 of preventing an acceleration of inflation beyond the Actual consumption index direct impact of increased commodity prices. The relatively low inflation of the recent past can 0.00 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 be clearly illustrated at an aggregate level with a model that explains median inflation in the developing Source: World Bank. world as stemming from commodity price increases in local currencies (measured as a median) and ⌬log(CPIt)ϭ0.01ϩ0.09 ⌬log(CPItϪ1)ϩ0.79 ⌬log(Pt), persistence (inflation tends to depend on past (1.39) (5.09) (11.60) inflation as a result of indexation and as inflationary expectations are adjusted). In the model, CPIt adjusted R2 ϭ 0.78. denotes consumer price inflation in developing Box figure 1.2b shows a dynamic simulation of countries, Pt denotes annual commodity prices, both the equation since the 1960s. in (median) local currencies for the 1962–2008 Inflationary pressures during the 1970s are well period. Numbers in parentheses denote t-ratios, and explained by a combination of commodity price in- ⌬ denotes the first-difference operator: creases and persistence. During the 1990s, however, many developing countries experienced high inflation unrelated to commodity prices and therefore not ex- Box figure 1.2a Inverse long-term correlation plained by the estimated equation. These increases in between inflation and growth inflation were caused more by loose policy reactions to debt crises, especially in Latin America, and the Percentage change Percentage change (5-yr moving average) (5-yr moving average) transition toward market economies in Europe. In 16 8 the recent period, inflation has actually remained Developing-country real GDP growth (right axis) lower than the model would predict, largely as a re- sult of institutional reforms, which made monetary 12 6 policy more independent in many countries and in- flation targeting more prevalent. 8 4 The literature provides a range of explanations for the relatively low inflation of recent years. 4 2 Dominant in the debate is the role of inflation expec- Developing-country tations, which have been brought down sharply by median inflation (left axis) institutional reforms. Increased competition in global 0 0 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 markets, making it more difficult to pass through Source: World Bank. increases in the higher costs of production, is another explanation. Moreover, the additional low-cost 31 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 supply from developing countries, notably China, in global markets carried deflationary effects. And Box figure 1.2c Commodities are a declining share in global merchandise trade the share of commodities in world production and trade has declined over time, as a result of which the Nominal shares (%) impact of commodity price increases is now substan- 30 tially less than during the 1970s (box figure 1.2c). 25 On the other hand, many of the factors that have kept inflation low over the last five years may have 20 lost a degree of efficacy. Indeed, with the recent rise Oil 15 in commodity prices, the share of commodities in the global economy, and with that, their effects on the 10 general price level, is increasing rapidly. Many fast- Ores and metals 5 growing developing countries have reached capacity Agriculture constraints in infrastructure, energy, and other inputs 0 to production, and the increase of low-cost goods in 1963 1968 1973 1978 1983 1988 1993 1998 2003 global markets is waning. With broader inflation Source: World Bank. rates rising, it becomes easier to pass through cost increases, and, importantly, low inflation expecta- tions might be revised upward quite quickly. These are serious challenges to be faced to prevent a clines in commodity prices, headline inflation will reemergence of a high-inflation environment. In the ease gradually, even if core inflation moves up mod- baseline forecast, we assume that as a result of the erately. But the probability of higher inflation is cer- sharp global growth slowdown and the recent de- tainly not negligible. Many countries that experienced the of fuels and basic foodstuffs across many sharpest run-up in inflation have been sub- countries in the Middle East and North Africa, jected to a dangerous combination of escalating and East and South Asia is contributing to food and energy prices and generally tight con- wider fiscal deficits, narrowing the room pol- ditions in domestic markets, caused by a rapid icy makers have for maneuver in other areas, increase in credit creation. Of the 24 countries including targeted income support, investment where inflation picked up by more than 5 per- in the Millennium Development Goals, and centage points within the past year, 10 are in countercyclical fiscal policy. Many monetary Europe and Central Asia, where inflation was authorities have faced a trade-off between spurred by very strong capital inflows or supporting growth and dampening inflation booming commodity revenues. Other countries and inflation expectations. Brazil, Indonesia, subject to strong domestic inflationary pres- Mexico, the Philippines, South Africa, and sures include Bolivia, Chile, the Philippines, Thailand have raised policy rates by 25 basis República Bolivariana de Venezuela, and points or more. The recent fall in commodity Vietnam. Some of the biggest jumps in head- prices and the global slowdown are likely to line inflation were seen in Sub-Saharan African ease this difficulty over time, and indeed, a countries, but that is largely because food shift toward monetary accommodation is now represents more than 50 percent of consump- under way to mitigate a portion of the growth- tion in many African countries. dampening effects of the financial crisis. The ramp-up of commodity prices over 2006–08 and the associated acceleration of Regional outlooks inflation have posed difficult policy challenges. GDP in East Asia and the Pacific increased by The continued practice of official subsidization 8.5 percent in 2008, down from 10.5 percent in 32 P R O S P E C T S F O R T H E G L O B A L E C O N O M Y trade and more difficult financing conditions. Figure 1.15 Key developments in 2008 for While the decline in oil and food prices will East Asia and the Pacific (excluding China) support external positions and provide some Percentage change relief on the inflation front, reduced investment 12 spending is expected to contribute to a substan- 2008 tial slowdown in regional growth to 6.7 percent 2007 9 2006 in 2009. A gradual recovery in key foreign mar- 6 kets will offer fresh impetus for exports and 3 production and will help return growth in the 0 region to a 7.8 percent pace by 2010. In Europe and Central Asia, output is likely Ϫ3 to increase by 5.3 percent in 2008, down from Ϫ6 7.1 percent in 2007, though growth held up re- Export Industrial Median Median Terms GDP growth production inflation policy rate of trade growth markably well during the first half of the year. (interest First-half GDP growth in Russia (7.8 percent), rate) Poland (6 percent), Turkey (5.8 percent), and Source: World Bank. Romania (8.8 percent) were grounded in strong domestic demand, along with higher oil prices and fiscal revenues for the region’s hydrocar- 2007. (Excluding China, growth in the region bon exporters. But in 2009 deteriorating exter- fell to 5.3 percent, from 6.2 percent in 2007.) nal positions and new risks from the global Of importance to the slowing pace of growth, banking crisis are likely to depress prospects for China’s GDP growth in the third quarter eased vulnerable countries, and the downside risks to 9 percent, from 10.6 percent in the first are substantial. Sovereign spreads jumped in quarter, on a slump in investment and exports. October 2008, notably for the Russian Federa- Rising oil and food prices boosted median in- tion and Turkey, and especially for Ukraine and flation in the region to 9 percent in 2008, com- Kazakhstan (figure 1.16). pared with 5 percent over the preceding 2 years. The deterioration in the outlook for Japan and the United States reduced export Figure 1.16 Sovereign bond spreads widen across Europe and Central Asia growth, which for East Asian countries outside Spreads in basis points of China fell from 10.5 percent in 2006 to 900 4 percent in 2008 (figure 1.15). In turn, manu- facturing output fell from 5 percent growth in 750 2007 to a decline of the same magnitude in 600 2008. And gross capital flows fell by a third, to $64 billion over the year to September 2008. 450 Prospects for 2009 and 2010 have dimmed 300 with the deterioration in the external environ- 150 ment. The global banking crisis has had little direct effect on the region, but several countries 0 Jul. Oct. Jan. Apr. Jul. Oct. are more vulnerable to spillovers in the form of 2007 2007 2008 2008 2008 2008 higher corporate spreads, reduced capital flows, and plummeting domestic equity mar- Bulgaria Hungary kets. Private sector investment in particular Poland Russian Federation Turkey stands at risk. Although China is well cush- ioned against coming shocks, several countries Source: JPMorgan-Chase. remain exposed to a steep downturn in world 33 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 While most countries have maintained for- ward momentum, a divergence in growth per- Figure 1.17 In Latin America and the Caribbean, current accounts of largest formance has emerged: Latvia is in recession, economies diverge the Romanian economy is overheating, and Current account balance as a share of GDP (%) the Kyrgyz Republic, Tajikistan, and 4 Moldova, which are receiving World Bank 3 2010 2009 support, are facing the impact of rising food 2 prices. The situation in Russia shifted dramat- 2008 2006 2007 1 ically from concerns about domestic overheat- 0 ing to fears of financial crisis, as equity prices Ϫ1 gyrated with the turmoil in global markets, Ϫ2 and oil prices fell. Ϫ3 Most countries have experienced strong growth in domestic demand, but net trade has Ϫ4 Brazil Argentina Mexico remained a drag on growth. At the same time, Source: World Bank. rapid credit expansion and wage escalation has made the region more vulnerable to deteri- oration in external financing conditions. The medium-term outlook points to a sharp decline growth, pressuring private sector investment in in regional growth to 2.7 percent in 2009, dri- particular. As commodity prices continue to ven by a falloff in investment tied to difficult weaken, some major exporters, Argentina of financing conditions and a marked weakening note, will likely see current account surplus po- in export market demand. Growth is projected sitions shift to deficit. For other countries, in- to firm to 5.0 percent by 2010, as credit markets cluding Brazil and Mexico, the depth of reces- stabilize, inflation pressures ease, and growth sion in the United States and Europe will turn in external markets resumes, paving the way exports to negative growth, while contraction for a revival in spending and exports. in imports should lead to a return of surplus Latin America and the Caribbean countries position (figure 1.17). have enjoyed four years of robust growth, GDP growth in the region is expected to while current account surpluses, accumulation drop to 2.1 percent in 2009 before recouping of reserves, and improved policies have served to 4 percent by 2010. Country-specific events to restrain core inflation rates, improve the could also pose a challenge: conditions in sev- quality of banking systems, and build up sub- eral Andean countries have tended toward less stantial buffers against financial contagion. stability; República Bolivariana de Venezuela However, in 2008 headline inflation jumped has seen another wave of nationalizations, and in response to higher oil and food prices, and its growth is expected to fall from 8.4 per- policy makers in countries such as Brazil and cent in 2007 to 3.2 percent by 2010; and Chile raised interest rates. Gross capital Argentina’s GDP is expected to slow from inflows to the region compressed by 45 per- 8.7 percent in 2007 to 4 percent by 2010, with cent between January and September 2008, a 1.5 percent growth trough in 2009. compared with the same period in 2007. The The developing countries of the Middle deterioration in external demand and in inter- East and North Africa region offer a good ex- national financial markets, combined with the ample of the diversity of effects stemming from recent falloff in commodity prices, reduced the ramp-up in global fuel and food prices—at GDP growth to 4.4 percent in 2008 from 5.7 both extremes of the spectrum. In oil-export- percent in 2007. ing economies, a rise in oil and natural gas The global slowdown and a shortfall in cap- revenues to $200 billion supported 5.8 per- ital flows present substantial risks to sustained cent growth in 2008, down from 6.4 percent 34 P R O S P E C T S F O R T H E G L O B A L E C O N O M Y in 2007. Slower domestic demand growth in Republic of Egypt. Moreover, oil-exporting the Islamic Republic of Iran (where GDP members of the Gulf Cooperation Council are growth declined from 7.8 percent to 5.6 per- vulnerable to losses on international invest- cent) was a key factor in this development. ment positions, potentially prompting a hiatus Outside Iran, growth among oil exporters in the recent buildup of foreign direct invest- stepped up to 5.9 percent. ment within the region. For the region’s oil- In the more-diversified economies that are importing economies, lower energy prices will highly dependent on oil and food imports, ex- reduce the import bill and provide some ports slowed in 2008 as growth turned slug- breathing space on the inflation front follow- gish among key trading partners in Europe ing the surge in prices in the first half of 2008. and the United States. But strong recovery in Growth for the region should recover to a Morocco following drought in 2007 and con- 5.2 percent pace by 2010 as external demand tinued solid performance in Tunisia and Jordan recovers, and declines in hydrocarbon prices boosted growth to 5.7 percent from 3.8 per- give way to a period of greater stability. cent. For the region as a whole, these develop- GDP growth in South Asia eased to an esti- ments yielded a flat profile of activity at 5.8 in mated 6.3 percent in 2008, from 8.4 percent in 2008 (figure 1.18). 2007 and from a 25-year high of 9 percent The region’s oil exporters will face the chal- during 2006. High food and fuel prices, lenge of diminished revenues in 2009. The tighter international credit conditions, and global oil price is anticipated to fall from its weaker foreign demand have led to worsening July 2008 peak ($145/bbl) to below $80 in external accounts and contributed to a 2009. Growth in oil-exporting countries is slowdown in investment growth. Deteriora- projected to slow to 3.9 percent in 2009. Al- tion in trade balances, however, has been off- though their economies are unlikely to be se- set in large part by large remittance inflows, verely affected by developments in financial particularly for Bangladesh, Nepal, and Sri markets, several countries stand more exposed Lanka, where remittances represent 8 percent to spillover effects from these developments, of GDP or more. Policy makers responded to including Lebanon, Jordan, and the Arab high commodity prices and rising inflation pressures by partially adjusting domestic fuel prices, cutting development spending, and Figure 1.18 Oil revenues, recovery from drought underpin growth in the Middle East (initially) tightening monetary policy. and North Africa in 2008 The global financial crisis is placing further GDP growth (%) World Bank average oil price ($/bbl) downward pressure on growth. Lower capital 8 110 inflows (down 40 percent, over January- Oil prices (right axis) 100 September 2008 compared with the same 6 90 period in 2007) and harder credit terms will 80 reduce private investment, while reduced remit- 4 70 tance inflows will add to pressures on growth. 60 Food and fuel price subsidies have pushed 50 fiscal outlays higher, reversing recent progress 2 40 in fiscal consolidation. And increasing deficits 30 are narrowing the scope to provide support 0 20 2000 2001 2002 2003 2004 2005 2006 2007 2008 for other urgent public programs, including the region’s overburdened infrastructure. The Diversified economies GDP (left axis) slowdown in growth is most apparent in India Oil exporters GDP (left axis) and Pakistan, where industrial production fell Source: World Bank data. sharply, and the momentum of production for South Asia has recently declined from a peak 35 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Figure 1.19 South Asian production slips in Figure 1.20 In Sub-Saharan Africa, primary the last months commodity exports increased as prices surged Industrial production (percentage change, saar) 20 Primary commodities as a share of total exports (%) South Asia 90 Developing 15 countries Sub-Saharan Africa 80 10 70 5 60 0 High-income OECD countries 50 Ϫ5 Sub-Saharan African oil-importing countries Jan. Jan. Jan. 40 2006 2007 2008 1976 1981 1986 1991 1996 2001 2006 Source: World Bank. Source: UN Conference on Trade and Development, Comtrade. of 12 percent in April 2008 to a decline of growth despite a sharp slowdown in global 2 percent in August (saar) (figure 1.19). trade (figure 1.20). South Asia’s GDP is expected to drop to The region’s growth is expected to decline to 5.4 percent in 2009 but to recoup to 7.2 per- 4.6 percent in 2009, before firming to 5.8 per- cent by 2010. Firming growth will be sup- cent by 2010 as a result of recovery in exter- ported by improving external demand and nal demand. Excluding South Africa, growth lower commodity prices. is anticipated to ease to 5.7 percent in 2009 Growth in Sub-Saharan Africa, outside of and to accelerate to 6.6 percent in 2010. But South Africa, increased to a remarkable 7 per- this scenario is subject to significant downside cent in 2007, the highest in some 35 years, as risks. Should the global slowdown prove much outcomes for both oil-importing and oil- deeper than anticipated, fostering a sharp fall exporting countries were robust. Growth in world trade growth, the contribution of net among oil exporters increased to 8.2 percent exports to African GDP growth will diminish. in 2007, exceeding 5.5 percent gains for a And many countries in the region have be- fifth year running; growth in oil-importing come more vulnerable to terms of trade economies breached a 25-year record, gaining shocks, as high fuel and food prices have led 5.4 percent. GDP advances have become more to a deterioration in external positions over broad-based and less volatile in recent years, the past years. Higher food and fuel prices especially among oil importers. And a notable have also widened the poverty gap, raising the and encouraging feature of Africa’s recent per- risk of possible social unrest. formance is the sustained contribution of in- vestment to overall GDP growth. In 2008, activity outside of South Africa re- World Trade mained strong at 6.6 percent as GDP gains among oil-producing countries eased moder- ately to 7.8 percent, joining the larger group of W orld trade volumes are expected to con- tract in 2009 for the first time since 1982 (figure 1.21). This decline is driven first oil-importing countries where GDP gains and foremost by a sharp drop in demand, as slowed to 4.2 percent in the year. Investment the global financial crisis imposes a rare simul- continues to provide an underpinning for GDP taneous recession in high-income countries growth, while net exports are contributing to and a sharp slowdown across the developing 36 P R O S P E C T S F O R T H E G L O B A L E C O N O M Y Figure 1.21 World trade is expected to Figure 1.22 Decline in high-income import decline in 2009 for the first time since 1982 growth affects developing-country exports Growth of global trade volumes (percentage change) Import volumes Import volumes (percentage change) (percentage change) 12 15 China exports 40 U.S. imports (left axis) (right axis) 9 10 30 6 5 20 3 0 10 Latin America & Caribbean exports 0 (left axis) Ϫ5 0 Jan. Jul. Jan. Jul. Jan. Jul. Jan. Ϫ3 1999 2000 2002 2003 2005 2006 2008 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 Source: World Bank data. Source: World Bank data. In addition, several countries (many in Latin America) that experienced a slowing of world. The global credit crunch is likely to af- exports because of low U.S. demand growth fect private investment especially, which is the benefited from higher commodity prices. most cyclical and most internationally traded Moreover, the impact on the volume of world component of GDP. At the same time, the trade was mitigated by the strong intra- credit crunch is restricting export finance. Al- regional growth of trade in East Asia, largely ready there is anecdotal evidence that commer- driven by China’s continuing integration into cial bank trade credits are drying up and that global markets. China’s import and export export receipts are becoming more difficult to growth continued to exceed 20 percent over insure. Similarly, exporting firms may cut back the past two years; while outside of China, ex- on shipments if their access to credit lines is port growth remained robust (figure 1.23). limited. Finally, the crisis has been associated with sharp, unpredictable swings in exchange rates, which also will hamper trade. Figure 1.23 Developing-country exports Signs of an economic slowdown have been have been strong, even outside China visible for some time (growth in U.S. import a Export volumes of developing countries (percentage change) demand was already falling in 2005), but they 35 Momentum (annualized 3 month over 3 month) have been building at a much more gradual 30 pace than occurred, for example, during the 25 Annual (12-month moving average) sharp correction in 2001, when import 20 growth dropped from plus 15 percent to 15 minus 5 percent within a year (figure 1.22). 10 The current gradual decline in demand growth 5 means that some exporting countries have had 0 time to shift to higher growth markets in de- Ϫ5 veloping countries. For example, while the Ϫ10 Jan. Jan. Jan. Jan. Jan. share of the United States in India’s exports 1992 1996 2000 2004 2008 fell from 17.1 percent in 2004 to 15.3 percent Source: World Bank data. in 2007, China’s share in India’s imports rose a. Excluding China. from 5.5 percent to 8.4 percent. 37 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 These mitigating and compensating factors 2009. The sharp downturn in world trade hits are unlikely to be active in 2009. The slow- the United States especially hard: export vol- down in high-income import demand has ac- umes are expected to drop 2.6 percent in 2009, celerated, few growth centers are left to which while imports contract 1.1 percent. Overall, the exports can be redirected, and commodity high-income OECD countries’ current account prices are falling. Thus developing countries deficit is projected to narrow by $185 billion to are set to experience a sharp, but likely tem- $375 billion in the year. porary, fall in their export revenues. Those The lower industrial-country deficit has its countries with insufficient reserves to sustain counterpart in lower surpluses in high-income import growth will need to rely on some com- oil exporters and in developing countries. The bination of exchange rate depreciation and current account surplus in developing countries slower growth to restrain imports. is expected to fall from a peak $500 billion, or Remittance flows to developing countries, 3.7 percent of GDP, in 2007 to $333 billion, or which reached an estimated $283 billion in 2 percent of GDP in 2009 (figure 1.24). While 2008 (Ratha, Mohapatra, and Xu 2008), China’s (and thus East Asia’s) surplus is antici- began easing in the second half of the year and pated to increase, in other regions, surpluses are are projected to slow sharply in 2009. Mi- expected to narrow, or deficits to widen. grant earnings in host-country currency terms Some appreciation of the impact of the are anticipated to be compressed by the reces- global recession on current account balances sion in the industrial economies, lower rev- can be gained by looking at countries grouped enues in high-income oil-exporting countries, by their primary commodity trade (here we and slower growth in many developing coun- exclude China, because the country’s massive tries that are destinations for migrants. current surplus—nearly $400 billion in While the baseline projection is for remit- 2008—masks underlying developments across tance flows to developing countries to decline smaller countries). The expected 26 percent as a share of recipient-country GDP from 1.8 fall in the price of oil and 23 percent fall in to 1.6 percent in 2009, the extent of the de- non-oil commodity prices (see the Commodity cline at the country level will depend critically on exchange rate developments. Recent swings in bilateral exchange rates have out- Figure 1.24 Developing-country current account surpluses to wane after 2008 weighed the expected change in remittances denominated in host-country currencies. Fu- Current account balance (US$ billions) 600 ture exchange rate movements will also play an important role. 500 All developing countries 400 Global current account balances are 300 expected to show substantial shifts 200 The global recession and attendant decline in 100 world trade and in commodity prices will have 0 a dramatic impact on current account balances. Ϫ100 Surplus positions in Japan and the Euro Area Ϫ200 should increase to $240 billion and $180 bil- 2000 2002 2004 2006 2008 2010 lion, respectively, during 2009 as commodity prices fall and trade volumes compress. Despite East Asia & Pacific South Asia the improvement in the U.S. terms of trade, its Middle East & North Africa Europe & Central Asia Latin America & Caribbean current account shortfall is expected to deterio- rate from $770 billion in 2008 (5.4 percent of Source: World Bank data. GDP) to $830 billion or 5.8 percent of GDP in 38 P R O S P E C T S F O R T H E G L O B A L E C O N O M Y Figure 1.25 Current account balances for Figure 1.26 Almost all currencies have commodity-exporting and -importing depreciated against the dollar developing-country groups (excluding % depreciation since Sept.15 –Oct. 30 China) 14 Current account balance as share of GDP 12 8 10 6 8 4 6 2007 2008 2009 2010 2 4 0 2 ؊2 0 High- East Europe Latin Middle South Sub- ؊4 income Asia & & America East & Asia Saharan ؊6 countries Pacific Central & North Africa Asia Caribbean Africa ؊8 ؊10 Source: World Bank. Oil exporters Oil importers / Oil importers Oil and food food exporters importers Source: World Bank data. firms, and investors. No developing-country currency has appreciated against the dollar by more than 0.5 percent during this period. On Markets section below) will shift the terms of average, currencies of developing countries trade in favor of oil- and food-importing have fallen by 15 percent against the dollar, but countries, following a string of at least five high-income-country currencies (save Japan’s), years of substantial losses. For developing- have also depreciated (figure 1.26). In general country oil exporters, the fall in global de- the competitiveness of the United States, Japan, mand will reduce both oil prices and export China (whose currency has held steady versus volumes (which are expected to shift from the dollar), and those countries whose curren- 5.1 percent growth in 2008 to 0.3 percent in cies have been pegged to the dollar will have 2009), and their current account surplus will been reduced; competitiveness for countries fall from a peak of 6.4 percent of GDP in 2008 whose currencies have depreciated will be im- to 1.4 percent in 2009 (figure 1.25). By con- proved in these markets. As a result, the strong trast, the current account deficit of developing- impetus that net exports have provided for country importers of both oil and food almost U.S. growth is likely to be attenuated; at the halves, from a peak of 8.1 percent of GDP in same time, net exports are likely to support the 2008 to 4.3 percent by 2009, because of lower growth recovery of many developing countries. commodity prices and a sharp slowdown of imports from 8.1 percent growth in 2008 to 1.5 percent in 2009. The impact of these global Commodity markets developments should begin to dissipate in 2010 as oil prices stabilize, the prices of nonen- ergy commodities decline by only 4.3 percent, C ommodity prices—which have been trend- ing higher since 2003—continued the ro- bust rise that began in 2007 into the first half and world trade begins to recover. of 2008. As of mid-November, prices have The financial crisis has induced major fluc- since fallen sharply, giving up most of their tuations in exchange rates during the autumn gains of the first half of the year. The abrupt of 2008. Almost every currency in the world decline reflects a classic response of commodi- has depreciated against the dollar and the yen, ties to slowing global growth at the end of a reflecting a “flight to quality” into U.S. Trea- boom (for more on this subject, see chapter 2), sury securities, the unwinding of yen-based a decline that has been amplified and acceler- carry trades, and the deleveraging of banks, ated by the financial crisis. In the summer of 39 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Figure 1.27 Commodity prices surged before Figure 1.28 Crude oil prices correct sharply retreating in the second half of 2008 after unprecedented run-up Commodity price indexes Commodity price indexes World Bank average crude oil price ($/bbl) (2000 ϭ 100, current US$) (2000 ϭ 100, current US$) 150 325 500 300 450 125 275 Non-energy prices 400 250 (left axis) 100 350 225 300 200 75 250 175 200 50 150 Energy prices 125 (right axis) 150 25 100 100 Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. 2004 2005 2006 2007 2008 2005 2006 2007 2008 Source: Datastream and World Bank. Source: World Bank data. 2008, energy prices were 80 percent higher in OECD member countries, appreciation of the dollar terms than a year earlier, while nonen- dollar, and concerns about demand prospects in ergy prices were 35 percent higher (figure 1.27 the wake of financial turmoil (figure 1.28). The and table 1.4). sharp decline in crude oil prices has also been a Almost all the advance in nonenergy com- significant contributor to declines in other com- modity prices during 2008 came from grains modities, because these markets are increasingly (up 60 percent), fats and oils (up 34 percent), linked through production costs and through and fertilizers (up 140 percent). Metals prices, the development of biofuels (see chapter 2). which increased rapidly between 2003 and 2008, picked up just 8 percent over the first six Falloff in demand in high-income months of 2008. Almost all commodity prices countries drives decline in oil prices peaked in early or mid-2008, and most have de- Oil demand in the OECD countries has been clined sharply since then. Crude oil prices declining for three years, with most of the re- dropped from $143/bbl in early July to less than duction in the United States, which was af- $50/bbl in mid-November. The price drop fected by slowing economic activity and the stemmed from weaker realized demand across consumption-dampening effects of higher oil and gasoline prices. U.S. oil demand fell 5.6 per- Table 1.4 Forecast of commodity prices cent over the first 10 months of 2008 (year-over- Percent change 2000–05 2006 2007 2008 2009f 2010f year). Gasoline consumption dropped 3 per- cent as consumers reduced the number of miles Energy 13.5 17.3 10.8 45.1 ؊25.0 0.9 driven and began switching to more energy- Oil 13.6 20.4 10.6 42.3 Ϫ26.4 1.8 efficient vehicles. Oil demand also slowed in Natural gas 10.4 33.9 1.0 57.2 Ϫ10.8 Ϫ4.2 Coal 12.7 3.1 33.9 97.8 Ϫ23.1 Ϫ10.0 Europe. Overall, OECD demand is expected to Nonenergy 8.3 29.1 17.0 22.4 ؊23.2 ؊4.3 fall by more than 2.2 percent during 2008 and Agriculture 6.0 12.7 20.0 28.4 Ϫ20.9 Ϫ1.3 by less than 2 percent in 2009. Demand in de- Foods 6.0 10.0 25.6 35.2 Ϫ23.4 Ϫ0.3 Grains 4.8 18.4 26.1 50.9 Ϫ27.7 2.6 veloping countries and emerging markets has Raw materials 5.0 22.7 9.0 13.0 Ϫ14.9 Ϫ2.7 continued to grow by about 4 percent, with de- Metals and mand strongest in Asia and the Middle East, the minerals 12.3 56.9 12.0 5.0 Ϫ25.5 Ϫ5.5 Copper 15.2 82.7 5.9 Ϫ0.6 Ϫ32.2 Ϫ4.2 latter fueled until recently by strong economic Source: World Bank data. growth and in some countries fuel subsidies and f. Forecast. thus low consumer prices (box 1.3). 40 P R O S P E C T S F O R T H E G L O B A L E C O N O M Y Box 1.3 Impact of commodity prices on external balances and capital flows D eterioration in external balances has become a significant problem for many developing coun- tries. Overall, in 2007, current account deficits ex- Box figure 1.3b Oil balances as a share of GDP in developing countries, 2000–07 ceeded 10 percent of GDP in about one-third of de- GDP (%) 15 veloping countries, up from about one-quarter in 2006. Twelve countries ran deficits in excess of 20 Oil exporters percent of GDP in 2007. In part, these deficits reflect 10 the impact of higher oil prices on oil-importing coun- tries: oil balances account for more than half of the 5 current account deficit in one of every two develop- China ing countries. Excluding the massive rise in China’s 0 surplus, the current account deficit of oil-importing Other oil importers countries has increased significantly during the rise Ϫ5 in prices, from close to zero in 2002–03 to about 2000 2001 2002 2003 2004 2005 2006 2007 $130 billion in 2007, an amount equal to 2.2 per- Source: World Bank. cent of GDP (box figure 1.3a). In contrast, the cur- rent account surplus of oil-exporting countries im- proved from 2 percent of GDP to more than 7 adjustments in trade and domestic absorption to ac- percent in 2005–06, though it declined to below 5 commodate the rise in oil prices. And there is little percent in 2007. correlation between the size of countries’ net oil bal- The rise in oil prices has contributed to, but does ance and the size of current account balances. Sev- not fully explain, this disparity in current account eral oil-importing countries continue to run sizable balances. The rise in oil-importing countries’ deficits current account surpluses (exceeding 10 percent of has been less than the increase in their net oil bal- GDP in four countries), whereas several oil-exporting ance, while the increase in oil-exporting countries’ countries are running sizable current account deficits surplus has been well below the improvement in (notably Kazakhstan and Sudan). Some countries their oil balance (box figure 1.3b). As should be (Botswana, Nepal, Paraguay, Swaziland, and Thai- expected, many countries have made compensating land) managed to run current account surpluses even though their deficits on the oil component of the trade balance exceeded 5 percent of GDP. Box figure 1.3a Oil balances in developing countries, 2000–07 How have countries been able to finance their US$ billions large external imbalances? 600 The financing of increased current account deficits 500 Oil exporters has not come principally from higher portfolio flows 400 or reserve drawdowns, but from foreign direct in- 300 vestment and aid. Much of the surge in private debt 200 and equity flows to developing countries over the 100 China past few years has gone to countries with sizable 0 current account surpluses. For example, private debt Ϫ100 flows to the 11 countries with current account Other oil importers surpluses in 2005–07 accounted for half of the total Ϫ200 2000 2001 2002 2003 2004 2005 2006 2007 to all developing countries (in 2007, Russia ran a Source: World Bank. current account surplus equal to 6 percent of its GDP and yet received $125 billion in private debt 41 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Developing countries with large external imbalances, 2007 (percent) Country Current account Oil balance Non-oil commodity balance Commodity balance FDI inflows Net ODA disbursements Burundi Ϫ37.6 Ϫ11.6 Ϫ0.4 Ϫ12.0 0.0 46.0 Seychelles Ϫ32.7 Ϫ36.5 0.7 Ϫ35.8 18.8 1.8 Togo Ϫ21.9 Ϫ8.5 4.6 Ϫ4.0 3.5 3.6 Nicaragua Ϫ21.5 Ϫ13.1 6.5 Ϫ6.6 0.1 13.8 Latvia Ϫ20.8 Ϫ3.2 1.2 Ϫ2.0 7.3 0.0 Georgia Ϫ20.0 Ϫ5.5 Ϫ1.8 Ϫ7.3 16.9 4.7 Fiji Ϫ18.8 Ϫ11.7 2.9 Ϫ8.8 11.9 1.8 Malawi Ϫ18.6 Ϫ4.3 11.6 7.3 — 21.3 Source: World Bank. Note: — ϭ not available. For Burundi, Fiji, Malawi, Seychelles, and Togo, data are for 2006. flows). And to date few countries have had to draw foreign direct investment covered over half of the down their ample foreign reserve holdings. Instead, current account deficit, and in 4 countries net official of the 13 countries with the largest current account development assistance (ODA) disbursements ex- deficits (and where data are available), in 8 countries ceeded 10 percent of GDP (box table). OPEC producers—reluctant to raise output Prices for many metals are falling significantly during the run-up in prices dur- on the back of weaker demand ing the first half of 2008—increased produc- Several metals prices have plummeted in recent tion at midyear, mainly through Saudi Arabia, months because of slowing global growth and which unilaterally agreed in June to lift output improving supply prospects. Nickel prices have by 0.5 million barrels a day (mb/d). Iraq’s out- fallen more than three-quarters from their 2007 put breeched 2.5 mb/d for the first time since peak, partly because of difficulties in the auto- 2001 as attacks on infrastructure subsided mobile and construction sectors. Prices have somewhat. But increases elsewhere in the Gulf fallen below the marginal costs of high-cost were partly offset by declines in Nigeria, producers, and some plants are being closed where civil strife continued to cause large and new projects delayed or reconsidered. Zinc supply disruptions. prices have fallen almost as much as nickel in As discussed in chapter 2, the non-OPEC percentage terms. Lead prices have fallen more supply response has been disappointing. Pro- than 60 percent on improving supply prospects. duction has been plagued by several factors Prices for these metals are expected to decline during the current decade, notably rising costs further as new capacity comes online. and taxes, and the ongoing depletion of aging Copper is among the few metals whose fields. Despite these constraints, non-OPEC price remained elevated during the first half of supplies are beginning to increase in a number 2008, despite weak demand; numerous supply of regions and are projected to rise in the disruptions tied to strikes in Latin America second half of 2008 and over 2009–10. and delays bringing on new capacity kept cop- As a result of weakening demand and ex- per prices high. However, prices plunged in pected supply increases, oil prices are antici- the second half of the year in the wake of the pated to average $75/bbl in nominal terms financial crisis and the weakening global eco- during 2008–10, implying a cumulative real nomic environment. China’s import demand decline of more than 30 percent. has been weak in 2008, and the slowdown in 42 P R O S P E C T S F O R T H E G L O B A L E C O N O M Y global housing construction more broadly Figure 1.29 Grains prices show sharp contributed to diminishing demand. Prices declines from recent peaks nonetheless remain well above production Commodity prices Commodity prices costs and are expected to continue to decline (current US$) (current US$) significantly through 2010 as new capacity 450 1,000 Wheat (left axis) comes online. 400 900 350 800 Aluminum—the one major metal whose 300 Maize (left axis) 700 price has not surged during the current cycle 250 600 because of the growth of capacity in China— 200 500 became more expensive recently because of 150 400 100 300 still-strong global demand and increasing Rice (right axis) 50 200 costs of electricity, a major input to the pro- Jan. Jan. Jan. Jan. duction of aluminum. The outlook for alu- 2005 2006 2007 2008 minum prices depends critically on the pace of Source: World Bank data. investment in new capacity (especially in China and the Middle East), as well as on the level of energy costs and deregulation of in November. Export bans that had been in power markets. Even if new capacity is con- place were either eliminated by many countries centrated in areas with stranded, low-cost en- or partly circumvented through bilateral ergy sources, such as the Middle East, there is agreements. For example, Egypt, which had limited downside potential for prices, because accumulated 7 million tons of rice during the aluminum has been fluctuating near the upper period of its export ban, is expected to curb the portion of the cost curve. intervention soon. Similarly, India has allowed Taken together, the index of metals and shipments of non-basmati rice to four African minerals prices is projected to fall 25 percent nations. in 2009 and an additional 5 percent in 2010 Oilseed prices also have fallen sharply. Palm compared to 2008. oil prices averaged less than $480 a ton in November, down from $1,250 a ton in March Prices of agricultural commodities are 2008. Similar declines took place in most edi- falling sharply from peaks ble oils (soybean oil dropped from $1,475 a Prices for food traded internationally increased ton to $835, and coconut oil from $1,470 a almost 60 percent during the first half of 2008 ton to $705 over the period). The weakening in dollar terms, with basic staples such as grains of edible oil prices reflects not only slowing and oilseeds showing the largest increases. economic growth but also improved supplies, Wheat prices more than doubled, from $200 a and perhaps mounting pressure in the Euro- ton to $440 between March 2007 and March pean Union (EU) to scale back biofuel man- 2008, while rice prices almost tripled in the four dates—most of the EU’s biofuel production is months ending April 2008 (figure 1.29). Soy- biodiesel, whose feedstock is rapeseed oil, a bean and palm oil prices increased 44 percent close substitute for palm and soybean oils. from 2007 to 2008. Prices have since declined Rubber prices began easing in July and sharply. Wheat prices, for example, fell to less August 2008, an unsurprising development be- than $240 a ton in November. Since their peak cause they track crude oil prices closely (syn- in April 2008, grain prices have declined by thetic rubber is made from petroleum). Signs more than 30 percent. The spike in rice prices in of weakening prices have also been evident in April and May 2008, on concerns regarding the beverages, with cocoa averaging a little over adequacy of global food supplies and export $2 a kilogram in November, down from $3.00 bans, appears to have subsided, with prices in June 2008. Other agricultural commodities, falling from nearly $1,000 a ton to $550 a ton especially raw materials and some foods such 43 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 as bananas and sugar, have experienced prices are expected to remain much higher smaller declines, because their price increases than during the 1990s and more than 60 per- were not as sharp and they are less closely cent higher than their levels in 2003. linked to energy prices. In the baseline, the very tight credit condi- Fertilizer prices experienced the largest in- tions observed in November are projected to crease among all commodity groups in 2008, dissipate during the first quarter of 2009— with the index up 116 percent between January which together with a strong crop this season and August 2008; prices were driven up by the should ensure that prices do not rise sharply in combination of strong demand growth (in re- the medium term. However, if farmers in high- sponse to high crop prices), limited surplus and middle-income countries are unable to get production capacity, higher production costs financing for seed and fertilizer purchases for related to high energy prices, and an export plantings for next season, plantings may be tax imposed by China to protect domestic lower than expected, which could cause agri- supplies. Phosphate prices (DAP), for exam- cultural prices to rebound during the 2009/10 ple, increased by almost 110 percent between crop year. Farmers in key agricultural producing January and August 2008 while urea prices and exporting countries, including Australia, doubled in just four months (December 2007 Argentina, Brazil, the United States, and the to April 2008). The decline in crude oil and European Union, rely on short-term financing grain prices, along with weak demand, how- for inputs (e.g., fertilizer) and longer-term ever, is now being reflected in fertilizer prices. financing for the purchase of machinery. The Urea, for example, declined to $250/ton (a short-term financing is typically guaranteed by two-year low) while DAP averaged below placing land as collateral and to a lesser extent $650/ton as of November 20. by hedging in futures markets for a minimum Current crop prospects are favorable. price guarantee (the latter mostly in the United Grain production is projected to increase States). The credit crunch combined with de- about 4 percent in the current crop year, and clining commodity prices has made banks oilseed production is anticipated to rise by reluctant to lend. The situation may worsen if twice as much. Although this production in- land prices begin to decline—there are already crease will allow some rebuilding of stocks, signs that land prices are falling in some EU continued growth of demand for biofuels countries—or if credit conditions do not begin should keep pressure on inventories. Maize to thaw. At the same time, farmers appear to used for ethanol in the United States is ex- have lost faith in hedging instruments. pected to increase to 33 percent of the crop in 2008, accounting for nearly all of the increase Commodity price declines carry significant in global maize consumption and causing implications for the terms of trade global maize stocks to fall. In contrast, large The decline of commodity prices anticipated increases in wheat and oilseed production for 2009 will drive sharp changes in develop- should allow some rebuilding of stocks. ing countries’ terms of trade. Some 30 coun- Stocks will remain low by historic standards, tries are expected to gain more than 1.5 per- however, and prices will remain vulnerable to cent of GDP from the decline in oil prices supply disruptions or demand surges. (figure 1.30). Of these, Cyprus, Guyana, Overall, grain prices are projected to de- Jamaica, Jordan, the Kyrgyz Republic, cline about 28 percent in 2009 and to recoup Moldova, Nicaragua, the Seychelles, and 3 percent in 2010. Fats and oil prices are an- Tajikistan stand to gain more than 2.5 percent ticipated to fall by 27 percent in 2009 and an- of GDP. And the fall in food prices will help to other 5 percent in 2010. And beverages are ease both external and fiscal positions (as the projected to decline 18 percent and 4 percent, cost of food subsidies declines) for many of respectively. Despite these developments, food the world’s poorest countries, including Benin, 44 P R O S P E C T S F O R T H E G L O B A L E C O N O M Y Figure 1.30 Most vulnerable countries will Figure 1.31 First-round income impact of benefit from the decline in grains and lower commodity prices will be positive in oil prices more than half of developing countries Oil price shock (as share of GDP) Terms of trade shock (as share of GDP) 5 6 Seychalles Vulnerable countries 4 Jordan 0 2 –5 0 –10 Ϫ2 Argentina –15 Ϫ4 –20 Ϫ6 Venezuela, Kazakhstan R.B. de –25 Ϫ8 Ϫ3 Ϫ2 Ϫ1 0 1 Source: World Bank. Grains price shock (as share of GDP) Source: World Bank. first-round income losses in excess of 1.5 per- cent of GDP (figure 1.31). Eritrea, Ghana, Guinea, Haiti, Madagascar, Niger, Senegal, and Togo. Key risks and uncertainties At the same time, oil-exporting countries will experience large terms of trade losses, with Angola, Azerbaijan, the Republic of Congo, T he freezing of credit markets, collapse of stock markets, large shifts in exchange rates and commodities prices, and unprece- Equatorial Guinea, Gabon, the Islamic Repub- dented policy reactions have combined to cre- lic of Iran, Kuwait, Libya, Nigeria, and Saudi ate an extremely uncertain environment for Arabia incurring first-round income losses in market participants and forecasters alike. Sev- excess of 10 percent of GDP. Weaker metals eral possible outcomes for the global economy prices are anticipated to reduce incomes by remain plausible at this juncture—even assum- more than 2 percent of GDP in Chile, Mauri- ing that a catastrophic meltdown of markets is tania, Mongolia, Papua New Guinea, Suri- avoided. Global GDP growth could reasonably name, and Zimbabwe. Countries that rely be expected to be as strong as 1.4 percent in heavily on grains exports are likely to be hit 2009 and as weak as 0.4 percent, compared hard. Exporters like Argentina (maize, soy- with the baseline projection of 0.9 percent beans, wheat), Bolivia (soybeans), The Gambia growth presented in this chapter. (groundnuts), Guinea-Bissau (groundnuts), The confidence interval around projections Guyana (rice), and Paraguay (soybeans) will for 2010 is even wider. Instead of the typical experience losses ranging from 1.6 percent to cyclical rebound envisaged in the baseline, 9 percent of GDP, though for some the impact output could remain subdued as consolidation will be softened by falling oil prices. in the banking sector acts as a persistent drag Taking into account the effects of commod- on growth, and credit growth remains almost ity price declines on both import and export stagnant for several years (see Hebling 2005; prices, more than half of the countries in a IMF 2008). Alternatively, the crisis may have sample of 162 economies are expected to see less pronounced direct effects on the real econ- an increase in the terms of trade, of which 24 omy, in which case the aggressive monetary will experience gains in excess of 1.5 percent loosening and large-scale fiscal stimulus that of GDP. About a quarter of the countries, in- the crisis has provoked could lead to a sharper cluding most oil producers, are seen to incur rebound in 2010. Such a scenario runs the risk 45 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 of reaccelerating inflation, which would likely the current downturn, and will they retain the need to be followed by a tightening of both underlying strength, confidence, and strong monetary and fiscal policies. macroeconomic fundamentals that under- In such an environment, policy makers in pinned the record growth of the past five both developing and high-income countries years? The danger for all countries is that too must be prepared to weather a worst-case sce- aggressive an effort to combat what looks to nario of even lower growth, including the pos- be an inevitable slowdown may prove too sibility of a decline in world GDP for the first costly and undermine the strong fundamentals time in the postwar period, as well as a finan- that had earlier underpinned growth. Coun- cial meltdown that could lead to a sudden stop tries need to react quickly and forcefully to of credit flows to all but the most creditwor- signs of weakness in their financial sectors, in- thy borrowers. Whatever the eventual out- cluding by liquidity injections and recapitaliz- come, the environment over the next two ing banks where necessary. years will be radically different from that Care must also be taken, however, to avoid which was expected only a few months ago, the possible entrenchment of inflationary and policies will need to adapt. pressures by ensuring that more general ef- Understandably (and correctly) under cur- forts to provide support to banking systems rent circumstances, with the world economy are highly targeted and efficient, and that any confronted with systemic financial risks, necessary liquidity injections are reabsorbed short-term attention is focused on dealing once growth revives. The long-term costs of with the immediate crisis, minimizing risks, such policies could be substantial even if they and reacting to rapidly evolving develop- help to lighten the coming recession. Policy ments. Major risks concern the possibility of makers must ensure that the steps taken are balance of payments and currency crises in in- clear and coherent. So far, the worst has been dividual countries—a real risk at this stage for avoided by huge government interventions. If at least some developing countries. A collapse the market comes to view such interventions of the domestic banking system in select de- as ineffective, because they are poorly under- veloping countries is also a tenable possibility. stood or seen as not addressing the most criti- In the case of Russia, where the economy is cal problems, then the policies likely will be flush with petrodollars, the authorities look to ineffective. In this case, global economic diffi- be in a position to rescue domestic financial culties could become very serious indeed. institutions. Other countries are less well positioned and may have to draw upon inter- national assistance, a development that should Long-term prospects and be undertaken quickly if necessary. The longer poverty forecast the global stress lasts, the more currencies may come under pressure. The increase in corpo- rate spreads still exceeds the increase in sover- D espite the current financial turmoil and sharp slowdown in growth anticipated for 2009, longer-term prospects for developing eign spreads by a large margin. In all cases countries have changed only modestly com- preventing a financial crisis in one country pared with last year’s forecast. In part prospects from infecting a broader group of countries are little changed because a slowdown had al- would be difficult. Therefore, instead of ex- ready been anticipated, albeit to a much lesser ploring the details of a potential crisis, it is degree. The primary reason, however, lies in the paramount to avoid a crisis altogether long-term supply potential of developing coun- through coordinated international action. tries, which should allow output to recoup the From a longer-term perspective, concerns lost production induced by the coming growth are of a very different nature. The question is: recession during the first five years of the next How will developing countries emerge from decade. 46 P R O S P E C T S F O R T H E G L O B A L E C O N O M Y Per capita GDP in developing countries Table 1.5 Poverty in developing countries over the period 2010–15 is expected to expand by region, selected years at a relatively rapid annual pace of 4.6 per- Region or country 1990 2005 2015 cent, much faster than the 2.1 percent pace of Number of people living on less than $1.25/day (millions) the 1990s and the 0.6 percent average of the East Asia and the Pacific 873.3 316.2 137.6 1980s, replicating the average performance of China 683.2 207.7 84.3 this decade. Improvements in macroeconomic Europe and Central Asia 9.1 17.3 9.8 Latin America and the Caribbean 49.6 45.1 30.6 policies (lower inflation, relaxation of trade Middle East and North Africa 9.7 11.0 8.8 restrictions, more flexible exchange rate South Asia 579.2 595.6 403.9 regimes, and lower fiscal deficits) have com- India 435.5 455.8 313.2 Sub-Saharan Africa 297.5 388.4 356.4 bined with structural reforms (privatization Total 1,818.5 1,373.5 947.2 and regulatory initiatives) to reduce uncertainty Number of people living on less than $2.00/day (millions) and generally improve incentives for invest- East Asia and the Pacific 1,273.7 728.7 438.0 ment. Projected future growth rates are higher China 960.8 473.7 260.9 than in the 1990s (and much more so than in Europe and Central Asia 31.9 41.9 26.7 Latin America and the Caribbean 86.3 91.3 72.4 the 1980s) in every developing region except Middle East and North Africa 44.4 51.5 33.3 East Asia and the Pacific, where growth is ex- South Asia 926.0 1,091.5 959.5 pected to decline somewhat because of an aging India 701.6 827.7 714.5 Sub-Saharan Africa 393.6 556.7 585.0 population. Total 2,755.9 2,561.5 2,115.0 Rapid growth should enable developing Percentage of the population living on less than $1.25/day countries, as a group, to achieve the Millennium East Asia and the Pacific 54.7 16.8 6.8 Development Goal of halving poverty by 2015. China 60.2 15.9 6.1 The poverty forecast for 2015 is 15.5 percent, Europe and Central Asia 2.0 3.7 2.2 Latin America and the Caribbean 11.3 8.2 5.0 well below the target of 20.9 percent—half of Middle East and North Africa 4.3 3.6 2.5 the revised 1990 level as explained in more South Asia 51.7 40.3 23.8 detail below. The East Asia and Pacific region India 51.3 41.6 25.4 Sub-Saharan Africa 57.6 50.9 37.1 has clearly surpassed its individual target, and Total 41.7 25.2 15.5 South Asia is on target. The main concern re- Percentage of the population living on less than $2.00/day mains Sub-Saharan Africa. Although the inci- East Asia and the Pacific 79.8 38.7 21.6 dence of poverty in the region has been de- China 84.6 36.3 18.9 clining over the past decade, at about 37.1 Europe and Central Asia 6.9 8.9 6.0 Latin America and the Caribbean 19.7 16.6 11.8 percent in 2015, the share of people living in Middle East and North Africa 19.7 16.9 9.3 extreme poverty will remain well above the South Asia 82.7 73.9 56.6 region’s target of 29 percent (table 1.5). India 82.6 75.6 57.9 Sub-Saharan Africa 76.2 73.0 60.8 This year’s poverty forecast is consistent Total 63.2 47.0 34.6 with the World Bank’s revised poverty esti- Source: World Bank. mates for developing countries. The new poverty estimates largely result from a revision of purchasing power parities (PPP) by using a and the incorporation of new and more recent new International Comparison Project survey household surveys (see box 1.4 and Chen and of prices paid by households. The 2005 survey Ravallion 2008 for more detail). improved on the 1993 data and methods used The new poverty estimates provide a signif- to prepare previous estimates. The new price icantly different picture of global poverty— data reveal that the cost of living is higher in back to 1990 and for the most recent year, 2005 low- and middle-income countries than had (figure 1.32). Global poverty in 1990, the bench- been suggested by past surveys. Other factors mark year for the Millennium Development influencing the changes to the poverty esti- Goals, is now estimated to have been 41.7 per- mates include revisions to national accounts cent of the developing-country population 47 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Box 1.4 The impact of the new price survey on poverty estimates reevaluated. The international poverty line is meant S urveys of prices are obviously critical in determin- ing the cost of the common basket of goods and services in each country that is used to define to capture a notion of extreme poverty. As such, it is calculated as the average poverty line of the poorest poverty. The price surveys determine the purchasing countries. Using the new PPP estimates, the new power parity (PPP) exchange rate used in translating poverty line for extreme poverty is now measured at domestic prices into international dollars. Compared $1.25 (in 2005 international dollars, and represents with the measure provided by market exchange the average of the poverty lines of the fifteen poorest rates, these PPP exchange rates provide a more accu- countries for which there is data). This new poverty rate measure of the affordability of nontraded goods line is about 14 percent lower than the old interna- in the poverty basket (because prices of nontraded tional poverty line, which in 2005 dollars is $1.45. goods vary enormously across countries at different This reflects the higher PPPs for the poorest coun- levels of development). Previously, the PPP exchange tries implied by the 2005 survey data. To capture a rates were based on a 1993 survey of prices that cov- broader notion of poverty, the World Bank’s poverty ered relatively few countries and used a weak survey forecast has also presented statistics relevant to the methodology. In 2005, the World Bank, in partner- so-called $2/day poverty line that was double the ship with other international organizations and na- $1/day poverty line and reflected the average of the tional statistical offices, concluded a new price sur- national poverty lines of the middle-income coun- vey that covers 146 countries—of which 101 are tries. The new $2/day poverty line, measured in 2005 developing—and between 600 and 800 products prices, represents the median of all of the national (World Bank 2008). The survey includes China for poverty lines in the available surveys. the first time and updates the earlier survey of India, The increased estimates of prices in many coun- which dated from 1985. The new price survey has tries and a lowering of the international poverty line had two impacts on measured poverty. have changed the picture of poverty globally—over First, it has revealed that prices paid by the poor time and in 2005. As reported in Chen and Raval- in developing countries are higher than thought previ- lion (2008), these two effects partially offset each ously, thereby reducing estimates of mean per capita other. The revisions in the PPPs alone, with no consumption (or income) based on a common unit, change in the poverty line, would have raised the that is, international dollars. In China, for example, poverty estimate in 2005 from the previous 17 per- average per capita consumption in 2005 was esti- cent to 32 percent. The reduction in the poverty line mated to be about $2,400 at the old PPP exchange to $1.25 a day lowers this estimate to 25 percent. rate but only about $1,400 at the new PPP exchange The net effect is to raise the poverty estimate for rate. These newer price levels imply quite naturally 2005 by 8 percentage points. The upward revision in that households can afford fewer goods and that the poverty level does not imply that the rate of many more are living on less than a $1 a day. poverty reduction, say between 1990 and 2005, has Second, in light of the new price survey, the defin- not been as rapid as previously reported. ition of the “international” poverty line has been (compared with the previous estimate of illustrative. The headcount index for 1990 28.7 percent using the old prices and guide- jumped from 33 percent to 60.2 percent. This lines). This implies that the target for the dramatic change was attributable mainly to poverty MDG is 20.9 percent, rather than the the poor price comparison basis for the ear- previous 14.4 percent. The revisions had a sig- lier estimate rather than to any underlying nificant affect on all regions, except Latin change in China itself. America and the Caribbean, which saw only The combination of a new estimate of mean minor adjustments. The case of China is consumption and a new poverty line also 48 P R O S P E C T S F O R T H E G L O B A L E C O N O M Y It should be noted that the impact on the Figure 1.32 Revised poverty estimates poverty forecast of the recent rise in food and following from new price survey energy prices is not fully reflected in these pro- Headcount poverty index in 1990 jections, which largely reflect neutral changes 70 in per capita incomes.4 As discussed in chap- 60 New ter 3, the increase in food prices between 50 January 2007 and January 2008 is likely to 40 Old have increased global poverty by between 30 130 million and 155 million people, or by 20 1.3–1.5 percentage points. With prices now 10 declining but not expected to return to their 0 earlier levels, at least some of this deteriora- tion is likely to be permanent. a ci ia an ia ar ca a a na ls di ric si Pa s As ta fri be f ic hi & st A In lA Af to A C ib h tra ut ic ran th ld Ea So en or or C a W N C Am Sah & & & a st b- pe er Ea La Su ro Notes Eu e dl tin id M 1. Prices are as of November 20, 2008. Source: World Bank data and staff calculations. 2. Total assets of U.S. households began to decline Note: The comparison reflects both revisions necessitated by the in the fourth quarter of 2007, as real estate values change in purchasing power parities and the new international dropped by $185 billion and financial assets fell by poverty line, which was $1.45 per day in 2005 dollars under the old methodology and has been revised down to $1.25 per day in $200 billion. By the second quarter of 2009, the 2005 dollars with the new methodology. cumulative decline in household assets amounted to $2.4 trillion, the equivalent of 16 percent of GDP. 3. It is difficult to make an exact comparison be- implies a change in the starting value of the cause last year’s forecast was benchmarked to 2004, growth-to-poverty elasticity. Even if the not 2005 as is this year’s forecast. As well, there have shape of the income distribution is broadly been (slight) revisions to historical national income and product accounts. the same as in earlier income surveys (as is the 4. Because of the inherent delays in processing case for many countries), the fact that the household surveys, the current forecast reflects surveys poverty line intersects the distribution at a dif- that were taken in 2005—before the rapid increase in ferent spot means that the impact of a given commodity prices in 2007 and the first half of 2008. increase in per capita incomes has changed. Nevertheless, the rate of improvement in the headcount poverty rate between 1990 and References 2005 has not changed that much using the Chen, Shaohua, and Martin Ravallion. 2008. “The De- new estimates.3 This year’s forecast reports an veloping World Is Poorer Than We Thought, But annual decline in global poverty between No Less Successful in the Fight against Poverty.” 1990 and 2005 of some 3.3 percent, which is World Bank Policy Research Working Paper, No. 4703, August. World Bank, Washington, DC. very close to the earlier estimated annual de- Helbling, Thomas, and Marco Terrones. 2003. “Real and cline of 3.2 percent. However, the higher Financial Effects of Bursting Asset Price Bubbles.” poverty level means that 25.2 percent of the In IMF World Economic Outlook, April 2003. developing world’s population was living on IMF. 2008. “Financial Stress and Economic Downturns.” less than $1.25 a day in 2005, compared with in IMF World Economic Outlook, October 2008. last year’s estimate of 18.1 percent for 2004. Ratha, Dilip, Sanket Mohapatra, and Zhimei Xu. 2008. As before, much of decline in global poverty “Outlook for Remittance Flows 2008–2010.” Migration and Development Brief 8. World Bank, between 1990 and 2005 results from in- Washington, DC. creased incomes in China, where the level of World Bank. 2008. Global Purchasing Power Parities extreme poverty fell from over 60 percent in and Read Expenditures: 2005 International Com- 1990 to less than 16 percent in 2005. parison Program. Washington, DC: World Bank. 49 2 The Commodity Boom: Longer-Term Prospects T he enduring importance of commodities to the world economy and their volatility has been driven home with the rise, and recent • Like earlier booms, this one ended when a slowdown in global growth eased de- mand pressures. The unusual strength decline, of prices for energy, metals, and food. and duration of this boom reflect the Before they began to fall in the second half unusual resilience, until now, of global of 2008, the real prices of energy and metals growth, particularly in developing more than doubled over the past five years, countries. while the real price of internationally traded food commodities increased 75 percent (see For oils and metals, an extended period of chapter 1 for more detail on the most recent low or falling prices created the conditions for developments in commodity markets). the boom and help explain the weak supply This chapter reviews the main characteris- response. tics of this most recent boom in commodity markets and examines the structure and behav- • Low prices throughout much of the ior of both their demand and supply, with a 1980s and 1990s reflected periods of view to better understanding prospects over the relatively weak growth and abundant medium to long term. The discussion does not spare capacity. Idle capacity arose, both include forests or fisheries, given their com- because energy demand declined in the plexity and the greater importance of issues wake of high oil prices in the 1970s and related to the public commons than for oil, early 1980s and because demand for oil metals, minerals, and agricultural products. and metals in the former Soviet Union Several important insights emerge from this (FSU) fell sharply when altered eco- chapter that are likely to drive developments nomic incentives caused these countries over the next several decades. to radically increase the efficiency with which commodities are used. The magnitude and duration of the com- • During the 1990s, much of the rising modity price boom are unprecedented. demand for oils and metals was met by the relatively easy rehabilitation of this • The upswing of the current boom lasted already-existing capacity. This helped to five years. Average commodity prices keep global commodity prices low and doubled in U.S. dollar terms (in part deterred investment in new supply boosted by dollar depreciation), making capacity, thus depressing activity in the this boom longer and stronger than any sectors supplying inputs to commodity boom in the 20th century. exploration and exploitation. 51 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 • As a result, a mismatch developed be- • Given continued technological progress tween the trend growth of demand and and appropriate policies, high oil prices the trend growth of supply capacity. will prompt and use development This mismatch became apparent in the of alternative energy sources (including early to mid-2000s, when spare capacity renewables) and greater efforts at con- was exhausted and demand began to servation, raising energy supplies and outstrip supply, pushing up oil and significantly reducing the demand for oil. metals prices. • For metals, slower growth in commodity- • Metals prices also were boosted by strong intensive developing countries (as popula- demand growth, linked to unusually high tion growth slows and income levels catch and rising metal intensities in China. up with the West), the easing of China’s Going forward, the intensity of metals de- investment surge, a rise in the share of mand in China should decline as invest- total output held by the less-commodity- ment rates fall and market mechanisms intensive service sector, and substitution provoke an increase in efficiency similar away from expensive materials should to that observed in the FSU. slow demand over the long term, facilitat- ing a decline in prices. The supply response in oil and metals is ex- pected to remain sluggish over the next few The extension of the boom to agricultural years, but new discoveries and technological markets mainly reflects the rising demand for progress are likely to boost supply over the biofuels and high energy prices. long run. • Higher energy and fertilizer prices raised • Ongoing shortages in the sectors that production costs in agriculture, and the provide exploration and exploitation combination of high oil prices and services, and the long lags between ini- biofuel subsidies and mandates boosted tial investments and the coming on- demand for some food crops. Poor har- stream of new production, suggest that vests in Australia also contributed to a supply conditions may remain relatively decline in grain stocks. tight in the oil and metals sectors and • Demand growth for food and feed in de- that prices, although declining, are un- veloping countries (such as China and likely fall to their 1990s levels. India) has not accelerated and was not a • Despite rising production levels, known major contributor to the rise in food reserves of most metals and oil have re- prices. mained fairly constant because of new • Real-side speculation (the decision to hold discoveries and improvements in extrac- on to physical stocks in anticipation of tion technology. further price increases) and financial in- • Although oil prices are likely to fall vestments along with policy reactions below existing levels during the current such as the imposition of export bans, also downturn, they are expected to rise contributed to the rapid increase in grain during the recovery and stabilize at and oilseed prices during 2007 and 2008. around $75 a barrel in real terms because new supplies—for example, from off- The prospects for growth in the supply of shore oil fields and Canadian tar sands— agricultural commodities at the global level are have higher production costs, and a ma- good, while demand growth is likely to slow. jority of known reserves are located in regions that are politically unstable or • Historically, agricultural productivity has not open to outside investors. increased more quickly than population, 52 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S allowing food production to keep pace Unless large-scale agricultural investment with growing demand, even as the share and knowledge creation and dissemination are of the population working in agriculture stepped up, food production in many of these declined. Over the next 20 years, assum- countries will not keep pace with demand. As ing sufficient investment is forthcoming a result, these countries will become increas- in developing and high-income countries, ingly dependent on imported food. the spread of more-intensive production Simulations suggest that if productivity techniques coupled with improved vari- growth in developing countries disappoints, eties that are emerging from recent ad- global food prices will be higher, and many vances in biotechnology, should allow developing countries—especially those with global productivity gains on par with his- rapidly growing populations—will be forced torical trends despite some productivity to import more-expensive food from high- losses caused by climate change. income countries, where productivity growth • Considerable potential remains for shows fewer signs of waning. bringing new (albeit somewhat less pro- The remainder of this chapter explores each ductive) land under cultivation in Latin of these themes in more detail. The next sec- America, Africa, and the FSU countries. tion compares the main characteristics of the • The demand for agricultural commodi- current commodity price cycle with earlier ties will slow as population growth ones. Then an examination of the long-term slows and as incomes in developing demand and supply sides of commodity mar- countries continue to rise (at higher in- kets follows. The chapter then brings the fore- comes, the incremental rise in demand casts for supply and demand in commodity for agricultural commodities sparked by markets together to form a base-case scenario further increases in income is relatively for prices, along with some alternative scenar- small). ios. While a wide range of future outcomes for • Robust supply growth and slowing de- supply, demand, and prices are possible, the mand are expected to reduce agricul- simulations support a highest-probability out- tural prices in the long run. Increased come where today’s high prices should induce demand for biofuels, however, will ex- sufficient additional supply to keep commodity tend the period of high prices unless prices well below their recent highs over the policies change or energy prices fall medium to long term—although they are not more rapidly than expected. expected to descend as low as they were in the • A more-rapid-than-expected warming of 1990s. A final section concludes. the planet could reduce agricultural pro- ductivity sharply, leading to rising food prices. Characteristics of the current While global supply prospects are good, un- commodity price boom less policy responds forcefully, food produc- tion in many developing countries may fall short of output gains B ooms and busts are relatively common occurrences in commodity markets (box 2.1 and figure 2.1). Like its predecessors, this Yield gains associated with the green revolu- episode of high prices has occurred during a tion are waning in many countries. Productiv- period of strong global growth and heightened ity levels in much of Africa and Europe and geopolitical uncertainty, and it generated sig- Central Asia are also declining; they are only nificant inflationary pressures (see chapter 1).1 one half those of best-practice developing However, this commodity boom was differ- countries, even after having controlled for dif- ent in important ways as well. It was among ferences in climate and soil. the most marked of the past century in its 53 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Box 2.1 Commodity price cycles I t is in the nature of commodities for their prices to show pronounced cyclical behavior. Indeed, some of the most influential early insights about the role Box figure 2.1a Volatility of production around trend, 1960–2007 of expectations in pricing behavior derived from ob- Bananas Sugar servations of how the interaction between prices and Rubber quantities in agricultural markets tended to generate Zinc Logs price cycles (Kaldor 1934). Tea Prices in commodity markets tend to exhibit cyclical Rice Copper behavior because supply decisions (how much to plant, Wheat how many mine shafts to dig) must be made by market Palm oil Maize participants well before the final sale price of the com- Lead Cotton modity is known. Because producers in the market are Soybeans uncertain about future demand and the production Cocoa Coffee decisions of other producers, the tendency in the aggre- Aluminum gate is for the independent production decisions to Petroleum Iron Ore overcompensate for short-term imbalances between Tin demand and supply and therefore for commodity prices Phosphate to be volatile. The longer the lag between the produc- 3 5 7 9 11 13 15 tion or investment decision of producers and the actual Percent increase in output, the longer the cycle in prices. Source: World Bank. Individual commodities differ in the extent to which they exhibit cyclical behavior and in the mech- anisms underlying the cycles. The output of industrial commodities tends to be most volatile, mainly be- Box figure 2.1b Volatility decomposition of cause their demand tends to fluctuate with the busi- global revenue for selected commodities, ness cycle and (in the case of crude oil) to be subject 1986–2006 to policy-related supply shocks (box figure 2.1a). Volatility decomposition of select commodities (global), 1986–2006 While prices of all commodities are sensitive to 60 spare capacity, the duration of booms and busts in Global revenue volatility (%) the metals, minerals, and the oil sectors tends to be 40 longer than in agricultural markets because of the longer lags between investing in new capacity and 20 the eventual increase in supply. 0 Their revenues also tend to be more volatile than revenues in agricultural commodities because Ϫ20 changes in production mainly reflect demand shocks. e C n C a e nc n a yb n r W s at ad il pe fe Ti o ic to Te So Cor n O he Zi oc ea R of Le ot op As a result, both prices and quantities move in C C tandem, rising during periods of high demand and declining in periods of low demand. In contrast, Contribution of: demand for agricultural products tends to be more Global price volatility (%) stable, and volatility tends to stem from supply Global output volatility (%) Residual (%) shocks. As a result, price movements tend to reduce revenue volatility among agricultural commodities Source: World Bank. because prices tend to move in the opposite direction of supply shocks—rising when supply is low and falling when supply is ample. Thus, for example, The current boom in agricultural prices is differ- copper, lead, and zinc have much higher price and ent in this regard, because it reflects a demand shock revenue volatility than maize, soybeans, and wheat, rather than a supply shock, meaning that prices have but the differences in output volatility are much less risen even as overall production (including that des- marked (box figure 2.1b). tined for biofuels) has increased. 54 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S Figure 2.1 The recent commodity boom was the largest and longest of any boom since 1900 Real non-energy commodity prices, index (1977–79 5100) 380 1917 (just prior to WW I) 330 1974 (first oil crisis) 280 1951 (postwar rebuilding) 230 2008 (forecast) 180 130 80 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 Source: Grilli and Yang (1988) for 1900 to 1947; World Bank for 1948 to 2008. magnitude, duration, and the number of com- The real U.S. dollar price of commodities has modity groups whose prices have increased. increased by some 109 percent since 2003, or 130 percent since the earlier cyclical low in The size of the price increases are 1999. By contrast, the increase in earlier major unprecedented booms never exceeded 60 percent (table 2.1). The magnitude of commodity price increases The unusual amplitude of the price in- during the current boom is without precedent. creases during this boom partly reflects the Table 2.1 Principal characteristics of major commodity booms Common features 1915–17 1950–57 1973–74 2003–08 Rapid global real growth — 4.8 4.0 3.5 (average annual percent) Major conflict and geopolitical World War I Korean War Yom Kippur War, Iraq conflict uncertainty Vietnam War Inflation Widespread Limited Widespread Limited second round effects Period of significant World War I Postwar rebuilding Not a period of Rapid buildup of infrastructure investment in Europe and Japan significant infrastructure in China investment Centered in which major Metals, Metals, agriculture Oil, agriculture Oil, metals, commodity groups agriculture agriculture Initial rise observed in prices of Metals, Metals Oil Oil agriculture Preceded by extended period No World War II destroyed Low prices and a Extended period of low prices or investment much capacity supply shock of low prices Percent increase in prices 34 47 59 131 (previous trough to peak) Years of rising prices prior to peak 4 3 2 5 Years of declining prices prior to trough 4 11 19 — Source: World Bank. — ϭ Not available. 55 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Figure 2.2 The real local currency price of Figure 2.3 Oil and metal prices led this commodities rose much less than the real boom, with food prices rising only much dollar price later Percent change, 2000–07 Real local currency commodity price indexes, CPI-deflated (Jan. 2000 5 100) 220 300 Energy 165 250 200 110 150 Food 55 100 Metals and minerals 0 50 Energy Metals Food Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. 2000 2001 2002 2003 2004 2005 2006 2007 2008 Nominal price increase (US$) Real US$ price increase (MUV deflated) Source: World Bank. Real price increase in developing countries Source: World Bank. Note: Real US$ price has been deflated by the unit value of manufactures (MUV); real price in developing countries represents real price of agricultural products was a trade-weighted average of local currency price increases deflated by local consumer prices increases. broadly stable, especially in developing coun- tries, and began to rise sharply only in early 2007 (figure 2.3). This is very different from the 1950s boom, fact that the U.S. dollar has been depreciating when post–World War II rebuilding (and fears during the same period and most primary of shortages) increased metals prices and poor commodity prices are quoted in dollars. The harvests raised agricultural prices, but the real commodity prices in developing countries price of oil remained flat. In the 1970s boom, (local currency prices deflated by local infla- agricultural and oil prices increased, but met- tion), have increased by much less than their als prices rose initially and then collapsed with dollar counterparts. The real dollar price of the decline in aggregate demand. internationally traded metals and minerals The current price boom is unusually long. rose by 158 percent between 2000 and 2007, The U.S. dollar price of internationally traded but by only 78 percent in developing coun- commodities has been rising for more than tries. Similarly, the real dollar price of interna- five years, much longer than the price booms tionally traded food commodities increased 64 of the 1950s and 1970s. Only the 1917 boom percent compared with a much lower 14 per- saw a sustained increase in commodity prices cent in developing countries (figure 2.2).2 over a similarly long period (four years). Typically a commodity price boom is fol- The boom covers a wide range of lowed by a bust as demand reacts to high commodities and has lasted much longer prices by contracting and supply reacts by ex- than previous ones panding. For example, the 1970s and 1980s This boom also differs from earlier ones in busts were associated with a sharp slowdown the breadth of commodities that have seen in world output, which eased demand pres- their prices rise sharply. The initial accelera- sures at the same time as supply was rebound- tion in prices was first visible in the oil mar- ing. Until most recently, the current boom has ket and was quickly followed by develop- been marked by a weak supply response (see ments in the metals and minerals market. The below) and sustained global growth. 56 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S The roots of the boom in the late 1980s and 1990s, which reduced in- centives to develop new deposits and to invest commodity prices in the physical and human capital required to T his commodity price boom has been sup- ported by strong growth in global demand, primarily from developing countries. With the expand supply. In agriculture, higher oil and fertilizer prices, along with increased demand from biofuels and a reduction in grain stocks, possible exception of a few metals, however, have been more important than fast growth the strong GDP growth of the past five years per se. does not by itself account for the magnitude or duration of the current boom (box 2.2). Global An extended period of low prices GDP was actually growing faster in the lead-up depressed investment in new capacity to the 1970s boom, with Japan—taking the The influence of low prices was perhaps most role China plays today—emerging as a new marked in the oil sector, where following the economic power with growth in excess of oil shocks of the 1970s and 1980s, conserva- 10 percent (figure 2.4). However, the strength tion efforts and substitution toward other and duration of this boom owes much to the sources of energy depressed demand for oil and resilience of developing-country growth, which oil prices. Indeed, it took 15 years for world oil continued at high levels for much longer than demand to regain its 1979 level. Meanwhile, the during previous episodes of high commodity expansion of oil production, particularly in the prices. On the one hand, this reflected the sur- North Sea, Mexico, and Alaska eliminated prising facility with which both industrial and the market power that the Organization of developing countries absorbed the initial very Petroleum-Exporting Countries (OPEC) had large hikes in commodity prices—itself a reflec- exploited to keep prices high even in the face of tion of the very buoyant external conditions, rapidly declining demand. By mid-1986, nom- including notably historically low interest rates, inal prices had fallen to less than $10 a barrel weak inflation, and ample liquidity (see World and OPEC’s spare production capacity was Bank 2007a, 2008). equal to 8.7 mb/d—more than 13 percent of Other important factors were also at work. world demand at that time.3 The supply response in extractive industries Global spare capacity was further aug- has been muted because of the low prices of mented during the 1990s, when demand for oil in the FSU declined precipitously and more or Figure 2.4 Global growth lasted longer and less permanently. As the prices of primary com- was stronger during the recent commodity modities were allowed to reflect world prices boom than in earlier ones and many of the energy- (and metals-) inten- Annual percent change in global GDP sive industries that had characterized the Soviet 8 era closed or retooled, demand for energy (and 1970s 2000s 7 boom boom metals) in these countries declined rapidly. 6 Overall, oil demand declined by 40 percent be- 5 tween 1987 (its peak) and 1999—or by 5 mil- 4 lion barrels a day—the equivalent of 7 percent 3 of world demand in 2000. 2 Initially, oil production in the FSU fell by 1 about as much, so there was an enormous 0 buildup of dormant capacity. Including 1967 1972 1977 1982 1987 1992 1997 2002 2007 OPEC’s surplus capacity of about 5 mb/d, Source: World Bank. total dormant capacity from these countries equaled around 10 mb/d in 1995 (figure 2.5).4 57 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Box 2.2 Developing-country growth and global commodity demand in the recent past T he growth surge of developing countries between 2003 and 2007 contributed to strong demand for commodities. Had output expanded more slowly, minum and 421 tons in the case of coal—so its de- mand surge contributed relatively little to overall mar- ket tightness. Indeed, by mid-2008, the price of alu- in line with the long-term growth potential of devel- minum rose by only 74 percent compared with its oping countries—estimated to be about 6.4 per- average value in the 1990s (versus 200 percent for cent—oil demand would have been lower by only metals and minerals in general), and coal rose by 392 about 1 million barrels a day, or just under 1.2 per- percent, about the same as natural gas, but much less cent of world consumption; demand for metals than oil. would have been about 1.5 percent lower and Importantly, despite rapid gains in developing- demand for grains about 1.9 percent lower. country GDP and income growth, grain demand did Overall, demand for most commodities at the not accelerate appreciably for developing countries global level rose less quickly than world GDP, and considered as a whole or for China alone. In fact, for most commodities, the contribution of Chinese consumption of wheat and rice declined, developing countries to the increase in commodity and China’s contribution to incremental global corn demand was in line with their GDP growth (box figure). Incremental developing-country demand for some commodities was much stronger than in Box figure 2.2 China was the key global high-income countries, both because developing- metals contributor to global demand growth country GDP was growing at a faster rate and Percent increase in global commodity demand, 2003–07 because relatively commodity-intensive manufactur- 40 ing activities were being transferred from high- 35 30 income to developing countries in this time period— 25 a factor that by itself should have had no impact on 20 global commodity demand. 15 10 Indeed, despite the acceleration in world GDP, 5 consumption for most commodities did not rise 0 rapidly. Coal and certain metals represent notable Ϫ5 um e n r P l at l exceptions, and here the demand of China has played oa pe oi ic or D he R in C C de op lG W um ru C ea a particular role. Between 2003 and 2007, China’s Al C R consumption of aluminum increased by 7.1 million Contributions to total from: tons, or 26 percent of world demand. Coal OECD China Rest of Ethanol consumption increased by 458 million (oil equivalent) the world production tons, or 18 percent of global demand. However, China’s production of these commodities increased by Source: World Bank. almost as much—7.0 million tons in the case of alu- The buildup of excess capacity meant that opment of existing wells declined by more the real price of oil during the 1990s remained than 50 percent, from $72 billion in 1980 to low, at $16 a barrel, equivalent to half the $30 billion in 1999 (figure 2.6).5 As a result, price experienced during 1985. It also meant demand for the inputs required for oil explo- that there was little incentive to invest in new, ration and extraction was weak, and capacity higher-cost oil fields. Overall spending by in these supporting industries declined, as did major American multinational oil companies the number of new engineers trained to find on exploration for new wells and the devel- and extract oil.6 58 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S With spare and dormant capacity Figure 2.5 Dormant capacity helped keep oil prices low in the 1990s absorbed, prices surged in 2004 By 2004, the dormant capacity that had been Bbl per day, millions created by the decline in demand in the FSU 20 had been reabsorbed. When demand growth (which had been subdued following the burst- 15 Total spare capacity ing of the Internet bubble) regained strength, supply was unable to keep pace, in turn re- 10 OPEC sulting in a surge in prices.8 spare 5 capacity Metal demand also declined sharply as nu- Former Soviet Union merous heavy industries in the FSU went out 0 dormant capacity of business. Global demand for metals and 1980 1985 1990 1995 2000 2005 minerals eased sharply beginning in 1990 Source: World Bank, British Petroleum, International Energy and only returned to trend rates in 1997 (fig- Agency, Petroleum Economics Ltd. ure 2.7). As was the case in the oil sector, the pickup in metals prices beginning in 2003 did not reflect unusually strong demand—except for aluminum—whose price, as it happens, Figure 2.6 Real spending by major American has been relatively stable. Rather, it reflected multinational oil companies declined by 60 low stock levels and depressed capacity. percent in the 1980s Indeed, the strong correlation between the US$ 2006, billions Real price per bbl, US$ 2000 prices of metals and minerals on the one hand 100 70 and oil on the other during 2003–06 is 80 60 unusual. Historically, the correlation between Crude oil prices (right axis) 50 the prices of these commodities tends to be 60 40 much less pronounced than between oil and 40 30 agricultural goods (table 2.2) because high oil 20 prices tend to cut into industrial production 20 10 and demand for metals, while food demand is 0 0 relatively inelastic. 81 83 85 87 89 91 93 95 97 99 01 03 05 19 19 19 19 19 19 19 19 19 19 20 20 20 Exploration (left axis) Development (left axis) Figure 2.7 Global metal demand also fell Source: Energy Information Agency; World Bank. during the transition 3-year, moving average of the % change in metal demand 10 As the transition continued, oil-producing 8 Aluminium Nickel firms in the region were able to rehabilitate 6 existing capacity relatively easily and to reorient 4 expanding output to Western markets, where 2 demand continued to rise. Between 1995 and 2005, world oil demand increased by nearly 0 14 mb/d, with 8 mb/d of that total being met Ϫ2 Zinc Copper by the dormant capacity in the countries of the Ϫ4 FSU and OPEC.7 As a result, underlying ca- 1985 1990 1995 2000 2005 pacity grew less than half as fast as demand Source: World Bank, International Monetary Fund. throughout the period. 59 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table 2.2 Comovement among major commodity prices, 1960–2007 Commodity Maize Wheat Rice Coffee Cotton Copper Aluminum Iron ore Gold Wheat 0.91 Rice 0.82 0.81 Coffee 0.70 0.45 0.63 Cotton 0.83 0.80 0.82 0.82 Copper 0.75 0.55 0.71 0.35 0.75 Aluminum 0.70 0.46 0.63 0.37 0.76 0.41 Iron ore 0.72 0.49 0.63 0.36 0.76 0.0 0.34 Gold 0.69 0.0 0.65 0.54 0.80 0.0 0.44 0.0 Crude oil 0.72 0.55 0.65 0.58 0.81 0.0 0.48 0.0 0.83 Source: World Bank. Note: The numbers are the adjusted R2s of a regression of each price on all other prices (individually), a time trend, and the MUV, both directions. The residual was tested for stationarity (5% level of significance). If cointegration was confirmed in one direction, the table reports the respective adjusted R2. If cointegration was found in both directions, the higher adjusted R2 is reported. If no cointegration was found, implying that any correlation would, in fact, be a spurious correlation, the result was not reported, and the respective cell shows 0.0 (e.g., gold with wheat or copper). Increasing prices sparked a boom in water jack-up rigs, whose day rates have in- investment in the oil, metals, and minerals creased fivefold in West Africa. markets Such factors have put upward pressure on Global private investment in exploration for the costs of developing new mines and oil nonferrous metals rose from $2 billion in fields. Operating costs for marginal producers 2002 to $7 billion in 2006 and to an estimated rose by 25 percent for copper and 28 percent $9 billion in 2007. Overall investment in the for aluminum between 2002 and 2005 (IMF sector more than doubled between 2001 and 2006), and in the case of at least one nickel 2005 in a number of mineral-rich countries in- project, they rose by 170 percent.9 Higher cluding Canada, Mexico, the Russian Federa- costs are reported to have increased the cost of tion, South Africa, and the United States extracting a barrel of crude from Canada’s oil (UNCTAD 2007). At the same time, invest- sands to $75, while deepwater offshore pro- ment in the oil sector increased dramatically, jects may cost more than $50 a barrel. 75 percent in the case of the American multi- Although higher prices are inducing sub- national companies (see figure 2.6). stantial increases in capacity in the input in- After years of low investment, the ability dustry, that capacity will not be in place for of service sectors to deliver inputs to the several years. As a result, some delivery times commodity-producing firms had atrophied. have more than doubled. For example, in the As a result, the surge in demand for invest- mining sector it currently takes 45 months to ment goods over the last several years has ex- deliver a grinding mill, compared with a more ceeded capacity by a wide margin and costs normal 20 months; for rope shovels the have skyrocketed. delivery time has gone from 9 months to 24. In the oil sector, operating costs have Large haul trucks, normally available within more than doubled, and the cost of inputs to 4 months, now take 2 years.10 Other services exploration and extraction have increased may take even longer to come into balance; substantially. For example, the day-rate price the training of technical personnel such as of semisubmersible rigs in the Gulf of engineers typically takes many years. Mexico (0–3,000 ft. water depth) increased As a consequence, it may take some time from $36,000 in 2000 to $325,000 in March before the surge in investment now under way 2008, a ninefold increase. Similar increases leads to a surge in the delivery of inputs, and have been observed in other items, such as even more time before delivery of inputs 60 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S translates into actual increases in oil, metal, of fertilizer and other chemicals that are energy and mineral production. All of this suggests intensive to produce. The impact across differ- that notwithstanding recent declines, supply ent countries is difficult to quantify owing to a will continue to be relatively scarce for several lack of data. In the United States, fuel, fertil- more years and that prices will remain higher izer, and chemicals accounted for 34 percent of than in the 1990s for some time. maize production costs and 27 percent of wheat production costs in 2007 (USDA 2008). The boom in agricultural prices reflects Energy, fertilizer, and chemicals would typi- both high costs stemming from oil prices cally make up a smaller share of production and increased demand from biofuels costs in developing countries, because produc- The rise in the price of agricultural commodi- tion is less intensive. Nevertheless such costs ties occurred much later than it did for either can be significant where intensive techniques oil or metals and minerals. Dollar prices were are used. Thus, fertilizer is estimated to have rising as early as 2003, but these increases accounted for 18 percent of variable costs for mainly reflected exchange rate movements. irrigated wheat in the Indian Punjab in 2002 Relative to consumer prices in developing and for 34 percent of soybean costs in the countries, internationally traded food prices Mato Grosso, Brazil (World Bank 2007b). were broadly stable until 2007, when the Second, high oil prices sparked an increase prices of internationally traded food commodi- in biofuel production in the United States and ties (such as maize, wheat, and soybeans) rose Europe that boosted demand for certain very rapidly (figure 2.8). grains and oilseeds thus contributing to their The timing of the rise in agricultural prices rapid price rise in the course of 2007 and early points strongly to the impact of energy markets 2008 (Mitchell 2008). Overall, two-thirds of (box 2.3) First, agriculture production is fairly the increase in world maize production since energy intensive. The increase in oil prices 2004 has gone to meet increased biofuel de- raised the price of fuels to power machinery mand in the United States, thereby reducing and irrigation systems; it also raised the price the quantity available for food and feed uses. Estimates of the impact of increased demand for biofuels on the rise in nominal maize prices range from 70 percent (Lipsky 2008), Figure 2.8 Real food prices were broadly to 60 percent (Collins 2008), to 47 percent stable in developing countries until mid-2007 (Rosegrant and others 2008). Food price indexes The increased demand for crops used for biofuels contributed to price increases for US$ nominal and domestic CPI-deflated price indexes (Jan. 2000 5 100) other food by reducing the land allocated to 300 other crops. For example, in the United States high prices increased land devoted to maize 250 Nominal US$ production by 22 percent in 2007, with most 200 of the increase at the expense of soybeans, the 150 production of which declined by 16 percent. Area planted to rapeseed and sunflowers— 100 used for biodiesel production—increased in Domestic real 50 Europe and elsewhere at the expense of wheat. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Moreover, rising prices for maize, wheat, and 2000 2001 2002 2003 2004 2005 2006 2007 2008 soybeans redirected consumer demand toward Source: World Bank. other food products, aggravating price pres- Note: Individual country data deflated by local consumer price index and aggregated by country shares in global imports. sures on other grains. For example, rice prices rose from $376 a ton in January 2008 to $907 61 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Box 2.3 The historical link between crude oil and other commodity prices C rude oil prices affect the prices of other commodi- ties in a number of ways. On the supply side, crude oil enters the aggregate production function of inflationary pressures. As a result, the demand (and hence the price) of precious metals often rise with oil prices, because investors and households view these most primary commodities through the use of various metals as more secure ways for storing wealth. energy-intensive inputs and, often, transportation over Crude oil price increases reduce the disposable long distances, an energy-demanding process. Some incomes of consumers, which, in turn, may slow commodities, such as aluminum, have to go through industrial production. In principle, lower disposable an energy-intensive primary processing stage. income should have a negative impact on the con- On the demand side, some commodities compete sumption of food commodities. However, because directly with synthetic products, which are produced the income elasticity for most food commodities is from crude oil (cotton with man-made fibers, natural small, this effect is limited, and the positive impact rubber with synthetic rubber). The demand for other of crude oil price increases on the prices of food commodities (maize, sugar, rapeseed, and other oils) commodities—through increased production and has increased to produce biofuels. And the price of transportation costs—tends to overshadow the energy commodities such as gas and coal are affected negative impact of reduced global consumption. because of their substitutability with crude oil. In contrast, the negative effect of high energy Increases in crude oil prices also increase the prices on industrial production reduces the demand disposable income of oil-exporting countries. Because for metals, thereby putting downward pressure on these countries are heavy consumers of some com- their prices. This tends to offset the positive effect modities (e.g. tea and gold), and demand for these from higher production and transportation costs. products is sensitive to incomes, high oil prices As a result the correlation between metals and oil sharply increased regional demand for these products. prices is much lower than between oil and food Finally, crude oil price spikes are often associated with prices (see table 2.2). a ton in April, partly in response to the grow- have the potential to produce ethanol prof- ing concern about the adequacy of global food itably from sugarcane on land that is not used supplies and the 120 percent increase in wheat for food crop production. Finally, nonfood prices during the previous six months. crops such as jatropha can be used to produce While biofuels have contributed to higher biodiesel in many developing countries.11 food crop prices, they also represent an op- In addition to the impact of oil markets, portunity for profitable production in devel- food prices were boosted by a series of poor oping countries (OECD 2007; GTZ 2006). wheat harvests, notably in Australia.12 Before Additional ethanol production need not imply the run-up of prices in 2007, wheat stocks had reducing food crops production. Brazil, for fallen to the second lowest level of the past example, is a low-cost producer of ethanol 40 years (figure 2.9). from sugarcane and has an estimated 180 mil- Reported global stocks of corn and rice de- lion hectares of pasture that could be used to clined before 2007, mainly due to a reduction of produce additional sugarcane for ethanol— very large government stocks in China. Because without reducing the food sugar crop. Many these stocks have been greatly underestimated Sub-Saharan African countries, including for the past 30 years (figure 2.10), current stock Angola, Mozambique, and Tanzania, also levels are not that different than what the world 62 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S forces that otherwise would have helped to Figure 2.9 Most of the decline in global grain attenuate the rise in prices and shorten the du- stocks reflects lower stocks in China ration of the boom. As discussed in chapter 3, Stock levels as a % of annual production although the various subsidies and price con- 40 trols that were in place or were introduced 35 Global stocks (with new muted the poverty impact of higher prices, 30 25 China data) they have also reduced producers’ incentives 20 to increase output and consumers’ incentives 15 to substitute less-costly items in their food 10 Global stocks baskets. And export bans limited supplies 5 (using older data for China) Global stocks (excluding China) available on international markets. For exam- 0 ple, India’s ban on rice exports in April 2008 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 was followed by other rice exporters, which Source: World Bank. prompted some countries, notably the Philip- pines, to increase rice imports to build up strategic reserves, thus further boosting inter- national prices. The activities of financial investors may Figure 2.10 Outside of China, only wheat stocks are unusually low have contributed to price rises as well. Tradi- tionally, hedgers and speculators have been Period of strong Stock levels as a % of annual production increase in the dominant players in futures exchanges, biofuel production 45 but over the past few years, investment funds 40 Wheat have become important players as well. Such 35 funds may have indirectly influenced commod- 30 ity prices. Since 2003 index fund investors, 25 who allocate funds across a basket of com- 20 modity futures, have invested almost $250 bil- 15 lion in U.S. commodity markets, about half of 10 5 Rice Corn it in energy commodities (Masters 2008). 0 While such purchases create no real demand 1960 1966 1972 1978 1984 1990 1996 2002 2008 for commodities, they may have influenced Source: World Bank. prices because these funds are large compared with their physical market counterparts and because they have expanded rapidly. Their in- fluence on prices is especially likely, if the rapid thought them to be during the early 1990s. It is expansion of these markets contributed to ex- thus unclear whether market participants took pectations of rising prices, thereby exacerbat- the decline in global stocks as a signal of com- ing swings, as argued by Soros (2008). ing scarcity or simply a return to stock levels The empirical evidence on whether such that were consistent with relatively low prices a funds have contributed to the recent price decade ago. surge is mixed. In the nonferrous metals mar- ket (where a similar buildup of financial posi- Government policy and investment fund tions has occurred), Gilbert (2008) found no activity may have exacerbated the increase direct evidence of the impact of investor activ- in commodity prices ity on the prices of metals but some evidence The extent of food price rises during this of extrapolative price behavior that resulted in boom was probably exacerbated by the ac- price movements not fully justified by market tions of governments, which impeded market fundamentals. He also found strong evidence 63 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 that futures positions of index providers over the past two years have affected soybean (but Figure 2.11 Demand for most commodities has grown less rapidly than GDP but more not maize) prices. Similarly, Plastina (2008) rapidly than population concluded that between January 2006 and Average annual growth rate, 1975–2006 February 2008, investment fund activity Lead might have pushed cotton prices 14 percent Tin Phosphate rock higher than they would have been otherwise. Iron ore On the other hand, two IMF (2006, 2008) Coffee Petroleum studies failed to find evidence that specula- Zinc tors have had a systematic influence on com- Population Cotton modity prices. A similar conclusion was Sugar Rice reached by a series of studies undertaken by Wheat the Commodities Futures Trading Commis- Bananas Maize sion, the agency that regulates U.S. futures ex- Copper Logs changes (Büyüks ¸ ahin, Haigh, and Robe 2008; Tea ITF 2008). Cocoa Rubber Although evidence that financial invest- GDP Aluminum ments have contributed to the rapid run-up in Soybeans commodity prices is limited, it seems likely Palm oil that real-side speculation (the decision to hold 0 1 2 3 4 5 6 7 8 9 stocks in anticipation of further price increases Percent or to order more than needed now for the Source: World Bank. same reasons) likely contributed to the rapid increase in prices during 2007 and 2008.13 has grown less quickly than GDP, albeit more quickly than population (figure 2.11). Long-term demand prospects Expressed another way, the commodity in- T he longevity of the current boom and the wide range of commodities that have been affected have prompted many observers to tensity of GDP has been declining. For oil and food, this process has been going on continu- ously since the 1970s. For metals, the same wonder if the global economy is moving into a trend was observed until the mid-1990s when new era characterized by relative shortage and it began to reverse (figure 2.12) permanently higher (and even permanently ris- More generally, growth in the demand for ing) commodity prices. This section looks at commodities is influenced by a wide range of demand and supply conditions in commodity factors including several fundamental economic markets over the medium to long term and drivers. concludes that slower population and GDP growth, changes in the structure of GDP, and Incomes and population. As per capita technological improvements in production incomes rise, demand for commodities also and use of commodities make this scenario tends to increase, but the sensitivity of unlikely. demand to an increase in income differs across Demand for (and supply of) commodities commodities and changes as income levels over the past 35 years has been rising steadily. rise. For example, at low-income levels, The quantity of energy consumed has increased demand for grains rises relatively quickly as by an average of 2.2 percent a year during income increases, but as per capita incomes 1970–2005, that of metals and minerals by reach about $3,000 dollars, the pace at which 3.1 percent, and that of food by around 2.2 per- grains demand rises declines, ultimately falling cent. However, demand for these commodities to close to zero. Thus, a 10 percent increase in 64 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S Table 2.4 Modern goods make less Figure 2.12 The quantity of most commodities intensive use of commodities used per unit of GDP was declining until (US$) recently Good Value per kilogram Commodity intensity of demand, index (1971 5 1.00) 1.10 Iron ore 0.04 1.05 Steam coal 0.07 1.00 Wheat 0.27 0.95 Crude oil 0.47 0.90 Standard steel 0.56 0.85 Newsprint 0.89 0.80 Supertanker 4.00 0.75 Motor car 33.00 Dishwasher 56.00 0.70 TV set 133.00 71 80 83 86 89 92 98 01 04 95 74 77 19 Submarine 222.00 19 19 19 19 19 19 20 20 19 19 19 Large passenger aircraft 1,334.00 Energy Metals Laptop computer 2,224.00 Metals (excluding China) Food Mobile telephone 4,448.00 Jet fighter 13,344.00 Source: World Bank. Windows 2000 Software, CD Rom 44,480.00 Telecom satellite 88,960.00 Banking services ϱ Source: Radetzki 2008a. incomes is associated with a 6 percent increase in grains demand in low-income countries but are much less intensive in their use of com- almost no increase in high-income countries modities. This trend is illustrated in table 2.4, (table 2.3). As a result, beyond a certain which shows the value per kilogram of a vari- income level, grains demand is mainly dictated ety of different products. Newer products, by population growth. The sensitivity of such as computers and mobile telephones, demand for metals to incomes is much higher have a growing share in world GDP and con- but tends not to change as income levels rise. tain very little in the way of commodities Energy is the reverse of grains, with the (proxied here by their weight). demand for energy rising more rapidly than The same effect can be seen at the sectoral incomes in high-income countries. level. Industrial activity tends to be more com- modity intensive than agricultural activity, The composition of GDP. Commodity de- which in turn is more commodity intensive mand depends on more than just GDP. The than services. Thus, part of the declining composition of demand also plays an impor- commodity intensity of demand over the past tant role. Over time, the commodity intensity 35 years reflects the rise of the service sector, of GDP has declined partly because demand which accounted for 50 percent of world GDP has evolved toward goods and services that in 1971 and 69 percent in 2005—a trend that is shared by both high-income and developing Table 2.3 Impact of a 10 percent increase countries. in incomes on commodity demand (Percent) Technological change. Increased efficiency Income group Grains Energy Metals in the use of commodities in production and consumption has also contributed signifi- Low 6.0 4.5 10.1 Lower middle 3.3 7.2 10.1 cantly to the dematerialization of economic Upper middle 1.4 9.2 10.1 activity. Examples include improvements in High 0.0 1.1 10.1 gas mileage in automobiles and the substitu- Source: World Bank. tion of artificial for natural fibers in clothing. 65 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table 2.5 Fundamental economic factors drive future commodity demand Average annual growth rate Period Per capita income Population GDP Share of services in GDP Share of services in GDP (percent) (percent) 1990s World 1.2 1.5 2.7 0.99 64.6 High income 1.8 0.7 2.5 0.89 67.8 Low and middle income 2.0 1.6 3.6 1.73 49.8 Low income 2.3 2.2 4.5 0.96 44.3 Middle income 2.2 1.2 3.5 1.84 50.8 2000s World 1.8 1.2 3.1 0.47 68.5 High income 1.7 0.7 2.5 0.51 71.8 Low and middle income 4.2 1.3 5.6 0.24 53.8 Low income 4.1 1.9 6.1 1.50 49.4 Middle income 4.6 0.9 5.5 0.04 54.5 2015–30 World 1.7 0.8 2.5 Ϫ0.41 50.3 High income 1.2 0.1 1.3 0.02 59.0 Low and middle income 3.9 0.9 4.9 Ϫ0.07 35.6 Low income 3.8 1.5 5.4 Ϫ0.02 44.0 Middle income 4.1 0.7 4.8 Ϫ0.08 35.0 Change (2015–30 vs. 2000s) World Ϫ0.2 Ϫ0.4 Ϫ0.6 Ϫ0.88 Ϫ18.3 High-income Ϫ0.5 Ϫ0.7 Ϫ1.2 Ϫ0.49 Ϫ12.8 Low and middle income Ϫ0.3 Ϫ0.4 Ϫ0.7 Ϫ0.31 Ϫ18.2 Low income Ϫ0.3 Ϫ0.4 Ϫ0.7 Ϫ1.52 Ϫ5.4 Middle income Ϫ0.5 Ϫ0.2 Ϫ0.7 Ϫ0.12 Ϫ19.5 Source: World Bank LINKAGES model. Long-term projections suggest that the to rise less quickly than they did during main factors driving commodity demand the 1990s. Nevertheless, developing- will slow country per capita incomes are projected To a significant degree, future demand for to triple, rising from $1,550 to $4,650 commodities will reflect the combined impact between 2004 and 2030. This means of, GDP growth, changes in the composition that, although global demand for grains of demand, and technological progress and some metals is likely to decelerate, (table 2.5). energy demand is likely to strengthen. • The composition of GDP is not expected • Population growth over the next two to continue to move toward services but decades is expected to slow significantly to stabilize more or less at current levels. from 1.2 percent during the 2000s to This suggests that commodity intensities about 0.8 percent in the period may decline less rapidly than they have 2015–30, which should help moderate in the past. commodity demand compared with past • Prospects for technological progress are demand. the least certain element likely to deter- • Per capita income growth is also pro- mine future commodity demand. Should jected to slow somewhat for the world as policy succeed in continuing past gains, a whole, mainly because incomes in the then this too should tend to moderate largest developing countries are expected commodity demand. 66 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S The remainder of this section discusses in A number of technologies currently available more detail how these factors and technologi- as prototypes or in early stages of commercial- cal change are expected to play out in individ- ization could help more than double fuel effi- ual commodity markets. ciency over the next several decades. In 2005, about 8 liters of fuel were needed to drive 100 Demand prospects for energy kilometers; by 2050, fewer than 3 liters may be Rising incomes and technology are expected needed (IEA 2008a). Even more optimistic sce- to play crucial roles in determining future en- narios project that by 2050, 90 percent of the ergy demand. Assuming no improvement in vehicles in the high-income world and 75 per- energy efficiency, given expected increases in cent in the developing world will be powered by incomes and population, demand for energy alternative fuels, such as plug-in hybrids (hybrid would rise by more than 120 percent between cars with large batteries that can be plugged now and 2030, with growth in developing into the main electrical network), electric, and countries responsible for three-fourths of that hydrogen-powered cars. Such a shift would increase. Assuming the composition of energy reduce considerably private transportation’s demand and supply did not change, that would dependence on liquid fuels. Indeed, prototype imply that demand for oil would more than and soon-to-be-released electric and hydrogen- double, from 82 mb/d in 2007 to 174 mb/d powered cars already exist (box 2.4). in 2030. Strong growth in developing countries is Efficiency gains and conservation efforts expected to dominate future energy reduced energy demand by 50 percent demand over the past 35 years Assuming that energy efficiency continues to Of course, these assumptions are somewhat improve at about the same rate as in the past, simplistic, viewed against the light of recent total demand for energy is projected to rise by history. Energy efficiency over the past 50 55 percent between now and 2030, with 80 years has in fact improved sharply. Since percent of that emanating from fast-growing 1960, the efficiency of jet transport has more developing countries (table 2.6). Overall, than tripled (Lee and others 2001) while fuel weaker population growth and technological efficiency in cars has also increased signifi- change are likely to outweigh the impact of cantly. Overall, between 1970 and 2004, tech- rising developing-country incomes and their nological change lowered energy demand 56 increased weight in overall demand. Hence the percent from what it would have been other- rate of growth of energy demand is expected wise (IEA 2007). Much of the improvement to ease over time, declining from an average of resulted from substitution and conservation 1.8 percent during the past 15 years to about prompted by higher prices. Ongoing techno- 1.3 percent in the period 2015–30. logical change and increased efficiency in In the baseline scenario, climatic and envi- China (Lin and others 2006) and the FSU ronmental concerns are expected to contribute countries (see earlier discussion) also played to a modest shift away from petroleum prod- important roles.14 ucts toward less carbon-intensive fuel sources, Looking forward, similar improvements in such as natural gas, and renewable fuels, such energy efficiency are possible if supported by as wind, solar, and geothermal. Oil’s share in an appropriate policy mix. Of particular im- overall energy consumption is expected to portance will be efficiency in the transport sec- decline, with demand rising more slowly. tor, which is expected to account for some Demand growth is projected to fall from 75 percent of the increase in future oil use, 1.7 percent a year in 2005–15 to 1.1 per- largely because of rising incomes and car own- cent in 2015–30, reaching between 112 and ership in developing countries (IEA 2007). 118 million barrels a day by 2030. 67 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Box 2.4 Alternative fuels for transportation H ydrogen and electricity are emerging fuels for transportation; fully ethanol-powered and flex- fuel cars are already well-established commercial Meanwhile, Honda is already leasing a limited number of hydrogen-fuel-cell-powered cars to the general public in southern California. While costs of successes in Brazil and increasingly in the United operation are similar to gas-powered cars, the cars States and Europe. Existing hybrid cars offer a themselves are extremely expensive and the leases 50 percent improvement in fuel efficiency for city being offered imply a substantial subsidy. The cost of driving, while plug-in hybrid cars have the potential fuel-cell stack systems (the mechanism that converts of reducing reliance on gasoline even more. hydrogen into power and that uses platinum) will Hydrogen-fuel-cell and all-electric cars could reduce have to decline tenfold before these vehicles become that dependence to zero, but considerable progress economically viable. needs to be made in increasing the efficiency of For both plug-in hybrids and electric cars, the battery technology and in the production and major stumbling block is the size, weight, and cost of conversion of hydrogen into electricity before these the battery required to power them. With current vehicles will be competitive. technology, the battery needed to power an electric Currently, most major car manufacturers have car 500 kilometers weighs five times as much as the prototype versions of all such cars. General Motors equivalent amount of gasoline and would cost has announced its intention to sell commercially as $50,000. Over the next several decades, technologi- soon as 2010 an extended-range electric vehicle (the cal progress achieved through the commercialization “Volt”), which is a battery-powered electric car that of hybrid cars is expected to raise battery efficiency uses a small flex-fuel engine to extend its range for and reduce costs, so that plug-in hybrids will be highway driving. The Volt is expected to be able to widely available by 2020. run up to 40 miles a day (more than the average Prospects for all-electric cars are less clear, mainly daily driving distance of 75 percent of Americans) on because of the time that it takes to recharge batter- batteries alone and 250 miles using its flex-fuel gen- ies, a factor that makes them much less attractive erator. The car is expected to have an EPA rating of than gas-powered vehicles. Here hydrogen-fuel-cell- 100 miles a gallon (Connor 2008), and its operating powered cars could have an advantage if the costs costs could be 0.02 cents a mile or one-sixth the cost associated with the fuel stack can be resolved. of a vehicle powered with gasoline at $3.80 a gallon (Padget 2008). Source: IEA 2008a. Another important feature of the composi- do not materialize, coal use is likely to be sub- tion of energy demand is the importance of jected to significant environmental regulation coal, which currently accounts for more than that could significantly reduce its economic a quarter of global energy consumption. Coal attractiveness. is primarily used by developing countries (62 percent), with China accounting for more The future path and mix of energy than 40 percent of global consumption. The demand will depend on policy baseline simulations indicate a slight increase Simulations suggest that a more aggressive in coal’s share, from 25.3 percent in 2005 to stance toward reducing carbon emissions 27.8 percent in 2015. However, the projection could generate a further moderation in energy is subject to two risks: on the upside, if new demand and in fossil-fuel use. For example, a clean coal technologies (including carbon se- $21 tax per ton of carbon dioxide could be ex- questration) come on board, coal’s share in pected to reduce demand for energy by 33 per- global energy consumption is likely to be cent (see the simulations at the end of the much higher. However, if such technologies chapter). Because of its high carbon content, 68 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S Table 2.6 Energy demand is projected to associated with relatively high commodity slow in the baseline scenario intensities. Like oil, the evolution of metals Contributions to annual average global growth in energy intensities reflects technological change, the demand (percentage points) growing importance of services in the eco- 1990–2005 2005–15 2015–30 nomies of high-income countries, and other World 1.4 1.1 0.6 structural changes in demand. High-income countries 0.7 0.4 0.3 Developing countries 2.2 3.4 2.0 After falling for years, metals intensities in Middle-income countries Ϫ0.1 2.4 1.5 Low-income countries 4.1 3.9 2.2 developing countries are rising, especially in China Shares in total energy demand (percent of total) The reversal of the trend decline in metals in- 1970 1990 2005 2015 2030 tensities that began in the mid-1990s (see fig- ure 2.10) reflects very different trends in high- Coal 26.0 25.3 25.3 27.8 28.2 Oil 44.0 36.7 35.0 32.9 31.5 income countries, most developing countries, Gas 16.0 19.1 20.6 21.2 22.3 and China (figure 2.13). The trend decline ob- Nuclear 1.0 6.0 6.3 5.6 4.8 served for all three groups between 1970 and Hydro 2.0 2.1 2.2 2.3 2.3 Biomass, waste 11.0 10.3 10.1 9.3 9.1 1990 has continued among high-income coun- Other renewables — 0.4 0.5 1.0 1.7 tries, apace with the continued transfer of Source: World Bank ENVISAGE model (forecast); commodity-intensive manufacturing activities IEA (historical data). to developing countries. In developing coun- — ϭ Not available. tries excluding China, the same process has driven a slight rise in metal intensities begin- demand for coal would decline most sharply ning in 1992, after their fall attributable to the under such a scenario, with natural gas and efficiency improvements associated with the other low-carbon energies increasing their end of the FSU. share in total demand. China stands out as the country where in- An even more aggressive set of policies, tensities have increased the most. After declin- including a significant policy initiative to in- ing for years, they began to rise gradually to- crease energy efficiency and reduce carbon ward the beginning of the 1990s and then emissions to below their 2005 levels, could see sharply accelerated around 1998, reflecting a energy demand fall even further (table 2.7). rapid increase in manufacturing activity and a Demand prospects for metals and minerals Figure 2.13 Metal intensities have declined Demand for metals and minerals is also steadily in high-income countries but have reversed in China since 1993 closely related to GDP and the mix of GDP— with manufacturing and investment activities Quantity of metals used per unit of GDP, index (1971 ϭ 1.00) 1.6 1.4 China Table 2.7 Energy demand could decline 1.2 further under more aggressive climate OECD change policies 1.0 Energy source Baseline Stable emissions Aggressive 0.8 (percent change in energy consumption) 0.6 Rest of the world 0.4 Coal 198 Ϫ15 Ϫ22 Oil 57 10 Ϫ29 0.2 Gas 96 68 25 1970 1975 1980 1985 1990 1995 2000 2005 Biomass, waste 48 144 214 Source: World Bank. Source: IEA 2008a. 69 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Box 2.5 Understanding the rise in Chinese metal intensities C hina’s accession to the World Trade Organiza- tion and the boom in manufacturing activity that accession generated certainly played a role in increas- changes entailed substantial investments in infrastruc- ture and were associated with a rapid increase in au- tomobile production—all heavy consumers of metals. ing metals demand. However, the long-term invest- As of 2007, more than 50 percent of Chinese ments in new capacity and infrastructure that began steel and 44 percent of copper demand was used in at the same time as WTO accession were likely just construction and infrastructure. While China’s as important. Overall investment in China increased specialization in manufacturing is likely to persist, from 36 percent of GDP in the early 1990s to investment rates are projected to decline over time around 45 percent currently, a result both of in- (the average life span of infrastructure investments creased manufacturing and rapid urbanization (over exceeds 50 years) so China’s metal intensity is ex- the same period, the share of the population living in pected to stabilize and then decline, as did the metal cities increased from 30 to 40 percent). Similarly, intensities of other Asian countries, such as Japan part of the increase in China’s energy demand was and the Republic of Korea, that followed a manufac- associated with an acceleration in steel and cement turing- and export-intensive development path production (Lin and others 2006). These structural (Mitchell, Tan, and Timmer 2007). sharp uptick in investment. The increase in the Chinese investment ratio came partly from the Figure 2.14 Metal intensities in China are much higher than elsewhere need to create capacity to meet the manufac- Metal intensity indexes, 2000–06 averages (high-income turing boom, but the increase also reflects sig- countries ϭ 1) nificant investment in support of infrastruc- 10 ture in response to increased urbanization 8 (box 2.5). Except for a few export- and manufactur- 6 ing-intensive Asian economies, other develop- 4 ing countries, including those at much higher levels of income than China, have not seen 2 metal intensities rise in this way. Metal inten- 0 sities in Brazil, India, and South Africa, for ex- Copper Aluminum Zinc Tin Lead Nickel ample, remained flat or continued to decline during the same period.15 As a consequence, High-income countries Developing countries (excluding China) the strong acceleration in metal demand ob- China served in China is not expected to be repeated in other developing countries. Source: World Bank. Not only have Chinese metal intensities been rising, they are also as much as 7.5 times as high as in high-income countries and 4 times as high as in other developing countries fact that the former Soviet Union also had (figure 2.14). While some of the same factors similarly high intensities before its economic (high investment rate, large manufacturing transition suggests that perhaps nonmarket sector) that explain the increase in Chinese in- factors continue to influence allocation of tensities likely explain these differences, the these resources in a way not seen elsewhere. 70 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S Slowing global growth and a decline Demand for food and other in Chinese metals intensity should see agricultural products demand growth for metals slow over the The weaker growth in population and GDP next 25 years expected over the next few decades (see table Over the next quarter of a century, metal in- 2.4) should cause global demand for food to tensities in developing countries are likely to grow less quickly over the next 25 years. stabilize and begin declining once again. Sev- Overall, the global population growth rate eral factors should contribute to the reasser- is projected to decline from an annual average tion of the earlier downward trend. of 1.6 percent between 1970 and 2005 to A slowing in the pace at which global man- about 1.0 percent over the following 25 years. ufacturing capacity is transferred to the devel- While most of the slowdown is expected to oping world is projected to result in a leveling take place in high-income countries, popula- off and eventual decline in manufactures’ share tion growth rates in every developing region in Chinese GDP, from about 40 percent in are expected to decline between 0.4 and 0.8 2005 to around 33 percent in 2030. This slow- percentage points (figure 2.15). ing in turn should be reflected in a decline in Rising incomes in developing countries metals intensities. Less-rapid growth in manu- imply that per capita food consumption will facturing and the gradual completion of invest- increase in most of these countries, but the ment projects are expected to cause the share impact on overall demand is expected to be of investment in GDP to decline considerably, small. As the earlier analysis suggested, a which should also serve to lower Chinese metal 10 percent increase in per capita income will intensities. Finally, the rising influence of mar- increase grain demand by 6 percent in poor ket forces in determining allocation decisions countries (those with per capita incomes in China should also cause a drop in the quan- below $2,000), but only by 2 percent in mid- tity of metal used per unit of output. dle-income countries.17 Most of the heavily In the rest of the developing world, similar populated developing regions have already forces should be at work, which, coupled with rising incomes and increased service-sector demand, is expected to reduce the metals Figure 2.15 Weaker population growth intensity of demand.16 should slow demand for food Nevertheless, growth in China and devel- Average annual % change in population oping countries more generally is expected to 3.0 continue to outpace growth in the rest of the 2.5 world throughout the projection period. 2.0 Given China’s high metal intensities, develop- 1.5 ing-country growth should keep global metal 1.0 intensities from falling, at least initially. How- 0.5 ever, the beginning of the decline in Chinese 0.0 metal intensities should be reflected in a sig- Ϫ0.5 nificant weakening in the rate of growth of ou s co es es a ia Am e Am a a ia co LD rie ric op ic ic As an ri tri er er R Lo com unt nt Af La Eur un ce metals demand during the period 2015–30. co WO O -in e c tin th e e or Overall, global demand for metals is expected m m N co in in h- e- to continue to grow somewhat more quickly w ig dl H id M than global GDP, at about 4.0 percent through 2015, before slowing to around 2.5 Population growth, 1970–2005 Population growth projections, 2005–30 percent in the period 2015–30, a pace signifi- cantly slower than that of projected GDP Source: UN 2006. growth itself. 71 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table 2.8 Developing countries will Figure 2.16 Per capita grain demand tends account for most of the projected demand to stop rising when income reaches around for various foods, 2000–30 $5,000 All Edible Grain consumption per capita (kg) agriculture Cereal oils Meats (Log scale) 1,000 WORLD 1.5 1.2 2.3 1.7 Developed 0.7 0.9 2.0 — 367 China Brazil Transition 0.5 0.8 1.7 — Russian Developing 2.0 1.4 2.5 2.4 Federation Sub-Saharan Africa 2.8 2.5 2.9 3.3 135 India Middle East and 2.2 2.1 2.3 3.3 North Africa 45 Latin America and 1.8 1.2 2.6 2.0 the Caribbean South Asia 2.3 1.6 2.7 4.0 18 East Asia and Pacific 1.7 1.2 2.4 2.1 0.4 1.1 2.9 8.1 22.0 59.8 Source: FAO (2006, pp. 33, 39–42, 47). GDP per capita (1,000 PPP $) — ϭ Not available. Source: World Bank. Note: Curve fitted on a log scale. Slower population growth will dampen demand for agricultural products Overall demand for food should slow over the achieved incomes associated with income elas- next few decades, despite income gains. The ticities close to 0.2 (figure 2.16).18 Food and Agriculture Organization (FAO) Demand for meat and dairy products (and estimates global food demand will increase by feed grains) will likely expand more rapidly about 1.5 percent a year between now and because these products tend to be more in- 2030, with cereals, edible oils, and meats grow- come elastic than basic food stuffs.19 For ex- ing at 1.2, 2.3, and 1.7 percent, respectively— ample, in Asia, demand growth for meat and somewhat slower than they did between 1990 edible oils outstripped population growth by a and 2006 (table 2.8). Developing countries wide margin over the past 15 years, even ris- have higher income elasticities, faster income ing somewhat faster than GDP in the case of and population growth, and relatively large edible oils (figure 2.17). populations, compared with high-income countries. Thus, three-quarters of the addi- tional global demand for food between now Figure 2.17 Demand for edible oils grew much faster than population in Asia and 2030 will emanate from developing countries. Average annual % growth, 1990–2005 10 The implications of biofuels demand for 8 agricultural prices The production of biofuels in Brazil, the 6 United States, and the European Union (which together account for more than 90 percent 4 of global output) has increased by 18 percent a year since 2000. Biofuels now use 16 percent World Asia 2 of global sugarcane production, 9 percent of 0 global vegetable oils production, and 13 per- Population GDP Cereals Edible oils Meats cent of global maize production, and have Source: World Bank. been the key contributor to the rise in food crop prices in recent years (Mitchell 2008). 72 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S The rapid expansion of production capac- ity in the United States and Europe was Figure 2.18 Food crop prices have become sensitive to oil prices prompted by generous subsidies and use man- Oil price per barrel versus food price per ton dates, but high energy prices have made con- tinued production without subsidies profitable a. Maize vs. Crude Oil Prices in many cases. As a result, demand for biofu- Maize ($/ton) els may mean that in the future prices for 350 crops used to produce biofuels will be higher, 300 and more volatile, than if these crops were 250 used only for food. Indeed, when oil prices exceed the thresh- 200 old of roughly $50 a barrel, a strong correla- 150 tion can be observed between the price of 100 crude oil and crop prices that does not exist when prices are below $50 a barrel (fig- 50 ure 2.18). At oil prices below $50 a barrel, 0 ethanol production is not very profitable. 0 20 40 60 80 100 120 140 Crude oil ($/bbl) However, at $50 a barrel, a 1 percent increase in oil prices results more or less in a 0.9 per- b. Wheat vs. Crude Oil Prices cent increase in maize prices, because every Wheat ($/ton) dollar increase in the price of oil increases the 500 profitability of ethanol and hence biofuel de- mand for maize.20 Since the oil market is 400 much larger than the market for maize (if all the maize currently produced in the world 300 were converted into ethanol, it would equal 200 only 8 percent of global gasoline supplies), the price of maize is now effectively determined 100 by the price of oil. The impact of biofuels is not limited to the 0 crops used for biofuel production. As more 0 20 40 60 80 100 120 140 cropland shifts to produce the now-more- Crude oil ($/bbl) profitable biofuel crops, then the supply of c. Soybeans vs. Crude Oil Prices other crops declines (or less productive land is Soybeans ($/ton) brought under cultivation), thus raising food 700 prices in general. As a consequence, the price of wheat and soybeans have also become more 600 sensitive to oil prices in excess of $50. 500 The future impact of the oil market on the 400 demand for food crops and their prices is un- 300 certain. Technological improvements may lower the cost of producing ethanol, in turn 200 lowering the threshold oil price above which 100 crops used for biofuels become sensitive to oil 0 prices. But technological change may also give 0 20 40 60 80 100 120 140 rise to other nonfood sources (such as cellulose) Crude oil ($/bbl) for biofuel production or to other energy alter- Source: World Bank. natives such as solar, wind, and hydrogen-based 73 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 systems. Should this occur, demand for biofuel Indeed, over the past 50 years these forces food crops would drop off and food prices have enabled global production of most com- with it. modities to rise despite falling, or at best sta- ble, real prices. Production of aluminum, for example, increased fivefold between 1965 and Long-term supply prospects 2007, while that of crude oil, copper, and wheat increased 2.6, 3.2, and 2.8 times, re- T he slowing of growth should bring com- modity prices down by roughly 25 percent in 2009 (see chapter 1). But over the medium spectively (figure 2.19). to long term, they are not expected to decline Technological change has kept extraction to the levels observed in the 1990s. How far costs in check even as the quality of mines they come down, and their future trajectory, and wells declined will depend not only on the demand factors Although the quality of newly discovered already discussed but also on the pace at which mines and oil wells (and the ease with which finite resources are exhausted; improvements they can be exploited) tends to be lower on in the efficiency with which commodities are average than older ones, technological im- found, extracted, and grown; and the policies provements have reduced the cost of produc- that are put into place to promote long-term ing most commodities over the past 50 years, supply. allowing effective supply to keep pace with demand (box 2.6). Energy and metals supply In the case of oil, declining yields from on- Supply prospects for both oil and metals de- shore wells pushed exploration into offshore pend on the competing forces of resource ex- fields that are much more difficult and ex- haustion and the declining quality of new pensive to exploit. Improved technologies al- sources, on the one hand, and the pace of new lowed these sources to be exploited prof- discoveries and improvements in the technol- itably even at low prices and even though ogy with which commodities are discovered they are much more challenging to drill than and extracted, on the other. existing wells. As a result, nearly all of the additional increase in global oil production since 1978 has come from offshore wells The world is unlikely to run out of oil, (figure 2.20).21 metals, and minerals in the foreseeable future Despite ultimately finite quantities of oil, met- als, and minerals in the earth’s crust, there is Figure 2.19 Output of virtually all commodi- little likelihood that the world will run out of ties has increased since 1965 natural resources (or food) in coming decades. Output volumes, 1965–2007, index (1965 ϭ100) The existence of ample (and growing) re- 550 serves, and a history of significant improve- 500 Aluminum 450 ments in the technology with which resources 400 are found and extracted, suggests that supply 350 will continue to rise in pace with demand. 300 True resource exhaustion is unlikely not least 250 Wheat 200 because, as resources become scarcer, their 150 prices rise, consumption declines, and alterna- 100 Copper Crude oil tives that once may have been uneconomic are 1965 1970 1975 1980 1985 1990 1995 2000 2005 substituted for the scarce (and expensive) Source: World Bank. commodity. 74 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S Box 2.6 Declining costs of resource extraction R ising costs for producing a unit of output repre- sent a good a priori indicator of increasing scarcity. The fact that the prices of most commodi- ones, technological change had nevertheless reduced the costs of production by more than the lower quality of the underlying vein or its remoteness had ties have remained stable or declined for most of the raised them. past 100 years is therefore a good indicator that at Similarly, the average cost of bringing a new oil least until 2003 the world was not running out of field into production declined from $29 a barrel in them (Radetzki 2008a). 1981 to $9 in 1999 (IEA 2001). These cost reduc- Production costs—especially for the marginal tions would be all the more marked if the numbers producer—are an even better indicator. For the me- were expressed in real terms. And although not all dian producer, the real cost of producing a ton of of this cost decline can be attributed to technological metal between 1985 and 2002 declined by 28 per- change, much can (Bohi 1999). Indeed, improve- cent for aluminum and copper and by 21 percent for ments in extractive technology allowed copper prices nickel (IMF 2006). For high-cost producers, the to decline more or less continuously between 1890 decline was the same for aluminum but was only and 1970 even as the average grade of copper ore in 18 percent for copper and nickel. Those numbers the United States fell from 6 percent to less than suggest that while new projects to extract copper 2 percent between 1890 and 1920 and to less than and nickel were more expensive than preexisting 1 percent by 1960 (Lowell 1970). ore beds or wells has meant that known re- Figure 2.20 Almost all of the additional oil serves of most extractive commodities have in- supply since the 1970s has come from nontraditional sources creased over time—despite rising production. Such technological improvements help ex- World oil production, millions of barrels per day 90 plain the substantial rise in estimates of re- serves over past decades. Two authoritative 75 sources of such data for oil are the Oil and 60 Gas Journal, which reports annual estimates 45 of proven reserves (figure 2.21), and the 30 Figure 2.21 Rather than declining, known oil 15 reserves keep rising 0 World crude oil reserves, billions of barrels 1970 1974 1978 1982 1986 1990 1994 1998 2002 1,400 Offshore Onshore 1,200 1,000 Source: Sandrea and Sandrea 2007. 800 600 Technology has also helped maintain 400 surprisingly stable ratios of reserves 200 to output 0 Advances in the technology with which new 1950 1958 1966 1974 1982 1990 1998 2006 reserves are discovered and in the efficiency Source: Oil and Gas Journal. with which the final product is extracted from 75 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table 2.9 Historically, estimates of oil reserves have kept pace with production Figure 2.22 Gas reserves are almost as large as oil reserves Date of assessment Billions of barrels (equivalent) Category 1981 1985 1990 1993 1996 2,500 Reserve growth (billions of barrels) 2,000 Cumulative 445 524 629 699 710 production Undiscovered 1,500 resources Known reserves 724 795 1,053 1,103 891 Undiscovered 550 425 489 471 732 conventional 1,000 resources Known reserves Expected reserve — — — — 688 500 growth Estimated total 1,719 1,744 2,171 2,273 3,021 resources 0 Oil Gas Total resources 74 70 71 69 76 still in ground Source: U.S. Geological Survey. (percent) Source: U.S. Geological Survey, World Bank calculations. Note: Estimated total resources is the sum of the first three rows. Total resources still in ground is one minus the ratio of cumulative production over total resources. — ϭ Data are not available (the concept of reserve growth total resources increased from 1.7 trillion bar- was first introduced in 1996). rels in 1981 to 3.0 trillion barrels in 1996, so the amount of known oil still in the ground re- mained stable, at around 70 percent of the total United States Geological Survey (USGS), of oil ever found (see table 2.9). which attempts to quantify the resource base Reserves of natural gas estimates are equally of the world’s major basins by including as- high. According to the USGS, they were at 2.3 sessments of known reserves, undiscovered re- trillion barrels of oil equivalent in 2003, almost sources, and reserve growth (table 2.9).22 as large as crude oil reserves (figure 2.22). Estimates from the Oil and Gas Journal, Yet, among the key hydrocarbon sources of which include unconventional sources of hy- energy, coal is perhaps the most abundant. As drocarbon fuels such as Canadian oil sands of 2007, the reserves-to-production ratio was and oil shale, show known reserves rising estimated at 133 years, according to BP. How- from just over 600 billion barrels in 1980 to ever, as mentioned earlier, the use of coal will 1.3 trillion barrels by 2008. Furthermore, the depend on the degree to which new techno- reserve estimates for a number of major pro- logical advances will be able to ameliorate the ducers in the Middle East have not changed environmental concerns. for years, reflecting both their current size Finally, expansion of nuclear energy (and compared with production levels (national- other renewable fuel) supplies could lessen the reserve-to-production levels imply adequate relative importance of hydrocarbon-based reserves for 82 years of production for the fuels. For example, in addition to the exis- Middle East–producing countries) and the fact tence of abundant feed stocks (at current con- that for decades these countries have not felt sumption rates, known uranium reserves are an incentive to explore in more depth the expected to last almost a century), current potential for additional reserves nor to verify modern nuclear technologies not only produce existing reserve estimates. much less nuclear waste but also have lower On the other hand, according to the USGS es- likelihood of accidents compared with nuclear timates (which include undiscovered resources), power plants in the past. 76 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S Reserves of metals and minerals have also Long before the world begins to run out of oil, tended to rise with output however, prices would begin to rise and con- The story for metals and minerals is somewhat sumption growth would slow. As a result, al- more nuanced. Reserves expressed as a share ternatives such as natural gas, nuclear power, of production for a number of metals did and renewable energy sources would increase decline during the 1980s and 1990s. In part their output share (see earlier discussion on this reflected their relative abundance (re- long-term demand). Reserves of crude oil serves exceeded more than 40 years for baux- would not decline as rapidly as they would ite, copper, iron ore, and nickel), continued have had prices not increased, and its use rising production levels, declining prices, and would be reserved for those products (plastics, underinvestment. It also reflected the fact that chemicals, and polymers) where few alterna- reserves are really a measure of the inventory tives exist. that producers have readily available for fu- ture delivery, rather than a measure of the Overall, high prices will encourage physical quantity remaining of a commodity. increased supply and substitution of With demand and prices weak, and invento- alternative sources ries (reserves) ample, firms had little incentive As indicated earlier, the supply of crude oil is to invest in additional inventory. expected to continue to expand over the next Since 2003, when metal prices began rising few decades, reaching about 112 mb/d by and production accelerated, exploration 2030. The supply of other energy sources is expenditures have picked up (see earlier dis- expected to increase more rapidly than that cussion). For some metals, the reserve-to- for oil, with coal and natural gas projected to production ratios have increased as a result increase their shares in total energy supply (table 2.10). from 46 percent in 2005 to 51 percent in 2030. Renewable energy sources are projected Increasing scarcity is unlikely to result in to see their share in total energy supply rise resource exhaustion from about 0.45 percent to about 1.7 percent Although the history of reserves data suggests over the same period (table 2.11). that much more oil is likely to be discovered, Biofuels are a source of renewable energy ultimately the quantity of available oil is finite. whose share of global liquids production has Table 2.10 Increased investment has stabilized reserve-to-production ratios for some commodities Year Oil Coal Bauxite Iron ore Copper Lead Nickel Tin Zinc Proven reserves billions of barrels (Millions of metric tons) 1980 667 — 25,000 250,000 493 127 55 10 162 1990 1,003 — 22,000 150,000 350 70 49 8 147 2000 1,104 984,211 24,000 140,000 340 64 58 7 190 2007 1,238 847,488 25,000 150,000 490 79 67 6 180 Reserves/production ratio (Years of production equivalent) 1980 29 — 280 280 64 36 77 42 26 1990 42 — 193 178 41 20 53 37 21 2000 40 230 178 132 26 21 46 29 22 2007 42 133 132 79 31 22 40 20 17 Source: Radetzki (2008a, 2008b), British Petroleum, U.S. Geological Survey. 77 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table 2.11 Oil’s share in global energy plastics most recently and by sand (fiber op- supply is projected to decline tics) in telecommunications applications. And Average annual growth rate the rapid expansion in demand for aluminum, (%) shown in figure 2.19, partly reflects its increas- Energy source 1990–2005 2005–15 2015–30 ing use as a lightweight alternative for steel. Another element of growing importance in Coal 1.8 3.3 1.5 the metals markets is the role of recycling, Oil 1.5 1.7 1.1 which currently ranges from 55 percent of Gas 2.3 2.6 1.7 Nuclear 2.1 1.1 0.4 final demand in the case of lead to about Hydro 2.1 2.7 1.6 5 percent in the case of zinc. In developed Biomass & Waste 1.6 1.5 1.3 economies, the proportion of metal available Other renewables 3.8 9.0 5.2 Total 1.8 2.3 1.4 from scrap is higher because of greater inven- tories embodied in old cars and infrastructure Share in total energy supply (percent) that can be recycled. Future increases in scrap’s share of the metal supply in emerging 1990 2005 2015 2030 economies will slow the rate of growth of de- Coal 25.3 25.3 27.8 28.2 mand for mined metal.24 Oil 36.7 35.0 32.9 31.5 Gas 19.1 20.6 21.2 22.3 Actual results will depend on policy Nuclear 6.0 6.3 5.6 4.8 Hydro 2.1 2.2 2.3 2.3 choices and technological progress Biomass, waste 10.3 10.1 9.3 9.1 Supply of both energy and metals over the Other renewables 0.4 0.5 1.0 1.7 long term depends critically on policies and Total 100 100 100 100 the pace of technological change. Rising con- Source: IEA 2008a. cerns about the environmental consequences of economic activity, notably but not exclu- reached 1.6 percent, largely because of govern- sively those associated with climate change, ment encouragement (box 2.7). Recent projec- may alter the regulatory environment in im- tions suggest that biofuel production will reach portant ways. the equivalent of 1.95 mb/d of oil by 2013 (a Emissions abatement policies may restrict 45 percent increase over 2008), corresponding the use of hydrocarbons, either through man- to 2.1 percent of the projected global oil de- dates or tax policy that alters the economics mand (IEA 2008b; FAPRI 2008).23 While pop- of both demand and supply—potentially ex- ular, biofuels are controversial, in part because tending reserve-to-production ratios signifi- energy is required to produce energy, so the net cantly. Environmental concerns may also re- addition to the global energy supply from strict the use of extraction and production corn-based ethanol is relatively small (Kojima, techniques in other primary sectors in ways Mitchell, and Ward 2006), and in part because that reduce supply or significantly raise pro- biofuels yield only limited environmental ben- duction costs. In the IEA’s aggressive emissions efits (Searchinger and others 2008; Fargione abatement scenarios, global oil demand falls and others 2008). by 29 percent. Long-term projections for metals and min- How successful alternative fuels and erals supplies are optimistic, with expectations improved extraction technologies will be in that production will increase by a further 3.0 enabling the kind of substitution and in- percent a year between now and 2030. At the creased supply that has been observed in the same time, the trend toward substitution of al- past will depend on how successful policy is in ternative metal products is likely to continue. supporting the creation and diffusion of new For example, copper initially displaced lead in technologies. Particularly important for poor plumbing applications, only to be displaced by countries will be efforts to create affordable 78 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S Box 2.7 The rise of biofuel production W hile biofuels have been used since the early days of the automobile (Henry Ford’s 1908 Model T car was designed to run on maize-based of biofuel use by 2010, whereas a 2008 European Commission directive proposed a 10 percent use mandate by 2020. ethanol), limited supplies and the availability of In the 1970s, Brazil offered incentives to both cheaper and more efficient petroleum products sugarcane producers and its car industry to encour- diminished the use of biofuels (except for a brief age biofuels, and by the mid-1980s, Brazil was pro- revival during the petroleum shortages of World ducing 3 billion gallons of sugarcane-based ethanol War II). a year, while 90 percent of Brazilian-made cars were In the United States, various amendments to the designed to run on ethanol. The biofuel program 1970 Clean Air Act and the 1992 Energy Policy Act almost collapsed during the 1990s when the price of were instituted that favored the use of biofuels, espe- oil was low, offshore oil discoveries weakened politi- cially maize-based ethanol. More recently, the 2007 cal support for biofuels, and high sugar prices Energy Independence and Security Act called for a strained the subsidy program and diverted sugarcane fourfold increase in biofuel production by 2022. As to the world market. However, the recent crude oil a result, an estimated 25 percent of U.S. maize out- price spike along with the introduction of “flex-fuel” put in 2007–08 was diverted to ethanol production. cars that can use any combination of gas and ethanol In 2007, the United States produced 6.6 billion gal- has encouraged reliance on ethanol. lons of ethanol, roughly equivalent to 4.5 percent of In Brazil, the government no longer provides its gasoline consumption. subsidies to either the car or the sugar industry, and The European Union began instituting mandatory the cost of producing ethanol is $1.40 a gallon (very use of biodiesel (mostly from rapeseed oil) as early as low compared with maize-based ethanol or edible 1992. During 2008, its biofuel output was expected oil–based biodiesel), making the industry competitive to reach 225,000 barrels a day of oil equivalent, rep- even if crude oil prices decline to $40 a barrel resenting about 1.5 percent of its crude oil consump- (Kojima and Johnson 2005). tion. The European Union has a target 5.75 percent and durable solar cells, whereas at the global companies, even in a consultancy capacity. In level efforts to reduce dependence on liquids the baseline scenario, more than 75 percent of for transportation—such as a breakthrough in the increase in global production is expected battery technologies or hydrogen generation— to come from OPEC member countries. will be key.25 Should they decide to restrict supply, oil prices The structure of energy markets, includ- could be sharply higher in the medium term, ing the market power and supply decisions and demand much lower. Although such an made by OPEC may also play a role. The episode would likely be very painful, ulti- concentration of oil reserves in the hands of mately it would speed the switch into alterna- a few countries could limit the increase in tive energy sources (much as it did in the exploration and production anticipated in re- 1980s) and result in a significant decline in the sponse to high prices (box 2.8). OPEC con- long-term demand for oil. trols three-quarters of the world’s oil reserves and dominates export markets.26 Moreover, a Agricultural supply number of producers have made their reserves Increases in cultivated land and yields are and fields off limits to private investors; two likely to result in strong growth in agricultural of these countries (Mexico and Saudi Arabia) production and declines in prices from their officially prohibit the participation of foreign current high levels, as has occurred during the 79 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Box 2.8 State-owned firms and output efficiency T he rising share of oil reserves and global produc- tion controlled by state-owned firms has prompted concerns about future supply. The (including profit remittances to the state and obligations to sell oil at below-market prices) or social mandates that limit the extent to which they are able concerns are about: to invest in new technologies, infrastructure, and fields. In some countries, such responsibilities have been • Cartel-like behavior associated with disappointing results. For example, • The efficiency and responsiveness of state-owned oil production in República Bolivariana de Venezuela firms to economic incentives has declined 19 percent since 2000, while it has been • The denial of access to multinational firms, which stagnant and is now declining in Mexico; both are have historically been among the most efficient countries with restrictive legislation or practice. State-owned firms need not be less responsive or This contrasts with the 45 percent increase in less efficient than privately owned ones. To maximize production and 49 percent increase in reserves (not productivity, however, policy makers need to ensure including the new Tupi field) recorded by Brazil’s that government-owned or -controlled firms are not state-owned Petrobras, which has been encouraged to overburdened with very high effective tax rates reinvest profits and hire foreign experts when needed. past 50 years. However, supply growth will remain sensitive to public policy as well as to Figure 2.23 Agricultural productivity has been rising rapidly over the past 20 years investments in infrastructure and research. Average, annual percentage change in agricultural TFP, Furthermore, prospects are subject to signifi- 1980–2000 cant risks, both upside (rapid technological 3.5 change) and downside (impacts of environ- 3.0 ment and climate change and links to oil 2.5 prices through inputs and biofuels demand). 2.0 Rising productivity and land under 1.5 cultivation have boosted agricultural production 1.0 The past half century has witnessed a steady 0.5 increase in agricultural output, both in ab- 0.0 solute and per capita terms. Total factor Africa South Asia North Europe Austral- productivity in the agricultural sector has in- America America asia creased by between 2.1 and 2.5 percent each Source: Coelli and Rao 2005. year (Coelli and Rao 2005; Martin and Mitra 2001) over the past 20 years, with the largest productivity gains recorded in Asia and North 1.7 percent for chicken and 3.5 percent for America (figure 2.23). pork between 1980 and 2005 (FAO 2006). Reflecting this strong productivity growth, Growth in productivity was responsible for most of the increase in agricultural output over half of the increase in output since 1960 in the past 40 years is attributable to increased China and India and between 30 and 40 per- yields rather than to increases in the quantity cent of the increase in other East Asian coun- of cropped land (figure 2.24). Similar gains tries (World Bank 2008). These productivity were observed in the livestock sector, with the improvements enabled a decline in the share of quantity of meat produced per animal rising by labor force employed in agriculture (even as 80 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S Figure 2.24 For key crops, most of the Figure 2.25 Yield growth has decelerated increase in output was due to increased recently yield, not increased area planted Annual % change in yields, 1965–99, 2000–08 Contribution to average annual increase in output, 1965–2008 4.0 5.0 3.5 4.0 3.0 Area growth 2000–2008 1965–1999 2.5 3.0 Yield growth 2.0 1.5 2.0 1.0 1.0 0.5 0.0 0.0 Wheat Rice Maize Soybeans Cotton Wheat Rice Maize Soybeans Cotton Source: World Bank calculations based on U.S. Department of Source: World Bank calculations based on U.S. Department of Agriculture data. Agriculture data. production and population increased) and a exhaustion of the gains that came from the in- 25 percent increase in the average caloric per troduction of green revolution technologies, capita consumption in developing countries persistently low commodity prices have also during the past 30 years.27 played a role. Yields gains in other commodi- Among developing countries, crop produc- ties have accelerated because of greater use of tivity increases (which control for increases in genetically modified varieties, which boosted inputs such as capital and labor) have been yields in cotton in China and India by 19 and driven mainly by the expansion of irrigation, 26 percent, respectively (World Bank 2007b). improved seed varieties, and increased use of In addition, maize yields have benefited from fertilizer. Worldwide, the area devoted to im- the more extensive use of techniques made proved varieties has been expanding continu- economically profitable by high prices. ously. In 2000, high-yielding grain varieties The recent slowing of productivity gains were used on 90 percent of planted area in and the spike in food prices have raised con- South and East Asia, up from 10 percent in cerns about long-term output trends. Fears of a 1970 (World Bank 2007b). The use of im- food shortage over the long term are unwar- proved varieties is expanding in all regions, in- ranted, however, given the enormous potential cluding Sub-Saharan Africa, where it now rep- for increasing agricultural output through cul- resents almost one-quarter of cropped land. tivating unused land and increases in yields. Fertilizer use is also up. In developing Although much of the best agricultural countries it has risen from only 10 percent of land is already in use, significant opportunities global use in the 1960s to 77 percent now for increasing output remain simply by in- (FAO 2008). However, fertilizer use in sub- creasing the amount of land under cultivation. Saharan Africa is minimal, accounting for less About 12 percent of arable land worldwide than 3 percent of global use versus a 40 per- that is not currently forested could be brought cent share in East Asia. into agricultural production relatively easily Most recently, yield growth has declined (Thompson 2008). Considerable amounts of for some commodities, notably wheat, rice, arable and unforested land in Africa could be and soybeans (figure 2.25). While such weak- brought into production assuming appropri- ening in yield gains has been attributed to ate infrastructure were put into place, while in 81 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Brazil about 180 million arable hectares that Figure 2.26 The stock of unused but poten- are currently used as pasture could eventually tially arable land is enormous be brought into food crops. Sizable amounts Millions of hectares of arable rain-fed cropland of unused or underutilized land also exist in 1,200 Ukraine and Russia.28 Another source of additional farmland is 1,000 the 18 million hectares in the United States and Currently unused Europe that have been set aside to reduce sup- 800 ply and keep producer prices high (Normila, Effland, and Young 2004). Recent changes to 600 the Common Agricultural Policy have autho- 400 rized European farmers to use about half of Already in use that land, which could see the amount of land 200 applied to agriculture in Europe rise by 3.5 percent this year. Similarly, the United States 0 recently released 1.5 million acres of the land a ia dl bea ca Ea unt me Eu cific d ric d an ati sia d ric As Pa an Af an L lA n i N eE n st ries M arib er a o So a Af fallowed by its conservation program. co -inc C m th t h tra e ia or as ut en p n d nA As C ro ra h ig ha However, the new land is less productive H Sa id b- Su than existing land and will be more costly to exploit, especially in an environment of high Source: Food and Agriculture Organization. prices for energy and equipment. Further- more, the expansion of new land (especially in Africa) will require large investments in infra- for extending the same kind of gains to other structure and likely will take decades to ex- regions, particularly Sub-Saharan Africa and pand significantly. many countries in Europe and Central Asia, These calculations do not include land that that have adopted these techniques less exten- is currently forested but that is suitable for sively (table 2.13).29 However, such expansion rainfed crop production. Such lands exceed by will require policies to encourage research and one and one-half times the total currently used for agriculture (figure 2.26). Bringing all of Table 2.12 Potential gains from extending this land into crop production is probably nei- the green revolution remain large ther desirable nor likely, but its existence Potential gain means that the agricultural supply potential of the planet is far from exhausted. Actual Potential Poential (Percent Region production production gain of current Technological gains are likely to drive (Millions of metric tons) production) continued increases in yields Much of the increase in agricultural productiv- High income 423 440 17 3.9 East Asia and ity over the past 50 years came about through the Pacific 501 508 7 1.4 often scientifically simple improvements in Europe and agricultural technique, including increased use Central Asia 130 191 60 46.5 Latin America and of irrigation, fertilizers, and commercially the Caribbean 140 161 21 15.0 optimized seeds. The adoption of these tech- Middle East and niques in the developing world is most ad- North Africa 50 57 7 14.3 South Asia 250 259 9 3.7 vanced in Asia, and its impact on yields is evi- Sub-Saharan dent in the very strong productivity growth Africa 56 81 25 43.9 enjoyed by the region over the past half cen- Total 1,551 1,697 146 9.4 tury (table 2.12). Considerable potential exists Source: World Bank. 82 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S Table 2.13 With some exceptions, yield productivity gains and to ensuring that such growth for key agricultural commodities gains benefit the poor. About 95 percent of has been highest in South and East Asia developing-country R&D expenditures in agri- Category Wheat Rice Maize Soybeans Cotton culture is publicly funded. As a result, this (Annual percent change in yields, 1965–2006) R&D is mainly dependent on administrative decisions, which may or may not respond to World 2.0 1.7 1.8 1.5 1.7 market conditions. Therefore, it is imperative Income level that efforts to increase food production in High income 1.6 0.9 1.6 1.3 1.6 Middle income 2.0 1.9 2.6 2.8 2.3 low-income countries should be part of a Low income 2.6 2.0 1.1 1.4 3.1 comprehensive effort that includes investment Region in R&D as well as dissemination efforts.30 East Asia and the Pacific 3.8 1.8 2.9 1.9 2.7 Notwithstanding the swings in the prices of Europe and agricultural products, agricultural R&D has Central Asia 0.1 0.0 0.8 Ϫ0.1 0.7 remained remarkably stable as a share of agri- Latin America and the Caribbean 2.0 2.5 2.6 1.3 2.1 cultural value added, at about 0.85 percent be- Middle East and tween 1981 and 2000. Moreover, developing North Africa 2.5 1.2 2.7 3.0 1.2 countries are spending much less on R&D South Asia 2.6 2.1 1.6 1.5 3.1 Sub-Saharan Africa 2.2 0.7 0.7 3.2 1.6 than are high-income countries, both in ab- solute terms and as a share of agricultural GDP Source: World Bank calculations based on U.S. Department of Agriculture data. (figure 2.27). Recent advances in biotechnology may offer developing countries additional improvements development (R&D) and extension directed in yields through the introduction of new plant particularly at small-holders. If these countries varieties with heightened resistance to drought, were to adopt more intensive techniques like rain, diseases, and pestilence—characteristics those used in Asia and elsewhere, global pro- duction of cereals could be increased by as much as 9.4 percent, enough to meet several years’ worth of increasing global demand. Figure 2.27 Developing countries spend less Based on similar observations, the FAO in on agricultural R&D than high-income countries its most recent long-term forecasting exercise expects global agricultural production to rise R&D spending as a share of agricultural GDP 2.5 by 1.5 percent a year for the next three decades, somewhat slower than over the past 2.0 50 years but still significantly faster than pro- jected population growth. 1.5 Prospects will depend on a number of uncertain factors 1.0 1981 1991 2000 Of course, the long-term supply prospects for agricultural commodities are far from certain. 0.5 Past productivity gains are an imperfect indi- cator of what might be expected in the future. 0.0 tri e ric n b ca H ries g an ati fric d fic ld Moreover, a number of looming issues in the un om Af ra un pin L A n or ib ri ci es a a D ean d nA a ha ar e Pa co nc W co elo th a C m Sa or ic t i h- global economy could affect supply conditions ev N Afr d b- an ig Su t es ia in important ways. As W Public investment in infrastructure and Source: Pardey, Alston, and Jones 2008. R&D will be critical to realizing potential 83 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Box 2.9 Genetically modified crops—the next green revolution? T he most important recent technological break- through in agriculture has been the development of genetically modified (GM) crops. These crops tend are unwilling to allow them to be distributed in countries where they are unable to enforce their property rights. to be more disease resistant than traditional varieties Some countries (such as China) have gotten around and lower cost because of increased yields and the this problem by developing their own varieties in pub- need for fewer pesticides. lic research agencies that they make available to small- Originally developed in the United States, they holders. Other countries (such as Burkina Faso) have have spread to many countries, including many in entered into agreements with private companies that the developing world. In 2006, farmers in 22 coun- allow them to develop GM seeds to be used by small- tries planted GM seeds on 100 million hectares, holders under a general licensing agreement. corresponding to about 8 percent of global crop area The current generation of GM technology has (World Bank 2007b). Although GM crops concentrated on internalizing resistance to diseases were initially taken up by commercial farming, and pests. Research in the pipeline, however, increasingly small farmers are now using the focuses on developing varieties with other charac- technology. teristics such as increased tolerance to drought, Yet GM crops have not been adopted widely in wetness, and temperature, as well as slowing developing countries despite considerable potential in product deterioration. As a result, whereas the crops, such as bananas, that suffer large losses from first generation of GM crops was tailored to the disease. This lack of uptake results partly from con- agriculture of the developed world, the second cerns over environmental and food safety risks and generation may be better suited to resolving the partly from private producers of these seeds that kinds of problems found in the production systems that might be especially desirable during a pe- In the long term, climate change and riod of climate change. However, like the chem- water scarcity could have significant ical-based pesticides and fertilizers that helped impacts on yields generate substantial improvements to yields Global temperatures are expected to rise by during the green revolution, they may also 0.4 degrees Celsius between now and 2030. carry with them hidden risks such as cross- This could lead to an overall decline in agri- plant genetic contamination and potential cultural productivity of between 1 and 10 per- health impacts because of unexpected interac- cent by 2030 (compared with a counterfactual tions with human biology. Transparent and where average global temperatures remained cost-effective regulatory systems that inspire stable), with India, Sub-Saharan Africa, and public confidence will be needed to evaluate parts of Latin America being most affected risks and benefits on a case-by-case basis. (see next section). Moreover, the diffusion of these innova- Over the longer term, the impacts of cli- tions into developing countries has been un- mate change could be much more serious, even, partly because of the high cost of these with agricultural productivity in many devel- seeds and their incompatibility with traditional oping regions, notably Africa, potentially agricultural methods and partly because of the declining by as much as 25 percent as com- unwillingness of seed companies to market pared with a baseline of temperatures remain- them into countries with weak regulatory ing stable at their 2030 levels (Cline 2007). frameworks and intellectual property regimes Sustainable water supply forms another (box 2.9). longer-term risk facing future agricultural 84 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S supply. About 85 percent of water use in agricultural prices is particularly uncertain, this developing countries goes to agriculture, with decline is expected to continue through the less than one-fifth of the cultivated area in de- forecast period. veloping countries producing two-fifths of the As outlined earlier, the growth in demand value of agricultural output (World Bank for agricultural products is expected to be 2007b). Already 15–35 percent of water with- somewhat weaker in the next several decades drawals worldwide are not sustainable, in the because of slower population growth and the sense that the amount being withdrawn from limited impact of higher incomes on food aquifers or rivers exceeds the rate at which the demand. On the supply side, the availability source is naturally resupplied. Perhaps the of additional land and further productivity most notable example of unsustainable use improvements should enable production to was the rapid expansion of cotton production keep pace with demand even as the agricul- in the Aral Sea basin, which has resulted in the tural sector continues to release labor to work disappearance of 90 percent of the sea’s sur- in other parts of the global economy. face area and a broadly based environmental Based on long-term forecasts of population disaster. Improving water management will re- and incomes and a continuation of the histori- quire countries to take more responsibility for cal experience of rising productivity, annual de- shared water resources, ensuring that they are mand and supply are projected to grow by priced appropriately and that adequate water about 1.7 percent on average between 2008 and management institutions are put in place to 2030. This would imply a continued decline in prevent a recurrence. agricultural prices of about 0.7 percent a year relative to manufacturing prices and the share of the unskilled labor force working in agriculture Projections declines by 6 percentage points (table 2.14). A s anyone following commodity markets over the recent past can attest, forecasting future demand, supply, and prices in commod- One particularly difficult issue in the long- term forecasts for agricultural production and prices concerns the impact of climate change. ity markets is—at best—a hazardous under- Human-induced global warming has begun to taking. While some commodities, especially change growing conditions around the world, extracted commodities such as oil and metals, particularly in developing countries. In many may become more scarce in coming decades, countries, and for many crops, ideal growing there is little likelihood of a serious shortfall in temperatures have been surpassed, stressing the supply. Nevertheless, the overall balance be- growth of plants. Perhaps more significantly, tween demand and supply is very uncertain. more-extreme water-related events are occur- It will depend on a wide range of factors, ring, including more periods of persistent including climate change, productivity develop- droughts, drier soils from higher temperatures, ments in commodity supply and commodity changing patterns of rainfall (for example the demand markets, GDP and population growth, monsoon arriving earlier or later), and more se- and the policy environment. The remainder of vere rainfall falling in shorter periods. These cli- this chapter attempts to quantify the range of mate events can reduce immediate production possible outcomes in commodity markets. and impair agricultural development, as poor farmers faced with drought may be forced to Agricultural prices are likely to decline sell or eat animals, while severe storms damage over the long term other types of capital such as irrigation canals. As discussed in chapter 1, agricultural prices Forecasts of the rise in temperature and the are forecast to decline over the next two years impact on agriculture over the next two but remain well above the levels of the first half decades are extremely uncertain. Lobell and of this decade. While the long-term outlook for others (2008) anticipate that southern Africa, 85 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table 2.14 Agricultural sector simulation results, 2005–30 Results in 2030 by scenario I. II. III. Global Developing- Strong demand Baseline productivity slowdown country slowdown for biofuels Total factor productivitya Developing countries 2.1 1.2 1.2 2.1 High-income countries 2.1 1.2 2.1 2.1 Outputa 1.7 1.9 1.9 2.4 Pricesa Ϫ0.7 0.3 Ϫ0.1 Ϫ0.5 Employment (unskilled in develoing countries)a Ϫ6.0 Ϫ4.8 Ϫ5.3 Ϫ5.4 Change in real incomeb Ϫ3.4 Ϫ2.3 Ϫ1.8 Source: World Bank ENVISAGE model. a. Change in share of total employment between 2005 and 2030. b. Percent of base income. South Asia, and parts of Latin America will of infrastructure, and R&D investments in de- rank among the hardest-hit areas, with maize veloping countries with lagging productivity. production in southern Africa, for example, As shown in Scenario I, should global agri- potentially falling as much as 30 percent cultural productivity rise by only 1.2 percent a below what it would have been without cli- year on average instead of the 2.1 percent pro- mate change by 2030. jected in the baseline, then prices, rather than Our base case in table 2.14 assumes signif- declining, can be expected to rise by as much as icant damage from climate change over the 0.3 percent a year relative to manufactures— long run. However, over the projection period reversing the trend decline of the past 100 years. 2030, the impacts are relatively modest. To Reduced productivity includes increasing the date, global temperatures have risen 0.8° C quantity of cereal required to produce meat since 1900 and are projected to rise a further and as a result total agricultural output rises, 0.4° C by 2030 (Cline 2007). Scaling Cline’s even though final consumption declines by 2080 estimates of damage to agriculture by 0.3 percent per annum. Final demand does not the estimated temperature change in 2030 decline by more, because lower productivity is leads to an overall decline in agricultural pro- partially compensated for by increased inputs, ductivity of between 1 and 10 percent by 2030 including a 1.2 percentage point increase in the (compared with a future where average global share of agricultural workers in the labor force temperatures remain stable), with Canada and compared with the base case. Overall, by the Europe least affected and India, Sub-Saharan end of the projection period, real incomes in de- Africa, and parts of Latin America most af- veloping countries would be lower by about fected.31 Were there to be no climate change 3.4 percent compared with the baseline. between now and 2030, global agricultural Consistent with Scenario II, should the productivity would be nearly 4 percent higher, weaker productivity be limited to developing and the world price of food 5.3 percent lower. countries, in part because climate change is ex- These projections are subject to other im- pected to affect them more adversely and per- portant uncertainties. In particular, the pro- haps because policy fails to step up infrastruc- jected productivity gains are contingent on ture, R&D, and dissemination of investments, policies being put in place that permit produc- the overall impact in markets would be atten- tivity gains to continue rising as they have in uated somewhat. Prices would fall by only the recent past. The policies include the re- 0.17 percent a year (compared with a decline moval of trade distortions, progress to limit of 0.7 percent a year in the base case), and the increase in carbon emissions, construction agricultural sector employment would rise 86 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S slightly compared with the baseline. But devel- scenario, global demand is expected to grow oping countries, especially those whose popu- twice as fast as it does in the baseline. In this lations continue to grow relatively rapidly instance, agricultural employment increases by would become much more dependent on high- 0.6 percent of the labor force, output of other income countries for their food supply. grains (including maize) rises by 350 percent, Scenario III examines the potential impact but food prices increase by much less, due to of biofuels production on food prices. While substitution away from these products. biofuels have made a major contribution to the rise in food prices over the past two years, Over the long run oil prices are expected their impact in the future is difficult to esti- to stabilize (in real terms) at around $75 mate. The decline in oil prices has already con- As described in chapter 1, despite rather recent tributed to the decline in food prices via its in- volatility, oil prices are not expected to fall fluence on biofuel demand for food crops. much below $60 in the medium term. Oil de- Should oil prices remain moderate as pro- mand should pick up as the global economy re- jected (see below), the influence of biofuels on covers, but supply conditions should also have food prices should also stabilize. If technolog- recovered, enabling the real price of oil to rise ical progress improves the attractiveness of gradually to around the $75 range. This fore- nonfood biofuels inputs, the link between oil cast assumes that, in the absence of policy and food prices may be broken. Alternatively, changes, demand for energy will continue to biofuels could have a significant impact on rise faster than GDP. The actual rate of food prices if oil prices remain high or the cost increase of demand and how it is met will of biofuels production declines. depend critically on policies, technological The simulation reported in table 2.14 ex- change, and the level of reserves. plores the implications of a permanent increase The simulations presented in table 2.15 il- in the rate of growth of demand for food prod- lustrate the potential impacts of four alterna- ucts as source material for biofuels. Under this tive scenarios. Table 2.15 Energy sector simulation results, 2005–30 Results in 2030 by scenario I. II. III. IV. High Carbon Alternative Weak oil 2004 Baseline demand tax energy supply Energy demand (average annual percent growth) Coal 4.9 5.7 2.2 2.5 5.4 Oil 1.6 1.8 1.6 1.4 0.2 Natural gas (excluding distribution) 1.3 1.8 1.0 Ϫ0.2 1.3 Total 3.0 3.5 1.7 1.6 2.9 Prices ($ per ton of oil equivalent) Coal 59 60 62 55 54 60 Crude oil 256 428 475 420 219 760 Natural gas 157 288 306 281 231 296 Production level Coal (metric tons) 5,680 18,312 21,907 10,184 10,185 19,993 Crude oil (mbd) 75 113 117 112 78 78 Natural gas (1e12 BTU) 59,435 82,951 93,105 76,020 56,156 84,356 Share in total energy supply (percent) Coal 33.4 53.9 57.2 37.7 42.3 63.1 Oil 47.3 33.5 30.5 46.2 45.6 23.8 Natural gas 19.3 12.5 12.3 16.1 12.1 13.0 Source: World Bank ENVISAGE model. 87 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 In Scenario I, energy demand rises 0.5 per- for traditional fossil fuels. In this scenario, the cent faster (3.5 percent versus 3.0 percent) than global energy demand is lower by about the in the baseline each year because energy-saving same amount as in the carbon tax scenario, but technologies and conservation measures fail to prices of crude oil and natural gas are much come onstream as rapidly as anticipated.32 This lower. By the end of the period, coal consump- results in higher prices for all forms of energy. tion is down by 45 percent from the base case The higher price of energy means that global (from 4.9 percent to 2.5 percent), while nat- GDP grows somewhat more slowly, with the ural gas and crude oil are 30 percent lower cumulative impact on the level of output, com- than they are in the carbon tax scenario. pared with the base case, equal to 2.7 percent The price of various forms of energy in the in 2030. Most of the increase in demand is con- long run is little different from the baseline centrated in the use of coal (in absolute and scenario because the additional carbon tax in- percentage terms). Relatively higher supply duces sufficient reductions in energy demand elasticities for coal and gas lead to higher vol- to lower the final price by almost as much as ume shifts for these two fuels, whereas the the tax itself. tighter supply of the oil markets leads to a con- Finally, under Scenario IV, oil reserves de- comitantly higher price rise for oil and a rela- plete more quickly than in the baseline scenario, tive shift away from oil consumption. either because current estimates of reserves Scenario II examines the impact of a more prove too optimistic or because additional tech- concerted effort to limit carbon emissions. In nology improvements do not materialize. In this this scenario, it is assumed that policies are put scenario, oil supply, instead of growing at about into place beginning in 2011 that are consistent 1 percent a year, is broadly stable, with pro- with achieving a target concentration of 500 duction of about 78 mb/d in 2030. Oil prices parts per million of carbon dioxide in the at- are about 80 percent higher and demand 32 mosphere by 2050. This implies a shadow percent lower than in the baseline, with the price of carbon of $21 per ton of CO2 in 2030 difference being made up by about a 9 percent and a stock of emissions of around 11 gigatons stronger growth in consumption of coal. of carbon in 2030, a reduction of 32 percent The price of oil in this scenario rises to from the base-case level.33 about $122 a barrel but not higher because of Such a carbon price would lead to a signif- increased supply from alternative energy icant drop in energy demand, with coal taking sources induced by the higher prices. the largest hit (from 4.9 percent to 2.2 per- Overall, the impact on global growth in cent). Coal would be most affected because it Scenario IV would be limited. By 2030 global releases the most carbon emissions per unit of GDP would be only 1.4 percentage points equivalent energy. But a more significant fac- below the level in the base case. The bulk of tor is the large wedge in the price of coal (per this decline would be felt by the middle- unit of energy) compared with oil and gas. In income developing countries, where energy other words, the uniform price of carbon has intensities are highest. a much larger percentage increase on the price Taken together, these scenarios illustrate of coal than on oil and natural gas. As a corol- the considerable uncertainty surrounding the lary, the countries with the greatest coal con- assumptions of the base case. Nevertheless, sumption experience the largest decline in even the pessimistic scenarios have a limited energy demand. impact on global welfare. Over the long run, Scenario III illustrates a situation where a economies have considerable potential to ad- combination of policies to promote conserva- just to higher oil prices through switching to tion, increase fuel efficiency, and invest in al- other energy sources and conservation, thus ternative sources of energy such as solar and moderating the impact of higher oil prices on wind power succeeds in reducing the demand growth and poverty reduction. 88 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S Conclusions projected to decline a further 20-odd percent (see chapter 1) in 2009, these prices are high T he almost unprecedented duration and size of the recent commodity price boom gave the impression, at least as can be judged enough to ensure that sufficient further supply will be forthcoming over the medium term. In by the popular press, that the world is running the longer run, metals demand should slow as out of natural resources. This is not true. A Chinese metal intensities first stabilize and combination of circumstances have shaped this then fall, both because of lower investment boom: an unusually long period of above- rates and because of a higher share of services potential growth among developing countries; in Chinese GDP. a long period of low oil and metals prices that In agriculture, slower population growth eroded supply capacity, in part driven by the should slow demand for food, while productiv- expansion of net oil exports from the transi- ity growth should be sufficient to ensure future tion economies of Eastern Europe once domes- supply at the global level. However, prospects tic prices increased to world levels; the depreci- for individual countries are less clear. Yields ation of the dollar; the increase in subsidies for have been declining among many of the coun- biofuels that diverted resources from growing tries that had the strongest gains from the crops for food; declines in grain stocks; increas- Green Revolution, unless they step up invest- ing demand from developing-country consumers ments in infrastructure and R&D and remain of oil and raw materials; and continued global open to new technologies, agricultural pro- economic expansion in the face of rising com- ductivity growth in developing countries may modity prices. As the rapid decline of commod- decline. Moreover, for those countries with ity prices since mid-2008 attests, the current relatively high population growth, many of boom is best understood as yet another cycle in which are in Africa, failure to make invest- a long history of commodity price cycles. ments to boost agricultural productivity may This does not mean that commodity prices see them cease to be self-sufficient and forced are necessarily going to fall all the way back to to import increasingly expensive food from the levels of the 1990s, nor are they likely to high-income countries where agricultural pro- return to recent heights when demand recov- ductivity continues to rise much faster than ers. In the oil and metals markets, it will take the population. time to build the machines and train the engi- Central to these forecasts, and particularly neers required to find and exploit new re- uncertain, are the prospects for technological sources, and this kind of exploration will re- progress. Technology will determine the avail- quire that oil prices be maintained at around ability of oil reserves and the costs of extrac- $75 a barrel in real terms. tion, the price levels at which different oil sub- However, in the long run, it will be difficult stitutes become profitable, the potential for to sustain very high oil prices (in excess of economizing on scarce oil and metals, and the $100 a barrel) for a lengthy period, because al- likelihood of rapid increases in crop yields. ternative sources of oil (such as Canadian oil Making assumptions for technological sands and more-expensive offshore sources) progress 25 years in the future is a perilous un- and substitutes for oil (such as solar, wind, and dertaking. Most likely to be missed are tech- biofuels) would become profitable, while the nological surprises that enable rapid increases potential for reductions in demand from con- in productivity. So in a sense these forecasts are servation remain large. On average, the weak- conservative. But even without counting on ening of global demand and increased supply technological miracles, under reasonable as- have caused metal prices to fall by more than sumptions the supply of commodities is likely 40 percent from their recent peaks. Neverthe- to increase rapidly enough over the long run to less, they remain 2.5 times higher than they meet anticipated increases in demand at prices were in the 1990s and even though they are that are lower than the current levels. 89 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Notes this ensures that future stocks are higher and future prices lower than they would have been otherwise. At 1. The 1916–17 boom was associated with the the same time it encourages producers to increase out- First World War. Similarly, all three booms since 1945 put, thereby accelerating a return to more normal prices. have been associated with a major, though geographi- 14. In member countries of the Organisation for cally confined, military conflict (Korea, Vietnam, and Economic Co-operation and Development, high prices Iraq) and heightened geopolitical uncertainty, which induced a substantial switch away from oil and toward translated into market fears about the availability of coal, natural gas, and nuclear power for electrical supplies. generation. 2. However, real prices of domestic food commodi- 15. Exceptions include nickel, which has been ris- ties in developing countries increased by an additional ing in Brazil; copper, which has been rising in India; 28 percent during the first three quarters of 2008. and aluminum, which has been rising in South Africa. 3. This capacity was partly and temporarily utilized 16. Although developing countries now account for during the time of the first Gulf war, when 5 mb/d of almost half of the world’s metal consumption, it should capacity was shut in Iraq and Kuwait. be noted that their average per capita use of metals is 4. OPEC surplus capacity typically refers to capac- only a fraction of that in the developed economies. ity that can be brought onstream within 90 days. Here, 17. These income levels correspond roughly to the OPEC’s surplus is conservatively estimated as that midpoint in the World Bank’s official range for lying dormant from previously higher (though not lower-middle-income countries and close to the peak) levels. upper range for upper-middle-income countries. 5. Although less important than in the past, these 18. At incomes of less than $1 a day (or annual per firms still account for almost 50 percent of global up- capita income of less than $350), consumption of basic stream spending. staples such as maize, wheat, and rice tends to increase 6. Upstream expenditures and the price of crude oil along with income. At higher incomes, per capita are highly correlated; the correlation coefficient between consumption of staples tends to remain stable, so the spending per barrel of oil and the price of oil is 0.95. growth of staples consumption falls below income 7. The balance of supply was made up from OPEC growth. natural gas liquids (1.8 mb/d); non-OPEC, non-FSU 19. The income elasticity for meat products exceeds production growth (3.1 mb/d); and rising OPEC capacity. 3.0 for per capita incomes below $4,500 and declines 8. The pickup in oil demand was led by China, to 2.6 for countries with incomes in excess of $25,000. where demand for electricity had outstripped supply 20. When oil costs $120 a barrel (as it did in early from public sector utilities, resulting in a spike in the 2008), wholesale gas prices would be around $3.25 a private use of diesel oil for electrical generators. gallon in the United States, and the fuel-equivalent 9. Private communication with David Humphreys, ethanol price would be $2.44 a gallon. At that price, chief economist at Norilsk Nickel. ethanol production from maize is profitable as long as 10. The contrast between inputs in metal and in- maize prices do not exceed $245 a ton, which was puts in the agricultural sectors is noteworthy. In agri- more or less the price of maize at that time. culture, the same type of machinery can be used for vir- 21. Global production from onshore sources in tually all crops in all countries of the world. However, 2004 was 54 mb/day, almost identical to the 1973 level. machinery in metals is custom-made for each mine. 22. Reserve growth refers to the increase in the es- 11. Jatropha curcus L. is a bush or small tree used timated sizes of fields that occurs as oil and gas fields as a hedge by farmers in developing countries because are developed. In the United States, the world’s most it is not browsed by animals. It produces a fruit with intensely explored country, reserve growth is a major high oil content, suitable for biodiesel production. component of remaining oil and gas resources. It is hy- 12. The poor harvests in Australia come against a pothesized that reserve growth can occur worldwide in backdrop of an unprecedented, decade-long period of similar proportions as exploration of new fields ma- unusually low rainfall and record-high temperatures, tures. Undiscovered resources, on the other hand, are which are at least partly a result of climate change. resources postulated from geologic information and These events have severely stressed water supplies in theory to exist outside of known oil and gas fields the east and southwest of the country (http://www.bom (Kleitt and others 2000). .gov.au/climate/drought/drought.shtml). 23. If all announced projects materialize, potential 13. When hoarding and real-side speculation occur capacity could reach 3.3 mb/d. in response to expectations of a future shortfall, stocks 24. Concerns over the environment are likely to be (and prices) tend to increase in the short run (relative to another constraint in future mining activities. a baseline where the behavior did not occur). In turn, 90 T H E C O M M O D I T Y B O O M : L O N G E R - T E R M P R O S P E C T S 25. Like electric cars, hydrogen-powered vehicles 33. The questions regarding who should bear the allow the consumption of the power and the consump- burden on reducing carbon emissions are critically tion of the propellant to be geographically separated. important but are set aside in this simulation to investi- For electric cars, the energy source (be it coal, nuclear, gate the impact on overall demand and prices. The rev- or solar) that powers the car is consumed at the power- enues generated by the price of carbon are assumed to producing plant, whereas for hydrogen-powered cars be recycled domestically with no international transfers. (as distinct from hydrogen fuel-cell cars), it is expended in the plant that separates the hydrogen from water. References Thus a hydrogen-powered car can be considered just Bohi, D. R. 1999. “Technological Improvements in another form of battery-powered car. Petroleum Exploration and Development.” In Pro- 26. 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Washing- www.nfuonline.com/x25294.xml. ton, DC: World Bank. 93 3 Dealing with Changing Commodity Prices A s discussed in chapter 2, the rise in pri- mary commodity prices between 2003 and mid-2008 was much larger and more sus- Commodity dependence need not hurt long- term growth. Indeed, high commodity prices provide a development opportunity but only tained than those of earlier decades. Although if the proceeds are not squandered and if the commodity prices have fallen sharply from right policies are adopted. their recent highs, they remain well above their levels in the early 2000s and are projected to • Although commodity-dependent econo- remain high relative to their levels in the 1990s mies have, on average, grown more slowly for a significant period of time. than more diversified economies, for most The boom in commodity prices has gener- economies dependence on commodities is ated dramatic transfers of income within and the result of slow growth, not the cause. among countries. While high commodity Several countries have achieved rapid de- prices have imposed a severe burden on many velopment based on the exploitation of consumers, they have also created significant natural resources. opportunities for producers. The short-term • To achieve the growth potentially inherent macroeconomic, balance of payment, infla- in commodity riches, countries need to im- tionary, and growth implications of these plement policies that minimize the poten- higher prices were discussed in chapter 1, tial disruptive effects of volatile export rev- while long-term prospects for commodity enues, exchange rate appreciation that can markets were discussed in chapter 2. erode the competitiveness of manufactur- This chapter focuses on the challenges ing, and incentives for rent seeking and that prolonged periods of high and then low corruption. commodity prices pose for developing coun- tries. In particular, it evaluates the policies Higher food prices, while damaging to urban adopted by both commodity-producing consumers, may help lower poverty in the and -consuming countries during this boom, long run. as well as the potential role of the interna- tional community in managing the commodity price boom to maximize the development im- • Higher agricultural prices provide addi- pact and protect the most vulnerable. tional income in the rural economy, where The main messages arising from this analy- more than 75 percent of the world’s poor sis are: live. Some of this income will go directly to 95 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 farmers, potentially helping them move be- ability of growth. Others that lack a long yond precarious forms of subsistence agri- history of oil or mineral development have culture. Another part will go to raise in- pursued less prudent policies that may have comes of farm workers and increase sewn the seeds of future difficulties. demand for related services such as trans- portation, inputs, and processing. High food and oil prices may have increased • For these potential gains to be realized gov- the number of people living in extreme ernment will need to pursue policies that poverty by between 130 and 150 million. invest in infrastructure, including roads and marketing institutions to move farm • High food and fuel prices have implied products to markets and inputs to farmers. enormous transfers in incomes between producers and consumers. High fuel prices Resource-dependent developing countries have reduced real incomes in oil-importing have done a better job than in the past of developing countries by some $162 billion managing the macroeconomic consequences dollars but increased them by some $400 of rapidly rising foreign currency earnings. billion in oil exporters. With the exception of a few import-dependent countries, food • Government spending in most countries is mainly consumed in the same country has responded more prudently to increased where it is produced. As a result, the redis- commodity revenues than in the past. In- tributive impact of high food prices is stead of spending temporary windfall re- mainly between domestic producers and serves, many governments have accumu- amounted to some $277 billion between lated foreign reserves, and created and January 2007 and August 2008. augmented sovereign wealth funds. As a re- • Within countries, the largest poverty im- sult, real effective exchange rates in most pacts have been among urban populations, resource-rich countries have appreciated by which have not benefited from increased less than in the past. Finally, resource- earnings to the same degree as the rural dependent countries are less corrupt and population. Impacts were also larger in more transparent when compared with countries with fewer domestic alternatives more diversified economies than in the to internationally traded grains, whose past. prices rose the most (maize, wheat, and • As a result, the nonresource sectors of these rice). countries are more likely to have avoided a large deterioration in international compet- To mitigate the poverty impacts of higher food itiveness, and a strong procyclical cut in prices in a fiscally responsible way, countries spending is less likely to accompany the re- need to respond with targeted measures. The cent decline in commodity prices. Improve- record so far is mixed at best. ments in governance may also have con- tributed to these developments and have • Strict targeting of assistance programs is es- increased the chances that revenues are sential to reach those most affected while being allocated toward projects that en- limiting the strain on fiscal accounts. The hance the long-term development potential costs of fully compensating people in devel- of countries. oping countries for higher food and fuel • Although in aggregate the story is encour- prices would be prohibitive both to coun- aging, some countries are experiencing tries and to the aid community. Costs range strong inflationary pressures that may re- between 6 and 27 percent of the GDP of in- duce their competitiveness and the sustain- dividual countries. 96 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S • Many policies imposed by countries so far kets, with potentially long-term impacts on (lower taxes, export restrictions, and price food policies. subsidies) have been costly and have im- • Efforts to improve information about and peded adjustment. Increased fiscal outlays coordination of global grain stocks could have exceeded 2 percent of GDP in many reduce the probability of another food cri- countries. Moreover, policies designed to sis. Similarly, the effectiveness of humani- keep domestic prices low have exacerbated tarian aid would be enhanced if the World and prolonged high market prices by re- Food Programme (WFP) were provided ducing incentives to increase production with a stable source of financing and a line and reduce consumption. of credit that would allow it to respond • Countries should seek to expand or create rapidly to emergencies. more-targeted safety net programs. Food • Biofuels policies that subsidize production, subsidy programs, fuel subsides, and tax impose high tariffs, and mandate consump- exemptions tend to be regressive, with tion need to be reconsidered in light of their most of the benefits accruing to the non- impact on food prices and their trade- poor. In contrast, well-targeted schemes, distorting effects. Such policies have led to involving some form of means testing or rapid expansion of biofuels production selection mechanisms such as geographic from food crops, such as maize and veg- targeting or a work requirement, are most etable oils, and have contributed to higher successful in reducing costs and concentrat- food prices as well as to environmental ing benefits among the poor. degradation. These policies have also re- duced opportunities for lower-cost devel- Some modest steps have been taken, but the oping-country producers to expand pro- international community can do much more duction and exports. to mitigate the impact of high prices and re- • A successful conclusion to the World Trade duce the likelihood of further spikes and new Organization’s Doha Round will not re- commodity booms. duce food prices in the near term, but it does offer the prospect of greater discipline • Given the magnitude of the problem, inter- in agriculture and more-rapid income national efforts to assist the poor need to growth in developing countries. focus on the most vulnerable. One ap- proach would be to direct aid to assisting The remainder of this chapter is organized as the extreme poor in IDA-eligible countries follows. The next section considers the perspec- (countries whose poverty and lack of access tive of commodity-producing countries, evalu- to market-based finance make them eligible ating the extent to which their policies have suc- for concessional lending and grants from ceeded in coping with volatility from the World Bank Group). The cost of com- commodity prices, thus avoiding some of the pensating the poor in these countries for pitfalls that have typically caused such countries the rise in food prices between January to grow less quickly than resource-dependent 2005 and December 2007 would be about countries. The following sections examine the $2.4 billion. boom from the perspective of consumers, focus- • International agreement is needed to place ing on the impact of high prices on the poor and more effective restrictions on the use of ex- the effectiveness of the antipoverty measures port bans, which have become too com- imposed and their impact on long-term adjust- mon. These bans have increased global ment. The chapter then considers the interna- food price volatility and reduced confi- tional response to the rise in food prices and sets dence in the reliability of world food mar- out some concluding remarks. 97 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Commodity dependence and Figure 3.2 Poorer countries are more growth dependent on nonfuel primary commodities E conomic dependence on primary com- modities has been long associated with % share of merchandise export revenues, 2006 70 Nonfuel commodities slow growth in development.1 While commod- 60 ity booms are often associated with a pickup in Other growth, countries heavily dependent on the ex- 50 ports of commodities have slower growth over 40 the long term than those with more diversified Fuels exports (the so-called resource curse). This sec- 30 tion argues that this relationship should not be 20 interpreted as causal and is, in fact, far from inevitable. Provided the right policies are 10 adopted, the resource-rich developing coun- 0 tries have much to benefit from a period of Low-income Lower-middle- Upper-middle- countries income countries income countries high commodity prices. The idea that there exists a resource curse Source: World Bank. derives from the observation that countries dependent on primary commodities for their 2006, and countries that mainly exported export revenues have tended, on average, to fuels raised their per capita GDP by 1.1 per- grow more slowly than more-diversified ex- cent a year (figure 3.2). By contrast, more- porters (figure 3.1). Developing countries, diversified exporters achieved per capita which in 1980 derived more than 70 percent growth of 1.6 percent a year. The same rela- of their export revenues from nonfuel primary tionship holds if countries severely affected by commodities, increased their per capita GDP conflict are excluded, although the nonfuel by only 0.4 percent a year between 1980 and primary commodity exporters fare somewhat better in this case. Figure 3.1 More-diversified developing Moreover, low-income countries tend to countries grew more rapidly from be more dependent on nonfuel commodity 1980 to 2006 exports than high-income countries (see fig- Average growth rate, % ure 3.2). More than 60 percent of the exports 1.8 Diversified exporters of low-income countries derives from nonfuel 1.6 commodities compared with about 33 percent Fuel 1.4 exporters for high-income countries. 1.2 Nonfuel primary Resource dependency reflects low GDP, 1.0 commodity exporters not resource wealth 0.8 However, resource dependence is not the same 0.6 as resource richness. Most countries that are 0.4 resource dependent (measured as the share of 0.2 non-oil primary commodities in exports) actu- 0.0 ally have relatively poor resource endowments All countries Excluding conflict countries (measured as per capita income derived from Source: World Bank. non-oil primary commodities). Conversely, Note: Diversified exporters include countries that depend on many countries that are rich in resources have fuel and nonfuel primary commodities as well exports of manufactures. low resource dependencies because, in addi- tion to having ample resources and large 98 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S Table 3.1 Non-oil or resource-rich countries have higher per capita incomes Figure 3.3 On average, poor countries are than resource-dependent countries, 2006 dependent on commodities but relatively resource poor Share of Net nonfuel nonfuel primary Value of per capita primary Share of primary primary commodity commodities in exports commodities in total Real GDP commodities exports (US$ thousands) merchandise exports (%) per capita in exports per capita 70 70 (US$) (percent) (US$) 60 60 Top countries dependent on non-oil primary commodities 50 50 1 Gambia, The 320 97 Ϫ81 40 40 2 Uganda 275 91 17 30 30 3 Cuba — 85 49 4 Ethiopia 146 84 6 20 20 5 Niger 168 83 3 10 10 6 Malawi 145 82 24 7 Jamaica 3,357 81 276 0 0 8 Rwanda 262 80 Ϫ4 Primary exports per capita Primary exports/exports (left axis) (right axis) 9 Chile 5,896 79 2,596 10 Burundi 102 79 Ϫ4 Low-income Lower-middle-income Top countries rich in non-oil primary commodities countries countries High-income Upper-middle-income 1 New Zealand 15,199 62 2,597 countries countries 2 Chile 5,896 79 2,596 3 Australia 23,262 48 2,389 Source: World Bank. 4 Netherlands 25,678 16 1,447 5 Norway 41,446 14 1,436 6 Ireland 30,736 10 1,265 7 Denmark 32,484 23 1,142 8 Canada 25,894 17 1,082 nants of growth, dependence on primary com- 9 Estonia 6,938 26 675 modities is associated with slower growth. 10 Kazakhstan 2,166 28 533 Several authors have found a negative rela- Source: World Bank. Note: — ϭ Not available. tionship in cross-section regressions between natural resource abundance and growth.2 resource sectors, they also have thriving in- Others find that natural resource abundance is dustrial and service sectors. Oil-exporting not responsible for the slow growth of re- countries are excluded from this comparison source-rich developing countries (Manzano because most of them are both resource rich and Rigobon 2007), and that there is a posi- and resource dependent. tive relationship between resource abundance Resource dependency primarily reflects low and both short-term (Collier and Goderis levels of GDP, not resource richness. While 2007) and long-term growth (Lederman and the top 20 non-oil resource-dependent coun- Maloney 2007) after accounting for other tries have an average annual per capita income growth determinants. of just $1,099, the annual income of the top 20 resource-rich countries is 11 times higher Commodity dependence may, but need (table 3.1). These trends are reflected more not, result in slower growth broadly. Even when oil exporters are included While the causality behind these correlations in the mix, low-income countries have the remains unresolved in the literature, there is highest dependence on primary commodities, consensus about the channels through which but the lowest level of primary commodity ex- commodity dependence could contribute to ports per capita, and the inverse is true for weaker growth. These include: rich countries (figure 3.3). Considerable efforts have been made to de- • A tendency for significant fluctuations in termine if, after controlling for other determi- export revenues, often exacerbated by 99 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Box 3.1 The impact of severe shocks on economic progress A s discussed in chapter 2, at the national level the revenues from commodities tend to be much more volatile year to year than at the global level, the average level of investment over the cycle. Higher risks may bias lenders toward shorter maturities, further raising the risks of investment. And volatility and they are more volatile than manufactures. As a of consumption reduces welfare directly if most result, countries for whom primary commodities rep- consumers are risk averse. resent a large share of exports experience higher lev- For countries with the same level of primary com- els of GDP volatility than countries with more diver- modity dependence, less-developed economies tend sified exports.a Indeed, export revenues, the real to be more sensitive to such swings because they lack exchange rate, and per capita output were all more the means of coping with volatility. In countries with volatile over the past 25 years among those develop- more-developed financial systems, individuals can ing countries where primary commodity exports borrow to smooth consumption over the cycle, firms represented more than 70 percent of total exports can borrow to sustain operations in bad times, and (box figure).b governments can run countercyclical fiscal policy to High volatility in these annual data reflects reduce the macroeconomic implications of adverse pronounced economic cycles that can have adverse shocks. By contrast, in less-developed countries with implications for growth and development.c Sharp underdeveloped domestic financial systems and weak booms and busts can lead to unemployment and un- access to international finance, these adjustment derutilized capital during downswings and to bottle- mechanisms tend to function poorly. As a result, the necks during upswings. High levels of uncertainty impact of volatility on long-term growth and welfare concerning future prices and demand can depress is more severe. Moreover, poor households suffer most from ad- verse shocks, because they tend to have lower levels Box figure 3.1 The impact of severe shocks of savings, have limited access to credit (and interest on economic progress rates from informal lenders tend to be high), and must therefore respond to negative shocks by cutting Economies dependent on primary commodities experience more volatility into already low levels of consumption. In addition, if workers lose labor experience and connections and Standard deviation of percentage change children leave school, these permanent losses in 40 Fuel exporters human capital may increase long-term poverty 35 (Ocampo 2003). 30 Whether month-to-month or day-to-day volatility Nonfuel primary exporters has similarly deleterious economic impacts is less 25 Diversified exporters clear. High-frequency volatility tends to increase 20 transaction costs and reduce activity levels, but it is less likely to cause the kind of cycles in investment 15 behavior and economic activity described above. 10 Moreover, high-frequency volatility is easier to over- 5 come through traditional financing mechanisms, such as short-term credit and inventory adjustments. 0 Export revenues Real exchange GDP per capita An illustration of the difference between eco- rate nomic cycles and measured volatility based on more Source: World Bank. frequent data is provided by the recent boom in Note: Volatility is defined as the standard deviation of percentage commodity prices. While this was the longest and changes over time (annual data). Commodity concentration largest commodity price boom in the past 100 years measured in 1980. Excludes countries with population of less than 1 million. (see chapter 2), price volatility, as measured by changes in monthly data, increased only modestly 100 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S until 2008. Indeed, only some of the commodities a. See Turnovsky and Chattopadhyay (1998) and Van der Ploeg that have experienced a sharp rise in price experi- and Poelhekke (2007) among many others. Cashin, Cespedes, enced greater volatility during the price rise than and Sahay (2002) show that volatile commodity prices in- they did previously (box table). Volatility did creased the volatility of real exchange rates for 58 countries increase for almost all of the principal commodities over 1980–2002. in 2008, reflecting the rise in prices earlier in the b. The more diversified exporters include countries that depend year and their subsequent decline. on both fuel and nonfuel primary commodities, as well as ex- porters of manufactures. Price volatility has not increased c. In cross-country regressions, Aghion and others (2005) find systematically that real exchange rate volatility lowered growth performance in developing countries over 1960–2000. Fatas and Mihov Average absolute monthly percent price change (2005) find that variability in inflation and government spend- Crude oil Copper Aluminum Coal ing were related to lower growth in a cross-section of 91 coun- tries. Aizenman and Marion (1996) find a negative relationship 2000–03 8.4 3.4 3.1 4.0 between volatility and private (but not total) investment, and 2004–07 6.9 6.2 4.6 5.7 Bleaney (1996) and Ramey and Ramey (1995) find a negative 2008 7.6 6.3 6.5 15.0 relationship between volatility and growth but not between volatility and investment. Empirically, there is a relatively ro- Wheat Corn Rice bust negative relationship between high volatility of growth rates and the level of development (Koren and Tenreyro 2003). 2000–06 4.5 5.0 2.9 However, the direction of causation is unclear. Rather than sug- 2007 7.9 6.1 1.8 gesting that volatility causes underdevelopment, the greater de- 2008 9.5 9.4 18.3 pendence of poorer countries on relatively volatile primary Source: World Bank. commodities may explain the correlation. Note: Volatility is defined as the average of the absolute value of the month-to-month percentage change in detrended prices. procyclical government spending, to accen- rents accrue to the private sector. Although tuate economic cycles, tending to depress more easily said than done, when government growth over the medium term (box 3.1); controls the resource rents, care must be exer- • A tendency for exchange rate appreciations cised to avoid forcing the economy down an associated with commodity booms to artificial capital-intensive path instead of weaken the competitiveness of the non- using the commodity rents to exploit the econ- commodity sectors of the economy (the omy’s comparative advantage, which could be so-called Dutch disease); and based on a combination of commodities, com- • A tendency for high commodity revenues modity-intensive sectors, and labor-intensive to incite individuals to attempt to appro- services. priate the wealth generated by the resource What determines whether resource wealth without investing in productivity or value- generates wider development is the extent to enhancing activities (rent-seeking behavior) which the proceeds are consumed (appropri- or, in the worst cases, to engage in outright ate for a permanent increase in income) or corruption. saved (appropriate for a temporary increase); whether they are invested in high- or low- Of course, abundant commodity wealth, or return enterprises; the extent to which rents a large rise in the value of commodities stem- accrue to the population at large or are ming from higher prices, can also contribute channeled through the government; and to a country’s development, if the implied in- whether they are deployed responsibly and come generated is fruitfully invested—for ex- transparently by governments, or used to ample, in infrastructure, education, and health fund a bloated civil service or are even stolen or in additional productive capacity when the outright. 101 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Overall, an abundance of natural resources government revenues are less sensitive to does not necessarily impair development and booms in agriculture prices because agricul- can in fact promote it, but it does present tural export crops are produced in many particular challenges that require appropriate locations by many producers, so production policies to overcome. expands to the point where, in normal times, there are no rents for governments to appropri- ate and no special tax regimes (Collier 2007). Managing primary commodity Although the evidence is not conclusive, the tendency for government spending to rise booms with windfall revenues, while still present dur- W hile dependence on primary commodi- ties does not condemn a country to slow growth, it does require careful management of ing the current commodity boom, is less pro- nounced than in the past. This in turn suggests that perhaps the strong growth that has been macroeconomic policy to reduce the impact of associated with higher commodity prices this volatile export revenues (see box 3.1). time may prove more sustained than in past In past decades, the governments of sev- booms.4 eral developing countries failed to react appropriately to commodity price booms, Resource-rich developing countries have increasing public expenditures on inefficient, shown greater fiscal restraint during the import-intensive investment projects (Cashin, current boom Cespedes, and Sahay 2002) and borrowing During this boom, resource-rich developing excessively—expecting export revenues to re- countries appear to have shown greater fiscal main high for longer than was the case.3 As a restraint than they did during earlier booms, result, many of them faced severe economic thereby reducing the risk of a procyclical cut difficulties when prices declined. For example, in government spending now that commodity the seeds for the Latin American debt crisis of prices are declining.5 The average general gov- the 1980s were sown by the accumulation of ernment budget surplus of oil-exporting coun- debts by countries during a period of high tries improved from 0.6 percent of GDP in commodity prices. The payments for these 2001 to 7.7 percent in 2007. Among develop- loans proved to be unsustainable when inter- ing-country exporters of oil, minerals, and est rates rose and commodity prices declined, agricultural products, public consumption has resulting in years of slow growth or economic increased more slowly than private consump- stagnation (Manzano and Rigobon 2007). tion, external debt has risen more slowly than during past booms, and government borrow- Commodity revenues ing has increased more slowly than private and fiscal spending borrowing (IMF 2008b). The tendency for a temporary rise in revenues While fiscal policy responses have been ex- to be reflected in an unsustainable rise in gov- tremely diverse,6 government expenditures of ernment spending has historically been an im- primary commodity exporters have increased portant explanation for the poor long-term less strongly than during the 1980s, a period growth performance of commodity-dependent like the current boom when the export rev- developing countries. Countries that are depen- enues of resource-dependent developing coun- dent on point resources—oil and metals—are tries increased by about 7 percent of GDP particularly vulnerable because the government (figure 3.4).7 is the direct recipient of a large share of boom In the 1980s, government spending revenues, either through ownership of the re- tended to increase procyclically—rising in line source or through taxing the rents accruing to with the boom in GDP caused by windfall a limited number of private firms. By contrast, commodity revenues. As a result, the ratio of 102 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S have also taken steps to increase the share of Figure 3.4 Government spending by primary the windfall revenues that accrue to the state, commodity exporters responded less to export booms in this decade than in the although care must be taken to avoid harming 1980s incentives for production (box 3.2). Percentage change of the share of GDP Much of the difference between the two 8 periods reflects more prudent behavior by Change in 6 exports/GDP governments in Sub-Saharan Africa. During 4 the 1980s boom, government expenditures in 2 countries dependent on primary commodities 0 in Sub-Saharan Africa rose even more quickly than GDP. In this decade, the ratio of govern- Ϫ2 Change in government ment expenditures to GDP has declined by al- Ϫ4 expenditures/GDP most 8 percentage points (figure 3.5). This Ϫ6 1980s 2000s trend contrasts with the spending pattern in Latin America and the Caribbean and the Source: World Bank. Middle East and North Africa (other regions Note: The country sample includes developing countries where primary commodities account for more than 70 percent of have too few observations to report useful merchandise exports. The figures represent the percentage point change in merchandise exports divided by GDP, and government expenditures divided by GDP, during the boom. Figure 3.5 Public expenditures in Sub- Saharan Africa grew much less quickly in the government expenditure to GDP was broadly 2000s than in the 1980s stable. On a cyclically adjusted basis, however, a. 1980s government spending rose. Because much of Percentage change of the share of GDP the additional money went to government 25 spending and transfer programs of a quasi- 20 permanent nature, the increased spending 15 10 proved hard to reverse when GDP slowed and 5 commodity prices reversed. Governments 0 were either obliged to cut spending procycli- Ϫ5 Latin America Middle East and Sub-Saharan cally as commodity prices fell, which exacer- and Caribbean North Africa Africa bated the cycle, or allow the deficit and debt Source: World Bank. to build up, increasing their macroeconomic vulnerability b. 2000s Most recently, governments have reacted Percentage change of the share of GDP much more prudently. As a consequence, 15 while government expenditure has increased 10 in real terms, it has declined as a share of GDP 5 by almost 5 percentage points. Government 0 expenditure among nonfuel exporters has de- Ϫ5 clined the most, perhaps reflecting concern Ϫ10 Latin America Middle East and Sub-Saharan that nonfuel commodity prices would remain and Caribbean North Africa Africa high only temporarily and the tendency for governments to absorb a smaller share of Change in exports/GDP Change in government expenditures/GDP windfall revenues from high prices for nonfuel commodities than from those for hydrocarbon Source: World Bank. resources.8 Fuels (and minerals) exporters 103 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Box 3.2 Efforts to capture a larger share of windfall commodity revenues A s commodity prices increased, a number of countries sought to increase the share of the windfall that accrues to the state. Several energy revenues will reduce the companies’ incentive to in- vest and lower confidence in the broader investment climate. An alternative approach, which is now being producers (including Argentina, Bolivia, Colombia, considered by several countries, is to base the gov- Ecuador, and República Bolivariana de Venezuela) ernment’s revenue share on the price. For example, have increased, or are considering increases in, the Colombia has proposed imposing an additional rates for royalties or taxes. A few countries have 5 percent tax on every $30 increase in the price of a forced the renegotiation of contracts or nationalized barrel of oil, thereby raising the tax rate to 75 per- exploitation rights, which has had a chilling effect on cent when oil exceeds $140 a barrel. This kind of investors’ willingness to participate in some markets. arrangement holds some promise of creating a stable Developed-country governments (for example, framework so that firms can evaluate investments Alaska in the United States and Alberta in Canada) accurately and governments can capture a fair share also are increasing their revenue share. of windfall revenues when price increases. The governments of several metal-producing It is understandable that countries wish to capture countries also have attempted to increase their share a rising share of revenues from nonrenewable re- of the rising profits in recent years (UNCTAD 2006). sources as prices increase. However, such efforts For example, Mongolia instituted increased rights need to be carefully calibrated to maintain appropri- for the government to acquire equities in new ate incentives for making new investments and maxi- ventures. The Democratic Republic of Congo is mizing current output. Countries with state-owned reviewing contracts for mineral extraction signed companies that control resource extraction have to since 1995 with the purpose of increasing the ensure that incentives facing these companies encour- government’s stake. Governments, including Chile, age efficiency. For example, whereas some state- Mongolia, Peru, South Africa, and Zambia, have owned energy firms (for example Brazil’s Petrobras) taken steps or are considering proposals to raise continue to enjoy very positive relations with service- mineral taxes or royalty fees. providing firms and are efficiently managed, others Countries that contract with private (often inter- (such as in Mexico and República Bolivariana de national) firms to exploit nonrenewable resources Venezuela) face very high effective tax rates that have revised contracts to reflect higher prices. The have resulted in chronic underinvestment, declining danger here is that arbitrary changes in their share of output, and poor efficiency. averages), where government spending has Bolivariana de Venezuela, could continue to been more procyclical—rising at about the produce oil at current rates until almost the same rate as GDP as during the 1980s. end of this century before exhausting all of the oil deposits detected under their soil Surprisingly the extent to which (table 3.2). However, other countries that are governments are saving from increased oil heavily dependent on deposits of oil or mineral revenues is only loosely correlated with resources could exhaust their reserves (as cur- the size of their reserves rently estimated) within one or two decades.10 For countries dependent on nonrenewable re- If resources are viewed as a national asset sources, the optimal fiscal response to primary of both current and future generations, then commodity price booms in part depends on countries with low reserves should be saving the importance and expected life span of the a much larger proportion of permanent (and resource.9 Some countries, such as República windfall) revenues—investing them in either 104 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S Table 3.2 Ratios of reserves to production vary greatly among oil exporters Figure 3.6 Oil-exporting countries with large (Percent) reserves spent a smaller portion of their revenue from the recent boom in oil prices, Share of oil in Ratio of oil reserves 2000–06 Countries merchandise exports to current production Percentage point change of the ratio Algeria 95.7 16.8 20 Angola 92.0 17.6 15 Azerbaijan 85.1 29.3 Equatorial Guinea 83.8 13.8 Exports/GDP 10 Gabon 71.1 25.3 Government Iran, Islamic Rep. of 89.8 86.7 5 expenditures/GDP Iraq 88.1 157.6 Kazakhstan 52.8 76.5 0 Libya 98.7 61.9 Nigeria 95.6 40.3 Ϫ5 Oman 85.2 20.5 High reserves Low reserves Congo, Rep. of 92.1 19.9 Source: OPEC Secretariat, World Oil, Oil and Gas Journal, Sudan 74.8 44.2 World Bank staff calculations. Syria, Arab Rep. of 58.3 19.7 Note: Includes countries where oil accounts for more than 70 Turkmenistan 81.0 9.2 percent of merchandise export revenues and data on oil reserves, Venezuela, R. B. de 80.5 77.6 oil production, and government expenditures are available Yemen, Rep. of 80.9 20.0 (Angola, Republic of Congo, Equatorial Guinea, Islamic Republic of Iran, Kazakhstan, Libya, Nigeria, Oman, Syrian Arab Republic, Source: World Bank, British Petroleum. Turkmenistan, República Bolivariana de Venezuela, and Republic of Yemen). productive potential or financial assets that exporters. However, much of the demand is will continue to generate an income even as going to investment goods. Investment de- the original resource is depleted.11 To a de- mand in commodity-dependent economies in- gree, this is what countries are doing. The creased 7.5 percentage points faster during share of government spending in total GDP this boom than during the 1980s. As a result, among countries with low reserves has de- the current private sector boom should be clined, whereas those with high reserves have increasing domestic productive capacity that been more procyclical (figure 3.6).12 will help countries sustain the high growth of Countries like Algeria, Angola, the Repub- the past several years. lic of Congo, Turkmenistan, and the Republic Reflecting the large share of commodity of Yemen, all of which have less than 20 years revenues that accrue to the government in oil- worth of reserves and rely upon hydrocarbon exporting countries and the relative prudence exports for 80 or more of their merchandise that these governments have displayed, im- exports, face serious challenges. Unless their ports in these countries have increased less savings from oil revenues are high, associated rapidly than GDP, and current account sur- expenditures are likely to lead to exchange pluses have improved significantly as a share rate appreciation, with serious negative im- of GDP during the recent oil price rise. This pacts on the non-oil sectors of their economies pattern is similar to, but more pronounced (see below). than, that prevailing during the 1980s boom (figure 3.7). Private sector saving from In part because the benefits of high agricul- commodity revenues tural prices accrue to a much wider segment While governments appear to be saving more of the population, the private sector in non- of the windfall than they did in the 1980s, oil-commodity exporters appears to have in- private sector spending is rising rapidly— creased spending sharply during the recent especially among non-oil primary commodity boom, with much of the increased demand 105 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 ness of the noncommodity sectors of the econ- Figure 3.7 Imports and current account omy. To the extent that the imports reflect in- positions suggest more savings from commodity revenues by oil exporters than by vestment, they are less worrisome if they are nonfuel commodity exporters creating the future productive potential that a. Oil exporters will allow these countries to continue growing strongly when commodity prices and incomes Percentage change of the share of GDP 30 weaken. 25 20 Most resource-rich countries are showing 15 10 fewer signs of real effective exchange 5 rate appreciation 0 Ϫ5 The relationship between export revenues and Ϫ10 the exchange rate is complex. While a real ex- Ϫ15 change rate appreciation is the appropriate re- Ϫ20 1980s 2000s sponse to a long-term improvement in the terms of trade, it may have a deleterious im- b. Non-fuel exporters pact on the economy if the appreciation Percentage change of the share of GDP proves short-lived. Potential negative effects 7 include adjustment costs, such as increased 6 5 unemployment or the bankrupting of mar- 4 ginal firms, and reductions in potential posi- 3 tive externalities in tradable goods sectors, 2 1 such as 0 Ϫ1 • More-rapid technological progress through Ϫ2 1980s 2000s learning by doing in industries character- ized by firm-specific knowledge Imports/GDP Current account/GDP • Demonstration effects, where the gains in Source: World Bank. efficiency of one firm are easily copied by others • Increased incentives for accumulation of having been met through imports. The ratio human capital of imports to GDP increased by 6 percentage • More-stable and faster-growing markets in points, and the current account balance has manufactures than primary commodities13 remained roughly stable despite a 23 percent rise in export revenues. During the most recent boom, there is some evidence that developing countries have suc- Real currency appreciation ceeded in limiting the appreciation of their cur- The rapid increase in imports and the stability rencies, thus reducing potential adjustment of the current account in the face of rising ex- costs as prices decline (figure 3.8). On average, port revenues and domestic demand is poten- the currencies of non-oil primary commodity tially disturbing, because it suggests that the exporters have actually depreciated by a modest domestic supply response in these countries 4 percent in real effective terms, while the cur- has been relatively weak. This situation is es- rencies of developing-country oil exporters have pecially problematic if the increased imports appreciated only 8 percent in real effective are consumption goods, and if they are associ- terms—although most recently domestic infla- ated with a real effective appreciation of the tion has risen to more than 10 percent in currency that has impaired the competitive- Angola, the Islamic Republic of Iran, República 106 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S Table 3.3 Assets in sovereign wealth Figure 3.8 Primary commodity exporters funds grow in commodity-exporting limited the real appreciation of their countries currencies during the recent boom ($US billions) Percentage change in trade-weighted real effective exchange rate Country As of mid-2008 10 Algeria 47.0 5 Azerbaijan 5.0 0 Botswana 6.9 Chile 15.5 Ϫ5 Recent boom Equatorial Guinea 2.9 Ϫ10 Iran, Islamic Republic of 12.9 1980s boom Kazakhstan 21.5 Ϫ15 Libya 50.0 Ϫ20 Mexico 5.0 Non-oil exporters Oil exporters Nigeria 11.0 Russian Federation 162.5 Source: IMF data. World Bank staff calculations. Timor-Leste 3.0 Trinidad and Tobago 2.0 Venezuela, R. B. de 22.0 Total 367.2 Figure 3.9 Many oil exporters are suffering Source: Sovereign Wealth Fund Institute (www.swfinstitute.org). significantly higher inflation Note: Latest available information as of June 2008, but all Annual % increase in CPI, 2007 estimates may not refer to 2008. Excludes funds with assets under $1 billion. Data for Equatorial Guinea as of 2005. 20 15 10 5 them into foreign-denominated assets. Oil- 0 exporting developing countries doubled their Ϫ5 Ϫ10 official foreign reserves from $36 billion in 2000 to $70 billion by mid-2008, or from ,R S a G ria O ia an Ka ubli n er ola n e N on .B n An an , R ad Al of kh f by ep uda ija .d Ira za c o er ge m ab st Az g go Ch . ba Li ep ig about four months of import cover to around R a, eight months in 2008. At the same time, some el on zu en C ne m of these countries created new sovereign Ve Ye Source: World Bank data. wealth funds (Algeria, Kazakhstan, and Libya) or greatly expanded preexisting sovereign wealth funds (Azerbaijan, Russian Federation, Bolivariana de Venezuela, and the Republic of and República Bolivariana de Venezuela) Yemen (see chapter 1 for a discussion of infla- (Griffith-Jones and Ocampo 2008). The assets tion and commodity prices) (figure 3.9).14 of developing-country exporters of oil and The limited currency appreciation in re- minerals in such funds reached $367 billion by sponse to the commodity price boom is in part mid-2008 (table 3.3). attributable to the fiscal restraint discussed earlier. Government expenditures fall most New entrants into oil production may be heavily on nontraded goods. As a result, in- exceptions to these welcome trends creasing government expenditures tend to Several resource-rich developing countries are raise the price of nontraded goods relative to enjoying the fruits of newly found natural traded goods, which causes the real exchange wealth or are experiencing their first com- rate to appreciate. modity boom as an independent state, notably Commodity-dependent countries also the oil-producing countries of central Asia avoided real appreciations by sterilizing the that were formerly part of the Soviet Union. inflows of foreign currency by converting These countries have less experience in 107 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 managing a resource boom than countries that must therefore pay particular attention to have been producing substantial amounts of macroeconomic management going forward to oil for many years. ensure that the current downturn in primary Perhaps because of this lack of experience, commodity prices does not lead to a sharp re- many of these countries show signs of experi- versal of economic progress. encing the same kind of macroeconomic Another troublesome aspect of the current volatility that characterized developing, re- boom, especially given the financial crisis, is the source-rich countries in the 1980s. Their cur- rapid increase in bank lending to commodity- rencies have appreciated in real terms (against dependent economies in Sub-Saharan Africa, the U.S. dollar) by 43 percent from 2001 to in part to finance investments in oil and min- 2007, their inflation rates are higher, and gov- eral projects. Despite enjoying substantial in- ernment expenditures have been rising in line creases in their export revenues, many of these with GDP (figure 3.10). economies remain poor and need to be partic- While these developments may be consistent ularly careful in incurring foreign currency with prudent management of newfound wealth liabilities on market terms. Commercial bank and a careful investment strategy designed to commitments to these economies rose from an enhance future production capacity, they mir- average of just under $2 billion a year in ror, disconcertingly, those of the 1980s among 1995–2000 to more than $5 billion a year in more established producers. New producers 2004–06, and to $11 billion in 2007 (fig- ure 3.11). These countries’ total stock of private- Figure 3.10 New oil exporters are experienc- source external debt has not increased signifi- ing more macroeconomic volatility than cantly above the $35 billion level reached in established producers 2000 and has fallen as a share of GDP. The % change downturn in commodity prices could result in 60 disappointing returns to these projects and 50 New producers difficulties in servicing this debt on the part of 40 firms, especially as existing loans come due in 30 Established producers the current environment of much tighter credit 20 conditions and higher risk premiums for 10 developing countries. Should companies have 0 Ϫ10 Real exchange Percentage Change in rate with US$ change in government Figure 3.11 Commercial bank lending to CPI, 2008 expenditure/ commodity-dependent economies in GDP, 2001–07 Sub-Saharan Africa is rising Source: World Bank and IMF data. Gross commitments, US$ millions 12,000 Note: New producers are defined as countries dependent on oil that began production after 1985 or were established as a country after 1985, including Azerbaijan, Chad, Equatorial Guinea, 10,000 Kazakhstan, Sudan, and the Republic of Yemen (Turkmenistan lacks data for inflation and the real exchange rate). The 8,000 established producers include Algeria, Angola, Republic of Congo, Gabon, Islamic Republic of Iran, Libya, Nigeria, Oman, and 6,000 República Bolivariana de Venezuela. We use the real exchange rate with the United States (rather than the trade-weighted real exchange rate as in figure 3.5), to include sufficient countries for 4,000 a useful comparison between the two groups. 2,000 a. Real exchange rate with the U.S. dollar, where increase indicates appreciation. Data for Equatorial Guinea are for 0 2001–04. ag , 01 02 03 04 05 06 07 er 00 20 20 20 20 20 20 20 e av –20 b. Percentage change in consumer price index in 2008. 95 19 c. Change in ratio of government expenditure to GDP from 2001 to 2007. Source: Loanware 2008. 108 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S Box 3.3 Combating the corrupting influence of high commodity revenues A recent example of efforts to reduce the scope for corruption in commodity-rich countries is the Extractive Industries Transparency Initiative. were supporting the initiative.a These developments could be strengthened if the home countries of multi- national companies were to require these firms to ac- Launched in 2002, it aims to increase the account- count more explicitly for the funds they disburse to ability of governments in resource-rich countries local governments.b through the publication of company payments and government revenues from oil, gas, and mining. As a. See the Transparency International Web site, transparency.org. of July 2008, 23 countries were in the process of b. Statement by Michel Roy, from the French NGO Secours meeting the conditions for transparency supported Catholique, published in a press release from Publish What You by the initiative, and 17 of 42 major oil companies Pay (www.publishwhatyoupay.org). difficulty refinancing, this could transfer into a average. These are relative rankings and thus sovereign risk—–especially in those cases cannot indicate absolute improvements in in- where the debtor firms are state-owned. dividual countries. Nevertheless, this progress may reflect the reforms instituted over the past Governance and transparency 10 years to counter the corrupting influence of Resource riches can yield disappointing high resource rents and may also indicate that growth outcomes by creating incentives and resource wealth is being more effectively de- opportunities for corruption, mismanage- ployed in promoting the overall development ment, and political instability. Resource of these economies (box 3.3). wealth has been a source of political conflicts in Africa (Gelb 1998) that have been enor- mously destructive of wealth, while in coun- Figure 3.12 Corruption is highest among tries with weak governance and institutions, fuel exporters, although the difference has the concentrated wealth deriving from point narrowed resources too often lends itself to corrupt Index practices by politicians and civil servants 0.0 Better charged with overseeing the firms exploiting them.15 Indeed, some econometric analyses Ϫ0.2 have found that dependence on oil, metals, Ϫ0.4 and minerals, where the government plays a central role in determining the allocation of Ϫ0.6 Diversified exporters rents, lowers the quality of institutions.16 Agricultural exporters Partly reflecting the influence of these in- Ϫ0.8 Oil and mineral exporters Worse centives, countries dependent on nonrenew- Ϫ1.0 able resources (equal to more than 70 percent 1996 2006 of merchandise exports) tended in 1996 to be Source: Kaufmann and others 2007; World Bank data. more corrupt than those dependent on agricul- Note: The lower the value of the index, the worse the level of tural commodities and more diversified exports corruption relative to other countries. Countries are classified as oil or mineral, or agricultural exporters if they earn more than 70 (figure 3.12).17 More recently, corruption levels percent of merchandise export revenues from these sources. Diversified exporters are all other developing countries. in the oil, metals, and mineral exporters have Classification is based on shares in 2000. drawn much closer to the developing-country 109 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Box 3.4 Successful sovereign wealth funds F or a sovereign wealth fund to be successful, trans- parent procedures must be established for manag- ing the allocation of resources to the fund and the in- rules when conflicts arose (IMF 2007). Such changes, although often needed, can limit the impact of the fund if they occur too frequently as has happened in vestment of these resources. For example, clear rules Oman (UNCTAD 2006). for forecasting prices (necessary for the calculation Transparency in the procedures governing the of permanent income that underlies allocation deci- fund must be matched by overall strong governance sions) and, where available, reliance on independent to ensure that fiscal policy is consistent with the allo- forecasts can help insulate allocation decisions from cation of resources to the fund. For example, in political pressures. National revenue funds in Nor- some instances governments have effectively circum- way and Botswana benefited from stable and democ- vented the goals of a sovereign wealth fund by bor- ratic political systems that encouraged decision mak- rowing (using the fund as collateral). In República ing based on long-term considerations (Eifert, Gelb, Bolivariana de Venezuela, for example, resources and Tallroth 2002). were deposited in the national revenue fund accord- Rules for the allocation of a share of resource rev- ing to the rules, but at the same time the government enues to a wealth fund must not be too rigid. Several borrowed heavily to finance procyclical expenditures countries have changed, bypassed, or eliminated such (Fasano 2000). Sovereign wealth funds (see chapter 2). At the macroeconomic level, The increased prevalence of sovereign wealth this manifests itself as greater GDP, exchange funds among resource-rich countries is another rate, and export volatility (see box 3.1). For recent innovation aimed at increasing the de- individual producers, this volatility increases velopment impact derived from mineral the riskiness and quantity of investment, espe- wealth, both by increasing the returns that cially in developing countries where financial countries receive on their savings from resource systems that could provide temporary financ- revenues and by insulating those savings from ing to bridge shortfalls are underdeveloped. procyclical spending and corrupt practices. As a result, the overall production potential of The success of these funds in managing nat- the sector rises less quickly, which may be re- ural resource revenue and reducing procyclical flected in poor growth outcomes. Perhaps spending has been mixed (Asfaha 2007). In more importantly, for the poor who are general, countries with sovereign wealth funds dependent on farm-related incomes (close to have tended to experience less-procyclical fis- 75 percent of all poor; see below) and living cal policies and less-volatile macroeconomic close to the subsistence level, the impacts can outcomes.18 However, the commodity here is be particularly devastating. unclear. Such funds tend to be most successful Traditionally, developing (and developed) in countries that are already fiscally prudent countries have sought to offset this kind of and are most likely to be established in coun- volatility with price stabilization schemes, tries with strong institutions. As such, sover- marketing boards, and the like (box 3.5). eign wealth funds are no substitute for strong However, the track record of these schemes fiscal institutions (box 3.4).19 has not been good and they have fallen into disfavor. More recently, countries are entering Dealing with revenue volatility into more market-based mechanisms such as The volatility of commodity prices and output long-term contracting arrangements and means that revenues also tend to be volatile market-based conditional contracts. 110 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S Box 3.5 National and international marketing strategies M arketing boards in developing countries typi- cally got their start during colonial times as a way to facilitate the export of agricultural commodi- grain reserves or insurance against extraordinary price fluctuations. Where reforms have been less successful, the weakness of private agricultural ties to Europe and to stabilize prices for food crops. marketing channels has been revealed by the rollback Newly independent governments generally retained of marketing boards, often leading to calls for rein- marketing boards because they provided a conve- statement of the powerful boards. nient way for the governments to maintain control Similar efforts to minimize volatility have been over the distribution of strategic commodities such tried at the global level as well. These included the as food staples and export crops. International Sugar Agreement of 1954 and interna- Marketing boards are state-controlled or state- tional agreements for tin (1956), coffee (1962), sanctioned entities legally granted control over the natural rubber (1980), and cocoa (1981). These purchase or sale of agricultural commodities (Barrett agreements used some combination of supply and Mutambatsere 2008). They flourished in the control, buffer stocks, and export controls to limit 20th century in both developed and developing price changes. All of these commodity agreements countries but have declined in number under pres- broke down or lapsed in the 1980s and 1990s either sure for domestic liberalization and international because of their ineffectiveness or because of difficul- trade rules. Where reforms have been widespread ties in coordinating production among members and successful, marketing boards have vanished or (Gilbert 2005). retreated to providing public goods, such as strategic Long-term contracting provides large-scale Such contracts are sometimes entered into producers with some protection from in the context of a foreign direct investment output volatility deal by either the resource-exporting country Over the past decade or so, a number of re- or, increasingly, a resource-importing country source-dependent developing countries have hoping to gain security of future supply.20 Sev- entered into long-term contracts with client eral African countries have entered into such countries that guarantee sales volumes and in relationships with Brazil, China, India, and some cases prices. These contracts cover an Malaysia, among others, in exchange for a extended period, sometimes with specific esca- stable demand-supply relationship and access lator clauses that ensure that prices, while to foreign capital (most often in the form of more stable than market prices, do not vary foreign direct investment) to develop domestic too far from market norms, causing one part- resources. ner or the other to renege on the deal. China, or Chinese state-owned firms, have Russia and oil-producing countries in Eu- taken equity positions in oil ventures in Africa rope and Central Asia have engaged in such equal to some $13.5 billion as of early 2007. contracts with Hungary, the Czech Republic, Investments have been made in Angola, Chad, Poland, and Ukraine as well as with several Côte d’Ivoire, Equatorial Guinea, Kenya, high-income countries. Because these con- Mauritania, Niger, Nigeria, São Tomé and tracts specify prices over the duration of the Principe, Somalia, and Sudan, but the bulk contract, these consuming countries have not of production is currently concentrated in observed as large a swing in energy costs as Angola, Nigeria, and Sudan (Downs 2007). other countries (and supplier countries have Chinese companies also have invested in the not experienced as large a boom). development of minerals, such as copper and 111 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 other resources in Zambia, and cobalt and cop- highly traded tropical products such as coffee per in the Republic of Congo (Lyman 2005). and cocoa, and for maize, soybeans, and Chinese companies also have invested in Latin wheat, which are produced and exported by America, with the bulk of this investment re- the United States. However, the over-the- lated to the production of primary commodi- counter market is more limited for the base ties, such as oil in Ecuador (Caspary 2008). metals exported by many developing coun- tries.21 Moreover, many agricultural products Market-based conditional contracts offer produced and consumed by developing coun- protection from both price and volume tries are difficult to hedge efficiently. volatility for large-scale market In any event, small-holders in developing participants countries have little access to these instru- Some countries are attempting to reduce the ments. The provision of agricultural risk insur- impact of volatile commodity prices through ance to small-holders also has proven difficult. market-based derivative instruments. Unfortu- State-managed insurance schemes have been nately, developing-country producers, and largely ineffective and unsustainable without particularly agricultural small-holders, have subsidies to cover premiums. One hopeful little access to the market-based risk manage- development is the advent of index-based ment instruments now available, because of a weather insurance. These schemes, which pro- lack of knowledge; lack of collateral for mar- vide for a different way of underwriting, and gins; the small scale of their operations; and transferring, weather risk to the market, are the complexities of executing, monitoring, now being scaled up by private initiatives in and administering hedging transactions. India and elsewhere. In addition to the direct These hurdles can be overcome through a benefits these contracts provide to producers, large domestic entity that pools price risk by reducing overall revenue volatility, they from many small producers and hedges them reduce the risk by potential lenders and can in international markets. In Mexico, the gov- improve farmers’ access to credit. ernment organization, ASERCA, does this to So far these efforts have been limited to hedge price risks for cotton farmers. Through large-scale farms. To bring similar benefits ASERCA, the government offers farmers the to small-scale producers, more direct govern- chance to participate in a program to guaran- ment involvement may be required to ensure tee a minimum cotton price for a fixed fee. that supply-chain actors, who are the only ac- ASERCA then hedges its price risk by using tors large enough to enter into such contracts, the fee to purchase a “put” option in interna- have the incentives to share their benefits with tional financial markets, which pays if the small-holders. international price of cotton falls below the specified price. This payoff is in turn paid out Food markets are more complicated to farmers, effectively providing them with politically market-based insurance against the cotton Food markets present a particularly difficult price falling below the specified minimum that risk management challenge, because the re- is demand driven and inexpensive to adminis- quirements (objectives) of consumers and pro- ter (Larson, Varangis, and Yabuki 1998). ducers are often in conflict. Historically, gov- The over-the-counter market is very active ernment interventions in food markets have for oil (over-the-counter risk management in- had significant adverse effects on the supply struments are highly liquid and can extend as side, creating strong disincentives for private far as seven years in the future) and precious sector storage, finance, and trade. All too metals (contracts are considered competitive often, the ensuing shortfall in private sector over the three-to-five-year time horizon). investment in these markets—and the corre- Exchange-traded instruments also exist for spondingly weak development of local and 112 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S Box 3.6 Malawi government hedging of maize price and supply risks, 2005–08 I n 2005–06, southern Africa experienced a severe drought-related food shortage. Affected countries included Malawi, Mozambique, Zambia, and majority of the maize to humanitarian operations. During the delivery period, spot prices for a metric ton of white maize rose $50–$90 above the ceiling Zimbabwe. Initial estimates suggested that as much price of the contract following increases in the as 2 million metric tons of maize imports might be SAFEX white maize price and transport costs over required. the October-January period. The maize purchased The government of Malawi, with assistance from through the option contract had a better delivery the World Bank and the British government, used performance than most other procurement call options from the South Africa Exchange Market procedures. (SAFEX) to help cap the cost of managing the food Since then the government, facing a projected shortage. The government was concerned about both maize surplus, worked with the World Bank to struc- high price increases and its ability to secure addi- ture contingent export contracts. These were put op- tional grain on world markets. As a result, a cus- tions structured to ensure foreign markets would tomized call option for 60,000 metric tons of white take up any surplus grain and provide a price floor maize with a total value of approximately $17 mil- in the case that maize prices fell. Although the con- lion and a premium payment of $1.53 million was tracts were not taken up, they did demonstrate how written. To ensure that the maize was delivered (if contingent contracting could be used to help manage needed), the contract was written on a delivered risk associated with surpluses. In May of 2008, the basis, thus combining the price for white maize on Malawi government issued a request for proposals the SAFEX exchange with the transport costs to for a repurchase option, which will be based on a Malawi. trade finance structure for grain held in the country In the event, with spot prices rising and the food combined with a call option. The objective of this shortage growing more severe in November and approach is to set up a second layer of grain reserves December 2005, the government exercised the call that operates financially through the private sector option, elected physical settlement, and allocated the (Dana, Gilbert, and Shim 2006; Dana 2008). regional trade—exacerbate the price and sup- Poverty impacts of higher ply volatility that the interventions were at- tempting to mitigate in the first place. commodity prices More recently, governments have used cus- tomized price and supply risk management W hile resource-rich countries have faced challenges in capitalizing on the rise in commodity prices, poor consumers confront contracts to help reduce volatility and ensure severe difficulties in coping with the substan- security of supply in a way that strengthens tial decline in real incomes. The rise in real rather than weakens private sector trade. commodity prices in developing countries was Trading companies and banks in southern much less marked than in the United States Africa are now offering contingent purchase (see chapter 1); nevertheless, the increases were agreements that use “call” options as a basis substantial and imply severe consequences for for physical supply contracts (box 3.6). Risk the poor in developing countries. management can also be enhanced by more- The rise in food prices presents the greater open borders and private trade, as in the suc- challenge for the poor, most of whom spend cessful management of flood-induced rice more than half of their incomes on food. The shortages in Bangladesh in 1998. 113 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 urban poor are most directly affected, both At the same time, the direct cost of higher because they consume more commercially energy prices may well underestimate their produced foods and because they are much total cost. While direct energy consumption less likely than the rural population to benefit may be low, higher energy prices increase the from increased revenues from food sales or prices of energy-intensive goods and services improved employment opportunities arising consumed by the poor. For example, surveys from higher food prices. The poor are less af- of poor communities in China, India, Indone- fected by rising fuel prices because they spend sia, and the Lao People’s Democratic Republic less of their incomes on fuel; however, high indicate that households have reacted to fuel prices are still a burden to the poor, espe- energy-induced increases in the prices of elec- cially those in colder climates. tricity and transportation by reducing lighting The remainder of this section explores in and increasing their isolation (UNDP 2007). more detail the impacts that higher prices have Moreover, the switch to lower-cost biomass had on the poor in developing countries. energy sources carries with it hidden costs in the form of increased indoor pollution, in- Higher oil prices and poverty creased incidence of respiratory disease, blind- As discussed previously, oil price increases ness, heart disease, and obstetrical problems since 2003 pushed up consumer spending in such as stillbirth and low birth weight (IEA oil-producing developing countries by some 2002). $400 billion in 2008, while the annual in- Many efforts to measure the poverty im- crease in the food bill due to the price in- pact of higher oil prices have taken an indirect creases between January 2007 and May route because few household expenditure sur- 2008 was some $240 billion—assuming in veys have enough detail on the consumption both cases that international prices were of petroleum or petroleum products to esti- fully passed through to consumers. Of mate poverty impacts directly.23 Some country course not all of these price increases have studies have relied on input-output tables been passed through. In these cases, the costs combined with household surveys, or on com- are either being borne by governments as in- putable general equilibrium models, to esti- creased expenditures or by firms in the form mate the impact of an oil price rise on poverty. of forgone revenues when price increases are The results are mixed, with most studies con- controlled. cluding that a 20 percent rise in oil prices Most estimates suggest that the poverty im- could impose a 1–3 percent reduction in the pact of higher oil prices was smaller than the incomes of poor households (table 3.4). impact of higher food prices, mainly because Global studies of the impact of oil prices on in most developing countries, the poor spend poverty have first estimated the impact of only about 10 percent of total household higher fuel prices on GDP and then the impact spending on energy, compared with 50 percent of lower GDP on poverty. For example, for food (Grosh, del Ninno, and Tesliuc Herrera and others (2005) estimate that a $10 2008). For example, the poorest 20 percent of increase in the price of a barrel of oil would Bolivians, Malians, and Sri Lankans spend reduce GDP in the short run by about 0.8 per- more than 40 percent of their income on food, cent in developing-country oil importers. They but only 3 percent on energy (World Bank calculate that poverty rates would increase in 2008a). Moreover, when energy costs rise, the the more severely affected countries by a range extremely poor tend to turn to alternative of 1.4–1.5 percentage points. sources of energy (principally biomass). Even A simplistic extrapolation of these results where the poor receive subsidized fuel for (which are based on an everything-else-equal cooking, consumption tends to be low, in part assumption) to the $110 increase in crude because they resell it on the black market.22 prices between 2003 and mid-2008, would 114 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S Table 3.4 Country studies suggest that high oil prices have large poverty impacts Study Country Impact on poor of 20 percent increase in oil price (unless otherwise specified) Coady and Newhouse (2005) Ghana Poor incomes decline by 3.6 percent World Bank (2003) Iran Cost of living of rural poor rises by 3.1 percent ESMAP Report done in 2001a Pakistan Cost of living of poor rises by 1.15 percent McDonald and van Schoor (2005) South Africa Rural households suffer drop in income of 0.76 percent, versus 0.83 percent for urban households, with poor households less affected than rich households Clements, Hong-Sang, and Gupta (2003) Indonesia 25 percent rise in oil prices reduces average real consumption by 2.5 percent, with high-income groups slightly more affected than low-income groups ESMAP (2005) Yemen Increasing fuels to import parity (62 percent) increases household expenditures by 14.4 percent for poorest decile Kpodar (2006) Mali Household expenditures of poor rise by 1.8 percent Source: Kpodar 2006. a. As cited in Kpodar (2006). lead to the conclusion that the GDP in devel- The rise in the food bill is attributable to oping-country oil importers would have higher prices declined by more than 8 percent and that the The balance of payments implications of the incidence of extreme poverty in developing rise in food prices are important for a few countries would have increased by some countries, including some oil or metals ex- 15 percentage points. However, everything porters, a few countries beset by civil conflicts, else was not equal and for most of the period and several small island states that sell services during which oil prices were rising, GDP in and import most of their needs, including oil-importing developing countries was ex- food. However, with the exception of a few panding by more than 6 percent a year (much foods such as palm oil and a few countries, in- faster than in the past). At least for the initial cluding several island states and some Middle increases in oil prices between 2003 and mid- Eastern countries, the bulk of food products 2006, such a simplistic calculation substan- are consumed in the same country where they tially overstates the impact of higher oil prices are produced. on GDP and poverty. Nevertheless, the increased food bill facing That said, the most recent oil-price hikes consumers has been extremely large, equaling occurred under very different conditions than on average about 2.4 percent of gross national the initial ones. Global capacity was con- income in developing countries, or 8.0 percent strained, inflation was rising, and the initial of government expenditures. For some coun- cushions that allowed the first oil price hikes tries, the costs rise as high as 20 percent of to be absorbed were exhausted (see chapter 1). gross national income, equal to the total of Partly as a consequence, global growth in oil- government expenditures (figure 3.13). importing developing countries slowed by The magnitude of these costs would make 1.7 percentage points between 2007 and it impossible for most governments (or the in- 2008. Although not all of that slowdown can ternational community) to completely finance be attributed to oil prices, if it were, applying the rise in expenditures on grains required to the poverty elasticities used by Herrera and maintain consumption at 2006 levels. As a re- Pang (2006) would lead to a conclusion that sult, the greater part of the adjustment must the most recent hike in oil prices may have in- be borne by consumers, while government in- creased headcount poverty rates by as much as terventions need to focus on programs that 1.7 or 2.0 percentage points. strictly target the poor. 115 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 • The importance of food in the budgets of Figure 3.13 The increased grain bill could the poor exceed 5 percent of GDP in more than 20 countries • Households’ ability to substitute between food items Estimated change in grain expenditures, % of GNI 25 A rise in the price of food relative to other 20 goods and services tends to raise poverty in the short term. The recent increase in interna- 15 tionally traded food prices (mostly grains and oilseeds) is estimated to have increased 10 poverty in eight of nine developing countries 5 studied by Ivanic and Martin (2008). This finding reflects the fact that most of the poor 0 in developing countries (including those in Countries rural areas) are net food buyers, as demon- Source: World Bank. strated by a number of studies based on de- tailed household surveys (Christiaensen and Demery 2007; Seshan and Umali-Deininger 2007; Byerlee, Meyers, and Jayne 2006). Higher food prices and poverty Analyzing the poverty impact of higher Although estimating the direct poverty effects food prices is complicated, however, because of high oil prices is difficult, a more direct ap- net sellers are disproportionately poor (Aksoy proach is possible for analyzing the poverty ef- and Isik-Dikmelik 2008). As a consequence, fect of higher food prices, because household high food prices can transfer income from expenditure surveys tend to provide more de- richer to poorer households. Moreover, over tail on the consumption of food. the longer run, higher food prices that boost Changes in food prices can affect poverty farm income may also increase other rural through consumption and income channels. incomes by boosting employment and wages On the consumption side, as food prices rise, among the landless rural poor. Thus the im- the cost of a given basket of food increases pact of rising food prices on poverty can differ and consumer welfare declines. However, for substantially between urban and rural areas. the segment of the population whose income depends directly or indirectly on agriculture Higher food prices increase urban poverty (that is, farmers, wage workers in agriculture, unambiguously and rural landowners), higher food prices rep- The overall impact of higher prices on poverty resent an increase in income. Thus, for each may be complicated to sort out, but there is household, the net welfare effect of an in- broad consensus that higher food prices in- crease in food prices depends on the combina- crease urban poverty, mainly because most of tion of a loss of purchasing power (consump- the urban poor have no offsetting income ef- tion effect) and, for some households, a gain fects. The upper panel of table 3.5 reports the in income (income effect). At the country estimated effects on urban poverty levels in level, the poverty effect of higher food prices the six World Bank regions of a hypothetical depends on 10 percent increase in food prices. The esti- mates are calculated using the Bank’s model • The initial incidence and depth of poverty for Global Income Distribution Dynamics • The proportion of the poor that have little (GIDD) (see box 3.7 for a discussion of the or no direct income from agriculture, such assumptions underlying this and other model- as the urban poor ing exercises reported here).24 116 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S Table 3.5 Higher food prices raise poverty more in urban areas than in rural areas Estimated change in poverty from a 10 percent increase in food prices Initial Change Poverty headcount Income gap ratio Poverty headcount Income gap ratio Region (percent) (percent) (percentage point) (percentage point) Urban population East Asia and the Pacific 13.2 20.3 2.9 1.2 Europe and Central Asia 2.5 8.7 0.6 2.5 Latin America and the Caribbean 3.7 37.6 0.3 0.0 Middle East and North Africa 2.7 17.8 0.6 1.1 South Asia 32.3 25.0 4.4 1.5 Sub-Saharan Africa 34.1 38.1 2.8 0.5 Developing world 15.3 27.1 2.2 0.8 Rural population East Asia and the Pacific 31.9 23.2 1.8 0.3 Europe and Central Asia 8.2 6.6 0.3 1.0 Latin America and the Caribbean 18.6 43.9 Ϫ0.2 0.2 Middle East and North Africa 15.4 22.9 0.3 0.2 South Asia 43.3 24.0 1.7 0.5 Sub-Saharan Africa 54.9 41.5 Ϫ0.2 Ϫ0.3 Developing world 37.1 28.2 1.2 0.1 Source: Computations using data from the World Bank’s GIDD. Note: The poverty line is set at 1.25 international dollars (2005) a day per capita. The ratio of food in total consumption among the poor is computed as described in De Hoyos and Lessem 2008. East Asia excludes China. The Middle East comprises only Jordan, Morocco, and the Republic of Yemen. The largest impacts, both in the increase urban poverty arising from the recent increase in the proportion of individuals in the urban in food prices is less than 1 percent of GDP for population living in absolute poverty (the the majority of countries, rising to 3 percent headcount poverty rate) and in the extent to of GDP among those most affected.26 The au- which the average income of the poor falls thors find that around 90 percent of the in- below the poverty line (the income gap ratio), crease in costs derives from a reduction in the are observed in East Asia, South Asia, and real incomes of households that were poor be- Sub-Saharan Africa and are attributable to the fore the price shock and that the rest is attrib- heavy weight that food plays in the household utable to an increase in the number of poor consumption basket in these regions and to caused by higher prices. the high initial poverty headcounts in these re- gions (see table 3.5). The increase in head- Higher food prices also tend to raise count poverty in Sub-Saharan Africa is some- poverty in rural areas, but by less what lower than in South Asia because food Most households under the extreme poverty represents a smaller share of the urban poor’s line live in rural areas. In 2000, 7 out of every overall budget.25 Low food shares in Latin 10 poor individuals lived in a household where America and the Caribbean and very low ini- agricultural activities represented the main tial poverty levels in Europe and Central Asia occupation of the head, with lower average in- mean that the urban poverty effects of higher comes among these households being a con- food prices in those regions are close to zero. stant pattern across all regions and countries In a similar exercise, Dessus, Herrera, and (Bussolo, De Hoyos, and Medvedev 2008).27 De Hoyos (2008) estimated that the increase The lower panel of table 3.5 reports the in financial resources needed to alleviate effect on rural poverty of the same uniform 117 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Box 3.7 Critical assumptions underlying the estimation of the poverty impact of food price increases T he poverty analysis reported in this chapter is based on microsimulations using the World Bank’s model for Global Income Distribution Dy- come from higher food prices. Because it is not possible to identify which households are self- employed and which are wage earners, the addi- namics (GIDD). The GIDD comprises household- tional income attributable to high food prices is level data for 73 countries covering around 60 per- distributed equally among them. This approach is cent of the developing world population. equivalent to assuming that all of the income goes In the reported simulations a number of simplify- to the self-employed (i.e., assuming that agricul- ing assumptions had to be made. tural wages and employment are constant) and that all of the agricultural wage earners in a given 1. All households within a country face the same in- centile work for a self-employed farmer from the crease in the real price of food, measured as the same centile. rise in the price of food deflated by the rise in the 4. Household-level information on food consump- average price of all nonfood items. Data are taken tion is available for only 21 countries in the from national consumer price indexes. GIDD. Engel curves, relating food shares to 2. The income generated by the rise in food prices is household per capita income (or consumption) redistributed to rural households in proportion to and other household characteristics (see De their agricultural-generated incomes. Information Hoyos and Lessem 2008) are estimated, and esti- on the share of rural household income from mated parameters plus a randomly drawn residual agricultural activities is taken from the “Rural are used to impute food shares in countries that Income Generating Activities” (RIGA), a project do not report this information. of the Food and Agriculture Organization (FAO) 5. The simulations show the instantaneous impact and World Bank based on 17 Living Standards of the rise in food prices, assuming no substitu- Measurement Surveys. This information is tion or conservation on the part of consumers extended to the remaining 56 countries in the (or producers). GIDD by estimating a simple polynomial relation- ship between the share of agricultural-related The technical annex to this chapter reports the income and the level of income (at the centile sensitivity of the poverty estimates to variation in level) across the 17 RIGA countries and then assumptions made concerning the size of the price applying the estimated coefficients to the shock and the distribution of resources within both remaining countries in the GIDD. the rural and urban sectors. 3. One issue is whether self-employed workers and wage earners are likely to share in the rise in in- 10 percent increase in food prices. It assumes ately larger than that of retail prices (see tech- that farm-related incomes of rural households nical appendix). also rise by 10 percent. This could be an un- In every region, the deterioration in the derestimate, because total spending on food rural poverty indicators is milder than it is for includes retailing and transportation margins. urban poverty, primarily because of the effect Assuming that all of the real increase in food of increased prices on the incomes of farmers. prices was attributable to increased food com- Rural poverty actually declines somewhat in modity prices, then the percentage increase in Latin America and Sub-Saharan Africa, farmgate prices would have been proportion- whereas it increases a fair amount in East Asia 118 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S Table 3.6 Observed real price shocks and food shares of consumption vary across Figure 3.14 Real food prices in developing developing regions countries rose less than prices of interna- tionally traded foods (Percent) Distribution of cumulative increases in relative food prices Food share (Local currency unit, January 2005–December 2007) Region Price Shock among the poor Percentage of developing countries Rural population 20 East Asia and the Pacific 12.4 71.5 Europe and Central Asia Ϫ0.2 63.4 15 Latin America and the Caribbean 6.9 51.2 Middle East and 10 North Africa 25.9 64.5 South Asia 5.0 65.3 5 Sub-Saharan Africa 9.6 68.0 Developing world 6.7 66.1 0 Ϫ20 0 20 40 Urban population Percentage change in real food prices East Asia and the Pacific 13.8 67.45 Europe and Central Asia Ϫ0.5 57.87 Source: World Bank. Latin America and Note: Real local currency price increase of internationally traded the Caribbean 1.6 44.06 food commodities is shown by vertical line. Middle East and North Africa 12.5 57.14 South Asia 4.8 64.41 Sub-Saharan Africa 4.9 52.99 or more than the average increase of real in- Developing world 4.1 60.43 ternationally traded food prices. The differ- Source: World Bank. ence between domestic and international prices arises because internationally traded and South Asia, reflecting the greater impor- foods represent only a small share of total tance of nonfarm incomes within the overall food consumption in most developing coun- incomes of the rural poor in those regions and tries. Moreover, different foods have very dif- the large share of food in consumption (see the ferent weights across developing countries, second column of table 3.6). and many developing countries have policies that have prevented local prices from fully re- The actual extent of food price increases flecting changes in international prices. varies widely across countries Table 3.7 reports the result of simulations The analysis so far has assumed that all food of the poverty impacts of the observed in- prices increased by a uniform 10 percent. In crease in real food prices. Like the earlier sim- fact, observed changes have been very differ- ulations, it assumes that the farm incomes in ent. As discussed in chapters 1 and 2, while rural households rise in line with the real in- prices of internationally traded commodities crease in national food prices.29 denominated in U.S. dollars increased by as As with the uniform shock, all regions ex- much as 74 percent between January 2005 cept Europe and Central Asia and Latin Amer- and December 2007, the real increase ob- ica and the Caribbean experience a significant served in individual developing countries was increase in the incidence and depth of poverty. much smaller. Indeed, among the 73 countries At the global level, the headcount ratio in- for which distinct monthly consumer price creases by 1.3 percentage points, representing index and household survey data are avail- an additional 130 million individuals falling able, the majority had real food price increases below the poverty line.30 of 12 percent or less (figure 3.14).28 Only four The largest increases in the absolute num- countries saw real food prices rise by as much ber of poor are in Asia and Sub-Saharan 119 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table 3.7 Poverty effects of the changes headcount ratio of 24 percent for urban and in relative food prices rural populations combined, a figure substan- January 2005–December 2007 tially higher than the 18 percent reported in Initial levels: Change in: Chen and Ravallion (2008), which includes China. The impact that this discrepancy has Poverty Income Poverty Income Region headcount gap ratio headcount gap ratio on the global poverty estimates depends on the difference between the poverty effects of (percent) (percentage point) higher food prices in China and those effects Urban population East Asia and in the average East Asian country. In the ab- the Pacific 13.2 20.3 6.3 2.7 sence of household-level information for Europe and China, the underlying assumption is that the Central Asia 2.5 8.7 0.0 0.2 Latin America and poverty impacts there (that is, the change in the Caribbean 3.7 37.6 0.1 Ϫ0.7 the headcount ratio and the income gap ratio) Middle East and will be equal to the average poverty effects for North Africa 2.7 17.8 2.4 5.7 South Asia 32.3 25.0 2.0 0.5 the region. Sub-Saharan Africa 34.1 38.1 1.7 0.3 Overall, the rise in food prices increases the Developing world 15.3 27.1 2.9 0.5 global poverty deficit (the amount that a per- fectly targeted poverty alleviation program Rural population East Asia and would need to spend to bring all of those liv- the Pacific 31.9 23.2 4.9 0.7 ing on less than $1 a day up to the poverty Europe and line) from 8.2 to 13.4 percent of developing- Central Asia 8.2 6.6 0.0 0.0 Latin America and country GDP, or an increase of $37 billion. the Caribbean 18.6 43.9 0.1 0.1 The income gap ratio (the average difference Middle East and between the incomes of poor people and the North Africa 15.4 22.9 0.7 0.9 South Asia 43.3 24.0 0.8 0.3 poverty line, expressed as a percent of the Sub-Saharan Africa 54.9 41.5 0.3 0.0 poverty line) rises by much more in urban Developing world 37.1 28.2 2.1 0.1 than in rural areas, reflecting increased earn- ings in rural areas when food prices rise. The Source: World Bank. Note: Computations using data from the GIDD. Poverty line difference is particularly dramatic in East Asia of 1.25 international 2005 dollars per day. The ratio of food and the Middle East, where the increase in the in total consumption among the poor is computed as de- scribed in De Hoyos and Lessem 2008. East Asia excludes income gap ratio in urban areas is more than China. The Middle East comprises Jordan, Morocco, and the 4 times larger than it is in rural areas. Republic of Yemen. The results presented in table 3.7 hide im- portant heterogeneities across countries. In- deed, the increase in the poverty headcount Africa, reflecting the large number of people and the deficit resulting from the rise in food in each of these regions living just above the prices is less than one-fifth of a percentage poverty line. The share of the urban popula- point for almost half of the countries ana- tion in extreme poverty is estimated to dou- lyzed. In around 40 percent of the countries ble from 2.7 to 5.2 percent in the Middle analyzed, higher food prices raise the head- East and North Africa and to increase by al- count ratio by at least 0.2 percentage point; most 50 percent in the East Asia and Pacific and in 6 countries, the change in relative region. prices reduces the incidence of poverty by at Some caution should be exercised in inter- least 0.2 percentage point. In some countries, preting the figure for East Asia because the the measured impact of higher food prices GIDD data set does not include China, by far on poverty is small, or even negative, because the largest country in the region. As a result, nonfood prices rose more quickly than food the GIDD model reports an initial poverty prices during the period in question.31 120 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S Over the long term, higher food prices will Dealing with high food raise incomes in the agricultural sector In most developing countries, higher food and fuel prices prices raise the number of poor and lower in- comes of the existing poor in the short term. T he priority for governments is to address the immediate needs of the poor while minimizing the impact on already-strained Over time, however, the impact on poverty budgets. Care must be exercised to do so in a becomes less clear. The increased incomes of way that does not exacerbate the crisis or im- food sellers will raise incomes in rural areas pair the economic adjustment of the economy (where the majority of poor live). The simula- to higher prices. Given the necessity to respond tions summarized here do not reflect the mul- quickly and the time and cost involved in gath- tiplier effects of higher food prices on incomes ering information on the poor, governments in the agricultural sector nor any long-term have tended to respond to the rise in food dynamic effects that may arise because agri- prices by increasing resources to existing an- culture has strong links to the rest of the econ- tipoverty programs. While a logical response, omy. These include backward links, when in many cases care has not been taken to farmers purchase inputs such as chemicals, clearly define the temporary boost in spending fertilizers, and farm equipment for agricul- to compensate for a temporary rise in food ture, and forward links, when agricultural prices by announcing, for example, a limited production provides raw materials to food time for improved benefits or by tying them and fiber processing in the nonfarm sector. explicitly to food prices to avoid creating an Moreover, increases in agricultural incomes unnecessary, permanent, and unsustainable are usually spent on locally produced goods fiscal burden. and services, which generate local employ- Over the medium term, governments need ment. In many African countries, for example, to put in place more efficient policies for pro- on average for every $1 of additional farm tecting the poor and supporting agriculture, so income, an additional $1.47 in net income that the next crisis can be met without seri- is generated in the wider economy, some of ously impairing incentives for production or which accrues to the poor (Delgado, Hopkins, ramping up wasteful spending. Such policies and Kelly 1998). would entail better targeted and more efficient The long-term impacts of higher agricul- safety nets, along with steps to achieve the po- tural prices are difficult to measure because tential for strong improvements in agricultural they are lengthy and complex (World Bank production described in chapter 2, including 2007). They depend in part on public invest- investing in agricultural research and infra- ments in roads, markets, irrigation, infrastruc- structure, promoting the diffusion of best ture, education, and health as well as on in- practices, and reducing carbon emissions to vestments in the main factors of agricultural minimize the extent of climate change in the production—land, labor, and capital—all of long term. which take a long time to adjust. Over time, increases in agricultural prices relative to other sectors slow migration out of agriculture The immediate response has been policies and increase capital investment, which results designed to mitigate the impact of rising in increased agricultural output.32 food and fuel prices To the extent that agricultural sectors do The immediate response of most countries to sustain more rapid growth because of higher the rapid rise in food and fuel prices during food prices, rural poverty will be reduced, espe- the course of 2008 has included a mix of mar- cially where the concentration of land owner- ket interventions and the scaling up of existing ship is low and labor-intensive technologies are antipoverty measures. Almost three-quarters used (Gaiha 1993; Datt and Ravillion 1998). of the 80 developing countries surveyed by the 121 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Figure 3.15 Developing countries have Figure 3.16 Countries have tended to expand responded to rising food prices with a cash transfers and school feeding programs variety of policies when responding to higher food prices Percent Percent 60 70 50 60 50 40 40 30 30 20 20 10 10 0 0 Cash Food for Food ration/ School None Reduce Increase Export Price None transfer work stamp feeding foodgrain foodgrain restrictions controls/ taxes stocks consumer Source: Revenga, Wodon, and Zaman 2008. subsidies Source: Revenga, Wodon, and Zaman 2008. Table 3.8 Fiscal costs of selected antipoverty measures vary widely World Bank in March 2008 have taken some policy action in response to the rise in food Number of Maximum Median countries increase increase prices (figure 3.15). where (percent of (percent of The most common response was reduced Measure implemented GDP) GDP) tariffs on imports combined with price con- Food tax decreases 31 1.1 0.1 trols or consumer subsidies, followed by bans Food price subsidies 28 2.7 0.2 or restrictions on exports and decisions to add Targeted transfers 21 2.0 0.2 Public sector wage hikes 10 1.9 0.6 to official grain stocks. Most oil-importing countries have passed through all or more Fuel subsidies 38 4.0 0.7 Fuel tax reductions 37 1.3 0.3 than all of the fuel price increases since 2003, but on average oil-exporting countries have Aggregate costs 79 4.8 0.7 passed through only about one-half of the in- Source: IMF 2008a. crease (Mati 2008).33 Indeed, as oil prices hit the $140 range, the fiscal cost of fuel subsidies try experience varied widely. Indeed, although became very large in some oil-exporting coun- the majority of countries increased spending— tries and represented a significant challenge to either because preexisting subsidy policies fiscal sustainability. Some 36 countries re- became much more expensive or because of sponded to higher fuel prices by increasing direct measures—some actually reduced the subsidies and 43 by lowering fuel taxes (IMF scope of programs and cut into spending be- 2008a). Those countries that have expanded cause of increased budgetary cost. existing safety net programs have favored cash transfers and school-feeding systems. Food for Policies need to be more targeted and work and food stamps were also popular op- more supportive of medium-term tions (figure 3.16). adjustment Overall, the additional fiscal costs of mea- Although subsidies and export restrictions sures aimed at offsetting higher fuel and food have helped dampen the immediate impact costs varies from zero to a maximum of of higher prices in the countries where they are 4.8 percent of GDP, with food and fuel price implemented, they are very expensive and subsidies the most costly measures imple- often poorly targeted. Moreover, they tend to mented (table 3.8). However, individual coun- exacerbate the extent and duration of the 122 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S crisis by reducing producers’ incentives to in- dating the national oil company to sell at crease output and consumers’ incentives to re- below cost) are also common and can be very duce demand. Over the medium-term, policy expensive.36 Estimates suggest that India’s makers need to redress the balance, placing total fuel subsidies amount to about 2 percent more emphasis on well-targeted antipoverty of GDP. Even after reform, the fuel subsidy in measures and on policies that promote in- Indonesia is expected to total 127 trillion creased supply and more prudent use of nat- Indonesian rupiah ($13.9 billion) in 2008 and ural resources. make up about 13 percent of the country’s total budget (more than the total of spending Subsidies and price floors are expensive on education and health). and poorly targeted antipoverty measures The imposition of export bans by food- Food and fuel subsidies tend to be costly and exporting countries has the same basic goal of poorly targeted, even when steps are taken to keeping consumer prices below the market make the subsidized material available only to level.37 Some 20 developing counties have certain segments of the population. For exam- introduced such bans since 2007, including ple, the Egyptian system of food subsidies is Argentina, China, Egypt, India, Kazakhstan, targeted at the poor by restricting access to Pakistan, Russia, Ukraine, and Vietnam. Sev- subsidized flour to the truly poor, by locating eral different policies have been used, includ- distribution points in poor neighborhoods, ing export taxes on a particular commodity and by using lower-quality products. Never- (India), taxes on transport (Kazakhstan), re- theless, the system is very expensive (with an stricting licenses to export (Argentina), and a estimated financial cost of 2 percent of GDP) complete ban on exports (Vietnam). and ineffective (World Bank 2005a). Between one-quarter and one-third of the poor do not Price containment policies distort benefit from it, and fully 83 percent of the incentives, reducing supply, limiting value of the food subsidies goes to the non- conservation, and exacerbating and poor. Moreover, those poor and vulnerable prolonging high prices households that do benefit receive so little that While expensive and generally poorly targeted, the net effect is to lift only 5 percent of the all of these policies (price subsidies, price population out of poverty. floors, and export bans) do succeed in limiting General fuel subsidies tend to be even more the immediate domestic impact of rising inter- regressive and more costly than food subsidies national prices. However, they do so at a cost. because they involve substantial leakages of Not only are they fiscally unsustainable in benefits to higher-income groups. A study of many cases, but they also tend to exacerbate five countries from various regions found that and prolong the price increase. Lower pro- on average 78 percent of fuel subsidies went to ducer prices mean that less new supply is forth- the richest 60 percent of households (Coady coming, while lower consumer prices means and others 2006). Even when targeted that demand is not curtailed—both domesti- through voucher programs, fuel subsidies tend cally and internationally. For example a series to be ineffective. In India, for example, about of steps taken by Serbia in 2007 to secure do- half of subsidized kerosene34 (which is made mestic supply, including a temporary ban on available to poor families on a quota basis at exports of wheat, maize, soybeans, and sun- 9 rupees a liter) is diverted to the black mar- flower backfired. Serbia’s wheat plantings fell ket where it is either sold at a higher price or to a 90-year low (partly because of bad is used to adulterate diesel, which sells for weather) and prices rose (USDA 2007). about 30 rupees per liter.35 The problem with export bans is even more More generalized price subsidies or price severe. Although they are domestically appeal- floors (including indirect ones such as man- ing, these bans decrease confidence of net 123 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table 3.9 Increasing rice self-sufficiency Figure 3.17 After India banned rice exports, can be more costly than relying on imports international prices rose Cost of rice US$/ton consumption 375 India banned rice Import Self- 360 exports Production Consumption Imports strategy sufficiency 345 (millions of metric tons) ($US billions) 330 China 123.2 133.8 10.6 28.8 43.2 315 Indonesia 33.8 36.1 2.3 7.8 11.6 300 Nigeria 2.2 3.7 1.6 0.8 1.2 Iran, 07 /07 08 07 08 /07 09 /07 09 /07 10 /07 10 /07 11 /07 11 /07 12 /07 12 /07 07 Islamic 1/ 8/ 7 4 8 1 5 9 3 6 0 4 /1 /3 /1 /2 /1 /2 /0 /2 /0 /2 /0 /1 07 Rep. 1.6 2.9 1.3 0.6 0.9 Iraq 0.1 1.1 1.0 0.2 0.4 Source: International Grains Council, USDA. European Note: Price for Thailand's export price ($/ton) for 100 percent B Union 1.7 2.6 0.9 0.6 0.8 white rice. Philippines 8.7 9.6 0.9 2.1 3.1 Bangladesh 25.3 26.0 0.8 5.6 8.4 Senegal 0.1 0.9 0.7 0.2 0.3 importers in the international trading system Côte d’Ivoire 0.5 1.2 0.7 0.3 0.4 as a reliable source of food. For example, fol- Total 197.2 217.9 20.7 46.8 70.3 lowing India’s ban on exports of premium rice Source: World Bank. on October 9, 2007, domestic prices remained well below international prices, but the with- drawal of supply from international markets Moreover, using a price subsidy or import sparked an almost immediate rise in interna- restrictions to boost domestic prices and in- tional rice prices (figure 3.17).38 duce additional production is often a costly Although countries’ food security concerns alternative to importing (table 3.9). For exam- are legitimate, a widespread return to policies ple, to increase domestic rice output by of food self-sufficiency could be very costly 10 percent, a country would have to increase depending on how quickly it is achieved, the domestic prices by as much as 50 percent.41 resource endowments of the country and the For the 10 largest rice importers over 2000–05 policies used to achieve it.39 If investments in (who imported about 10 percent of their total research and infrastructure are made to im- consumption), achieving self-sufficiency in prove productivity, the costs may not be too this way would imply a $24 billion dollar in- high. Although the rate of return on such crease in food costs compared with the current investments is high, it can take many years situation where the rice is imported—mainly to raise production enough to achieve self- because the extra 50 percent would have to sufficiency. be paid both on the rice currently produced If price policies are used to boost domestic domestically as well as on the new rice to be production, the costs could be very high and produced (currently imported). the effectiveness uncertain. First, the supply A better approach would be to enter into response of the agricultural sector as a whole long-term supply arrangements, such as those is low (Cavallo 1988).40 Raising the total of discussed earlier in the context of the oil mar- agricultural production as opposed to produc- ket. Under these agreements, importing coun- tion of a single crop takes many years. Thus, tries could agree to buy a minimum amount of unless a policy is very carefully constructed, it grain or other food crop each year in exchange risks increasing production in one food item at for a commitment by the exporting country the expense of reduced production (and in- to meet larger imports when needed. Alterna- creased dependence) in another. tively, countries might make more intensive 124 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S use of the kinds of conditional contracting re- countries with weak administrative capacity. cently used by Malawi (see box 3.6). Finally, public works programs, in food or cash (such as in Cambodia and Mozambique), Over the medium term, countries need to can be effective only for a few areas and for move toward more flexible and targeted people who are currently unemployed. social safety net schemes Household targeting systems—such as Having weathered the initial consequences of proxy means tests or means tests, sometimes high food and fuel prices, countries need to community-based decision making, or hybrids transfer more of the burden of dealing with among these—can be effective in directing re- high prices to better-targeted social safety nets sources to the poor. Where a household tar- and market mechanisms. Doing so will bring geting system is not in place, a combination of both fiscal and economic benefits, in the form geographic targeting, self-targeting, or demo- of increased poverty reduction, reduced cost, graphic targeting can produce at least moder- and lower commodity prices. ately good results, reducing the cost of admin- There is no magic prescription for effective istrative targeting.42 For example, school social safety nets, especially among developing feeding programs targeted geographically to countries where both fiscal and administrative poor rural areas may have relatively low resources are often in short supply. Successful errors of inclusion. Self-targeting can be systems usually consist of several individual achieved by setting low wages for labor-inten- programs that complement each other as well sive public works. Open market operations as other public or social policies. Ultimately, for food sales can be geographically targeted the particular policy mix put into place will to slum areas, with a limitation on quantity depend on the country context. and provision of an inferior staple commodity Nevertheless, there is general consensus on inducing some degree of self-targeting. Fees the relative strengths and weaknesses of dif- for networked electricity can be differentiated ferent forms of support. A loose ranking of by use level or neighborhood. Provision of for- programs would favor targeted cash transfers tified weaning foods that are culturally ac- of adequate coverage, generosity, and quality ceptable for only very young children is a as the best option and could include increasing good use of demographic targeting. pensions and unemployment benefits when they target the poor (box 3.8). Although the economics of reform are Emergency food aid distribution, used in solid, eliminating existing but inefficient places like Afghanistan and Angola, often in antipoverty measures is politically difficult partnership with agencies such as the World Removing subsidies is difficult and can be met Food Programme (WFP), ensure food security with strong opposition and violent protest. for vulnerable groups and are appropriate Nevertheless, given the fiscal burden that where markets are functioning poorly or such subsidies impose—especially on oil where foreign assistance is only available in- importers—governments have little choice but kind, but the physical transfer and potential to reform. While many different approaches leakages can make these programs costly. have been followed, those that have worked School feeding programs can be used for a have tended to use a strategy that replaces the quick response, but these do not typically ad- subsidy with a better-targeted benefit, pre- dress child malnutrition at its most critical ceded by an effective publicity campaign that point—when children are in their infancy. Con- emphasizes the poorly targeted nature of the ditional cash transfer programs can help foster existing subsidy (Kojima and Bacon 2006). increased use of health and education services Several countries have used some variation and are generally most efficient, but they are of this approach. Chile made a one-time pay- not always a feasible option in low-income ment of $28 to low-income households to 125 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Box 3.8 Conditional cash transfers are most effective in getting money to the poor T argeted cash transfers are the cornerstone of safety net programs in most of the countries with safety nets. They help protect poor households adroit managers in getting the most from a program cannot be overemphasized. Conditional cash transfer programs have a good by providing them with the resources they need to reputation and are an effective mechanism for direct- maintain a minimum level of consumption. These are ing assistance toward the poor. Large-scale condi- the most flexible programs and can be adapted to tional cash transfer programs were developed in particular circumstances. It is not surprising that tar- Mexico (Progresa, Oportunidades) and in Brazil geted cash transfers are used in countries of varying (Bolsa familia) and later spread to other countries in income level, from Albania to Mexico to Zambia. Latin America and the Caribbean and to the rest of Even poor countries can afford to allocate re- the world. Those programs are well targeted to poor sources for safety net programs. The fiscal costs of a families through a combination of geographic priori- well-targeted safety net for the poorest need not be tization and household assessment mechanisms and unduly high. For a large share of developing coun- are particularly efficient in providing transfer to the tries, spending on overall safety nets has been on the poor. Administrative costs are relatively low, averag- order of 1–2 percent of GDP in recent years. How- ing about 5 percent of total program costs after ever, the costs of the responses differ according to start-up, compared with food-based programs, the scope, generosity, and degree of targeting: rang- whose administrative costs average 36 percent of ing from a mere 0.04 percent of GDP in Chile (for a total program costs. However, because they are more well-targeted response) to more than 1 percent of difficult to set up than unconditional programs and GDP in Ethiopia (for lifting the value added tax on might exclude the neediest where services are scarce, food grains, raising the wage on the cash-for-work cash transfer programs can be part of an emergency program, and distributing wheat to the urban poor response, for example to high food prices, where at a subsidized price). A careful fiscal-planning exer- they are already established. cise will be needed in each country. Such a plan Care must be taken to ensure that the policy re- should seek to protect critical growth-enhancing sponse to temporary crises is temporary. Although a spending and prune low-priority expenditures, and permanent increase in fiscal space may be justified in be embedded in a medium-term fiscal sustainability countries that have underinvested in adequate safety strategy so that the longer-term fiscal sustainability net systems, in countries that already had broadly of the program is ensured. For the poorest countries, adequate safety nets a temporary expansion of bene- international assistance will be essential. fits may be best. Permanent changes in the benefit The quality and care with which programs are levels or scope of the transfer program can be designed and implemented, including the selection, avoided by targeting additional benefits at those al- provision, and monitoring of benefits, have a large ready qualified for a program; making payments in a impact on program efficiency and effectiveness. lump sum or explicitly time-limited fashion. No program is a guaranteed success, and few are guaranteed failures. The role of good systems and Source: Grosh, del Ninno, and Tesliuc 2008. compensate for higher fuel prices and provided and diesel prices and nearly triple kerosene extra cash compensation to 1.4 million house- prices in 2005 with no substantial opposition. holds consuming less than 150 kilowatt-hours Ghana combined prior analysis of who bene- of electricity a month. Indonesia used an effec- fited from fuel subsidies with a campaign pub- tive public relations campaign, coupled with a lishing the measures that would be used to cash compensation scheme and general trust in compensate for removing subsidies in a suc- the government, to more than double gasoline cessful effort to remove subsidies (box 3.9). 126 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S Box 3.9 Removing fuel subsidies in Ghana G hana could not continue fuel subsidies as world oil prices rose in 2004, and the government launched a poverty and social impact assessment to mitigate their impact. A series of interviews with government officials and trade union representatives followed. The Energy Ministry used newspaper ad- study the situation. Guided by a steering committee vertisements with charts to show that Ghana’s fuel of stakeholders from ministries, academia, and the prices were the lowest in West Africa, after Nigeria’s. national oil company, the assessment was completed The mitigation measures, which were transparent in less than a year. By the time the government an- and easily monitored by society, included an immedi- nounced the 50 percent price increases in February ate elimination of fees at government-run primary 2005, it could use the assessment findings to make and junior secondary schools and a program to its case for liberalizing fuel prices to the public— improve public transport. Although the trade unions including the fact that the price subsidies mostly remained opposed to the price increases, the public benefited the better-off. generally accepted them, and no large-scale The minister of finance launched the public rela- demonstrations occurred. tions campaign with a broadcast explaining the need for the price increases and announcing measures to Source: Bacon and Kojima 2006. The international response to world. During such episodes, short-term assis- tance is urgently needed to avoid hardship. high commodity prices However, effective targeting of assistance is T he effectiveness of the policy response to the recent rise in food and fuel prices will, in the main, depend on the ability of in- critical. The cost of compensating all con- sumers for the rise in food prices alone since January 2007 is impossibly large—perhaps dividual governments to put in place well- more than $270 billion annually. Moreover, targeted programs to ameliorate hardship insulating consumers from the effects of price and to provide the infrastructure, services, increases (and taxing producers to finance this and appropriate incentives required to raise assistance) delays the necessary adjustments in food production and encourage adjustments demand and supply that will eventually bring to high food and fuel prices. For the poorest prices down. countries, some form of additional assistance Even if a program could be devised that will be required, while for other countries in- concentrated aid only on the poor, it would ternational coordination may be required to cost some $38 billion annually, or about help restore confidence in global food mar- 14 percent of all official development aid in kets and provide emergency assistance for 2007. Focusing international assistance on poor consumers. the poorest countries makes sense, in part be- The loss of real income from higher food cause higher proportions of their populations prices is too great to compensate all are extremely poor and because their own fis- consumers cal resources are particularly weak. The total As discussed earlier, the rise in food and fuel cost of reversing the poverty impact of higher prices substantially reduced the purchasing food prices in IDA-eligible countries would power of the poor throughout the developing be a more manageable $2.4 billion. 127 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Box 3.10 The international response to rising food prices T he UN secretary-general established a Task Force on the Global Food Security Crisis aimed at pro- moting a unified response to the global food price through food aid and balance of payments support to countries. The medium-term response has been to assist countries to put in place revised policies and challenge. An initial meeting was held in June 2008, measures to help farmers, particularly small-scale attended by 181 countries, and 60 nongovernmental producers, to increase production and integrate into and civil society organizations. local, regional, and international markets along with The summit concluded with a declaration calling measures to moderate the fluctuations in food grain on the international community to increase assis- prices through increased stockholding capacity and tance for developing counties, in particular the least better use of risk management practices. Longer-term developed countries and those that are most nega- responses have focused on how to increase the re- tively affected by high food prices. The immediate re- siliency of food production systems to challenges sponse was to call for increased humanitarian assis- posed by climate change. tance to those hardest hit by the rise in food prices The international community has reacted have not been used (because high prices have swiftly to the rise in food prices reduced the compensatory amounts payable The international community has been quick to farmers) to farmers in developing countries, to recognize the serious risks that higher food mostly in Africa; and the World Food Pro- prices posed for the poor. The United Nations gramme has pledged $214 million to provide has established a Task Force on the Global assistance to vulnerable groups. Food Security Crisis to formulate a unified re- For its part, the World Bank has created a sponse to the food crisis (box 3.10). $1.2 billion rapid financing facility, the Global Donors ramped up existing programs and Food Crisis Response Program (GFRP), to ad- launched new initiatives to speed the provi- dress immediate needs arising from the food sion of food aid to the poor. Examples include crisis. The facility includes $200 million in the Food and Agricultural Organization has grants targeted at vulnerable poor countries, launched the Initiative on Soaring Food Prices, with priority given to the most fragile states. which assists small-holders in critically af- The GFRP strives to create a balance be- fected countries (beginning with Burkina tween short-run food stabilization and mea- Faso, Haiti, Mauritania, and Senegal) to ob- sures to ensure that countries are able to cope tain seeds, fertilizers, and animal feedstock; better in the medium term. Countries can se- the International Fund for Agricultural Devel- lect measures most relevant to their individual opment (IFAD) is making up to $200 million situations from program components that from existing loans and grants available to im- address price policies, social protection and prove poor farmers’ access to seeds and fertil- nutrition, and immediate supply response pro- izer; bilateral donors (for example, the U.S. visions for getting seeds and fertilizers to Agency for International Development and farmers. the U.K. Department for International Devel- The World Bank is also establishing a mul- opment) are focusing existing programs on tidonor trust fund, with an initial contribution countries most affected by the food crisis; the from Saudi Arabia, to help the poor respond European Union has committed ⇔ €1.0 billion to high energy and food prices. This fund will in funds from European farm subsidies that operate in parallel with the GFRP and will 128 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S provide priority assistance to countries whose made it very expensive for the WFP to pur- economies are most severely affected by the chase food on international markets, threaten- increase in the price of imported fuel, that ing its capacity to deliver emergency humani- have already embraced or are pursuing ener- tarian aid in a timely manner. gies policies that are more fiscally sustainable, A strengthening of the financing arrange- and that propose cost-effective social safety ments for the WFP could markedly improve the net programs. efficiency of its operations, allowing for an ex- pansion in food aid and a reduction in costs.44 Improvements are required in the Financing of the WFP depends on voluntary architecture for humanitarian aid to contributions from donor countries that are strengthen the response to the food crisis largely tied to assistance for specific countries The dramatic increase in food prices has un- or programs on a year-to-year basis.45 As a re- derlined the importance of improving the effi- sult, WFP programs can be designed and im- ciency of programs to deliver emergency food plemented only after financing is committed. aid. Bilateral food aid programs are largely Contributions are often based on surplus dis- based on the disposal of surplus commodities. posal, with provision that the food be trans- This approach has played an important role in ported on the carriers of the donating nation. garnering political support for the provision These arrangements are major constraints of food aid. However, 60–86 percent of the on the WFP’s ability to respond flexibly and aid is tied, either directly to commodities pro- efficiently to the need for assistance. The time vided by the donor country or through con- required to obtain donor commitments makes straints on the use of cash donations (FAO it difficult to respond to unexpected shocks. 2006). As a consequence, the cost of this aid The timing of commitments also can mean can be 30–50 percent higher than nontied that food purchases must be made when prices sources (OECD 2005). Moreover, tied food are at seasonal highs rather than following aid of this type slows the delivery of food aid, harvest when prices are at seasonal lows. Sev- and reduces supplier incentives in local food eral donors provide commodities rather than markets. 43 cash, significantly increasing the cost of food Progress is being made in improving the compared to local purchases. Providing an an- administration of food aid programs. Some nual dollar budget equivalent to the value of donors have lifted requirements that food aid current commitments would dramatically im- be procured domestically and have shifted prove the efficiency of WFP operations. Given from providing commodities to providing the volatility of food prices, this budget might cash, making it possible to purchase some food be supplemented by a line of credit upon locally. Resources have shifted toward the pro- which it could draw in years when either vision of emergency aid, implying an improve- prices or needs are unusually high. ment in the targeting of food aid (FAO 2006). Additional efforts to provide cash aid and Steps to assist the replenishment of allow the food to be purchased where and international grain stocks would help from whom made most economic sense would The role that low stocks have played in the reduce costs and help make food aid a more rise of food prices has raised the issue of efficient instrument in reducing poverty. whether or not an international food stockpile Improvements in food aid management are should be created to help prevent a repetition required at the international level as well. The of the past year’s high prices, in part by ensur- main multilateral provider of food assistance ing that supply would be available to the is the UN’s World Food Programme, which market and by dissuading speculative behav- delivers more than half of the humanitarian ior. While an appealing notion, it is not clear food aid in the world. Higher food prices have that such a stockpile would be effective—or 129 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 needed. To have a significant dampening effect strictions may be desirable. Currently, unlike on the market, such a stockpile would have to countervailing duties, the conditions that must be large and would be very expensive to create be met before export restrictions are intro- and maintain. Rough calculations suggest that duced are ill defined, and although there is a a stockpile equivalent to 10 percent of global requirement that the World Trade Organiza- production would cost about $66 billion tion be notified of their implementation, it is to create and some $8–10 billion annually not enforced.47 Even the enhanced rules pro- to maintain.46 Moreover, the creation of the posed under the Doha Round should probably stockpile would add significantly to global be strengthened.48 Helpful measures might in- food demand and price pressures during the clude including stricter (even pre-) notification period in which it was being created. Nor is it requirements, limits on the allowed duration clear that a global stockpile would actually in- of restrictions, and possibly a definition of the crease world stocks. The public stock increase conditions under which such restrictions may well be matched by a reduction in private might be admissible. stocks, thus transferring the costs of keeping a Policy makers should also consider phasing stock to the public sector without necessarily out biofuel subsidies and production man- improving the stability of the market. dates, especially where these are coupled with A more effective strategy might be to im- tariffs that restrict imports from lower-cost prove information flows about stocks and cre- producers. This step would both reduce pres- ate mechanisms by which they can be man- sure on food prices and help low-cost and aged. Currently most stocks are held by a environmentally cleaner developing-country limited number of major producers and im- biofuel producers that are currently shut porters. It may be possible to create an inter- out of major markets by these rules.49 There national agreement that provides for the shar- are indications that a number of developed ing of some of these costs—perhaps along the countries are beginning to reexamine their lines of the International Energy Agency biofuel policies, but it remains a contentious agreement governing oil reserves. As in that issue. agreement, the rules for accumulating and dis- More fundamentally, decades of trade- tributing grain stocks would need to be clearly distorting policies (such as tariffs, quantitative defined to prevent their being used for surplus restrictions, and subsidies) are partly responsi- disposal or price support and to ensure they ble for the current spike in food prices, having are used for humanitarian purposes. encouraged inefficient agricultural production in rich countries and discouraged efficient More multilateral discipline in trade policies production in developing countries (Chauf- would help mitigate the rise in food prices four 2008). The kind of agricultural trade bar- A range of multilateral and trade policies rier reductions contemplated in the Doha (export restrictions, biofuel subsidies, tariffs, Round might lead to higher agricultural prices mandates, and global protection of agriculture in the short term, but in the long run, they more generally) have contributed to the rise should help establish a more transparent, in food prices. Moreover they have reduced rules-based, and predictable food trading sys- confidence in the international food trading tem that would stimulate trade and raise in- system and interfered with consumer and pro- comes around the world. An ambitious pro- ducer incentives, reducing supply and increas- gram could reduce global poverty by as much ing demand. As a result, the price hike has as 8 percent (World Bank 2004).50 been larger and longer lasting than it would Moreover, removal of the rules that allow have been otherwise. such trade restrictions would help ensure that, A strengthening of existing international as prices come down, countries cannot intro- rules governing the imposition of export re- duce new subsidies and restrictions in an effort 130 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S to prevent domestic producers’ prices from de- food prices has presented the greater challenge clining as sharply as they would otherwise. because the poor in developing countries spend as much as half of their incomes on food, while fuel is a smaller share of their expenditures. The Conclusions rise in food prices has increased poverty and T he rise in primary commodity prices since 2003 was much larger and more sustained than those of earlier periods. This boom gen- boosted the cost of many countries’ poorly tar- geted and inefficient subsidy programs, which by limiting the impact of food and fuel prices erated dramatic transfers of income within and impede the necessary adjustment to high prices. among countries and has imposed severe bur- The expansion of existing programs and the dens on some consumers. However, it has also adoption of emergency measures are under- created opportunities for producers and these, standable, given the magnitude of the oil and if managed properly, can provide significant food price increases, the potentially dire impli- growth opportunities. The boom has also ex- cations for the poor, and the limited time. How- posed weaknesses in domestic and interna- ever, the high cost of this response underlines tional policies that have contributed to and the importance of putting in place well-targeted prolonged the period of high prices and re- and efficient safety net programs, so that next duced confidence in international markets. time countries can address the needs of the For commodity producers, commodity poor without incurring undue fiscal costs. This dependence need not hurt long-term growth. episode has also shone light on the need for Although commodity-dependent economies international coordination to encourage coun- have, on average, grown more slowly than tries to avoid counterproductive policies and more-diversified economies, for most to marshal aid resources to help the poor. economies dependence on commodities is the Policies to deal with the rising food and result of slow growth, not the cause. To fuel prices have often exacerbated the prob- achieve the growth potential inherent in com- lem by slowing necessary adjustments. Such modity riches, countries need to implement policy responses have included price controls policies that minimize the potential disruptive and export bans that have impaired incentives impacts of volatile export revenues, exchange to reduce consumption and invest in the addi- rate appreciation that can erode the competi- tional capacity that would help bring prices tiveness of manufacturing, and incentives for down, while weakening confidence in the rent seeking and corruption. It would appear international trading system. that producing countries have responded to The dramatic increase in food prices has higher prices in a more prudent manner dur- underlined the importance of improving the ing this boom than in the past. Fiscal policy efficiency of programs to deliver emergency has been less procyclical than in the past, food aid and transition these programs from countries have made greater efforts to save largely surplus disposal programs to effective windfall profits, and rate appreciation has humanitarian assistance programs with fewer been muted. As a result, they are less likely to constraints on their use. A range of multilat- endure the major setbacks that characterized eral and trade policies (export restrictions, the 1980s as prices declined. An exception to biofuels subsidies, tariffs, mandates, and this generally welcome response has been the global protection of agriculture more gener- performance of countries with newfound ally) have contributed to the rise in food commodity wealth and some newly indepen- prices and need to be reconsidered. The Doha dent resource-rich countries that may have Round, while not likely to lower food prices repeated some of the mistakes of the past. in the near term, would provide longer-term Consumers have faced daunting challenges discipline to agricultural policies and raise from the commodity price boom. The rise in incomes around the world. 131 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Technical Annex: Sensitivity Another important assumption driving the estimated poverty effects is the allocation of Analysis the revenues from higher food prices to differ- T he poverty effects of higher food prices discussed in chapter 3 are based on a num- ber of assumptions. This annex reports the ent households. In the central scenario, pro- ducer prices are increased by the same pro- portion as consumer prices. To the extent that sensitivity of the results (change in the number all of the increase in retail food prices is at- of poor and the change in the income gap tributable to an increase in farmgate prices, ratio) under different assumptions regarding then the proportional increase in farmgate the nature of the price shock and the propor- prices should have been larger than that expe- tion of increased food expenditures that accrue rienced by retail prices.51 The other issue is to agricultural households. how the price change affects the incomes of The results presented in the main text de- different households. In the kind of short-term flate the increase in food prices by the non- simulation being conducted here, wages and food deflator. More traditionally in high- employment are normally held constant. income countries, where food represents a Therefore, only the incomes of self-employed small share of total spending, real food prices agricultural workers or landowners, who sell are deflated by the overall consumer price the final product, should increase, not those of index. If the whole consumer price index had agricultural wage laborers. Unfortunately, the been used to deflate the increase in food GIDD database does not distinguish between prices, the overall shock would have been different income sources. Therefore the data much smaller and hence the estimated poverty in the GIDD is complemented with informa- effects would have been milder. Under this tion from the Rural Income Generating Activ- scenario, labeled “real price change” in table ities (RIGA) project. RIGA is an FAO–World 3A.1, the total number of poor would be Bank funded project that uses data from 21 around half as large as in the central scenario. (household) Living Standards Measurement Table 3A.1 Sensitivity analysis Real price change Relative price change Central Scenario: Self-employment Self-employment All agricultural agricultural incomes All agricultural agricultural incomes Region incomes affected affected incomes affected affected Change in number of poor (million) East Asia and the Pacific 52.1 59.9 103.7 114.7 Europe and Central Asia 0.0 0.0 0.1 0.1 Latin America and the Caribbean 0.4 0.8 0.7 1.3 Middle East and North Africa 1.9 3.0 4.6 7.2 South Asia 10.8 14.3 16.8 24.4 Sub-Saharan Africa 2.0 2.2 5.7 5.9 Developing world 67.2 80.3 131.6 153.5 Change in income gap ratio (percent) East Asia and the Pacific 0.36 0.43 0.78 0.93 Europe and Central Asia 0.00 0.00 0.00 0.00 Latin America and the Caribbean 0.00 0.01 0.01 0.01 Middle East and North Africa 0.03 0.06 0.09 0.15 South Asia 0.17 0.24 0.28 0.43 Sub-Saharan Africa 0.10 0.11 0.30 0.32 Developing world 0.16 0.21 0.33 0.41 Source: World Bank. 132 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S Surveys (LSMS) to identify the various income Numerically, if the landowner’s share in the generating activities of rural households.52 value of output initially is 50 percent, then the The information on total agricultural incomes percent increase in his revenues will be twice and self-employment agricultural incomes re- that of the increase in the retail price (assum- ported in RIGA is used to estimate the econo- ing all the changes in retail price are translated metric relationship between this and per- into increases in profits). capita household income and consumption, In the central scenario, all agricultural in- which was then used to impute agricultural in- comes are raised by the same amount as retail come shares in all the households included in prices. This is tantamount to assuming that the GIDD (De Hoyos and Medvedev 2008).53 wages, self-employed profits, and other costs If the short-term price increase benefits all rise by the same proportion as the increase only self-employed landowners, the increase in consumer food prices. of self-employment agricultural incomes It is also equivalent to assuming that all of should be larger than the increase in retail the increase in farm incomes accrue to prices. At the limit, if agricultural wages and landowners but that all the farm workers employment are held constant, then all of the work for poor landowners. additional income would accrue to landown- An alternative assumption is to assume that ers and none to farm workers. only landowner incomes and other incomes rise in the same proportion as consumer Mathematically, prices. This essentially assumes that none of the agricultural workers work for proper * Q1 ϭ ⌸1 * SE ϩ W1 * E ϩ other costs, c P1 landowners. Under this assumption, the head- count poverty rate increases by substantially where P1c , Q are the retail price and quantity more— 153 million (see results in table 3A.1 1 consumed of good 1, respectively. ⌸1, W1 are under the label “self-employed agricultural in- remunerations of self-employed workers (in- comes affected”). cluding the return to land to self-employed The lower panel of table 3A.1 reports the landowners) and wage earners, respectively. change in the income gap ratio (Foster, Greer, Rearranging: and Thorbecke 1984)—the average difference between the per capita income of poor house- c ϭ ⌸ SE EAG other costs holds and the poverty line stated as a percent of P1 1 ϩ W1 ϩ , Q Q Q the poverty line—for the various scenarios. The differences in the income gap ratio between dif- where SE͞Q is profits share in total output. ferent scenarios confirm that larger poverty im- We denote these as alpha and those of other pacts are found when the change in relative costs as beta, giving us: prices is used as the shock and when only self- other cost employment agricultural household incomes are c ϭ ⌸ ␣ ϩ W (1 Ϫ ␣ Ϫ ␤) ϩ ␤ P1 . 1 1 Q assumed to respond to change in relative prices. Taking the total derivative while holding wages and other costs constant gives us: Notes 1. The idea that dependence on natural resources d c d may impede development dates back at least to the de- P ϭ␣ ⌸ dt dt cline of Spain, a period when it was benefiting from substantial gold inflows from the New World in the or 17th century (Landes 1999). The idea was forcefully restated by development theorists in the decades fol- d 1 d c lowing World War II (such as Prebisch 1950 and Singer ⌸ϭ P. dt ␣ dt 1950) and continues to attract attention. 133 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 2. Sachs and Warner (1995, 2001) are perhaps the largest outliers in the sample (São Tomé and Principe, most influential. See also Gylfason, Herbertsson, and whose government expenditures declined by 45 per- Zoega (1999); Leite and Weidmann (1999); Auty centage points, and Paraguay, whose export revenues (1998); and Bravo Ortega and De Gregorio (2005). rose by 37 percentage points of GDP). Gylfason (2001) finds that resource dependence is as- 9. For any given price forecast, countries with 70 or sociated with lower education levels, implying that 80 years of reserves at current production levels have a economies dependent on primary commodities have higher permanent income from the oil price rise than limited incentives to invest in human capital. Lederman countries with only 10 or 20 years of reserves at cur- and Maloney (2007) find that the Sachs and Warner re- rent production. Thus, assuming countries wish to sults are not robust to data modifications and changes smooth the revenue flow over an extended period of in estimation techniques. time, countries with large reserves relative to produc- 3. Bevan, Collier, and Gunning (1991) provide tion should spend a larger share of the current revenues case-study evidence of excessive expenditures, debt ac- than countries with smaller reserves. cumulation, and low-quality investments during com- 10. The countries of concern here are mostly oil ex- modity price booms in Sub-Saharan Africa. Cudding- porters. Based on available data, only one country ton (1989) finds that many developing countries (Zambia) relies on minerals for more than 70 percent overspent during and after the 1970s boom. of export revenues. (Botswana’s dependence on dia- 4. Manzano and Rigobon (2006), for example, find monds would be another example, except that a large that the post-boom slowdown in Latin America in the share of diamond exports are counted as processed 1980s was almost entirely explained by the debt over- goods in trade statistics.) hang accumulated during the boom period. 11. The calculation of the life span of reserves is 5. The average data presented in this section tend to subject to considerable uncertainty, given that geolo- obscure the great diversity of country experiences, be- gists are continually increasing estimates of reserves, cause both the rate of increase in government expendi- and changes in technology and in prices raise the share tures and in exports (relative to GDP) vary enor- of proven reserves that can be exploited profitably (see mously. The difference between changes in the ratio of chapter 2). exports to GDP and changes in the ratio of government 12. This calculation does not take into account the expenditures to GDP may be viewed as a rough sum- share of the increase in export revenues captured by the mary indicator of the fiscal response to primary com- government. Most of the high-reserves countries con- modity booms. In both the 1980s and the 2000s, this trol their oil resources through a state company, but difference varied by as much as 60 percent of GDP even so the government may not see the full proceeds between countries. from the increase in price. 6. Historically, the very different circumstances fac- 13. A brief discussion of this type of reduction in ing individual countries were reflected in diverse fiscal the context of the Dutch disease is given in Sachs and responses to commodity booms. For Sub-Saharan Warner (1995). See also the references they cite and Africa, see Deaton and Miller (1995); for a more geo- Torvik (2001). graphically diverse collection of countries, see Collier 14. Comparisons with the experience of the 1980s and Gunning (1994). are difficult to draw because of missing data for oil- 7. This analysis includes developing countries exporting countries. Moreover, after initially appreci- where primary commodities accounted for more than ating, the currencies of many non-oil primary 70 percent of merchandise exports. Boom periods are commodity exporters depreciated sharply in real terms defined as sequential increases in merchandise export in the 1980s in reaction to the debt crisis, so that for- revenues that average more than 10 percent a year. eign exchange was limited, despite the rise in export Thus “booms” do not represent trough-to-peak earnings. changes in prices but simply periods of rapid growth 15. On corruption, see Lane and Tornell (1999), in export revenues in countries dependent on primary Baland and Francois (2000), Torvik (2002), and Wick commodities. We report simple averages of the per- and Bulte (2006). On resource wealth and civil wars, centage point change in the ratios of exports and gov- see Collier and Hoeffler (2004). On inefficient distrib- ernment expenditures to GDP. ution of rents, see Acemoglu and Robinson (2001). 8. Because of the small number of countries in the 16. Mehlum, Moene, and Torvik (2006) provide sample for fuel exporters during the 1980s (owing to evidence that natural resource abundance has a nega- the lack of government expenditure data for many tive impact on growth only in countries with poor in- countries), these results must be treated with caution. stitutions. Murshed (2004) finds that oil and mineral The basic results for nonfuel primary commodity ex- wealth slows growth through impairing institutional porters remain robust to the exclusion of the two development. 134 D E A L I N G W I T H C H A N G I N G C O M M O D I T Y P R I C E S 17. Oil and mineral wealth can be more heavily price index (CPI) over the period January 2005–- taxed than agricultural wealth (see above) and thus December 2007. This differs from the common prac- generates more opportunities for corruption. tice in high-income countries where the numerator is 18. The relationship between government revenues the level of the overall CPI including food prices. The and expenditures has been found to be weaker in coun- definition adopted here provides a better measure of tries with national revenue funds than in countries the relative increase in food prices because food is a without such funds (Davis and others 2001; Crain and very large share of the overall CPI in most develop- Devlin 2003). Analysis of 15 oil-dependent economies ing countries. Were the more usual measure to be em- over 30 years indicates that national revenue funds are ployed, the real price increases would be seriously associated with reduced volatility of broad money and underestimated. prices, but the relationship with real exchange volatil- 29. For details on this and other reported simula- ity is weak (Shabsigh and Ilahi 2007). tions, see De Hoyos and Medvedev (2008). 19. In countries with strong political institutions (as 30. Despite a very different methodology and a measured by the existence of effective checks and bal- much smaller sample set, Ivanic and Martin (2008) ances in decision making), government consumption is arrive at a similar figure—105 million. unrelated to changes in oil revenues (that is, it is not 31. In part, this reflects the influence of higher oil procyclical), but in countries with weak institutions, prices on nonfood prices—-the numeraire used for cal- government consumption is strongly related to oil rev- culating real food price increases. Unfortunately, too enues (Humphreys and Standbu 2004). few countries had information on the actual impact of 20. Such deals are, by no means a new phenome- high fuel prices on the consumer price index to use a non. Firms from high-income countries have entered nonfood non-oil index to deflate the increase in food into such contracts for several decades. prices. 21. Factors such as delivery specifications, contract 32. An analysis of Argentina suggests that a 10 per- liquidity, particular industry structures in various cent increase in prices will increase output by 3.6, 7.1, countries, and transportation differences make defin- and 17.8 percent after 5, 10, and 20 years respectively ing standardized contracts more difficult. (Cavallo 1988), a result that is consistent with Bin- 22. “Indian Fuel Prices, Too Hot to Touch,” Econ- swanger’s (1989) estimate that long-run effects may omist, November 29, 2007. take between 10 and 20 years to play out. 23. Estimating the impact of rising metals prices is 33. The pass-through was defined as the ratio of even more difficult, because metals tend to enter into absolute changes since December 2003 in the retail the consumption basket of households only indirectly price of fuel and the local currency price of the relevant in the form of manufactured goods. fuel import product. 24. The GIDD data set consists of 73 recent house- 34. Many countries subsidize kerosene, which is hold surveys for low- and middle-income countries used for lighting and cooking fuel by the poor, and complemented with more aggregate information on in- unlike gasoline and diesel, whose retail prices rose come distributions for 25 high-income and 22 devel- by more than the international price in 2007, the oping countries, together representing 90 percent of median increase in domestic kerosene prices was only the world’s population. 85 percent of the international price increase (Mati 25. According to household surveys in Africa, the 2008). relationship between food shares and per capita house- 35. “Indian Fuel Prices, Too Hot to Touch.” Econ- hold incomes is concave, that is, for very low levels of omist, November 29, 2007. income, food shares accelerate as the households be- 36. For example, diesel is kept artificially cheap by come richer. The household surveys indicate that in ex- preventing state oil companies from raising prices; in tremely poor households, consumption items such as return these companies issue oil bonds that the govern- wood or kerosene are incompressible. ment guarantees. 26. The cost is estimated as the change in the 37. Export bans are not new (the United States im- poverty deficit (Atkinson 1987), that is, the variation posed one on soybeans in the 1970s and the European in financial resources required to eliminate poverty Union banned wheat exports in 1995), but their use under a perfect targeting scenario. has become more common. 27. This share assumes the same poverty line for 38. India’s ban was later replaced by a minimum rural and urban areas. Ravallion, Chen, and Sangrula export price, which was then replaced by another com- (2007) use a higher poverty line for urban areas and plete ban on exports. Other factors also contributed to show that the rural share of poverty is 75 percent. the increase in international rice prices, including the 28. Real price increases are calculated as the total thinness of the international rice market and a simulta- increase in the ratio of the food and nonfood consumer neous decision by consuming countries to increase 135 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 demand to build stockpiles. Increased government-to- 10 percent in developing countries, respectively, could government rice sales, which are not subject to the ban, yield gains in developing countries of $315 billion over have reduced its effectiveness. 10 years along with gains of $170 billion for rich coun- 39. Reacting to its inability to secure imports of rice tries (World Bank 2004). in early 2007, the Philippines recently passed policies 51. The difference would stem from transport, mer- aimed at achieving rice self-sufficiency. chandising, and other costs. 40. Although the supply of a single crop may re- 52. For more details on the LSMS household surveys spond quickly to an increase in prices, supply is nor- see http://www.worldbank.org/LSMS/. For a complete mally achieved through crop switching. description of the RIGA project, including publication 41. Binswanger (1989) estimates the long-term of the first results, see Carletto and others (2007). price elasticity of supply to be approximately 0.2. 53. Notice that given the data restrictions, all rural 42. Self-targeted programs are designed to mini- households are assumed to have positive agricultural mize the incentives the nonpoor may have to partici- and self-employment agricultural income shares, and pate, typically achieved through a mix of rationing therefore a good part of the distribution story behind benefits (such as limiting food quantities), imposing higher food prices is lost. physical requirements (such as manual work for food), and limiting the subsidies to inferior commodities. 43. For example, delivery of emergency food aid provided under U.S. Title II takes five months, on av- References erage (CARE 2006). Acemoglu, Daron, and James A. Robinson. 2001. “In- 44. This discussions is based on “Strengthening the efficient Redistribution.” American Political Sci- World Food Program’s Role in Humanitarian Food ence Review 95: 649. Assistance,” a note prepared by World Bank staff. Aghion, P., G. M. Angeletos, A. 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China registered a dimin- Recent Developments ished 9.4 percent advance, down from 11.9 S ubstantial headwinds buffeted the economies of East Asia and the Pacific during 2008, causing GDP growth to slow sharply, from the percent during 2007, on a slowdown in in- vestment and smaller positive contributions to growth from net exports. The larger members 10.5 percent pace of 2007 to 8.5 percent in of the Association of South Eastern Asian the year. The surge and relapse of crude oil Nations (ASEAN)—Indonesia, Malaysia, and and non-energy commodity prices affected a Thailand—grew 5.2 percent in the year, down large and diverse set of countries in the region, from 6.1 percent during 2007. Growth in from the hydrocarbon-exporting countries of Vietnam dropped by 2 full percentage points Indonesia, Malaysia, Papua New Guinea, and to 6.5, in part as oil and non-energy com- Vietnam, to food and agricultural raw materi- modities prices slumped, while a group of als exporters, Thailand, the Philippines, and smaller economies saw a pick-up in growth to again Indonesia and Malaysia. The fall to 5.1 percent from 3.7 percent, on the back of negative ground in U.S. and Japanese import recovery in Fiji and continued strong growth demand—under way for more than two years in Papua New Guinea, powered by oil exports in the case of the United States—began to take (table A1). a toll on the region’s export growth and to Even before the financial crisis intensified, dampen the earlier buoyancy of intra-region there were signs of slowing growth. In China, trade.1 GDP in the third quarter of 2008 eased to a What began in August 2007 as financial dif- gain of 9 percent (year-over-year) from 11.2 ficulties in the United States tied to subprime percent in the final quarter of 2007, marking a mortgage-based securities had turned into a fifth consecutive quarter of slowing growth global financial crisis as of October 2008, rais- (figure A1). Thailand and Malaysia witnessed ing risk perceptions for several economies in a larger falloff, with Thailand dropping to 2.9 East Asia. Equity markets were hard hit, percent in the second quarter from 7.1 (saar) in spreads on international sovereign- and espe- the fourth quarter of 2007, and Malaysia cially corporate debt increased sharply, ex- falling to 4.2 percent from 6.7 percent, on change rates depreciated rapidly, and gross softer exports and private consumption. In capital flows to the region fell by half during contrast, growth in Indonesia accelerated, the first 9 months of 2008. Slower investment boosted by public spending financed from in- growth in East Asia is now expected to spill creases in windfall revenues thanks to high over into still weaker production, employ- prices for hydrocarbons, fats, and oils. ment, household spending, and GDP growth. 141 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table A1 East Asia and Pacific forecast summary (annual percent change unless indicated otherwise) 1991–2000a 2005 2006 2007 2008e 2009f 2010f GDP at market prices (2000 US$)b 8.4 9.1 10.1 10.5 8.5 6.7 7.8 GDP per capita (units in US$) 7.1 8.2 9.2 9.7 7.6 5.9 7.0 PPP GDPc — 9.1 10.0 10.5 8.4 6.7 7.8 Private consumption 7.3 7.5 2.6 3.4 5.6 6.7 7.9 Public consumption 9.0 10.9 9.5 11.8 13.0 13.4 10.4 Fixed investment 10.3 12.6 12.6 12.9 10.5 6.9 8.4 Exports, GNFSd 11.7 18.5 18.6 15.4 8.3 2.6 9.7 Imports, GNFSd 11.2 11.0 11.6 10.9 10.8 3.4 11.7 Net exports, contribution to growth 0.3 4.1 4.6 3.8 0.2 0.0 0.5 Current account balance/GDP (%) 0.1 5.8 8.6 10.5 9.0 8.7 7.7 GDP deflator (median, LCU) 6.7 6.5 5.8 4.0 7.5 6.6 4.9 Fiscal balance/GDP (%) Ϫ0.7 Ϫ1.1 Ϫ0.6 0.2 Ϫ0.9 Ϫ1.4 Ϫ1.5 Memo items: GDP East Asia excluding China 4.8 5.4 5.7 6.2 5.3 4.0 5.3 China 10.4 10.4 11.6 11.9 9.4 7.5 8.5 Indonesia 4.2 5.7 5.5 6.3 6.0 4.4 6.0 Thailand 4.5 4.5 5.1 4.8 4.6 3.6 5.0 Source: World Bank. Notes: — ϭ not available. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 U.S. dollars. c. GDP measured at PPP exchange rates. d. Exports and imports of goods and nonfactor services. e. Estimate. f. Forecast. umes are expected to decline from 8.3 percent Figure A1 GDP growth eases in several East in 2008 to 2.6 percent; investment to ease to Asian economies 7 percent (still relatively strong due to devel- GDP growth (percentage change, saar) opments in China), and net trade to contribute 12 no impetus to regional growth for the first 10 time in some years. 8 Commodity prices plummet; 6 export-market growth contracts East Asia (excluding China), along with the 4 Latin America region, has benefitted from high 2 food and fuel prices from 2005 through mid- Chinaa Thailand Malaysia Indonesia 2008. During this period, terms of trade Q4, 2007 Q1, 2008 Q2, 2008 Q3, 2008 improved by a cumulative 10.3 percent in Viet- nam, 4 percent in Indonesia, and 4.8 percent in Source: World Bank and national agencies. Malaysia. In contrast, the terms of trade a. China ϭ year-on-year. moved against China by a substantial 11.4 per- cent, with little effect, however, on the current Regional GDP is projected to slow to 6.7 account surplus. The steep decline in commod- percent in 2009, the weakest since the dot.com ity prices since mid-2008 should benefit China recession of 2001, and prior to that, the East and other oil importers in the region, helping Asia crisis of 1997–98. Regional export vol- to improve East Asia’s aggregate terms of trade 142 R E G I O N A L E C O N O M I C P R O S P E C T S by 3.5 percent in 2009, with China’s picking in demand for high-tech products. Export up 5.5 percent. growth is also slowing in Malaysia and Thai- Sharply higher food and fuel prices and land, which are experiencing sluggish manu- overheating in several economies accelerated factures shipments as well as the effects of inflation in the region, from a median 5.7 per- commodity price declines on the dollar value cent increase during 2007 to 11.9 percent by of oil and agricultural exports. As recession July 2008 (year-over-year). September figures deepens across the countries of the Organisa- (8.2 percent) suggest that favorable inflation tion for Economic Co-operation and Devel- responses are coming in step with the falloff in opment (OECD) during the course of 2009, commodity prices and improved terms of East Asian export volumes are likely to fall trade since mid-2008. Headline consumer sharply—to negative territory for many price inflation has eased substantially in countries—with China seeing a modest ad- China, for example, from a peak of 8.5 per- vance of some 4.2 percent, down from the cent in April to 4 percent by October 2008; 10.1 percent gain of 2008. but Indonesia and the Philippines continue to witness building price pressures, stoked in the Ripples of the financial crisis are former by still strong consumer demand. reaching East Asia The spread of technical recession from the The region was spared significant fallout dur- United States to Japan and the Euro Area dur- ing the early stages of the financial crisis in ing the second half of 2008 has begun to make 2007, because, outside of China, holdings of a dent in export performance for the region, securities backed by subprime U.S. mortgages with China’s outbound shipments (in dollar were quite small. But with the intensification terms) easing below 20 percent growth (year- of the crisis, effects within the region are over-year) in October from the 30 percent pace spreading. A sharp increase in risk aversion at of early 2007 (figure A2). Growth of exports the global level, plus a process of deleveraging from Hong Kong, China, reflecting in large by firms and banks that have suffered large part transshipments from the mainland, have losses in both high-income and developing halved to 5 percent. And the falloff in export countries, resulted in a heavy sell-off of global, performance is particularly acute in Singapore including East Asian, equities. The benchmark and Taiwan, China, where exports are now de- MSCI Asia-Pacific Index plummeted by a cu- clining, affected in particular by a sharp drop mulative 50 percent from January through October 2008, while China’s ‘B’ share market in Shanghai is off a full 75 percent. The pro- Figure A2 Export growth in East Asia turns down on falling OECD demand ceeds of these sales have been converted out of local currencies, resulting in a sharp deprecia- Export values (US$, percentage change, 3-month moving average year-on-year) tion for many regional currencies against both 35 the dollar and the yen (figure A3). The Philip- China 30 pine peso, for example, has given up some Thailand 18 percent against the dollar over 2008 to 25 date and 30 percent versus the yen. These de- 20 velopments have sharply increased the cost of 15 capital for regional firms and escalated the 10 local currency cost of international debt ser- 5 Malaysia Hong Kong, vicing, both factors likely to dampen private China 0 investment outlays in the coming months. Jan. May Sep. Jan. May Sep. 2007 2007 2007 2008 2008 2008 In international debt markets, sovereign Source: Haver Analytics. spreads for East Asia jumped by some 610 basis points since the spring of 2008, reaching 143 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Figure A3 Exchange rates decline sharply Figure A4 Gross capital inflows to East Asia as carry trades unwind contracted 40 percent in 2008 Local currency unit/US$ index (Jan. 01, 2008 ϭ 100) US$ billions 120 60 Philippine peso 50 110 Malaysian ringgit 40 100 30 90 20 Japanese yen Thai baht 10 80 Jan. 1 Mar. 1 May 1 Jul. 1 Sep. 1 Nov. 1 0 2008 2008 2008 2008 2008 2008 Bond issuance Equity issuance Bank borrowing Source: Thomson/Datastream. Note: Increase implies weaker local currency. Jan.–Aug. 2007 Jan.–Aug. 2008 Source: World Bank. 825 basis points as of late October, well above the high of 450 basis points at the peak of the East Asian crisis in 1998. But as conditions in the same period in 2007. The bulk of the international markets began to unfreeze, and falloff may be traced to sharp contractions in more and more countries announced fiscal the issuance of initial public equity offerings stimulus packages to underpin their (IPOs), largely from China, which were off economies, spreads narrowed once more to 65 percent, from $56 billion to $19 billion in 560 basis points during the first week of No- the year, in line with the deterioration of con- vember. As of November 7, 2008, spreads ditions in international markets. But banking were up by a modest 50 basis points for flows also dropped 12.5 percent to $35 bil- China, 300 points for Malaysia, 250 points in lion, and bond issuance eased by 7.5 percent the Philippines, but a more-substantial 570 to $7 billion (figure A4). points in Indonesia. Spreads for corporate bor- In contrast, FDI flows to the region surged rowers have increased by far more, and those by some two-thirds to a fresh record $175 bil- for noninvestment grade corporations—the lion in 2007, with FDI to China picking up majority of private sector issuance in the 75 percent to near $140 billion, and with ad- region—have skyrocketed (see chapter 1). For vances of 40 percent in Malaysia to $8.5 bil- several countries in East Asia, the hike in lion. Estimates for 2008 suggest a modest in- spreads has become problematic, effectively crease in overall FDI flows, showing some shutting down bond issuance as a cost-effective resilience in the face of the crisis. Measured by means of finance. the extent to which sovereign spreads have Given the process of deleveraging now increased, equity markets declined and ex- under way among high-income financial insti- change rates depreciated since September 15, tutions, the retreat from regional equity mar- together with the sharp falloff in capital flows kets should be viewed together with a sub- in the last year, East Asian economies hit hard- stantial falloff in capital flows to the region est by the crisis to date include Fiji, Indonesia, over the course of 2008. Gross capital flows to the Philippines, Thailand, and Vanuatu. East Asia and the Pacific, not including for- eign direct investment (FDI), dropped from Difficult policy decisions $100 billion to $60 billion from January The general stance of policy in the region is through August 2008, down 40 percent from moving from a tightening posture—initiated 144 R E G I O N A L E C O N O M I C P R O S P E C T S to deal with rising inflation—to a more re- 5.2 percent in 2008, as export volumes decline laxed one; large efforts have been made to free by a percentage point, and the squeeze on up liquidity to support banking systems from commercial credit hits fixed investment, drop- the contagion of financial stress from the high- ping it from growth of 8.8 percent in 2008 income countries. Moreover, measures to under- to 3.6 percent. Lower commodity prices and pin growth at a time of downside risks have weaker import demand are projected to im- also come to the fore. In China, bank rates prove the group’s current account surplus to were raised to 7.47 percent in January to help $58 billion in 2009 from $55 billion in 2008. dampen inflation, then reduced to 6.66 per- Among smaller countries, including Fiji, the cent on October 28, as the risk of financial Lao People’s Democratic Republic, and Papua disruptions and loss of liquidity in the banking New Guinea, output growth is projected to system increased in importance. Further slow to 3.4 percent from 5.1 percent in 2008, actions undertaken by China to prop up eco- on the back of a sharp 5 percent decline in nomic activity have included the announce- exports. ment of a massive $586 billion stimulus pro- Recovery in regional growth during 2010 gram to focus on infrastructure, housing and is anticipated to be fairly swift. The downturn income support, and increasing export tax re- in investment should be relatively short-lived, bates. In contrast, the Philippines first reduced as credit and capital flows begin to thaw, and policy rates to 7 percent to stimulate growth, expectations for stronger domestic and exter- then raised rates in four steps of 25 basis nal demand underpins a revival in regional points to 8 percent to help stem a ramp-up in capital spending to 8.4 percent (see table A1). inflation. Export growth is expected to rebound to 9.7 percent in the region (to 10.7 percent for Medium-term outlook China), as OECD and regional demand re- As always, developments in China will play a turn to positive territory. Moreover, a moder- key role in shaping the region’s growth profile ation in East Asian inflation, as the surge in through 2010. China’s buffers against the commodity prices passes out of calculation, financial crisis are impressive: $1.6 trillion in will help to restore purchasing power to international reserves; a fiscal surplus of 1 per- households and support a renewal in spend- cent of GDP; and a current account surplus of ing. Inflation as measured by the median GDP almost $400 billion or 10.4 percent of GDP in deflator for the region is expected to decline 2008. Policy efforts to underpin exports and from 7.5 percent in 2008 to 4.9 percent by household spending—to maintain GDP 2010. growth at rates near 9 percent in 2009 and Under these conditions, aggregate GDP for forward—should carry positive effects. But an the region is anticipated to grow 7.8 percent in extreme falloff in export volume growth to 2010, underpinned by 8.5 percent growth in 4.2 percent, on the back of recession in high- China. For East Asia excluding China, GDP is income countries, and slippage in investment expected to grow 5.3 percent in 2010, up from to 8 percent in the year is projected to slow 4 percent. Current account positions are pro- GDP growth to 7.5 percent in 2009, from the jected to vary across countries, easing to 9.4 percent pace of 2008 (table A2). A step- 8.8 percent of GDP in China, to 4.4 percent in down in China’s import growth to 6.5 percent the larger ASEAN members to minus 5.7 per- will dampen the momentum of intraregional cent among the smaller countries of the region. trade, causing exports for East Asia in aggre- gate to slide to 2.6 percent from the 8.3 per- Risks cent advance of 2008. The favorable external environment that came Growth among the larger ASEAN coun- to benefit the region in the past five years tries is expected to ease to 3.8 percent from has shifted dramatically to the downside. Given 145 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table A2 East Asia and Pacific country forecasts (annual percent change unless indicated otherwise) 1991–2000a 2005 2006 2007 2008c 2009d 2010d Cambodia GDP at market prices (2000 US$)b — 13.5 10.8 10.2 6.7 4.9 6.0 Current account balance/GDP (%) — Ϫ5.7 Ϫ4.7 Ϫ6.0 Ϫ15.3 Ϫ11.2 Ϫ8.0 China GDP at market prices (2000 US$)b 10.4 10.4 11.6 11.9 9.4 7.5 8.5 Current account bal/GDP (%) 1.5 7.2 9.9 12.2 10.7 10.2 8.8 Fiji GDP at market prices (2000 US$)b 2.1 0.7 3.6 Ϫ6.6 1.7 Ϫ1.0 3.0 Current account bal/GDP (%) Ϫ3.7 Ϫ13.3 Ϫ24.1 Ϫ15.6 Ϫ22.6 Ϫ23.6 Ϫ22.5 Indonesia GDP at market prices (2000 US$)b 4.2 5.7 5.5 6.3 6.0 4.4 6.0 Current account bal/GDP (%) Ϫ0.4 0.1 2.9 2.6 0.8 Ϫ0.1 Ϫ0.4 Lao PDR GDP at market prices (2000 US$)b 6.3 7.1 8.1 7.9 6.8 4.5 7.5 Current account bal/GDP (%) Ϫ12.5 Ϫ19.3 Ϫ9.7 Ϫ16.4 Ϫ16.0 Ϫ17.2 Ϫ16.8 Malaysia GDP at market prices (2000 US$)b 7.1 5.0 5.8 6.4 5.5 3.7 4.6 Current account bal/GDP (%) Ϫ0.4 14.6 17.2 16.7 22.0 17.5 16.4 Papua New Guinea GDP at market prices (2000 US$)b 4.8 3.3 2.6 6.2 5.5 4.5 5.5 Current account bal/GDP (%) 2.4 8.5 17.5 21.6 24.1 9.8 7.7 Philippines GDP at market prices (2000 US$)b 3.0 4.9 5.4 7.2 4.0 3.0 4.1 Current account bal/GDP (%) Ϫ3.1 2.0 4.0 4.1 0.4 3.6 3.5 Thailand GDP at market prices (2000 US$)b 4.5 4.5 5.1 4.8 4.6 3.6 5.0 Current account bal/GDP (%) Ϫ1.2 Ϫ4.3 1.1 6.3 2.2 5.2 5.0 Vanuatu GDP at market prices (2000 US$)b 4.1 6.5 7.2 5.0 4.5 3.0 5.2 Current account bal/GDP (%) Ϫ8.2 Ϫ14.3 Ϫ8.1 Ϫ9.8 Ϫ14.4 Ϫ7.1 Ϫ5.3 Vietnam GDP at market prices (2000 US$)b 7.6 8.4 8.2 8.5 6.5 6.5 7.5 Current account bal/GDP (%) Ϫ5.1 0.2 1.2 Ϫ0.2 Ϫ8.5 Ϫ3.4 Ϫ2.6 Source: World Bank. Note: — ϭ not available. Growth and current account figures presented here are World Bank projections and may differ from targets contained in other World Bank documents. American Samoa; Micronesia; Federated States of Kiribati; Marshall Islands; Myanmar; Mongolia; N. Mariana Islands; Palau; Korea, Dem. Rep. Of; Solomon Islands; Timor-Leste; and Tonga are not forecast because of data limitations. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 U.S. dollars. c. Estimate. d. Forecast. the sensitivity of regional GDP growth to adverse developments in financial markets. trade, the possibility of a more extended pe- Should sovereign and especially corporate riod of recession, or only sluggish activity spreads not retreat from current levels, the among the OECD countries, represents one of region could face difficulty financing new in- the primary risks to growth in East Asia. Such vestment and sustaining current projects. As a a scenario would be predicated on a more pro- result, investment activity would continue to longed period than projected for the financial be depressed and the recession deeper; in that sector in the high-income countries to redress case, the risk that a country in the region could their balance sheets and for lending to resume. suffer significant exchange rate pressure or a A second area of risk relates to continued balance of payments crisis cannot be ruled out. 146 R E G I O N A L E C O N O M I C P R O S P E C T S Europe and Central Asia disrupted Hungary’s slow recovery of domestic demand and led the country to accept an emer- Recent developments gency €15 billion Standby Arrangement with T he rapid GDP growth in Europe and Cen- tral Asia of the past 20 years, which largely reflected the enormous reform efforts under- the International Monetary Fund. Growth in Turkey eased from 4.6 percent to 3 percent in 2008, as financial and exchange rate pressures taken by countries in the region (including picked up in the second half of the year those associated with accession to the Euro- (table A3). pean Union), eased in 2008 and is expected to GDP among the Commonwealth of Inde- give way to a sharp slowdown in 2009. The pendent States (CIS) slid from the robust 8.6 global financial crisis is expected to cut heavily percent registered in 2007—grounded in a surge into capital inflows and investment in the re- in activity across hydrocarbon exporters—to gion. Moreover, a number of countries are par- 6.4 percent in 2008, reflecting reduced in- ticularly vulnerable because of high current ac- comes as oil prices declined, and the effects of count deficits that in many instances have been the banking crisis in Russia (growth in Russia reliant on short-term capital inflows for their eased from 8.1 percent to 6.0 percent). Exclud- financing. ing Russia and Kazakhstan (where growth Regional GDP growth fell almost 2 per- slowed sharply from 8.5 to 4 percent), GDP centage points to 5.3 percent in 2008, moder- declined less dramatically in the remaining ating from 7.1 percent in 2007, tied largely to CIS states, falling from 10.4 to 8.5 percent in a sharp falloff in growth during the second the year. half of the year. The financial crisis and asso- The commodity price surge of 2006 ciated growth slowdown outside of the region through mid-2008 contributed directly to is eroding macroeconomic buffers, including high inflation across almost all countries of international reserves, and is placing banking the region. Most countries tightened mone- sectors in several countries (notably, Hungary, tary policy to stem second-round effects the Russian Federation, and Ukraine) under from the initial price hikes, while substantial severe stress. Even economies with little direct currency appreciation (against the dollar) exposure to troubled U.S. financial assets are helped to mitigate inflation pressures to a likely to be hit hard by direct and indirect degree. Romania posted the highest interest spillover effects from the financial crisis. rates in the European Union, while Turkey scored the highest across all developing and The region exhibits diverse performance advanced economies in Europe. The global GDP growth slowed across the region during food crisis had not caused the serious social 2008. The group of Central and Eastern tensions witnessed in other regions, because European countries (CEE), (including Bulgaria, almost all countries in Europe and Central Poland, Romania, and the middle-income Asia have more or less adequate social safety Baltic states but excluding Turkey), saw nets in place. The World Bank is currently growth ease from 6.6 percent to 5.5 percent in helping to finance seed purchases and nutri- the year. Slowing demand in the Euro Area tional programs for the Kyrgyz Republic, dampened export performance, while over- Moldova, and Tajikistan. And with three heating in several countries required a mix of major grain exporters (Kazakhstan, Russia, fiscal and monetary tightening to stem infla- and Ukraine) relaxing previously imposed tionary pressures. Growth in the Baltic states export bans amid the region’s best harvest in has come close to a standstill, with Estonia a decade, food prices are expected to moder- and Latvia falling into recession and Lithuania ate, helping to ease the earlier jump in head- faring little better. The global financial crisis line inflation. 147 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table A3 Europe and Central Asia forecast summary (annual percent change unless indicated otherwise) 1991–2000a 2005 2006 2007 2008e 2009f 2010f GDP at market prices (2000 US$)b Ϫ1.1 6.4 7.5 7.1 5.3 2.7 5.0 GDP per capita (units in US$) Ϫ1.3 6.3 7.4 7.0 5.3 2.7 5.0 PPP GDPc Ϫ1.2 6.3 7.7 7.4 5.7 2.6 5.1 Private consumption 0.6 7.0 8.2 8.5 8.4 5.3 6.2 Public consumption 0.0 3.6 5.2 5.5 4.9 3.3 4.0 Fixed investment Ϫ7.0 11.0 14.9 15.4 10.0 Ϫ0.7 7.2 Exports, GNFSd 0.3 5.6 8.0 7.8 9.4 5.4 10.1 Imports, GNFSd Ϫ2.8 10.6 15.5 18.8 14.7 6.3 11.0 Net exports, contribution to growth 1.1 Ϫ2.0 Ϫ3.4 Ϫ5.5 Ϫ3.6 Ϫ1.2 Ϫ1.8 Current account balance/GDP (%) Ϫ0.7 2.6 1.5 Ϫ0.6 Ϫ0.8 Ϫ4.1 Ϫ4.5 GDP deflator (median, LCU) — 6.8 5.8 7.5 10.9 8.9 6.8 Fiscal balance/GDP (%) Ϫ5.0 2.6 2.9 2.4 1.9 1.1 1.1 Memo items: GDP Transition countries 2.3 6.1 6.7 5.7 4.4 2.6 4.8 Central and Eastern Europe 1.4 4.3 6.6 6.6 5.5 3.2 4.7 Commonwealth of Independent States Ϫ4.3 6.8 8.4 8.6 6.4 2.9 5.2 Russian Federation Ϫ3.9 6.4 7.4 8.1 6.0 3.0 5.0 Turkey 3.7 8.4 6.9 4.6 3.0 1.7 4.9 Poland 3.8 3.6 6.2 6.6 5.4 4.0 4.7 Source: World Bank. Note: — ϭ not available. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 U.S. dollars. c. GDP measured at PPP exchange rates. d. Exports and imports of goods and nonfactor services. e. Estimate. f. Forecast. Figure A5 Deepening global financial crisis Intensification of global crisis begins affects Europe and Central Asia to exact toll Percent Basis points (inverted scale) The sudden deepening of the financial crisis in Ϫ0 0 the United States during September and Ϫ10 60 October, and the accompanying start of Ϫ20 120 deleveraging across financial institutions world- Ϫ30 180 wide, triggered a wave of sell-offs in emerging Ϫ40 240 market assets across the globe. Widening sov- Ϫ50 300 ereign spreads, sharp currency depreciation, and a halving of domestic equity prices have Ϫ60 360 tio n ne ey Bu n ia ia a ia nd been witnessed across emerging markets. The ra ia a ni tv an ar rk ai st la n de ss ua La lg Tu kr kh om Po Fe Ru th U za magnitude and extent of these developments Li R Ka in Europe and Central Asia are of concern (figure A5). % change in stock market in Sept. and Oct., 2008, local currency Recent spikes in sovereign spreads for a % change in exchange rate versus number of countries in the region have US$ in Sept. and Oct., 2008, (-) depreciation dwarfed those witnessed in earlier periods of % change in capital flows, Jan.–Aug. 2008 vs. Jan.–Aug. 2007 flare-up since the start of financial turmoil in increase in JPMorgan sovereign 2007. Except for Kazakhstan and Russia, bond spread in Sept. and Oct., 2008 (right axis) where massive central bank intervention has Source: World Bank. taken place, other regional currencies have 148 R E G I O N A L E C O N O M I C P R O S P E C T S depreciated quite sharply, reversing almost all national wealth fund to boost domestic stock the gains of the last two years. Moreover, markets directly. gross capital inflows to the region (equity As in Russia, Ukraine’s banks have relied IPOs, bond issuance, and bank lending) de- on foreign bank- and other loans to fund do- clined to $123 billion from January through mestic lending. And about $1 billion to ser- August 2008, from $187 billion in the like vice foreign debts is due during the final period of 2007, a drop of some 34 percent. months of 2008. Facing rating agencies’ These developments underscore the swift downgrades, and massive withdrawals from spread of effects from the deterioration in the banking system during the first three international financial markets and point to weeks of October (amounting to $3 billion or more difficult financing conditions ahead, about 4 percent of total deposits), the central with funding for fixed investment in the bank banned preterm withdrawals, injected region—a primary driver for growth—under further liquidity, and imposed exchange particular uncertainty. controls. On the real side of the economy, Activity in Russia already showed signs of Ukraine is starting to see decline in the metal- slowing before fall 2008, when the financial lurgy industry and in exports of these prod- crisis entered a more intense phase. Industrial ucts (which provide 40 percent of export production over the first eight months of revenues), as global production and metal 2008 declined by 2.3 points to 4.9 percent, prices cool. These negative developments have compared with the same period in 2007, and prompted Ukraine to seek an IMF loan of growth in fixed capital investment almost $16.4 billion. Turkey’s second-quarter GDP halved. Gross capital inflows did halve to deteriorated sharply to 1.9 percent year-over- $74 billion in the January–August period, year from 6.7 percent a quarter earlier. And compared with $150 billion for all of 2007. given Turkey’s traditional reliance on short- Moreover, the credit crunch appeared to be term debt and external financing, the debt draining domestic liquidity from the economy rollover situation is no better for Turkey than either directly (given that Russia is Europe’s for Russia and Ukraine; Turkey holds more third largest bank borrower) or indirectly than $280 billion of foreign debt, of which through the interbank and corporate sectors. one-sixth is short term. The Russian stock market crisis forced Based on credit-default swap prices, multiple suspensions of trading, and the gov- Kazakhstan stands second in the global ernment has taken all possible measures to league of economies as riskiest for severe mitigate growing financial and economic dif- banking disruptions—after Iceland. The gov- ficulties. These include but are not limited to ernment has $15 billion dollars ($10 billion cutting banks’ reserve requirements and oil of which from its oil fund) available to stabi- companies’ export duties several times; inject- lize the banking situation. Many other coun- ing liquidity (more than $200 billion in fed- tries in Central and Eastern Europe carry eral budget fund deposits, subordinated similar vulnerabilities in terms of banking loans, and the like), increasing coverage of re- exposures, external deficits, and reliance on tail bank deposit insurance by 75 percent; in- foreign capital flows, and governments have tervening in the foreign exchange market, ev- reacted to address them while trying to reas- idenced in a decline of more than $100 billion sure investors and depositors. In Bulgaria, in reserves between August and October; Poland, and Romania, guarantees on individ- committing an additional $50 billion of re- ual bank deposits have been raised in line serves to solve refinancing difficulties in with EU levels; Hungary, the Slovak Repub- banks and companies (estimated to hold $80 lic, and Slovenia have all enacted unlimited billion-90 billion in debt service due in 2009); government guarantees on private bank and using another $20 billion from its deposits. 149 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Medium-term outlook countries suggests the potential for a sharp The outlook for 2009 appears fairly sobering slowdown in regional GDP growth to 2.7 per- at this juncture. Slower growth in the region’s cent in 2009 from the 5.3 percent advance of main trading partners, the EU, (and for the 2008. But under assumptions that global credit CIS countries) Russia and China, will limit ex- markets begin to function once more by early port opportunities. For example, the auto fab- to mid-2009, and that growth in OECD centers rication and export–industry, which had been starts to pull-up at the same time, regional performing well in Turkey and some CEE growth is anticipated to firm to 5 percent by countries, will be put to a difficult test. De- 2010. CIS countries outside of Russia are ex- clines in equity markets will tend to raise the pected to realize a rebound in exports and a cost of capital for domestic firms and could pick-up in consumer spending, as growth re- delay privatization plans. Moreover, in coun- covers from 2.8 percent in 2009 to 5.7 percent. tries where foreign banks have a dominant And gradual revival in Euro Area demand helps presence, local subsidiaries may feel the pinch CEE exports pick-up from 2.5 percent gains in from headquarters in the high-income coun- 2009 to 7.6 percent by 2010, supporting a tries, further escalating difficulties in domestic move in GDP from 3.2 percent to 4.7 percent. credit markets and contributing to a slow- Lower oil prices will help alleviate a portion of down in economic activity. the current account burden in oil importing Table A3 shows that still-robust gains in in- countries, especially Turkey, and a large num- vestment continued during 2008—an advance ber of Central European countries. of 10 percent for the region; Russia gained 16 percent, other CIS countries grew capital Risks spending 14 percent, with the CEE countries up In the short term, the financial system will be 10.5 percent. But a flattening in domestic and tested. In Russia, for example, the largest foreign demand and much more difficult fi- banks have enjoyed generous government sup- nancing conditions are expected to cause real port, but private and smaller banks may face investment to stagnate in 2009, with related de- liquidity shortages and possibly large-scale clines in orders, production, and employment. withdrawals should the situation worsen. Signs of the slowdown have already begun Russia currently is home to 1,100 banks, of to emerge. In Russia, for example, Sberbank which the 20 largest account for 70 percent of and Gazprom, the leading state bank and state household deposits and corporate loans. Out- company, both plan to cut back on workforce side Russia, the financial sector in a number of and investment; the third-largest steelmaker, countries is dominated by banks from Western Magnitogorsk, is reducing workforce levels by Europe, carrying the potential risk of conta- 3,000; truck manufacturer KamAZ plans to gion from difficulties being experienced by curtail production by 20 percent; and car- their home-country institutions. maker GAZ also foresees substantially less do- In the medium-term, divergent perfor- mestic and export demand. Russia’s GDP is mance in 2008 should not belie either the anticipated to drop to 3 percent in 2009, from common factors underlying growth in Europe the 6 percent pace of 2008 (table A4). How- and Central Asia or the associated common ever, financial support policies enacted to date, risks. Recent growth has been supported by plus the substantial amount of international domestic demand and enabled by easy access reserves held by the country, should help Rus- to external financing in bank lending, bond sia weather the depth of global crisis in 2009 issuance, and FDI, while net exports continue and rebound to growth of 5 percent by 2010.2 to offer a substantial drag on growth. Rapid Deterioration in the external environment— credit expansion and accommodative wage and the fragile set of current conditions in a policies have been widespread, while domestic large number of European and Central Asian saving is insufficient, while pro-cyclical fiscal 150 R E G I O N A L E C O N O M I C P R O S P E C T S Table A4 Europe and Central Asia country forecasts (annual percent change unless indicated otherwise) 1991–2000a 2005 2006 2007 2008c 2009d 2010d Albania GDP at market prices (2000 US$)b 1.4 5.5 5.0 6.0 6.0 5.0 5.5 Current account balance/GDP (%) Ϫ5.6 Ϫ6.8 Ϫ7.3 Ϫ10.0 Ϫ11.2 Ϫ5.3 Ϫ4.7 Armenia GDP at market prices (2000 US$)b Ϫ3.8 13.9 13.3 13.7 9.0 6.4 6.7 Current account balance/GDP (%) Ϫ12.0 Ϫ1.1 Ϫ1.8 Ϫ6.2 Ϫ7.6 Ϫ4.3 Ϫ4.3 Azerbaijan GDP at market prices (2000 US$)b Ϫ5.2 26.2 34.5 25.0 17.7 10.4 7.8 Current account balance/GDP (%) Ϫ15.8 1.3 17.7 30.7 41.6 30.7 28.4 Belarus GDP at market prices (2000 US$)b Ϫ1.2 9.4 9.9 8.2 9.2 5.0 5.8 Current account balance/GDP (%) — 1.4 Ϫ4.1 Ϫ6.4 Ϫ5.5 Ϫ6.2 Ϫ6.4 Bulgaria GDP at market prices (2000 US$)b Ϫ1.7 6.2 6.3 6.2 6.0 2.4 6.0 Current account balance/GDP (%) Ϫ2.3 Ϫ12.3 Ϫ15.7 Ϫ21.6 Ϫ24.3 Ϫ15.6 Ϫ13.6 Croatia GDP at market prices (2000 US$)b Ϫ1.5 4.3 4.8 5.6 3.5 2.3 5.1 Current account balance/GDP (%) 1.0 Ϫ6.6 Ϫ7.6 Ϫ8.6 Ϫ9.9 Ϫ4.2 Ϫ3.2 Georgia GDP at market prices (2000 US$)b Ϫ9.3 9.6 9.4 12.4 3.5 4.0 6.0 Current account balance/GDP (%) — Ϫ11.9 Ϫ16.2 Ϫ21.5 Ϫ21.9 Ϫ20.7 Ϫ22.0 Kazakhstan GDP at market prices (2000 US$)b Ϫ3.6 9.7 10.7 8.5 4.0 1.9 6.2 Current account balance/GDP (%) Ϫ2.1 Ϫ1.9 Ϫ2.2 Ϫ6.9 0.1 Ϫ7.0 Ϫ7.2 Kyrgyz Republic GDP at market prices (2000 US$)b Ϫ4.0 Ϫ0.2 2.7 8.2 6.6 4.2 5.6 Current account balance/GDP (%) Ϫ10.6 Ϫ2.4 Ϫ10.6 Ϫ7.2 Ϫ10.6 Ϫ5.6 Ϫ2.4 Lithuania GDP at market prices (2000 US$)b Ϫ3.3 7.9 7.7 8.8 4.0 Ϫ0.3 2.0 Current account balance/GDP (%) Ϫ5.8 Ϫ7.1 Ϫ10.7 Ϫ13.6 Ϫ13.9 Ϫ12.2 Ϫ10.9 Latvia GDP at market prices (2000 US$)b Ϫ2.8 10.6 12.2 10.3 Ϫ0.8 Ϫ3.5 0.7 Current account balance/GDP (%) Ϫ1.6 Ϫ12.4 Ϫ22.7 Ϫ22.8 Ϫ15.2 Ϫ10.5 Ϫ8.2 Moldova GDP at market prices (2000 US$)b Ϫ9.8 7.5 4.0 3.0 6.5 4.0 4.0 Current account balance/GDP (%) — Ϫ8.3 Ϫ11.5 Ϫ15.8 Ϫ17.7 Ϫ4.4 Ϫ5.8 Macedonia, FYR GDP at market prices (2000 US$)b Ϫ0.9 4.1 3.0 5.1 5.5 4.8 5.6 Current account balance/GDP (%) — Ϫ1.4 Ϫ0.4 Ϫ3.4 Ϫ9.8 Ϫ4.4 Ϫ3.5 Poland GDP at market prices (2000 US$)b 3.8 3.6 6.2 6.6 5.4 4.0 4.7 Current account balance/GDP (%) Ϫ3.5 Ϫ1.2 Ϫ2.7 Ϫ3.8 Ϫ5.4 Ϫ6.2 Ϫ5.6 Romania GDP at market prices (2000 US$)b Ϫ1.7 4.1 7.9 6.0 8.6 3.2 5.8 Current account balance/GDP (%) Ϫ4.8 Ϫ8.7 Ϫ10.5 Ϫ13.7 Ϫ15.5 Ϫ8.6 Ϫ7.4 Russian Federation GDP at market prices (2000 US$)b Ϫ3.9 6.4 7.4 8.1 6.0 3.0 5.0 Current account balance/GDP (%) — 11.1 9.6 6.1 6.0 Ϫ3.4 Ϫ5.0 Turkey GDP at market prices (2000 US$)b 3.7 8.4 6.9 4.6 3.0 1.7 4.9 Current account balance/GDP (%) Ϫ1.1 Ϫ4.7 Ϫ6.0 Ϫ5.7 Ϫ8.4 Ϫ3.9 Ϫ3.1 (continued) 151 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table A4 (continued ) (annual percent change unless indicated otherwise) 1991–2000a 2005 2006 2007 2008c 2009d 2010d Ukraine GDP at market prices (2000 US$)b Ϫ8.0 2.7 7.9 7.7 6.0 Ϫ3.0 4.4 Current account balance/GDP (%) — 2.9 Ϫ1.5 Ϫ4.2 Ϫ6.5 Ϫ2.2 Ϫ1.3 Uzbekistan GDP at market prices (2000 US$)b Ϫ0.2 7.0 7.3 9.5 8.0 7.0 6.5 Current account balance/GDP (%) Ϫ0.9 13.1 14.3 18.8 20.6 14.7 13.1 Source: World Bank. Note: — ϭ not available. Growth and Current Account figures presented here are World Bank projections and may differ from targets contained in other Bank documents. Bosnia and Herzegovina, Montenegro, Serbia, Tajikistan, Turkmenistan, and Yugoslavia are not forecast because of data limitations. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 U.S. dollars. c. Estimate. d. Forecast. policy is underway in a number of countries, such as Belarus, Romania, Russia and Ukraine. Figure A6 Core inflation is rising in several countries of Europe and Central Asia The potential for second-round inflation effects remains a problem in the region. The CPI inflation (percentage change, year-on-year) 16 reversal in commodity prices since mid-2008 has been reflected in a flattening or decline in 12 inflation trends in at least 12 countries amid some indications of a falloff in core inflation 8 (figure A6).3 However, because domestic fac- tors such as government spending and strong 4 wage growth also drive prices, inflation ex- pectations remain high, and the potential for 0 Jan. May Sep. Jan. May Sep. Jan. May Sep. a wage spiral is notable. Moreover, recent 2006 2006 2006 2007 2007 2007 2008 2008 2008 sharp currency declines and loosening of monetary policy, together with other aggres- Croatia Kazakhstan Latvia Poland Lithuania Turkey sive measures to resist the economic down- Russian Belarus turn, may drive up inflation and endanger Federation fiscal positions, causing problems in the Source: World Bank. longer run. For many small and poorer countries that rely on remittances as an important source of financing, a downturn in neighboring coun- Beyond the set of immediate challenges, a tries in Western Europe and the CIS implies longer-term concern is the set of substantial less in remittance flows from migrants bottlenecks to growth that have been reached abroad, raising the need for financing from in infrastructure and labor markets in devel- other sources and potentially exacerbating oping countries in general, and in a large num- poverty. This said, historical evidence shows ber of European and Central Asian countries remittances tend to be relatively resilient dur- in particular. Faster GDP growth in the future ing a downturn, and should help cushion the is likely only if countries can take the neces- slowdown. sary steps to improve the supply of essential 152 R E G I O N A L E C O N O M I C P R O S P E C T S utilities and upgrade transport, communica- tions, and other key infrastructure. Such im- Figure A7 Contributions to GDP growth in Latin America and the Caribbean provement, together with a diminishing of in- Percentage points stitutional and structural inefficiencies could 8 help alleviate current constraints on growth in the longer run. 6 GDP 4 Latin America and 2 the Caribbean 0 Recent developments Ϫ2 T he global financial crisis has come to affect Latin America and the Caribbean after a period of exceptional GDP growth. The region Ϫ4 92 93 94 00 01 02 03 04 05 06 07 08 19 19 19 20 20 20 20 20 20 20 20 20 grew at an annual rate of 5.3 percent over 2004–08, the strongest pace in the last three Net exports Private consumption decades. GDP gains were led by República Investments Government consumption Bolivariana de Venezuela, which advanced at a Source: World Bank. 10.5 percent clip; Argentina at 8.4 percent; and Peru at 7.4 percent. Growth was also broad-based during this period, with the Caribbean countries gaining 5.9 percent annu- health than it was five years ago, or at the end ally and Central American countries growing of the previous growth spurt. But this healthy 3.7 percent. The oil-exporting economies of starting position will be seriously tested by the the region saw GDP pick up at a 5.7 percent global crisis, which has already led to a with- rate, and oil importers also grew briskly at drawal of funds from regional equity markets 5.3 percent. Only two countries grew slower by international investors, sharply depreciat- than 3 percent per year over the period— ing currencies and soaring sovereign- and cor- Jamaica at 1.6 percent and Haiti at 1.4 per- porate bond spreads. The U.S. and European cent. The last period of strong region-wide recessions and the turnaround to decline in growth occurred in 1991–94 when GDP ad- global commodity prices further darken the vanced 4.2 percent annually (figure A7). external environment for the region. A favorable external environment of high During 2008, Latin American GDP ad- commodity prices and strong import demand vanced 4.4 percent, still robust, albeit down in high-income countries supported the re- from the strong 5.7 percent pace of the previ- gion’s recent growth performance. The role of ous year. Buffers in the form of large levels of the external environment is emphasized in reserves and current account surpluses miti- Izquierdo and others 2008; Calvo and Talvi gated the impact of slowing exports to the 2007; and Österholm and Zettelmeyer 2007. United States to a degree. Latin America’s ex- However, the region has also made genuine ports lost momentum, however, growing only progress in maintaining independent mone- 1.7 percent in 2008 compared with 5 percent in tary policy and increasing the credibility of 2007, while the region’s current account posi- central banks, introducing exchange rate flex- tion dropped from a surplus of 0.5 percent of ibility, deepening local currency debt markets, GDP to a deficit of the same magnitude. and providing supportive fiscal policy (World Output gains were quite differentiated Bank 2008c). Because of the improvements in across key countries and sub regions in Latin policy and in the external environment, the re- America and the Caribbean. The outright gion is in better macroeconomic and fiscal decline in U.S. imports adversely affected 153 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Mexico’s exports, sending them from growth 3.6 percent, largely because of a downshift in of 3.3 percent in 2007 to contraction of exports tied to the slowdown in U.S. demand 0.9 percent in 2008, and contributing to a (table A5). slowdown in GDP growth from 3.2 percent to Although not yet visible in GDP figures, a 2 percent over the period. Argentina’s growth large number of countries in the region are al- performance also slipped, from 8.7 percent in ready subject to adverse spillover effects of the 2007 to 6.6 percent in 2008, on the back of financial crisis. Between September 15, when slowing consumer spending and exports. In Lehman Brothers announced bankruptcy, and contrast, Brazil maintained GDP gains at a the end of October, equity markets lost half of still-robust 5.2 percent pace, with its economy their dollar values; currencies, especially those grounded in stronger consumer outlays and of Brazil, Chile, and Mexico depreciated pre- investment, further supported by favorable cipitously against the dollar; the cost of cor- terms-of-trade developments during the first porate and government borrowing on interna- half of the year. tional bond markets surged; investment GDP growth eased in the Caribbean, de- spending appeared to be slowing, and the clining from 6 percent in 2007 to 4.6 percent availability of trade finance tightened. These in 2008. The falloff was linked in part to developments have added to the region’s con- hurricane damage but also to weaker exports cerns regarding falling commodity prices (on and a negative contribution of trade to GDP. the upside of which food and oil exporters And Central American GDP slowed by more benefited greatly), slowing remittance inflows than a percentage point to 2.2 percent from and rising inflation. Table A5 Latin America and the Caribbean forecast summary (annual percent change unless indicated otherwise) 1991–2000a 2005 2006 2007 2008e 2009f 2010f GDP at market prices (2000 US$)b 3.3 4.6 5.6 5.7 4.4 2.1 4.0 GDP per capita (units in US$) 1.6 3.3 4.2 4.4 3.1 0.9 2.8 PPP GDPc 4.2 4.6 5.5 5.7 4.4 2.2 4.1 Private consumption — 5.8 6.3 6.9 5.4 3.1 4.6 Public consumption — 3.0 4.6 4.0 4.5 2.4 2.6 Fixed investment 4.7 11.3 14.6 12.2 14.6 Ϫ4.1 8.8 Exports, GNFSd 8.1 8.1 7.7 5.0 1.7 Ϫ2.1 2.4 Imports, GNFSd 10.9 11.9 14.3 11.9 12.3 Ϫ3.9 6.9 Net exports, contribution to growth Ϫ0.4 Ϫ0.8 Ϫ1.6 Ϫ1.9 Ϫ2.9 0.6 Ϫ1.4 Current account balance/GDP (%) Ϫ2.8 1.4 1.6 0.5 Ϫ0.6 Ϫ0.3 0.0 GDP deflator (median, LCU) 11.3 5.7 8.0 7.5 10.2 6.7 5.5 Fiscal balance/GDP (%) — 1.2 1.4 1.3 0.9 0.6 0.4 Memo items: GDP Latin America excluding Argentina 3.1 3.9 5.1 5.2 4.1 2.2 4.1 Central America 3.6 3.0 5.1 3.6 2.2 1.4 3.3 Caribbean 3.6 6.7 8.7 6.0 4.6 3.3 4.7 Brazil 2.5 2.9 3.8 5.4 5.2 2.8 4.6 Mexico 3.5 2.8 4.9 3.2 2.0 1.1 3.1 Argentina 4.5 9.2 8.5 8.7 6.6 1.5 4.0 Source: World Bank. Note: — ϭ not available. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 U.S. dollars. c. GDP measured at PPP exchange rates. d. Exports and imports of goods and nonfactor services. e. Estimate. f. Forecast. 154 R E G I O N A L E C O N O M I C P R O S P E C T S Credit conditions tighten, capital flows filed for bankruptcy protection in October plummet because of financing difficulties. And Contro- Sovereign spreads, as measured by JPMorgan- ladora Comercial Mexicana, a large super- Chase Emerging Market Price Index (EMBI), market chain, also filed for bankruptcy after have increased rapidly since mid-September sustaining losses from derivatives trading. throughout the region, with the largest rise As a result of falling equity markets and (over 1,000 basis points) for Argentina and repatriation of foreign funds to home curren- República Bolivariana de Venezuela (figure cies, many of the region’s currencies have A8). The corporate bond market is seeing a experienced sharp depreciation since mid- similar trend, with soaring corporate spreads. September, a situation that runs the risk of Moreover, gross capital inflows to the region reigniting inflation, even as commodity prices halved over January–August 2008 compared decline. After several years of appreciation, the with the like period in 2007. Bond issuance Brazilian real started to decline in early July dropped 46 percent to $18.5 billion; equity (figure A9). The central banks of Argentina, IPO issues virtually vanished in the hostile cli- Brazil, Chile, and Mexico sold dollars on the mate of 2008 (down 75 percent); and bank spot market during October to prevent their borrowing dropped one-third to $36 billion currencies from sliding further. Mexico offered over the year to date. direct financing to commercial banks. Brazil Tighter financing conditions and expecta- relaxed reserve requirements, eliminated taxes tions of weaker demand growth have led cor- on foreign investment, authorized state-owned porations and governments alike to review banks to buy stakes in financial institutions, investment plans. The Republic of Korea’s and allowed the central bank to enter into Hyundai, India’s Reliance, and Brazil’s Petro- currency swaps with other central banks. bras have either announced or postponed Another consequence of tightened credit decisions on investment plans in Brazil. conditions has been vanishing export credit Petroleos de Venezuela has postponed several refining projects across the Caribbean and Central America. The Mexican airline Aladia Figure A9 Exchange rates in Latin America and the Caribbean fell sharply against the dollar in late 2008 Figure A8 Bond spreads have increased Local currency unit/US$ index (Jan. 1, 2008 5 100) sharply for many Latin American countries 130 Spreads in basis points 120 700 600 1710 1475 110 500 100 400 90 300 80 200 Jan. 1 Feb. 20 Apr. 10 May 30 Jul. 19 Sep. 07 2008 2008 2008 2008 2008 2008 100 0 Argentina Brazil l le a o ru a . d a, Chile Colombia zi bi ic in hi . B uel Pe a e ex om nt Br C ge z Mexico Peru M ne ol Ar C Ve R Venezuela, R. B. de Jan. 1, 2008 Nov. 10, 2008 Source: Thomson/Datastream. Source: JPMorgan-Chase. Note: Increase = weaker local currency. 155 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 lines, which allow exporters to purchase inflation. Although Latin America has the goods and services they need to support their largest surplus in food trade of all developing export sales. Exporters now face a double hit, regions, food price inflation adversely affects with slowing import demand in high-income most of the population, because households countries on the one hand, and more expen- are net buyers of food. Poor people are also sive credit to support export operations on the affected disproportionately because they other. Anecdotal evidence from Brazil suggests spend a larger share of their income on food. that the fall of Lehman Brothers precipitated Two developments have occurred in recent a collapse in export credit in Brazil, leading months that are likely to help ease the pressure foreign investors and companies to repatriate of food inflation. Central governments across billions of dollars from Brazil. Shrinking ex- the region raised interest rates in the first half port credit could lead to difficult conditions of 2008 to stem inflationary pressures. More for businesses that supply inputs to exporters, importantly, commodity prices began to with ripple effects to the rest of the economy. plummet after reaching historically high levels in mid-2008. The latest inflation numbers Remittance inflows are slowing (September 2008) for the region were gener- Worker remittances are an important source of ally lower than their peak levels in the preced- income for many Latin American countries. The ing months (figure A10). region has sent 28.3 million workers abroad— 5.1 percent of the region’s population—who Medium-term outlook send back $60 billion, on average, to their home GDP growth in the region is expected to fall countries (World Bank 2008a). The United off sharply to 2.1 percent in 2009 from States is the primary recipient of the region’s 4.4 percent in 2008, driven by a sharp decline emigrants, followed by Spain and Italy. In eight in capital spending—from robust growth of Latin American countries, remittances account for more than 10 percent of GDP. Mexico is the largest recipient with $25 billion in receipts. But the slowdown in the U.S. housing market and Figure A10 Inflation still high in Latin America and the Caribbean despite sharp the resulting loss of construction jobs led to a falloff in food and fuel prices 4.2 percent decline in remittances to Mexico Consumer price inflation (percentage change year-on-year) over January–August 2008, compared with the 12 same period of 2007. No evidence of similar large-scale decline has yet come to light in other 9 regional economies. 6 Inflation remains high, notably in food Rapid economic growth in Latin America also 3 brought with it a ramp-up in inflation, which in 2008—abetted by the price surge for oil and 0 food traded internationally—was at its highest Jan. May Sep. Jan. May Sep. Jan. May Sep. 2006 2006 2006 2007 2007 2007 2008 2008 2008 level in a decade. Food prices rose substan- tially faster than the overall consumer price Argentina Brazil index for most countries (World Bank 2008b), Mexico Colombia Latin America Peru and fundamental changes in global food dy- & Caribbean Chile namics appear to be under way. High energy prices, climate change, and rising biofuel Source: World Bank. production have driven the rise in food price 156 R E G I O N A L E C O N O M I C P R O S P E C T S 14.6 percent in 2008 to a decline of 4 percent. the current account in 2009 and 2010 Increasing cost of capital for business, chan- (table A6). neled through falling domestic equity markets, Mexico’s close economic ties to the U.S. widening spreads on international corporate economy are expected to slow its growth bonds, and depreciating exchange rates is an- sharply in 2009. Export volume growth— ticipated to combine with expectations for a which was already in negative territory in sharp falloff in both domestic and overseas 2008—is projected to drop by 5 percent in sales growth, leading to a retrenchment in pri- 2009. Argentina will perhaps see the sharpest vate capital outlays (see table A5, earlier). growth falloff in the region as it experiences Falling investment is expected to lead to declines in export market demand, commod- similar declines in regional imports, because ity prices, and investment. Peru, Panama, and the import content of investment tends to be the Dominican Republic will also slow after quite high in Latin America. With imports de- very high growth averaging 8 percent for the clining almost 4 percent in 2009 and exports last four years. falling 2 percent, the contribution of trade to growth will shift to positive 0.6 points of growth for the first time in 20 years. But the Risks drop in investment and in export revenues With the onset of the financial crisis, skyrock- also carry multiplier effects through the re- eting costs of capital, or an outright shutdown gional economy, with real household spending in credit flows, are the primary risks faced by easing to a 3.1 pace from 5.4 percent in 2008, the region. Should sovereign and corporate and GDP growth slowing to 2.1 percent. GDP spreads not retreat from current levels, Latin could rebound fairly quickly to 4 percent America could have difficulty financing new gains by 2010, should global credit markets investment projects and sustaining current thaw, risk aversion subside, and OECD coun- projects. Although central banks worldwide tries revive on the back of renewed vigor in have undertaken steps to inject liquidity into consumer spending—in step with the antici- banking systems, a marked thawing of inter- pated remission of inflation pressures. These bank rates and revival of credit flows has yet developments represent a substantial change to be seen. from recent global forecasts prepared in June The favorable external environment that 2008, when the region was expected to grow benefited the region in the past five years has 4.3 percent in 2009 and 4.2 percent in 2010 almost vanished. Both high-income and (see Global Development Finance 2008, developing-country GDP growth is slowing, World Bank 2007d). diminishing demand for Latin America’s com- Growth in Brazil is expected to slow from modities, manufactures, and services exports. 5.2 percent in 2008 to 2.8 percent in 2009. In- Although inflation is still much higher than flation has already started to level off, in part in early 2007, increases in headline inflation as a result of the Central Bank of Brazil’s rais- appear to have peaked in July or August ing policy interest rates, amid falling com- 2008 in the seven largest economies in the re- modity prices. Consumer price inflation is ex- gion. Although inflation will likely continue pected to diminish from 6.3 percent in 2008 to to ease given declining commodity prices, a 4.8 percent in 2009. Brazil is likely to witness potential revival of inflation remains a con- its first current account deficit since 2002, tied cern, given depreciating currencies, a move to developments in the income accounts, as toward monetary accommodation (mitigat- repatriation of profits by foreign companies is ing a portion of the economic downturn), under way. However, a decline in the imports and the potential for second-round inflation of capital goods is expected to help improve effects. 157 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table A6 Latin America and the Caribbean country forecasts (annual percent change unless indicated otherwise) 1991–2000a 2005 2006 2007 2008c 2009d 2010d Argentina GDP at market prices (2000 US$)b 4.5 9.2 8.5 8.7 6.6 1.5 4.0 Current account balance/GDP (%) Ϫ3.1 2.8 3.7 3.0 0.4 Ϫ3.2 Ϫ2.3 Belize GDP at market prices (2000 US$)b 5.9 3.1 5.6 3.0 2.8 2.1 2.9 Current account balance/GDP (%) Ϫ7.3 Ϫ13.6 Ϫ1.2 Ϫ3.0 Ϫ3.7 Ϫ3.7 Ϫ1.6 Bolivia GDP at market prices (2000 US$)b 3.8 4.4 4.8 4.6 4.1 3.6 4.3 Current account balance/GDP (%) Ϫ6.1 6.5 11.5 13.4 13.3 9.9 8.3 Brazil GDP at market prices (2000 US$)b 2.5 2.9 3.8 5.4 5.2 2.8 4.6 Current account balance/GDP (%) Ϫ2.0 1.7 1.3 0.1 Ϫ1.3 0.6 1.1 Chile GDP at market prices (2000 US$)b 6.4 5.7 4.3 5.1 4.2 3.4 4.7 Current account balance/GDP (%) Ϫ2.7 1.2 5.0 4.3 Ϫ0.8 Ϫ0.8 0.0 Colombia GDP at market prices (2000 US$)b 2.5 4.7 6.8 8.2 3.7 2.6 4.7 Current account balance/GDP (%) Ϫ1.9 Ϫ1.6 Ϫ2.9 Ϫ2.6 Ϫ3.0 Ϫ1.5 Ϫ0.6 Costa Rica GDP at market prices (2000 US$)b 5.2 5.9 8.8 6.8 4.0 3.9 4.9 Current account balance/GDP (%) Ϫ3.6 Ϫ4.9 Ϫ1.9 Ϫ8.7 Ϫ2.2 Ϫ3.3 Ϫ6.9 Dominica GDP at market prices (2000 US$)b 1.8 3.1 4.0 3.2 3.1 Ϫ1.5 3.3 Current account balance/GDP (%) Ϫ16.9 Ϫ32.6 Ϫ0.3 Ϫ0.4 0.4 6.2 6.9 Dominican Republic GDP at market prices (2000 US$)b 6.0 9.3 10.7 8.5 5.2 2.6 4.5 Current account balance/GDP (%) Ϫ3.2 Ϫ1.9 Ϫ3.7 Ϫ5.7 Ϫ9.5 Ϫ8.0 Ϫ3.8 Ecuador GDP at market prices (2000 US$)b 1.8 6.0 3.9 1.9 2.5 0.8 2.1 Current account balance/GDP (%) Ϫ2.3 0.8 3.5 2.3 5.2 5.4 4.0 El Salvador GDP at market prices (2000 US$)b 4.6 3.1 4.2 4.2 2.0 2.6 2.9 Current account balance/GDP (%) Ϫ2.0 Ϫ5.3 Ϫ4.7 Ϫ6.0 Ϫ8.4 Ϫ5.5 Ϫ5.2 Guatemala GDP at market prices (2000 US$)b 4.1 3.2 4.5 5.7 2.8 3.1 3.3 Current account balance/GDP (%) Ϫ4.6 Ϫ4.5 Ϫ4.4 Ϫ5.1 Ϫ7.5 Ϫ5.3 Ϫ4.3 Guyana GDP at market prices (2000 US$)b 4.9 Ϫ2.2 4.8 5.5 4.8 4.0 3.1 Current account balance/GDP (%) Ϫ15.4 Ϫ12.1 Ϫ19.7 Ϫ15.4 Ϫ18.2 Ϫ16.6 Ϫ15.1 Honduras GDP at market prices (2000 US$)b 3.3 6.1 6.3 6.3 3.1 4.0 4.8 Current account balance/GDP (%) Ϫ7.7 Ϫ3.0 Ϫ4.7 Ϫ10.6 Ϫ14.7 Ϫ9.6 Ϫ8.3 Haiti GDP at market prices (2000 US$)b Ϫ1.3 1.8 2.3 3.5 3.0 3.8 3.9 Current account balance/GDP (%) Ϫ1.7 Ϫ6.4 Ϫ7.6 Ϫ1.8 Ϫ11.9 Ϫ12.1 Ϫ13.1 Jamaica GDP at market prices (2000 US$)b 1.9 1.8 2.5 1.2 0.9 0.8 2.3 Current account balance/GDP (%) Ϫ2.7 Ϫ11.4 Ϫ10.9 Ϫ11.7 Ϫ17.0 Ϫ12.8 Ϫ10.8 Mexico GDP at market prices (2000 US$)b 3.5 2.8 4.9 3.2 2.0 1.1 3.1 Current account balance/GDP (%) Ϫ3.7 Ϫ0.7 Ϫ0.3 Ϫ0.6 Ϫ1.0 Ϫ1.7 Ϫ1.7 Nicaragua GDP at market prices (2000 US$)b 3.4 4.3 3.7 3.5 2.2 1.5 2.9 Current account balance/GDP (%) Ϫ28.7 Ϫ15.3 Ϫ16.4 Ϫ17.7 Ϫ20.9 Ϫ19.0 Ϫ15.4 (continued) 158 R E G I O N A L E C O N O M I C P R O S P E C T S 1991–2000a 2005 2006 2007 2008c 2009d 2010d Panama GDP at market prices (2000 US$)b 5.1 7.2 8.5 11.5 7.8 3.3 6.2 Current account balance/GDP (%) Ϫ4.8 Ϫ3.1 Ϫ7.2 Ϫ5.4 Ϫ7.6 Ϫ9.4 Ϫ9.1 Peru GDP at market prices (2000 US$)b 4.0 6.4 7.6 9.0 8.5 5.2 6.6 Current account balance/GDP (%) Ϫ5.5 1.6 3.0 1.3 Ϫ2.2 Ϫ1.6 Ϫ1.6 Paraguay GDP at market prices (2000 US$)b 1.8 2.9 6.0 6.8 4.2 3.0 3.8 Current account balance/GDP (%) Ϫ2.2 0.5 2.0 0.8 0.0 Ϫ1.0 Ϫ0.8 St. Lucia GDP at market prices (2000 US$)b 3.1 7.3 4.5 4.0 4.4 4.8 5.0 Current account balance/GDP (%) Ϫ11.6 Ϫ17.4 Ϫ23.4 Ϫ21.4 Ϫ21.8 Ϫ20.7 Ϫ19.8 St. Vincent and the Grenadines GDP at market prices (2000 US$)b 3.1 1.5 4.5 5.5 6.3 Ϫ0.6 5.6 Current account balance/GDP (%) Ϫ18.8 Ϫ26.3 Ϫ25.9 Ϫ24.5 Ϫ24.7 Ϫ24.2 Ϫ20.0 Uruguay GDP at market prices (2000 US$)b 3.0 6.6 7.0 7.4 4.7 2.8 3.0 Current account balance/GDP (%) Ϫ1.5 0.1 Ϫ2.3 Ϫ0.7 Ϫ1.7 Ϫ1.4 Ϫ0.9 Venezuela, R. B. de GDP at market prices (2000 US$)b 2.1 10.3 10.3 8.4 5.3 1.0 3.2 Current account balance/GDP (%) 2.6 17.5 14.8 8.8 8.7 9.0 8.0 Source: World Bank. Note: Growth and current account figures presented here are World Bank projections and may differ from targets contained in other World Bank documents. Barbados, Cuba, Grenada, and Suriname are not forecast because of data limitations. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 U.S. dollars. c. Estimate. d. Forecast. Middle East and North Africa among the more diversified economies picked Recent developments up from 3.8 percent in 2007 to 5.7 percent, led by a strong recovery from drought in Morocco T he Middle East and North Africa region has been affected dramatically by develop- ments in global commodity markets over the (table A7). last three years, notably in 2008.4 As a result Commodity price changes carry extreme there have been substantial up- and downshifts effects across the region in terms of trade, current account positions, The region has undergone tortuous change and external financing requirements. These linked to global commodity prices through the shifts have occurred at the same time as the ex- last years—from gradual increases to a surge in ternal environment for growth and for interna- crude oil, food (especially grains), and raw ma- tional finance deteriorated markedly. Still, re- terials prices from 2005 through mid-2008—to gional GDP held up well through 2008, with a sudden and forceful unwinding of the bubble domestic demand, notably investment financed during the second half of 2008. On the upside in large part by FDI, providing impetus for of the commodity run, the developing oil ex- growth. The pace of GDP growth for the de- porters—Algeria, the Arab Republic of Egypt veloping countries of the region was un- (though a more diversified economy), the Is- changed in 2008 from the strong 5.8 percent lamic Republic of Iran, the Syrian Arab Repub- registered in 2007. A falloff in the Islamic Re- lic, and the Republic of Yemen—accumulated public of Iran’s hydrocarbon sector eased GDP $82 billion in additional revenues over growth among oil-dominant economies from 2003–07, with receipts coming to stand at 6.4 percent in 2007 to 5.8 percent. And growth $130 billion in the latter year. During the first 159 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table A7 Middle East and North Africa forecast summary (annual percent change unless indicated otherwise) 1991–2000a 2005 2006 2007 2008* 2009† 2010† GDP at market prices (2000 US$)b 3.7 4.2 5.3 5.8 5.8 3.9 5.2 GDP per capita (units in US$) 1.6 2.5 3.6 4.0 4.0 2.2 3.5 PPP GDPc 4.8 4.3 5.4 6.3 5.7 3.8 5.0 Private consumption 3.9 5.0 6.2 6.1 7.0 4.2 6.0 Public consumption 4.2 5.6 4.2 1.8 8.7 5.4 5.4 Fixed investment 3.9 7.8 4.8 16.8 18.9 7.0 10.5 Exports, GNFSd 3.1 9.5 6.7 6.0 10.1 Ϫ2.1 4.9 Imports, GNFSd 1.4 14.0 7.6 14.3 19.8 1.7 8.8 Net exports, contribution to growth 0.4 Ϫ1.7 Ϫ0.6 Ϫ3.1 Ϫ4.3 Ϫ1.3 Ϫ2.2 Current account balance/GDP (%) Ϫ0.3 10.9 14.9 12.8 13.5 6.0 4.1 GDP deflator (median, LCU) 9.1 6.3 8.0 5.3 14.1 6.6 7.2 Fiscal balance/GDP (%) 4.0 5.5 0.7 1.3 2.0 0.0 Ϫ1.0 Memo items: GDP Middle East and North Africae 3.4 5.1 4.9 5.1 5.9 4.1 5.5 Resource poor and labor abundantf 4.2 3.8 6.3 5.6 6.5 4.3 5.9 Resource rich and labor abundantg 3.3 4.6 4.5 6.1 5.1 3.6 4.5 Resource rich and labor importingh 3.0 6.5 4.2 4.1 6.0 4.3 6.0 Egypt, Arab Rep. 4.3 4.4 6.8 7.1 7.2 4.5 6.0 Iran, Islamic Rep. 3.7 4.3 5.9 7.8 5.6 3.5 4.2 Algeria 1.7 5.3 1.8 3.1 4.9 3.8 5.4 Source: World Bank. * Estimate. † Forecast. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 U.S. dollars. c. GDP measured at PPP exchange rates. d. Exports and imports of goods and nonfactor services. e. Geographic region includes these high-income countries: Bahrain, Kuwait, and Saudi Arabia. f. Arab Rep. of Egypt, Jordan, Lebanon, Morocco, and Tunisia. g. Algeria, Islamic Rep. of Iran, Syrian Arab Rep., and Republic of Yemen. h. Bahrain, Kuwait, Oman, and Saudi Arabia. half of 2008, revenues jumped a further current surplus position is projected to drop 50 percent to nearly $200 billion. Since then, steeply to 8 percent of GDP during 2009 and however, the financial crisis and expectations to 5.4 percent by 2010. Real-side growth will of much lower global growth have caused oil be affected as revenue declines are likely to re- prices to plunge from peaks of nearly sult in downsizing of ambitious investment $150/bbl in early July to near $65/bbl by projects or postponement of planned pro- end-October 2008. As a result, regional oil grams. At the same time, the Organization of exporters are now experiencing a substantial Petroleum Exporting Countries (OPEC) will downshift in hydrocarbon receipts, terms of likely attempt to set limits on the decline in oil trade, and current account surplus posi- prices by constraining oil production, which tions that will manifest more clearly in 2009 will depress the oil sector in many economies, (figure A11). with ripple effects to the non-oil economy and The oil exporters’ current account surplus the private sector. increased from 17.2 percent of GDP in 2007 The diversified economies of the region, only moderately to 18.7 percent in 2008, but including Jordan, Lebanon, Morocco, and global economic recession in 2009 will pres- Tunisia, are to varying degrees highly depen- sure oil prices lower and yield a sizable addi- dent on imports of oil and refined petroleum tional falloff in world oil demand. The group’s products, as well as on food and feedstuffs, 160 R E G I O N A L E C O N O M I C P R O S P E C T S set against the background of subsequent con- Figure A11 Current account positions in the certed policy rate reductions across the OECD Middle East and North Africa set to shift dramatically countries, a step-up in economic stimulus plans and the beginnings of a thaw in credit Current account balance as a share of GDP (%) 20 markets, spreads in Egypt eased to 350 points, 15 but those in Lebanon escalated to 730 basis 10 points by early November. 5 Equity markets across the region echoed 0 the sharp declines seen by emerging markets Ϫ5 generally, as international (and domestic) in- Ϫ10 vestors withdrew funds from the asset class. Middle East & Oil Diversified From peak levels in the spring through early- North Africa exporters economies November 2008, the Egyptian bourse dropped 2006 2007 2008 54 percent, Morocco’s exchange fell 33 per- 2009 2010 cent, and the Gulf Cooperation Council (GCC) markets in aggregate declined 50 percent. This Source: World Bank. contrasts with a 54 percent decline in the MSCI index which covers all emerging mar- notably wheat and coarse grains. Their terms kets (figure A12). of trade worsened by 4.2 percent in 2008, Gross capital flows to countries in the re- pushing the group’s current account deficit to gion have also declined, and may be expected 7.3 percent of GDP (not witnessed since the to weaken further. Bond issuance dropped by Asia crisis of 1997) from 3.6 percent in 2007 two-thirds from $4.6 billion to $1.5 billion (see figure A11). Looking forward, these between January and August 2007 and the economies will benefit from lower commodity like period of 2008. Equity issuance declined prices through 2010, and current account from $2.1 billion to $750 million or 65 per- deficits are projected to decline to 0.7 and 0 cent in the period as well. But a surge in bank percent of GDP in 2009 and 2010 respectively. borrowing from $4 billion to $14 billion in the period offset the downturn in other Effects of financial crisis are fairly muted, but several countries are vulnerable Figure A12 Markets in the Middle East and To date, the direct effects of the financial cri- North Africa are hard hit by financial crisis sis experienced by most developing economies MSCI equity market price indexes (percentage change, US$) in the region have been relatively mild. Banks 200 Egypt, and investment companies in the Middle East Morocco Arab Rep. of and North Africa were not large holders of 175 subprime mortgage-backed securities, or 150 “toxic assets” (though there may be questions concerning portfolios of sovereign wealth 125 funds in the Gulf States). Indirect effects, how- 100 ever, have become evident. Following the an- nouncement of the U.S. financial rescue plan 75 GCC market average in early October 2008, spreads on sovereign MSCI total debt increased 170 basis points for Lebanon 50 Jan. 1 May 1 Sep. 1 Jan. 1 May 1 Sep. 1 and 100 points for Egypt; but these increases 2007 2007 2007 2008 2008 2008 contrasted well with the average rise of 250 Source: Morgan-Stanley. basis points for all developing economies at Note: Gulf Cooperation Council (GCC). that time. With country-specific developments 161 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 finance components. Moreover, preliminary the developing oil exporters picked up from data for September show declines across all negative ground in the first quarter to 3 per- segments of flows to the region. The process cent in the third, as growth in the non-oil sec- of deleveraging across high-income financial tors in both Algeria and the Islamic Republic institutions appears to have raised the possi- of Iran well outpaced sluggish conditions in bility for a potentially sharp reduction in cap- hydrocarbons. Output among the high-income ital flows, particularly syndicated bank lend- GCC economies continued to grow quickly, ing and to a lesser degree bond issuance, for underpinned by a continued rapid pace of the region. This is likely to carry adverse ef- commercial and residential real estate develop- fects across countries, but with highly differ- ment in Bahrain, Qatar, Saudi Arabia, and the entiated outcomes.5 United Arab Emirates (UAE). Production gains Several countries stand exposed to the risk for the group jumped from 3 percent to 10 per- of adverse developments in international fi- cent by the third quarter, with Qatar up 12 per- nancial markets, which could negatively af- cent, Saudi Arabia climbing 11 percent, and fect investment spending and growth. These the UAE moving to 20 percent growth in the countries may suffer from fragilities in macro- period. economic structure (for example, a string of The surge in global prices for crude oil, substantial current account- or fiscal deficits) food, and feed grains (50 percent or more or from the presence of stress points made during the first half of 2008), together with clearer by the heightening of investor risk overheated domestic demand in several aversion. economies in the region (notably Egypt, the The vulnerability index presented in chap- Islamic Republic of Iran, and a number of ter 1 (a weighted measure of the exposure of a GCC countries), led to a sharp rise in con- country to developments in sovereign spreads, sumer price inflation across the Middle East equity markets, and exchange rates, as well as and North Africa (figure A13). Consumer in gross capital inflows) suggests that Lebanon, prices for the diversified economies (GDP- Syria, Jordan, and Egypt have been among the weighted) accelerated to 7 percent in August more affected countries in the region, though 2008 from a trough nearer 1.5 percent in the vulnerability of these economies is low in mid-2007; much of the increase was centered contrast with the average exposure for other regions. Under a global scenario in which fi- nancial markets require a prolonged period to Figure A13 Inflation rises across the Middle return to balance, these countries might find East and North Africa themselves at risk of adverse capital move- Consumer price inflation (percentage change, year-over-year) ments, pressures on equity markets, exchange 24 rates, and eventually investment and growth. Egypt, Arab Rep. of 20 Production is mixed; inflation ramps 16 Developing oil exporters higher, denting budgets across the region 12 Industrial production for the diversified economies of the region tailed off in late 2008, 8 GCC shifting from gains of 8 percent (on a GDP- 4 weighted basis) during the first quarter to 4.5 Diversified percent by the third quarter (year-over-year). 0 Jan. Jul. Jan. Jul. Jan. Jul. This decline reflects the increasingly sluggish 2006 2006 2007 2007 2008 2008 performance of exports to key European and Source: World Bank data. U.S. markets as well as emerging softness in do- Note: Gulf Cooperation Council (GCC). mestic demand. In contrast, production among 162 R E G I O N A L E C O N O M I C P R O S P E C T S in Jordan, where inflation reached 20 percent. in countries such as Egypt, Jordan, Morocco, Aggregate inflation for developing oil exporters and Tunisia, funded in large part by direct in- also breached 20 percent, mainly reflecting de- vestment flows from the GCC. velopments in the Islamic Republic of Iran, Sectors benefiting from FDI have diversi- where substantial monetary stimulus led to fied from real estate and tourism-related prop- overheating, pushing inflation to 27 percent; erties toward industrial and infrastructure consumer prices in Egypt rose to a 24 percent projects in the past few years. FDI to the de- pace, pushed up primarily by rising food veloping countries of the region increased prices and expanding domestic demand fueled more than five-fold from $4.7 billion in 2000 by monetary growth. to $26.4 billion in 2006; preliminary estimates Inflation remains a key challenge for the re- for 2007 suggest a moderate downshift to gion. Although extensive reliance on fuel and $21.5 billion, reflecting diminishing levels of food subsidies helps limit inflationary pres- flows to Egypt, Jordan, and Tunisia. sures, it comes at a very high fiscal cost. Not Recent examples of FDI-driven develop- only do such steps reduce fiscal space to ad- ments include the Mediterranean Gate pro- dress other priorities, as discussed in chapter 3, ject, which aims to turn Tunis into a regional they tend to be very inefficient mechanisms for hub for finance, business, and technology. alleviating poverty. Iranian energy subsidies ex- Work has begun on the first $1 billion of the ceeded 20 percent of GDP in 2007—08. Food $25 billion project, which is slated to house and energy subsidies in Egypt increased to 1.9 2,500 international firms and provide and 6.9 percent of GDP in fiscal 2008, up from 350,000 jobs over a 20-year period. In Jordan, 1.3 and 5.5 percent, respectively, in fiscal 2007. Aqaba Development signed a $100 million Second-round inflationary effects have been agreement to develop an industrial port at boosted in several countries that responded to Aqaba to handle potash exports. And in high food prices by increasing wages of select Morocco, construction is under way on a new groups to help mitigate the worst of the impact Renault/Nissan production site—the plant will on living standards. sponsor about 6,000 direct jobs, with 90 per- cent of production exported. Domestic demand, underpinned Among the region’s oil exporters, Algeria by substantial FDI, drives growth experienced a fillip to growth in 2008, to 4.9 in the region percent from 3.1 in 2007, as gains continued at Strong gains in consumer spending, and espe- a rapid 6 percent clip in the non-oil sector, no- cially in fixed investment, have been the key tably in construction and services linked to in- factors supporting growth across the region in frastructure projects (table A8). Algeria stands 2008—all the more so as exports of the oil- in fair stead to weather financial spillovers from dominant economies have been restrained in an the global crisis; at end-September 2008, reserves effort to prop up crude oil prices, and those of stood at $140 billion, up $30 billion from end- the diversified economies have been increas- 2007. A falloff in the oil sector to 2 percent pres- ingly affected by the slowdown in export mar- sured growth in the Islamic Republic of Iran ket demand. Investment in the region grew al- from 7.8 percent in 2007 to 5.6 percent. Over- most 20 percent in 2008, accounting for 3.4 all GDP was supported by industry, which points of the region’s 5.8 percent growth in the advanced 7.4 percent, services (6.8 percent), year, while consumer spending grew 7 percent and agriculture (6.2 percent). Growth is being (see table A7, earlier). Large infrastructure in- powered by a highly expansionary fiscal policy, vestment projects, such as the Programme which has pushed inflation toward 30 percent; Complémentaire de Soutien à la Croissance and public spending is anticipated to move (PCSC) in Algeria, find counterparts in new real higher still ahead of presidential elections slated estate, commercial, and industrial developments for 2009. 163 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table A8 Middle East and North Africa country forecasts (annual percent change unless indicated otherwise) 1991–2000a 2005 2006 2007 2008c 2009d 2010d Algeria GDP at market prices (2000 US$)b 1.7 5.3 1.8 3.1 4.9 3.8 5.4 Current account balance/GDP (%) 3.2 21.6 24.7 21.2 23.3 12.2 9.8 Egypt, Arab Rep. GDP at market prices (2000 US$)b 4.3 4.4 6.8 7.1 7.2 4.5 6.0 Current account balance/GDP (%) 0.9 2.3 2.4 0.3 Ϫ5.1 Ϫ2.7 Ϫ1.3 Iran, Islamic Rep. GDP at market prices (2000 US$)b 3.7 4.3 5.9 7.8 5.6 3.5 4.2 Current account balance/GDP (%) 1.2 20.4 27.6 28.5 36.3 17.9 12.1 Jordan GDP at market prices (2000 US$)b 5.1 7.3 6.3 6.0 5.5 4.2 6.0 Current account balance/GDP (%) Ϫ4.3 Ϫ17.7 Ϫ8.1 Ϫ13.9 Ϫ14.9 Ϫ0.8 0.0 Lebanon GDP at market prices (2000 US$)b 7.2 1.0 0.0 2.0 5.5 4.0 4.5 Current account balance/GDP (%) — Ϫ12.8 Ϫ5.3 Ϫ8.7 Ϫ16.4 Ϫ6.5 Ϫ5.9 Morocco GDP at market prices (2000 US$)b 2.4 2.4 7.8 2.7 6.2 4.0 6.0 Current account balance/GDP (%) Ϫ1.4 1.7 2.0 Ϫ0.3 Ϫ4.5 1.0 1.7 Syrian Arab Rep. GDP at market prices (2000 US$)b 5.1 4.5 5.1 6.6 3.7 2.5 4.2 Current account balance/GDP (%) 1.0 1.0 2.7 1.2 2.4 Ϫ2.0 Ϫ3.3 Tunisia GDP at market prices (2000 US$)b 4.7 4.2 5.7 6.3 5.1 3.7 5.8 Current account balance/GDP (%) Ϫ4.3 Ϫ1.1 Ϫ2.0 Ϫ2.6 Ϫ3.9 0.0 0.8 Yemen, Rep. GDP at market prices (2000 US$)b 5.5 4.6 3.2 2.8 2.7 5.7 4.0 Current account balance/GDP (%) Ϫ4.3 3.7 8.1 Ϫ0.5 1.3 1.3 2.5 Source: World Bank. Note: Growth and current account figures presented here are World Bank projections and may differ from targets contained in other World Bank documents. Djibouti, Iraq, Libya, and West Bank and Gaza are not forecast because of data limitations. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 U.S. dollars. c. Estimate. d. Forecast. Growth in Egypt continued its strong mo- the Middle East and North Africa to potential mentum into 2008, moving from GDP gains of repercussions from developments in interna- 7.1 percent in 2007 to 7.2 percent, as invest- tional financial markets. ment advanced by more than 30 percent In Syria, domestic demand, supported by funded in large part by FDI. Egypt has been the strong output gains in transport, communica- largest recipient of FDI in the region, attracting tions, finance and real estate, and public ad- $13 billion (8.4 percent of GDP) in fiscal 2008, ministration, drove growth of 3.7 percent dur- up from $11 billion in the previous fiscal year. ing 2008. Declining oil production is the key But the country’s equity markets have been challenge facing the economy. Oil output hard hit by recent financial turmoil, with the dropped 23 percent between 2003 and 2007, CASE index off more than 50 percent since increasing pressure to expand the scope for May 2008. Moody’s and Fitch had earlier low- private non-oil activities. Similar falloffs in oil ered the outlook on the country’s Ba1 rating to production in the Republic of Yemen continue negative from stable, citing inflation and the to plague the economy, restraining GDP fiscal deficit as primary concerns. Egypt ap- growth there to 2.7 percent in 2008; though a pears among the more exposed economies in coming online of large natural gas facilities in 164 R E G I O N A L E C O N O M I C P R O S P E C T S 2009 should yield a fillip to growth by more during 2007, on a strong rise in consumer than 3 percentage points at that time. spending. At the same time, inflation lofted Among the more-diversified economies, into double digits on the back of food and fuel growth in Morocco recouped sharply to 6.2 prices, as well as high public sector wage percent in 2008 from the drought-inflicted 2.7 settlements. Lebanon managed to finance its percent outturn of 2007. Vigor in non- large trade deficit through stronger exports of agricultural sectors, especially in telecommu- services and higher net inflows from abroad. nications, financial services, and construction, has driven growth. Policies to control domes- The medium-term outlook tic prices––food and fuel subsidies, temporary The global downturn and financial crisis will waivers on customs duties for cereals, and ac- exact a toll on growth in the Middle East and tions to fight price speculation––have helped North Africa, but one that will be less dramatic maintain overall inflation at relatively low lev- than, for example, in Europe and Central Asia els compared with many countries in the re- or South Asia, where country exposure and gion. But subsidies have tripled in two years, fragility of initial conditions are considerably reaching close to 6 percent of GDP in 2008. In more pronounced. As world oil demand falls Tunisia, GDP eased to 5.1 percent growth in sharply, any decisions by the region’s oil ex- 2008, from 6.3 percent in 2007, largely be- porters to curtail output to set a “floor” under cause of deterioration in the external environ- oil prices—will play a large role in shaping ment, in particular the economic slowdown in growth profiles. And the shift from windfall the EU. Remaining import tariffs on EU goods revenue gains to current account surplus posi- were dismantled in January within the frame- tions of less than 6 percent of GDP by 2010, work of the EU-Tunisia Association Agree- much weaker oil revenues, tighter credit con- ment, and steps have been taken in the financial ditions, and weaker demand for the region’s sector to reduce unsound and nonperforming exports (including tourism) are expected to loans by improving credit risk appraisals. cause investment to decelerate sharply, rising Over the first seven months of 2008, foreign by 7 percent in 2009 after growing 18.9 per- investment in industry increased 47.2 percent, cent in 2008. widening from the earlier focus of FDI in As a result, the region’s GDP is anticipated tourism. to slow from 5.8 percent in 2008 to 3.9 per- Jordan’s growth slipped to 5.5 percent cent in 2009. Growth among the oil exporters from 6 percent in 2007, on the back of still- as well as the diversified economies is antici- buoyant domestic demand, financed in part by pated to fall to about 4 percent in 2009 (figure large capital inflows. Heavy public sector out- A14). Recovery in 2010, predicated upon a lays in 2008 (and anticipated in the draft 2009 quick resolution of the financial crisis in high- budget) suggest that fiscal and financing pres- income countries and a moderate revival of sures will continue in the short term. The rise OECD growth, would see GDP pick-up to 5.2 in fuel and food prices, together with expan- percent, led by a return to 5.7 percent growth sionary policy, has pushed inflation above 22 among the diversified economies. A very grad- percent as of August, and the current account ual buildup in global oil demand is likely to deficit widened to almost 15 percent of GDP restrain GDP gains among the oil-exporting in the year. These circumstances place Jordan countries to 5 percent in 2010. Mainly reflect- at some risk of interruption in private capital ing cuts in oil production, export volumes are flows in the short term, but official develop- projected to decline 2.1 percent in 2009, while ment assistance and worker remittances may the regional current account surplus falls to help the country bridge the potential financing 6 percent of GDP, from 13.5 percent in 2008. gap. Finally, in Lebanon, GDP picked up to a Recovery for the region in 2010 hinges on 5.5 percent pace in 2008, from 2 percent a pickup in exports and a moderate upturn in 165 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 is unlikely, prices below $50/bbl could be in Figure A14 Notable slowing of growth across the cards, with attendant adjustments required the Middle East and North Africa in 2009 by the region’s exporters. GDP growth (%) A second element of concern for the region 7 is the potential for unrest among the populace 6 under the potentially harsh conditions of a 5 global recession. A slowdown in remittance 4 inflows would carry direct effects to poor fam- 3 2 ilies in need of income to sustain household 1 consumption. And government budgets will 0 remain under pressure, in part to maintain 2007 2008 2009 2010 subsidies for basic goods. Oil exporters Diversified economies GCC countries South Asia Source: World Bank. Recent Developments investment, but primarily on a 1.8 percentage G DP growth in South Asia slowed markedly in 2008 to 6.3 percent from 8.4 percent in 2007.6 The onset of the financial crisis in the point pickup in household outlays to growth United States and Europe in mid-September of 6 percent, as the earlier run-up in commod- 2008—which led to severe financial turmoil in ity prices and consumer price inflation moder- emerging markets, including in many South ates, giving way to gradual stabilization and Asian countries—ushered in a downshift in ac- to a pick-up in consumer purchasing power. tivity that started to take hold in late-2008. The region’s current account position should Growth had already begun to wane in the re- continue to narrow to some 4 percent of GDP, gion prior to the onset of the global crisis, as providing a new set of “initial conditions” rising inflationary pressures and tight credit from which developments into the next conditions had started to take a toll on domes- decade are likely to spring. tic activity, while already slowing external de- mand and high international commodity prices Risks led to a deterioration in external positions. Uncertainty surrounding the medium-term The initial effects of the global financial cri- path for oil prices is probably the element of sis in South Asia were sharp corrections in re- greatest risk confronting the region. Where gional equity markets. Bourses in India, Pak- the global price of oil settles, grounded in the istan, and Sri Lanka dropped 57 percent, 39 fundamentals—as well as by pressures exerted percent, and 35 percent, respectively, over the by OPEC—will determine the potential year through mid-November (and 66, 50, and growth path for the oil-dominant economies 39 percent, when measured in U.S. dollars). of the region. The “base case” view posits Notably in Pakistan, curbs on the sale of equi- world crude oil prices remaining within a $65 ties were imposed in August, effectively pre- to $75/bbl range through 2010, moving to- venting the exit of existing investors and dis- ward a real equilibrium price of $60/bbl in couraging potential new investors. 2007 dollars by 2015. But substantial down- Equity sell-offs and ‘flight-to-quality’ con- sides to this price forecast can be envisioned tributed to significant currency depreciation in should the slowdown in developing-country some countries, with local currencies in India, GDP growth fall much below the 4.5 percent Pakistan, and Nepal7 falling by 21 percent, posited for 2009. Although a repeat of 30 percent, and 21 percent, respectively, 1985–86, when oil prices tumbled to $10/bbl against the U.S. dollar, over the year through 166 R E G I O N A L E C O N O M I C P R O S P E C T S mid-November. The Sri Lankan rupee depreci- with substantial and sustained increases ated by nearly 2 percent when the Central through the middle of 2008, a greater degree Bank allowed the peg against the U.S. dollar of feed-through of higher food and fuel prices to adjust at end-October 2008. In contrast, to households in these countries became in- the Bangladeshi taka appreciated slightly (2 per- evitable. Tighter credit conditions, moderating cent) over the same period. demand, higher prices, and diminishing levels Notably, the region’s banking sectors have of confidence weighed on consumer and busi- been largely insulated from the crisis, given ness spending alike. And investment growth very limited exposures to the toxic debt instru- decelerated to single digits from the robust ments tied to U.S. sub-prime mortgages. With growth witnessed during recent years. respect to the associated impacts of the finan- The slowdown in growth during 2008 cial crisis on the real economy—as financing reflected increasing weakness in the region’s for corporations, loans for households, and two largest economies, India and Pakistan trade credit for exporters have become signifi- (table A9). In India, growth slowed across all cantly more difficult to obtain—indications of sectors, with tighter monetary policy, rising in- a fall-off in external and domestic demand have flationary pressures, and mounting fiscal and begun to trickle in. For example, India’s goods current account deficits weighing down eco- exports contracted 12 percent in October (year- nomic activity. The more recent onset of the over-year). This comes on the heels of a sub- global financial crisis resulted in sharp losses stantial deceleration in export growth to 10 per- in India’s equity markets and drove down the cent in September from 27 percent in August value of the rupee. Foreign institutional in- despite the marked weakening of the rupee. Sri vestors pulled out of India to cover losses in Lanka’s exports also declined, falling 9.4 per- high-income countries and as risk aversion cent in September, contrasted with growth of heightened across the globe. 16.6 percent and 24.1 percent in August and In Pakistan, the economy deteriorated July, respectively. Further, consumer confidence sharply over the course of 2008, as headline in- in India has deteriorated, with the index related flation surged, and the current account and fis- to consumer spending down for a fourth con- cal deficits jumped on the back of rising oil and secutive month in October.8 food prices. Political turmoil and ongoing Weaker conditions in South Asia were evi- security concerns have also taken a toll on dent in the region prior to the onset of the Pakistan’s economy, while the global financial global financial crisis, and were marked by an crisis added substantial downward pressures increasingly challenging global environment. on its financial markets. Prior to reaching an In particular, sharply negative terms-of-trade agreement with the IMF for standby credit in effects from the rise in oil and global non- mid-November, Pakistan came close to a full- energy commodity prices, which peaked in mid- blown balance of payments crisis. In neigh- 2008, acted as a drag on regional growth and boring Afghanistan, the economy has been contributed to a doubling of the regional cur- hurt by a decline in agricultural output caused rent account deficit in the year. Rising interna- by poor precipitation, a sharp rise in interna- tional prices also contributed to a pronounced tional food prices, and the wheat export re- buildup in South Asia’s inflation pressures. strictions imposed by Pakistan, in addition to Higher prices, particularly for food and fuel, the disruptive effects of the spreading insur- undermined real household incomes—with gency. And while GDP growth in Bhutan re- the poorest households generally affected the mained vibrant at 14.4 percent in 2008, it most—thus crimping household expenditures. moderated from the 17 percent expansion of Several governments attempted to offset the 2007, stemming from the initial boost from the international price hikes with domestic subsi- first full year of operation of the immense Tala dies, placing strains on fiscal balances. But hydropower project. 167 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table A9 South Asia forecast summary (annual percent change unless indicated otherwise) 1991–2000a 2005 2006 2007 2008e 2009f 2010f GDP at market prices (2000 US$)b 5.2 8.7 9.0 8.4 6.3 5.4 7.2 GDP per capita (units in US$) 3.1 6.9 7.2 6.9 4.8 4.0 5.8 PPP GDPc 6.3 8.7 9.0 8.4 6.3 5.4 7.2 Private consumption 3.9 7.0 6.0 7.5 5.7 4.7 5.7 Public consumption 4.7 8.8 10.0 4.9 8.8 9.2 6.7 Fixed investment 5.5 14.6 16.5 13.5 7.1 4.8 10.7 Exports, GNFSd 10.6 7.0 17.3 7.3 4.3 3.7 8.3 Imports, GNFSd 9.8 12.9 21.9 7.0 6.5 2.7 7.8 Net exports, contribution to growth Ϫ0.1 Ϫ1.0 Ϫ0.8 0.0 Ϫ0.5 0.2 0.0 Current account balance/GDP (%) Ϫ1.6 Ϫ1.2 Ϫ1.5 Ϫ1.6 Ϫ3.5 Ϫ2.0 Ϫ1.9 GDP deflator (median, LCU) 8.2 6.5 9.2 8.4 9.7 8.0 6.0 Fiscal balance/GDP (%) Ϫ7.7 Ϫ5.9 Ϫ6.1 Ϫ6.4 Ϫ8.1 Ϫ8.6 Ϫ8.0 Memo items: GDP South Asia excluding India 4.4 6.7 6.4 6.1 6.1 4.0 5.2 India 5.5 9.2 9.7 9.0 6.3 5.8 7.7 Pakistan 3.9 7.7 6.2 6.0 6.0 3.0 4.5 Bangladesh 4.8 6.0 6.6 6.4 6.2 5.7 6.2 Source: World Bank. Note: To simplify presentation across countries and with other regions, annual national income and product account data for South Asia are reported in calendar years, although official country data are originally reported by fiscal year for Bangladesh, India, Pakistan, and Nepal. a. Growth rates over intervals are compound average; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 U.S. dollars. c. GDP measured at PPP exchange rates. d. Exports and imports of goods and nonfactor services. e. Estimate. f. Forecast. In contrast with broadly declining activity and rising remittance inflows. These factors in the region, growth in Bangladesh held supported an increase in household incomes steady, with domestic demand buoyed by a and private consumption, despite a buildup in sharp increase in remittance inflows and by ro- inflation pressures. bust garment exports recorded in the first half The general deterioration in regional trade of 2008. With relatively thin capital markets, balances has been offset by large remittance Bangladesh’s equities experienced much more inflows, which represent a sizable, and gener- muted declines than those experienced in other ally increasing share of GDP: during 2007, regional markets. Growth in Sri Lanka has 14 percent in Nepal, 8 percent in Bangladesh also proven resilient in 2008, primarily be- and Sri Lanka, 4 percent in Pakistan, and 3 cause of a marked rise in agricultural produc- percent in India. FDI inflows remained strong tion and a boom in tea exports, which helped through the first half of 2008, helping to ease to offset slower growth in garment exports. external financing requirements. In India, FDI While its equity markets also suffered sharp surged to 3 percent of GDP in 2008, up from corrections with the global financial crisis, the 1.4 percent in 2007. FDI inflows to Pakistan Sri Lankan rupee, which was pegged to the remained relatively steady through the sum- U.S. dollar early in 2008, remained stable mer of 2008—on course to match the 3.7 per- against that currency. Partially in consequence, cent of GDP recorded in 2007—but the real appreciation of the Sri Lankan rupee has extreme financial and economic difficulties contributed to substantial widening of the cur- encountered during the second half of the year rent account deficit. In Nepal, growth firmed were likely to have changed that for the worse. in 2008, helped by higher agricultural output In 2007, FDI inflows to Sri Lanka and 168 R E G I O N A L E C O N O M I C P R O S P E C T S price subsidies for food, fuel, and fertilizer Figure A15 Key international finance links in contributed to higher fiscal outlays. In some South Asia, 2007 cases (India, Bangladesh, Pakistan), the subsi- Share of GDP (%) dies contributed to a reversal in the general 9 trend toward fiscal consolidation in recent Inward years. Downward pressure on the revenue remittances 6 stream, resulting from the deceleration in Portfolio FDI inflows inflows growth, also played a role. As a consequence, a number of regional governments had begun 3 to cut development spending. With low, or in many cases, negative real in- terest rates, monetary policy is also broadly ex- 0 India Pakistan Sri Lanka Bangladesh pansionary in South Asia. Prior to the onset of the global financial market crash in September Source: World Bank. 2008, some countries had tightened monetary conditions through interest rate hikes (India) or slower credit growth (Sri Lanka) in an effort Bangladesh reached 1.7 and 1 percent of GDP to curtail rising inflationary pressures. Later in respectively (figure A15). the year, however, as the credit crunch became In contrast, net portfolio flows to the region manifest, regional monetary authorities turned sharply negative during the first half of quickly responded by injecting liquidity into 2008, shifting from vibrant inflows of recent banking systems through various measures, in- years. In India, where portfolio inflows surged cluding lowering required reserve ratios and to 3 percent of GDP in 2007, outflows are reducing policy interest rates. projected to exceed 1 percent of GDP in 2008. With the increase in global risk aversion and rebalancing of portfolio holdings in the high- Medium-term outlook income countries, gross capital flows deceler- The outlook for regional growth is highly un- ated in 2008, with an especially sharp falloff in certain, because of the sustained degree of equity and bond issuance and a somewhat less volatility and synchronized nature of the slow- pronounced decline in bank borrowing. Falter- down across countries—and because the full ing investor confidence led to higher interna- extent of financial disruption on both the re- tional bond spreads, with those for Pakistan gional and global economies remains unclear. and Sri Lanka spiking to prohibitive levels in South Asian GDP growth is projected to step September and October. Hard currency re- down to 5.4 percent in 2009 from 6.3 percent serves were drawn down to varying degrees, as in 2008. Continued financial sector volatility investors pulled out of regional markets and as and balance sheet weakness will translate into central banks sought to shore up currencies. ongoing risk aversion. That is expected to lead Fiscal policy across South Asia is broadly to a further contraction in portfolio inflows expansionary, with deficits generally exceed- and mute the prospects for FDI, primarily af- ing 4.5 percent of GDP—they are projected to fecting India and Pakistan, which receive the reach 8.5 percent in India, 7.5 percent in Pak- lion’s share of the region’s inflows. In turn, istan and Sri Lanka, and 4.7 percent in these factors are projected to lead to a sharp Bangladesh in 2008. Nepal is an exception, falloff in private investment growth. Equity where the 2008 deficit is projected at 2.8 per- price declines are expected to generate negative cent of GDP, although that would be double wealth effects, especially in the case of India, the 2007 deficit. In 2008, budget deficits rose where market capitalization reached 160 per- across the region—or remained high—as cent of GDP in 2007, up from 90 percent in 169 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table A10 South Asia country forecasts (annual percent change unless indicated otherwise) 1991–2000a 2005 2006 2007 2008c 2009d 2010d Bangladesh GDP at market prices (2000 US$)b 4.8 6.0 6.6 6.4 6.2 5.7 6.2 Current account balance/GDP (%) Ϫ0.4 Ϫ0.3 2.0 1.2 0.8 0.7 0.7 India GDP at market prices (2000 US$)b 5.5 9.2 9.7 9.0 6.3 5.8 7.7 Current account balance/GDP (%) Ϫ1.2 Ϫ1.0 Ϫ1.0 Ϫ1.2 Ϫ3.1 Ϫ1.7 Ϫ1.9 Nepal GDP at market prices (2000 US$)b 5.0 3.1 3.7 2.6 5.5 3.8 4.9 Current account balance/GDP (%) Ϫ6.3 0.0 Ϫ0.1 Ϫ1.2 1.2 1.0 0.8 Pakistan GDP at market prices (2000 US$)b 3.9 7.7 6.2 6.0 6.0 3.0 4.5 Current account balance/GDP (%) Ϫ3.7 Ϫ3.3 Ϫ5.4 Ϫ5.8 Ϫ8.1 Ϫ4.6 Ϫ3.2 Sri Lanka GDP at market prices (2000 US$)b 5.2 6.0 7.7 6.8 6.3 4.0 5.5 Current account balance/GDP (%) Ϫ4.6 Ϫ3.2 Ϫ5.3 Ϫ4.4 Ϫ7.5 Ϫ5.7 Ϫ5.5 Source: World Bank. Note: Growth and Current Account figures presented here are World Bank projections and may differ from targets contained in other World Bank documents. Afghanistan, Bhutan, and Maldives are not forecast because of data limitations. a. Growth rates over intervals are compound average; growth contributions, ratios and the GDP deflator are averages. b. GDP measured in constant 2000 U.S. dollars. c. Estimate. d. Forecast. 2006 and where the housing boom has begun current account deficit is expected to narrow to lose steam (table A10). substantially. Additionally, the recent sharp Weakening foreign demand is expected to depreciation of local currencies against the lead to a significant slowing in regional export dollar for India, Pakistan, and Nepal will help growth, including services. In particular, the in- boost export competitiveness. This should formation technology and communications sec- help offset partially the negative effects of the tor is considered vulnerable to shifts in financial coming contraction in world trade. sector activity, and clothing and tourism rev- To help cushion the downturn related to the enues are vulnerable to shifts in discretionary financial crisis, South Asian governments are spending. Potential mitigating factors include seen to pursue countercyclical measures, al- cost-cutting measures by companies in high- though fiscal space is limited. Thus, monetary income countries to the benefit of outsourcing policy measures will often be the key mecha- suppliers (such as India) and shifts in spending nism for response to the crisis, although reduc- to low-priced retailers, such as Wal-Mart, to the tions in policy rates should be undertaken with benefit of their suppliers (such as Bangladesh). care where there is pressure on the exchange Recession in high-income countries and a slow- rate. Even with tight budget envelopes, re- down in growth among the Gulf oil exporters gional governments can improve the efficiency are expected to depress remittances inflows. of public outlays by more directly targeting However, the set of unfavorable global safety net programs to the benefit of the poor. conditions are anticipated to lead to lower In addition, and particularly where both fiscal commodity prices, which will not only pro- and monetary policy responses are con- vide a fillip to real household incomes, but strained, expansion of structural reforms also provide governments with greater scope should be pursued to stimulate growth in the for fiscal stimulus. Falling commodity prices near term and improve prospects for the will reduce the import bill and boost the re- medium and longer terms. Examples include gion’s terms of trade. At the regional level, the improving governance and management of 170 R E G I O N A L E C O N O M I C P R O S P E C T S public sector firms, rationalizing government protracted sluggish growth and risk aversion, finances, enhancing openness where it could weaknesses in the region’s financial sector improve stability (such as FDI), and improving could emerge. the quality of physical and financial infrastruc- Whereas India holds sizable foreign ex- ture. Moving forward with existing planned change reserves (despite recent draw-downs) investment programs, which often take years to help weather more negative than expected to develop, will support current activity and growth dynamics, other countries in the re- build capacity for eventual recovery. gion have seen widening trade deficits and Given strong underlying growth dynamics capital outflows reduce their reserve holdings, in South Asia, the negative feedback effects of increasing their vulnerability to sustained the global financial crisis are expected to be pressure on currencies. Countries holding sub- temporary. A relatively rapid rebound is ex- stantial short-term debt obligations would be pected in 2010, with a projected revival of more vulnerable. In the Maldives, the rapid GDP growth to 7.2 percent by 2010. Private buildup of debt obligations with the construc- consumption and investment growth are fore- tion boom following the tsunami is of con- cast to gain steam, supported by strengthening cern. Sri Lanka has a large public debt (equiv- global demand and a rebound in consumer alent to 83 percent of GDP in 2007), with and business confidence. Commodity price de- 44 percent of the debt external, albeit primarily creases are projected, which will support a re- concessional; the country’s fiscal position is duction of inflationary pressures within the thus vulnerable to higher interest rates and ex- South Asian economies. The region’s median change rate depreciation. The Sri Lankan cur- inflation rate will have peaked in 2008 at 9.7 rency peg against the dollar could come under percent, although sustained pipeline pressures pressure, because the foreign reserve cover is will prevent a rapid easing, with inflation relatively low. Bhutan also holds significant moderating incrementally to 8 percent in 2009 external debt obligations, but these are held and 6 percent by 2010. primarily by India for the development of hydroelectric power, which Bhutan is in turn Risks exporting to India. Should a deeper crisis lead Given the synchronized and widespread nature to a falloff in foreign assistance, countries sig- of the current crisis, downside risks to the nificantly reliant on aid (such as Afghanistan) baseline are pronounced. A more prolonged would be more adversely affected. and pervasive credit crunch than envisioned in In contrast, should the current global fi- the baseline would lead to a deeper global re- nancial crisis be resolved relatively quickly, cession. That in turn would likely lead to out- and growth dynamics prove more favorable right contraction of South Asia’s private fixed than projected, policy makers would face very investment (compared with the sharp slowing different challenges. Inflationary pressures of growth found in the baseline), driven in part could return to the forefront—as counter- by a crimping of FDI inflows. South Asia’s ex- cyclical measures could become effectively ports would also likely contract instead of pro-cyclical—leading to higher internal and ex- slow, and remittances could compress sharply, ternal deficits, hindering investment (through especially were destination countries to send crowding out), and acting as a drag on growth. migrants home. With the growth slowdown, household incomes would decline and unem- ployment rise. Progress in poverty alleviation Sub-Saharan Africa could slow markedly. While the region’s bank- Recent Developments ing sector has not been exposed to the toxic debt instruments that have plagued many high- income countries, in a downside scenario of S ub-Saharan Africa’s economy expanded 5.4 percent in 2008, the first time in more than 45 years that growth exceeded 5 percent 171 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 for five years in succession—this despite sub- stemming from inadequate investment in en- stantial deterioration in the external environ- ergy, roads, railways, and ports over the past ment during the year. GDP gains have been decades. This constraint along with high food broad-based and less volatile, even in oil-im- and fuel prices has contributed to the upturn porting economies, as strong commodity ex- in inflation witnessed across the subcontinent port revenues and capital inflows underpinned during the year (table A11). domestic demand. Another notable and en- couraging feature of the recent growth spurt is South African growth eases the sustained contribution of fixed investment Growth in the Republic of South Africa to growth, which carries positive implications trailed growth in other African economies in for long-term potential growth. 2008, slowing markedly to an estimated 3.4 Strong external demand, high commodity percent from 5.1 percent in 2007. Power out- prices, and relatively robust private capital in- ages plagued output growth in the mining sec- flows invigorated growth across a large spec- tor, and household consumption slowed trum of economies, whether resource rich or sharply, undercut by slower growth of credit, resource poor. Oil-importing economies, out- falling asset prices, and higher food and fuel side of South Africa, grew 5.2 percent in 2008, prices. The region’s largest economy has felt down from 5.8 percent in 2007, while oil-ex- the repercussions of the intensification of the porting countries grew by more than 7.5 per- financial crisis since September 15. Increased cent for a second consecutive year. However, risk aversion vis-à-vis emerging markets several years of above-trend economic expan- caused asset prices in South Africa to plum- sion have pushed a larger number of African met, putting pressure on the rand, which has economies up against capacity constraints depreciated nearly 25 percent in nominal Table A11 Sub-Saharan Africa forecast summary (annual percent change unless indicated otherwise) 1991–2000a 2005 2006 2007 2008e 2009f 2010f GDP at market prices (2000 US$)b 2.3 5.9 5.9 6.3 5.4 4.6 5.8 GDP per capita (units in US$) Ϫ0.5 3.4 3.4 4.3 3.4 2.7 3.8 PPP GDPc 3.2 6.2 6.1 6.7 5.7 4.9 6.1 Private consumption 1.3 5.2 6.5 6.5 3.4 3.5 5.2 Public consumption 2.4 6.2 6.0 6.2 5.4 6.0 7.4 Fixed investment 3.6 14.8 19.4 20.3 12.7 7.7 9.9 Exports, GNFSd 4.6 6.2 4.7 5.4 5.9 4.5 7.2 Imports, GNFSd 4.5 12.8 12.8 11.9 7.6 5.6 9.4 Net exports, contribution to growth 0.1 Ϫ2.3 Ϫ3.1 Ϫ2.9 Ϫ1.2 Ϫ0.8 Ϫ1.6 Current account balance/GDP (%) Ϫ2.0 2.4 0.7 Ϫ0.3 1.0 Ϫ3.5 Ϫ3.7 GDP deflator (median, LCU) 10.2 7.2 7.3 6.3 8.6 6.5 4.1 Fiscal balance/GDP (%) Ϫ4.7 0.2 1.0 Ϫ1.9 Ϫ0.6 Ϫ1.3 Ϫ1.5 Memo items: GDP Sub-Saharan Africa excluding South Africa 2.6 6.4 6.2 7.0 6.6 5.7 6.6 Oil exporters 2.0 7.5 6.8 8.2 7.8 6.6 7.3 CFA countries 2.5 4.0 2.4 3.4 4.5 4.3 5.0 South Africa 1.8 5.0 5.4 5.1 3.4 2.8 4.4 Nigeria 2.8 7.2 5.2 6.5 6.3 5.8 6.2 Kenya 1.9 5.7 6.1 7.1 3.3 3.7 5.9 Source: World Bank. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 U.S. dollars. c. GDP measured at PPP exchange rates. d. Exports and imports of goods and nonfactor services. e. Estimate. f. Forecast. 172 R E G I O N A L E C O N O M I C P R O S P E C T S Higher fiscal spending, a slowdown in FDI, Figure A16 Bond spreads for African and drying up of credit suggests that private countries jumped after mid-September investment growth, which has already been af- Spreads in basis points fected by tighter monetary policy, will slow 1400 Ghana further. The intensification of political ten- 1200 sions within the ruling African National Con- 1000 gress Party, which led to the resignation of 800 Gabon President Thabo Mbeki several months before the end of his term, is likely to have a minimal 600 direct impact on the economy but will add to 400 South Africa uncertainties faced by investors now worried 200 about a possible shift in economic policy. Sep. 1 Sep. 11 Sep. 21 Oct. 1 Oct. 11 Oct. 21 Oct. 31 2008 2008 2008 2008 2008 2008 2008 Outside of South Africa, large commodity windfalls have fueled growth in resource-rich Source: JPMorgan-Chase. countries. Encouragingly, growth is spilling over to other sectors outside oil and mining, as effective terms since the beginning of 2008. part of the windfall is spent. In Nigeria, the Like most emerging markets, South Africa saw non-oil economy is booming, despite contin- spreads on its sovereign bonds surge, by more ued unrest in the Niger Delta that caused oil than 450 basis points between the beginning of output to drop 11.2 percent in the second September and mid November 2008; equity quarter of 2008. Despite underperformance in prices plummeted 40 percent in dollar terms the oil sector, second-quarter growth acceler- over the same period (in local currency the loss ated to 6.7 percent, from 5.5 percent in the was 21.7 percent) (figure A16). first, as output in non-oil industries picked up Helped by higher exports of gold and plat- to 8.5 percent, mainly on strong growth in inum, South Africa’s current account deficit agriculture, trade, and telecoms, which to- retreated to 7.3 percent of GDP in the second gether accounted for 95 percent of non-oil quarter of 2008, from 8.9 percent in the pre- growth. In Angola, GDP growth remained ro- vious quarter. Lower prices for its main ex- bust in the first half of the year, and growth in ports, together with weaker external demand, the non-oil sector will approach 20 percent will cause the current account deficit to rise to this year, marginally down from 21.5 percent 8 percent of GDP this year from 7.3 percent in in 2007, as the construction, agriculture, and 2007. With portfolio inflows financing three- communication sectors continue to expand at fourths of South Africa’s current account an impressive pace. deficit in 2007, and with the increased volatil- High energy and agricultural prices and ity of these inflows, South Africa may find it lower agriculture output caused by unfavor- difficult to finance its large current account able weather conditions have affected indus- deficit, especially if FDI inflows are also trial output in some countries. Indeed, in many falling. Meanwhile, fiscal financing require- West African countries the food processing sec- ments are much more modest; South Africa is tor has contracted due to lower agricultural expected to run a small budget deficit in 2009, output and higher input costs. Surges in food after being almost in-balance in 2008. Fur- and fuel prices have pushed headline consumer thermore, government indebtedness remains price inflation into double digits in almost half low, with debt at 23.3 percent of GDP as of of the countries in Sub-Saharan Africa, with March 2008, and foreign debt accounting for median inflation moving rapidly to nearly 13 less than 20 percent of total. This means that percent as of September 2008; median food in- the government has room to borrow domesti- flation increased to more than 17.7 percent cally to finance countercyclical policies. (figure A17). For example in Ethiopia, headline 173 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 fected to varying degrees, with transport con- Figure A17 African headline inflation jumps tracting 2.2 percent; strong performance in as food prices skyrocket mining and construction prevented a more Median CPI inflation (year-on-year) dismal growth outcome. A resumption of 20 conflict is also threatening growth prospects Food in the Democratic Republic of Congo. 16 12 Medium-term outlook The rapid and marked deterioration in the ex- 8 ternal environment will cause growth in Sub- Saharan Africa to slow, coming in at 4.6 per- Headline consumer price inflation 4 cent in 2009, a pace below 5 percent for only Jan. Jul. Jan. Jul. Jan. Jul. Jan. Jul. 2005 2005 2006 2006 2007 2007 2008 2008 the first time in five years (see table A11, ear- lier). Direct effects of the global financial and Source: World Bank. economic crisis are likely to be much more lim- ited than in other regions, because African economies are less integrated into the interna- inflation surged as high as 64 percent in 2008, tional financial system and rely relatively less as food inflation breached 80 percent. In some on international capital and bond markets to cases, core inflation also accelerated, as second- finance investment. round inflation effects through wage settle- For Africa, weaker external demand and ments incorporating expectations of higher in- lower commodity prices will be the major flation were concluded. For example, in South mechanisms through which the financial crisis Africa, unit labor costs increased 10.5 percent will be transmitted. Declines in demand in key in the second quarter of 2008, spurred by av- external markets will take a toll on exports, erage wage increases of 9.6 percent in the first and the contribution of trade to GDP growth nine months of the year. is likely to be negative in 2009. Perhaps more High import prices in conjunction, in some importantly, export revenues will be affected cases, with strong investment demand (invest- by markedly lower commodity prices next ment carries high import content in Africa) led year, eroding government and corporate fi- current account balances to deteriorate in nances and affecting farmers’ incomes ad- more than one of every two countries during versely. Additional adverse factors coming to 2008 relative to 2007. Thirteen of 44 countries affect Sub-Saharan Africa, potentially with experienced a worsening in excess of 2 percent some lag, are a slowing pace of worker remit- of GDP, and 19 of 44 countries registered cur- tance receipts, and importantly for many low- rent account deficits in excess of 10 percent of income countries, possible moderation in Of- GDP. In Ghana, for example, the trade deficit ficial Development Assistance (ODA) flows. breached 26.2 percent of GDP in the second More of an issue for commodity-rich coun- quarter of 2008 and is expected to reach more tries, gross portfolio flows to the region are ex- than 30 percent in 2009. The deficit excluding pected to fall markedly as credit becomes official transfers is likely to rise to more than scarce and more expensive and investors’ risk 17 percent of GDP. aversion intensifies. Official aid may also be Political instability can still derail growth, squeezed by reduced fiscal space in donor as it did in Kenya, where output contracted countries as they tackle financial crises at 0.8 percent in the first quarter of 2008 (year- home. As a result, fragile countries that rely over-year). Political tensions caused a sharp heavily on aid are faced with a potential deteri- contraction in tourism arrivals and in the oration in growth prospects. Moreover, reces- agriculture sector. Other sectors were also af- sion in high-income countries will undermine 174 R E G I O N A L E C O N O M I C P R O S P E C T S tourism arrivals and revenues, as well as remit- bounce back to 6.7 percent by 2010. In oil- tances, which represent a significant share of exporting economies, growth will slow by GDP for Cape Verde, the Gambia, Kenya, more than a full percentage point to 6.6 per- Liberia, Lesotho, and the Seychelles, among cent, but the exporters will remain the fastest- other countries. However, for countries where growing group of countries in the region, currencies depreciated heavily with respect to while growth in oil-importing countries out- donor country currencies, receipts in local cur- side South Africa is projected to ease to 4.6 per- rency terms could still increase. cent, a rate still above the historical trend Countries with very large current account (table A12). deficits, including Burundi, Eritrea, the Gambia, South Africa’s economic growth is likely to Ghana, Madagascar, Malawi, Rwanda, Togo, weaken further in 2009, falling below 3 per- and the Seychelles will need to adjust domestic cent for the first time in almost a decade, as demand to lessen import growth as financing tighter monetary policy and high inflation external deficits becomes more difficult, and causes household consumption to falter. Pri- as export revenues and transfers are dimin- vate investment growth will continue to decel- ished by slower global growth. Many of these erate, pushed down by tighter credit markets economies are especially vulnerable because and as demand in main export markets con- they have low levels of international reserves, tracts (figure A18). Large asset price declines in many cases covering less than three months and associated negative wealth effects, along of imports. with slower credit creation will undermine While oil exporters hold sufficient re- household consumption, and together with sources to weather the global economic down- weaker external demand will cut into manu- turn, many oil-importing economies have facturing output. Although investment growth been hit hard by higher food and fuel prices in South Africa is projected to ease in 2009, it and are less well equipped for the coming will still remain one of the engines of growth downturn. In a number of cases, increased for the country, as the South African govern- subsidies have limited fiscal space for counter- ment continues to bring forth large projects in cyclical spending. Over the past year, as food the energy sector to address the chronic elec- prices surged, many governments removed or tricity deficit and in infrastructure ahead of suspended tariffs on imported foods, which the 2010 World Football Cup. The falloff in undercut tariff revenues. In addition, a less- South Africa’s GDP growth will carry reper- than-full pass-through of higher international cussions for neighboring economies that trade oil prices led to a large increase in fuel subsi- heavily with South Africa and receive remit- dies in some countries, further reducing fiscal tances from expatriate workers in South room. While the movement to lower food and Africa. fuel prices will bring some relief, countries re- main in a weakened state. Risks Overall, aggregate GDP growth in Sub- With the world economy at a crossroads, risks Saharan Africa is projected to decline to 4.6 facing Sub-Saharan Africa have intensified. If percent in 2009 from 5.4 percent in 2008, on the concerted efforts of policy makers around the back of weaker investment outlays, falter- the globe fail to re-establish trust in the inter- ing export performance, and softer private national financial system, the world economy consumption. As external demand gradually risks a deeper and more prolonged recession. recovers over the second half of 2009 and into As a result, Sub-Saharan Africa’s growth 2010, growth should firm to 5.8 percent by would drop more sharply than envisaged in the latter year. Excluding South Africa and the base forecast. Nigeria, growth is projected to ease by a full Among African countries, South Africa is percentage point to 5.6 percent in 2009 and to probably the country most directly exposed to 175 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table A12 Sub-Saharan Africa country forecasts (annual percent change unless indicated otherwise) 1991–2000a 2005 2006 2007 2008e 2009f 2010f Angola GDP at market prices (2000 US$)b 0.8 20.6 18.6 24.7 15.8 11.1 11.3 Current account balance/GDP (%) Ϫ6.1 16.8 20.9 14.1 17.8 8.9 9.2 Benin GDP at market prices (2000 US$)b 4.8 2.9 3.8 4.7 5.0 5.1 5.7 Current account balance/GDP (%) Ϫ6.8 Ϫ6.3 Ϫ7.3 Ϫ7.0 Ϫ8.6 Ϫ9.5 Ϫ9.5 Botswana GDP at market prices (2000 US$)b 6.2 4.0 2.1 6.0 4.7 4.1 4.5 Current account balance/GDP (%) 8.1 15.3 18.2 19.3 9.5 7.4 5.2 Burkina Faso GDP at market prices (2000 US$)b 4.0 7.1 5.5 3.6 4.1 4.6 5.5 Current account balance/GDP (%) Ϫ5.6 Ϫ12.4 Ϫ11.7 Ϫ13.1 Ϫ14.2 Ϫ12.8 Ϫ12.2 Burundi GDP at market prices (2000 US$) b Ϫ1.7 0.9 5.1 3.4 4.4 4.0 5.1 Current account bal/GDP (%) Ϫ3.4 Ϫ28.4 Ϫ36.0 Ϫ37.6 Ϫ38.9 Ϫ36.2 Ϫ36.7 Cape Verde GDP at market prices (2000 US$)b 5.8 11.9 10.8 6.5 6.7 5.1 6.3 Current account bal/GDP (%) Ϫ8.3 Ϫ3.5 Ϫ9.6 Ϫ15.5 Ϫ13.9 Ϫ11.9 Ϫ12.8 Cameroon GDP at market prices (2000 US$)b 1.4 2.0 3.2 3.4 3.9 4.0 4.4 Current account bal/GDP (%) Ϫ2.9 Ϫ2.4 Ϫ2.1 Ϫ2.3 Ϫ0.5 Ϫ4.3 Ϫ4.6 Central African Republic GDP at market prices (2000 US$)b 1.6 2.2 4.1 3.8 3.4 4.2 4.8 Current account balance/GDP (%) Ϫ4.3 Ϫ7.1 Ϫ7.4 Ϫ7.3 Ϫ7.0 Ϫ6.7 Ϫ7.1 Chad GDP at market prices (2000 US$)b 2.3 7.9 Ϫ0.5 0.7 1.6 2.8 3.0 Current account balance/GDP (%) Ϫ5.5 Ϫ6.3 Ϫ7.3 Ϫ8.2 Ϫ3.8 Ϫ7.0 Ϫ8.8 Comoros GDP at market prices (2000 US$)b 1.1 4.2 0.5 1.8 0.6 1.2 2.5 Current account balance/GDP (%) Ϫ6.8 Ϫ4.6 Ϫ5.5 Ϫ4.8 Ϫ7.2 Ϫ6.3 Ϫ6.8 Congo, Dem. Rep. GDP at market prices (2000 US$)b Ϫ5.6 6.5 5.6 6.3 10.7 8.3 11.9 Current account balance/GDP (%) 2.0 Ϫ10.0 Ϫ9.8 Ϫ12.2 Ϫ11.9 Ϫ13.4 Ϫ10.1 Congo, Rep. GDP at market prices (2000 US$)b 1.4 7.7 6.2 Ϫ1.4 9.1 7.4 9.7 Current account balance/GDP (%) Ϫ16.5 15.1 Ϫ3.9 Ϫ23.0 6.8 2.6 11.6 ˆ d’Ivoire Cote GDP at market prices (2000 US$)b 2.3 1.2 0.9 1.5 2.6 3.1 4.9 Current account balance/GDP (%) Ϫ4.0 0.2 3.4 Ϫ0.2 0.7 Ϫ3.2 Ϫ3.8 Eritrea GDP at market prices (2000 US$)b — 4.8 Ϫ1.0 1.3 1.2 2.0 4.2 Current account balance/GDP (%) — Ϫ26.1 Ϫ29.5 Ϫ30.2 Ϫ32.8 Ϫ22.1 Ϫ19.0 Ethiopia GDP at market prices (2000 US$)b 2.9 10.2 11.5 11.1 8.8 6.0 7.3 Current account balance/GDP (%) Ϫ0.8 Ϫ13.7 Ϫ12.3 Ϫ11.8 Ϫ11.6 Ϫ8.9 Ϫ8.6 Gabon GDP at market prices (2000 US$)b 1.7 3.0 1.3 5.4 3.7 4.2 4.0 Current account balance/GDP (%) 5.6 15.9 15.5 15.4 19.6 10.3 8.1 Gambia, The GDP at market prices (2000 US$)b 3.3 5.0 6.5 6.4 5.3 4.5 5.4 Current account balance/GDP (%) Ϫ1.6 Ϫ10.9 Ϫ13.8 Ϫ16.9 Ϫ19.8 Ϫ17.4 Ϫ16.3 Ghana GDP at market prices (2000 US$)b 4.3 5.9 6.2 6.5 6.0 5.6 6.0 Current account balance/GDP (%) Ϫ6.5 Ϫ10.3 Ϫ12.6 Ϫ14.2 Ϫ17.1 Ϫ15.6 Ϫ16.0 (continued) 176 R E G I O N A L E C O N O M I C P R O S P E C T S 1991–2000a 2005 2006 2007 2008e 2009f 2010f Guinea GDP at market prices (2000 US$)b 4.1 3.3 2.8 1.8 4.3 3.7 4.6 Current account balance/GDP (%) Ϫ5.6 Ϫ4.9 Ϫ1.7 Ϫ2.4 Ϫ4.9 Ϫ7.1 Ϫ7.2 Guinea-Bissau GDP at market prices (2000 US$)b 1.5 3.5 4.2 2.7 2.9 2.8 3.4 Current account balance/GDP (%) Ϫ24.0 Ϫ7.2 Ϫ19.3 Ϫ15.9 Ϫ10.9 Ϫ12.1 Ϫ10.8 Kenya GDP at market prices (2000 US$)b 1.9 5.7 6.1 7.1 3.3 3.7 5.9 Current account balance/GDP (%) Ϫ1.6 Ϫ1.4 Ϫ2.3 Ϫ3.7 Ϫ8.0 Ϫ6.4 Ϫ5.5 Lesotho GDP at market prices (2000 US$)b 3.5 2.9 7.2 4.9 4.1 3.2 4.2 Current account balance/GDP (%) Ϫ13.4 Ϫ6.9 0.7 Ϫ0.2 1.8 4.6 4.5 Madagascar GDP at market prices (2000 US$)b 1.7 4.6 4.9 6.3 6.8 6.0 10.4 Current account balance/GDP (%) Ϫ7.8 Ϫ12.4 Ϫ9.4 Ϫ14.2 Ϫ21.0 Ϫ15.7 Ϫ4.8 Malawi GDP at market prices (2000 US$)b 3.4 2.7 8.2 8.4 7.9 6.5 7.9 Current account balance/GDP (%) Ϫ8.5 Ϫ11.8 Ϫ19.3 Ϫ17.9 Ϫ20.7 Ϫ19.8 Ϫ19.6 Mali GDP at market prices (2000 US$)b 4.0 6.1 5.3 3.1 5.1 3.9 5.1 Current account balance/GDP (%) Ϫ8.9 Ϫ8.2 Ϫ6.4 Ϫ9.9 Ϫ9.1 Ϫ10.5 Ϫ10.4 Mauritania GDP at market prices (2000 US$)b 2.9 5.4 11.6 0.9 2.1 5.9 6.4 Current account balance/GDP (%) Ϫ0.3 Ϫ49.0 Ϫ2.8 Ϫ4.9 Ϫ4.4 Ϫ9.4 Ϫ10.7 Mauritius GDP at market prices (2000 US$)b 5.3 4.6 3.5 5.4 5.0 3.8 5.3 Current account balance/GDP (%) Ϫ1.6 Ϫ5.0 Ϫ10.0 Ϫ8.4 Ϫ10.0 Ϫ8.2 Ϫ8.3 Mozambique GDP at market prices (2000 US$)b 5.0 8.4 8.7 7.0 6.0 6.3 6.4 Current account balance/GDP (%) Ϫ16.4 Ϫ11.6 Ϫ9.0 Ϫ15.8 Ϫ17.0 Ϫ16.0 Ϫ16.3 Namibia GDP at market prices (2000 US$)b 4.2 4.7 4.1 3.8 3.6 3.1 4.5 Current account balance/GDP (%) 3.1 4.3 18.8 20.9 23.0 21.3 20.1 Niger GDP at market prices (2000 US$)b 1.8 7.2 5.1 3.2 4.9 3.6 4.9 Current account balance/GDP (%) Ϫ6.9 Ϫ9.1 Ϫ9.2 Ϫ10.9 Ϫ14.5 Ϫ13.7 Ϫ15.4 Nigeria GDP at market prices (2000 US$)b 2.8 7.2 5.2 6.5 6.3 5.8 6.2 Current account balance/GDP (%) Ϫ0.8 31.5 22.5 21.8 20.3 7.0 4.6 Rwanda GDP at market prices (2000 US$)b 0.2 6.0 5.5 6.0 8.0 5.0 5.5 Current account balance/GDP (%) Ϫ1.2 Ϫ3.9 Ϫ15.7 Ϫ15.6 Ϫ21.7 Ϫ15.7 Ϫ16.7 Senegal GDP at market prices (2000 US$)b 3.1 5.6 2.3 4.6 4.5 4.7 5.9 Current account balance/GDP (%) Ϫ5.7 Ϫ6.5 Ϫ9.3 Ϫ11.7 Ϫ14.4 Ϫ12.7 Ϫ12.8 Seychelles GDP at market prices (2000 US$)b 4.5 1.2 5.3 7.3 2.3 0.5 3.0 Current account balance/GDP (%) Ϫ7.4 Ϫ29.0 Ϫ22.6 Ϫ31.4 Ϫ30.2 Ϫ27.4 Ϫ23.8 Sierra Leone GDP at market prices (2000 US$)b Ϫ4.7 7.3 7.4 6.4 5.8 5.1 6.5 Current account balance/GDP (%) Ϫ9.0 Ϫ14.3 Ϫ8.8 Ϫ7.2 Ϫ8.3 Ϫ9.6 Ϫ9.7 South Africa GDP at market prices (2000 US$)b 1.8 5.0 5.4 5.1 3.4 2.8 4.4 Current account balance/GDP (%) Ϫ0.2 Ϫ4.0 Ϫ6.5 Ϫ7.3 Ϫ8.0 Ϫ8.1 Ϫ8.3 Sudan GDP at market prices (2000 US$)b 5.8 8.6 11.8 10.1 10.3 8.0 8.1 Current account balance/GDP (%) Ϫ8.2 Ϫ10.8 Ϫ13.6 Ϫ10.7 Ϫ6.8 Ϫ8.9 Ϫ9.0 (continued) 177 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Table A12 (continued ) (annual percent change unless indicated otherwise) 1991–2000a 2005 2006 2007 2008e 2009f 2010f Swaziland GDP at market prices (2000 US$)b 3.1 2.3 2.1 3.2 2.2 1.8 1.9 Current account balance/GDP (%) Ϫ2.4 3.3 5.9 9.5 10.7 10.7 9.3 Tanzania GDP at market prices (2000 US$)b 2.9 6.8 6.2 7.1 7.2 6.3 7.0 Current account balance/GDP (%) Ϫ12.5 Ϫ7.0 Ϫ12.9 Ϫ12.7 Ϫ14.2 Ϫ12.7 Ϫ12.9 Togo GDP at market prices (2000 US$)b 2.2 1.2 4.1 2.3 0.8 2.4 3.3 Current account balance/GDP (%) Ϫ8.5 Ϫ21.8 Ϫ17.6 Ϫ16.0 Ϫ22.1 Ϫ16.9 Ϫ16.9 Uganda GDP at market prices (2000 US$)b 6.8 6.7 8.4 8.9 7.9 5.9 7.6 Current account balance/GDP (%) Ϫ7.0 Ϫ4.8 Ϫ7.6 Ϫ8.0 Ϫ8.8 Ϫ9.3 Ϫ9.9 Zambia GDP at market prices (2000 US$)b 0.7 5.2 6.2 6.2 6.1 4.6 6.0 Current account balance/GDP (%) Ϫ10.6 Ϫ10.0 Ϫ7.3 Ϫ7.2 Ϫ5.5 Ϫ8.1 Ϫ9.5 Zimbabwe GDP at market prices (2000 US$)b 0.9 Ϫ5.3 Ϫ4.2 Ϫ6.3 Ϫ4.9 Ϫ2.1 Ϫ2.1 Current account balance/GDP (%) Ϫ7.5 28.5 30.7 36.6 40.2 18.1 18.6 Source: World Bank. Note: — ϭ not available. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 U.S. dollars. c. Growth and current account figures presented here are World Bank projections and may differ from targets contained in other World Bank documents. d. Liberia, Somalia, Sa ˇ o Tomé and Príncipe, are not forecast because of data limitations. Current account balances exclude official transfers. In SACU members they include nonduty SACU transfers. e. Estimate. f. Forecast. the current global financial turmoil. South Figure A18 Economic growth to slow in Africa’s risk of financial contagion, however, Sub-Saharan Africa is limited by low exposure to “toxic” assets GDP growth (%) and foreign currency risks. However, a “flight 9 to quality” could cause large portfolio out- 8 7 flows, which would imperil the country’s abil- 6 ity to finance its large current account deficit, 5 which in turn could trigger sharp depreciation 4 of the rand and higher inflation. 3 Sub-Saharan African countries that are less 2 integrated with international financial and 1 capital markets would suffer more from lower 0 external demand, dwindling tourism revenues, 2005 2006 2007 2008 2009 2010 remittances, or aid. Commodity prices would Oil importers, excluding South Africa fall further in such a scenario, causing export South Africa revenues in many countries to fall sharply and Oil exporters eroding fiscal positions, corporate profitabil- Source: World Bank. ity, and incomes. Vulnerability to external shocks, including terms-of-trade shocks, has 178 R E G I O N A L E C O N O M I C P R O S P E C T S increased over the past couple of years, as ex- middle- and high-income countries, the availability of ternal and fiscal balances have deteriorated in economic data is insufficient for inclusion in the report; these include Djibuti, Iraq, Libya, and the West Bank many countries. Several countries have and Gaza. For recent developments and the outlook for reached a point where external imbalances are a broader range of Middle Eastern and North African unsustainable and a shut-off of financing, or economies, see Economic Developments and Prospects, large negative terms-of-trade shocks, could 2008, The Middle East and North Africa Region lead to balance of payments and currency World Bank, 2008. crises, with adverse consequences for hard- 5. Several GCC countries have responded forcefully won macroeconomic stability and long-term to head off financial contagion. Qatar on October 13 launched a $5.3 billion plan to purchase up to 20 per- growth. Moreover, fragile economies that rely cent of shares in banks listed on the Doha stock ex- heavily on external aid and face daunting re- change. This followed by one day an announcement construction and stabilization challenges will that United Arab Emirates would guarantee all de- see their efforts to normalize the situation de- posits and savings in national banks, as well as all in- railed by lack of sufficient external financing. terbank operations in the Emirates. And Saudi Arabia A sharp deceleration in growth would have cut interest rates in line with the Federal Reserve, while significant consequences for poverty reduction indicating that some $40 billion would be made avail- able to local banks. in Africa. According to Arbache and Page 6. National income and product account figures are (2007), had the region avoided some of the presented in calendar years, although originally re- sharpest declines in per capita GDP growth, ported in fiscal years by Bangladesh, India, Nepal, and overall growth would have been 1 percentage Pakistan. For example, fiscal year 2007/08 is reported point faster every year for the past three as calendar year 2007 for India, and as 2008 for decades. Another risk is that the large-scale in- Bangladesh, Nepal, and Pakistan, due to differences in jection of liquidity into the global financial the timing of their fiscal years. 7. Nepal’s currency is pegged to the Indian rupee. system comes to fuel inflation if monetary au- 8. Source: Boston Analytics Consumer Sentiment thorities fail to reverse polices at the first signs Index (BACSI), which is based on a monthly survey of a turnaround. targeting Indian consumers across 11 cities (Delhi, Mumbai, Kolkata, Chennai, Hyderabad, Bengaluru, Nagpur, Kochi, Lucknow, Chandigarh, and Jaipur). See http://www.bostonanalytics.com/news.html. Notes 1. A downturn in the global high-tech cycle, in which East Asia plays a key role in the production and References export of higher-tech goods, also contributed to the Arbache, Jorge Saba, and Page, John (2007). “More slowing of trade growth. Growth or Fewer Collapses? A New Look at 2. Russia currently holds somewhat less than Long Run Growth in Sub-Saharan Africa.” Policy $500 billion in reserves, along with two large oil funds Research Working Paper 4384, World Bank. (about $140 billion and $50 billion, respectively, as of Calvo, Guillermo, and Ernesto Talvi. 2007. “Current September 2008); it also has ample fiscal and current Account Surplus in Latin America: Recipe against account surpluses (the latter, $90 billion, or 8 percent Capital Market Crises.” http://www.rgemonitor of GDP as of September 2008). .com/latam-blog/58/current_account_surplus_ 3. Core inflation is calculated as headline CPI net of in_latin_america_recipe_against_capital_market_ food, household energy, and transport fuels. Data for crise. Belarus, Russia, and Turkey, where detailed sub- DJF (Dow Jones Factiva). 2008. http://www.factiva.com. indexes are not available, are from official sources di- Fajnzylber, Pablo, and J. Humberto Lopez. 2008. “The rectly, which may use different definitions and calcula- Development Impact of Remittances in Latin tion methods. America.” In Remittances and Development: 4. This report covers the developing (that is, low- Lessons from Latin America, ed. Pablo Fajnzylber and middle-income) countries of the Middle East and and J. Humberto Lopez. Washington, DC: World North Africa region, and thus excludes high-income Bank. economies Bahrain, Kuwait, Qatar, Saudi Arabia, and ISI (ISI Emerging Markets). 2008. http://www.securities the United Arab Emirates. In addition, for a number of .com. 179 G L O B A L E C O N O M I C P R O S P E C T S 2 0 0 9 Izquierdo, Alejandro, Randall Romero, and Ernesto World Bank. 2008a. Migration and Remittances Fact- Talvi. 2008. “Booms and Busts in Latin America: book 2008. Washington, DC: world Bank. The Role of External Factors.” Research Depart- ______. 2008b. “Rising Food Prices: The World Bank’s ment Working Paper 631. Inter-American Devel- Latin America and Caribbean Region Position opment Bank, Washington, DC. http://www.imf Paper.” Washington, DC. .org/external/np/seminars/eng/2007/whd/pdf/ ______. 2008c. “Shockwaves from the North: Latin session1-2.pdf. America and the External Deterioration.” Chief Österholm, Pär, and Jeromin Zettelmeyer. 2007. “The Economist Office, Latin America and the Caribbean Effect of External Conditions on Growth in Latin Region. http://siteresources.worldbank.org/ America.” Working Paper 07/176. International EXTLACOFFICEOFCE/Resources/870892- Monetary Fund, Washington, DC. http://www.imf 1197314973189/Shockwaves.pdf. .org/external/pubs/ft/wp/2007/wp07176.pdf. 180 Eco-Audit Environmental Benefits Statement The World Bank is committed to preserv- Saved: ing endangered forests and natural re- • 31 trees sources. The Office of the Publisher • 1,466 pounds of has chosen to print Global Economic solid waste Prospects 2009 on recycled paper with • 11,419 gallons 30 percent post-consumer waste, in accor- of wastewater dance with the recommended standards • 2,751 pounds of for paper usage set by the Green Press net greenhouse Initiative, a nonprofit program sup- gases porting publishers in using fiber that is • 22 million not sourced from endangered forests. British thermal For more information, visit www. units of total greenpressinitiative.org. energy T “While developing countries he eruption of the worldwide financial crisis has radically recast entered this tumultuous prospects for the world economy. Global Economic Prospects period with much improved 2009: Commodities at the Crossroads analyzes the implications of fundamentals, this crisis is the crisis for low- and middle-income countries, including an in-depth look at long-term prospects for global commodity markets and the expected to test severely both policies of both commodity producing and consuming nations. them and the international financial system. In the longer Developing countries face sharply higher borrowing costs and reduced access run, even after developing- to capital. This will cut into their capacity to finance investment spending— country growth recovers, ending a five-year stretch of developing-country growth in excess of 6 percent annually. The looming recession presents new risks, coming as it does on the commodity supply should keep heels of the recent food and fuel crisis. pace with demand, but policy will need to foster conservation Commodity markets, meanwhile, are at a crossroads. Following decades of low efforts and technological prices and weak investment in supply capacity, commodity prices first spiked— progress. In particular, if poor spurred on by five years of very fast developing-country growth—and have now countries are to maintain plummeted in response to the financial crisis. domestic food self-sufficiency, In the longer run, commodities are not expected to be in short supply. Prices governments will need to should be higher than they were in the 1990s but much lower than in the strengthen investment in rural recent past. These higher prices should provide producers with sufficient infrastructure, agricultural incentive to discover new supplies, improve output from existing resources, research, and technological and promote greater conservation and substitution with more abundant outreach.” alternatives. At the same time, slower population growth will ease the pace at which commodity demand grows. Policies to limit carbon emissions and boost agricultural investment, along with the dissemination of efficient techniques, —Justin Yifu Lin should also contribute to this long-term outcome.. Senior Vice President and Chief Economist This year’s Global Economic Prospects also looks at government responses to the The World Bank recent price boom. Producing-country governments have saved more of their windfall revenues, and are therefore less likely to be forced to cut into spending now that prices have declined. The spike in food prices tipped more people into poverty, which led governments to expand social assistance programs. These programs need to be better targeted to the needs of the very poor so that governments can respond effectively the next time there is a crisis. For additional information, please visit www.worldbank.org/prospects. An online companion to the prospects section of this report, including access to additional data and analysis not reported here, is also available at www.worldbank.org/globaloutlook. ISBN 978-0-8213-7799-4 SKU 17799